SIKKIM-MANIPAL UNIVERSITY

A Project report on Ration Analysis

A Case study of the Company Kampala Nissan Limited

By: SOUMYA RAGHURAM

OCTOBER 2007
1.0 INTRODUCTION

Financial ratio analysis is the calculation and comparison of ratios which are derived
from the information in a company's financial statements. The level and historical
trends of these ratios can be used to make inferences about a company's financial
condition, its operations and attractiveness as an investment.

Financial ratios are calculated from one or more pieces of information from a company's
financial statements. For example, the "gross margin" is the gross profit from
operations divided by the total sales or revenues of a company, expressed in percentage
terms. In isolation, a financial ratio is a useless piece of information. In context,
however, a financial ratio can give a financial analyst an excellent picture of a company's
situation and the trends that are developing.

A ratio gains utility by comparison to other data and standards.

Ratio analysis has a very broad scope. One aspect looks at the general (qualitative)
factors of a company. The other side considers tangible and measurable factors
(quantitative). This means crunching and analyzing numbers from the financial
statements. If used in conjunction with other methods, quantitative analysis can
produce excellent results.

Ratio analysis isn't just comparing different numbers from the balance sheet, income
statement, and cash flow statement. It's comparing the number against previous years,
other companies, the industry, or even the economy in general. Ratios look at the
relationships between individual values and relate them to how a company has performed
in the past, and might perform in the future.

For example current assets alone don't tell us a whole lot, but when we divide them by
current liabilites we are able to determine whether the company has enough money to
cover short term debts.

The biggest part of fundamental analysis involves delving into the financial statements.
Also known as quantitative analysis, this involves looking at revenue, expenses, assets,
liabilities and all the other financial aspects of a company. Fundamental analysts look at
this information to gain insight on a company's future performance. A good part of this
tutorial will be spent learning about the balance sheet, income statement, cash flow
statement and how they all fit together.

Ratio analysis serves to answer questions, such as:

• Is the company’s revenue growing?

• Is it actually making a profit?
• Is it in a strong-enough position to beat out its competitors in the future?
• Is it able to repay its debts?
• Is management trying to "cook the books"?

Of course, these are very involved questions, and there are literally hundreds of others
you might have about a company. It all really boils down to one question: Is the
company’s stock a good investment? Think of fundamental analysis as a toolbox to help
you answer this question.

When it comes to analyzing fundamentals, the income statement lets investors know
how well the company’s business is performing - or, basically, whether or not the
company is making money. Generally speaking, companies ought to be able to bring in
more money than they spend or they don’t stay in business for long. Those companies
with low expenses relative to revenue - or high profits relative to revenue - signal
strong fundamentals to investors.

Financial ratio analysis groups the ratios into categories which tell us about different
facets of a company's finances and operations. An overview of some of the categories
of ratios is given below.

• Leverage Ratios which show the extent that debt is used in a company's capital
structure.
• Liquidity Ratios which give a picture of a company's short term financial situation
or solvency.
• Operational Ratios which use turnover measures to show how efficient a company
is in its operations and use of assets.
 • Profitability Ratios which use margin analysis and show the return on sales and
capital employed.
• Solvency Ratios which give a picture of a company's ability to generate cash flow
and pay it financial obligations

What do the Users of Accounts Need to Know?

Investors to help them determine whether they should buy shares in the
business, hold on to the shares they already own or sell the shares
they already own. They also want to assess the ability of the
business to pay dividends.

Lenders to determine whether their loans and interest will be paid when due

Managers might need segmental and total information to see how they fit into
the overall picture

Employees information about the stability and profitability of their employers

to assess the ability of the business to provide remuneration,
retirement benefits and employment opportunities

Suppliers and businesses supplying goods and materials to other businesses will
other trade read their accounts to see that they don't have problems: after all,
creditors any supplier wants to know if his customers are going to pay their
bills!

