Question

QUESTION FIVE [20]

The following information has been extracted from the financial statements of YDI Limited: Extract of Statement of Comprehensive Income for the year ended 31 December 2019 2018 R R Sales 2 000 000 1 600 000 Cost of sales 940 000 800 000 Operating profit 600 000 520 000 Profit before tax 520 000 450 000 Profit after tax 364 000 315 000 Extract of Statement of Financial Position as at 31 December Assets 2019 2018 R R Non-current assets 2 000 000 1 400 000 Inventories 600 000 800 000 Accounts receivable 400 000 400 000 Cash and cash equivalents 2 000 2 000 3 002 000 2 602 000 17 R R Equity and liabilities Shareholders’ equity 2 000 000 1 500 000 Long-term loan 700 000 800 000 Accounts payable 182 000 142 000 Bank overdraft 120 000 160 000 3 002 000 2 602 000 Note: 1. All purchases and sales of inventories are on credit. 2. Dividends paid during the year amounted to R218 400. 3. The issued share capital consisted of 500 000 ordinary shares. Required: 5.1 Calculate the following ratios for the year ended December 2019. Where applicable, round off answers to two decimal places. 5.1.1 Operating margin (2) 5.1.2 Debtors collection period (2) 5.1.3 Acid test ratio (2) 5.1.4 Return on equity (2) 5.1.5 Debt to equity (2) 5.1.6 Earnings retention ratio (2) 5.1.7 Earnings per share (2) POSTGRADUATE DIPLOMA IN MANAGEMENT – ACADEMIC AND ASSESSMENT CALENDAR REGENT BUSINESS SCHOOL (RBS) July 2020 18 5.2 Suggest two (2) ways in which YDI Limited can improve on its collections from debtors. (2) 5.3 Comment on the current ratio which dropped from 3.98:1 in 2018 to 3.32:1 in 2019. (2) 5.4 Recommend two (2) ways in which YDI Limited can improve its profitability.

Answer 1

5.1.1 Operating Margin

= Operating Profir / Net sales

= 600,000 / 2,000,000

= 0.3 or 30%

5.1.2 Debtors Collection Period

= 365 / (Credit Sales / Average Debtors)

= 365 / (2,000,000 / 400,000)

= 73 Days

5.1.3 Acid Test Ratio

= (Current Assets - Stock) / Current Liabilities

= 402,000 / 302,000

= 1.33

5.1.4 Return on Equity

= Profit After Tax / Equity

= 364,000 / 2,000,000

= 0.182 or 18.2%

5.1.5 Debt to Equity

= Total Debt / Equity

= 700,000/ 2,000,000

= 0.35 or 35%

5.1.6 Earnings Retention Ratio

=( Profit After Tax - Dividend ) / Profit After Tax

= 145600 / 364000

= 0.4 or 40 %

5.1.7 Earning per share

= Profit after Tax / Number of shares

= 364,000 / 500,000

= 0.728

5.2 Ways of Improving Collections from Debtors

1. Offer better terms for payment upfront

Consider discounts for payments upfront (be careful with this one as you need to weigh up the benefits versus costs - redo your budgets).

2. Reduce Trading Terms

What are your trading terms at the moment? Can you reduce them from say 30 days to 7 days? Be sure to give notice to your existing customers. For new customers it should be a no-brainer.

3. Hire a part-time debt collector or restructure

Determine whether any of your admin staff have time to set aside to chase debtors. If not, consider hiring a part time person to perform this role.

5.3 Comment on Current Ratio

The Company's current ratio has changes from 3.98 to 3.32

Ideal Current ratio is between 1.2 to 2.

YDI Ltd is far away from Ideal ratio but it's moving towards it. YDI ltd should try harder to bring it to ideal level

5.4 Ways to Improve Profitability

1) Prepare a strategic plan with 1-year, 3-year, and 5-year goals

Business takes time to develop, therefore, you need to create a strategy that has a five-year outlook at the minimum. Each year needs to define how your business will grow over the years. As your business grows over the years, it will become more complex, which means your financial plan needs to grow with your business.

2) Determine up to five key success factors for your business

Your business will need to operate under five principles that will determine its success. Once these principles are determined, you will need to monitor these factors weekly to ensure that your actions align with them. These key factors should focus on growth and prosperity. Sales and expense controls should definitely be two factors that are also within your success factors. Without these two factors, you will find it hard for your business to be profitable.