- 20 Marks
Question
BB is the owner of a business supplying goods to other traders. He has just received the financial accounts for his business for the year ended 31st December 2014 from his accountant. These are reproduced below.
Income Statement for the year ended 31st December 2014
| Description | GH¢ |
|---|---|
| Sales | 400,000 |
| Cost of sales | (300,000) |
| Gross Profit | 100,000 |
| Expenses | (70,000) |
| Net Profit | 30,000 |
Statement of Financial Position as at 31st December 2014
Note: Inventory on 1st January 2014 was valued at GH¢48,000.
BB has also obtained comparative information about a competitor for the year ended 31st December 2014.
| Description | Competitor |
|---|---|
| Net profit margin | 6% |
| Return on capital employed | 10.50% |
| Current ratio | 4.2:1 |
| Liquid (acid test) ratio | 0.3:1 |
| Rate of inventory turnover | 4 times |
Required:
a) Calculate for BB each of the following ratios for the year ended 31st December 2014 (where appropriate, calculations should be approximated to two decimal places):
i) Net profit margin. (2 marks)
ii) Return on capital employed (using the closing year end value for capital employed). (2 marks)
iii) Current ratio. (2 marks)
iv) Liquid (acid test) ratio. (2 marks)
v) Rate of inventory turnover. (2 marks)
b) Based on the ratios calculated in part (a) and all other information provided, demonstrate the performance (profitability and liquidity) of BB’s business. (10 marks)
Answer
a) Financial Ratios for BB’s Business
Net profit as a percentage of sales = 4.65%
Return on capital employed = 15.11%
Current ratio = 7.89:1
Liquid (acid test) ratio = 1.78:1
Rate of inventory turnover = 6 times
b) Performance Analysis
BB’s business shows strong profitability, with a Net Profit Margin of 7.50%, which is lower than the competitor’s 6%. However, BB’s Return on Capital Employed (ROCE) is higher at 15.11% compared to the competitor’s 10.50%, indicating efficient use of capital in generating profits.
BB’s liquidity position is robust, with a Current Ratio of 7.89:1 and a Liquid Ratio of 1.78:1, both significantly higher than the competitor’s ratios. This indicates that BB’s business is more capable of covering short-term liabilities with available assets, demonstrating a healthier liquidity position.
The Rate of Inventory Turnover is also higher for BB at 6 times compared to the competitor’s 4 times, suggesting that BB is more efficient in managing and selling inventory.
Overall, while BB’s net profit margin is slightly lower, the business is outperforming the competitor in terms of capital efficiency, liquidity, and inventory management, indicating a strong operational performance.
- Tags: Financial Ratios, Liquidity, Performance Comparison, Profitability
- Level: Level 1
- Uploader: Theophilus