Question Tag: Return on Capital Employed

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  • 20 Marks

MA – Nov 2019 – L2 – Q1a – Performance analysis

Calculation of key financial ratios for GRAT Authority and evaluation of financial performance from 2017 to 2018.

GRAT Authority operates passenger railway services and is responsible for the maintenance of track signaling equipment, and other facilities such as stations. In recent years it has been criticized for providing poor services to the traveling public in terms of punctuality, safety, and the standard of facilities offered to passengers. Last year, GRAT Authority invested over GH¢20 million in new carriages, station facilities, and track maintenance programs in an attempt to address these criticisms.

Summarized financial results for GRAT Authority for the last two years are given below:

Extracts of Statement of Profit or Loss account for the year ended 31 December

Statement of Financial Position as at 31 December

Required:

a) Calculate the following ratios for GRAT Authority for 2017 and 2018, clearly showing your workings.

i) Return on capital employed (ROCE)
ii) Net profit margin
iii) Asset turnover
iv) Current ratio

b) Evaluate the financial performance of the entity in 2017 and 2018 as revealed by the above ratios.

c) Suggest THREE (3) non-financial indicators that could be useful in measuring the performance of a passenger railway service and explain why your chosen indicators are important.

d) Explain the term short-termism and suggest ways in which a long-term view can be encouraged.
(Total: 20 marks)

a) Financial ratios

(2 marks each for every ratio calculated = 8 marks)

b) Profitability

  • Return on capital employed has fallen from 2017 to 2018, caused by a decrease in operating profit and an increase in capital employed. The fall in operating profit may have been caused by an increase in costs, while the new investment program will have caused an increase in capital employed.
  • Asset turnover has fallen. Sales have only increased by 2.8% between 2017 and 2018, so the new investment program may not yet have had a significant effect on sales.
  • In the short term, the investment program has increased assets and costs but has not yet influenced sales.

    • (4 marks)

  • Liquidity: The current ratio has deteriorated, so the firm’s ability to meet its short-term obligations from its short-term resources has been reduced. The expenditure on the investment program may have decreased the cash balance between 2017 and 2018, causing the deterioration in liquidity.

(2 marks)

c)

d) Short-termism is when there is a bias toward short-term rather than long-term performance.
Steps that could be taken to encourage managers to take a long-term view include:

  • Making short-term targets realistic. If budget targets are unrealistically tough, a manager will be forced to make trade-offs between the short and long term.
  • Providing sufficient management information to allow managers to see what trade-offs they are making.
  • Evaluating managers’ performance in terms of contribution to long-term objectives.
  • Linking managers’ rewards to share price to encourage goal congruence.
  • Setting quality-based targets as well as financial targets.

(Any 2 points for 2 marks)

  • 20 Marks

FR – Nov 2021 – L2 – Q4 -Financial Statement Analysis

Analysis of financial ratios and performance of Bebebe Ltd for 2019 and 2020.

The following are the accounts of Bebebe Ltd (Bebebe), a company that manufactures playground equipment for the year ended 30 November 2020.

Statement of Comprehensive Income for the year ended 30 November:

Required:

a) Calculate, for both years, the return on equity and the return on capital employed. (4 marks)

b) Calculate, for both years, TWO (2) investment ratios to a potential investor. (4 marks)

c) Calculate, for both years, TWO (2) ratios of interest to a potential long-term lender. (4 marks)

d) Comment on the performance of Bebebe to a potential shareholder and lender using the ratios calculated above. (5 marks)

e) Explain THREE (3) weaknesses in these ratios.

(3 marks)

From the viewpoint of a potential shareholder who would be interested in the returns on their investment, ratios such as Return on Equity (ROE), Dividend per Share (DPS), and Earnings per Share (EPS) are crucial.

  • The ROE has improved from 15.93% in 2019 to 19.4% in 2020, indicating better utilization of shareholders’ funds.
  • EPS increased from GH¢0.30 to GH¢0.43, which could boost shareholder confidence as it suggests that the company is generating higher earnings per share.

