Financial Management Topic 10

 

FINANCIAL STATEMENT ANALYSIS

 

QUESTION 1

1. b) The following data was extracted from the books of Sky Ltd. for the year ended 31 December

 

Total sales Total assets turnover      Total debt to total assets Current ratio Inventory turnover         Average collection period Fixed assets turnover Gross profit margin

Sh.20 million 2 times 30% 3:1 5 times 18 days 5 limes 25%

2012:

 

 

 

Assume 360 days in a year.

 

Required:

A statement of financial position of Sky Ltd. as at 31 December 2012.

QUESTION 1

1. d) Statement of financial position

 

Other current assets Account receivable Inventory Current assents Fixed assets Total assets Debt(total debt) Equity

sh. (million) 2 1 10 3 7 10

 

 

QUESTION 2

1. c) The management of Docarex Ltd. is considering a number of funding options for a new project. The new project could be funded by sh. 10 million of equity or debt.

 

The data below was extracted from the financial statements of Decorex Ltd. under each funding option.

 

	Equity finance Sh. “ million”	Debt. Finance Sh. “ million”
Long – term liabilities 10% debenture Capital  Ordinary share capital of sh.0.5.par value Share premium Reserves	–   11. 0 4.0	10.0   3.5 1.5

  Statement of financial position (extract):

 

	Sh. “million”
Revenue Gross Profit Expenses (excluding finance charge) Operating profit	100 20 (15)

Income statement (extract):

 

The corporation tax rate is 30%

 

 

Required: 

1. Return on capital employed (ROCE) under each of the two funding options.
2. Return on equity under each of the two funding options.

• Explain the impact on the performance of Docarex Ltd. of financing by debt rather equity.− When considering the return on equity (ROE), the-geared option (debt finance) achieves a higher return than the equity finance option.

  − This is because the debt (10%) is costing less than the return on capital (25%).

  − The excess return on that part funded by debt passes to the shareholder enhancing their return.

   

   

  Impact of the performance of Docarex Ltd

 

QUESTION 3

The following data was extracted from the financial statements of Madrex Ltd. for the year ended 30

November 2012:

 

Income statement for the year ended 30 November 2012 

Sales Cost of sales (including Sh.20 million depreciation) Operating profit I meres, Profit before tax Profit after tax  Dividend proposed Retained earnings	200 120 80   5 75 22 53 10
43

Sh.”Million” 

 

Statement of financial position as at 30 November 2012

	Sh. “million”	Sh. “million”
Non- curent assets Current assets: Inventory Receivables Cash   Equity and liabilities:  Equity 10% Long-term loan   Current liabilities:  Trade payables Dividend payable Tax payable	25 33 40             20 10 22	400       98 498   396 50           52 498

 

Additional information: 

Madrex Ltd. has made the following projections for the year ending 30 November 2013:

1. Sales will increase by 10%.
2. Plant and machinery will be purchased costing Sh.12 million
3. Inventory days            80  Receivable days  75  5. Trade payable days          50
4. Depreciation                 Sh.15 million

 

Assume 365 days in a year.

 

Required: 

Cash flow projection for the year ending 30 November 2013.

 

QUESTION 4

(a) The following data was obtained from the books of Chepe Ltd. for the year ended 30 November 2012:

Current ratio    1.7

Debt/Equity ratio                                                      1.5

Interest cover                                                            3.2

Current liabilities       Sh.600,000 Total asset turnover           1.4times

Fixed asset turnover                                                  5.6 times

Gross profit margin                                                   30%

Earnings before interest and tax (EBIT)/sales 5%       5%

 

Required: 

• Income statement for the year ended 30 November 2012.
• A condensed statement of financial position as at 30 November 2012.

