Question Tag: Liquidity Ratio

b)
Assessment of Liquidity and Profitability

i) Liquidity:

• Danyi:
  Danyi has a strong liquidity position with a current ratio of 3.33:1 and a liquid ratio of 2.78:1. This suggests that Danyi has sufficient liquid assets to cover its current liabilities and is in a good position to meet short-term obligations.
• Napo:
  Napo’s liquidity is much weaker, with a current ratio of 1.00:1 and a liquid ratio of 0.62:1. This indicates that Napo may struggle to cover its current liabilities, especially when inventory is excluded from liquid assets.

ii) Profitability:

• Danyi:
  Danyi has a gross profit margin of 50.00% and a net profit margin of 18.75%. The ROCE of 21.43% suggests that Danyi is generating a decent return on the capital employed, though it is lower than Napo’s.
• Napo:
  Napo demonstrates higher profitability with a gross profit margin of 55.00% and a net profit margin of 27.50%. The ROCE of 31.43% indicates that Napo is using its capital more efficiently to generate profits compared to Danyi.

(8 marks)

c)
Advice to Management

• For Danyi:
  1. Improve Inventory Management: Danyi should consider reducing its inventory levels to further improve its liquidity and increase the efficiency of its operations.
  2. Enhance Profit Margins: Danyi may need to focus on increasing its net profit margin by either reducing operating expenses or improving sales pricing strategies.
  3. Invest Surplus Cash: Given Danyi’s strong liquidity, the management should consider investing surplus cash in revenue-generating opportunities to enhance profitability.
• For Napo:
  1. Strengthen Liquidity: Napo should prioritize improving its liquidity by tightening credit control, collecting receivables more efficiently, and reducing reliance on bank overdrafts.
  2. Review Cost Structure: Napo should carefully review its cost structure to ensure that operating expenses do not erode profitability, particularly focusing on cost control measures.
  3. Optimize Working Capital: Napo should work towards optimizing its working capital by reducing inventory levels and improving cash flow management.