From the viewpoint of a potential lender, the company’s Interest Cover ratio and Debt/Equity ratio would be key indicators of its ability to meet debt obligations:

  • Interest Cover has increased from 10.5 times in 2019 to 12.9 times in 2020, suggesting that the company is generating sufficient profits to cover its interest payments comfortably.
  • The Debt/Equity ratio decreased from 26.55% to 22.39%, indicating a decrease in financial risk as the company relies less on debt relative to equity.

e) Weaknesses in Ratios:

  1. Historical Nature:
    Ratios are based on historical financial information, and therefore may not reflect future performance.
  2. Comparability Issues:
    Different companies use different accounting policies, which can affect the comparability of ratios, such as using different depreciation methods.
  3. Industry Differences:
    Ratios may vary significantly across different industries, making it difficult to benchmark a company’s performance against others outside of its industry.
  • 20 Marks

FR – Nov 2015 – L2 – Q2 – Financial Statement Analysis

This question requires calculating financial ratios and analyzing Kack Ltd's financial performance and position for the year ended 31 March 2015 compared to the previous year.

Kack Ltd is a listed company that assembles domestic electrical goods which it then sells to both wholesale and retail customers. Kack Ltd’s management was disappointed in the company’s results for the year ended 31 March 2014. In an attempt to improve performance, the following measures were taken early in the year ended 31 March 2015:

  • A national advertising campaign was undertaken.
  • Rebates to all wholesale customers purchasing goods above set quantity levels were introduced.
  • The assembly of certain lines ceased and was replaced by bought-in completed products. This allowed Kack Ltd to dispose of surplus plant.

Kack Ltd’s summarised financial statements for the year ended 31 March 2015 are set out below:

STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME
FOR THE YEAR ENDED 31 MARCH 2015

Description GHSm
Revenue (25% cash sales) 4,000
Cost of sales (3,450)
Gross profit 550
Operating expenses (370)
Operating profit 180
Profit on disposal of plant (note (i)) 40
Financial charges (20)
Profit before tax 200
Income tax expense (50)
Profit for the year 150

STATEMENT OF FINANCIAL POSITION
AS AT 31 MARCH 2015

Description GHSm GHSm
Non-current assets
Property, plant, and equipment (note (ii)) 550
Current assets
Inventory 250
Trade receivables 360
Bank nil
Total current assets 610
Total assets 1,160
Equity and liabilities
Equity
Stated capital (400m shares) 100
Income surplus 380
Total equity 480
Non-current liabilities
8% loan notes 200
Current liabilities
Bank overdraft 10
Trade payables 430
Current tax payables 40
Total current liabilities 480
Total equity and liabilities 1,160

Below are ratios calculated for the year ended 31 March 2014:

  • Return on year-end capital employed (profit before interest and tax over total assets less current liabilities): 28.1%
  • Net assets (equal to capital employed) turnover: 4 times
  • Gross profit margin: 17%
  • Net profit (before tax) margin: 6.3%
  • Current ratio: 1.6:1
  • Closing inventory holding period: 46 days
  • Trade receivables’ collection period: 45 days
  • Trade payables’ payment period: 55 days
  • Dividend yield: 3.75%
  • Dividend cover: 2 times

Notes:

  1. Kack Ltd received GHS 120 million from the sale of plant that had a carrying amount of GHS 80 million at the date of its sale.
  2. The market price of Kack Ltd’s share throughout the year averaged GHS 3.75 each.
  3. There were no issues or redemption of shares or loans during the year.
  4. Dividends paid during the year ended 31 March 2015 amounted to GHS 90 million, maintaining the same dividend paid in the year ended 31 March 2014.