Customers the continuance of a business, especially when they have a long term
involvement with, or are dependent on, the business

Governments and the allocation of resources and, therefore, the activities of

their agencies business. To regulate the activities of business, determine taxation
policies and as the basis for national income and similar statistics
Local community Financial statements may assist the public by providing information
about the trends and recent developments in the prosperity of the
business and the range of its activities as they affect their area

Financial analysts they need to know, for example, the accounting concepts employed
for inventories, depreciation, bad debts and so on

Environmental many organizations now publish reports specifically aimed at

groups informing us about how they are working to keep their environment
clean.

Researchers researchers' demands cover a very wide range of lines of enquiry

ranging from detailed statistical analysis of the income statement
and balance sheet data extending over many years to the qualitative
analysis of the wording of the statements

1.2 REASONS FOR CHOOSING THE TOPIC:

Ratio analysis has always fascinated me as it is an area through which we can

understand the overall business of a company. It tells a layman how a company is
performing using simple analysis and with numbers.
1.3 AIMS AND OBJECTIVES OF THE STUDY

• The study seeks to investigate the various relationships between the variables in
the financial statements of Kampala Nissan Limited and interpret them.

• The interpret the main accounting ratios in terms of what they tell the
observer about liquidity, profitability, etc. of Kampala Nissan Limited

• The reason for changes in accounting ratios over time and its consequences on the
affairs of the company.

• The use and limitations of ratio analysis in decision making as applied to a number
of different businesses .

• To interpret the profitability, solvency, liquidity, operational and leverage ratios

of Kampala Nissan Limited and a similar company in the industry and find reasons
for the differences.

• Explain how financial ratio analysis helps financial managers assess the health of
a company.

1.5 LIMITATIONS OF THE STUDY

During the course of the study, the following limitations were encountered.

• Non availibality of Accurate Information:

 Since the project study was taken up during the time which happened to be the
year end for the companies, more details could not be collected because the staff
were obviously busy with the closure of books of accounts.

• Time constraint
Given the limited time in which the research was to be done, I could not collect data
from all the divisions. However, I ensured that the headquarter was targeted since this
is where the major operations are done

• Confidential Information
Some of the company information’s were highly confidential and hence these were not
availed to me.

• As I lived abroad it was difficult to get answers to all the questions I wanted
from the company based in Kampala

• Since am an amateur in doing Projects some ratios I couldn’t do an indept

analysis.

Despite the above constraints, I was able to work hard and achieve the reliable results
so as to complete the research successfully.

SECTION 2
2.0 METHODOLOGY USED TO GATHER INFORMATION:

2:1 RESEARCH DESIGN

The study used a blend of descriptive and analytical designs, well aware that none of
them singly would give sufficient/reliable findings in a study of this nature.
Consequently, both quantitative and qualitative methods were employed in data
collection and analysis.

2:2 sampling method

The use of financial statements for 2 years and industry average has been covered and
are interpreted in this project study.

2:2:1 sampling size

Analyzed and interpreted 20 ratios of the company

2:3 DATA COLLECTION: SOURCES, METHODS AND INSTRUMENTS

2:3:1 Sources

The study used both primary and secondary sources because the latter were considered
to be insufficient for this study, if used alone.

2:3:2 Primary Sources

The audited financial statements of the company and the annual reports and basic
documents were collected.
2:3:3 Secondary Sources

I had a face to face chat with the financial controller of the company and with his
assistant accountants. Also used financial information from other companies in the same
industry.

2:4: Data Collection Methods

A number of methods were used during data collection because no single method can
appropriately give concrete findings singly. Methods used included interviews and
observations.

I also used secondary data mainly from textbooks and journals.

2:5 DATA PROCESSING AND ANALYSIS

Data collected in 2.4 above were edited with a view of checking for completeness and
accuracy. This was done with corresponding to their tax auditors and to the Uganda
Revenue Authority.

The statistical package for social scientists (SPSS) for windows release 6.1 was used
for the main data analysis. Frequencies, groups and tables were produced from these
data and used to enhance understanding of father discussion in the subsequent chapter.

