Financial management revision question and answer

The following are the financial statements of Richardo Ltd. for the year ended 31 March 1995:

All sales are net and on credit.
The following industry ratios are also provided to you.

Required
(a) Calculate the ratios shown above for Richardo Ltd. and present them in columnar form along the industry averages.
(b) Comment upon the following about Richardo Ltd. in relation to the industry averages:
(i) Liquidity position
(ii) Financial risk
(iii) Overall performance
ANSWER

Richardo Ltd Industry


(b) (i)Liquidity position
– This is shown current and acid test ratios
– Both ratios are lower than industrial average
– This could indicate a poor working capital policy with high liquidity risk

(ii) Financial risk
– This is shown gearing ratios in particular times interest earned ratio
– The ratio is lower than industrial average indicating high interest charges (high gearing) or low gearing profits. The gearing (debt – equity ratio) is 16001500 =1.07 times which is relatively high.
– The firm is financing most of its assets using borrowed debt capital.

(iii) Overall performance
– The performance is shown profitability ratios which include net profit margin, return on equity and return on investment. The ratios are higher than industrial average.
– The firm is therefore able to generate high returns on its capital and sales. The firm has high profitability yet its financial risk and gearing are high. It is therefore a high risk, high return investment.

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