Required:

a) Calculate ratios for the year ended 31 March 2015 (showing your workings) for Kack Ltd, equivalent to those provided above.
(10 marks)

b) Analyse the financial performance and position of Kack Ltd for the year ended 31 March 2015 compared to the previous year.
(10 marks)
(Total: 20 marks)

a) Ratios Calculation

Ratio Description Formula Calculation Result
Return on Capital Employed (ROCE) Profit before Interest and Tax / Total Assets – Total Current Liabilities 220 / 680 × 100 32.3%
Net assets turnover Turnover / Net Assets 4,000 / 680 5.9 times
Gross profit margin Gross Profit / Turnover 550 / 4,000 × 100 13.8%
Net profit margin Profit before Tax / Turnover 200 / 4,000 × 100 5%
Current ratio Current Assets / Current Liabilities 610 / 480 1.27:1
Closing inventory holding period Average Inventory / Cost of Sales × 365 250 / 3,450 × 365 26 days
Trade receivables collection period Trade Receivable / Credit Sales × 365 360 / 3,000 × 365 44 days
Trade payables payment period Trade Payables / Credit Purchase × 365 430 / 3,450 × 365 45 days
Dividend yield Dividend per Share / Market Price × 100 22.5 / 375 × 100 6%
Dividend cover Net Profit after Tax / Dividend Paid 150 / 90 1.67 times

b) Analysis of Financial Performance and Position

The first thing to notice about Kack’s results is that the ROCE has increased by 4.2 percentage points, from 28.1% to 32.3%. On the face of it, this is impressive. However, we have to take into account the fact that the capital employed has been reduced by the plant disposal and the net profit has been increased by the profit on disposal. So, the ROCE has been inflated by this transaction, and we should look at what the ROCE would have been without the disposal. Taking out the disposal gives us the following ratios:

Ratio Description Calculation Result
ROCE without disposal 180 / (680 + 80) × 100 23.7%
Net asset turnover without disposal 4,000 / 760 5.3 times
Net profit margin without disposal 160 / 4,000 × 100 4%

Comparing these ratios to those for the period ended 31 March 2014, we can see that ROCE has fallen. This fall has been occasioned by the fall in the net profit margin. The asset turnover has improved on the previous year after adding back the disposal.

The gross profit percentage is 3.2% down on the previous year. This is probably due to the rebates offered to wholesale customers, which will have increased sales at the expense of profitability. The replacement of some production lines by bought-in products will probably also have reduced profit margins. Sales may have been increased by the advertising campaign, but this has been an additional expense charged against the net profit.

Kack’s liquidity has also declined over the current year. The current ratio has gone down from 1.6 to 1.3. However, there has been a sharp decline in the inventory holding period, probably due to holding less raw material for production. It could be that the finished goods can be delivered directly to the wholesalers from the supplier, reducing the current ratio. The receivables collection period has remained fairly constant, but the payables payment period has decreased by 10 days. This fall in the payables period may indicate that the finished goods supplier demands prompt payment. The liquidity situation would have been much worse without the GHS 120 million from the plant sale.

The dividend yield has increased from 3.75% to 6%, which looks attractive to potential investors. However, the dividend amount is the same as last year, meaning that the dividend per share is unchanged. Therefore, the increase in dividend yield can only have come from a fall in the share price, which reflects the market’s dissatisfaction with Kack’s performance. Furthermore, the dividend cover has declined, indicating that the same dividend has been paid on less profit.

Conclusion: Kack’s overall performance and position have declined compared to the previous year, and the plant disposal has helped mask the underlying issues.

  • 15 Marks

CR – May 2019 – L3 – Q4 – Analysis and interpretation of financial statements

The question requires calculation of financial ratios and analysis of the financial performance and cash position of Madina Ltd for the year ended 30 September 2018.

Below are the recently issued financial statements of Madina Ltd, a listed company, for the year ended 30 September 2018, together with comparatives for 2017.

Statement of Profit or Loss for the year ended 30 September:

Details 2018 (GH¢’000) 2017 (GH¢’000)
Revenue 125,000 90,000
Cost of Sales (100,000) (75,000)
Gross Profit 25,000 15,000
Operating Expenses (13,000) (11,000)
Finance Costs (4,000) –
Profit before Tax 8,000 4,000
Tax (at 25%) (2,000) (1,000)
Profit for the year 6,000 3,000

Statement of Financial Position as at 30 September:

