Westminster International University in Tashkent

4ECON008C Financial Accounting, Semester I, 2016/2017

Tutorial 11
Task 1 A Ltd and B Ltd, two separate companies manufacture IT equipment. Their financial
statements at 31.12.2014 are the followings:

Profit and Loss Accounts for the year ended 31.12.2014

A B
$000 $000
Sales 2,150 1,512
Cost of sales 1,430 1,148
Gross Profit 720 364
Other Expenses 250 190
Operating Profit 470 174
Interest on Debentures 20 60
Net profit before tax 450 114
Taxation 100 30
Net Profit after tax 350 84
Dividends 200 80
Retained Profit 150 4

Balance Sheets as at 31.12.2014

A B
$000 $000 $000 $000
Fixed Assets cost 2,750 3,420
Depreciation 980 2,524
1,770 896
Current Assets
Stock 420 340
Debtors 900 680
Cash 40
1,360 1,020
Creditors due within one year
Creditors 360 400
Dividends 200 80
Overdraft 200 560
760 1,040
Net current assets 600 (20)
Net assets 2,370 876
Debentures 10 % 200 600
2,170 276
Capital and Reserves
Ordinary share capital 1,200 200
Retained profits 970 76
2,170 276

Required:
1. Calculate the following ratios:
a) ROCE
b) Current Ratio

1
c) Acid Ratio
d) Debtors Collection Period
e) Gross Profit Rate
f) Interest Coverage Ratio
g) Stock Turnover
h) Days Stock in Inventory
i) Asset Turnover
j) Total Debt to Total Asset
k) Gearing

2. Drawing upon your knowledge of accounting, comment upon the differences and similarities of the
accounting ratios for A and B. Which business seems to be the most efficient? Give possible reasons.

Answers:

1. Calculation of ratios:
470
a) ROCE ( A)  2,370  100  19.8%
174
ROCE ( B )   100  19.9%
876

1,360
b) CurrentRat io( A)   1.79 times
760

1,020
CurrentRat io ( B )   0.98 times
1,040

1,360  420
c) AcidTestRa tio( A)   1.24 times
760

1,020  340
AcidTestRa tio( B )   0.65 times
1,040

900
d) DebtorsCollectionPeriod ( A)  2,150  365  153 days

680
DebtorsCollectionPeriod ( B )   365  164.2 days
1,512

720
e) Gross Pr ofitRate( A)  2,150  100  33.5%

364
Gross Pr ofitRate( B )   100  24.1%
1,512

470
f) InterestCo verageRatio( A)   23.5 times
20

174
InterestCoverageRatio( B )   2.9 times
60

2
 1,430
g) StockTurnover ( A)   3.4 times
420

1,148
StockTurno ver ( B)   3.38 times
340

420
h) DaysStockInInventory( A)  1,430  365  107.2 days

340
DaysStockInInventory( B )   365  108.1 days
1,148

2,150 2,150
i) AssetTurnover ( A)  1,770  1,360  3,130  0.69 times

1,512 1,512
AssetTurno ver ( B )    0.79 times
896  1,020 1,916
The business is not generating a sufficient volume of business given its investment in total assets. To
become more efficient, sales should be increased. Or some assets should be disposed

760  200 960

j) TotalDebtT oTotalAsse t ( A)  1,770  1,360  3,130  0.30 times

1,040  600 1,640

TotalDebtToTotalAsset ( A)    0.86 times
896  1,020 1,916

200
k) Gearing ( A)  1,200  970  200  100  8.44%

600
Gearing ( B )   100  68%
600  200  76

2.
a) ROCE is very similar for both companies.
b) A’s liquidity is much better than B’s. This might be because of large bank overdraft of B.
c) Acid test ratio of A is higher than B’s. B’s acid test ratio is below 1 (only 0.65), which means that
this company may have liquidity problems.
d) Debt collection period for A is shorter than for B.
e) Gross profit rate for A is 33.5$ out of 100$, while its only 24.1$ for B.
f) Interest coverage ratio for A is much higher than for B. This means that company A has the better
safety margin in meeting its interest payment commitments than B.
g) Stock turnover is very similar for both companies.
h) Days stock in inventory is also almost the same for both companies.
i) Asset turnover for B is better than for A.
j) B’s assets are financed more by loans than those of A’s.
k) B is high geared and thus potentially at risk if profit will decrease. B is high has high risk and it
might be risky for ordinary shareholders. A is low geared and appears to be stable.

