FR – MAY 2021 – L2 – Q4a – Performance Analysis

Analyze Zeus Ltd's performance and position from 2018 to 2020, including calculations.

Question

You are the Financial Controller of Konka Ltd. Zeus Ltd is a competitor in the same industry, and it has been operating for 20 years. Summaries of Zeus Ltd’s statements of profit or loss and financial position for the previous three years are given below.

Summarised Statement of Profit or Loss For the year ended 31 December

	2018	2019	2020
Revenue	840	981	913
Cost of sales	(554)	(645)	(590)
Gross profit	286	336	323
Administration and selling expenses	(186)	(214)	(219)
Profit before interest and taxes	100	122	104
Finance cost	(6)	(15)	(19)
Profit before taxation	94	107	85
Taxation	(45)	(52)	(45)
Profit after taxation	49	55	40
Dividends	24	24	24

Summarised Statement of Financial Position as at 31 December

	2018	2019	2020
Assets
Non-current assets
Intangible assets	36	40	48
Tangible assets at net book value	176	206	216
Total Non-current assets	212	246	264
Current assets
Inventories	237	303	294
Receivables	105	141	160
Bank	52	58	52
Total Current Assets	394	502	506
Total Assets	606	748	770

Equity and Liabilities
Equity
Stated capital	100	100	100
Retained earnings	299	330	346
Total Equity	399	430	446
Non-current liabilities
Long-term loans	74	138	138
Current liabilities
Trade payables	53	75	75
Other payables	80	105	111
Total Current Liabilities	133	180	186
Total Equity and Liabilities	606	748	770

Required:
a) Analyzing the performance and position of Zeus Ltd and showing any calculations in an appendix to this report.
(15 marks)

Answer

Performance Analysis of Zeus Ltd from 2018 to 2020

Profitability

The gross profit margin has remained relatively static over the three years, although it rose by approximately 1% in 2018. ROCE, while improving slightly in 2019 to 21.5%, has dropped dramatically in 2020 to 17.8%. The net profit margin has also fallen in 2020, despite the improvement in the gross profit margin. This marks a rise in expenses which suggests that they are not well controlled. The utilisation of assets compared to the turnover generated has also declined, reflecting the drop in trading activity between 2019 and 2020.

Operating Efficiency

It is apparent that there was a dramatic increase in trading activity between 2019 and 2020, but then a significant fall in 2020. As a result, revenue rose by 17% in 2019 but fell by 7% in 2020. The reasons for this fluctuation are unclear. It may be the effect of some kind of one-off event, or it may be the effect of a change in product mix. Whatever the reason, it appears that improved credit terms granted to customers (receivables payment period up from 46 to 64 days) have not stopped the drop in sales.

Liquidity

Both the current ratio and quick ratio demonstrate an adequate working capital situation, although the quick ratio showed a slight decline. This is because there has been an increased investment over the period in inventories and receivables, which has been only partly financed by longer payment periods to trade payables and a rise in other payables (mainly between 2019 and 2020).

Solvency

The level of gearing of the company increased when a further GH¢64 million was raised in long-term loans in 2020 to add to the GH¢74 million already in the statement of financial position. Although this does not seem to be a particularly high level of gearing, the debt/equity ratio rose from 18.5% to 32.0% in 2020. The interest charge has increased to GH¢19 million from GH¢6 million in 2019. The 2020 charge was GH¢15 million, suggesting that either the interest rate on the loan is flexible or that the full interest charge was not incurred in 2020. The new long-term loan appears to have funded the expansion in both fixed and current assets in 2020.

Appendix:

Ratio	2018	2019	2020
Gross profit margin	34.0%	34.30%	35.40%
ROCE	21.1%	21.50%	17.80%
Profit margin	11.9%	12.40%	11.40%
Assets turnover	1.78	1.73	1.56
Gearing ratio	15.6%	24.30%	23.60%
Debt/equity ratio	18.5%	32.00%	30.90%
Interest cover	16.7	8.1	5.5
Current ratio	3.0	2.8	2.7
Quick ratio	1.2	1.1	1.1
Receivables collection period (days)	46	52	64
Inventory turnover period (days)	156	171	182
Payables payment period (days)	35	42	46