Details 2018 (GH¢’000) 2017 (GH¢’000)
Non-Current Assets
Property, Plant, and Equipment 105,000 45,000
Goodwill 5,000 –
Total Non-Current Assets 110,000 45,000
Current Assets
Inventory 12,500 7,500
Receivables 6,500 4,000
Bank – 7,000
Total Current Assets 19,000 18,500
Total Assets 129,000 63,500
Equity and Liabilities
Equity
Share Capital 50,000 50,000
Retained Earnings 7,000 6,000
Total Equity 57,000 56,000
Non-Current Liabilities
8% Loan Notes 50,000 –
Current Liabilities
Bank Overdraft 8,500 –
Trade Payables 11,500 6,500
Current Tax Payable 2,000 1,000
Total Current Liabilities 22,000 7,500
Total Equity and Liabilities 129,000 63,500

Additional Information:

  • On 1 October 2017, Madina Ltd acquired 100% of the net assets of Aboabu Ltd for GH¢50 million. In order to finance this transaction, Madina Ltd issued GH¢50 million 8% loan notes on the acquisition date.
    Aboabu Ltd’s results for the year ended 30 September 2018 are shown below:

Aboabu Ltd’s Statement of Profit or Loss for the year ended 30 September:

Details GH¢’000
Revenue 35,000
Cost of Sales (20,000)
Gross Profit 15,000
Operating Expenses (4,000)
Profit before Tax 11,000
Tax (at 25%) (2,750)
Profit for the year 8,250
  • Aboabu Ltd has not paid any dividend during the year, but Madina Ltd paid a dividend of GH¢0.05 per share.
  • The following ratios have been calculated for Madina Ltd for the year ended 30 September 2017:
    • Return on capital employed: 7.1%
    • Gross profit margin: 16.7%
    • Net profit (before tax) margin: 4.4%

Required:

a) Calculate the equivalent ratios for Madina Ltd for 2018:
i) Including the results of Aboabu Ltd acquired during the year. (3 marks)
ii) Excluding all effects of the purchase of Aboabu Ltd. (3 marks)

b) Analyse the performance of Madina Ltd for the year ended 30 September 2018. (5 marks)

c) Analyse the cash position of Madina Ltd as at 30 September 2018. (4 marks)

a)

Madina Ltd

Equivalent ratios
i) Including Aboabu Ltd:

ii) Excluding the effects of Aboabu Ltd:

 

Candidates are to be mindful that the financial statements of Madina Ltd for the year
ended 30 September 2018 includes the results of Aboabu Ltd acquired during the year.
It is useful to re-draft a statement of profit or loss without the effects of Aboabu Ltd.

Statement of profit or loss

Note: Capital employed will be made up of share capital and retained earnings, as no
loan notes will exist without the purchase of Aboabu Ltd. Retained earnings without
Aboabu Ltd will actually be GH¢1.75 million. This can be calculated in two ways:

Closing retained earnings of GH¢7 million less GH¢8.25 million from Aboabu Ltd’s
profit, plus GH¢3 million increase in profit after tax relating to the interest on the loan
notes (GH¢4 million interest saved less GH¢3 million tax relief at 25%).

An alternative calculation of retained earnings would be GH¢6 million in 2017 plus
GH¢0.75 million from Madina Ltd’s profit excluding Aboabu Ltd less GH¢5 million
dividend (GH¢0.05 per share), which would also give GH¢1.75 million.

A final alternative calculation of retained earnings would be closing retained earnings
of GH¢7 million less the original profit of GH¢6 million plus the GH¢0.75 million
profit excluding Aboabu Ltd, to give GH¢1.75 million.

 

Part (b) Performance Analysis

The acquisition of Aboabu Ltd has significantly improved the overall financial performance of Madina Ltd. Key observations include:

  • Revenue Growth: Including Aboabu Ltd, revenue increased by GH¢35 million (from GH¢90 million in 2017 to GH¢125 million in 2018, and an additional GH¢35 million from Aboabu Ltd).
  • Profitability: The gross profit margin increased from 16.7% in 2017 to 25% in 2018 (including Aboabu Ltd). Without Aboabu Ltd, the gross profit margin would still have improved to 20%.
  • Efficiency: The return on capital employed (ROCE) shows a substantial improvement, rising from 7.1% in 2017 to 21.5% in 2018 when including Aboabu Ltd. Without the acquisition, ROCE would still show an improvement at 11.2%.
  • The acquisition positively impacted profitability and capital efficiency, contributing to the overall growth of the company.