 

QUESTION 5

(a) The following data was obtained from the summarised statement of financial position of Ngamani Ltd. as at 30 November 2012:

 

	Sh ‘000’	Sh ‘000’
Non-current assets Current assets Current liabilities Net current assets’ 9% loan notes   Ordinary shares (Sh.0.25 par value) 7% preference shares (Sh.1 par value) Share premium account Retained earnings	5,900 (2,600)	15,350     3,300 (8,000) 10,650 2,000 1,000 1,100

 

Additional information: 

1. The current price of ordinary shares is at Sh.1.35 ex-dividend.
2. A dividend of Sh.0.1 is payable during the next few days. The expected growth rate is 9% per

annum.

3. The current price of the preference shares is Sh.0.77 and the dividend has recently been paid.
4. The loan notes interest has also been paid recently and the loan notes are currently trading at Sh.80 per Sh.100 nominal value. The loan notes were issued one year ago to finance new investment.
5. The applicable corporate tax is 30%

 

Required: 

• Gearing ratio using book values.
• Gearing ratio using market values.
• Weighted average cost of capital (WACC).

 

QUESTION 6

2012. a) The following statement of financial position was extracted from the books of XYZ Ltd. for the year ended 31 March 2011 and 31 March 2012.

	2011 Sh. (Million)	2012 Sh. (Million)
Assets Current assets  Cash Accounts receivable Inventory Total   Non-current assets Plant and equipment Total assets               Liabilities and owners’ equity  Current liabilities Accounts payable           Notes payable Total Long term debt Owners’ equity Common stock and paid-in surplus Retained earnings           Total Total liabilities and owners’ equity	84 165 393 642     2.731 3,373       312 231 543 531   500 1,799 2,299 3,373	98 188 422 708       344 196 540 457   550 2,041

 

Required:

• The total debt ratio for the years 2011 and 2012.
• The equity multiplier ratio for the years 2011 and 2012.
• The capital gearing ratio for the years 2011 and 2012.

 

 

QUESTION 7

1. a) Highlight three problems that could be faced by a firm with a high gearing level.
   

 

QUESTION 7

Problems that could be faced by a firm with a high gearing level: 

1. i) High fixed interest payments which could led to liquidation if not paid  ii) Low earnings per share if the firm records poor performance

iii) High risk as perceived by investors. The firm  find it difficult to raise additional funds or cost of additional funds would be too high

 

 

QUESTION 8

(e) Explain the purpose of financial ratio analysis and why a careful reading of the financial statements is not enough.

QUESTION 8

1. Explain the purpose of financial ratio analysis and why a careful reading of the financial statements is not enough.

• Ratios help in determining the liquidity levels of the firm
• Necessary for determining the gearing level of the firm
• They determine in determining the performance of the firm in terms of profitability and even try to make comparisons with other firms in the same industry.
• Help in determining the turnover of stocks.

 

QUESTION 9

2009. a) The following statement of financial position relates to Mageuzi Ltd. as a t 31 December 2009.

 

   Mageuzi Ltd. 

Statement of financial position as at 31 December 2009

                                        Sh. “million”     Sh. “million”

Fixed assets (net book value)                                       13

Current assets:                                 

Stock                                                 3

Debtors                                             2

5

 

Current liabilities                             

Creditors         6          1                      12 Financed by.

Ordinary share capital             4 Retained earnings                  6

Long term debt

12

 

Additional information:

1. Sales in the in the year ended 31 December 2009 amounted to sh. 20 million. The sales for the current year ending 31 December 2010 are expected to increase by sh. 4 million.
2. The net profit margin and retention ratio for the year ended 31 December 2009 were 8 % and 30% respectively. These ratios are expected to be maintained in the foreseeable future.
3. All assets and current liabilities are expected to change in the current year ending 31 December 2010 at the same percentage as the change in sales.

 

Required: 

2010. The amount of external financial requirements for the year ending 31 December 2010.
2011. A proforma statement of financial position as at 31 December 2010.

 

 QUESTION 10

2009. b) The following information relating to Kawaida Ltd. Was obtained from the financial statements of the company for the year ended 30 November 2009.

 

	Shs. “000”
Ordinary share capital (sh. 20 par value)	80,000
10 debentures	12,000
Profit after tax for the year	12,000

 

Additional information:

1. The shares of the company are currently quoted on the stock exchange at sh. 72 per share.
2. Corporation tax rate is 30%.

