MME40001 Engineering Management 2 Topic: Financial Ratios

Tutorial 5: Analysis and Interpretation of Financial Statements

Problem 1:
Balance sheet extracts as at 30 June
2008 2009 2010
Current Assets $ $ $
Cash 3,000 16,000 20,000
Receivables 100,000 45,000 35,000
Inventories 120,000 68,000 65,000
Total current assets 223,000 129,000 120,000
Non- current assets 240,000 210,000 198,000

Income statement for the years ended 30 June

2009 2010
$ $
Net sales (all credit) 600,000 500,000
Less cost of sales 360,000 380,000
Gross profit 240,000 220,000
Less operating expenses
General 170,000 140,000
Interest 25,000 15,000
Net profit 45,000 65,000
Less tax 13,500 19,500
Net profit after tax 31,500 45,500

Calculate the following ratios for 2009 and 2010:

a) Return on assets
b) Net profit margin
c) Gross profit margin
d) Asset turnover
e) Average inventory turnover period
f) Average settlement period for debtors
g) Interest cover ratio (times interest earned)

Problem 2:

Ratio Business A Business B

Return on total assets (ROA) 20% 17%
return on owners' equity 30% 18%
Average settlement period for debtors 63 days 21 days
Average settlement period for creditors 50 days 45 days
Gross profit percentage 40% 15%
Net profit percentage 10% 10%
Inventory turnover period 52 days 25 days

Abstracted from Atrill, Mclaney, Harvey, and Jenner, Accounting An Introduction, 4e, 2009. Pearson. 1
Describe what this information indicates about the differences in approach between the two businesses. If
one of them prides itself on personal service and the other on competitive prices, which do you think is
which and why?

Problem 3:
A Ltd and B Ltd operate electrical wholesale stores in Sydney. The accounts of each company for the year
ended 30 June 2009 are as follows:

Balance sheet extracts as at 30 June 2009

A Ltd B Ltd
$'000 $'000 $'000 $'000
Current Assets
Cash at bank 100.6 109.0
Debtors 176.4 321.9
Inventory at cost 592.0 403.0
869.0 833.9
Non-current assets
Freehold land and building at cost 436.0 615.0
less accumulated depreciation 76.0 360.0 105.0 510.0
Fixtures and fittings at cost 173.4 194.6
less accumulated depreciation 86.4 87.0 103.4 91.2
447.0 601.2
Total assets 1,316.0 1,435.1

Current liabilities
Trade creditors 271.4 180.7
Dividends payable 135.0 95.0
Income tax payable 32.0 34.8
438.4 310.5
Non-current liabilities
Debentures 190.0 250.0

Capital and reserves

Paid-up ordinary capital (issued at $1) 320.0 250.0
Reserves 355.9 289.4
Retained profit 11.7 335.2
687.6 874.6
Total liabilities and shareholders’' equity 1,316.0 1,435.1

Abstracted from Atrill, Mclaney, Harvey, and Jenner, Accounting An Introduction, 4e, 2009. Pearson. 2
 Income statement for the years ended 30 June 2009
A Ltd B Ltd
$'000 $'000 $'000 $'000
Sales 1,478.1 1,790.4
Less cost of sales
Opening inventory 480.8 372.6
Purchases 1,129.5 1,245.3
1,610.3 1,617.9
Less closing inventory 592.0 1,018.3 403.0 1,214.9
Gross profit 459.8 575.5

Less
Wages and salaries 150.4 189.2
Directors' salaries 45.4 96.2
Rates 28.5 15.3
Heat and light 15.8 17.2
Insurance 18.5 26.8
Interest expenses 19.4 27.5
Postage and telephone 12.4 15.9
Audit fees 11.0 12.3
Depreciation
Freehold buildings 8.8 12.9
Fixtures and fittings 17.7 327.9 22.8 436.1
Net profit before tax 131.9 139.4

Income tax 32.0 34.8

Net profit after taxation 99.9 104.6
Add retained profit brought forward 46.8 325.6
146.7 430.2
Dividends proposed 135.0 95.0
Retained profit carried forward 11.7 335.2

All purchases and sales are on credit. The market values of the shares in each company at the end of the
year were $6.50 and $8.20 respectively. Calculate six different ratios which are concerned with liquidity,
gearing, and investment. What can you conclude from the ratios you have calculated?