The data collected was edited, coded and summarized into tables. Frequencies and
percentages were used to code the data and to ensure completeness and accuracy.
2.5 STUDY AREA

The study was conducted completely focusing on the financial information of the
company. The particular departments examined were the accounting and auditing
departments.
 Section 3

THEORETICAL ANALYSIS OF THE FINANCIAL RATIOS

Financial ratios are widely used for modelling purposes both by practitioners and
researchers. The firm involves many interested parties, like the owners, management,
personnel, customers, suppliers, competitors, regulatory agencies, and academics, each
having their views in applying financial statement analysis in their evaluations.
Practitioners use financial ratios, for instance, to forecast the future success of
companies, while the researchers' main interest has been to develop models exploiting
these ratios. Many distinct areas of research involving financial ratios can be discerned.
Historically one can observe several major themes in the financial analysis literature.
There is overlapping in the observable themes, and they do not necessarily coincide with
what theoretically might be the best founded areas, ex post. The existing themes
include

• the functional form of the financial ratios, i.e. the proportionality discussion,
• distributional characteristics of financial ratios,
• classification of financial ratios,
• comparability of ratios across industries, and industry effects,
• time-series properties of individual financial ratios,
• bankruptcy prediction models,
• explaining (other) firm characteristics with financial ratios,
• stock markets and financial ratios,
• forecasting ability of financial analysts vs. financial models,
• Estimation of internal rate of return from financial statements.

The history of financial statement analysis dates far back to the end of the previous
century (see Horrigan, 1968). However, the modern, quantitative analysis has developed
into its various segments during the last two decades with the advent of the electronic
data processing techniques. The empiricist emphasis in the research has given rise to
several, often only loosely related research trends in quantitative financial statement
analysis. Theoretical approaches have also been developed, but not always in close
interaction with the empirical research.

Technically, financial ratios can be divided into several, sometimes overlapping

categories. A financial ratio is of the form X/Y, where X and Y are figures derived from
the financial statements or other sources of financial information. One way of
categorizing the ratios is on the basis where X and Y come from (see Foster, 1978, pp.
36-37, and Salmi, Virtanen and Yli-Olli, 1990, pp. 10-11). In traditional financial ratio
analysis both the X and the Y are based on financial statements. If both or one of them
comes from the income statement the ratio can be called dynamic while if both come
from the balance sheet it can be called static (see ibid.). The concept of financial ratios
can be extended by using other than financial statement information as X or Y in the
X/Y ratio. For example, financial statement items and market based figures can be
combined to constitute the ratio.
The traditionally stated major purpose of using financial data in the ratio form is
making the results comparable across firms and over time by controlling for size. This
basic assertion gives rise to one of the fundamental trends in financial ratio analysis (or
FRA for short, in this paper). The usually stated requirement in controlling for size is
that the numerator and the denominator of a financial ratio are proportional.
The seminal paper is this field is Lev and Sunder (1979). They point out, using
theoretical deduction, that in order to control for the size effect, the financial ratios
must fulfill very restrictive proportionality assumptions (about the error term,
existence of the intercept, linearity, and dependence on other variables in the basic
financial variables relationship models Y = bX + e and its ratio format Y/X = b + e/X). It
is shown that the choice of the size deflator (the ratio denominator) is a critical issue.
Furthermore, Lev and Sunder bring up the problems caused in multiple regression
models where the explaining variables are ratios with the same denominator. This is a
fact that has been discussed earlier in statistics oriented literature like in Kuh and
Meyer (1955).
In finance, a financial ratio is a ratio of selected values on a enterprise's financial
statements. There are many standard ratios used to evaluate the overall financial
condition of a corporation or other organization. Financial ratios are used by managers
within a firm, by current and potential stockholders (owners) of a firm, and by a firm's
creditors. Security analysts use financial ratios to compare the strengths and
weaknesses in various companies.[1] If shares in a company are traded in a financial
market, the market price of the shares is used in certain financial ratios.
Values used in calculating financial ratios are taken from the balance sheet, income
statement, cash flow statement and (rarely) statement of retained earnings. These
comprise the firm's "accounting statements" or financial statements.
Ratios are always expressed as a decimal value, such as 0.10, or the equivalent percent
value, such as 10%.
Financial ratios quantify many aspects of a business and are an integral part of financial
statement analysis. Financial ratios are categorized according to the financial aspect of
the business which the ratio measures. Liquidity ratios measure the availability of cash
to pay debt. Activity ratios measure how quickly a firm converts non-cash assets to
cash assets. Debt ratios measure the firm's ability to repay long-term debt.
Profitability ratios measure the firm's use of its assets and control of its expenses to
generate an acceptable rate of return. Market ratios measure investor response to
owning a company's stock and also the cost of issuing stock.

