EXAM NUMBER: LK353 STUDENT ID: 090204427
FINANCIAL ACCOUNTING COURSEWORK PART A
i)
FINANCIAL ACCOUNTING COURSEWORK PART A
ii)
FINANCIAL ACCOUNTING COURSEWORK PART A
iii)
FINANCIAL ACCOUNTING COURSEWORK PART B
Task 1
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Task 2
Fab Footwear Limited
COMMENTS ON CASH FLOW INFORMATION REVEALED BY CASH FLOW
STATEMENTS
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Based on the cash flow statement, the company’s net cash flow position has deteriorated considerably for the period ended 2008/09 compared to 2007/08, where net decrease in cash has increased overwhelmingly to £1,070,000, from £10,000, an increase of 10,600%.
Closer examination has revealed: Cash inflow generation from operation has increased significantly by 30% to £860,000 (2008/09) from £660,000, despite dramatic increase in stock by 320% from (£100,000 to £420,000), and trade debtors by 133% from (£180,000 to £420,000) in the period, which adversely affected the cash inflow from the operation. If these increases did not occur, this amount would be considerably more. Regardless of this favourable increase, the net cash inflow from the operation activities has decreased noticeably by 35% to £300,000 in 2008/9 (£460,000 in 2007/08). The reason for this is because of significant increases in: interest expenses to £300,000 that is 200%, tax payments of 250% to £140,000 and dividend payments of 100% to 120,000.
The net cash outflow from investing activities has increased dramatically from £270,000 in 2007/08 to £1,370,000 an increase of 407%, of which payments to acquire tangible non-current assets are responsible for this outflow. It appears that this was financed entirely from operating cash inflows. Financing activities net cash outflows has only recorded loan repayment of £200,000 in 2007/08 and nil outflows for 2008/09.
Overall, the company’s net cash position has worsened in 2008/09 to overdraft of £1,060,000 from (cash of £10,000 in 2007/08), of which acquisition of tangible non-current assets, increase in stock and trade debtors, and increase in interest, tax payments and dividends are to be blamed from this worsening position.
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Task 2
NAME OF
RATIO
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CALCULATION
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RATIO
FOR
2008
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RATIO
FOR
2009
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EACH RATIO
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a)
Profitability
Sales Growth
Return on Shareholders’ Funds (ROSF)
Return on Capital Employed (ROCE)
Gross Profit
Margin
Net profit Margin
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Increase in sales x 100
Prior year sales
Profit before Tax x100
Shareholders’ Funds
Operating Profit x 100
Capital employed
Gross Profit x 100
Sales
Operating Profit x 100
Sales
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1000 x 100
2000
= 50%
600 x100
820
= 73%
700 x100
1020
= 69%
1600 x100
3000
=53%
700 x 100
3000
=23%
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1400 x 100
3000
= 47%
640 x 100
1100
= 58%
940 x 100
1300
= 72%
2000 x100
4400
= 46%
940 x 100
4400
= 22%
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Report
To: The Board of Directors of Fab Footwear Limited
Subject: Fab Footwear’s Profitability and liquidity Position
The purpose of this report is to explain the profitability and liquidity position of the company based on the accounting periods 2007/08 and 2008/09.
Profitability
The profitability ratios measure the level of return made by the company for the investors, and based on these main ratios; ROCE and ROSF, the company has performed impressive although, for ROSF has decreased slightly, that is 72% and 58% (2008/09), compared to 69% and 73% (2007/08) respectively. The contributory factor to these high returns stem from the strong sales growth of 47% in 2008/09 and 50% in 2007/08, of which gross profit margin represents 46% and 53%. Although these have decrease slightly in 2008/09 based on 2007/08 percentages, this is still considered to be significant. The net profit margin calculated is similar for both years that are 22/23% (£940,000 and £700,000 respectively), despite high provision for depreciation of £660,000 for new fixed acquired. It appears that the company is efficient in managing overhead cost at the same time. This is the reason for the strong ROCE. In the year 2008/09, interest cost has increased to £300,000 from £100,000; this contributes to the slight decrease the ROSF.
It should be noted that the definition of profit is the surplus of sales revenue over expenses, and the calculation of profit are base on accounting rules that includes items and provisions that are not cash, and as most sales are made on credit, profit calculated does not equates to cash.
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b)
Liquidity Ratio
Current Ratios
Acid Test Ratio/Liquidity
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Current Assets
Current Liabilities
Current Assets – Stock
Current Liabilities
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670
620
= 1.08: 1
670-180
620
= 0.8:1
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1520
1900
= 0.8:1
1520-600
1900
= 0.5: 1
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Liquidity
The liquidity ratios assess the company’s ability to meets its short-term obligations, by evaluation the short-term assets coverage short-term of liabilities. Both ratios; current ratio and the acid test ratio has indicated a strong weakness in this coverage based on reasonable coverage of 1.5:1, where current ratios coverage has decline from 1.08:1 to 0.8:1 time, and acid test ratio, assuming stock is slow moving, also decline from 0.8:1 to 0.5:1 coverage in 2008/09. Regardless of the significant increase in current assets’ stocks to £420,000 and trade debtors to £420,000, totalling £840,000; for greater increase current liabilities’ because of the bank overdraft borrowing (£1,060,000) and accruals (£100,000), totalling £1,160,000 in 2008/09 have override such increase, of which contribute to the worsening position. In 2008/09, the company has a bank overdraft of £1,060,000 compared to £10,000 cash in 2007/08.
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c)
Efficiency
Stock Turnover
Debtors Collection Period
Creditors Payment Period
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Cost of Sales
Stock
Trade Debtor x 365
Sales
Trade Creditors x 365
Cost of Sales
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1400
180
= 7.8 time
380 x 365
3000
= 46 Days
160 x 365
1400
=42 Days
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2400
600
= 4 times
800 x365
4400
= 66 Days
180 x 365
2400
=27 Days
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Efficiency
The company has show signs of weaknesses in moving stock in general. This has decrease from 7.8 times in 2007/08 to 4 times. In addition, collection of from trade debtors has also worsened from 46 days to 66 days, with improvement in creditors payments, from 42 days to 27 days. These weaknesses would have adverse contribution to cash position, because cash are tied up in stock and trade debtors.
The company is facing a serious problem where short-term liquidity is concern as the bank overdraft is not secured and usually temporary. If action is not taken, the company may not have enough cash to pay creditors and meet loan interest obligation. The company should take action to secure additional finance either from shareholders or borrowing, as well as corrective measures to improve working capital.
Conclusion
The company is overtrading, where the impressive massive sales growth, is caused by credit sales instead of cash that contributes to the high investors’ return. The short-term liquidity is very poor because of the company inefficiencies in working capital management, and the financing of non-current assets acquisition from operation cash inflows, instead of alternative financing.
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