Financial Analysis for XYZ Ltd and Bulls Corporation

Question

Question 1

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XYZ Ltd. is a group of doctors, dentists, professional sports players and celebrities with excess funds who wish to find small companies with great innovative ideas and invest in them. Several of the small companies present their idea to XYZ under a televised show broadcasted on national TV.

The following information has been derived from 3 years’ financial statements of ABC Ltd., one of the small companies looking for investment from XYZ.

Balance Sheets, December 31
2015 2014 2013
Current assets
Cash 50,000 45,000 94,000
Account receivable, net 130,000 120,000 110,000
Merchandise inventories 250,000 230,000 195,000
Other current assets  45,000  53,000  42,000
Total current assets 475,000 448,000 441,000
Property, plant & equipment, net  196,000  191,000  175,000
Total assets 671,000 639,000 616,000
Current liabilities
Accounts payable 175,000 195,000 185,000
Accrued liabilities    1,000    6,500  21,000
Total current liabilities 176,000 201,500 206,000
Long-term liabilities  230,000  250,000  295,000
Total liabilities  406,000  451,500  501,000
Shareholders’ equity
Common shares 110,000 95,000 65,000
Preferred shares, note 5 25,000 25,000 25,000
Retained earnings  130,000  67,500  25,000
Total shareholders’ equity  265,000  187,500  115,000
Total liabilities and shareholders’ equity 671,000 639,000 616,000

 

Income statements 2015 2014
Net sales £723,700 £694,000
Cost of goods sold 347,350 344,500
Gross margin 376,350 349,500
Operating expenses 183,500 179,750
Income from operations 192,850 169,750
Interest expense 37,525 39,450
Income before income tax 155,325 130,300
Income tax expense 38,831 32,575
Net income £116,494 £97,725

Additional information:

  1. The common shares are traded on the stock exchange. At the end of 2015, the value of the share was £15.00, and at the end of 2014, the value per share was £14.00.
  2. The number of shares outstanding on the market is as follows:
    1. 2015: 25,000
    2. 2014: 15,000
    3. 2013: 10,000
  3. All sales are made on credit.
  4. The company’s income tax rate is 25%.
  5. The preferred shares are cumulative, no par value, £2.50, 10,000 shares authorised and 2,000 shares issued and outstanding.

To answer this question:

Assume that you, the consultant, have been hired by XYZ to assist in the analysis of the financial statements and provide a recommendation whether XYZ should invest or not invest in this company. Justify your recommendation based on the calculation of the following financial ratios:

  • Current ratio (liquidity)
  • Operating profit margin (profitability)
  • ROSF (profitability)
  • Average settlement period for trade receivables (efficiency)
  • Earnings per share (investment)

Question 2

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Bulls Corporation has a December 31 fiscal year end. The controller of the company is currently completing the financial statements of the company in order to present them at the next board meeting. He completed most of the work but did not get around to finishing the cash flow statement. He gives you the following financial information in order for you to help him with the preparation of the cash flows.

Balance Sheet 2015 2014
Cash £38,500 £8,000
Accounts receivable, net 20,000 29,500
Merchandise inventory 37,000 38,000
Prepaid insurance 9,500 15,000
Land 54,500 40,600
Equipment, at cost 104,500 90,700
Less: accumulated amortisation (30,500) (15,500)
Patent 49,000 53,200
Total assets £282,500 £259,500
Accounts payable £ 58,500 £ 42,000
Income taxes payable 16,500 11,500
Advertising payable 5,000
Dividends payable 40,000 10,000
Notes payable 40,000 83,000
Share capital 93,000 78,500
Retained earnings 29,500 34,500
Total liabilities and shareholders’ equity £282,500 £259,500

 

Sales £1,090,000
Cost of goods sold 672,000
Gross profit 418,000
Operating expense
Salaries expense 195,000
Advertising expense 35,000
Rent expense 67,500
Insurance expense 34,500
Amortisation expense 25,000
Total operating expenses 357,000
Income from operations 61,000
Interest expense 2,500
Gain on sale of equipment 7,500
Income before income taxes 66,000
Income tax expense 4,000
Net income £62,000

Additional information:

  1. Bulls Corp. purchased equipment for £36,300 in cash during the year.
  2. Bulls Corp. sold equipment for cash during the year.
  3. No patent has been purchased nor sold in the year.
  4. Accounts payable relates solely to transactions with suppliers for inventory.

To answer this question

  1. Prepare a complete cash flow statement using the indirect method for the 2015 fiscal year.
  2. Compute the following amounts:
    1. Cash collected from clients during the year.
    2. Cash paid for advertising expense.
    3. Cash paid to suppliers for inventory.

