Income statement and balance sheet, Financial Management

The following are extracts of the Income Statement and Balance Sheet for Umar plc.

Extract Balance Sheet at 30 June

20X2               20X1

£'000  £'000                £'000  £'000

Current assets      

Inventories                                                                             84                                74

Trade receivables                                                                    58                                46

Bank                                                                                     6                                10                                                                                                               148                              130

Current liabilities      

Trade payables                                                                        72                                82

Taxation                                                                                 20                                20

                                                                                            92                                102

Net current assets                                                                   56                                  -

Extract Income Statement for the year ended 30 June

                                                                                         20X2               20X1

                                                                                    £'000  £'000         £'000  £'000

Turnover                                                                            418                   392

Opening inventory                                                                74                      58

Purchases                                                                           324                  318

                                                                                        398                  376

Closing inventory          (84)                              (74)

                                 104                              314

                                  302                             90

Gross profit                                                                           

Calculate and comment on the following ratios for Umar plc:

1 Current ratio

2 Quick ratio

3 Inventory days

4 Trade receivable days

5 Trade payable days

6 Working capital cycle in days

Solution:

1 Current ratio   = 148 / 92 = 1.61   for 20X2

=130 / 102 = 1.27   for 20X1

Current ratio has increased, meaning that organisation is more liquid. This is because of the fact that inventory and trade receivables have increased (which are non-productive assets) and trade payables have been reduced. While this may be better for the current ratio, it may not necessarily mean that company is operating more efficiently. Has it increased its inventory piles since it anticipates higher sales and doesn't want to run out? Is it offering its credit customers longer time to pay to increase sales? Why are they paying their suppliers quicker? Certainly it would be better to take as long as possible?

2 Quick ratio      = (148 -84) / 92 =   0.70  for 20X2

= (130 -74) / 102 =   0.55  for 20X1

In 20X2 current liabilities are better covered than 20X1. Bad management of working capital perhaps...investigate further.

3 Inventory days=  (74 + 84) x 0.5 / 314 x 365 days =  91.8 days for 20X2

=  (58 + 74) x 0.5 / 302 x 365 days =   79.8 days for 20X1

Inventory is taking longer to sell; this could indicate poor inventory management. Why have inventory levels risen? Maybe company is taking a cautious approach and wants to ensure enough is available to meet customer needs. Though this is resulting in additional costs (unproductive asset)

4 Trade receivable days = 58/ 418 x 365 days = 50.6 days for 20X2

= 46 / 392 x 365 days= 42.8 days for 20X1

The collection of debts is worsening. Have the credit terms been extended to increase sales. Are there new customers who weren't screened properly, resulting in delayed payments? Is there a delay in issuing invoices, lack of screening new customers? Are the yearend figures representatives of year? Perhaps there are seasonal fluctuations which need to be considered. Further investigation required as yet again this is an unproductive asset.

5 Trade payable days     = 72 / 324 x 365 = 81.1 days for 20X2

= 82 / 318 x 365 = 94.1days for 20X1

(Alternatively could have used cost of sales)

Suppliers are being paid quicker, which is good for relationship with suppliers though bad for cash flow purposes. It is still quite high and might jeopardise supplier relationship, discounts foregone etc. Trade credit is a free source of finance and company should try to maximise this.

6 Working capital cycle

20X2    20X1

Inventories days                                                          91.8    79.8

Plus        

Trade receivables days                                                50.6    42.8

Minus

Trade payables days                                                    (81.1)    (94.1)

Equals

Working capital cycle (in days)                                  61.3    28.5

In  20X2,  working  capital  cycle  increased  to  61.3  days  from  28.5  days  in  20X1. Company is taking longer to covert its inventories into cash. Management of inventories, receivables and payables has deteriorated and this needs to be investigated and corrected.

Posted Date: 8/30/2013 2:59:41 AM | Location : United States







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