- 15 Marks
FR – L2 – Q100 – Presentation of Financial Statements
Question
BNN Co is considering acquiring an interest in its competitor JB Co Ltd. The managing director of BNN Co has obtained the three most recent statements of financial position of JB Co Ltd as shown below.
JB Co Ltd – Statement of Financial Position at 31st December
| 20X7 GH$’000 | 20X8 GH$’000 | 20X9 GH$’000 | |
|---|---|---|---|
| Non-current assets | |||
| Land and buildings | 11,460 | 12,121 | 11,081 |
| Plant and equipment | 8,896 | 9,020 | 9,130 |
| 20,356 | 21,141 | 20,211 | |
| Current assets | |||
| Inventories | 1,775 | 2,663 | 3,995 |
| Trade receivables | 1,440 | 2,260 | 3,164 |
| Cash | 50 | 53 | 55 |
| 3,265 | 4,976 | 7,214 | |
| Total assets | 23,621 | 26,117 | 27,425 |
| Equity | |||
| Share capital | 8,000 | 8,000 | 8,000 |
| Retained earnings | 6,434 | 7,313 | 7,584 |
| 14,434 | 15,313 | 15,584 | |
| Non-current liabilities | |||
| 12% debentures 20X9–20Y2 | 5,000 | 5,000 | 5,000 |
| Current liabilities | |||
| Trade payable | 390 | 388 | 446 |
| Bank | 1,300 | 2,300 | 3,400 |
| Income taxes payable | 897 | 1,420 | 1,195 |
| Dividend payable | 1,600 | 1,696 | 1,800 |
| 4,187 | 5,804 | 6,841 | |
| Total equity and liabilities | 23,621 | 26,117 | 27,425 |
Required:
Prepare a report for the managing director of BNN Co. commenting on the financial position of JB Co Ltd. and highlight any areas that require further investigation (using gearing and liquidity ratios only).
Answer
To: Managing Director of BNN Co
From: Accountant
Date: XX, XX, XX
Subject: The financial position of JB Co Ltd
Introduction
This report has been prepared on the basis of the three most recent statements of profit or loss and statements of financial position of JB Co Ltd covering the years 20X7 to 20X9 inclusive. Ratio analysis used in this report is based on the calculations shown in the appendix attached.
Debt and liquidity
The debt ratio measures the ratio of a company’s interest-bearing debt finance to its equity finance (shareholders’ funds). Although we have no information as to the norm for the industry as a whole, the debt ratios appear reasonable. However, it should be noted that it has risen substantially over the three-year period.
When reviewing JB Co’s liquidity, the situation has improved over the period. The current ratio measures a company’s ability to meet its current liabilities out of current assets. A ratio of at least 1 should therefore be expected. JB Co Ltd did not meet this expectation in 20X7 and 20X8.
This ratio can be misleading, as inventory is included in current assets. Because inventory can take some time to convert into liquid assets, a second ratio, the quick ratio, is calculated which excludes inventories. As can be seen, the quick ratio, although improving, is low, and this shows that current liabilities cannot be met from current assets if inventories are excluded. As a major part of current liabilities is the bank overdraft, the company is obviously relying on the bank’s continuing support with both short- and long-term funding. It would be useful to find out the terms of the bank funding and the projected cash flow requirements for future funding.
Conclusion
The review of the three-year financial statements for JB Co Ltd has given rise to a number of queries which need to be resolved before a useful conclusion can be reached on the financial position of JB Co Ltd. It may also be useful to compare JB Co’s ratios to those of other companies in the same industry in order to obtain some idea of the industry norms.
WORKINGS – Calculation of relevant ratios
| 20X7 | 20X8 | 20X9 | |
|---|---|---|---|
| Debt equity ratio | 5,000 / 14,434 × 100 = 34.6% | 5,000 / 15,313 × 100 = 32% | 5,000 / 15,584 × 100 = 32% |
| Current ratio | 3,265 / 4,187 = 0.78:1 | 4,976 / 5,804 = 0.86:1 | 7,214 / 6,841 = 1.05:1 |
| Quick ratio | (3,265 – 1,775) / 4,187 = 0.36:1 | (4,976 – 2,663) / 5,804 = 0.40:1 | (7,214 – 3,995) / 6,841 = 0.47:1 |
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