Questions

● Quick test
1 Snappy Ltd is a manufacturer and retailer of handbags. The following are extracts from the
company’s draft financial statements.

Statements of profit or loss for the years ended 31 December

20X7 20X6
£000 £000
Revenue 3,900 4,300
Cost of sales (2,652) (2,795)
Gross profit 1,248 1,505
Distribution costs (302) (430)
Administrative expenses (91) (210)
Profit from operations 855 865
Finance costs (4) (15)
Profit before tax 851 850
Tax (290) (285)
Profit for the year 561 565

Statements of financial position at 31 December

20X7 20X6
£000 £000
ASSETS
Non-current assets 770 810
Current assets
Inventories 470 340
Trade and other receivables 470 360
Cash and cash equivalents 20 40
960 740
Total assets 1,730 1,550
EQUITY AND LIABILITIES
Equity
 20X7 20X6
£000 £000
Equity share capital 350 350
Retained earnings 790 325
Total equity 1,140 675
Non-current liabilities
Borrowings 50 150
Current liabilities
Trade and other payables 270 455
Taxation 240 270
Borrowings 30 –
540 725
Total equity and liabilities 1,730 1,550

Required:

(a) Perform horizontal and vertical analyses on these financial statements.

(b) Comment on what this shows and identify the areas requiring particular investigation.

2 The statements of profit or loss for the years ended 31 December 20X9 and 20X8, and the
statements of financial position at these dates for Squirt Ltd are shown as follows.

Statements of profit or loss for the years ended

20X9 20X8
£000 £000
Revenue 1,200 900
Cost of sales (600) (525)
Gross profit 600 375
Operating expenses (300) (225)
Operating profit 300 150
Interest (60) (15)
Profit before tax 240 135
Taxation (90) (45)
Profit for the year 150 90

Statements of financial position at 31 December

 20X9 20X8
£000 £000 £000 £000
Non-current assets 1,800 1,320
Current assets
Inventory 300 360
Trade receivables 96 66
Cash – 18
396 444
Total assets 2,196 1,764
Equity 1,653 1,592
Non-current liabilities
Loan 300 75
Current liabilities
Trade payables 180 97
Bank 63 –
243 97
2,196 1,764

(a) Calculate the following ratios for the company for each of the two years:
(i) Return on capital employed
(ii) Asset turnover
(iii) Net profit margin
(iv) Gross profit percentage
(v) Current ratio
(vi) Liquid ratio
(vii) Inventory turnover
(viii)Receivables collection period
(ix) Payables payment period.
(b) Comment on the financial performance and financial position of Squirt Ltd based on
these ratios.

●● Develop your understanding

3 Smokey plc, an engineering company, has approached its bank for a £5 million long-term
secured loan to finance the rebuilding of part of its plant to comply with new regulations to
control emissions.
You are a financial advisor in the bank and you have extracted the following information
from the latest financial statements of the company.
 Year ended 31 March 20X4 20X5
Return on capital employed 27% 30%
Gross profit margin 45% 47%
Net profit margin 18% 25%
Asset turnover 1.5 1.2
Inventory turnover 4.7 times 5.8 times
Receivables collection period 46 days 35 days
Payables payment period 26 days 34 days
Current ratio 0.9 1.2
Acid test (liquid) ratio 0.6 0.9

Required:
Write a report to your manager which:

(a) analyses the financial performance and position of the company based on these ratios
(b) recommends whether the bank should be willing to lend.

4 The statements of financial position and statements of profit or loss for the year ended 30
June 20X6 of Gold Ltd and Silver Ltd, two companies in the same industry, are given as
follows.

Statements of financial position at 30 June 20X6

Gold Ltd Silver Ltd
£ £ £ £
Non-current assets: cost 90,000 30,000
Accumulated depreciation 30,000 10,000
60,000 20,000
Current assets
Inventories 85,500 30,000
Receivables 33,000 20,000
Cash 16,500 10,000
135,000 60,000
Total assets £195,000 £80,000
Equity
Equity share capital 142,500 45,000
Retained earnings 7,500 5,000
150,000 50,000
 Gold Ltd Silver Ltd
£ £ £ £
Current liabilities 45,000 30,000
Total equity and liabilities £195,000 £80,000

Statements of profit or loss for the year ended 30 June 20X6

Gold Ltd Silver Ltd
£ £ £ £
Revenue 240,000 120,000
Opening inventory 58,500 20,000
Purchases 171,000 85,000
229,500 105,000
Closing inventory (85,500) (30,000)
Cost of sales (144,000) (75,000)
Gross profit 96,000 45,000
General expenses (84,000) (39,000)
Profit before tax 12,000 6,000
Taxation (3,000) (1,000)
Profit for the year £9,000 £5,000
Dividends paid £6,000 £1,500

You may assume that inventories have increased evenly throughout the year.

