• 20 Marks

CR – Nov 2014 – L3 – SB – Q3 – Presentation of Financial Statements (IAS 1)

Analyze Prochain Plc’s financial performance and calculate key ratios for loan covenants.

Prochain Plc

The Directors of Prochain Plc have pursued an aggressive policy of expansion in the last two years. They have developed several new products and market share has increased.

The financial statements for the year ended 31 December 2013, which will be presented to the Board of Directors at its next meeting, are being finalised. The financial statements at the year-end are presented below:

Statement of profit or loss and other comprehensive income for the year ended 31 December

The results of the company as well as certain key ratios that will form part of the covenants in respect of the loan facilities will be discussed at the Board of Directors meeting.

Notes:

  1. The movement on the revaluation reserve relates to property, plant, and equipment revalued in the year.
  2. The movement on other reserves relates to the gains on the investments available for sale.
  3. The bonds are repayable on 1 July 2015.

Required:

(a) Based on the results of Prochain Plc for the year ended 31 December 2013, calculate the key ratios for the loan.
(8 Marks)

(b) Prepare a report commenting on the financial performance for the year in relation to the key ratios for the loan.
(12 Marks)

(Total 20 Marks)

b.

Report on Prochain Plc

Financial Performance

  1. Revenue and Profitability:
    • The aggressive expansion policy pursued in the last two years increased revenue by 18%.
    • The company maintained a gross profit margin of 29%, indicating consistency in its core operations.
    • However, the profit margin dropped by 3.6% due to a substantial 55% increase in distribution, administrative expenses, and finance costs.
  2. Return on Capital Employed (ROCE):
    • ROCE fell from 19.5% in 2012 to 14.6% in 2013.
    • The decrease is attributed to declining profit while capital employed increased due to the revaluation of assets.

Financial Position

(Based on Key Ratios for Loan Covenants)

  1. Gearing:
    • Gearing improved, decreasing from 40.73% in 2012 to 32.7% in 2013, staying within the bank’s threshold of 50%.
    • This reduction indicates lower financial risk for Prochain Plc.
    • However, bonds payable are due for repayment in less than 12 months (July 2015). The company must secure long-term funding for trade, expansion, and bond repayment.
  2. Interest Cover:
    • Interest cover declined from 11.9 times in 2012 to 9.8 times in 2013, which still meets the bank’s target of 9.5 times.
    • Despite meeting the target, the falling margin and the impact of higher interest on bonds may further decrease interest cover, posing a risk.
    • The interest rate of 6% on bonds could exacerbate the issue, as the margin is already close to the acceptable threshold.
  3. Current and Quick Ratios:
    • The current ratio fell from 1.9 in 2012 to 1.45 in 2013, below the bank’s target of 1.5:1.
    • The quick ratio dropped from 1.13 in 2012 to 0.71 in 2013, also below the target of 1.1:1.
    • These changes suggest a working capital problem that requires the Board’s immediate attention.
    • Cash held decreased significantly, moving from a positive balance of N120,000,000 to an overdraft of N270,000.
  4. Recommendations:
    • Consider selling investments that performed well during the year to inject more working capital into operations.
    • Address working capital issues promptly to meet liquidity requirements and maintain favorable financial ratios.
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