Finance & Accounting Essay Example | Topics and Well Written Essays - 1000 words

Finance & Accounting - Essay Example Wallace defines Tests of Reasonableness "as non-statistical models using operating or external data as well as financial data to predict an amount under examination" (Wallace, 1994, Section on Evaluating Analytical Procedures). As Wallace illustrates, Tests of Reasonableness include accounting and non-accounting variables in the model, with the aim of enhancing "the reliability of a test of reasonableness compared to single variable and financial ratio analysis." On the company's purchases, the going-rate for the exchange rate between UK and the import country source's respective currencies, multiplied by the average volume of clothing purchases, can be used to evaluate the reasonableness of the current month's purchases. For the company's sales, the average sales of a retail clothing company of similar size, multiplied by the company's average monthly sales volume, can be used to test the reasonableness of the current month's sales. Lastly, the average salary (including commission) of employees who work in similar industries (of the same size) in England, multiplied by the company's total number of employees, can be used to check the reasonableness of the company's wage expenses. Wallace explains that Financial Ratio Analysis "tend... of a retail clothing company of similar size, multiplied by the company's average monthly sales volume, can be used to test the reasonableness of the current month's sales. Lastly, the average salary (including commission) of employees who work in similar industries (of the same size) in England, multiplied by the company's total number of employees, can be used to check the reasonableness of the company's wage expenses. Financial Ratio Analysis Wallace explains that Financial Ratio Analysis "tends to be more effective than single-component procedures because it explicitly considers interrelationships among financial variables" (Wallace, 1994, Section on Evaluating Analytical Procedures). This approach entails comparing one entry in the financial statements versus another entry, to draw implications regarding the company's financial or operational state. For example, a low net income-to-sales or gross margin ratio can possibly suggest that the company is losing significant amounts of money in its operations, because its operating expenses cannot justify the sales and revenues that it is receiving. Comparing these ratios against industry benchmarks can suggest how well the company is faring, against the whole retail clothing industry. Moreover, the ratios 'days sales in receivables,' 'days sales in inventory,' and 'inventory turnover' can give an idea of the efficiency of its collection efforts on its receivables, as well as how fast it needs to replenish its inventory to keep up with periodic demands. Regression Analysis Regression Analysis "involves the creation of a model using operating and external data as well as financial data" (Wallace, 1994, Section on Evaluating Analytical Procedures). This type of analysis, however, is more precise than the basic