Tutorial 3

Analysis & Interpretation of Financial Statement

Suggested Answer

Question 1

Woodpeckers Bhd.

YE 31/3/18 YE 31/3/17

Increase in revenue
= 7,520 - 5,730 x 100%
5,730
= 31.24 %

(1
) Return on capital employed
= NP x 100%
CE
= 7,520 - 3,150 - 2,640 x 100%
24,260
= 7.13 % 9.53%

(2
) Gross profit margin
= GP x 100%
Revenue
= 7,520 - 3,150 x 100%
7,520
= 58.11 % 47.14%

(3
) Net profit margin
= Net profit x 100%
Revenue
= 1,730 x 100%
7,520
= 23.01 % 28.51%

(4
) Current ratio
= Current assets
Current liabilities
= 13,230
9,450
= 1.40 :1 1.12 : 1
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Analysis of financial performance and working capital of Woodpeckers for the year
ended 31/3/18

The expansion of the operations of Woodpeckers has resulted in more than 31.24% increase
in revenue, this showed that the launch of the new drug is very successful in capturing the
market share of new customers.

The return on capital employed of Woodpeckers however has deteriorated by 1.76%, this
mainly contributed by the huge investment in the highly sophisticated equipment invested by
the company in order to manufacture the new drugs. These investment costs incurred required
a substantial number of years to recover through the sales of the drugs.

With significant increase in the gross profit margin by 10.97%, it proved that the new drugs
extracted a very high profit margin as compared with other existing products produced by
Woodpeckers. The main reason might be the new drug is a very demanding product among
the patients and it has been proven very successful in combating the patients’ diabetes
successfully.

Although the gross profit margin is high, the net profit margin of Woodpeckers is lower this
year by 5.5% as compared with previous year. The main reason might be there are substantial
marketing cost being incurred in order to promote the new products to the markets, which
subsequently diluted the increase in the gross profit. On top of that, it might be the company
paid a higher amount of sales commissions to the sales personnel in order to increase the
sales of the new drugs.

From the point of view of working capital, the current ratio has increased from 1.86 times to
1.40 times. This might be due to the increase in the closing inventories hold by the company
at end of the year to cater for the increase in the demand of the customers. However, the
decrease in the current ratio might also due to increase in the trade receivables for which
Woodpeckers might have given extended credit terms to the customers on their debt
settlements in order to increase the sales of the company. However, by delay in the debt
collections, Woodpeckers might have liquidity problem and running out of cash to settle their
payable within the credit terms granted and thus increased the balance of current liabilities at
end of the year. Woodpeckers might facing short-term liquidity problem in foreseeable future
and the company need to look into other mode of financing.
[Total: 10 marks]

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Question 2

(a) Banyan Bhd.

(i)

Gross profit margin = Gross profit x 100%

Turnover
= 412,500 - 216,300 + 37,400 - 32,500 - 45,800 + 51,200 x 100%
412,500
= 206,500 x 100%
412,500
= 50.06%

(ii)
The changes in the inventory valuation of Banyan Bhd. from FIFO to WA method is
considered as a change in the accounting policy in accordance with IAS 8 / MFRS 108
Accounting Policies, Changes in Accounting Estimates and Errors.

The is a retrospective accounting adjustment and Banyan is required to adjust the opening
balance of each affected components of equity for the earliest period as if the accounting
policies have been always applied.

Banyan need to restate the closing inventory amount for the year ended 31 October 2021 by
increase the closing inventory and consequently reduce the cost of sales by RM5.4 million
(RM45.8 million – 51.2 million) in the SOPL and increase the corresponding closing
inventory in the SOFP by the same amount.

Journal entry:
DR CR
RM’000 RM’000
Inventory (BS) 5,400
Inventory (IS) 5,400

(Restated closing inventory as at 31/12/21)

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(b) Nobu Bhd.

(i) Gearing ratio = Prior charged capital x 100%

CE
145,800 + 18,100 + 24,400 x 100%
465,300 + 175,300 + 24,400
= 188,300
665,000
= 28.32%

(ii)
By extending the repayment period of the short-term loan, Nobu’s current ratio will be
improved

The set back is the gearing ratio will be increased and in future, the company might have
difficulty to secure for new external loans and the company is considered as a high-risk rating
company.

Such an extension of repayment terms might cum with an increase in the interest rate charged
by the bank and this have a long- term impact on Nabu’s interest cover ratio.

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Question 3

BlueberryCake Bhd.

(a) Computation of ratios

2018 2017
(i) ROCE
PBIT x 100% 1,870 x 100% 3,380 x 100%
CE 23,440 19,900
= 7.98% = 16.98%

(ii) Gross profit margin

GP x 100% 11,810 x 100% 14,260 x 100%
Sales 19,450 22,480
= 60.72% = 63.43%

(iii) Net profit margin

PBIT x 100% 1,870 x 100% 3,380 x 100%
Sales 19,450 22,480
= 9.61% = 15.04%

(iv) Asset turnover

Sales 19,450 22,480
CE 23,440 19,900
= 0.83 x = 1.13 x

(v) Current ratio

Current assets 3,950 2,650
Current liabilities 4,050 990
= 0.98 x = 2.68 x

(vi) Quick ratio

Current assets - Inventory 3,370 2,310
Current liabilities 4,050 990
= 0.83 x = 2.33 x

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(vii) Inventory holding period
Inventory x 365 days 580 x 365 days 340
Cost of sales 7,640 8,220
= 27.71 days = 15.10 days

(viii) Receivable collection period

Receivable x 365 days 1,540 x 365 days 940

Sales 19,450 22,480

= 28.90 days = 15.26 days

(ix) Payable payment period

Trade payable x 365 days 2,110 x 365 days 740
Cost of sales 7,640 8,220
= 100.80 days = 32.86 days

