Question

The following information is a condensed version of the financial statements for Enchanting Florist Ltd for the two years ended 30 June 2016 and 30 June 2017.

	30 June 2016	30 June 2017
Sales (all on credit)	550,000	650,000
Cost of goods sold	200,000	280,000
Depreciation	40,000	40,000
Interest	20,000	25,000
Other expenses	100,000	110,000
Total expenses	360,000	455,000
Net profit before tax	190,000	195,000
Income tax	57,000	59,000
Net profit after tax	133,000	136,000

Comparative balance sheets
	30 June 2016		30 June 2017
Current assets		86,000		88,000
Cash on hand	3,000		2,000
Accounts receivable	55,000		51,000
Inventory	28,000		35,000
Non-current assets		410,000		470,000
Property, plant & equipment	400,000		450,000
Intangible assets	10,000		20,000
Total assets		496,000		558,000
Current liabilities		19,000		42,000
Bank overdraft	–		25,000
Accounts payable	19,000		17,000
Non-current liabilities		200,000		200,000
Mortgage loan (10%)	200,000		200,000
Total liabilities		219,000		242,000
Net assets		277,000		316,000
Equity
Ordinary capital ($1.00 shares)	200,000		230,000
Preference capital (10%)	40,000		40,000
Reserves	10,000		10,000
Retained earnings	27,000		36,000
Total Equity		277,000		316,000
Ordinary dividends paid	120,000		123,000
Preference dividends paid	4,000		4,000
Total ordinary equity at 1 July 2011	225,000
Inventory at 1 July 2011	25,000

Market value of ordinary shares

$3.50

$3.75

Calculate the following ratios for each year:

Liquid ratio

Net profit ratio

Times interest cover

Earnings per share

Price Earnings Ratio

Return on equity (shareholder’s funds)

Debtor collection period (turnover rate)

Inventory turnover

Compare and explain the link between the movement in the earnings per share and the price earnings ratio. What may explain the difference in the movement in these two ratios? )

Give two actions that the business may have taken to improve the debtor turnover rate.

Solutions:

Part 1

Ratio	2016	2017
Liquid ratio
Net profit ratio
Times interest cover
Earnings per share

Earnings per share
Price Earnings Ratio
Return on equity (shareholder’s funds)
Debtor collection period (turnover rate)
Inventory turnover

Part 2

Part 3

Answer 1

(1) Workings:

(i) Liquid ratio = Liquid assets/Current liabilities

=(Curent assets - inventory)/Current Liabilities

For 2016 = (86000-28000)/19000= 3.05

For 2017= (88000-35000)/42000= 1.26

(ii) Net profit ratio= [Net profit after tax/Net sales ]* 100

For 2016 = (133000/550000)*100 = 24.18%

For 2017= (136000/650000)*100 = 20.92%

(iii) Times interest cover ratio = EBIT/ Interest expenses

For 2016 = (190000+20000)/20000 = 10.05 times

For 2017 = (195000+25000)/25000= 8.8 times

(iv) Earnings per share= (Net profit - preference dividend)/ Number of shares

For 2016 = (133000-4000)/(200000/1) = $ 0.645

For 2017 = (136000-4000)/(230000/1)= $ 0.573

(v) Price earning ratio = Share price/ EPS

For 2016 = 3.50/0.645 = 5.426

For 2017 = 3.75/ 0.573 = 6.545

(vi) Return on equity = Net profit after tax/ Shareholders equity

For 2016 = 133000/ 200000 = 0.665

For 2017 = 136000/230000 = 0.591

(vii) Debtor collection period = [ Average Debtors / Credit sales] * 365

For 2016 = (55000/ 550000) * 365 = 36.5 days i.e 37 days approx

For 2017 =( [{51000+55000}/2]/650000) * 365 = 29.8 days i.e 30 days approx

The opening recievables for 2016 is not given so i assumed it as zero. Alternatively we can only take closing accounts recievbale and not average recievables for 2017

(viii) Inventory turnover ratio = Cost of goods sold / Average inventory

For 2016 = 200000/28000= 7.14 times

For 2017 = 280000/([28000+35000]/2)= 8.89 times

The opening inventories for 2016 is not given so i assumed it as zero. Alternatively we can only take closing inventory and not average inventory for 2017

Ratio	2016	2017
Liquid ratio	3.05	1.26
Net profit ratio	24.18%	20.92%
Times interest cover	10.05 times	8.8 times
Earnings per share	$ 0.645	$ 0.573

Price Earnings Ratio		5.426	6.545
Return on equity (shareholder’s funds)		0.665	0.591
Debtor collection period (turnover rate)		37days	30days
Inventory turnover		7.14 times	8.89 times

(2) The price earning ratio is computed by dividing the market price by the earnings per share which is the link between the two. As we can see the earnings per share has decreased but the price earning ratio has increased in 2017 as compared to 2016 . This is primarily because of increase in market price in 2017

(3) The two actions that the business may have taken to improve the debtor turnover rate are:

(a) design a clear credit policy

(b) increase collection efficiency

(c) reward timely payments by giving them discounts