Question 1

Outback Brewery plc is a brewing company. One of the company's main suppliers of
yeast and hops has recently gone out of business and Outback Brewery plc is now
seeking an alternative and reliable supplier. Two companies have been identified as
potential suppliers. Both of these companies prepare accounts to 31 December each
year and Outback Brewery plc has obtained copies of each company's financial
statements for the year ending 31 December 2010. A summary of these statements is
provided as follows:

Income statements for year ending 31 December 2010

Oliver Ramsey
Ltd Ltd
£000 £000
Revenue 5,720 6,310
Cost of sales (3,840) (4,240)
Gross profit 1,880 2,070
Operating expenses (760) (1,080)
Operating profit before interest 1,120 990
Interest payable (50) (350)
Profit before taxation 1,070 640
Taxation (320) (210)
Profit after taxation 750 430

Continued
Statements of financial position at 31 December 2010

Oliver Ramsey Ltd

Ltd
£000 £000 £000 £000
Non-current assets 4,570 6,330
Current assets
Inventories 510 890
Trade receivables 670 1,090
Bank balance 340 -
1,520 1,980
Current liabilities
Trade payables 450 1,130
Other payables 320 210
Bank balance - 440
770 1,780
Net current assets 750 200
5,320 6,530
Non-current liabilities
Loan 500 3,500
4,820 3,030

Share capital 2,000 2,000

Retained earnings 2,820 1,030
4,820 3,030

 Requirement
(a) For Oliver Ltd and Ramsey Ltd calculate three profitability ratios, two liquidity /
efficiency ratios, and any other two relevant ratios which may be used to analyse
the performance of these companies. (14 marks)

Continued
(b) Comment briefly on the results of your calculations from (a), and make a
recommendation to the management of Outback Brewery plc as to which of the two
companies seems likely to be the more reliable supplier. (10 marks)

(c) Identify any limitations in your analysis and state any further information which
should be obtained before a final decision is made. (6 marks)

(Total 30 marks)

Continued
Continued
(a) (Max 14 marks)

Oliver Ltd
Profitability:
ROCE 1,120 ÷ 5,320 x 100 21.1%
Gross profit percentage 1,880 ÷ 5,720 x 100 32.9%
Net profit percentage either 1,120 ÷ 5,720 x 100 19.6%
or 1,070 ÷ 5,720 x 100 18.7%
1 mark
or 750 ÷ 5,720 x 100 13.1%
for
Liquidity:
each
Current ratio 1,520 ÷ 770 1.97
correct
Quick assets ratio 1,010 ÷ 770 1.31
ratio
Efficiency:
(max 7
Inventory holding period 510 ÷ 3,840 x 365 48 days
marks)
Trade receivables collection period 670 ÷ 5,720 x 365 43 days
Trade payables payment period 450 ÷ 3,840 x 365 43 days
Capital structure:
Capital gearing ratio 500 ÷ 5,320 x 100 9.4%

Ramsey
Ltd
Profitability:
ROCE 990 ÷ 6,530 x 100 15.2%
Gross profit percentage 2,070 ÷ 6,310 x 100 32.8%
Net profit percentage either 990 ÷ 6,310 x 100 15.7%
or 640 ÷ 6,310 x 100 10.1%
1 mark
or 430 ÷ 6,310 x 100 6.8%
for
Liquidity:
each
Current ratio 1,980 ÷ 1,780 1.1
correct
Quick assets ratio 1,090 ÷ 1,780 0.6
ratio
Efficiency:
(max 7
Inventory holding period 890 ÷ 4,240 x 365 77 days
marks)
Trade receivables collection period 1,090 ÷ 6,310 x 365 63 days
Trade payables payment period 1,130 ÷ 4,240 x 365 97 days
Capital structure:
Capital gearing ratio 3,500 ÷ 6,530 x 100 53.6%

Note:
The trade payables payment period has been calculated with reference to cost of
sales, since the figures for purchases are not available.

Credit will be given for other acceptable ratios that may be offered

Continued
(b) (10 marks)

The main points which should be made are as follows:

Profitability

 Oliver is making a better return on capital.

 Both companies have a similar GPP, perhaps indicating that similar prices are
charged to customers.
 Oliver has a better NPP (whichever method of calculation is used). This
suggests that Oliver has better control over its overheads. Up to 3 marks

Liquidity

 Oliver has better liquidity (as measured by both liquidity ratios).

 Ramsey's quick assets ratio is especially worrying.
 Ramsey has no cash at all and borrowings, whilst Oliver has cash in the bank
and comparatively low borrowings. Up to 2 marks

Efficiency

 Oliver takes a total of 91 days to turn inventories into cash.

 Ramsey takes much longer to turn inventories into cash (140 days) and is
therefore less efficient. However, the company might be deliberately holding
larger stocks and offering longer credit so as to attract customers. This is
beneficial from Western's point of view, so long as it is sustainable in the long
term.
 Ramsey pays its suppliers much later than Oliver. This may be a sign of
efficiency but may also be a sign that Ramsey is struggling to pay its debts
and could find it difficult to obtain credit in future. Up to 3 marks

Gearing

 Oliver is very low-geared.

 Ramsey is comparatively high-geared and may find it difficult to service its
high level of debt and/or to obtain further long-term finance. 1 mark

Conclusion

Oliver is the sounder company. Ramsey might offer larger stocks and more
generous credit terms but Oliver would seem to be the better choice if Outback
Brewery plc is seeking a long-term, reliable source of supply. 1 mark

Continued
(c) (6 marks)

Further information required / Limitations

 financial statements for several previous years (to detect trends)

 year-average figures
 accounting policies for each company
 industry-average ratios
 projections for the future
2 marks for each up to max of 6 marks

Credit given for other relevant comments

Continued