Assignment No 1 - POF

Topics: Financial Statement Analysis & Time Value of Money

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Q No 1: The Balance Sheet of LZC Ltd at the end of the year as under:-

EQUITIES AMOUNTS ASSETS AMOUNTS

Equity Share Capital(Rs.100 par) Rs.1,000,000 Plant & Equipment Rs.640,000

Retained Earnings 368,000 Land & Building 80,000

Sundry Creditors 104,000 Cash/Bank 260,000

Bills P/A 200,000 Marketable Securities 150,000

Other Current Liabilities 20,000 Notes Receivable 200,000

Long Term Loans 200,000 Sundry Debtors 440,000

(40,000)
Bonds P/A 300,000 Less:-Allow for B/D

80,000 Account Receivable 400,000

Inventory 530,000

Prepaid Insurance 12,000

2,272,000 TOTAL 22,72,000

Statement of Profit & Loss for the year ended:-

Sales (All on Credit) Rs.4,000,000

Less: Cost of Goods Sold (3,080,000)

Gross Profit 920,000

Less:- Operating Expenses (680,000)

Net Profit 240,000

Less 30% Income Tax (72,000)

Net Profit After Tax 168,000

Sundry Debtors, Sundry Creditors and Stock at the beginning of the year were Rs.300,000, 500,000 and
400,000 respectively. Credit Purchases during the year were Rs.3, 000,000.

REQUIRED: -a) use vertical analysis and interpret light Zone financial strength

The vertical analysis for the company

Assets Amount %
Plant and Equipment 640,000 28.17%
Land & Building 80,000 3.52%
Cash/Bank 260,000 11.44%
Marketable securities 150,000 6.60%
Notes receivable 200,000 8.80%
Account receivable 400,000 17.61%
Inventory 530,000 23.33%
Prepaid insurance 12,000 0.53%
Total 2,272,000 100.00%
Equity share capital 1,000,000 44.01%
Retained earnings 368,000 16.20%
Sundry creditors 104,000 4.58%
Bills P/A 200,000 8.80%
Other current liabilities 20,000 0.88%
Long term loans 200,000 8.80%
Bonds P/A 300,000 13.20%
80,000 3.52%
Total 2,272,000 100.00%

From the vertical analysis, we draw the following conclusions:

1. The company's fixed asset constitute 28.17%+3.52% = 31.69% of total assets and hence the
current assets of the company is 68.31% of total assets. The company's current liabilities
constitute 4.58%+8.80%+0.88% = 14.26% of total assets. Hence, we can conclude that the net
working capital of the company is very high and the company has higher proportion of cash
balance than the proportion of sundry creditors. This considerably reduces the liquidity risk of
the company.

2. The company's long term liability constitutes 8.80%+13.20%+3.52%= 25.53% of total assets
and this proportion of long-term liabilities is well covered by the proportion of fixed assets
which stands at 31.69%.

3. The proportion of total equity is 44.01%+16.20% = 60.21% and is higher than the proportion
of long-term liabilities of 25.53%. Hence the company has low financial leverage.
4. Overall the company's financial position is strong with high proportion of net working capital
and low financial leverage. The high net working capital can also indicate that the company is
paying its supplier much faster than the time taken to generate cash from sale of inventory.

b) Calculate and interpret the following ratios.

1) Debtors Turnover in Times

Debtor turnover in times = Credit sales/Average debtors

Credit sales = 4000000

Average debtors = (Beginning debtors+Ending debtors)/2 = (300000+400000)/2 =

350000

Therefore, debtor turnover in times = 4000000/350000 = 11.43

So in a year, the company collects its receivables from customers 11.43 times

ii) Average collection period/Debtors Turnover (in days)

Average collection period/Debtors Turnover (in days) = Number of days in 1

year/debtor turnover in times

Assuminh 1 year = 365 days, average collection period/Debtors Turnover (in

days) = 365/11.43 = 32 days (rounded to nearest integer)

The company takes 32 days on average in a year to collect cash for its credit sales

(iii) Stock turn over in times

Stock turnover in times = Cost of goods sold/Average inventory

Cost of goods sold = 3080000

Average inventory = (Beginning inventory+Ending inventory)/2 = (400000+530000)/2 = 465000

Therefore, stock turnover in times = 3080000/465000 = 6.62

The company sells its inventory at an average rate of 6.62 times in a year

V) Current Ratio

Current Ratio = Total current assets/Total current liabilities

Total current assets = Cash+marketable securities+Notes receivable+Accounts
receivable+Inventory+prepaid insurance = 260000+150000+200000+400000+530000+12000 =
1552000

Total current liabilities = Sundry cerditors+Bills P/A + Other current liabilities =

104000+200000+20000 = 324000

Therefore, current ratio = 1552000/324000 = 4.79

The current ratio indicates the liquidity position of the company. A current ratio of 4.79 times
means that the current assets of the company are more than 4 times its short term obligations

vii) Quick Ratio

Quick ratio = (Cash+marketable securities+Notes receivable+Accounts receivable)/Total current

liabilities = (260000+150000+200000+400000)/324000 = 3.12

The quick ratio indicates the position of liquid assets of a company and a artio of 3.12 shows that
its short term obligations are completely covered by its liquid assets

vii) Gross Profit Percentage

Gross Profit Percentage = Gross profit/Sales = 920000/4000000 = 23.00%

This is a measure of the company's efficiency in generating gross profit from sales. A higher
gross profit percentage impels the company's efficiency in managing its cost is better.

viii) Net Profit Percentage

Net Profit Percentage = Net profit after tax/Sales = 168000/4000000 = 4.20%

This is a measure of the company's performance and efficiency in generating net profit from
sales. .

ix) Return on Equity

Return on equity = Net profit after tax/Total equity = 168000/(1000000+368000) = 12.28%

This is a measure of the company's profitability and indicates the company's management's
performance. A higher return on equity means the company is generating more profit from its
equity investment.

xii) Total Assets Turnover

Total Assets Turnover = Sales/Total assets = 4000000/2272000 = 1.76

This is a measure of the company's efficiency and indicates the company's asset performance. A
higher asset turnover means the company is generating more sales from its assets.

x) Du Pont Ratio

Du Pont Ratio = Net Profit Percentage*Total Assets Turnover*Equity multiplier

Net Profit Percentage and Total Assets Turnover are already calculated above.

Equity multiplier = Total assets/Total equity = 2272000/(1000000+368000) = 1.66

Therefore, Du Pont Ratio = 4.20%*1.76*1.66 = 12.28%

Du Pont ratio segregates the return on equity into three components, which are net profit
percentage, total assets turnover and equity multiplier. As each of these components, improves
the company's profitability becomes better.