Part (c) Cash Position Analysis

  • Bank Overdraft: The company has moved from a cash surplus position in 2017 (GH¢7 million) to a significant bank overdraft of GH¢8.5 million in 2018. This indicates a potential liquidity issue.
  • Current Liabilities: The increase in trade payables (from GH¢6.5 million to GH¢11.5 million) suggests the company is relying more on credit from suppliers to finance operations.
  • Acquisition Financing: The acquisition of Aboabu Ltd was financed by issuing GH¢50 million 8% loan notes. This increased non-current liabilities but also resulted in higher finance costs (GH¢4 million).
  • Working Capital Management: Despite the acquisition, the current ratio has deteriorated. In 2017, current assets of GH¢18.5 million exceeded current liabilities of GH¢7.5 million, whereas in 2018, current assets of GH¢19 million are lower than current liabilities of GH¢22 million. This indicates potential liquidity risks and a strain on short-term cash flow.

 

  • 20 Marks

FM – March 2023 – L2 – Q4 – DCF: taxation and inflation | Introduction to Investment Appraisal

Explain the stages in the capital investment decision-making process, compute the discounted payback period and Return on Capital Employed for an investment proposal, and describe categories of financial markets with examples.

a) Explain the stages in the Capital Investment decision-making process. (5 marks)

b) Dragon Ltd is evaluating an investment proposal to manufacture a product called “Chiputronic” and the information below has been provided by the Research and Development team:

  • Initial Investment: GH¢4 million
  • Selling Price (current price terms): GH¢40 per unit
  • Expected Selling Price Inflation: 3% per annum
  • Variable Operating Cost (current price terms): GH¢16 per unit
  • Fixed Operating Cost (current price terms): GH¢340,000
  • Expected Operating Cost Inflation: 4% per annum
Year Annual Demand (units)
1 70,000
2 90,000
3 130,000
4 50,000

It is expected that whatever is produced will be sold with no stock left, and there will be no scrap value expected at the end of the four years. The discount rate used in the company is 15%.

Required:
i) Compute the discounted payback period. (5 marks)
ii) Calculate the Return on Capital Employed (Accounting Rate of Return) based on average investment. (5 marks)

c) Financial markets facilitate the interaction between those who need funds and those who have funds to invest.

Required:
Explain TWO (2) categories of financial markets and give TWO (2) examples of each. (5 marks)

a) The key stages in the Capital Investment decision-making process are as follows:

  1. Identifying Investment Opportunities:
    The first stage involves identifying potential investment opportunities. This could come from various sources such as the analysis of the business environment, research and development activities, or strategic objectives of the company.
  2. Screening Investment Proposals:
    Once potential investments have been identified, the next stage involves screening these proposals. This is done to ensure that the investment opportunities align with the available capital resources and the strategic objectives of the company.
  3. Analyzing and Evaluating Investment Proposals:
    At this stage, the selected investment proposals are subjected to thorough analysis and evaluation. This involves assessing the profitability, risk, and return associated with each investment. The evaluation may include various financial appraisal techniques such as Net Present Value (NPV), Internal Rate of Return (IRR), and Payback Period.
  4. Approving Investment Proposals:
    After analysis, the investment proposals that meet the required criteria are passed on to the relevant level of authority for approval. The decision to approve or reject a proposal is usually based on the recommendations from the analysis. High-value investments may require approval at the board level.
  5. Implementing and Monitoring the Investment:
    Once an investment proposal is approved, the necessary resources are allocated for implementation. The investment is then monitored continuously to ensure that it delivers the expected outcomes. This stage also involves reviewing the performance of the investment and making adjustments as necessary.

