Financial management revision question and answer

CPA-Financial-Management-Section-3 Revision kit

Three years ago, Mrs. Rehema Waziri was retrenched from the Civil Service. She invested substantially all her terminal benefits in the shares of ABC Ltd., a company quoted on the stock exchange. The dividend payments from this investment makes up a significant position of Mrs Waziri‟s income. She was alarmed when ABC Ltd. dropped its year 2001 dividend to Sh.1.25 per share from Sh.1.75 per share which it had paid in the previous two years.

Mrs Waziri has approached you for advice and you have gathered the information given below regarding the financial condition of ABC Ltd. and the finance sector as a whole.

ABC Ltd. Balance Sheets as at 31 October


ABC Ltd. Income Statements for the year ending 31 October


Industry Financial Ratios (2001)
Quick ratio 1.0
Current ratio 2.7
Inventory turnover 7 times
Average collection period 32 days
Fixed asset turnover 13.0 times
Total assets turnover 2.6 times

Industry Financial rations
Net income to net worth 1.8%
Net profit margin on sales 3.5%
Price-Earnings (P/E) ratio 6 times
Debt/Equity ratio 50%
Notes:
1. Industry ratios have been roughly constant for the past four years.

2. Inventory turnover, total assets turnover and fixed assets turnover are based on the year-end balance sheet figures.

Required:
(a) The financial ratios for ABC Ltd for the past three years corresponding to industry ratios given above.

(b) Arrange the ratios calculated in (a) above in columnar form and summarise the strengths and weaknesses revealed these ratios based on:

(i) Trends in the firm‟s ratios
(ii) Comparison with industry averages.

(The summary should focus on the liquidity, profitability and turnover ratios).
ANSWER


(b) Liquidity
• Is indicated quick ratio and current ratio
• Trend wise the company liquidity deteriorated
• Compared to industry ratios are below the norm. Company‟s liquidity is below industry norm.

Profitability is indicated net income to networth and profit margins on sales
• Trend wise it is clear the company‟s profitability has declined over the years
• Cross-section wise the company is performing below the industry norm.
• Turnover (activity) is indicated the turnover ratios and average collection period

Trend wise

The inventory turnover has declined alarmingly. The average collection period has also alarmingly increased. The FA turnover has been stable while total asset turnover has declined. The company is deteriorating in its use of assets.

Cross section wise
The company ratios are below average

Conclusion
The company is indeed facing due financial times. All indications are that a restructuring is necessary.

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