ANSWER TO QUESTION A1

Please note all amounts in this solution are in GBP currency

(1)Cost of Sales=opening Inventory + purchases - closing inventory

37,500+250,000-150,000=135,000

(2)Building are Depreciated with the straight-line method for 50 years

Cost of Building 750,000/50= 15,000

50% (7500) is added in Cost of Sales and 50% (7500) is added in admin expense

Revised cost of sales= 135,000 (1) + 7,500=142,500

Revised Admin expense=177,500

Motor Depreciated with reducing balance= (125,000-80,000) x 0.2-=9,000 depreciation

Revised Distribution cost=110,000+9,000=119,000

Distribution Cost after Bad Debts=119,000-6,000=113,000

Revised receivable with Bad Debt Adjustment= 345,000-6,000=339,000

Allowance for Receivable=349,000x0.08=27,120

(3)Distribution cost of 400 will be charged in the current income statement as an expense and
will show as a liability in Balance Sheet and same treatment will be done with 2,500 admin
expense

Revised New distribution expense=113,000+400=113,400

Revised New Admin expense =177,500+2,500=180,000
Revised Payable = 190,000+400+2,500=192,900

(4)Interest Expense for the Year 2020

121,500x0.06=7,290

(5) Dividend Paid w will be deducted from retained earnings

660,000-62,000=598,000
Income Statement for Year-End Jan 2020
GBP
Revenue 760,000
Cost of Sales (142,500) from (2)
Gross Profit 617,500
Admin Expenses (180,000) from (3)
Distribution Costs (113,400) from (3)
Profit before Interest and Tax 324,100
Interest Expense (7,290) from (4)
Corporation Tax (55,000)
Net Profit 26,1810

Balance Sheet for Year-End Jan 2020

Assets
Non-Current Assets GBP
Buildings 750,000
Plant and Machinery 325,000
Motor Vehicles 125,000
Accumulated Depreciation Buildings - (15,000) From (2)
Accumulated Depreciation Plant & -
Machinery (80,000)

Accumulated Depreciation Motor (45,000+9,000 From (2)

-
Cars )
Total Non-Current Assets 1,051,000
Current Assets
Prepayments 175,000
Closing Inventory 150,000
Bank Balance 107,330
Receivable 339,000 From (2)
Allowance for Receivable (27,120) From (2)
Total Current Assets 746,880
Total Assets 1,645,210

Liabilities
Non-Current Liabilities
Bank Loan 121,500
Current Liabilities
Trade Payables 192,900
Overdraft 55,000
Total Liabilities 369,400
Equity
 Share Capital 390,00
0
Share Premium 25,000
Retained Earnings 598,000 From (5)
Profit of Jan 2020 261,810
Total Equity 1,275,810
Total Equity and Liabilities 1,645,210

Answer to QuestionA2
(a) Explain the purpose of ratio analysis, what type of information it reveals, and the
limitations of its use.

Ratio analysis helps accountants and businesses to see trends in financial indicators. For
example, if revenues have a negative trend for consecutive periods (quarters or years
maybe), then digging deep into the reasons for the negative trend may reveal reasons like
sluggish inventory moments, loss of customers, or an overall downfall in the industry
sales. So, it leads to corrective actions from the management. Furthermore, ratio analysis
can be used to track the progress of a company towards its set targets. For example, an
 operating profit margin of 10% is achieved as opposed to a set target of 15% then there is
scope for improvement. Ratio analysis can also reveal the level of resource utilization in a
company. For example, ROCE or Asset turnover ratio can be helpful in this. Finally, the
analysis can be used to benchmark performance with peer companies in an industry.

Ratio analysis can reveal information like the company areas of financial strength. For
example, superior performance in sales means the company's marketing department is
contributing well. On the other hand, if the operating margin is not healthy then it may
reveal (upon digging for the causes) that the company has cost control problems. The
analysis can also reveal the success of new products and geographical locations. It can
also reveal how a company is doing against its competitors and the industry average.

