SOLUTIONS MANUAL

CHAPTER
Financial Statement
3 Analysis

1 Students to follow the web-link provided and would need to explain the points that they have
noted from the web-link. Answers to vary. In the main, students need to observe the comments
made, in particular in relation to how to interpret the results.

2 Given the following information:

Current assets: RM18 million
Current ratio: 4.2

This means that the current liabilities is RM18m / 4.2 = RM4,285,714

DEF Sdn Bhd seeks to increase the amount of stocks of raw materials and finished goods.
Assuming that the increase in stocks of raw materials and finished goods is undertaken via use of
credit extended by trade creditors.

The lowest the current ratio is permitted to drop is 3

Hence, let the increase in stocks of raw materials and finished goods be ‘x’.

This means:

18,000,000 + x = 3
4,285,714 + x
Solving for ‘x’, we get x = (18,000,000 – 3 × 4,285,714) = 2,571,429
2
This means that DEF Sdn Bhd can increase its stock level by RM2,571,429, beyond which it will
breach the condition for current ratio as set by Maybank Berhad.

3 Perniagaan Salmah Sdn Bhd

(a) Gross profit margin

gross profit × 100%= 9,870 × 100% = 0.5875 or 58.75%

revenue 16,800
(b) Operating profit margin

operating income × 100% = 3,870 × 100% = 0.2304 or 23.04%

revenue 16,800
(c) Net profit margin

profit after tax × 100% = 2,254 × 100% = 0.1342 or 13.42%

revenue 16,800

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(d) Current ratio

current assets = 3,000 + 5,000 + 1,150 = 9,150 = 2.07
current liabilities 2,310 + 1,500 + 600 4,410
(e) Acid test ratio
current assets – stock = 5,000 + 1,150 = 6,150 = 1.39
current liabilities 2,310 + 1,500 + 600 4,410
(f) Stock turnover ratio
cost of goods sold = 6,930 = 2.31
stocks 3,000
(g) Stock turnover days
stock 3,000
× 365 days = 365 days = 158 days
cost of goods sold 6,930
(h) Debtors turnover ratio
credit sales = 16,800 = 3.36
trade debtors 5,000
(i) Debtors turnover days
trade debtors × 365 days = 5,000 365 days = 109 days
credit sales 16,800
(j) Creditors turnover ratio
credit purchases = 6,930 = 3
trade creditors 2,310

Note:
If it is not stated in the question as to the value for credit purchases, it can be worked out if
the question provides the opening stock balance. In this case, the credit purchases would be
assumed to be:
Credit purchases = Closing stock – opening stock + cost of goods sold

However, if the opening stock value is not provided, students may assume:
Credit purchases = cost of goods sold

(k) Credit turnover days

trade creditors × 365 days = 2,310 × 365 days = 122 days

credit purchases 6,930
(l) Debt ratio

total long term borrowings = 3,600 = 0.355 or 35.50%

total equity 10,140
(m) Interest cover ratio

earnings before interest and tax = 3,870 = 5.23

interest expense 740
(n) Earnings per share
Assuming that the number of shares in the firm is 5,000

Hence, EPS = earnings attributable to ordinary shareholders × 100%

number of ordinary shares in issue
2,254
= × 100%
5,000
= 45 sen

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(o) Return on capital employed

earnings before interest and tax (EBIT) × 100% = 3,870
× 100%
capital employed 3,600 + 10,140
= 28.17%

(p) Return on assets

profit after tax × 100% = 2,254 × 100% = 12.42%

total 18,150
(q) Return on equity
profit after tax 2,254
× 100% = × 100% = 22.23%
total shareholders’ equity 10,140

4 (a) GHI’s trade debtors’ average collection period is given by:

trade debtors × 365 days

credit sales
Given that the total sales for the year was RM19,500,000.
75% of the sales were made on credit.
Hence, credit sales = 75% × 19,500,000 = RM14,625,000

Trade debtors’ average collection period is hence

1,156,000 × 365 days = 28.85 days

14,625,000
(b) Given that the target trade debtors’ collection is to be reduced to 22 days.
Credit sales = RM14,625,000 (see part a above)
Hence, the targeted level of trade debtors (say, represented by ‘x’) is:

x × 365 days = 22 days

14,625,000
x = 14,625,000 × 22 = RM881,507
365
(c) Given that the gross profit margin is 25%,
This means that the gross profit is 25% × sales = 25% x RM19,500,000
= RM4,875,000
Cost of goods sold = RM19,500,000 – 4,875,000 = RM14,625,000

Alternatively, it could have been computed as 75% × RM19,500,000 = RM14,625,000

Stock turnover is given as 7 times.

Stock turnover ratio = cost of goods sold = 7

stocks
Hence, GHI Sdn Bhd’s stock level is 14,625,000 = RM2,089,286
7
(d) Current ratio = current assets
current liabilities
= 3,100,000
660,000
= 4.70

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5 Debt-total assets ratio is given as:

Debt / total assets

Hence, equity-total assets ratio shall be:

1 – [debt / total assets]

Based on information given in the question:

Debt-total assets Equity-total assets
Firm X 0.60 0.40
Firm Y 0.40 0.60

Return on total assets is given as:

Firm X: 25%
Firm Y: 32%

Based on Du Pont model,

Return on equity = (Return on assets) × total assets
equity
The return on equity for X and Y are:
Firm X: 25% × 1/0.40 = 0.625 or 62.5%
Firm Y: 32% × 1/0.60 = 0.533 or 53.3%

Firm X has the greater return on equity.

institution whose primary source of profits is through financial asset transactions. Examples of
such financial institutions include banks, insurance companies, and complex multi-function
financial institutions.

