Question

You have the following financial statements for two building companies and have been asked to compare them:

Income statements for the year to 31st December 2019

	Potts Ltd	Tony Ltd
	£`000	£`000
Sales	3500	3880
Cost of Sales	(900)	(1000)
Gross Profit	2600	2880
Operating expenses	(560)	(790)
Operating Profit	2040	2090
Interest Payable	(57)	(76)
Profit Before Taxation	1983	2014
Taxation	(80)	(68)
Profit After Taxation	1903	1946
Dividends	(35)	(42)
Retained Profits	1868	1904

Statements of financial position as at 31st December 2019

	Potts Ltd	Tony Ltd
	£`000	£`000
Non-current assets	3,056	3,768
Current assets
Inventories	350	245
Trade receivables	270	257
Cash at bank	120	80
Less: Current liabilities
Trade payables	(70)	(65)
Taxation	(68)	(42)
Non current liabilities
Long-term loan	(800)	(1000)
Net assets	2,858	3,243
Shareholders' funds
£1 ordinary shares	700	800
Retained earnings	2,158	2,443
	2,858	3,243

Additional information:

• All purchases and sales were on credit”

Required:

1. Calculate the following ratios for each company.

1. Pre-tax Return on Equity (use total shareholders’ funds as your denominator)
2. Operating profit margin
3. Net profit (before tax) margin
4. Trade receivable (debtor) period in days
5. Current ratio
6. Acid test ratio (Quick ratio)
7. Gearing ratio (use debt + equity as your denominator)
8. Interest cover
9. Dividend cover
10. Dividend per share (in pence)

[30 marks]

2. “Amy Ltd supplies, installs and maintains burglar alarms systems for business clients. The accountant has provided a horizontal analysis and is concerned about the firm's performance.”

Amy Ltd: comparison to previous year
	2017	2018	2019
Accounts receivable	1.20%	8.2%	7.4%
Inventory	8.4%	1.7%	4.9%
Sales	-3.0%	1.2%	5.4%
Non-current assets	2.3%	4.8%	7.6%
Borrowings	3%	9.8%	19.8%

Required: provide a brief report on the results of the analysis? Comments should include any concerns you may have.

(Maximum word count: 100)

Answer 1

i. Pre-tax Return on Equity (use total shareholders’ funds as your denominator)
Formula :	Pre tax Income
	Shareholder's Equity
	Potts Ltd	Tony Ltd
Profit Before Taxation	1983	2014
Shareholder's Equity	2,858	3,243
Pre - tax Return on Equity =	0.693842	0.62103

ii. Operating profit margin
Formula :	Operating Profit
	Net sales
	Potts Ltd	Tony Ltd
Operating Profit	2,040.00	2,090.00
Sales	3,500.00	3,880.00
Operating Profit Margin =	0.58	0.54
iii. Net profit (before tax) margin
Formula :	Net profit before tax
	Net sales
	Potts Ltd	Tony Ltd
Profit Before Taxation	1,983.00	2,014.00
Sales	3,500.00	3,880.00
Net profit (before tax) margin =	0.57	0.52
iv. Trade receivable (debtor) period in days
Formula :	Trade Receivable
	Credit sales
	Potts Ltd	Tony Ltd
Trade receivables	270.00	257.00
Sales	3,500.00	3,880.00
Trade receivable (debtor) period in days =	28.16	24.18
v. Current ratio
Formula :	Current asset
	Current Liability
	Potts Ltd	Tony Ltd
Quick assets	390.00	337.00
Current Liability	138.00	107.00
Current ratio =	2.83	3.15
vi. Acid test ratio (Quick ratio)
Formula :	Current asset - Inventory
	Current Liability
	Potts Ltd	Tony Ltd
Current assets	740.00	582.00
Current Liability	138.00	107.00
Quick ratio =	5.36	5.44
vii. Gearing ratio (use debt + equity as your denominator)
Formula :	Debt
	Debt + Equity
	Potts Ltd	Tony Ltd
Debt	800.00	1,000.00
Equity	2,858.00	3,243.00
Gearing ratio =	0.22	0.24
viii. Interest cover
Formula :	Earning before interest
	Interest
	Potts Ltd	Tony Ltd
EBIT	2,040.00	2,090.00
Interest Payable	57.00	76.00
Interest Cover ratio =	35.79	27.50
ix. Dividend cover
Formula :	Net Income
	Dividend
	Potts Ltd	Tony Ltd
Profit After Taxation	1,903.00	1,946.00
Dividends	35.00	42.00
Dividend Cover ratio =	54.37	46.33
x. Dividend per share (in pence)
Formula :	Dividend
	Number of share
	Potts Ltd	Tony Ltd
Dividends	35.00	42.00
Number of shares	700.00	800.00
Dividend per share =	0.05	0.05

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