Despite its merits, ratio analysis has its limitations. The results are based on historical
events and hence the analysis is of limited use. In other words, the tool is not forward-
looking but backward-looking. The analysis is also vulnerable to management distortion of
information and hence it can disguise an investor or other stakeholder. Ratios can be
interpreted differently by different users and there is no standard definition of right and
wrong performance. Finally, it ignores the non-financial indicators which can be more
interesting. For example, the number of repeat customers, employee satisfaction, and
returned products can reveal some real issues.

(b) Calculate:

Ratio Formula 2020 2019

1)    Gross profit margin Gross profit/revenue 39.79% 36.27%
2)    Operating profit margin Profit from 30.35% 28.08%
operations/revenue
3)    Return on capital employed Profit from operation/Non- 65.49% 68.14%
current liabilities+ Equity
4)    Inventory holding period Inventory/COS*365 25 days 21 days
 5)    Settlement period for trade Accounts receivable 37 days 31 days
receivables balance/total net sales*365
6)    Settlement period for trade Accounts payable 4.55 4.53
payables balance/COS*365 days days
7)    Current Ratio Current assets/Current 8.41 6.95
liabilities times times
8)    Acid Test Ratio Current assets- 6.87 5.55
Inventories/Current liabilities times times
9)    Interest cover Profit from 77.57 72.66
operations/finance costs times times
10) Gearing Ratio Non-current liabilities/Non- 8.44% 8.91%
current liabilities+ Equity

(c) Using the information provided by these ratios, comment on the financial performance of
Hove plc advising whether Brighton plc should invest in Hove plc or not?

The investment opportunity looks good for Brighton Plc. Hove Plc has a growing Gross
profit margin and operating profit margin which means the profit potential is good. The
slight decrease in ROCE does not look too concerning (some of the assets might not have
started paying off at full potential) considering the good gross and operating margins.

The working capital ratios need improvement if the investment is made as to the trade
receivables, payables and inventories days have increased. It looks like the receivables
credit payment period is 30 days which has increased to 37 days. The nature of the
business needs to be looked into as the payables days it too low.

The current ratio and acid test ratios are strong which suggests strong liquid assets to pay
off current liabilities. Finally, solvency is also strong as the company is low geared (having
low long-term obligations/financing entered into compared to the levels of equity
financing). The strong interest cover ratio means that there are enough operating profits
to cover the interest costs of the company.
Answer to Question b1

(a) (I)

Project A
(GBP)
Capital Investment -160,000
Profit for One year after depreciation 40,000
Adding back depreciation as it’s a non-cash expense 16,000/5=32,000
Profit of one Year adding back depreciation 72,000
Profit for five years 360,000
Net Profit 200,000
The payback period is calculated as time in which initial investment is recovered =initial
investment/profit per year=160000/72000=2.2 years.
More precisely Payback period of project A is almost 2 years and 3 months.

Project B
Year 1 Year 2 Year 3 Year 4 Total
130,00
Sales (GBP) 110,000 0 148,000 151,000 539,000
Material cost (GBP) -40,000 -50,000 -59,000 -60,500 -209,500
Labor cost (GBP) -20,000 -24,000 -27,600 -28,200 -99,800
Fixed cost excluding depreciation (GBP) -10,000 -10,000 -10,000 -10,000 -40,000
Net Profit 40,000 46,000 51,400 52,300 189,700

The payback period in case of unequal profit per year will be calculated as follow
40000 of initial investment is recovered in year one. Year 2 profit is 46000. Profit per month is
46000/12=3833x10.5months=40246.5
The total Initial investment is 80000 so its recovery will recover in almost 1 year 10.5 months.
More Precisely its 1 year 10 Months

(a)(II)
As per the above figures Project B should be chosen as its payback period is less and profit is
more than Project A
(B)(I)

Project B
Profit Amount(GBP) PV at 9% NPV
Year
1(GBP) 40,000 0.917 36,680
Year
2(GBP) 46,000 0.842 38,732
Year
3(GBP) 51,400 0.772 39,680.8
Year
4(GBP) 52,300 0.708 37,028.4
NPV(GBP) 152,121.2

(B)(ii)

NPV of Project B is 152,121.2. So it has positive NPV as the investment required for it is 80,000

The project should be accepted.

