Question

Question 2 Frankfurt Limited and Madrid Limited are both engaged in retailing, but they seem to take a different approach to it according to the following information: Frankfurt Madrid Ltd Ltd 20% 17% 17% 30% 18% 63 days 21 days Return on capital employed (ROCE) Return on ordinary shareholders' funds (ROSF) Average settlement period for trade receivables Average settlement period for trade payables Gross Profit margin Operating profit margin Average inventories turnover period 50 days 45 days 40% 15% 10% 10% 52 days 25 days (a) Describe what this information indicates about the differences in approach between the two businesses. If one of them prides itself on personal service and one of them on competitive prices, which one do you think is which and why?

Answer 1

Conclusion: Frankfurt Ltd. focuses on personal service and Madrid Ltd. focuses on Competitive prices.

Basis of Conclusion:

Let us analyse the ratios provided in the question:

1. GROSS PROFIT & OPERATING PROFIT MARGIN: There is a large difference between the gross profit margin and operating profit margin of Frankfurt whereas the difference is very reasonable in case of Madrid. This indicates that Madrid is spending reasonable amount on the business facilities like rent, entertainment, consumable stores etc. but Frankfurt is spending a considerable amount of its revenue on these facilities. This indicates that Frankfurt is more oriented towards providing personal service to its customers and Madrid is following the competitive prices approach.
2. AVERAGE SETTLEMENT PERIOD OF TRADE RECEIVABLE AND PAYABLE: Trade Payable settlement period of both the companies is similar. However, there is a difference in the average settlement period of trade receivables. This indicates that Madrid is more efficient to convert its receivables into cash and invest them in its business whereas Frankfurt give its debtors fairly long time to pay their debts. This also indicates that Frankfurt is more customer oriented and Madrid is more oriented towards en-cashing its customers at early stage to invest the proceeds in business.
3. ROEC & ROSF: These values indicates that despite of all the facts discussed earlier, Frankfurt is able to earn higher returns on its Equity as compared to Madrid. This is because Frankfurt has invested a lower amount as Equity as Compared to Madrid. This also implies that Madrid focuses on competitive prices and need to higher its sales by investing more whereas the case is not same with Frankfurt.
4. AVERAGE INVENTORIES TURNOVER: Assuming the inventory levels to be same, the reason behind the difference in ratio could be sales revenue. Frankfurt is having low sales revenue as compared to Madrid. The probable reason behind this could price charged from customers i.e. Frankfurt is charging high prices from its limited number of customers whereas Madrid is charging reasonable price from its large number of customers. The difference also indicates that Madrid is following the strategy of competitive prices and Frankfurt is following the strategy of Customer satisfaction.

After analyzing all the ratios, the conclusion mentioned above is justified.