Question

During the planning for the audit of Moon Limited, a retailer with suburban and country supermarkets, you undertake ratio analysis and discussion with the management. Discussion with management reveals the following:

• During the last two years the client has expanded its operations and opened 7 new stores, increasing the total number of stores to 20.
• It takes four to five years for a new store to become profitable.
• The industry has been badly hit by Covid-19 and the country stores are suffering even more as a result of the drought. There are 10 country stores.
• The current share price is $12.50. The expansion has been funded by debt and the number of issued shares has not changed in the last three years.

The following ratios were calculated:

	2020	2019	2018
Current ratio	2.01	1.55	1.75
Quick ratio	0.96	1.08	1.15
Net asset backing per share ($)	22.48	23.28	23.25
Return on shares ($)	0.03	0.15	0.20
Inventory turnover (times)	2.70	3.60	4.20
Interest cover (times)	1.3	2.6	3.1

Required:

Based on the above analytical procedures and the discussion with management identify four business risks that the company is facing and explain from the information available why they constitute a significant risk.

Answer 1

According to the details provided in the question, it can be seen that the quick ratio is decreasing over time. In 2018, the ratio was 1.15, in 2019 it was 1.08, whereas in 2020 the inventory turnover is 0.96.Quick ratio, also known as the acid test ratio measure the ability of the company to repay the short term debts with the help of the most liquid assets and it is calculated by adding total cash and equivalents, accounts receivable and the marketable investments of the company and then dividing it by its total current liabilities. The quick ratio of the company has decreased from 1.15 in 2018 to 0.96 in 2020. Quick ratio is a sign of solvency of an organization and should be analyzed over a time period and also in the circumstances of the industry the company controls in. Quick ratio also know as acid-test ratio measures the liquidity of the company using more liquid assets of the company. It can be seen that the quick ratio of the comapny is decreasing, means the liquidity of the company is decreasing. hence, the comapny may face liquidity risk in the near future

According to the details provided in the question, the company's net asset backing per share ($) is decreasing. The net asset value represents a fund’s market value. When expressed at a per-share value, it represents a fund’s per unit market value. The per-share value is the price at which investors can buy or sell fund units. When the value of the securities in the fund goes up, the net asset value goes up. Conversely, when the value of the securities in the fund goes down, the NAV goes down. It has shown in the question that the net asset backing per share ($) is decreasing year on year. Net tangible assets per share is calculated by taking a companys net tangible asset number and dividing it by the total number of shares outstanding.  In 2018 the net asset backing per share ($) was 23.25, whereas in 2020 it is 22.48. A decreasing trend reflects that the market value of the market value of the securities is falling. Additionally, it also means that the companys assets are reducing, which can indicate a cash crunch and, potentially, a long-term decline in revenues. Another is a decrease in accounts receivable with a corresponding increase in inventory. This can indicate that sales are slowing and inventory balances are building

Return on shares is a profitability ratio calculated as net income divided by average total assets that measures how much net profit is generated for each dollar invested in assets. It determines financial leverage and whether enough is earned from asset use to cover the cost of capital. According to the question, the return on shares ($) is decreasing. In 2018, the return was 0.20, in 2019 it was 0.15, whereas in 2020 the return was 2.70. A decreasing trend in return on shares reflects thet the revenue of the company is decreasing over the years

According to the details provided in the question, it can be seen that the inventory turnover (times) is decreasing over time. In 2018, the ratio was 4.20, in 2019 it was 3.60, whereas in 2020 the inventory turnover is 2.70. The measure of how long a company holds its inventory before selling it is referred to as the inventory turnover ratio. When a company’s inventory turnover is decreasing, it means that it is holding its inventory longer than previously measured time periods. Because of the impact of COVID-19 the sales of the retail store must have decreased, due to which the inventory turnover is showing a decreasing trend

The interest coverage ratio measures the company's ability to make interest payments, such as in its debt service. A ratio above one indicates that the company is able to pay its interest, while a ratio below one means that its interest payments exceed its earnings.The interest coverage ratio is used to see how well a firm can pay the interest on outstanding debt. According to the details provided in the question, the interest coverage (times) is decreasing over time. In 2018, the interest coverage was 3.1 times and in 2020 it is 1.3 times. A decreasing trend relfects that the companys ability to pay interest on debt is falling.

Thus, according to the above analysis and discussion with the management the major four risks identified are: risk of reducing sales, risk of liquidy, risk of decreasing market value and risk of reduction in the total value of assets