- 20 Marks
Question
The following are extracts from the financial statements of Sky Ltd:
Required:
a) Prepare the following ratio analysis for 2018 financial year.
i) Current ratio
ii) Acid test ratio
iii) Net Profit Margin
iv) Return on capital employed
v) Receivables day
vi) Payables day
vii) Inventory turnover
(10 marks)
b) Comment on FIVE (5) of the ratios you have calculated.
Note: The following industry averages are provided to enable you to write your comment:
- Current ratio: 1.9:1
- Acid test ratio: 0.9:1
- Net profit margin: 6%
- Return on Capital Employed (ROCE): 25%
- Receivable days: 45 days
- Payable days: 38 days
- Inventory turnover: 4.4 times
(10 marks)
Answer
a)
b) Commentary on Financial Ratios
- Liquidity Ratios (Current Ratio and Acid Test Ratio):
- The Current Ratio of 2.41:1 is above the industry average of 1.9:1, indicating that Sky Ltd has a comfortable liquidity position, meaning it can cover its short-term liabilities with its current assets. However, a ratio above 2:1 might indicate excessive cash tied up in inventory or receivables.
- The Acid Test Ratio of 1.11:1 is also above the industry average of 0.9:1, which suggests that the company has enough liquid assets to cover its immediate liabilities without relying on inventory.
- Profitability Ratios (Net Profit Margin and ROCE):
- The Net Profit Margin of 8% is higher than the industry average of 6%, indicating that Sky Ltd is efficient in converting its revenue into profit. However, the drop in net profit margin from the previous year should be addressed.
- The ROCE of 3% is significantly below the industry average of 25%, indicating that the company is not generating sufficient returns on its capital employed. This is a concern for investors and indicates inefficient use of the company’s capital resources.
- Receivables Days:
- The Receivables Days of 27 days is better than the industry average of 45 days, indicating that Sky Ltd is effective in collecting its receivables quickly. This improves cash flow but should be monitored to ensure credit terms are not too strict, potentially losing sales.
- Payables Days:
- The Payables Days of 28 days is close to the industry average of 38 days. This suggests that Sky Ltd is paying its suppliers in a timely manner, possibly even earlier than the average, which might allow the company to take advantage of early payment discounts.
- Inventory Turnover:
- The Inventory Turnover of 5.8 times is higher than the industry average of 4.4 times, indicating that Sky Ltd is efficient in managing its inventory, selling goods at a quicker pace, and reducing the risk of obsolescence. This is a positive sign for operational efficiency.
(10 marks evenly spread using ticks)
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