Answer

Financial Analysis for XYZ Ltd and Bulls Corporation

Current ratio (liquidity)

The current ratio measures a company’s liquidity and the ability of the company to settle short-term debts using current assets such as cash, trade receivable, and inventory (Pradad & Sinha, 1990). The current ratio is obtained by dividing current assets by the current liabilities.

Total current assets: £475,000

Total current liabilities: £ 176,000

Current ratio for 2015=

Current ratio for 2014 =

Current ratio for 2013 =

A ratio that falls between 1.5 and 3 indicates that the company can be able to settle its obligations (Pradad & Sinha, 1990). In all the three years, the company could be able to settle its obligations, which indicates that it is financially sound.

Operating profit margin (profitability)

Operating profit margin is important since it helps analyze the pricing strategy of a company as well as its operating efficiency. Operating profit margin gives the idea about the company’s profitability before interest, taxes, and basing on each amount of sales (Pradad & Sinha, 1990). Operating margin is given by the operating income of the company divided by the net sales, and the result expressed as a percentage.

x 100

= 26.6%

The results indicate that the company earned £0.26 for every dollar of sale made in 2015, which is an increase from the £0.24 earnings from every dollar of sale made in 2014. This is good earnings for the company.

Return on Shareholder Funds (ROSF)

ROSF measures the profitability of a company (Vause, 2009). It is given by the following formula:

Particulars 2014 2015
Net income 97,725 116,494
Preference dividend paid (5,000) (5,000)
Net Profit after taxation and preference dividend 92,725 111,494
Ordinary share capital 95,000 110,000
Retained earnings 67,500 130,000
Ordinary share capital and reserves 162,500 240,000

 

The results indicate that the company was profitable during 2014 and 2015, which saw shareholders earn returns for their investment as detailed by the percentages. In 2014, the shareholders earned higher returns compared to 2015.

Average settlement period for trade receivables

This is an examination of the trade receivables with regard to collection period (Vause, 2009). The aim is to assess the period taken by customers to pay the company.

days

The average settlement period is 60 days. The company should aim at reducing the settlement period to 30 days.

Earnings per share (investment)

This shows the basic earnings or revenue per share.

Net income less preferred dividends for 2015: 116,494 – 5,000 = 111,494

= £5.57

= £7.42

The earnings per share indicate that the company was profitable. In 2015, the company could be able to give £5.57 to every shareholder from its total income.

Basing on the above analysis, XYZ should invest in this company. The financial ratios indicate that ABC Ltd. is financially sound, and thus it would be a good opportunity to invest in the company.

 

Question 2

  1. Complete cash flow statement using the indirect method for the 2015 fiscal year
Particulars Amount (£)
Operating Activities
Net profit before tax and adjustment of extraordinary items 62,000
Adjustments for:
            Equipment amortization 25,000
            Patent amortization 4,200
            Gain on sale of assets (7,500)
Adjusted income figure 83,700
Changes in current liabilities and assets
Accounts receivable (Decrease) 9,500
Prepaid insurance (increase) 5,500
Merchandise inventory (Decrease) 1,000
Accounts payable (increase) 16,500
Advertising payable (Increase) 5,000
Income tax payable (Increase) 5,000
Cash flow from operating activities 126,200
Investing Activities
Equipment sales 20,000
Purchase of equipment (36,300)
Purchase of land (13,900)
Cash flow from investing activities (30,200)
Financing Activities
Share capital increases 14,500
Notes payable cleared (43,000)
Dividend payment (37,000)
Cash flow from financing activities (65,500)
Net cash inflow from operating, investing and financing activities 30,500
Beginning cash (Add back) 8,000
Closing cash balance 38,500

 

  1. Compute the following amounts
  • Cash collected from clients throughout the year.

Particulars Amount (£)
Total Sales 1,090,000
Opening accounts receivable 29,500
Closing accounts receivable (20,000)
Total cash collected 1,099,500

 

  • Cash paid for advertising expense
Particulars Amount (£)
Total advertising expense 35,000
Closing advertising expense payable (5,000)
Total advertising expenditure 30,000

 

  • Cash paid to suppliers for inventory

Particulars Amount (£)
Cost of goods sold 672,000
Opening stock (38,000)
Closing stock 37,000
Stock purchases 671,000
Opening accounts receivable 29,500
Closing accounts receivable (20,000)
Cash paid to suppliers for stock 680,500

 

References

Pradad, M., & Sinha, K. (1990). Principles of management accounting. India: Motilal       Banardidass.

Vause, B. (2009). Guide to analysing companies. New York: Bloomberg Press.

Financial Accounting and Reporting

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