(C)

Break-even sales is the number of sales required to cover all costs of a given period
Project B
Year 3
Material cost (GBP) 59,000
Labor cost (GBP) 27,600
Fixed cost excluding depreciation (GBP) 10,000
Total Cost 96,600

In project B total cost for year 3 is 96,600. So break-even point sales for year three should be
GBP 96600

(D)(I)
In marginal cost, we only include direct costs per unit. In the current case its
(59,000+27,600)/700=123.71 GBP per unit

In Absorption costing, we include fixed cost also in the number of units with direct costs.
(59,000+27,600+10,000)/700=138 GBP per unit

(D) (II)
Assuming that budgeted and sold units at the year-end are the same both costing methods will
give the same profit. In marginal cost profit full fixed cost is written off in that period while in
absorption costing fixed costing is absorbed in units and carry forward to next year in case all
produced units are not sold.

D (III)
If production units exceed sales units then the profit for absorption costing method will be
higher than marginal cost because In marginal cost profit full fixed cost written off in that
period while in absorption costing fixed costing is absorbed in units and carry forward to next
year in case all produced units not sold.
Answer to Question B2 (A)

Cash paid Cash Cash

Cash in for Paid in paid for Cash Plant Cash in Net
Sales(0 materials(0 Wages(0 Rent(0 Overhead(0 Payment(0 bank(0 Total(0
Month 00) 00) 00) 00) 00) 00) 00) 00)
Septem
ber 28,500 0 -13,000 -3,000 -2,000 10,500
October 72,750 -50,000 -17,000 -2,000 3,000 6,750
Novemb
er 92,500 -60,000 -21,000 -2,000 -60,000 -50,500
Decemb -
er 83,250 -30,000 -12,000 -3,000 -2,000 -145,000 108,750
January 73,000 -30,000 -14,000 -2,000 27,000
Februar
y 87,500 -70,000 -13,000 -2,000 2,500
March 92,750 -80,000 -14,000 -3,000 -2,000 -25,000 -31,250
-
Total 530,250 -320,000 -104,000 -9,000 -14,000 -230,000 3,000 143,750

Notes
For cash in Sales, each month sales is divided in half and then 5% discount is deducted from it
Like for September =60,000,000/2x0.95=28,500,000

October month cash on sales is recorded in the same method with 30,000,000 cash from sales
added from September
90,000,000/2x0.95=42,750,000+30,000,000 from September=72,750,000
rest of months will follow the same procedure

(B)
As per the cash flow table mentioned above, Amna plc will not face any problem in September
and October as the business is showing positive cash flows
However, the problem will arise for her in November when she needs to make Payment for the
plant. It's 60 million in November, 145million in December, and 25million in March. These are
capital expenses so it needs to be financed through bank loans so it does disturb company
regular cash flows.

Again cash flows for January and February are positive as there is no capital expense. Overall
company cash flow can be managed if Amna PLC finds a way to outsource its capital expense
through a bank loan. Another thing that can be followed is that Amna plc can increase its
vendor credit days so its cash outflow reduces. One more suggestion is to reduce credit terms
with customers in this case company can collect cash in the same month the sale is made. Thus
improving overall cash flow. Combing the effects of bank loans, vendor's credit day increase
and customer credit day’s reduction can help Amna PLC to tackle its cash flow problem, and
then the company can survive. Another option for Amna PLC is to lease out its production
plants. Doing this will cause lesser cash outflows for the company.