Question

In: Accounting

Stepfall Ltd had the following ratios at 31 December 2017 and 31 December 2016: 2017 2016...

Stepfall Ltd had the following ratios at 31 December 2017 and 31 December 2016: 2017 2016 Gross profit margin 27% 31% Return on capital employed 15% 22% Current ratio 1.1:1 0.7:1 Acid test ratio 0.8:1 0.6:1 Trade receivable days 33 days 48 days Inventory holding days 42 days 57 days Which ONE of the following statements is TRUE?

a) The company’s profitability, working capital management and liquidity have improved.
b) The company’s profitability and working capital management have deteriorated but liquidity has improved
c) The company’s profitability, working capital management and liquidity have deteriorated.
d) The company’s profitability has deteriorated, but working capital management and liquidity have improved.

Solutions

Expert Solution

Ans:

The correct answer is Option "d".

Profitability:

In 2016 Gross profit ratio is 31% and Return on capital employed is 22%. In 2017, Gross profit ratio decreased to 27% and Return on capital employed has come down to 15%, Which means, the company's profitability has deteriorated.

Liquidity:

In 2016 the current ratio was 0.7:1, Which means the company does not have enough current assets to meet the payment schedule of current liabilities. In 2017 the Current ratio is 1.1:1, it implies that, the company has enough current assets to pay off its current liabilities. Since, the current ratio is increased, the liquidity of the company has improved.

In 2016 the Acid test ratio was 0.6:1, Which means the company does not have enough Quick assets to meet the payment schedule of current liabilities. In 2017 the Acid test ratio is 0.8:1, it implies that, the company has enough Quick assets to pay off its current liabilities. Since, the Acid test ratio is increased, the liquidity of the company has improved.

Note: Quick assets includes all current assets except inventory stock and prepaid expenses.

Working capital management:

In 2016, Trade receivables collection period was 48 days, and In 2017 it is 33 days, which means the company is able to collect Trade receivable earlier than last year, which can improve the working capital.

In 2016, Inventory holding period is 57 days and In 2017 it is 42 days, it means the company is using it's inventory effectively by reducing the Inventory holding period, It can reduce the carrying cost and it helps in improving working capital management.

Thank you,

ekkarill92 answered 1 year ago
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