Question

Both Alison plc and Barbara plc operate wholesale electrical stores throughout the UK. The financial statements of each business for the year ended 30 June 2016 are as follows

Statement of Financial Position as at 30 June 2016

Statement of Profit and Loss for the year ended 30 June 2016

Note: All purchases and sales were on credit.

a）For each business, calculate two ratios that are concerned with each of the following aspects (eight ratios in a total of each business):

i.profitability

ii.Efficiency

lii.Liquidity

IV. Gearing

b) Compare the profitability, efficiency, liquidity and gearing ratios of the two companies. Explain what a comparison of each ratio indicates about the relative performance and position of the two companies.

c) Explain the effect of a company’s gearing on its profitability

Alison plc Barbara plc £m £m Non-current assets Property, plant and equipment (cost less depreciation) Land and buildings 360.0 510.0 Fixtures and fittings 87.0 91.2 447.0 601.2 Current assets Inventories 592.0 403.0 Trade receivables 176.4 321.9 91.6 84.6 Cash at bank 853.0 1300.0 816.5 Total assets 1417.7 Equity and liability Equity 320.0 367.6 250.0 624.6 874.6 Share capital Retained earnings 687.6 Noncurrent liabilities 190.0 Loans 250.0 Current liabilities Trade pavables 275.7 17.4 406.4 16.0 Tax payable 422.4 1300.0 293.1 Total equitv and liabilities 1417.7 Barbara plc Alison plc £m £m 1790.4 1478.1 1018.3) Revenue 1214.9 Cost of sales 575.5 459.8 Gross profit 408.6) 308.5) Operating expenses 166.9 151.3 Operating profit 27.5 19.4) Interest payable 139.4 131.9 Profit before taxation 34.8 104.6 32.0) Taxatiorn 99.9 Profit for the year

Answer 1

a. & b.

Alison Plc

Barbara Plc.

Comments

i.Profitability Ratios

Net Profit Margin(Net Profit / Net Revenue)

99.9 / 1,478.10

104.60 / 1790.40

Alison co. has a higher profit margin as compared to Barbara

6.76%

5.84%

It shows that the indirect exp[enses of Alison is lower as compared to that of Barbara

Return on Equity(Net Profit / Shareholders equity)

99.9 / 320.0

104.60 / 250.0

ROE of Barbara is higher than Alison's. It means that Barbara is giving

31.22%

41.84%

a higher rate of return to equity shareholders as compared to alison

ii.Efficiency ratio

Inventory Turnover = Cost of goods sold(COGS) / Average inventory

1018.30 / 592.0

1214.90 / 403

As the Inventory turnover of Brbara is higher it means that its inventory management is better than that of alsions

1.72 times

3.01 times

Accounts Receivable Ratio = Net credit sales / Average accounts receivable

1478.10 / 176.40

1790.40 / 321.90

Since the Accounts receivable ratio of Alison is more it shows that it is giving

8.38 times

5.56 times

more time to its debtors for making payment

iii.Liquidity ratio

Current Ratio = Current asset / Current liability

853.0 / 422.40

816.50 / 293.10

The higher current ratio of Barbara shows that it has more liquidity as compare dto alison

2.02 times

2.78 times

Quick ratio = (Current assets - Inventories) / Current liability

261.0 / 422.40

413.50 / 293.10

There is high difference in the current ratio and quick ratio of alison

0.62 times

1.41 times

It shows that most of its current assets consists of Inventory

iv.Gearing Ratio

Debt-to equity ratio = Total Debt / Total Equity

190 / 687.60

250 / 874.60

Both the company's has low and almost identical Debt-Equity ratio

0.28 times

0.29 times

which shows that both the company's are a low debt company

Times Interest earned = EBIT / Total Interest

151.30 / 19.40

166.90 / 27.50

Higher Times interest earned ratio of Alison shows that the Interest portion of expense

7.80 times

6.07 times

which is fixed is lower as compared to Barbara

c)

If a company has more debt as compared to other, it means that the company will have to pay more Interest on those debts.

Thus it will lower its Net income. Similarly if there is less debt then the Net income will be higher