Financial ratios allow for comparisons

• between companies
• between industries
• between different time periods for one company
• between a single company and its industry average.

The ratios of firms in different industries, which face different risks, capital
requirements, and competition, are not usually comparable.

Profitability ratios

Profitability ratios measure the firm's use of its assets and control of its expenses to
generate an acceptable rate of return.

Gross margin
Profit margin
Operating margin
Net margin

Gross profit margin = (Sales - Cost of goods sold) / Sales

Operating profit margin or Return on Sales (ROS) = Earnings before interest and
taxes / Sales

Net profit margin = Net profits after taxes / Sales

Return on equity (ROE)

= Net profits after taxes / Stockholders' equity or tangible net worth

= Net profit / Equity

Return on investment (ROI ratio or Du Pont ratio) = Net income / Total assets

Asset turnover = Sales / Assets

• Risk adjusted return on capital (RAROC)

• Return on capital employed (ROCE)
• Cash flow return on investment (CFROI)
• Efficiency ratio

A Pictorial View of Profitability Ratio

Liquidity ratios
Liquidity ratios measure the availability of cash to pay debt.

Current ratio = Current assets / Current liabilities

• Looks at the ratio between Current Assets and Current Liabilities

• Current Ratio = Current Assets : Current Liabilities
• Ideal level? – 1.5 : 1
• A ratio of 5 : 1 would imply the firm has £5 of assets to cover every £1 in
liabilities
• A ratio of 0.75 : 1 would suggest the firm has only 75p in assets available to
cover every £1 it owes
• Too high – Might suggest that too much of its assets are tied up in unproductive
activities – too much stock, for example?
• Too low - risk of not being able to pay your way

Acid-test ratio (Quick ratio) = (Current assets - Inventories) / Current liabilities

• Also referred to as the ‘Quick ratio’

• (Current assets – stock) : liabilities
• 1:1 seen as ideal
• The omission of stock gives an indication of the cash the firm has in relation to
its liabilities (what it owes)
• A ratio of 3:1 therefore would suggest the firm has 3 times as much cash as it
owes – very healthy!
• A ratio of 0.5:1 would suggest the firm has twice as many liabilities as it has cash
to pay for those liabilities. This might put the firm under pressure but is not in
itself the end of the world!

Below is a Pictorial view of Liquidity Ratio

Activity ratios

Activity ratios measure how quickly a firm converts non-cash assets to cash assets.

• Average collection period = Accounts receivable / (Annual credit sales / 360

days)
• Collection period (period end)
• Average payment period = Accounts payable / (Annual credit purchases / 360
days)
• Inventory turnover ratio = Cost of goods sold / Average inventory
• Inventory conversion ratio = Inventory conversion to cash period (days) = 360
days / Inventory turnover
• days Inventory

Gearing ratios
Debt ratios measure the firm's ability to repay long-term debt. Debt ratios measure
financial leverage.
Debt ratio = Total liabilities / Total assets

Debt to equity ratio = (Long-term debt + Value of leases) / Stockholders' equity

Long-term debt/Total asset (LD/TA) ratio = long-term debt / Total assets

Times interest-earned ratio = Earnings before interest and taxes EBIT / Annual
interest expense

Overall coverage ratio = Cash inflows divided by

Lease expenses plus
Interest charges plus
Debt repayment / (1-t) plus
Preferred divident / (1-t)

A Pictorial view of Gearing Ratio

Market ratios

Market ratios measure investor response to owning a company's stock and also the cost
of issuing stock.
Payout ratio = Dividend / Earnings, or
= Dividend per share / Earnings per share

Note: Earnings per share is not a ratio, it is a value in currency. Earnings per share =
Expected earnings / Number of outstanding shares

P/E ratio = Price / Earnings per share

Cash flow ratio or Price/cash flow ratio = Price of stock / present value of cash flow
per share

Price to book value ratio (P/B or PBV) = Price of stock / Book value per share

A Pictorial View of Market ratios

SECTION 4

PROFILE OF THE COMPANY

Kampala Nissan Limited was incorporated on 5th April 2000 under the laws of Uganda.

