Question

ASSIGNMENT 1
GBSw LTD
Chooye Haatimba (CH), a recent MBA graduate, was recruited as a Loan Officer of an indigenous bank. He had previous banking experience at the bank. His first assignment in this position was to review the account of GBSw, a long-standing client of the bank. GBSw has applied for an increase in their line of credit from K36,000 to K48,000 and also requested a 10-year extension on a K24,000 due on October 2020. CH’s started by doing some research into the background of the company. The company was formed in 1978 by Austin Simamba, in mid-40’s, who decided to own and operate his own business in the country. The company manufactured and sold high quality sporting wear. It remained small until 2000’s. Sales grew steadily, going from K51,600 in 2000, to K110,400 in 2005, and   K241,200 in 2010, and K308,400 in 2015. Of these sales 70% were on credit. Until 2010, GBSw had been a operated by the Simamba family. In 1994 Manns Simamba took over from his father in 1994. Under his management GBSw was growing tremendously in sales and profits. Upon his retirement in 2014, GBSw was sold two times within the next year – first to a group of Ndola businessmen and then to a group of Kitwe businessmen headed by Martin Haambotwe, thus ending the 36-year Simamba control of the business. The Simamaba family had been quite conservative in their management of GBSw, limiting the product line to high quality sporting wear sold only in sporting shops and specially approved men’s wear stores, but the Haambotwe syndicate took a more aggressive approach. They expanded the product line to include sporting shorts, sporting jackets, T-shirts and sweaters, drastically expanding the discount stores. This expansion in the product line was financed in large part through the issuance of K90,000 10% long term loan in October 2018. This debt was due in 15 years (2033), and carried a sinking fund provision of K6,000, with the first sinking fund payment being made one year after the debt was issued. Apart from the K24,000 bank loan due in June 2020, this was the first long term debt that GBSw had contracted, previously limiting the capital structure to ordinary shares. The Haambotwe group was hopeful that this aggressive expansion, relying on heavily on the good name of GBSw, would help to recapture the company’s growth recorded in the 2000’s. For the past four years the Bank has granted GBSw a line of credit for K36,000. The need for seasonal borrowing for GBSw is a result of its highly seasonal sales pattern and limited production facilities. Throughout the year GBSw is forced to keep production near full capacity, building large inventories that will be reduced from mid-July through December when 90% of the sales take place. Thus, for GBSw, short term borrowing generally reaches a peak in August and is completely repaid by the end of November. While they have had a line of credit of K36,000 for the past four years, the company’s high credit was only for K31,200 in August 2018. In preparing his report for the Bank, CH will be required to prepare a statement of cash flow for the past 2 years, to provide some insight into how GBSw has used its funds in the past. A complete ratio analysis of the firm, focusing on liquidity, debt, coverage, and profitability ratios, also will be necessary. In addition to the calculations of these ratios and an analysis of them, a tentative recommendation on both the line of credit and the loan extension is required by CH.
2
The analysis will be based upon the financial data in Exhibits 1,2 and 3. EXHIBIT 1                                                                        GBSw Ltd              Statement of Income for years ending August 31, 2017 through 2019
2017 2018 2019                      K000 K000 K000 Net sales 247.2 290.4 308.4 Cost of goods sold 176.4 207.6 220.8 Gross profit   70.8   82.8   87.6 Other operating expenses (Admin, selling and general)   11.916   21.936 26.796 Depreciation      7.8     7.8     7.8    19.716 29.736   34.596 Profit before interest and taxes   51.084 53.064   53.004 Finance cost (Interest expense)     2.4     2.4     2.4 Profit before tax   48.684 50.664 50.604 Income tax    17.039 17.732 17.111 Net profit after tax   31.645 32.932 33.493 Dividends paid    19.800 22.050 22.050 Retained profit   11.845 10.882 11.443   
  