Problem 4: The following details concern the business of N. Shakey, who is worried about the profitability
and financial structure of his business at 30 June 2010, especially since the bank is requiring repayment of
his overdraft.

30 June 2009 30 June 2010

Sales (credit) $60,000 $90,000
Cost of goods sold 39,000 63,000
All other expenses 12,000 21,000

Abstracted from Atrill, Mclaney, Harvey, and Jenner, Accounting An Introduction, 4e, 2009. Pearson. 3
 Cash at bank 12,000 (18,000)
Inventory 18,000 33,000
Trade debtors (net) 12,000 30,000
Non-current assets (net) 24,000 48,000
Creditors 6,000 9,000
N. Shakey Capital 60,000 72,000
Non-current Liabilities - 12,000
Inventory at 1 July 2008 was $15,000
Trade debtors at 1 July 2008 were $10,000

(a) Calculate the following ratios for 2009 and 2010:

i. Net profit margin
ii. Rate of return on owner’s equity
iii. Current ratio
iv. Acid test ratio
v. Gearing
vi. Inventory turnover period

(b) Write a short report to the owner about:

i. Profitability
ii. Shot-term liquidity
iii. Long-term solvency.

Problem 5: Threads Ltd manufactures nuts and bolts which are sold to industrial users. The abbreviated
accounts for 2009 and 2010 are given below.

Threads Ltd
Income statement for the year ended 30 September
2010 2009
$'000 $'000 $'000 $'000
Sales 1,200 1,180
Less cost of sales (750) (680)
Gross profit 450 500
Less
Operating expenses (208) (200)
Depreciation (75) (66)
Interest (8)
(291) (266)
Net profit before tax 159 234
Tax (48) (80)
Profit after tax 111 154
Dividends (72) (70)
Retained profit for the year 39 84

Abstracted from Atrill, Mclaney, Harvey, and Jenner, Accounting An Introduction, 4e, 2009. Pearson. 4
 Threads Ltd
Balance sheet as at 30 September
2010 2009
$'00 $'00 $'00
0 0 0 S'000
Current assets
Bank 4 32
Debtors 156 102
Inventory 236 148
396 282
Non-current assets (see note 1) 687 702
Total assets 1083 984
Current liabilities
Bank overdraft 26
Creditors 76 60
Accruals 16 18
Dividends payable 72 70
Income taxation 48 80
238 228
Non-current liabilities
Bank loan (see note 2) 50
Shareholders' equity
Paid-up capital (issued at $1 per share) 500 500
Retained profits 295 256
795 756
Total liabilities and shareholders' equity 1083 984

Notes
1. Non-current assets:
Fixtures
and
Buildings fittings Vehicles Total
$'000 $'000 $'000 $'000
Cost 1.10.2009 900 100 80 1080
Purchases 40 20 60
Cost 30.09.2009 900 140 100 1140
Accumulated depreciation
1.10.2009 288 50 40 378
Charge for year 36 14 25 75
Accumulated depreciation
30.09.2010 324 64 65 453
Net book value 30.09.2010 576 76 35 687

Abstracted from Atrill, Mclaney, Harvey, and Jenner, Accounting An Introduction, 4e, 2009. Pearson. 5
2. The bank loan was taken up on 1 July 2009 and is repayable in six years from that date. It carries a fixed
rate of interest of 12% per annum and is secured by a fixed and floating charge on the assets of the company.
(a) Calculate the following financial statistics for both 2010 and 2009, using end-of-year figures where
appropriate:
(i) return on total assets
(ii) net profit margin
(iii) gross profit margin
(iv) current ratio
(v) liquid or acid test ratio
(vi) average settlement period for debtors
(vii) average settlement period for creditors
(viii) average inventory turnover period

(b) Comment on the performance of Threads Ltd from the viewpoint of a company considering supplying
them with a substantial amount of goods on usual credit terms.
(c) What action could a supplier take to lessen the risk of not being paid if Threads Ltd gets into financial
difficulty?

Abstracted from Atrill, Mclaney, Harvey, and Jenner, Accounting An Introduction, 4e, 2009. Pearson. 6