The registered office address of the company is 32, Jinja Road, P.O.Box 2692, Kampala,
Uganda.

The principal activity of the company is to carry on the business of buying, selling,
repairing and servicing of new and used vehicles mainly dealing in Nissan Vehicles.

The share capital of the company is Shs. 1,000,000 divided into 1000 ordinary shares of
Shs. 1000 each.

The directors of the company are Mr. Salim Punjani and Mr. Shafiq Punjani who have
equal shares in the company.

The company’s finance controller is Mr. H Raghuram and the Sales Manager is MR.
Valerie Makerie.

The Finance controller is backed by 2 assistants and same for Sales Manager.

The other workers are in the workshops who are casual laborers.

The company auditors are PKF Uganda.

The company’s year ending is 31st December.

SECTION 5

ANALYSIS, INERPRETTION AND GRAPHICAL REPRESENTION OF THE

RATIOS OF KAMPALA NISSAN LIMITED
1) Profitability Ratios (ALL FIGURES IN SHS’000)

a) Gross Profit Margin ratio

How to calculate???

GP Ratio = Gross profit for the year / Net sales for the year *100

2005 2004

= 814,856 *100 1,001,497 *100

9,105,037 12,674,280

= 8.95% 7.90%

According to the market report competition in the year 2005 was much higher than in
2004. There were many new entrants in the motor vehicle market, which led to intense
competition for bidding purposes. And so the company lost out on some important
tenders, which can attribute to the reduction in sales in 2005. The cost of sales went
down by 29%. This was due to high closing stock compared to 2004 and so unsold stock
was held up in the bond. Hence, even with a fall in sales the gross profit margin
increased.

9.00%
8.80%
8.60%
8.40%
8.20%
8.00% Gross Profit
7.80%
7.60%
7.40%
7.20%
2005 2004

b) Net Profit margin ratio

How to calculate??
 NP ratio = Net Profit for the year/ net sales for the year *100

2005 2004

= 305,680 *100 517,756 *100

9,105,937 12,674,280

= 3.36% 4.09%

The net profit for the year has decreased by around 40%. This was due to low sales in the year
compared to 2004. There was no major decrease in administrative expenses. The decrease in turnover
of over 28% is the major contributor for the fall in net profit ratio.

4.50%
4.00%
3.50%
3.00%
2.50%
2.00% Net Profit ratio
1.50%
1.00%
0.50%
0.00%
2005 2004

c) Administrative expense ratio

How to calculate???
 Administrative expense ratio = Administrative expenses/ net sales *100

2005 2004

= 435,545 * 100 430,567 *100

9,105,937 12,674,280

= 4.78% 3.40%

There were no major increases in administrative expenses. It increased by a small

margin of only 1.1%. The increase in the ratio is due to the effect of the decrease in
sales of 28%.

5.00%

4.00%
Administrativ
3.00% e expense
ratio
2.00% Expense
increase
1.00%

0.00%
2005 2004

d) Operating expenses ratio

How to calculate???
 Operating expense ratio = operating expenses / sales *100

2005 2004

= 73,622 *100 80,468 *100

9,105,937 12,674,280

= 0.8% 0.6%

There is no significant increase in this ratio. Expenses have decreased by 9%. This was mainly
contributed by no rent in the period.

9.00%
8.00%
7.00%
6.00%
operating
5.00%
expense ratio
4.00%
expense
3.00% decrease
2.00%
1.00%
0.00%
2005 2004

e) Finance expense ratio

How to calculate????
 Finance expense ratio = finance expenses/ net sales *100

2005 2004

= 56,994 *100 39,631 *100

9,105,937 12,674,280

= 0.62% 0.31%

Finance expense constitutes of interest and exchange fluctuation differences. The

increase in the ratio is due to realized exchange losses made during the year due to
purchases made in different currencies and their subsequent fluctuations in the
market.