(x) Gearing ratio

Prior charged capital x 100% 3,530 x 100% 2,900 x 100%

CE 23,440 19,900
= 15.06% = 14.57%

(xi) Interest cover

PBIT 1,870 3,380
Interest 950 520
= 1.97 x = 6.50 x

(xii) Earnings per share

PAT 670 2,620

No. of ordinary shares 11,380 10,500

= 5.89 sen = 24.95 Sen

(13) PE ratio
Share price 113 215
EPS 5.9 25.0
= 19.19 x = 8.62 X

(13 marks)
(Alternative formulae use are acceptable)

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(b)

Analysis of BlueberryCake Bhd.’s company financial performance and position:

Profitability and return

The profitability of BlueberryCake has reduced dramatically over the last one year, from a
Return on Capital Employed (ROCE) of 16.98% in 2017 to 7.98% in 2018.

The ROCE has been affected by drop in asset turnover from 1.13 time to 0.83 time (that is,
fewer sales being generated due to competitive market) and a dramatic drop in profit margin.
The decline in profit margin (from 15.04% in 2017 to 9.61% in 2018) could well be caused
by the high levels of fixed costs. Sales have fallen but BlueberryCake has not been able to
reduce its costs, especially ‘other operating costs’, in proportion.

Unless the firm can find a way of converting some of its fixed costs (such as salaries and
rent) into variable costs, to reduce its operating gearing, the chances of BlueberryCake
remaining profitable in 2019 are slim.

Short-term liquidity

Both the current ratio and quick ratio of BlueberryCake are below 1 in 2018, it shows that the
company have short-term liquidity to settle its debt when fall due, especially the 3.5%
redeemable preference shares which will be due in December 2018. The company need to
consider now how to finance the repayment of such debt as soon as possible.

Management efficiency ratio

The inventory holding period has increased slightly in 2018 from 15 days to 24 days, this
might be due to some of the unpopular products are not saleable. It is not surprising that with
low sales, inventories are increasing. However, for bakery shops, most of the inventories are
likely to be perishable items, for example, breads, cakes and pastries etc except for cookies
which still can be consume for more than one month, so there may be a need to write off
some of the inventory if this situation continues, and this will further reducing the
profitability of the company.

The receivables collection period have increased from 15.26 days to 28.9 days, this might be
due to increase in the number of customers who paid via credit cards and it delay the cash
collection by the company.

The payables payment period has increased dramatically, from 33 days in 2017 to 59 days in
2018. BlueberryCake is clearly paying its suppliers much slower than in the past. The
company is running the risk of upsetting suppliers by delaying in their payment. Standard
terms of credit in most industries are 30 days, so although BlueberryCake is currently
benefiting from the credit which the suppliers are involuntarily supplying, there is a risk that
supplier relationships may be close to breakdown.

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Long-term liquidity

The balance sheet gearing position has not changed significantly in the last one year for
which it increased slightly from 14.57% to 15.06%. This is mainly due to the 3.5%
redeemable preference shares have been reclassified from non-current liabilities to current
liabilities. However, BlueberryCake in fact have increased its long-term borrowing
significantly by 127% [(3,530-1,550)/1,550] in 2018. The proceeds from the loan are mainly
for purchase of new kitchen equipment.

The interest cover has dropped alarmingly from 6.5 times in 2017 to 1.97 times in 2018. This
has happened because of the drop in profitability identified above. If the BlueberryCake’s
sales continue to drop, and some of the inventory has to be written off, the interest cover
could drop below 1 in future.

In conclusion, despite the alarming drop in interest cover, the large amount of cash on the
balance sheet, BlueberryCake does not have a problem with its gearing at the moment.

Shareholders’ investment ratios

The huge rise in P/E ratio in 2018 appears to be a blip caused by the extremely low
profitability (earnings per share) in that year. In general, the stock market information makes
grim reading for BlueberryCake.

The share price has dropped by 90% over the last one year (from RM2.15 to RM1.13) which
means that BlueberryCake’s shares have significantly under-performed the market. Also,
because of this drop in share price, and the fact that BlueberryCake has paid no dividends, the
overall shareholder return from Blueberry’s shares has been negative.

Given the current lack of profitability, and the fear that profitability might deteriorate in
future, it is likely that the BlueberryCake share price will continue to drop in the near future.

BlueberryCake has not paid a dividend recently, so dividend yield is zero and dividend cover
cannot be computed. Also, a declining share price coupled with no dividends paid out mean
that there has been a negative shareholder return.

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(c)
Conclusion and recommendations

The main areas of concern regarding BlueberryCake’s current position are:

1. Low profitability, partly caused by stiff competition in the market

2. High levels of cash, making BlueberryCake an attractive takeover target,

3. Poor management of working capital, and the risk that supplier relationships might be
strained.

BlueberryCake needs to address these issues quickly if it is to escape the downward spiral
towards corporate failure. In particular, the key recommendations are:

1. A broader product range should help to stabilise BlueberryCake’s sales and

profitability. BlueberryCake can shift from mass-produced baked goods to
handcrafted specialty products which will attract a higher profit margin and targeting
different market niche. BlueberryCake should also considered to set up a cafes
serving coffee and tea to customers who wish to consume the baked goods in its
premises. The company can also consider to provide additional services for special
occasions (such as weddings, birthday parties, anniversaries, or even business events).

2. Implement a new working capital management policy, working closely with central
kitchen to ensure that inventory levels are better monitored and to reduce wastage of
goods.

3. The company has to consider to raise fund in short-term to repaid its 3.5% redeemable
preference shares which is due for repayment in four-month time via long-term
financing / external borrowing for which its gearing ratio is still very low.