Question

Style Limited (Adapted from Dyson p 245, 10.9) 2018 £ 000 2017 £ 000 2017 000 000 000 000 000 1,900 1,500 420 685 Income Statement Sales (all credit) Cost of Goods Sold Opening stock Purchases (all credit) 80 2018 £ 000 Statement of Financial Position Fixed Assets (NBV) Current Assets Inventory 250 Trade debtors Bank 1,100 Less: Current Liabilities Bank overdraft Trade creditors 100 375 100 1,400 1,500 200 995 Less closing stock 1,075 100 500 Gross Profit Expenses Net profit 1941 Total Assets less Current Liabilities 1,310 1.105 100 Long Term Liabilities Bank loan Capital and reserves Ordinary share capital Retained profit Long Term Liabilities & Equity Required: (a) Calculate the following accounting ratios for the two years 2018 and 2017 respectively: Profitability ratios Liquidity and solvency ratios 900 310 1,310 900 205 1,105 1. Gross profit margin 31.58% 35% 6. Current ratio 5.24 4.05 2. Net profit margin 5.53% 7. Acid test ratio Efficiency ratios Returns 3. Inventory turnover period 37.44 8. Return on capital employed 70.19 163.29 52.14 8.12% 18.68% 4. Receivables settlement period 91.25 9. Return on shareholders funds 9.5% 5. Payable settlement period 29.35 (4 marks)

Comment on:
a) the company's performance for the year to 30 June 2018
b) the limitations of ratio analysis

Answer 1

a) Company's performance for the year to 30 june 2018

• As gross profit margin for the year 2018 is 31.58% which is less than 35% which is in the year 2017 it inturn affects the net profit margin of the company as it can be seen that the net proft margin has been decreased to 5.53% in 2018 from 7% in 2017.
• When net profit margin decreases it impacts on the net profitability of the company.
• A low current ratio indicates that company may have problems in meeting short term obligations.As the current ratio is 5.24%,company cannot convert it liquid assets into cash.
• Companies with the acid test ratio less than 1 does not posses enough liquid assets to pay current liabilities (Here the acid test ratio is 4.05%).
• In the year 2018 inventory turnover ratio is 70.19 which is higher than 35.44 .Company's performance in the case of inventory turnover ratio is a positive.As, it indicates higher inventory turnover ratio ( because inventories are the least form of liquid asset).
• A lower return on capital employed indicates that the capital resources are not being properly utilized in the company in turn affecting its performance.
• Lower return on shareholder's funds indicates less money is being returned to the investors. Return on shareholder's funds determines and effects the financial health of the company.
• Since the receivables settlement period is higher i.e 163.29 it indicates that the payments made by the clients to company are slower which in turn affects it performance.
• A higher payables settlement period indicates that the company has plenty of cash to pay off its short term debt. In turn company is managing it debt and cash flow effectively.

b) Limitations of Ratio Analysis

• Firm can make year end changes to financial statements to improve ratios.
• Ratios ignore price level changes due to inflation.
• Accounting ratios completely ignore the qualitative aspects of the firm.
• There are no standard definitions for ratios.So, different formulas can be used.
• Accounting ratios does not resolve any financial problems of the company.