Task 2 From Financial statements of Ocean LTD, a retailer, identify:

3
1. Five points of interest from comparing this year’s results with those of the previous years
2. Calculate the following ratios for Ocean Ltd to enable you to assess the performance of the company in the
current year. Identify any further information you might find useful.
a) ROCE
b) Gross Profit margin
c) Stock Turnover
d) Debtors Turnover
e) Days Stock in Inventory
f) Current Ratio
g) Acid Ratio
h) Gearing Ratio
i) Interest Cover

Profit and Loss Accounts for the years ended

31.12.2013 31.12.2014
$000 $000
Sales 1,168 1,944
Cost of sales 778 1370
Gross Profit 390 574
Wages and salaries 156 202
Depreciation 32 62
Other Expenses 108 124
Operating Profit 94 186
Interest on Debentures 16
Net profit before tax 94 170
Taxation 32 78
Net Profit after tax 62 92
Dividends 32 46
Retained Profit 30 46

Balance Sheets as at
$000 $000
31.12.2013 31.12.2014
Fixed Assets cost 560 856
Current Assets
Stock 94 124
Debtors 140 312
Cash 78 32
312 468
Creditors due within one year
Creditors 78 218
Dividends 32 46
Taxation 32 78
142 342
Net current assets 170 126
Creditors greater than 1 year
Debentures 10 % 0 160
730 822
Capital and Reserves
Ordinary Share Capital 544 590
Retained Profits 186 232
4
 730 822

Answers:
1. Here is the list of possible changes in year 2014 compared those with the results of year
2013

a) Sales have increased by 66 % from 2013 levels.

b) Cost of the sales has increased by 76 % on 2013 levels.
c) All expenses have increased
d) Profit after tax increased by 50 %
e) Fixed assets increased substantially
f) Net current assets reduced but stock, debtors, creditors all increased in value
g) Debentures and shares issued 2014, more capital raised

94
2. a) ROCE   12.83% (2013)
730
186
ROCE   18.95% (2014)
982
This indicates an increase in profitability of the business from the increased investment

390
b) Gross Pr ofitM arg in  1,168  33.4% (2013)
574
Gross Pr ofitM arg in   29.54%
1,944 (2014)

This reduction in the ratio is probably due to a decrease in sales prices which has generated more
sales or an increase in cost of goods sold.

778
c) StockTurno ver ( 2013)   8.3 times
94
1,370
StockTurnover (2014)   11 .05 times
124

140
d) DebtorsCollectionPeriod (2013)  1,168  365  43.75 days

312
DebtorsCollectionPeriod ( 2014)   365  58.6 days
1,944

94
e) DaysStockInInventory(2013)   365  44.1 days
778

124
DaysStockInInventory( 2014)   365  33 days
1,370

312
f) CurrentRatio(2013)   2.2 times
142
468
CurrentRat io( 2014)   1.4 times
342

5
 312  94
g) AcidTestRa tio (2013)   1.5 times
142

468  124
AcidTestRa tio(2014)   1 times
342

h) Gearing (2013)  notrelevan t

160
Gearing ( 2014)   100  16.3%
590  232  160

i) InterestCoverageRatio(2013)  notrelevant

186
InterestCoverageRatio( 2014)   11 .7%
16

Task 3

Janet owns some shares in a company. She has received the most recent financial statements that the
company has produced, which are shown below. You have agreed to prepare an analysis of the
financial performance and liquidity of the company for her.
Required:
i) Calculate six accounting ratios for 2013 and 2014, which could be used to analyse the
financial performance and liquidity of Quadrop Ltd. State the formulas used for calculating
the ratios
ii) Using the ratios you have calculated in part (a) comment on the performance and liquidity of
Quadrop Ltd.
iii) What additional information about Quadrop Ltd would help you to interpret the ratios?

