Financial Reporting Questions and Answers

Questions

Answers:

Question 2

  1. Cash flow statement
RJV plc
Cash flow statement for the period ended 31st march 2014
Net profit 4,531
Adjusted for
Depreciation 16,401
Operating profit before working capital changes (20,932)
Net Cash Flow from operating activities
increase in inventory (1914)
increase in Trade Debtors (2288)
increase in bank overdraft 110
Increase in trade creditors 2,354 (1738)
19,194
Cash generated from operating activities
interest paid -2,608
Dividend paid -1,100
tax paid -5,500 (9,208)
9,986
Net Cash from investing activities
cash flow from acquisition of assets (103,675)
Net Cash from financing activities
Proceeds from issue of shares 61,163
Debentures 24,902
Proceeds from share premium 10,692 96,757
Net increase in cash flow 3,128
cash and cash equivalents at the end of the period 7,425
(4,297)

 

  1. Workings

Cash used for acquisition of fixed assets in the year

Plant and machinery at cost 2013                   143,000

Less accumulated depreciation                       11,099

Value at 2013                                                  131,901

Plant and machinery at cost 2014                   263,076

Accumulated depreciation                              27,500

Value at 2014                                                  235,576

Acquired assets 2014 = 235,576-131,901 = 103,675

Cash used on taxation

Bal from 2013  Bank                         8,800

Bal c/d                                                5,500

                                                           14,300

1 April 2013                                         8,800

P/L Appropriation                                5,500

 14,300

Bal b/d                       5,500

 

Cash raised from financing

Ordinary shares 2014 299,663 less ordinary shares 2013 (238,500) = 61,163

Share premium 2014 22,000 less share premium 2013 (11,308) = 10,692

Debentures 2014 32,602 less debentures 2013 (7,700) = 24,902

Question 3

a) Ratios

Working capital (current ratio)

Current ratio = current assets/current liabilities

= 43,890:22,880 = 1.92:1

Stock turnover (days)

Stock turnover = cost of sates/average stock

= 330,000/22,143 = 15

= 365 days/15 = 24 days

Debtors Payment period (days)

Debtors Payment period in days = (365 × Average debtors) ÷ sales

= (365 × 19,646)/440,000

= 16 days

Creditors Payment period (days)

Creditors Payment period = (365 × Average creditors)/sales

= (365 × 16,093)/440,000

= 13 days

Working capital operating cycle (days)

Working capital operating cycle = stock turnover + debtors collection period – creditors payment period

Working capital operating cycle = (24+16-14) days

= 26 days

Operating profit margin

Operating profit margin = (operating profit/sales) × 100

= (14,399/440,000) × 100 = 3.27%

Return on Capital Employed

Return on capital employed = (operating profit/total capital employed) × 100

Return on Capital Employed = (14,399/546,588) × 100 = 2.63%

Net asset turnover

Net asset turnover = Annual sales/net assets

= 440,000/546,588 = 0.8 times

b) Performance of RJV plc

Compared to the industry overall, RJV has performed below average in most of the ratios. In terms of profitability, RJV plc can be considered to be making profits because its profitability ratios are positive. However, the company performs poorly compared to the industry average. For instance, the net asset turnover of the company is lower than the industry’s mean performance (0.8 compared to industry’s mean of 0.94). In this case, RVJ a unit value of an asset results in 0.8 units of annual sales. Compared to the industry’s average performance, RVJ does not utilise its assets well like an average company in the industry. Furthermore, Return on capital employed of 2.63% is below the industry’s average of 4.7%. This means that the company gets less returns per capital or asset employed compared to the overall industry. The operating profit margin of 3.27% is also below the mean performance of the industry (5%). This shows that the company is poor in managing its cost of sales and operating costs compared to an average company in the industry.

In terms of liquidity, RVJ plc is more liquid than an average company in the industry because the current ratio of the company (1.92:1) is higher than the current ratio of the industry average (1.6:1).

In terms of efficiency, RVJ seems to be less efficient than average companies in the industry. This is because most of its efficiency ratios are less than the industry mean. For example, the working capital operating cycle of the company is 26 days compared to the industry’s mean of 12 days. This shows that the company does not manage its working capital operations efficiently compared to average companies in the industry. The company keeps stock longer than other average firms in the industry (24 days compared to 17 days of the industry) and pays creditors faster than average firms in the industry.

c) Relationship between ROCE, Operating profit margin, and net asset turnover

These ratios belong to the same class – profitability ratios. They are all based on how the company utilizes its capital or assets to get revenue and returns. ROCE determines the amount of profit that each asset provides the company while net assets turnover determines the amount of sales/revenue that each asset provides for the company (Bull, 2008). Operating profit margin determines how the company uses its working capital to make profits.

d) Ratios as a forecasting tool

Financial ratios can be used to compare the financial performance of a company from one year to another (Bull, 2008). Therefore, the financial performance of RVJ plc for 2015 can be predicted using its financial statements. The financial ratios above can be used to predict the company’s financial performance in 2015 because they may tell about the ability of the company to manage its financial activities in future. For instance, the current ratio for this year is higher than the mean of the overall industry. This shows that the company’s liquidity is good as it enters the financial year 2014/2015; hence it is able to meet its debts as they fall due. Furthermore, the assets can still be used to generate more revenue in 2015 because the current profitability ratios are positive, meaning that the company is still able to utilize its capital and assets to generate revenue and profits.

e) Non-financial information

There is additional non-financial information that can be used to assess the future performance of RVJ plc. This information includes the size of the firm and important assets such as corporate image, quality of products, customer loyalty, technological operations, etc (Hey-Cunningham, 2006). The market structure also determines future performance of the firm. If the company is a monopoly, it can still perform well in future even if the current year’s financial ratios are poor.

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