1Question 1

Belt plc and Braces plc were in the same industry. The following information appeared
in their 20X9 accounts:
Belt Braces
Bm Bm
Revenue 200 300
Total operating expenses 180 275
Average total assets during 20X9 150 125
Required:
(a) Calculate the following ratios for each company and show the numerical
relationship between them:
(i) Their rate of return on the average total assets.
(ii) The net profit percentages.
(iii) The ratio of revenue to average total assets.
(b) Comment on the relative performance of the two companies.
(c) State any additional information you would require as:
(i) A potential shareholder.
(ii) A potential loan creditor
The aim is to interrogate the differential performance of the two companies. There is a
temptation to merely comment that a ratio is better or worse than the other. In this
question, it is the differential strengths and weaknesses that need to be highlighted.
(a) Belt Braces
Revenue 200 300
Operating expenses 180 275
Operating profit 20 25
Return on total assets 20/150 × 100 = 13.3% 25/125 × 100 = 20%
Net profit % 20/200 × 100 = 10% 25/300 = 8.3%
Turnover of total assets 200/150 = 1.33 300/125 = 2.4
Numerical relationship:
Rate of return on total assets 10 × 1.33 = 13.3% 8.33 × 2.4 = 20%
(b) Based on these ratios, Braces appears to be performing better with its rate of return
on total assets being 50% higher.
However, looking at the other ratios:
Belt has a marginally better net profit percentage. It would be helpful to learn if this is
due to achieving higher prices or a better control over operating cost.
Braces, on the other hand, achieves a much higher asset utilisation indicating a more
efficient use of the available resources.
(c) In addition to an appraisal such as that above Potential shareholders would enquire:
• How is the operating profit split between equity and loan funding?
• What is the gearing ratio? D/D+E
• What are the P/E ratios?
Potential loan creditors would enquire:
• Is there asset security available?
• What is the interest cover?

(a) Profitability – ROCE

• Camel Ltd is the most profitable of the three companies.
• An inspection of the secondary ratios shows that this is due to efficient utilisation of
assets as its net profit ratio is well below that of the other two companies.
• Examination of gross profit percentages confirms the observation that Camel Ltd
seems a high-volume, low-margin business compared with the others.
Liquidity
• Ali Ltd has a current ratio that is out of line with the other two, being very much
higher, suggesting surplus investment in working capital.
• The acid test ratio reinforces this view and also indicates that Baba Ltd appears to
have a liquidity problem with current liabilities considerably greater than cash and
debtors (despite having the greatest number of weeks’ debtors outstanding of the three
companies).
• Baba Ltd also has considerably more weeks of stock outstanding than the other two
companies which may be linked with the high level of creditors.
• Ali Ltd also has stock levels well in excess of Camel Ltd explaining, in part at least,
the high current ratio.
Dividends
Camel Ltd is paying out a higher proportion of profits in dividends, which may have
the effect of raising shareholder loyalty and the bid price.
Conclusion
• Baba Ltd appears to have considerable liquidity problems arising out of excess
investment in stock.
• Camel Ltd is a lean enterprise which is able to survive on a lower gross profit margin
because of superior asset utilisation. Why is the gross profit margin low?
(b) Why the statement of financial position is unlikely to show the true market
value of the business?
The accounting policy in the United Kingdom is to state fixed assets at cost less
depreciation or at historical cost (HC) modified by revaluation of all or selected
classes of fixed assets.
The true market value of a listed company is available from the market capitalisation
figure based on current share prices.
The true market value of an unquoted company is not readily available and would
require future cash flows to be evaluated
Question 5
You are informed that the non-current assets totalled A350,000, current liabilities
A156,000, the opening retained earnings totalled A103,000, the administration
expenses totalled A92,680 and that the available ratios were the current ratio 1.5, the
acid test ratio 0.75, the trade receivables collection period was six weeks, the gross
profit was 20% and the net assets turned over 1.4 times.
Required:
Prepare the statement of financial position from the above information.
Current assets are 1.5 times the current liabilities = 1.5 × 156,000 = 234,000.
Liquid assets are 0.75 times the current liabilities = 0.75 × 156,000 = 117,000.
Inventory is current assets less liquid assets = 234,000 – 117,000 = 117,000.
The net assets are total assets less current liabilities = 584,000 – 156,000 = 428,000.
Sales are 1.4 times net assets = 1.4 × 428,000 = 599,200.
Trade receivables have a 6-week collection period = 6 × 599,200/52 = 69,138.46
Cash is liquid assets – trade receivables = 117,000 − 69,138.46 = 47,861.54
Gross profit is 20% of 599,200 = 119,840
Net profit is gross profit less administration expenses = 119,840 – 92,680 = 27,160
Opening capital is net assets – retained earnings = 428,000 – (103,000 + 27,160) =
297,840

Statement of financial position

Non-current assets 350,000
Current assets Inventory 117,000
Trade receivables 69,138.46
Cash 47,861.54
234,000
Total assets 584,000

Current liabilities 156,000

Capital 297,840
RE (103,000 + 27,160) 130,160
Total L+E 584,000
Question 11
Chelsea plc has embarked on a programme of growth through acquisitions and has
identified Kensington Ltd and Wimbledon Ltd as companies in the same industrial
sector, as potential targets. Using recent financial statements of both Kensington and
Wimbledon and further information obtained from a trade association, Chelsea plc has
managed to build up the following comparability table:
Kensington Wimbledon Industrial average
Profitability ratios
ROCE before tax % 22 28 20
Return on equity % 18 22 15
Net profit margin % 11 5 7
Gross profit ratio % 25 12 20
Activity ratios
Total assets turnover = times 1.5 4.0 2.5
NCA turnover = times 2.3 12.0 5.1
AR collection period in weeks 8.0 5.1 6.5
Inventoryholding period in weeks 21.0 4.0 13.0
Liquidity ratios Current ratio 1.8 1.7 2.8
Acid test 0.5 0.9 1.3
Debt–equity ratio % 80.0 20.0 65.0
Required:
(a) Prepare a performance report for the two companies for consideration by the
directors of Chelsea plc indicating which of the two companies you consider to be a
better acquisition.
(b) Indicate what further information is needed before a final decision can be made.