Question

Prezzo plc runs a chain of restaurants in the UK that serve mainly Italian style food including pizza, pasta, and grilled dishes as well as a few Chimichanga Mexican restaurants. During 2012, the number of restaurants in the group increased from 184 to 210. Prezzo shares are listed on AIM, which is a stock market for smaller growing companies. Extracts from Prezzo’s annual report 2012, including financial statements for the year to 30 December 2012 and extracts from the director’s report, are given:

Table FA.1

Prezzo plc Extracts from the statement of profit or loss for the years:
		2012 £’000	2011 £’000
Sales		144,524	123,873
Cost of sales		123,614	105,221
Gross profit		20,910	18,652
Administration costs		(3,582)	(2,540)
Operating profit		17,328	16,112
Net interest received /(paid)		(4)	19
Profit before tax		17,324	16,131
Taxation		(4,380)	(4,389)
Profit for the financial period and total comprehensive income		12,944	11,742
Earnings per share		5.66p	5.17p

Table FA.2

Prezzo plc Extracts from the statement of financial position as the financial year-ends:
		2012 £’000	2011 £’000
Non-current assets
Intangibles		1,508	1,560
Property, plant and equipment		112,957	97,431
Other non-current assets		4,804	4,748
		119,269	103,739
Current assets
Inventories		4,559	3,838
Trade receivables		3,578	1,927
Other current assets		5,823	5,129
Cash		4,367	39
		18,327	10,933
Total assets		137,596	114,672
Equity
Share capital		11,458	11,385
Retained profits and other reserves		80,245	67,422
		91,703	78,807
Non-current liabilities		9,506	8,730
Current liabilities		36,387	27,135
Total equity and liabilities		137,596	114,672

Table FA.3

Prezzo plc Extract from the statement of cash flows for the 2012 financial year
		2012 £’000
Cash flows from operating activities (after tax)		27,190
Cash flows from investing activities
Purchase of property, plant and equipment		(24,098)
Proceeds from sale of property, plant and equipment		1,387
Cash flows from financing activities
Issue of new shares		421
Equity dividend paid		(572)
Net increase in cash balances		4,328
Cash balances at 1 January 2012		39
Cash balances at 30 December 2012		4,367

Required:

a) Using extracts from the Annual Report, compute the following profitability ratios for Prezzo plc for 2012 and 2011 and interpret your findings, giving a possible reason for any observed changes in each ratios:

• return on capital employed

• operating profit margin

• use of assets

• gross profit margin

Identify one other profitability ratio that might enable you to gain a better understanding of the company's profitability. Compute that ratio for both years and discuss your findings.

b) Use ratios to assess the liquidity of the company at both year-ends and explain what has caused the movement in the ratios between the two year-ends.

c) Use the company’s statement of cash flows to discuss what has happened to the company’s cash position during 2012.

d) Complete the following table of share information and investment ratios:

Table FA.4

	2012	2011
Earnings per share
Dividend per share	0.25 pence	0.225 pence
Share price at the year-end	67.5 pence	56.5 pence
Dividend yield
Dividend cover
Price to earnings ratio

Interpret the investment ratios, explaining what they reveal to shareholders about the return their shares have generated.

e) Describe two other sources of information that might have enabled you to give a fuller interpretation of the company’s performance and financial position and explain how that information could have been used.

Answer 1

a.) Return on capital employed:

= Net Operating Profit/Capital Employed

= Net Operating Profit/Total Assets- Current Liabilities

2012 2011

=17,328/137,596 -36,387 = 16,112/114,672 -27,135

=0.17 = 0.18

The return on capital employed ratio shows how much profit each dollar of employed capital generates. Obviously, a higher ratio would be more favorable because it means that more dollars of profits are generated by each dollar of capital employed.

For instance, a return of .17/.18 indicates that for every dollar invested in capital employed, the company made 17/18 cents of profits.

Operating Profit Margin:

=Operating Profit/Total Revenue

2012 2011

=17,328/144,524 =16,112/123,873

=0.11 =0.13

The operating profit margin ratio indicates how much profit a company makes after paying for variable costs of production such as wages, raw materials, etc. It is also expressed as a percentage of sales and then shows the efficiency of a company controlling the costs and expenses associated with business operations.

Use of Assets:

=Total Sales/Opening Assets+Closing Assets/2

As information, about the opening and closing assets is missing,this ratio cannot be calculated.

It is a tool to see which firms are making the most use of their assets and to identify weaknesses in firms.

Gross Profit Margin:

=Gross Profit/Total Sales

2012 2011

= 20,910/144,524 =18,652/123,873

=0.14 =0.15

The gross profit method is an important concept because it shows management and investors how efficiently the business can produce and sell products. In other words, it shows how profitable a product is.

Return on Assets:

=Net Income/Total Assets

2012 2011

=12,944/137,596/2 =11,742/114,672/2=0.

18    =0.20

Calculating the ROA of a company can be helpful in comparing a company's profitability over multiple quarters and years as well as comparing to similar companies. However, it's important to compare companies of similar size and industry.

b.)Liquidity Ratios:

Current Ratio:

=Current Assets/Current Liabilities

2012 2011

=18,327/36,387 =10,933/27,135

=0.50 =0.40

Acceptable current ratios vary from industry to industry and are generally between 1.5% and 3% for healthy businesses. ... When a current ratio is low and current liabilities exceed current assets (the current ratio is below 1), then the company may have problems meeting its short-term obligations (current liabilities).

Quick Ratio:

=Quick Assets/Current Liabilities

2012 2011

=18,327-4,559/36,387 =10,933-3,838/27,135

=0.37 =0.26

A quick ratio that is greater than 1 means that the company has enough quick assets to pay for its current liabilities.

c.) The current cash flow from operating activities and negative financing and investing activities is actually the most ideal position for any company as the company is able to cover all his costs from the profits that the company is earning and is able to save and have retained earnings.

d.) Earnings per share

=Net Income-Preferred Dividends/Weighted Average Shares Outstanding

2012 2011

=5.66p =5.17p

Price to Earnings Ratio

=Market price/Earnings per ratio

2012 2011

=67.5p/5.66p =56.5p/5.17p

=11.9 =

Dividend Yield

=Annual dividend/Current Stock Price

Dividend Cover

=1/Dividend Yield