(Marks allocation: 1 mark for each stage = 5 marks)

b)

i) Computation of the discounted payback period:

Net Present Value: GH¢1,091,686
Discounted Payback Period: 2 + (1,379,417/1,946,723) = 2.71 years

(Marks are evenly spread using ticks = 5 marks)

ii) Return on Capital Employed (ROCE):
Total Accounting Profit:
Year 1=GH¢1,365,600

Less Total Depreciation (Total cost since no scrap value): GH¢4,000,000

Net Profit: GH¢3,135,750

Average Profit:


ROCE

 

c) Categories of Financial Markets:

  1. Money Market:
    Money markets are financial markets where short-term financial instruments are traded, typically with a maturity of one year or less.
    Examples: Government treasury bills, Commercial papers.
  2. Capital Market:
    Capital markets are financial markets where long-term financial instruments are traded, typically with a maturity of more than one year.
    Examples: Government bonds, Corporate bonds, Equities.

(Marks allocation: 2.5 marks for each market category with examples = 5 marks)

 

  • 10 Marks

FM – April 2022 – L2 – Q1b – Capital structure

Calculate the capital structure of Boom Ltd and determine the earnings required to achieve a 25% return for equity holders.

Boom Ltd is into the provision of online conference call facilities which has become popular due to the rising trend in Covid-19 cases in Ghana. The company has 10 million issued shares currently at GH¢50 each, 3 million preference shares trading at GH¢25 each, and 5,000 bonds also trading at GH¢600 each.

Required:
i) Calculate the Capital Structure of the Company. (4 marks)
ii) How much should the company earn annually to achieve a return of 25% per annum on capital employed for equity holders if the dividend rate on preference shares per annum is 20% and the coupon on the bonds is 18%? In Ghana, interest paid on debt is tax deductible and corporate tax is at 25%. (6 marks)

i)

Capital Structure Amount (GHS millions) Share (%)
Equity Shares (10 million x 50) 500 86.50
Preference Shares (3 million x 25) 75 12.98
Bonds (5,000 x 600) 3 0.52
Total 578 100

(4 marks)

i) The required annual return to satisfy providers of funds is calculated as follows:

Equity return x total equity/Total capital + Preference share return x preference shares/Total Capital + (Bonds return x net tax) x Bonds/Total Capital

= 21.62% + 2.85% + 0.07%
= 24.28%
Annual Return in GHS = 24.28/100 x 578m
= 140.338 million

(6 marks)

  • 20 Marks

FA – Mar 2024 – L1 – Q5 – Interpretation of financial statements (Financial Ratios)

Calculate financial ratios and report on the reasons for Ziekah Ltd's deteriorating cash flow.

You are the financial accountant for Ziekah Ltd, a company that manufactures household furniture. Ziekah Ltd has experienced both a reduction in sales revenue and cash flow during the last financial period. You are provided with the following information regarding Ziekah Ltd for the years ended 31 October 2022 and 2023:

Statement of Profit or Loss for Years Ended

2023 (GH¢000) 2022 (GH¢000)
Revenue 1,000 1,400
Cost of sales (600) (700)
Gross profit 400 700
Operating expenses (150) (280)
Operating profit 250 420
Interest on debentures (60) (100)
Profit before tax 190 320
Tax (24) (40)
Profit after tax 166 280

Statement of Financial Position as at

2023 (GH¢000) 2022 (GH¢000)
Non-current assets
Property, plant, and equipment 2,320 2,400
Intangible assets 1,300 800
Total non-current assets 3,620 3,200
Current assets
Inventory 82 78
Trade receivables 138 134
Bank – 300
Total current assets 220 512
Total assets 3,840 3,712
Equity and liabilities
Issued share capital 1,600 1,600
Retained earnings 1,224 1,058
Total equity 2,824 2,658
Non-current liabilities
10% Debentures 600 1,000
Current liabilities
Bank overdraft 342 –
Trade payables 74 54
Total current liabilities 416 54
Total equity and liabilities 3,840 3,712

Required:

a) Calculate the following ratios for both years:

  • i) Operating profit margin.
  • ii) Return on capital employed.
  • iii) Acid test ratio.
  • iv) Receivable days.

