- 20 Marks
Question
Lamido Limited is a courier service company which operates in Nigeria and West Africa.
Initially, Lamido Limited experienced strong growth, but in recent periods the company has been criticised for under investing in its non-current assets.
Lamido Limited statement of financial position as at December 31
| 2022 | 2021 | |
|---|---|---|
| ₦’000 | ₦’000 | |
| Non-current assets | ||
| Property, plant and equipment | 317,000 | 174,000 |
| Intangible assets | 20,000 | 16,000 |
| 337,000 | 190,000 | |
| Current assets | ||
| Inventories | 580 | 490 |
| Trade and other receivables | 6,100 | 6,300 |
| Cash and equivalents | 9,300 | 22,100 |
| Total current assets | 15,980 | 28,890 |
| Total assets | 352,980 | 218,890 |
| Equity and Liabilities | ||
| Equity | ||
| Ordinary share capital | 3,000 | 3,000 |
| Retained earnings | 44,100 | 41,800 |
| Revaluation surplus | 145,000 | NIL |
| Total equity | 192,100 | 44,800 |
| Liabilities: | ||
| Non-current liabilities | ||
| 6% loan notes | 130,960 | 150,400 |
| Current liabilities | ||
| Trade and other payables | 10,480 | 4,250 |
| 6% loan notes | 19,440 | 19,440 |
| Total current liabilities | 29,920 | 23,690 |
| Total equity and liabilities | 352,980 | 218,890 |
Other extracts from Lamido Limited financial statements for the years ended December 31.
| 2022 | 2021 | |
|---|---|---|
| ₦’000 | ₦’000 | |
| Revenue | 154,000 | 159,000 |
| Profit from operations | 12,300 | 18,600 |
| Finance cost | (9,200) | (10,200) |
| Cash generated from operation | 18,480 | 24,310 |
The following information is also relevant:
i. Lamido Limited had exactly the same delivery volumes in 2022 as in 2021 with customers‟ base being the same in both years.
ii. In October 2022, Lamido Limited had to renegotiate its operating licenses in three of its countries of operation. This led to increase in the fees Lamido Limited had to pay to operate in these countries. The operating licenses in five other countries are due to expire in December 2022 and Lamido Limited is currently negotiating with the concerned authorities of these countries.
Required:
a. Calculate the following ratios for the years ended December 31, 2021 and 2022:
i. Operating profit margin
ii. Return on capital employed
iii. Net asset turnover
iv. Current ratio
v. Interest cover
vi. Gearing (Debt/equity)
(6 Marks)
Note: For calculation purposes, all loan notes should be treated as debt.
b. Comment on the performance and position of Lamido Limited for the year ended December 31, 2022 and highlight any issues which Lamido Limited should be considering in the near future.
(14 Marks)
Answer
Lamido Limited
a. Computation of relevant ratios for the year ended December 31, 2021 and 2022
| Ratios | Formula | 2022 | 2021 |
|---|---|---|---|
| Operating profit margin | PBIT x 100 Revenue | = 7.99% | 18,600 x 100 159,000 = 11.7% |
| Return on capital employed | PBIT x 100___ Capital employed | 12,300 x 100 342,500 = 3.6% | 18,600 x 100 214,640 = 8.7% |
| Net asset turnover | Revenue___ Net asset/equity | 154,000 192,100 = 0.8 times | 159,000 44,800 = 3.55 times |
| Current ratio | Current assets Current liabilities | 15,980 29,920 = 0.53:1 | 28,890 23,960 = 1.21:1 |
| Interest cover | PBIT___ Fixed interest | 12,300 9,200 = 1.34 times | 18,600 10,200 = 1.82 times |
| Gearing Ratio | Debt equity | (130,960+19,440)x100 192,100 = 78.3% | (150,400+19,440)x100 44,800 = 379% |
b. Comments on performance and position of Lamido Ltd for the year ended December 31, 2022
Performance:
i) Lamido LTD‟S revenue has declined in the year. As Lamido has had exactly the same delivery volumes in the year, the decline in revenue must be due to company‟s reducing units prices of certain courier packages. To substantiate this, it would be helpful to see the number of packages delivered by Lamido LTD during the year.
ii) In addition to the decline in revenue, there has been a decline in the operating profit margin in the year. As the volumes delivered by Lamido LTD has remained the same, it would appear that some costs incurred by Lamido LTD were relatively fixed and may not have changed significantly during the year. It has been noted that there has been an increase in the operating licence fees incurred by Lamido Ltd during the year. This would again cause the operating profit margin to fall.
iii) Return on capital employed has declined significantly due to a decline in the profit from operations, and the revaluation of non-current assets in the year by the company. This means that there is a large revaluation surplus in year 2022 which was not the case in year 2021. This will have the effect of reducing the return on capital employed due to a much larger total balance in equity. If the return on capital employed is calculated without this, it would be 6.2%, which still represents a decline in performance.
iv) Net assets turnover declined from 3.55 times to 0. 8 times. This will again be affected by the revaluation surplus, making the two years incomparable. If this is removed from the calculation, the net asset turnover will decrease slightly to 3.27 times, which is still a decrease in performance.
Position:
i) The value of non-current assets rose significantly in the year by ₦147 million. A large proportion of that will be due to the revaluation which took place, leading to an increase of ₦145 million. This suggests that Lamido LTD acquired some new assets in the year, which was not defined.
ii) The level of debt in the business is a concern, as this forms a significant portion of the company’s financing, and appears to incur a large annual repayment. The reduction in the current ratio can be attributed to the large decrease in cash, which is likely to be due to the debt repayment made.
iii) It is worth noting that Lamido LTD is almost completely funded by debt with a relatively small amount held in share capital. Therefore, there is an opportunity for a new investor to consider putting more money into the business in a forms of shares, the investing company then repaying some of the loans held by Lamido LTD. As the company is currently repaying ₦19.44 million a year on the loans, it may be more sensible to repay loan, if possible, freeing up a lot more cash for growing the business or to be returned annually in the form of dividends, also saving ₦9.2 million a year in interest.
Areas of concern for the future:
There are a number of things to consider regarding the future performance of Lamido LTD.
i) Operating licences in five countries which are due for renegotiation. If the fees are raised, this will lead to reduction in profit being made by Lamido LTD.
ii) The debt appeared to being repaid in annual installments of N19.44 million, meaning that Lamido LTD needs to generate sufficient cash to repay loan each year before returning profit to the owner. In addition to this, ₦9.2 million interest means that the business appears currently unable to return any cash to investors.
Finally, Lamido LTD‟S business model is heavily depended on large expensive items of non-current assets. There has been criticism of under-investment in these, which could lead to large potential outlays in the near future to replace the assets.
Conclusion: Lamido LTD has not shown a weakened performance in the current year, but appears to be profitable business at its core. The major issue with the business is the level of debt, which is resulting in ₦19.44 million annual repayments and ₦9.2 million annual interest. A new investor who will be able to reduce these debts as part of any future purchase, would be able to put the business in a much stronger cash position and profit performance.
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