Question

QUESTION 5:

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

                                        $                   $

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

                                                    $                     $

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                                                           

                                                        

                                              $                    $

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        

5.1.2 Debtors collection period       

5.1.3 Acid test ratio        

5.1.4 Return on equity        

5.1.5 Debt to equity         

5.1.6 Earnings retention ratio        

5.1.7 Earnings per share        

5.2 Suggest two (2) ways in which YDI Limited can improve on its collections from debtors.            

5.3 Comment on the current ratio which dropped from 3.98:1 in 2018 to 3.32:1 in 2019.           

5.4 Recommend two (2) ways in which YDI Limited can improve its profitability.

Answer 1

Solution :                       
                      
5.1.1   Operating Margin Ratio = Operating Profit / Net Revenue                  
       =   6,00,000/200000          
       =   3.00          
                      
5.1.2   Debtors Collection Period = Average Debtors * 365 /Net Credit Sales                  
       =   400,000 * 365 / 20,00,000          
       =   73          
                      
   ( Note : All the sales are on credit )                  
                      
5.1.3   Acid Test Ratio = Quick Assets / Current liabilities                  
       =   4,00,000 + 2000 / 182000 + 120000          
       =   1.33          
                      
   ( Note : Quick assets do not include inventory and prepaid expences)                  
                      
5.1.4   Return on equity = Net Income / Average Shareholders Equity * 100                  
       =   364000 /1750000 * 100          
       =   20.80%          
                      
5.1.5   Debt to Equity = Debt / Equity                  
       =   700000 +120000 / 2000000          
       =   0.41          
                      
5.1.6   Earning Retention Ratio = 1 - Payout Ratio                  
       =   1 - 0.6          
       =   0.4          
                      
   where payout ratio = dividend paid /net profit after tax                  
       =   218000/364000          
       =   0.6          
                      
5.1.7   Earning per share = Total earning / Outstanding shares                  
       =   364000 / 200000          
       =   1.82          
   ( Assumed that the face value of 1 share is 10 Rs each )                  
                      
5.2   The 2 ways in YDI ltd can improve its collection from debtors are :                  
   Hire recovery agents                  
   Reduce the credit period allowed to customers                  
                      
5.3   Since the current ratio has dropped, the liquidity available to the company has reduced. The company may face short term financial crunch to pay off its current liabilities.                  
                      
5.4   The 2 ways to improve the profitability are :                  
   By increasing the profit margin                  
   By controlling unnecessary operating expenses