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RISK MANAGEMENT

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CASE STUDY SERIES-By Sanjay Saraf Sir

Case Study 12 Answers

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CA FINAL

RISK MANAGEMENT

IN-HOUSE

CASE STUDY SERIES-By Sanjay Saraf Sir

Case Study 12 Answers

Powered By -

CA FINAL

RISK MANAGEMENT

IN-HOUSE

CASE STUDY SERIES-By Sanjay Saraf Sir

Case Study 12 Answers

Powered By -

1

Ratio Analysis Case Study

Stortford Yachts Limited

Answer to Question 1.

Ratio calculations :

1. Return on capital employed

% Return on capital employed is calculated as:

Net profit before tax and dividend / Capital employed x 100

Years 2009 2010 2011Net profit before tax and dividend 0.73 0.87 0.78Capital employed 2.71 3.12 3.47ROCE 26.9% 27.9% 22.5%

2. Asset turnover ratio

Asset turnover is calculated as:

Turnover / Capital employed (total assets)

Years 2009 2010 2011Turnover 4.90 5.30 6.60Capital employed 2.71 3.12 3.47Asset turnover 1.81 times 1.70 times 1.90 times

3. Net profit margin

Net profit before tax and dividend / turnover x 100

Years 2009 2010 2011Net profit before tax and dividend 0.73 0.87 0.78Turnover 4.90 5.30 6.60Net profit margin 14.9% 16.4% 11.8%

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4. Current ratio

This is calculated as:

Current assets / current liabilities

Years 2009 2010 2011Current assets 1.66 1.91 2.49Current liabilities 1.35 1.56 1.90Current ratio 1.23 : 1 1.22 : 1 1.31 : 1

5. Acid test ratio

This is calculated as:

Current assets - stock / current liabilities

Years 2009 2010 2011Current assets - stock 1.17 1.36 1.89Current liabilities 1.35 1.56 1.90

0.87 : 1 0.87 : 1 0.99 : 1

6. Debtors collection period

Debtors collection period is calculated as:

Debtors / turnover (sales) x 365

Years 2009 2010 2011Debtors 1.14 x 365 1.32 x 365 1.84 x 365Turnover 4.90 5.30 6.60Debtors collection period 85 days 91 days 102 days

7. Gearing ratio

Gearing ratio is calculated as:

Loan capital / total capital employed x 100

Years 2009 2010 2011Loan capital 2.21 x 100 2.21 x 100 2.21 x 100Total capital employed 2.71 3.12 3.47Gearing ratio 81.5% 70.8% 63.7%

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8. Labour cost as % of sales

2009 2010 2011Labour costs 0.93 x100 0.98 x100 1.25 x100Turnover 4.90 5.30 6.60Labour cost as % of sales 18.9% 18.5% 18.9%

9. Operating costs as % of sales

Years 2009 2010 2011Operating costs 4.17 x100 4.43 x100 5.82 x100Turnover 4.90 5.30 6.60Operating costs as % of sales 85.1% 83.6% 88.2%

10. Distribution costs as % of sales

Years 2009 2010 2011Distribution costs 0.44 x100 0.49 x100 0.61 x100Turnover 4.90 5.30 6.60Distribution costs as % of sales 8.98% 9.24% 9.24%

11. Administrative costs as % of sales

Years 2009 2010 2011Administrative costs 0.19 x100 0.22 x100 0.27 x100Turnover 4.90 5.30 6.60Administrative costs as % of sales 3.87% 4.15% 4.09%

4

Answer to Question 2.

Summary of ratios

Ratio 2009 2010 2011Industry

Average

See

Notes

% Return on capital employed 26.9 27.9 22.5 26% 1

Asset turnover (times) 1.81 1.70 1.90 1.79 times 2

Net profit margin (%) 14.9 16.4 11.8 14.5% 3

Current ratio 1.23:1 1.22:1 1.3:1 1.5:1 4

Acid test ratio 0.87:1 0.87:1 0.99:1 1.03:1 5

Debtors collection period (days) 85 91 102 83 days 6

Gearing ratio (%) 81.5% 70.8% 63.7% 32% 7

Labour costs as % of sales 18.9 18.5 18.9 18.1% 8

Operating costs as % of sales 85.1 83.6 88.2 85.5% 9

Distribution costs as % of sales 8.98 9.24 9.24 9.5% 10

Administration costs as % of sales 3.87 4.15 4.09 4.5% 11

5

Notes :

1. Return on capital employed :Though it stayed just above the industry average for the first two years, therehas been a significant decline in 2011 to a level below that of the industrialsector average for that year. The fall is quite significant and needs somecareful investigation. Has the firm lost out in terms of competitiveness? Hastheir turnover grown slower than their competitors? There is some evidencethat the problem may be cost control with their operating costs as a % of salesincreasing significantly in 2011. Something to investigate further!

2. Asset turnover :The company is generating more turnover in relation to their assets than itscompetitors. The figure did fall below the industry average in 2010, but theyappear to have corrected this. The implication of this is that they are workingtheir existing assets harder to generate more sales. Profitability of these saleshas not improved but that is a different issue.

3. Net profit margin :The reduction in overall performance is highlighted here in the reduction ofthe net profit margin. This is a worry and the firm needs to look carefully attheir cost control and see why their net profit has fallen so sharply.

4.

&

5.

Current ratio & Acid test ratio :

The current and acid test ratios are measures of the liquidity position of thefirm and are always best looked at together. The current ratio includes ALLcurrent assets, but the acid test ratio looks at current assets without stock asthis is considered to be hard to sell quickly. A firm may therefore have ahealthy current ratio as they have plentiful current assets, but a poor acid testratio as a high proportion of their current assets are held as stock. The figuresfor this firm indicate a fairly sound level of liquidity, though are marginallybelow the desired level and a little below the industry average. However,liquidity is strengthened in 2011 and this could indicate improved stock controlor improved credit control. However, the latter is unlikely as the debtorcollection period has increased significantly.

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6. Debtors collection periodThe figure for the debtor collection period is higher than the industry averageand rising significantly. Credit controls need to be tightened. The key optionshere are to put more rigid controls in place to collect debts and/or to pay bills alittle later (though this can cause problems in relationships with suppliers). Ifthe firm does not sort out these problems then they could start to face workingcapital shortages.

7. Gearing ratioThe gearing ratio for the firm is well above the industry average, though it hasbeen falling year by year as the loan capital has stayed the same and capitalemployed has grown with higher retained profit being added to the capitaleach year. The gearing ratio for the industry is fairly low, but the higher gearingratio for Stortford Yachts may expose them to external influences. Any changein interest rates will lead to higher interest payments and may reduce theirprofitability.

8. Labour costs as a % of salesLabour costs as a percentage of sales have been held fairly steady over theperiod indicating reasonable control over labour costs. However, the figure isslightly above the industry norm for period.

9. Operating costs as a % of salesThere has been a significant increase in the relationship of operating costs tosales, which indicates that operating overheads and some other direct costsrequire tighter controls. This needs careful looking at by the firm as it is likely tobe the principal cause of the poor profit performance indicated by the fall inthe ROCE and net profit margin.

10.

&

11.

Distribution and administrative costs as a % of sales

These figures appear to compare favourably with the industry as a whole. Thisindicates reasonable control over these costs, so the firm needs to lookelsewhere for their overhead cost control problems (as mentioned above).