45.00%
40.00%
35.00%
30.00%
25.00%
finance ratio
20.00%
exchange losses
15.00%
10.00%
5.00%
0.00%
2005 2004

f) Return on Capital employed

How to calculate???
 ROCE = Net profit before tax and interest / capital employed +fixed borrowings *100

2005 2004

= 305680 *100 517,756 *100

931,551+462,442 766,017+394,165

= 21.79% 44.50%

The drastic reduction in the ROCE is due to the high decrease in net profits by almost 50%. This
profit reduction was due to low turnover due to competition in the market by new and existing
entrants in motor industry. And the finance controller also quoted that the sedan cars and the 4 wheel
station wagon sales very low than budgeted and also prices had to be reduced to face the increasing
competition. The company was doing well in the pick up category of its vehicles. The company had
better retained earnings because of the previous year’s accumulated profits. In addition, ROCE also
declined due to an increase in fixed assets, which were funded by borrowings. The increased
borrowings resulted an increase in interest charge, which in turn reduced the profit after tax.

100

80

60
ROCE
40 profit

20

0
2005 2004

g) Return on Investment

How to calculate???
 ROI = Net profit after tax/ shareholders fund *100

2005 2004

= 165,534 *100 333,803 *100

931,551 766,017

= 17.77% 43.58%

The decrease in the ratio is due to drop in profits by over 50%. This was the major reason in the poor
ratio. The major factor leading to this was due to the decrease in turnover by over 28%.

50
45
40
35 ROI
30
25 Decrease in
20 profits
15 Decrease in
10 Sales
5
0
2005 2004

h) Return on Total assets

How to calculate???
 ROA = Income before tax and interest/ total assets *100

2005 2004

= 305,689 *100 517,756 *100

3,104,396 2,288,617

= 9.8% 22.62%

This ratio has declined due to the reduction in profits, which was caused, by a 28%
decline in turnover for 2005. This could be attributed to factors such as increased
competition, reduced selling prices, and low sales of some of the units.

25

20

15

ROI
10

0
2005 2004

2) Liquidity ratios (ALL FIGURES IN SHS’000)

a) Current ratio
How to calculate???

Current ratio = current assets / current liabilities

2:1 is the ideal ratio

2005 2004

= 3,104,396 2,288,617
1,778,893 1,183,399

= 1.75: 1 1.93: 1

Generally there has been a decline in the liquidity of the company. This is because of the increase in
trade and other payables that is due to the change in the creditor’s payment period from 40 to 50
days. The increase was not fully matched with the increase in trade and other receivables due to the
changed debtor’s payment period. When enquired with the financial controller the reason he said for
the increase in debtor period was due to payments due from government that was delayed and it
resulted in the delay in payment to creditors.
This ratio shows that the company has inadequate working capital.

1.95

1.9

1.85

1.8
current ratio
1.75

1.7

1.65
2005 2004

b) Quick ratio

How to calculate???
 Quick ratio= Current assets- (stock + prepaid expenses)/ current liabilities

1: 1 is the ideal ratio

2005 2004

= 3,104,396-1,850,250 2,288,617-1,290,659
1,778,893 1,183,399

= 0.71: 1 0.84: 1

The company has high value closing stock. This was because of unexpected low sales of units in the
year. There was high competition and so all the tenders were not rewarded to the company. This ratio
is below the recommended ratio of 1:1 signifying the company’s incapability to pay off creditors there
and then if a need arises.

0.9
0.8
0.7
0.6 Quick ratio
0.5
0.4
Increase in
0.3
closing stock
0.2 43%
0.1
0
2005 2004

3) Efficiency ratios (ALL FIGURES IN SHS’000)

a) Assets Turnover ratio

 How to calculate???

= Cost of sales / net assets

Or sales/ net assets

2005 2004

= 9,105,937 12,674,280
77,580+3,104,396 58,154+2,288,617

= 286.17% 540.07%

There are 2 major factors that led to the decline of the ratio. Firstly, as explained the
decrease in sales of over 28% and secondly increase in stock of over 43%. Due to the
declined sales stock was held up. And also debtor’s days were increased so that the
company can meet the competitor’s debtor day’s policies.