 

Required: 

Using the above information, compute and interpret the following financial ratios:

1. i) Times interest earned ratio. ii) Price earning P/E ratio.

 

 

QUESTION 11

1. b) Faidika Ltd. has an issued share capital of sh. 200 million which is made up of 8 million ordinary shares each of sh. 25 par value.

 

The income statement of the company for the year ended 31 December 2008 was as follows.

Sh. “000”         Sh.”000” Gross profit              190,000

Deduct: variable costs                          70,000

Fixed costs(including depreciation)       40,000            (110,000)

Earnings before interest and tax                                     80,000

Interest on debentures                                   (20,000)

Earnings before tax                                        60,000

Taxation                                                      (18,000)

Earnings after tax                                           42,000

Dividend                                                      (16,000)

Retained earnings                                           26,000

 

The company is planning on introducing a new production process that is expected to improve operational efficiency. Under the new production process, variable costs are expected to decrease by sh. 1,500 per unit of output. However, fixed costs are expected to increase by sh. 15 million per annum partly due to additional depreciation on the fixed assets purchased for the production process.

 

Additional information: 

1. Variable costs for the year ended 31 December 2008 related to a production and sales level of 20,000 units.
2. Capital requirements for the new production process will be met through an issue of sh. 100 million debentures at an interest rate of 12% per annum.
3. Sales and stock levels for the year ending 31 December 2009 are not expected to change.
4. The process earnings (P/E) ratio of the company for the year ended 31 December 2008 was 13:1. This ratio is expected to be maintained in the year ending 31 December 2009.
5. The corporation rate of tax is 30%.

 

 Required: 

2008. Earnings per share (EPS) and market price per share (MPS) for the year ended 31 December 2008.
2009. Expected EPS and MPS for the year ending 31 December 2009.

• Assume that, instead of issuing debentures, the company decided to finance the capital project through a rights issue of 1,500,000 shares.

Compute the expected EPS for the year ending 31 December 2009.

 

 

QUESTION 12

1. a) Sunrise Limited presented the following financial statements for the year ended 31 December 2008:

Income for the year ended 31 December 2008.

		Sh.	Sh.
Sales			9.040,000
Cost of sales:	Opening stock	2,500,000
	Purchases	6,820,000
		9,320,000
	Closing stock	(2,860,000)	(6,460,000)
Gross profit			2,580,000
expenses			(2,640,000)
Net loss			(60,000)

 

Balance sheet as at 31^st December 2008

	Sh.	Sh.
Non-current assets
Premises	5,600,000
Fixtures and fittings (ne book value)	500,000
Motor vehicle (net book value)	1,040,000	7,140,000
Current assets:
Stock	2,860,000
Debtors	3,260,000
	6,120,000
Current liabilities:
Trade creditors	2,900,000
Bank overdraft	2,800,000
	5,700,000
Net current assets		420,000
Ne assets		7,560,000
Financed by:
Ordinary share capital		2,000,000
Retained profit		3,160,000
Long term loans		2,400,000
Capital employed		2,400,000
		7,560,000

 

Assume a 360 – day year.

 

Required: 

1. i) Operating cash style ii) Quick ratio iii)       Current ratio iv) Debt to equity ratio
2. v) Operating margin ratio vi) Debt turnover ratio

 

 QUESTION 13

The following   summarized financial statements relate to Jasmine Ltd. for the year ended 31 October 2008.

                              Income statement

	Sh. “000”
sales	450,000
Profit before tax
Less : Taxation
Profit after tax
Dividend
Retained earnings

 

Balance sheet

	Sh “000”	Sh “000”
Non-current assets		285,000
Current assets	219,000
Less current liabilities	(154,000)
Working capital
Financed by:
Ordinary share capital		75,000
reserves		135,000
Shareholders’ equity		210,000
Long term liability:
Bank loan		139,500
Total equity and long term liability		349,500

 

 

The company is in the process of preparing a financial budget for the year ending 31 October 2009.