Required:

(a) Calculate the following ratios for each company:

(i) Return on capital employed
(ii) Asset turnover
(iii) Net profit margin
(iv) Gross profit margin
(v) Current ratio
(vi) Liquid (acid test) ratio
(vii) Inventory turnover
(viii)Receivables collection period
(ix) Payables payment period.
(b) Discuss the main conclusions drawn from a comparison of the ratios calculated for
each company.
 Micawber & Sons, an unincorporated business founded approximately 20 years ago, is in
5 the retail trade. Since then, the business has shown increasing profits. Summarised
financial statements for the last two completed financial years are as follows.

Statements of profit or loss for the years ended 31 December

20X6 20X5
£000 £000
Revenue 940 800
Cost of sales (583) (480)
Gross profit 357 320
Expenses (259) (222)
Interest (20) (6)
Profit for the year 78 92

Statements of financial position at 31 December

20X6 20X5
£000 £000 £000 £000
Non-current assets
Cost 1,227 807
Accumulated depreciation 546 404
681 403
Current assets
Inventory 240 150
Accounts receivable 33 23
Bank and cash 28 97
301 270
Total assets £982 £673
Capital 543 501
Non-current liabilities
Long-term bank loan 280 60
Current liabilities 159 112
Total capital and liabilities £982 £673

Required:
(a) Calculate the following ratios for Micawber & Sons for the financial year ended 31
December 20X6 (the ratios for year ended 31 December 20X5 have already been
 calculated):

Year ended 31 December 20X5

(i) Return on capital employed 17.5%
(ii) Net profit percentage 12.3%
(iii) Gross profit percentage 40.0%
(iv) Expenses as a percentage of revenue 27.8%
(v) Asset turnover 1.4
(vi) Current ratio 2.4
(vii) Liquid ratio 1.1
(viii) Inventory turnover 114 days
(ix) Payables payment period 85 days

(b) Using the financial statements, together with the ratios in part (a), comment on the
financial performance and position of Micawber & Sons for the year ended 31
December 20X6 in comparison with the previous year.

●●● Take it further

6 Deepa & Co. is an unincorporated family business and wholesaler, importing silk fabric
from Far Eastern countries, and selling on to specialist curtain and upholstery retailers.
During the year ended 31 December 20X1 the business entered into a new contract with
the local branches of a national retail chain. The business also expanded its warehouse
and automated its office processes in the year.
Summarised financial statements for 20X1 and 20X0 for the business are as follows.

Statements of profit or loss for the years ended 31 December

20X1 20X0
£ £ £ £
Revenue 382,100 289,800
Cost of sales (275,150) (194,170)
Gross profit 106,950 95,630
Administrative expenses 45,235 44,240
Distribution costs 16,430 14,680
Interest 1,875 –
(63,540) (58,920)
Profit for the year 43,410 36,710

Statements of financial position at 31 December

 20X1 20X0
£000 £000 £000 £000
Non-current assets 130,000 78,750
Current assets
Inventory 24,650 15,600
Accounts receivable 22,850 11,275
Bank and cash 3,750 11,700
51,250 38,575
Total assets 181,250 117,325
Capital 77,760 73,350
Non-current liabilities
5% bank loan, repayable 20X5 50,000 –
Current liabilities
Accounts payable 53,490 43,975
Total capital and liabilities 181,250 117,325

Required:

(a) Calculate the following ratios for Deepa & Co. for the financial years ended 31
December 20X1 and 20X0:
(i) Return on capital employed
(ii) Net profit percentage
(iii) Gross profit percentage
(iv) Administrative expenses as a percentage of revenue
(v) Distribution costs as a percentage of revenue
(vi) Asset turnover.
(b) Using both the summarised financial statements and the ratios from part (a) produce a
report that provides an analysis of the financial performance of Deepa & Co. for the
year ended 31 December 20X1 in comparison with the previous year.
(c) Give details of any other information you would require to improve your analysis of the
financial performance of the business, providing reasons for the requirement.

7 The following financial data is available for Ash plc:

Extracts from statements of financial position at 31 March

20X5 20X4 20X3
£000 £000 £000
Equity
 20X5 20X4 20X3
£000 £000 £000
Equity share capital (20p shares) 6,000 5,000 5,000
6% irredeemable preference share capital (£1 shares) 1,000 1,000 1,000
Share premium 5,500 1,200 1,200
Retained earnings 2,610 1,890 2,270
Total equity 15,110 9,090 9,470
Non-current liabilities
7% debentures (20X8) 5,000 5,000 3,000
Current liabilities 7,140 7,530 6,180
Total equity and liabilities 27,250 21,620 18,650

Retained earnings columns from statements of changes in

equity for the years ended 31March
20X5 20X4 20X3
£000 £000 £000
At start of year 1,890 2,270 1,700
Profit for the year 4,230 2,180 2,880
Dividends paid (3,510) (2,560) (2,310)
At end of year 2,610 1,890 2,270

Extracts from the statements of profit or loss for the years

ended 31 March
20X5 20X4 20X3
£000 £000 £000
Profit before tax 6,040 3,200 3,960
Tax (1,810) (1,020) (1,080)
Profit after tax 4,230 2,180 2,880
20X5 20X4 20X3
Market price per equity share 72p 58p 60p

Ash plc issued the additional debentures on 1 September 20X3 and the new equity shares
on 1 April 20X4.

