Week 8b:Financial Statement Analysis & PerformanceExercises

The following ratios were given for 2 similar businesses:Which firm has a stronger financial position?

Zaitun TradingChantra TradingInventory turnover ratio6 times8 timesCurrent ratio2 times3 timesGross profit margin30%40%Net profit margin15%10%

Activity:Chantra has a higher inventory turnover ratio. Inventory is sold/replaced more times than Zaitun.Liquidity:Chantra is more liquid than Zaitun.Profitability:Chantra has a higher gross profit margin makes more profit per sale. However, on a net profit basis (after deducting all expenses), Zaitun has a higher margin.

Orchid PalaceIncome Statement for the year ended 31.12.2012

Sales2,500,600Less: Sales returns(35,000)2,465,600Opening inventory550,000Add: Purchases1,100,000Add: Transportation inwards100,000Less: Purchases returns(80,000)Less: Closing inventory(380,700)Cost of goods sold1,289,300Gross profit1,176,300

Orchid PalaceIncome Statement for the year ended 31.12.2012 (Contd.)All sales were on credit basis.

Salesmen salaries160,000Distribution expenses128,000Electricity & water20,000Administrative expenses97,000Depreciation of equipment25,000Depreciation of land & buildings50,000Marketing expenses85,000Consultancy expenses100,000Salaries & wages expense350,0001,015,000Interest expense(10,000)Net profit 151,300

Orchid PalaceBalance Sheet as at 31.12.2012

Non-current assetsLong-term liabilitiesLand & buildings1,700,000Bank loan1,000,000Less: Provision for depreciation(380,000)1,480,000

Equipment850,000Current liabilitiesLess: Provision for depreciation(250,000)500,000Accounts payable569,0001,980,000Current assetsOwners equityInventory380,700Capital1,371,300Accounts receivable360,000Bank & cash219,600960,300Total assets2,940,300Total liabilities & owners equity2,940,300

Calculate the following ratios for Orchid Palace:Current ratioQuick ratioInventory turnover ratioNumber of days sales in receivablesNon-current assets turnover ratioTotal assets turnover ratioDebt ratioTimes interest earned ratioDebt to equity ratioGross profit marginNet profit marginReturn on assets ratio

Liquidity ratios:Current ratio= Current assets/Current liabilities= 960,300/569,000= 1.69

Quick ratio= (Current assets Inventory Prepayments)/Current liabilities= (960,300 380,700)/569,000= 1.02 * Note that both CR & QR are > 1. Generally, this means that the firm is moderately liquid.

Activity ratios:Inventory turnover ratio= Cost of goods sold/Average inventory= 1,289,300/(0.5 X [550,000 + 380,700])= 1,289,300/465,350= 2.77

Number of days sales in receivables= Average accounts receivable/Average daily sales= 360,000/2,465,600 X 365 days= 53.29 days

*Take accounts receivable @ 31.12.2012 as the average.

Activity ratios (Contd.):Non-current assets turnover ratio= Net sales/Non-current assets (net)= 2,465,600/1,980,000= 1.25

Total assets turnover ratio= Net sales/Average total assets= 2,465,600/2,940,300= 0.84

*Average total assets => use total assets @ 31.12.2012

Gearing ratios:Debt ratio= Total liabilities/Total assets X 100= (1,000,000 + 569,000)/2,940,300 X 100= 53.36%

Times interest earned ratio= Net profit/Interest expense= 151,300/10,000= 15.13 times

Debt to equity ratio= Long term debt/Owners equity= 1,000,000/1,371,300= 0.73

Profitability ratios:Gross profit margin= Gross profit/net sales X 100= 1,176,300/2,465,600 X 100= 48%

Net profit margin= Net profit/net sales X 100= 151,300/2,465,600 X 100= 6%

Return on assets ratio= Net profit after tax/Total assets X 100= 151,300/2,940,300 X 100= 5%* Since there is no tax, take net profit after tax = net profit.