Question

The following information has been extracted from the financial statements of YDI Limited: Extract of Statement of Comprehensive Income for the year ended 31 December 2019 2018 R R Sales 2 000 000 1 600 000 Cost of sales 940 000 800 000 Operating profit 600 000 520 000 Profit before tax 520 000 450 000 Profit after tax 364 000 315 000 Extract of Statement of Financial Position as at 31 December Assets 2019 2018 R R Non-current assets 2 000 000 1 400 000 Inventories 600 000 800 000 Accounts receivable 400 000 400 000 Cash and cash equivalents 2 000 2 000 3 002 000 2 602 000 R R Equity and liabilities Shareholders’ equity 2 000 000 1 500 000 Long-term loan 700 000 800 000 Accounts payable 182 000 142 000 Bank overdraft 120 000 160 000 3 002 000 2 602 000

Note: 1. All purchases and sales of inventories are on credit. 2. Dividends paid during the year amounted to R218 400. 3. The issued share capital consisted of 500 000 ordinary shares. Required:

5.1 Calculate the following ratios for the year ended December 2019. Where applicable, round off answers to two decimal places.

5.1.1 Operating margin (2)

5.1.2 Debtors collection period (2)

5.1.3 Acid test ratio (2)

5.1.4 Return on equity (2)

5.1.5 Debt to equity (2)

5.1.6 Earnings retention ratio (2)

5.2 Earnings per share (2) 5.2 Suggest two (2) ways in which YDI Limited can improve on its collections from debtors. (2)

5.3 Comment on the current ratio which dropped from 3.98:1 in 2018 to 3.32:1 in 2019. (2)

5.4 Recommend two (2) ways in which YDI Limited can improve its profitability. (2)

Answer 1

Operating margin = Operating profit / Sales * 100 = 600,000 / 2,000,000 * 100 = 30 %

Debtors collection period = ( 365 / Sales ) * Average Accounts Receivable = ( 365 / 2,000,000) * 400,000 = 73 days

Acid test ratio = ( Cash + Accounts Receivable ) / Accounts Payable = ( 2,000 + 400,000 ) / 182,000 = 2.21 : 1

Return on Equity = Profit After Tax / Average Shareholders Equity = 364,000 / 1,750,000 * 100 = 20.8 %

Debt to Equity = Total Liabilities / Shareholders Equity = 1,002,000 / 2,000,000 = 0.501 or 50.1 %

Earnings retention ratio = ( Profit after tax - Dividends) / Profit after tax = ( 364,000 - 218,400 ) / 364,000 * 100 = 40 %

Earnings per share = Profit After Tax / Ordinary Shares Outstanding = 364,000 / 500,000 = R 0.73 per share

Two ways of improving collection from debtors:

• Making an offer of early payment discount to debtors
• Charging interest on outstanding debt

Current ratio has dropped mainly because inventories have dropped from 800,000 to 600,000 from 2018 to 2019. Current ratio can be improved by improving collection from debtors, and by repaying the bank overdraft.

Two ways for improving profitability:

• Better control on operating expenses
• Increasing selling price if the firm has pricing power.
• Improving asset turnover