Custom «Accounting Assignment» Essay Paper

Short-term sources of finance are required by business entities in order to support their daily transactions such as payment of wages and purchase of inventory. They include overdrafts, short-term loans, trade credit, and lease finance (Business Finance n.d.).

Overdrafts are a result of payments exceeding incomes within the current account of a business. They are perceived as deficits, which are financed by the bank. Overdrafts are a certain type of loan facilities, which are meant for current account holders only. They are characterized by faster processing and higher flexibility. They have set limits, which should not be exceeded by business entities or account holders. The main purpose of such overdrafts is to cover majorly short-term deficits within a business. Business entities can access such loan facility at any time, however their limits tend to depend on their scale and size of operations.

Interest rates that are charged on overdrafts are unique in nature. Somehow they are higher compared to other types of loans offered by the banks. If repayment period lapses, then such interest rates triple, thus making it very expensive to pay off. Business owners need to be extra careful when they are dealing with these kinds of overdrafts. If an overdraft is one of a hardcore type, that is overdraft, which ever exists within the business and chances of repayments seem to be low, banks may decide to covert such loans into normal types.

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Short-term loans are normally given by banks for a specified period. Such loans come in fixed amounts, which will be repaid with interest. Banks allow customers to use short-term loans to pay back interest plus the principal using defined instalments. This type of loan requires a covenant or agreement where both parties must play their roles. The borrower commits to pay required amounts after specific time periods. Normally, the rates of interests are calculated in advance. If a borrower fails to repay one instalment, then the bank will charge penalties and fines, while interest rates remain the same. This is one way of ensuring that borrowers comply with the laid down terms and conditions governing and regulating financial lenders. Accessing short-term loans may require varying collaterals. Different banks will require some type of security based on their lending policies. After acceptance of loan application, short-term loans take some time before they are approved. If the loan is not repaid according to schedule, the bank may decide to recover its money through available securities provided during loan application.    

Trade credit is a type of loan facility used to acquire goods and services. It is one method used within the business environment to finance transactions. Such credits do not have interest at all. However, they are offered on a short-term basis, for example, many of them do not exceed 90 days. It can be used to purchase both current and fixed assets. Around the world, business entities have varying levels of capital. Trade credits allow them to acquire goods on credit with commitments to pay later. This facility is a helpful for many businesses since it has no interest charged on balances. Businesses can take possession of various items of trade and pay later when funds are available. This facility is not easy to get because lenders for goods and services normally demand that certain conditions must be met.

Leases are used by businesses when they do not have the ability to buy an asset or a good. However, in some cases, business entities can be in need for an asset for a short period of time and, therefore, leasing would be the best option. When business entity enters into a lease agreement, the ownership rests with the lesser, while possession remains in the hands of the lessee (Business Entity). The lessee uses an asset for a pre-determined specified amount of time agreed. During such period, rental fees must be paid by the lessee. There are two types of leases available: one is operating lease and the other is a financial lease. Under the operating lease, the lessee cannot make major adjustments to the property, while a financial lease gives user rights to make several adjustments to the property.

a. Explain how they have been financing or meeting their short term obligations.

(5 marks)

It is clear that two companies are utilizing short-term debt to finance their operations. During two years, annual report of Toshiba indicates a slight drop of reliance on short-term borrowings (Toshiba 2012). However, Hitachi’s annual report shows a rise in the use of short-term debt in years 2011 and 2012. (5 marks)

b. Calculate liquidity ratios (current ratios, and acid test or quick ratio) and efficiency ratios (debtor days, creditor days, and stock turnover days) for each of the companies.(15 marks)

 Liquidity Ratios

1.  Current ratio = Current assets/Current liabilities

2.  Quick ratio/Acid test ratio = (Current assets – inventories)/Current liabilities 

Toshiba Limited

Current Ratio 2012:   3001417/2659260=1.129

                        2011:   2799668/2498309=1.121

Acid test ratio 2012:   (3001417-884264)/2659260=0.796

                        2011:   (2799668-864382)/2498309=0.775

Hitachi Company Limited

Current ratio   2012:   5162186/4110873=1.256

                        2011:   4900029/4088824=1.198

Acid test ratio            2012:   (5162186-1413252)/4110873=0.912

                        2011:   (4900029-1341766)/4088824=0.870

Efficiency Ratios:

Debtor days = (Trade debtors/revenues) x365

Toshiba Company Limited

Debtor days          2012:   (1307634/6100262) x365=78.2

                             2011:   1124180/6398505 x365=64.1

Hitachi Company Limited

Debtor days          2012:   2343470/9665883 x365=88.5

                             2011:   2090919/9315807 x365=81.9 

Creditor days= (Trade payables/cost of sales)x365

Toshiba Company Limited

Creditor days       2012:   1293028/4633558 x365=101.9

                             2011:   1194229/4897547 x365=89.0

Hitachi Company Limited

Creditor days       2012:   1325784/7278971 x365=66.5

                             2011:   1257188/6967433 x365=65.9

Stock turnover days = 365/inventory turnover

Inventory turnover = sales/closing stock

Toshiba Company Limited

2012:  Inventory turnover = 6100262/884264=6.89

            Stock turnover days = 365/6.89=52.9

2011:   Inventory turnover = 6398505/864382=7.40

            Stock turnover days = 365/7.40=49.3

Hitachi Company Limited

2012:  Inventory turnover = 9665883/1413252=6.8

            Stock turnover days = 365/6.8=53.7

2011:   Inventory turnover = 9315807/1341768=6.9

            Stock turnover days = 365/6.9=52.9

c. Using the liquidity ratios, compare and comment on the liquidity positions of the two companies. (5 marks)

Liquidity ratios for these two companies appear to be somehow stable during 2011 and 2012. However, Hitachi has high ratios compared to Toshiba. This means that liquidity position for Hitachi is higher than that of Toshiba. During the two periods, Hitachi had more cash to run its transactions when compared to Toshiba. 

d. Using the efficiency ratios, explain which of the two companies is more efficient in managing its working capital. (5 marks)

On debtor days, Toshiba has high collection rate shown by a lower ratio compared to that of Hitachi. Hitachi can run into debt collection problems because its ratios indicate that many people do not pay their accounts early enough (Hitachi Limited 2012). Toshiba enjoys the highest credit time while Hitachi does not. Ratios indicate that Toshiba enjoys credit facilities because it takes them longer time to repay. Toshiba renews its inventory faster than Hitachi. The ratios indicate that Hitachi’s stock of goods stays more in their shelves before being sold out.