Question

The following ratios have been calculated from the most recent financial statements for Goodman Enterprises and Kwiksave Limited. Both businesses operate in the retail industry.

			Goodman Enterprises			Kwiksave Limited
Average collection period				55 days		22 days
Gross profit margin				39%		13%
Average days in inventory				46 days		23 days
Net profit margin				9.9%		9.9%

REQUIRED:

1. Compare and contrast the profitability and liquidity of Goodman Enterprises and Kwiksave Limited on the basis of the ratios above. (word limit: 300 words)

2. Explain which of the two businesses is likely to be operating in a price-competitive environment and to what extent this has impacted on their net profit margin. (word limit: 150 words)

Answer 1

a. The gross profit margin is the percentage of revenue that exceeds the Cost of goods sold. A high Gross profit margin indicates that a company is producing profits over and above its costs. In the above question, Goodman enterprises has a gross profit margin of 39% whereas Kwiksave Limited has a Gross profit margin of 13% which clearly indicates that Goodman enterprises has a higher gross profit margin when compared with Kwiksave Limited. This means that for every dollar Goodman limited generated in sales, it generated 39 cents in gross profit before other business expenses were paid. Though Gross profit margin provides a general indicator of profitability, but it is not a precise measurement.

Net profit margin is the ratio of net profits to revenues for a company or business segment. It shows how much of each dollar collected by the company as revenue translates to profit. It is an important disctinction since mere increase in revenue do not necessarily translate into increased profitability. In the above case, Goodman Limited as well as Kwiksave limited has the same net profit margin of 9.9% which means, though Goodman limited has a high Gross Profit margin, the ultimate profit is the same for both the companies due to other additional expenditure which Goodman Limited has incurred.

Average collection period is the average number of days it takes to turn accounts receivable into cash. Average collection period can tell the owner the liquidity of his or her company's accounts receivable. In the above question, Goodman Limited takes 55 days to convert into cash whereas Kwiksave Limited takes approximately less than half the time, i.e; 22 days which clearly indicates that Kwiksave Limited's liquidity is higher when compared to Goodman Limited.

Average days in inventory is a measure that calculates the number of days the company holds its inventory before selling it. That means the number of days funds are tied up in inventory. In the above question, it can be seen that Goodman Limited has an average days in inventory of 46 days whereas Kwiksave Limited has only 23 days which means that Kwiksave Limited's liquidity is good when compared to that of Goodman Limited.

b. Out of the two companies, Goodman Limited and Kwiksave Limited, Kwiksave Limited is likely to be operating in a price competitive environment due to its good liquidity in terms of Average collection period and average days in inventory. Proper management of working capital is essential to a company's fundamental financial health and operational success as a business. Efficient working capital managment helps maintain smooth operations and can also help to improve the company's earnings and profitability. Due to high inventory outstanding, Goodman Limited has not been able to quickly turn its inventory into sales. This can be due to poor sales performance or the purchase of too much inventory. Having too much idle inventory is detrimental to a company as inventory may eventually become obsolete and unsellable and can effect the cashflow. As we can see how even when Goodman Limited has high Gross profit margin but ended up having equal net profit margin to Kwiksave limited due to poor liquidity which could have caused to incur higher expenditure such as Inventory storage costs like Warehouse rent, etc.