 

Additional information:

1. From past experience, the management of the company have determined that for each sh. 1.00 of additional sales, total investment of sh. 1.50 in fixed assets, stock and debtors would be required.
2. The management have also determined that for each sh. 1.00 of additional sales, the company would require trade credit amounting to sh. 0.60.
3. The company has maintained a constant dividend payout ratio.
4. Any requirements for internal funds are to be met from the retained earnings for the year ending 31 October 2009.

 

Required:

1. External finance (if any ) required in year 2009 assuming that the sales for the year increase by 20%
2. Expected maximum growth in sales in year 2009 assuming that the company only utilizes internal funds.

• Briefly explain three limitations of your estimates in (b) (i) and (ii) above.

 

 

QUESTION 14

The following balance sheet was prepared by the management of Mambo Ltd. as at 31 December 2007.

 

	Sh “000”	Sh”000”
Non-current assets		13,000
Current assets
Inventory	3,000
Trade receivables	2,000
	5000
Current liabilities:
Trade and other payables	6,000
Working capital		(1,000)
Net assets		12,000
Financed by:
Ordinary share capital		4,000
Retained earnings		6,000
Long term debt
Total equity and long term liabilities

 

The management of the company is evaluating the expected financial requirements for the year ending 31 December 2008 and has sought your advice as a financial consultant.

 

The following additional information has been provided to you:

1. Sales revenue for the year ended 31 December 2007 was sh. 20 million while the projected sales revenue for the year ending 31 December is sh. 24 million.
2. Total assets and current liabilities for year 2008 are expected to increase in the same proportion as the increase in sales revenue.
3. The average after tax net profit margin of 8% per annum is expected to be maintained in year 2008.
4. The current dividend payout ratio of 70% is also expected to be maintained in the year 2008.
5. Any additional finance required in year 2008 would be obtained through bank loans.

Required: 

2008. i) The amount additional long term required in year 2008, if any, to finance the expected increase in net assets. ii) Projected balance sheet of the company as at 31 December 2008.

 

June 2008 Question One B

QUESTION 15

100. c) The earnings yields of excel Ltd. is 20% and the current market price per ordinary share is Sh100. Each Share has a par value of Sh.50. The dividend for the current year is expressed as 10% of the par value.

 

Required:

1. i) The earnings per share ii) The dividend cover

iii)     The price earnings ratio

 

QUESTION 16

1. a) The following is an extract of the balance sheet of Shauri Moyo limited as at 31 December 2005

                                                                        Sh ‘000’

Capital and Liabilities                                    

Ordinary Share capital: 1 million ordinary          10,000

Shares of Sh. 10 each  20,000 Capital Reserves                        90,000 Revenue Reserves                     30,000

10% Debentures                                                150,000

 

Additional Information;-

1. The profit before interest and tax for the year ended 31 December 2005 was Sh. 9,000,000
2. The dividend payout ratio for the year 2005 was 40%
3. The market price per share as at 31 December 2005 was Sh. 36
4. The Corporation tax rate is 30%

 

Required:

1. i) Gearing Ratio ii) Dividend yield iii)          Times interest earned ratio iv)          Return on capital employed
   1. Interpretation of results in (i) & (iii) above Gearing ratios: 

   Vyumba Ltd uses more externally borrowed funds in its capital structure as a compared to   Mijengo Ltd. This means that Vyumba Ltd is more risky as compared to Mijengo Ltd.

    

    Price Earnings Ratio: The P/E ratio indicates the number of years an investor will take to recover his    investment in the firm given the MPS and EPS.

   Vyumba Ltd has a lower P/E of 14.88 meaning that investors can recover their investors faster as compared   to investors in Mijengo Ltd.

