Question

Question 1

Brooklyn plc manufactures and sells only one product and the accountant has been asked to prepare a report that will highlight the areas that should be focussed on at the next meeting of the Directors of the company.

Details of the results and ratios have been calculated from the financial statements, using the attached formulae.

                                                                                    2016               2017            2018

Sales – units                                                           160 000            200 000           220 000

                                                                                    £000              £000               £000  

Sales                                                                            16 000          17 000                18 700

Profit before interest and tax                                           800               980                  1 053

Profit after tax                                                                  490             595                    588

Non-current Assets                                                       5 000             5 400               7 500

Cash                                                                                 ---                    600                200                        

Profitability ratios

Gross Profit margin                                                     30.0%              39.7%              45.0%

Net Profit margin                                                        5.0%              5.8%              5.6%

Return on Capital Employed                                     10.0%              9.1%              8.1%

Return on Shareholders’ Funds                                   8.2%              9.7%              9.3%

Liquidity and management of working capital ratios

Current ratio                                                               3.0                  4.4                 3.75

Acid Test / Quick ratio                                             1.3                  1.9                 1.50

Inventory – days                                                         95                  142                    160

Receivables – days                                                     46                  51.5                54.6

Payables – days                                                          57                     57                      71

Gearing ratio                                                               25%               43%                  51.5%

                       

Required

1. Prepare a report that will assist the Board members to focus on the issues that should be addressed in the period from 2016 to 2018. The possible causes of any changes in the ratios that have occurred over the period should be highlighted in the report.

2. Suggest ways by which the Return on Capital Employed could be improved during the next year.

Answer 1

Date -

a.

We hereby bring you the following extracts out of the data from 2016 to 2018. We analyzed following from the ratio analysis of the company and want to bring your focus on certain thing which may be affecting the company growth.

Gross profit ratio has been increasing since the first year with increase in sales revenue. Net profit increased for year 2017 but then fell down showing that company may not be effective in its sales margins and might be bearing fixed costs which decrease profits.

Return on capital employed has been falling since the very first year which shows that company has not been using its resources and funds in a well manner. This shows company is less efficient in its resource utilization and profitability.

Return on shareholders fund went up and fell down showing fall in the value of shares in the third year due to less returns and profits.

Current Ratio is to be focused on as this ratio is too high in relation to what an ideal ratio should be. An ideal ratio should be 2:1 but here it has crossed beyond 3 and even 4 in tear 2017.

Quick ratio is also higher than the ideal ratio of 1:1 and is higher for 2018 compared to 2016 and 2017.

A great focus should be lent towards Inventory Days as it is increasing and it is too high for a business to run smoothly. A business is able to turn its inventory into sales in approx 90-160 days it is almost half an year. The business is facing difficulties in converting its inventories into sales and should focus on spending more on marketing and selling activities.

Days receivables are also increasing showing the business is taking more time than previous years to convert its credit sales to cash.

Days in payables are high and increasing showing the business has a good reputation and getting more credit to purchase goods from markets.

Gearing ratio shows the dependency on debt. and it is increasing from past years and it also increases the fixed costs related to raising the debt. which results in higher interests being paid and lower profits left with the business at the end of the year.

The possible causes of these issues are that company is not focusing on its marketing activities and hence left with more inventories. Dependency of fixed costs sources of raising funds are increasing and that of capital is decreasing leading to higher interest costs and lower net profits and hence less return on capital employed.

b.

Return on capital employed could be increased by raising funds through equity rather than debt. which will decrease interest costs and raise profits. Another way could be spending more on marketing which will lead to higher and faster conversion of inventories to sales.