FINANCIAL ACCOUNTING COURSEWORK PART B
Task 2
| NAME OF
RATIO
|
CALCULATION
|
RATIO
FOR
|
RATIO
FOR
|
COMMENT ON
EACH RATIO
| |
a)
Profitability
Sales Growth
Return on Shareholders’ Funds (ROSF)
Return on Capital Employed (ROCE)
Gross Profit
Margin
Net profit Margin
| Increase in sales x 100
Prior year sales
Profit before Tax x100
Shareholders’ Funds
Operating Profit x 100
Capital employed
Gross Profit x 100
Sales
Operating Profit x 100
Sales
| 1000 x 100
= 50%
600 x100
= 73%
700 x100
= 69%
1600 x100
=53%
700 x 100
=23%
|
1400 x 100
= 47%
640 x 100
= 58%
940 x 100
= 72%
2000 x100
= 46%
940 x 100
= 22%
|
Report
To: The Board of Directors of Fab Footwear Limited
Subject: Fab Footwear’s Profitability and liquidity Position
The purpose of this report is to explain the profitability and liquidity position of the company based on the accounting periods 2007/08 and 2008/09.
Profitability
The profitability ratios measure the level of return made by the company for the investors, and based on these main ratios; ROCE and ROSF, the company has performed impressive although, for ROSF has decreased slightly, that is 72% and 58% (2008/09), compared to 69% and 73% (2007/08) respectively. The contributory factor to these high returns stem from the strong sales growth of 47% in 2008/09 and 50% in 2007/08, of which gross profit margin represents 46% and 53%. Although these have decrease slightly in 2008/09 based on 2007/08 percentages, this is still considered to be significant. The net profit margin calculated is similar for both years that are 22/23% (£940,000 and £700,000 respectively), despite high provision for depreciation of £660,000 for new fixed acquired. It appears that the company is efficient in managing overhead cost at the same time. This is the reason for the strong ROCE. In the year 2008/09, interest cost has increased to £300,000 from £100,000; this contributes to the slight decrease the ROSF.
It should be noted that the definition of profit is the surplus of sales revenue over expenses, and the calculation of profit are base on accounting rules that includes items and provisions that are not cash, and as most sales are made on credit, profit calculated does not equates to cash.
| |
b)
Liquidity Ratio
Current Ratios
Acid Test Ratio/Liquidity
|
Current Assets
Current Liabilities
Current Assets – Stock
Current Liabilities
|
670
= 1.08: 1
670-180
= 0.8:1
|
1520
= 0.8:1
1520-600
= 0.5: 1
|
Liquidity
The liquidity ratios assess the company’s ability to meets its short-term obligations, by evaluation the short-term assets coverage short-term of liabilities. Both ratios; current ratio and the acid test ratio has indicated a strong weakness in this coverage based on reasonable coverage of 1.5:1, where current ratios coverage has decline from 1.08:1 to 0.8:1 time, and acid test ratio, assuming stock is slow moving, also decline from 0.8:1 to 0.5:1 coverage in 2008/09. Regardless of the significant increase in current assets’ stocks to £420,000 and trade debtors to £420,000, totalling £840,000; for greater increase current liabilities’ because of the bank overdraft borrowing (£1,060,000) and accruals (£100,000), totalling £1,160,000 in 2008/09 have override such increase, of which contribute to the worsening position. In 2008/09, the company has a bank overdraft of £1,060,000 compared to £10,000 cash in 2007/08.
| | c)
Efficiency
Stock Turnover
Debtors Collection Period
Creditors Payment Period
|
Cost of Sales
Stock
Trade Debtor x 365
Sales
Trade Creditors x 365
Cost of Sales
|
1400
= 7.8 time
380 x 365
= 46 Days
160 x 365
=42 Days
|
2400
= 4 times
800 x365
= 66 Days
180 x 365
=27 Days
|
Efficiency
The company has show signs of weaknesses in moving stock in general. This has decrease from 7.8 times in 2007/08 to 4 times. In addition, collection of from trade debtors has also worsened from 46 days to 66 days, with improvement in creditors payments, from 42 days to 27 days. These weaknesses would have adverse contribution to cash position, because cash are tied up in stock and trade debtors.
The company is facing a serious problem where short-term liquidity is concern as the bank overdraft is not secured and usually temporary. If action is not taken, the company may not have enough cash to pay creditors and meet loan interest obligation. The company should take action to secure additional finance either from shareholders or borrowing, as well as corrective measures to improve working capital.
Conclusion
The company is overtrading, where the impressive massive sales growth, is caused by credit sales instead of cash that contributes to the high investors’ return. The short-term liquidity is very poor because of the company inefficiencies in working capital management, and the financing of non-current assets acquisition from operation cash inflows, instead of alternative financing.
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