 

 

QUESTION 17

1. a) Mijengo Ltd. And Vyumba ltd are medium-sized companies dealing in the sale of new residential houses. The following information was extracted from the financial records of the two companies for the year ended 31^st December 2005:

Mijengo Ltd     Vyumba Ltd

	Sh.	Sh.
Ordinary Share Capital (Sh. 5 par) 7% Preference Share Capital (Sh. 20 par) Operating profit for the year 12% debenture capital Market price per ordinary share (31 December 2005) Retained profits balance: 1 January 2005	14,400,000 350,000 12,000,000 1,750,000 42.75 18,000,000	3,600,000 10,500,000 12,000,000 13,500,000 135 25,000,000

 

The corporation tax rate is 30%

Required:

1. i) Gearing ratio for each company ii) Earnings per share for each company iii) Price earnings ratio for each company iv)       Interpret your result obtained in (i) and (ii) above

 

 

QUESTION 18

Ushindi Limited presented the following financial statements on 30 June 2004

 

Income statement for the year ended 30 June 2004                            

               Sh.

Sales (all on credit)                              4,000,000 Operating Profit                                                  440,000 Less: debenture interest                    40,000

400,000 Corporation tax                                                  176,000

Ordinary dividend proposed                                           224,000

Retained Profit                                                              107,200

116,800

 

Trade Creditors              Bank Overdraft  Corporation tax              Dividend payable				238,400 878,400 176,000 107,200	(1,400,000)	120,000
						1,800,000

Sh.                       Sh.	Sh.
Fixed Assets:                                                                                   Freehold property (Net book Value) Plant and Machinery (Net Book Value)  Motor Vehicle (Net Book Value) Furniture and Fittings	480,000 800,000 200,000 200,000 1,680,000
Current Assets:

Stock                 Debtors Investment					1,000,000 400,000 120,000
Current Liabilities:					1,520,000

Balance Sheet as at 30 June 2004

 

Financed by:   

 

Authorised share capital: 800,000 Sh. 1 ordinary                                                        800,000

Shares              400,000  Issued and fully paid: 400,000 Sh. 1 ordinary 200,000 shares          800,000

Capital reserve            400,000 Revenue reserve           1,800,000

Loan capital: 400,000 Sh. 1 10% debentures                                                             

 

Additional Information

1. An analysis of the industry in which the company operates reveals the following industrial average

Current Ratio       1:5:1

Quick Ratio         0:8:1

2. The purchases for the year were Sh. 2,160,000 while the cost of sales was Sh. 3,000,000.
3. The market price of the company’s shares as at 30 June 2004 was Sh. 5

 

Required:

1. Compute the following ratios for Ushindi Limited
2. i) Return on capital employed ii) Turnover of capital iii)       Operating expenses ratio iv)       Accounts receivable turnover in days v)       Dividend yield vi)       Price earnings ration vii) Market value to book value ration viii) Current ratio
3. Compare the company’s liquidity performance with that of the industry.
   1. c) Compare the company’s liquidity performance with that of the industry average.
   • This can be determined using the current ratio and quick ratio.
   • In all the instances above, the industry average ratios were greater than that of the company.
   • This might be because the company does not have as many current assets as the other firms in the industry.
   • The implication is that the company may not be able to meet its short-term financial obligation as and when they fall due as compared to other firms in the industry.

    

 

QUESTION 19

	Sh.‘000’
Total fixed assets (Net book value) Operating cost (excluding debt interest) Dividends declared and paid Cash and bank balances	75,000 39,150 4,220 3,125

Pokea Cellphone Operators Ltd. started operations on 1 September 2002. The company raised the required equity capital of Sh.65million and debt at an annual rate of interest of 18% before commencing business. Given below are some statistics extracted from the books of the company in respect to the financial statements prepared to 31 August 2003

 

 

 

 

Eighty percent (80%) of the sales were on credit. The current asset on 31 August 2003 consisted of only stock, debtors and cash and bank balances as given above, while current liabilities consisted of only creditors and tax provided for in respect of the year to 31 August 2003. Taxation was provided for at the rate of 30%.

You are provided with the following ratios, which have been determined from the financial statements of Pokea Cell Phone Operators Ltd.

