Chapter8S - Financial accounting for decision makers(5th...

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Unformatted text preview: Financial accounting for decision makers (5th edition) Atrill and McLaney Exercise solution Chapter 8 SeaSwift plc The ratios for 2008 are as follows Return on capital employed Operating profit/ equity plus non­current liabilities = 135/(409 + 300) (x 100%) = 19.0% Return shareholders’ funds Profit for the year/equity = 78/409 (x 100%) = 19.1% Gross profit margin Gross profit/sales revenue = 359/837 (x 100%) = 42.9% Operating profit margin Operating profit/sales revenue = 135/837 (x 100%) = 16.1% Sales revenue to capital employed Sales revenue/equity plus non­current liabilities = 837/(409 + 300) = 1.18 times Inventories holding period Inventories held/ inventories used = 43/253 (x 365) = 62.0 days [Note: SeaSwift plc makes yachts to order and therefore has no inventories of finished goods. It has been assumed that all the inventories at the year end is raw materials (rather than work in progress).] 1 Financial accounting for decision makers (5th edition) Atrill and McLaney Exercise solution Trade receivables collection period Trade receivables/Sales revenue = 96/837 (x 365) = 41.9 days (Assuming that all of the business’s sales are on credit.) Trade payables collection period Trade payables/purchases = 45/255 (x 365) = 64.4 days (Assuming that all of the purchases are on credit and that the trade payables relate only to purchases of raw materials inventories.) Current ratio Current assets/current liabilities = 176/90 = 1.96 : 1 Acid test (or quick assets) ratio Current assets, excluding inventories/current liabilities = (176 – 43)/90 = 1.48 : 1 Gearing ratio Borrowings/(equity plus borrowings) = 300/(409 + 300) (x100%) = 42.3% Interest cover ratio Operating profit/interest payable = 135/30 = 4.5 times Earnings per share Profit for the year/number of ordinary shares = £78 million/200 million = £0.39 2 Financial accounting for decision makers (5th edition) Atrill and McLaney Exercise solution Price/earnings ratio Current market price per share/earnings per share = £5.10/£0.39 = 13.1 times Dividend yield ratio Dividend per share (grossed up for tax)/ current market price per share = [(£20 million/200 million) x 100/90]/5.10 (x 100%) = 2.2% Dividend cover ratio Profit for the year/total dividend = 78/20 = 3.9 times We can tabulate the two years’ results as fo llows 2007 Profitability ratios Return on capital emplo yed (%) Return on ordinary shareho lders’ funds (%) Gross profit margin (%) Operating profit margin (%) Activity ratios Sales revenue to capital emplo yed (times) Inventories ho lding period (days) Trade receivables collection period (days) Trade payables co llect ion period (days) Liquidity ratios Current 0.99 : 1 1.96 : 1 1.08 78.8 56.2 83.9 1.18 62.0 41.9 64.4 14.9 13.1 43.8 13.8 19.0 19.1 42.9 16.1 2008 3 Financial accounting for decision makers (5th edition) Atrill and McLaney Exercise solution Acid test Gearing ratios Gearing (%) Interest cover (times) Investors’ ratios Earnings per share (£) Price/earnings (times) Dividend yie ld (%) Dividend cover (times) 0.23 15.2 2.4 3.1 0.39 13.1 2.2 3.9 52.4 2.9 42.3 4.5 0.73 : 1 1.48 : 1 Comment on the ratios In 2008 there was a significant ly higher ratio for return on capital emplo yed than was the case in 2007, which would normally be seen as desirable. This has been achieved mainly through an increased sales revenue to capital emplo yed ratio, which more than overcame thesmall decrease in the gross profit margin. Thus the business was more effect ive at making sales revenues in 2008 than it was in 2007. Operating profit margin rose because of the strong increase in turnover, despite an increase in the amounts spent on operating expenses. Liquidit y improved dramatically fro m a level that was probably an unhealt hy one, to one that would probably be considered fairly strong. This was achieved through the reduction in both the amount of time for which inventories were held and the time taken to collect trade receivables. Credit suppliers (trade payables) were more prompt ly paid in 2008 than they were in 2007. This represents a reduction over the year in the extent to which the business took advantage of the availabilit y o f this 4 Financial accounting for decision makers (5th edition) Atrill and McLaney Exercise solution theoretically cost­free form of finance. This may have been done deliberately wit h a view to improving relat ions with suppliers. Partly through the eliminat ion of the overdraft, and partly as a result of relat ively high ploughed­back profit expanding reserves, the gearing ratio dropped significant ly. The increased profit with no increase in the number of shares issued led directly to an increase in earnings per share. The price/earnings ratio diminished despite a much better profit performance by the business in 2007. This can be explained by the fact that the share price is driven by investors’ expectations of the future of the business. Thus the pr ice in 2007 reflected the future, rather than the 2007 profit, which was used in the calculat ion of that year’s ratio. Generally we have a picture of a business that has significant ly improved in most aspects of its performance and posit ion over the year. It was more profitable, which led to strong cash flows and, therefore, to much better liquidit y and lower capital gearing. 5 ...
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