QUESTION FOUR Your company is making a review of the financial performance for t
ID: 2814665 • Letter: Q
Question
QUESTION FOUR
Your company is making a review of the financial performance for the past three years and you have been called upon to interpret the ratios indicated in the table below. Comment of the profitability and asset management performance of the company for each of the three years using these ratios.(12 marks)
Company Ratio
2009
2010
2011
Current Ratio
1.4
0.8
0.4
Stock Turnover
9.2 times
11.4 times
10.5 times
Debtor Days
34 days
20 days
36 days
Creditor Days
40 days
40 days
50 days
Gross Profit margin
20%
30%
28%
Asset Turnover
K1.30
K1.10
K0.56
b) A colleague of yours recently retired and would like to start a business but is unsure of how to manage certain aspects of the business. You have been approached to advise your close colleague regarding this matter. Explain to your colleague how to manage Debtors and marketable securities in their business. (10 marks)
Company Ratio
2009
2010
2011
Current Ratio
1.4
0.8
0.4
Stock Turnover
9.2 times
11.4 times
10.5 times
Debtor Days
34 days
20 days
36 days
Creditor Days
40 days
40 days
50 days
Gross Profit margin
20%
30%
28%
Asset Turnover
K1.30
K1.10
K0.56
Explanation / Answer
a) When we talk about profitability we see that gross margin has improved from 20% to 28% which symbolises that company's profitability has increased over the years.
When we talk about asset management performance, we can say that company is not able to manage its assets properly. We can see that even with increased revenue which is evident from higher profitability ratio, the asset turnover ratio had gone down from 1.30 to 0.56 which shows poor utilisation of company's assets. Also the company's debtor days and credit days is increasing which symbolises that company is having trouble generating cash from debtor and its ability to pay creditors is also falling due to which the company Current liability is increasing and Current ratio i falling.
The only positive thing is that company's stock turnover ratio is improving which shows that company is able to manage its inventory more effectively.
b) When we talk about debtors, its important to provide goods on credit in order to increase sales, but its also important to manage debtors properly so that the money is recovered on time and the company is having sufficient money to pay its creditors. So in order to manage debtors, what we need to do is ensure we provide credit to very limited and trustworthy debtors and credit period should be lesser than the time period in which we need to pay creditors and we need to ensure that the debtor pays on time.
With regards to marketable securities, the company should park its surplus money into marketable securities to earn some investment income, but this should be the primary purpose of taking loans, that means only the money which are not required right now for few days may be few months, should be parked in marketable securities.