a) Report to the Chief Executive Officer of Oxtom Ltd

Introduction:
This report analyses the financial performance of Pep Ltd from 2016 to 2018, covering its profitability, liquidity, and solvency using key financial ratios. The appendix contains the detailed calculations.

Profitability:
Pep Ltd’s profitability has fluctuated over the three-year period. The gross profit margin increased slightly from 34% in 2016 to 35.4% in 2018, reflecting better control over cost of sales. However, the net profit margin decreased from 11.9% in 2016 to 9.3% in 2018 due to rising finance costs and administrative expenses. The return on capital employed (ROCE) decreased significantly from 21.1% in 2016 to 17.8% in 2018, indicating a decline in the company’s efficiency in generating profits from its capital base.

Liquidity:
Pep Ltd’s liquidity position appears stable, with a current ratio consistently above 2:1. In 2018, the current ratio was 2.7, which suggests that the company can comfortably cover its short-term liabilities. However, the quick ratio has remained relatively low, at around 1.1 in 2017 and 1.2 in 2018, indicating potential liquidity concerns if inventories cannot be quickly converted to cash.

Solvency:
Pep Ltd’s gearing ratio increased from 18.5% in 2016 to 30.9% in 2018, primarily due to an increase in long-term loans. The interest cover ratio has also deteriorated, dropping from 16.7 times in 2016 to 5.5 times in 2018, as finance costs have risen significantly. This suggests increased financial risk as Pep Ltd’s ability to cover its interest obligations has weakened.

Efficiency:
The inventory turnover period increased from 156 days in 2016 to 182 days in 2018, indicating slower inventory turnover, which could be a concern. The receivables collection period has also increased from 46 days in 2016 to 64 days in 2018, suggesting that Pep Ltd is taking longer to collect debts from customers.

Appendix – Key Ratio Calculations:

b) Areas Requiring Further Investigation:

1. Increased Gearing and Financial Risk:
   Pep Ltd has significantly increased its debt levels, which has led to higher finance costs and lower interest cover. It is essential to investigate the reasons for this increased borrowing and assess the sustainability of the company’s current debt levels.
2. Slower Inventory Turnover:
   The increase in inventory turnover days suggests that Pep Ltd may be facing challenges in selling its products. It would be important to investigate the reasons for this, including potential issues with demand, product quality, or stock management.
3. Extended Receivables Collection Period:
   Pep Ltd is taking longer to collect payments from customers. This could indicate credit control issues or customer payment difficulties. Further investigation into the company’s credit policies and the quality of its receivables is required.