EXHIBIT 2                                                                       GBSw Ltd                        Statement of financial position as at August 31,2017 to 2019             2017            2018            2019 K’000 K’000 K’000 K’000 K’000 K’000 ASSETS       Non-current assets 274.80 324.00 414.00 Accumulated depreciation   75.60    79.20    82.80    199.20 244.80 331.20 Goodwill 144.00 144.00 144.00 Non-current assets 343.20 388.80 475.20 Current assets       Inventory (Note 1)    43.20   57.60    75.60 Trade receivables     16.80   21.60    18.00 Cash and bank   25.20   21.60    19.20 Total current assets   85.20 100.80 112.80 Total assets 428.40 489.60 588.00 Current liabilities       Line of credit 28.80 31.20 28.80 Trade payables    8.40 12.00 19.20 Accrued expenses   3.60    6.00    9.60 Total current liabilities 40.80 49.20   57.60
3
Bank loan (due June 2020) 24.00 24.00 24.00 Long term debt - - 90.00    24.00 24.00 114.00 Total liabilities 64.80 73.20 171.60 Assets less liabilities 363.60 416.40 416.40 Equity       Ordinary share capital 192.00 204.00 204.00 Share premium 120.00 156.00 156.00 Revenue reserves    51.60    56.40    56.40 Equity 363.60 416.40 416.40       
Note 1 Inventory   2017 2018 2019 K’000 K’000 K’000 Raw materials and supplies    9.60 12.00   14.40 Work in progress 31.20 42.00   55.20 Finished goods   2.40   3.60     6.00 Total inventory 43.20 57.60   75.60
EXHIBIT 3 INDUSTRY AVERAGES FOR SELECTED RATIOS RATIO AVERAGE Gross profit margin 23.4% Net profit margin    9.64% Return on assets (Earning power) 7.96% Asset turnover 0.826 times Inventory turnover 3.877 times Average collection period 40.3 days Current ratio 1.943 Acid test ratio 0.969 Total debt to equity 0.636 Long term debt to total capitalisation 0.487 Interest coverage ratio 4.533 times
Required 1. Compute the financial ratios for GBSw for 2017 to 2019 2. Comment on the strengths and weaknesses revealed by this analysis 3. If a value for annual cash flow before interest and taxes was available, what other ratio might be useful? Is such a ratio meaningful? Why? 4. Assuming that a value for annual cash flow before interest and taxes is not available, how might the interest coverage be modified to examine coverage other fixed charges for GBSw? What does this analysis indicate? (Use 35%as the tax rate)
4
5. Prepare a statement of cash flow for 2018 and 2019. What is the significance of such an analysis? 6. Prepare a proforma statement of income for GBSw for 2018 and 2019. What is the purpose of this analysis? 7. What should CH’s recommendation be? Justify your answer  

Answer 1

Statement of Income
	2,017.00	2,018.00	2,019.00
Net Sales	247.20	290.40	308.40
Cost of Goods Sold	176.40	207.60	220.80
Gross Profit	70.80	82.80	87.60
Other Operating Expenses:
Admin, Selling and General expenses	11.92	21.94	26.80
Depreciation	7.80	7.80	7.80
Total Other Operating Expenses	19.72	29.74	34.60
Profit before Interest and Taxes	51.08	53.06	53.00
Finance Cost (Interest Expense)	2.40	2.40	2.40
Profit before Tax	48.68	50.66	50.60
Income Tax	17.04	17.73	17.11
Net Profit after Tax	31.65	32.93	33.49
Dividends Paid	19.80	22.05	22.05
Retained Profit	11.85	10.88	11.44