Quadrop Ltd
Profit and loss accounts for the year ended 31 May
2014 2013
£000 £000 £000 £000
Sales 1,886 1,150
Cost of sales (940) (680)
–––––– ––––––
Gross profit 946 470
Administration costs (349) (223)
Distribution costs (185) (115)
Interest payable (68) (13)
–––––– ––––––
(602) (351)
–––––– ––––––
Net profit before tax 344 119
Taxation (95) (55)
––––– –––
Net profit after tax 249 64
–––– ––––

6
Balance sheets as at 31 May
2014 2013
£000 £000 £000 £000
Fixed Assets
Tangible fixed assets 950 530
Intangibles 400 –
–––––– ––––––
1,350 530
Current assets
Stock 240 130
Debtors 165 85
Bank – 300
–––––– ––––––
405 515
–––––– ––––––

Creditors: amounts falling due within one year

Creditors 187 145
Taxation 80 50
Overdraft 120 –
–––––– ––––––
387 195
–––––– ––––––
Net current assets 18 320
–––––– ––––––
Total assets less current liabilities 1,368 850

Creditors amounts falling due after one year

Debentures (650) (150)
–––––– ––––––
718 700
–––––– ––––––
Capital and reserves
Ordinary share capital 400 400
Share premium 150 150
Revaluation reserve 50 50
Profit and loss reserve 118 100
–––––– ––––––
Total equity 718 700
–––––– ––––––

Answers
1.
132
1) ROCE  * 100%  15.5% (2013)
850
412
ROCE   30% (2014)
1368

470
2) Gross Pr ofitM arg in  1,150 *100%  40.9% (2013)
946
Gross Pr ofitM arg in  * 100%  50.2% (2014)
1,886

7
 64
3) Net Pr ofitM arg in  1,150 * 100%  5.6% (2013)
249
Net Pr ofitM arg in  * 100%  13.2% (2014)
1,886

515
4) CurrentRat io(2013)   2.6 times
195
405
CurrentRatio( 2014)   1.05 times
387

515  130
5) AcidTestRa tio (2013)   1.98 times
195

405  240
AcidTestRa tio( 2014)   0.4 times
387

680
6) StockTurnover (2013)   5.2 times
130
940
StockTurno ver (2014)   3.9 times
240

85
7) DebtorsCollectionPeriod ( 2013)  1,150  365  27 days

165
DebtorsCollectionPeriod ( 2014)   365  31.9 days
1,886

130
8) DaysStockInInventory ( 2013)   365  69.8 days
680

240
DaysStockInInventory ( 2014)   365  93.2 days
940

150
9) Gearing (2013)   100  17.6%
400  150  50  100  150
650
Gearing(2014)   100  47.5%
400  150  50  118  650

2.

Return on Capital Employed has increased from 15.5% to 30% despite taking out long-term loans.
This level of return to shareholders should be acceptable and attractive to perspective shareholder.
Gross Profit Margin has increased significantly. This may be because Quadrop Ltd has obtained
better discounts from its suppliers. Alternatively, its market position or location may be allowing it
to change its customers premium prices.
Net Profit Margin has improved as percentage of sales, but not by the same increase in the gross
profit percentage. It may be that extra expenses ( for example in marketing) are being incurred to
generate the higher level of sales.

8
Current Ration has fallen. The company may be suffering from liquidity problems and may not be
able to make payments as they fall due. The financial statements show that cash balances have fallen
from a £300,000 to an overdraft of £ 120,000
Acid Ratio has deteriorated from the previous year and is worryingly low. The business clearly has
cash flow problems.
Stock Turnover has fallen suggesting that there may be some stock control problems. Alternatively
the company may be changing the mix/type of goods. It sells resulting in different turnover ratios.
Debtors Collection Period has increased from previous year by nearly five days. The slower
collection days of invoices will be contributing to the poor liquidity situation.
Gearing. There has been significant increase in gearing of the company. It has taken additional
debentures presumably to finance additional fixed assets.

3. The following additional information may be helpful to interpret the ratios:

- the nature of Quadrop Ltd’s business;

- industry average ratios;

- the general economic conditions that exist;

- the size of Quadrop Ltd in comparison to its competitors