 

Fixed Assets turnover                                                                   1.8 Times

Gross profit margin                                                                      45%

Stock turnover                                                                             4.4 times

Interest cover        4 Times Average debt collection period (based on 360 days of the year)    84 days

Current ratio                                                                                2.5:1

 

Required:

1. In respect of the year ended 31 August 2003, you are required to prepare the company’s:
2. i) Trading Profit and Loss account ii) Balance Sheet
3. The following statistics have been provided with respect to the industry in which the company operates:

Acid test ratio                     1.2:1

Return on equity                  21%

Capital gearing ratio             36%

 

Required:

Comment on the performance of the company relative to these industry statistics

Comment:

1. i) Liquidity
2. Classification: This can be observed using the Acid test ratio.
3. Observation: The co. has a higher acid test ratio than the industry average in both cases this ratio is greater than the recommended level of 1:1
4. Reason: The companies in this industry may be holding more liquid current assets instead of investing the funds in long-term projects.
5. Implications: This implies that the firms in this industry will be liquid most of the time but their profitability is likely to decrease because the return of current assets is less than the return of long term projects.

 

1. ii) Profitability
2. Classification: This can be observed using the return on equity ratio.
3. Observation: The ratio for the company is less than that of the industry average.
4. Reason: This is because the company is less profitable than that of the industry average.
5. Implication: This is because the co. has more current assets compared with the industry average.

 

iii)     Gearing

1. Classification: This can be observed by using the capital-gearing ratio.
2. Observation: The ratio for the company is higher than that of the industry average.
3. Reason: This is because the company has used more fixed return capital (Debt) in its capital structure.
4. Implication: This implies that the co. will be paying more fixed financing charges in the form of interest compared with the industry average.

 

 

QUESTION 20

1. Outline four limitations of the use of ratios as a basis of financial analysis
   

   QUESTION 20

   limitations of the use of ratios as a basis of financial analysis

2. 1. They are historical in nature
   2. They ignore the effects of inflation on the performance of the firm
   • Differences in accounting policies by firms
   1. They ignore the qualitative aspect of the firm
   2. Different firms in the same industry have different sizes, levels of technology and diversification of risks.
   3. It is not possible to carry out a cross-sectional and industrial analysis for monopolistic firms vii. Different writers and users may interpreter and compute similar ratios differently. This

   impairs the extent to which ratios can be relied upon.

 

1. The company’ ordinary shares are selling at sh. 20 in the stock market
2. The company has a constant dividend payout of 10%

Required:

1. i) Acid test ratio ii) Operating Ratio

iii) Return on total capital employed iv) Price earnings ratio

1. Interest coverage ratio
2. Total assets turnover

 

1. c) Determine the working capital cycle for the company.

 

QUESTION 21

Madawa Chemicals Ltd. is in the process of forecasting its financial needs for the coming year ending 31 October 2003.  The company attained a turnover ofSh.300 million for the current year ended 31 October 2002.

 

The following are the summarized financial statements of the company for the year ended 31 October 2001:

Profit and Loss Account

Sh. “million’

Turnover                                                        300

Profit before tax                                              54

Taxation

Profit after tax                                                 36

Dividend                                                          9

Retained profit

 

Balance Sheet

Net Assets: Fixed assets (net) Current assets Current liabilities

146 103

190     43 233

Financed by: Issued ordinary shares Reserves   Medium and long-term debt

50   90 140   93 233

Sh.   “million’        Sh. “million’

 

 

 

From past experience, it has been disclosed that each additional Sh.1 of sales made by the company requires, on average, a total investment in fixed assets, stocks and debtors of Sh.1.50.  The Sh.1 additional sales also results in the generation of automatic financing of 40 cents as various creditors spontaneously arise with the increase in sales.

 

The net profit margin after tax and the dividends payout ratio which apply for the year ended 31

October 2002 will also be relevant into the foreseeable future.

 

Required:

1. i) The amount of external finance that will be needed during the year ending 31 October 2003 if sales are expected to increase by 15% in the year. ii) The maximum expected sales growth that can be achieved in the year ending 31 October 2003 if only internally generated funds are used.