(8 marks)

b) Write a report to the Managing Director of Ziekah Ltd explaining why the cash flow of the company has deteriorated during the current financial year. You should base your report on both the ratios calculated in (a) and any additional information provided in the financial statements.

a) Calculation of Ratios

b) Report to the Managing Director of Ziekah Ltd

To: Managing Director, Ziekah Ltd
From: Financial Accountant
Date: March 2024
Subject: Analysis of Deteriorating Cash Flow

Introduction: The purpose of this report is to analyze the reasons for the deteriorating cash flow of Ziekah Ltd during the current financial year, based on the financial ratios calculated and other relevant information.

Analysis:

  1. Operating Profit Margin:
    • The operating profit margin has decreased from 30% in 2022 to 25% in 2023, indicating that the company is generating less profit from its revenue. This decline could be due to increased costs or lower sales prices, which has negatively impacted cash inflows.
  2. Return on Capital Employed (ROCE):
    • ROCE has dropped significantly from 10.91% in 2022 to 7.73% in 2023, reflecting a reduced efficiency in using capital to generate profits. This decrease suggests that the company’s investments are not yielding as high returns as they did in the previous year, which could be straining cash resources.
  3. Acid Test Ratio:
    • The acid test ratio has fallen sharply from 8.04:1 in 2022 to 0.33:1 in 2023, indicating a serious liquidity issue. The company’s ability to meet its short-term obligations without relying on inventory has drastically weakened, suggesting that cash flow is under significant pressure.
  4. Receivable Days:
    • The receivable days have increased from 34.93 days in 2022 to 50.37 days in 2023, meaning it is taking longer for the company to collect payments from customers. This delay in cash collection is likely contributing to the cash flow problems.

Conclusion: The analysis indicates that the company’s cash flow issues stem from a combination of reduced profitability, inefficiency in capital usage, poor liquidity, and slower customer payments. To address these issues, Ziekah Ltd may need to focus on cost control, improving operational efficiency, and enhancing its credit control procedures to accelerate cash collections.

Recommendations:

  1. Review and reduce operating expenses to improve profitability.
  2. Reassess capital investments to ensure they are generating adequate returns.
  3. Improve liquidity management by maintaining a better balance between current assets and liabilities.
  4. Implement stricter credit policies to reduce receivable days and improve cash inflows.
  • 20 Marks

FA – Nov 2023 – L1 – Q5 – Interpretation of financial statements (Financial Ratios)

Calculate and interpret financial performance ratios for Edumfa Ltd in comparison to a competitor.

The following summarised information is available in respect of Edumfa Ltd for the year ended 31 July 2022:

The performance ratios for a competitor company for the same period are as follows:

Description Ratio
Return On Capital Employed (ROCE) 25.2%
Asset turnover rate 1.06
Acid test ratio 0.9:1
Return on equity 31.5%
Receivables collection period 38 days

Required:

a) Calculate the performance indicators for Edumfa Ltd as shown for the comparable company. (10 marks)
b) Comment on the performance of Edumfa Ltd for the year ended 31 July 2022 using the information you calculated in (a) above. (10 marks)

a) Computation of Ratios for Edumfa Ltd

Total Marks for 5a: 10

b) Comments on the Performance of Edumfa Ltd:

  1. Return On Capital Employed (ROCE):
    • Edumfa Ltd’s ROCE is 21.38%, which is lower than the competitor’s 25.2%. This suggests that Edumfa Ltd is less efficient in generating profits from its capital employed compared to its competitor.
  2. Asset Turnover Rate:
    • Edumfa Ltd’s asset turnover rate of 1.14 is higher than the competitor’s 1.06. This indicates that Edumfa Ltd is more efficient in using its assets to generate sales compared to the competitor.
  3. Acid Test Ratio:
    • Edumfa Ltd’s acid test ratio is 2.09:1, significantly higher than the competitor’s 0.9:1. This suggests that Edumfa Ltd is in a stronger liquidity position, with more liquid assets available to cover its short-term liabilities.
  4. Return on Equity (ROE):
    • Edumfa Ltd’s ROE is 32.75%, slightly higher than the competitor’s 31.5%. This indicates that Edumfa Ltd is generating a higher return on shareholders’ equity compared to its competitor, which is a positive indicator for the company’s investors.
  5. Receivables Collection Period:
    • Edumfa Ltd’s receivables collection period is 58 days, which is longer than the competitor’s 38 days. This suggests that Edumfa Ltd takes longer to collect payments from its customers, which may indicate weaker credit control or more lenient credit terms compared to the competitor.