600.00%
500.00%
asset turnover
400.00%
300.00% sales
200.00% decrease

100.00% inventory
increase
0.00%
2005 2004
 b) Fixed assets turnover ratio

How to calculate???

Fixed assets turnover ratio = Sales/ net fixed assets

2005 2004

= 9,105,937 12,674,280
77,580 58,154

= 117.37% 217.94%

Additions to fixed assets were made during the year through borrowings. The major reason the ratio
has fallen down is due to drop in sales by over 28%.

250.00%

200.00%

150.00% Fixed assets

turnover
100.00% Sales drop

50.00%

0.00%
2005 2004
c) Stock turnover ratio

How to calculate???

Stock turnover ratio = cost of goods sold/ average inventory

Or sales/ closing stock

2005 2004

= 8,291,061 11,672,783
1,850,250+1,290,659 1,290,659+2,507,176
2 2

= 5.27 times 6.15 times

The company had stocked a lot of car units in anticipation of winning the tenders. But due to high
competition not all the stocks could be sold. SO at the year-end the company had a lot of stock held
up at their bond and warehouse. And so closing stock value at hand is very high. So hence is the decline
in the ratio.
 6.2
6
5.8
5.6
5.4 Stock turnover

5.2
5
4.8
2005 2004

d) Age of inventory

How to calculate???

Age of inventory = no: of days in a year/ inventory turnover ratio

= (Average stock / cost of goods sold) *365

2005 2004

= 1,570,455 *365 1,898,918 *365

8,291,081 11,672,783

= 69 days 59 days

As discussed earlier, due to the increased competition the sales were not high as expected and so the
stock was held up at the year-end. So the number of days it took to recycle the stock to sales
increased.
 70
68
66
64
62
turnover days
60
58
56
54
2005 2004

e) Debtors turnover ratio

How to calculate???

Debtors turnover ratio = credit sales/ closing Debtors

2005 2004

= 9,105,937 12,674,280
951,773 895,156

= 9.56 times 14.16 times

The company has to give more credit facilities to customers to compete with other companies in the
same industry. Hence the debtors have increased by around 6%. According to the finance controller in
motor industry 90% of the sales are in credit terms as it involves huge amounts of cash.
The ratio has declined as an effect of reduction in turnover compared to the previous years. This was
due to increased competition.
 16
14
12
10
8
Debtors turnover
6
4
2
0
2005 2004

f) Debtors collection period

How to calculate???

= Closing debtors/ Net credit sales *365

2005 2004

= 951,773 *365 895,156 *365

9,105,937 12,674,280

= 38.15 days 25.78 days

As explained earlier, the company had to increase its debtor’s days, as there were many competitors
in the market. This strengthened the bargaining power of buyers and credit facility was used as one
of the strategies in attracting the customers.
 40
35
30
25
20
Debtor days
15
10
5
0
2005 2004

g) Creditors turnover ratio

How to calculate???

= Net credit purchase / accounts payable

2005 2004

= 8,291,081 11,672,783
995,227 470,458

= 8.33 24.8

This ratio indicates that the creditors are not paid in time. This was because the debtor payment
period increased and so the liquidity position also weakened. And according to the accountant since the
company does regular business with the suppliers the creditors payment period was extended.
 25

20

15
creditors turnover
10

0
2005 2004

h) Creditors payment period

How to calculate???

= Accounts payable/ purchases *365

2005 2004

= 995,227 *365 470,458 *365

8,291,081 11,672,783

= 43.8 days 15 days

The payment period has increased by around 29 days. This was because the debtor collection days had
gone up and so the company’s liquidity position had weakened and it could not meet its creditors in
time. Available cash was limited. It was lying in debtors. But since the company has a good reputed
position in the market the suppliers were not worried in receiving the cash later. When checked in
2006 the company is back in a good position and creditor days have reduced significantly.
 45
40
35
30
25
Creditor days
20
15
10
5
0
2005 2004

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15. Chartered Association of Certified Accountants (2000), Internal Audit and its
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