• The maximum growth in sales that can be achieved in the year ending 31 October 2003 if the company wishes to maintain its current level of financial gearing.
• Briefly comment upon the weaknesses of the method of forecasting used above.
• Limitation of forecasting method
  • The net profit margin may vary from the current 12%
  • Companies normally try to maintain a constant or slightly increasing dividend per share rather than the constant dividend payout ratio which is assumed in the question.
  • Fixed assets, stocks and debtors are unlikely to increase in direct proportion to sales similarly, creditors.
  • Internally generated cash is taken to be retained profits this ignores non-cash items (depreciation)

 

 

QUESTION 23

 

(b) Liquidity

• Is indicated by quick ratio and current ratio
• Trend wise the company liquidity deteriorated

 

• Compared to industry ratios are below the norm. Company’s liquidity is below industry norm.

Profitability is indicated by net income to net worth and profit margins on sales • Trend wise it is clear the company’s profitability has declined over the years

• Cross-section wise the company is performing below the industry norm.
• Turnover (activity) is indicated by the turnover ratios and average collection period

 

Trend wise 

The inventory turnover has declined alarmingly. The average collection period has also alarmingly increased. The FA turnover has been stable while total asset turnover has declined. The company is deteriorating in its use of assets.

 

Cross section wise 

The company ratios are below average

 

Conclusion

The company is indeed facing due financial times. All indications are that a restructuring is necessary.

 

 QUESTION 24

Rafiki Hardware Tools Company Limited sells plumbing fixtures on terms of 2/10 net 30.  Its

 

1998		1999 Sh.’000’	2000 Sh.’000’
	Sh.’000’
Cash Accounts receivable Inventory Net fixed assets     Accounts payable Accruals Bank loan, short term Long term debt Common stock Retained earnings     Additional information: Sales Cost of goods sold Net profit	30,000 200,000 400,000 800,000 1,430,000   230,000 200,000 100,000 300,000 100,000 500,000 1,430,000     4,000,000 3,200,000 300,000	20,000 260,000 480,000 800,000 1,560,000   300,000 210,000 100,000 300,000 100,000 550,000 1,560,000     4,300,000 3,600,000 200,000	5,000 290,000 600,000 800,000 1,695,000   380,000 225,000 140,000 300,000 100,000 550,000 1,695,000     3,800,000 3,300,000 100,000

financial statements for the last three years are as follows:

 

 

 

Required:

 

• For each of the three years, calculate the following ratios:

 

Acid test ratio, Average collection period, inventory turnover, Total debt/equity, Net profit margin and return on assets.

• From the ratios calculated above, comment on the liquidity, profitability and gearing positions of the company.

 

(b)           When commenting on ratios, always indicate the following:

• Identify the ratios for a given category e.g when commenting on deficiency, identify efficiency or turnover ratios.
• State the observation made e.g ratios are declining or increasing in case of trend or time series analysis.
• State the reasons for the observation.
• State the implications of the observation.

 

Comment on liquidity position:

• This is shown by acid test/quick ratio
• The ratio improved slightly in 1999 but declined in year 2000.
• The ratio is lower than the acceptable level of 1.0
• This is due to poor working capital management policy as indicated by increasing current liabilities while cash is consistently declining.
• The firm’s ability to meet its set financial obligations is poor due to a very low quick ratio.

 

 

Comment on profitability position:

• This is shown by net profit margin and return on total assets.
• Both ratios are declining over time
• This is particularly due to decline in net profits thus decline in the net profit margin and increase in total accounts as net profit decline thus reduction in ROTA.

The firm’s ability to control its cost of sales and other operating expenses is declining over time e.g Sales – Net profit will indicate the total costs

Comment on gearing position:

• This is shown by debt/equity ratio
• This was 50% in 1998 and declined to 46.2% in 1999 and 2000
• It has been fairly constant
• This is due to the constant long term debt and ordinary share capital
• The decline in 1999 and 2000 was due to increase in retained earnings

 

Generally the firm has financed most of its assets with either short term or long term debt i.e current liabilities + long term debt