Required:
 Calculate the following ratios for Ash plc for the years ended 31 March 20X5, 20X4 and
(a)
20X3:
(i) Return on equity
(ii) Earnings per share
(iii) Price earnings
(iv) Dividend per share
(v) Dividend cover
(vi) Dividend yield
(vii) Gearing.
(b) On the basis of the ratios calculated in part (a), produce a report for a potential equity
investor, advising whether to invest in the company or not.

8 The financial statements of Mono plc for 20X7 and 20X6 are as follows.

Statements of financial position at 31 December

20X7 20X6
£000 £000
Non-current assets
Freehold premises 3,875 4,025
Plant and equipment 2,607 2,167
6,482 6,192
Current assets
Inventories 1,435 2,625
Receivables 3,900 2,277
Cash 13 198
5,348 5,100
Total assets 11,830 11,292
Equity
Equity share capital (50p ordinary shares) 1,000 1,000
Share premium 350 350
Retained earnings 5,979 5,864
7,329 7,214
Non-current liabilities
9% Redeemable debenture stock 20X7–20Y1 2,000 2,500
Current liabilities
Payables 2,501 1,578
Total equity and liabilities 11,830 11,292
Statements of profit or loss for the years ended 31 December
20X7 20X6
£000 £000
Revenue 11,450 10,874
Profit before tax 434 721
Taxation (119) (178)
Profit after tax 315 543
Dividends proposed and paid 200 200
Year end share price £3.15 £4.20

Notes to the accounts

1 Analysis of operating profit

20X7 20X6
£000 £000
Revenue 11,450 10,874
Cost of sales (6,764) (6,351)
Gross profit 4,686 4,523
Administrative expenses (4,072) (3,577)
Operating profit 614 946

2 Operating profit is stated after charging:

20X7 20X6
£000 £000
Depreciation 890 750
Auditor’s remuneration 55 50
Leasing charges 95 115
Director’s emoluments 135 120

3 Interest paid

20X7 20X6
£000 £000
Payable on debenture stock 180 225

Required:
 Analyse the financial performance of Mono plc as an investment prospect during the
two years of 20X6 and 20X7.
9 Jewelax Ltd is a long-established chain of provincial fashion boutiques, offering mid-price
clothing to a target customer base of late teens/early twenties. However, over the past
eighteen months, the company appears to have lost its knack of spotting which trends from
the catwalk shows will succeed on the high street. As a result, the company has had to
close a number of its stores just before its year end of 31 December 20X2.
You have been provided with the following information for the years ended 31 December 20X1
and 20X2.

Statement of cash flows for the year ended 31 December

20X2 20X1
£000 £000
Cash flows from operating activities
Cash generated from operations 869 882
Interest paid (165) (102)
Tax paid (13) (49)
Net cash from operating activities 691 731
Cash flows from investing activities
Dividends received – 55
Proceeds from sales of investments 32 –
Proceeds from sale of property, plant and equipment 1,609 12
Net cash generated from investing activities 1,641 67
Cash flows from financing activities
Dividends paid – (110)
Borrowings taken out 500 100
Net cash generated from/(used in) financing activities 500 (10)
Net change in cash and cash equivalents 2,832 788
Cash and cash equivalents brought forward 910 122
Cash and cash equivalents carried forward 3,742 910

Reconciliation of profit before tax to cash generated from

operations
20X2 20X1
£000 £000
Profit before tax 2,293 162
 20X2 20X1
£000 £000
Investment income – (55)
Finance cost 165 102
Depreciation charge 262 369
Loss on disposal of investments 101 –
Profit on disposal of property, plant and equipment (1,502) (2)
(Increase) in inventories (709) (201)
(Increase)/decrease in trade and other receivables (468) 256
Increase in trade and other payables 727 251
Cash generated from operations 869 882

Extracts from the statement of comprehensive income and statement of financial position for
the same period were as follows.

20X2 20X1
£000 £000
Revenue 2,201 3,102
Equity and liabilities
Equity
Equity share capital 100 100
Retained earnings 7,052 4,772
7,152 4,872
Long-term liabilities
Borrowings 1,500 1,000
Current liabilities
Trade and other payables 1,056 329
9,708 6,201

Required:

(a) Comment on the above information, calculating three cash flow ratios to assist you in your
analysis.
(b) You have now learnt that the financial controller of Jewelax Ltd has been put under severe
pressure by his operational directors to improve the figures for the current year. Discuss
how this pressure might have influenced both the above information and other areas of the
financial statements.