The most recent balance sheet for Supremo Ltd is presented here below

The most recent balance sheet for Supremo Ltd is presented here below

The company is about to embark on an advertising campaign which is expected to raise sales from their present level of Sh.27.5 million to Sh.38.5 million the end of next financial year. The firm is presently operating at full capacity and will have to increase its investment in both current and fixed assets to support the projected level of sales. It is estimated that both categories of assets will rise in direct proportion to the projected increase in sales.

For the year just ended, the firm‟s net profits were 6% of the year‟s sales but are expected to rise to 7% of projected sales. To help support its anticipated growth in assets needs next year the firm has suspended plans to pay cash dividends to its shareholders. In years past, a dividend of Sh.6.60 per share has been paid annually.

Supremo‟s trade creditors and accrued expenses are expected to vary directly with sales. In addition, notes payable will be used to supply the added funds to finance next years operations that are not forthcoming from other sources.

Required:
a) i)Estimate the amount of additional funds to be raised through notes payable.

ii) What one fundamental assumption have you made in making your estimate?

b) Prepare pro-forma balance sheet of Supremo Ltd. on 30 November 1996.
c) i)Calculate and compare Supremo Ltd.‟s current and debt ratios before and after
growth in sales.
ii) What was the effect of the expanded sales on these two dimensions of Supremo‟s financial condition?
ANSWER

Since the firm has suspended payment of cash dividend then all net profit shall be retained earnings.

a) Identify item in balance sheet that vary with sales.


Fundamental Assumption
3. There is no inflation

After the growth in sales there was increase in current liabilities due to external financing using notes payable. This tend to decrease current ratio and increase in debt ratio of the firm i.e after growth in sales 62.7% of total assets were financed with short term and long term liabilities while the remaining 37.3% were financed with owners equity.

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