Cost of sales and functioning costs, Financial Management

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Entity A is significantly smaller than B in terms of revenue and would not impact LOP's revenue to the same extent. However A earns a noticeably better gross profit margin at 26% as opposite to 17% for B. A's margin is closer to LOP's and would have a less unenthusiastic impact. It maybe suggests that A has targeted a similar market to LOP, whereas B has focussed on income at the expense of margin - high volume / low margin strategy. On the other hand, it could indicate that the two entities categorize costs differently between cost of sales and other functioning costs - especially when we consider the difference in net profit margin.
Entity B earns an improved net profit at 11% and would have less impact on LOP's net margin. A's figure of 9% emerge very low with its GP at 26%. It could be that this is a minor entity and not able to take benefit of economies of scale, has high fixed costs or has poor cost control. A has high gearing and the associated finance costs are also include an impact on net profit.

The gearing of A would have a important consequence on the results of LOP as gearing is at 65% as opposed to B's gearing of 30% and LOP's 38%. However when we consider this mutually with the available lending rates, it perhaps propose that the management of A have shrewdly capitalised on low lending rates and funded the entity through exterior finance. The low gearing of B however, probably gives room to increase borrowing if necessary in the future.

The P/E ratio is a vital ratio for investors and LOP's ratio would be unfavourably affected by either acquisition. A's P/E ratio is significantly lower than B and LOP but it is difficult to make an evaluation of the applicable risk of the entities when they are judged by different markets.

(b)

The things are listed on different exchanges and so may prepare their monetary statements using different accounting standards. This will decrease the comparability of financial highlights. The ratios provided tell us nothing about the competence of the entities and the fit of management styles could be an imperative factor in a takeover situation. The entities could apply dissimilar accounting policies that could impact on the ratios, eg equity could be improve by a revaluation of non-current assets which would decrease the gearing ratio and could mask an enhance in borrowings.


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