6 Given the following information:

(a) Net profit margin of 8%
(b) Net profit of RM432.500
(c) Trade debtors’ balance of RM358,000

Ignoring the tax effects

Sales = 432,500 = RM5,406,250

8%
5% of sales is on cash terms
95% of sales is on credit terms
Hence, the firm’s trade debtors’ turnover days is given as:
358,000
× 365 days = 25.44 days
95% × 5,406,250
7 Students to follow the web link and analyse the 30 ratios that are referred to in the tutorial
concerned. Performs the computations concerned and identify the lessons to be learnt.
The ratios are under the following headings:
(i) Liquidity measurement ratios
(ii) Profitability indicator ratios
(iii) Debt ratios
(iv) Operating performance ratios
(v) Cash flow indicator ratios

On the whole, the concepts are similar.

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8–9 Students to follow the web-links provided. There are several video presentations that students
can view and listen. Students would need to explain the points that they have noted from the
web-links. Answers to vary.

10 Ratios that may be computed include the following:

Year 1 2 3
Gross profit margin 580 600 670
× 100% × 100% × 100%
= gross profit × 100% 1,920 2,160 2,440
revenue = 30.21% = 27.78% = 27.46%
Net profit margin 34 32 30
× 100% × 100% × 100%
profit before tax 1,920 2,160 2,440
= × 100%
revenue = 1.77% = 1.48% = 1.23%
Net profit margin 30 30 28
× 100% × 100% × 100%
profit after tax 1,920 2,160 2,440
= × 100%
revenue = 1.56% = 1.39% = 1.15%
current assets 720 780 950
Current ratio = = 2.48 = 2.44 = 1.86
current liabilities 290 320 510
cost of sales 1,340 1,560 1,770
Stock turnover ratio = = 3.35 = 3.71 = 3.93
stocks 400 420 450
Debtors turnover days 320 360 500
× 365 × 365 × 365
trade debtors 1,920 2,160 2,440
= × 365 days
credit sales = 60.83 days = 60.83 days = 74.80 days
Credit turnover days 150 160 290
× 365 × 365 × 365
trade creditors 1,340 1,560 1,770
= × 365 days
credit purchases = 40.86 days = 37.44 days = 59.80 days
Debt ratio 240 160 80
= 0.47 = 0.30 = 0.14
total long term borrowings 510 540 560
=
total equity
Interest cover ratio 60 60 66
= 2.31 = 2.14 = 1.83
earnings before interest and tax 26 28 36
=
interest expense

Main points to note:

• Gross profit margin has deteriorated continuously over the 3 year period from 30.21% (Year 1)
to 27.46% (Year 3)
• However, it appears that the operating expenses as a proportion of sales is very high. This is
evident given that the net profit margin for all three years is significantly very low, being at less
than 2% for all three years (whether measured at before-tax or after tax)
• The long term borrowings portion appear to be reducing over the three year period. Debenture
balance was RM240,000 in Year 1, and through the periodic instalments paid by the firm, by
Year 3, the balance was RM80,000.
• The need to settle the debentures (long term debt) may have taken its toll on the firm as the
firm now appears to have been forced to rely more on short term liabilities.
• The bank overdraft balance has steadily rose from RM140,000 (Year 1) to RM220,000 in
Year 3.

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• The position of the firm is not helped by the fact that the short term interest rates has been
rising (as mentioned in the question).
• Hence, despite the gross profit margins being somewhat maintained over the three year period,
the interest expenses have been increasing from RM26,000 (Year 1) to RM36,000 (Year 3)
• The interest cover ratio has also deteriorated over the same period, indicating that if the trend
remains unchanged, the firm is likely to face the possibility of being unable to service the
interest expense in time to come.
• Another indicator of cash flow difficulty faced by the firm is the increase in debtor turnover
days over the three year period, as debtors are now taking longer periods to settle their debts.
• But this impact may have been partially offset by the increase in creditor turnover days as the
firm has taken longer period to pay the creditors.
• In the longer term, this may lead to the problem of negative effect on the goodwill of the firm
in the eyes of the suppliers.
• Another indicator of the cash flow/liquidity problem faced by the firm is the measure of
approximate operating cash flows generated by the firm, which may be computed as follows:

Year 1 2 3
Profit before tax 34,000 32,000 30,000
Add: depreciation 36,000 26,000 22,000
70,000 58,000 52,000

The computations as shown above ignore the movements in trade debtors, trade creditors and
stocks over the same period.

In any case, the trend appears to be one of deteriorating cash flows by the firm.

• In conclusion, the finance director of ABC Sdn Bhd appears to be justified to be concerned
about the poor liquidity of the firm and steps ought to be taken to arrest the problem before it
gets out of hand and becomes un-manageable for the firm.

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