Question

Sparkle​ plc, a high class jewellery retail​ company, reported the following figures.

Income Statement​ (Profit and Loss​ Account)

for year ended 30 September 2019

	£m
Revenue	2,480
Cost of sales	(1,100)
Gross profit	1,380
Administration and selling expenses	(678)
Operating profit	702
Debenture interest	(31)
Profit before taxation	671
Taxation	(154)
Profits for the year	517

Note:

The directors have recommended a dividend of 11.4 pence per year in total in respect of 2019 to be paid following approval at the next annual general meeting.

The market price of one share is 800 pence.

Statement of financial position​ (Balance Sheet) as at 30 September 2019

	£m
Non-current (fixed) assets (net of depreciation)	785
Current assets:
Inventories (stocks)	341
Trade receivables (debtors)	801
Cash	110
Total current assets	1,252
Total assets	2,037
Current liabilities:
Trade payables (creditors)	(90)
Other payables and accruals	(654)
Total current liabilities	(744)
Non-current liabilities:
7% Debentures	(440)
Total liabilities	(1,184)
Total net assets	853
Share capital and reserves:
Issued share capital
(1,360m ordinary shares of 25p nominal value)	340
Retained earnings	513
Total Equity	853

1. Compute the​ following of Sparkle plc (calculate to one decimal place):
   1. Gross profit margin.
   2. Inventory Turnover
   3. Current ratio
   4. Acid test
   5. Debt/Equity ratio
   6. Price/Earnings ratio
2. Critically discuss SIX limitations of ratio analysis.

Answer 1

a. Compute the​ following of Sparkle plc (calculate to one decimal place):	Calculation	Ratio
i. Gross profit margin [Gross profit/Revenue]	=1380/2480 =	55.6%
ii. Inventory Turnover [Cost of sales/Inventory]	=1100/341 =	3.2
iii. Current ratio [Current assets/Current liabilities]	=1252/744 =	1.7
iv. Acid test [(Cash+Debtors)/Current liabilities]	=(110+801)/744 =	1.2
v. Debt/Equity ratio [Total debt/Total equity]	=1184/853 =	1.4
vi. Price/Earnings ratio [MPS/EPS]	=800/38 =	21.1
[EPS = 517/1360 = 0.38]
b. Critically discuss SIX limitations of ratio analysis.
1] Ratios ignore price level changes due to
inflation. This is particularly relevant when ratios
using figures of fixed assets are considered.
2] Ratios are susceptible to manipulations of some
figures in the financial statements.
3] Ratios ignore qualitative aspects. For instance,
the current ratio does not consider the aging of
receivables.
4] There are no universal standards for ratios.
Usually this is overcome by using industry average
ratios as the standard.
5] Ratios need careful intrepretaion by an expert.
Hence, they are not understood by a layman.
6] Ratios are historical. They do not look into the
future.