Total Marks for 5b: 10

  • 20 Marks

FA – Aug 2022 – L1 – Q5 – Interpretation of financial statements (Financial Ratios)

Calculation and comparison of financial ratios for two businesses to assess performance, followed by a discussion of which business is performing better.

a) Garu and Gushegu are two businesses that compete in the same market and have been trading for a number of years. The following information relates to their results for the year ended 31 December 2021:

Account Garu (GHȼ’000) Gushegu (GHȼ’000)
Sales 4,455 5,264
Cost of Sales 2,549 2,632
Net Profit 1,075 1,137
Inventory at 1 January 820 518
Inventory at 31 December 1,040 498
Capital Employed 2,428 1,953
Receivables 1,200 1,324
Bank 75 980
Payables 750 720

There are no other current assets or current liabilities.

Required:
Calculate the following ratios for each of the two businesses: i) Return on Capital Employed (ROCE)
ii) Gross Profit Margin
iii) Current Ratio
iv) Liquid (Acid Test) Ratio
v) Inventory Turnover
(10 marks)

b) Using the ratios calculated, discuss which of the two businesses appears to be performing better.
(10 marks)

b)
Performance Comparison of Garu and Gushegu

  • Return on Capital Employed (ROCE):
    Gushegu has a higher ROCE of 58.22% compared to Garu’s 44.28%. This indicates that Gushegu is more efficient in generating profit from its capital employed.
  • Gross Profit Margin:
    Gushegu’s gross profit margin of 50.00% is higher than Garu’s 42.78%, suggesting that Gushegu has better control over its cost of sales relative to its sales revenue.
  • Current Ratio:
    Gushegu has a better current ratio of 3.89:1 compared to Garu’s 3.09:1, indicating that Gushegu is in a stronger position to meet its short-term obligations with its current assets.
  • Liquid (Acid Test) Ratio:
    Gushegu also has a stronger acid test ratio of 3.2:1 compared to Garu’s 1.7:1. This suggests that Gushegu has a higher proportion of liquid assets to cover its current liabilities, which is a positive indicator of liquidity.
  • Inventory Turnover:
    Gushegu’s inventory turnover is significantly higher at 5.18 times compared to Garu’s 2.74 times. This indicates that Gushegu is more efficient in managing and selling its inventory, which can contribute to better cash flow and profitability.

Conclusion:
Based on the ratios calculated, Gushegu appears to be performing better overall compared to Garu. Gushegu has stronger profitability, liquidity, and inventory management, making it a more efficient and potentially more profitable business.

(10 marks evenly spread)

  • 20 Marks

FA – April 2022 – L1 – Q5 – Interpretation of financial statements (Financial Ratios)

Calculation and interpretation of key financial ratios for two companies to assess profitability and liquidity.`

The Statement of Profit or Loss and Statements of Financial Position of two manufacturing companies in the same sector are set out below:

Required:
a) Define and calculate the following ratios for each company:
i) Net profit percentage
ii) Return on capital employed
iii) Average receivables collection period
iv) Average payables period
v) Inventory turnover
(15 marks)

b) A not-for-profit organisation issues a different set of financial statements than the statements produced by a business organisation (profit making). When it comes to bookkeeping for a not-for-profit organisation, many processes remain the same as that of a business organisation. However, differences in terminology apply when managing the books of a not-for-profit organisation.

Required:
What terminology will be used for the following:
i) Profit for the period
ii) Loss for the period
iii) Equity reserve
(5 marks)

a) Calculation of Ratios for Kwansah Ltd and Ofori Ltd

i) Net Profit Percentage

b)
Terminology for Not-for-Profit Organisations

i) Profit for the Period
Surplus

ii) Loss for the Period
Deficit

iii) Equity Reserve
Accumulated Funds

(5 marks)

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