Statement of Financial Position
	2017	2018	2019
ASSETS
Non-Current Assets:	274.80	324.00	414.00
Acumulated Depreciation	75.60	79.20	82.80
Net Non-Current Assets	199.20	244.80	331.20
Goodwill	144.00	144.00	144.00
Total Non-Current Assets	343.20	388.80	475.20
Current Assets:
Inventory	43.20	57.60	75.60
Trade Receivables	16.80	21.60	18.00
Cash and Bank	25.20	21.60	19.20
Total Current Assets	85.20	100.80	112.80
Total Assets	428.40	489.60	588.00
Current Liabilities:
Line of Credit	28.80	31.20	28.80
Trade Payables	8.40	12.00	19.20
Accrued Expenses	3.60	6.00	9.60
Total Current Liabilities	40.80	49.20	57.60
Bank Loan	24.00	24.00	24.00
Long Term Debt	-	-	90.00
Net Assets	363.60	416.40	416.40
EQUITY
Ordinary Share Capital	192.00	204.00	204.00
Share Premium	120.00	156.00	156.00
Revenue Reserves	51.60	56.40	56.40
Total Equity	363.60	416.40	416.40

Computation of Financial ratio for the Year 2017 to 2019:

1. GROSS PROFIT MARGIN RATIO

Gross Profit Margin Ratio
	2017	2018	2019
Gross Profit	70.8	82.8	87.6
Sales	247.2	290.4	308.4
Gross Profit Margin Ratio	28.64%	28.51%	28.40%

2. NET PROFIT MARGIN RATIO

Net Profit Margin Ratio
	2017	2018	2019
Net Profit	31.645	32.932	33.493
Sales	247.2	290.4	308.4
Net Profit Margin Ratio	12.80%	11.34%	10.86%

3. RETURN ON ASSETS (EARNING POWER)

Return on Assets (Earning Power)
	2017	2018	2019
Net Profit	31.645	32.932	33.493
Total Assets	428.4	489.6	588
Return on Assets (Earning Power)	7.39%	6.73%	5.70%

4. ASSETS TURNOVER RATIO

Assets Turnover Ratio
	2017	2018	2019
Sales	247.2	290.4	308.4
Total Assets	428.4	489.6	588
Assets Turnover	0.577 times	0.593 times	0.524 times

4. INVENTORY TURNOVER RATIO

Inventory Turnover Ratio
	2017	2018	2019
Cost of Goods Sold	176.4	207.6	220.8
Inventory	43.2	57.6	75.6
Inventory Tunover	4.083 times	3.604 times	2.921 times

5. AVERAGE COLLECTION PERIOD

Average Collection Period
	2017	2018	2019
Accounts Receivables	16.8	21.6	18
Sales	247.2	290.4	308.4
Average Collection Period	24.8 days	27.15 days	21.3 days

6. CURRENT RATIO

Current Ratio
	2017	2018	2019
Current Assets	85.2	100.8	112.8
Current Liabilities	40.8	49.2	57.6
Current Ratio	2.088	2.049	1.958

7. ACID TEST RATIO

Acid Test Ratio
	2017	2018	2019
Cash	25.2	21.6	19.2
Accounts Receivables	16.8	21.6	18
Current Liabilities	40.8	49.2	57.6
Acid Test Ratio	1.029	0.878	0.646

8. TOTAL DEBT TO EQUITY RATIO

Total Debt to Equity Ratio
	2017	2018	2019
Total Liablities	64.8	73.2	171.6
Equity	363.6	416.4	416.4
Total debt to Equity ratio	0.178	0.176	0.412

9. LONG TERM DEBT TO TOTAL CAPITALISATION

Long Term Debt to Capitalisation Ratio
	2017	2018	2019
Bank Loan	24	24	24
Long Term Debt	-	-	90
Total Long Term Debt	24	24	114
Equity	364	416	416
Total Capitalisation	388	440	530
Total Debt to Capitalisation Ratio	0.062	0.054	0.215

10. INTERST COVERAGE RATIO

Interest Coverage Ratio
	2017	2018	2019
Profit before Interest and Tax	51.084	53.064	53.004
Interest Expense	2.4	2.4	2.4
Interest Coverage Ratio	21.285 times	22.11 times	22.085 times