Managing Finance & Budgets Lecture 4 Follow-Up Activities and Solutions
Dec 17, 2015
Managing Finance & Budgets
Lecture 4 Follow-Up
Activities and Solutions
Activity One
Discuss the following:
Imagine you are the proprietor of a hotel and restaurant. Identify a series of key ratios which would help you to monitor on a day to day basis how well the hotel is performing.
Activity One - Solutions
Key ratios to monitor how well a hotel is performing.
These might include: % Room occupancy Average customer payment Reservations as a % of total occupancy Cleaning Costs per room Average direct cost per room occupancy Total Overheads bill per day’s operation Total Salaries as a percentage of turnover % food wastage per day
… and many more!
Activity Two
Calculate and comment on profitability ratios for the two years shown:
YEAR 1 YEAR 2SALES 2,240,000 2,681,200COST OF SALES 1,745,400 2,072,000OVERHEADS 252,000 362,800INTEREST 24,000 6,200TAX 60,200 76,000DIVIDENDS 40,200 60,000SHARE CAPITAL 300,000 334,100RESERVES 198,300 302,500LONG TERM LOANS 200,000 60,000
Activity Two Solution: Gross Margin%
The P & L Account Shows: Sales £2,240,000 Gross Profit £494,600
(NB Gross Profit = Turnover – Cost of Sales)
Gross Margin% = 494600 x 100 = 22.1%
2240000The company makes 22p for every £1 it brings in. This can be used to pay overheads etc.
The company makes 22p for every £1 it brings in. This can be used to pay overheads etc.
Activity Two Solution: Net Margin%
The P & L Account Shows: Sales £2,240,000 Net Profit after Tax and Dividends £118,200
(NB
Net Profit = Turnover – Cost of Sales- Overheads)
Net Margin% = 118200 x 100 = 10.8%
2240000After paying all outstanding costs, the company makes 11p for every £1 it brings in.
After paying all outstanding costs, the company makes 11p for every £1 it brings in.
Activity Two Solution: ROSF%
The P & L Account Shows: Net Profit after Tax and Dividends £118,200
Share Capital £300,000 Reserves £197,500
£497,500
ROSF% = 118200 x 100 = 31.8%
497500The company is making 32p for every £1 invested by shareholders.
The company is making 32p for every £1 invested by shareholders.
Activity Two Solution: ROCE%
The P & L Account Shows: Net Profit (before Tax & Interest) £242,600
Share Capital £300,000 Reserves £197,500 LT Loans £200,000
£697,500
ROCE% = 242600 x 100 = 34.8%
697500 Including loans, the company makes 35p for every £1 invested in the business.
Including loans, the company makes 35p for every £1 invested in the business.
Activity Three
Calculate and comment on liquidity ratios for the two years shown:
YEAR 1 YEAR 2
DEBTORS 240,800 210,200
BANK ACCOUNT 33,500 41,000
OPENING STOCK 241,000 300,000
CLOSING STOCK 300,000 370,800
TRADE CREDITORS 221,400 228,800
DIVIDENDS OWING 40,200 60,000
CORPORATION TAX OWING 60,200 76,000
CASHFLOW FROM OPERATIONS 231,000 251,400
Activity Three Solution: Current Ratio
Current Assets : Trade Debtors £240,800 Bank Account £33,500 Closing Stock Value £300,000
£574,300Current Liabilities: Trade Creditors £221,400 Dividends Owing £40,200 Corporation Tax Owing £60,200
£321,800
Current Ratio = 574300 = 1.8 321800 The business owns
almost twice as much as it owes
The business owns almost twice as much as it owes
Activity Three Solution: Acid Test Ratio
Current Assets excluding Stock : Trade Debtors £240,800 Bank Account £33,500
£274,300Current Liabilities: Trade Creditors £221,400 Dividends Owing £40,200 Corporation Tax Owing £60,200
£321,800
Acid Test Ratio = 274300 = 0.9 321800
Excluding stock, the business owns almost as much as it owes..
Excluding stock, the business owns almost as much as it owes..
Activity Three Solution: Cash-Flow to Obligations Ratio
Current Assets excluding Stock : Net Cash-Flow from Operations £231,000
Current Liabilities: Trade Creditors £221,400 Dividends Owing £40,200 Corporation Tax Owing £60,200
£321,800
Cash-Flow to Obligations = 231,000 = 0.7
Ratio 321800 The currently available cash in circulation is about three-quarters of what is needed to pay current debts
The currently available cash in circulation is about three-quarters of what is needed to pay current debts
Activity Four
Use the figures shown in Activity Two to calculate and comment on financing ratios for the two years shown.
Profitability (Activity 2) Year 1 Year 2
Sales 2,240,000 2,681,200Cost of Sales 1,745,400 2,072,000
Gross Profit 494,600 609,200Overheads 252,000 362,800Net Profit 242,600 246,400
Interest 24,000 6,200Tax 60,200 76,000
Dividends 40,200 60,000Net profit after tax and dividends 118,200 104,200
Share Capital 300,000 334,100Reserves 197,500 301,700LT Loans 200,000 60,000
Activity Four Solution: Gearing
Long Term Loans: £200,000
Share Capital £300,000 Reserves £197,500 LT Loans £200,000
£697,500
Gearing% = 200000 x 100 = 28.7%
697500Just over a quarter of the company’s financing comes through loans
Just over a quarter of the company’s financing comes through loans
Activity Four Solution: Interest Cover
Net Profit: £242,600
Interest due £24,000
Interest Cover = 242600 = 10.1
24000
The company makes 10 times as much as it needs to service its loans
The company makes 10 times as much as it needs to service its loans
Activity Five
Use the figures shown in Activities Two and Three and the additional figures shown below to calculate and comment on efficiency ratios for the last two years:
YEAR 1 YEAR 2
CREDIT PURCHASES 1,804,4002,142,800
NUMBER OF EMPLOYEES 14 18
Activity Five Solution: Stock Turnover Period
Opening Stock Value £241,000 Closing Stock Value £300,000
Cost of Sales £1,745,400
Stock Turnover (Days)
= (241000+300000)/2 x 365
1745400
= 56.7 daysStock is held on average for 57 days
Stock is held on average for 57 days
Activity Five Solution: Average Settlement period for Debtors
Trade Debtors £240,800
Total Sales £2,240,000
Average Settlement Period = 240800 x 365
2240000
= 39.2 daysDebtors take 39 days on average to pay the money.
Debtors take 39 days on average to pay the money.
Activity Five Solution: Average Settlement period for Creditors
Trade Creditors £221,400
Total Sales £1,804,400
Average Settlement Period = 221400 x 365
1804400
= 44.7 daysThe company takes 45 days on average to pay its bills.
The company takes 45 days on average to pay its bills.
Activity Five Solution: Sales to Capital Employed
Total Sales £2,240,000
Share Capital £300,000 Reserves £197,500 LT Loans £200,000
£697,500 Sales to Capital Employed
= 2240000 697500
= 3.2The turnover of the business is three times the total capital invested in it.
The turnover of the business is three times the total capital invested in it.
Activity Five Solution: Sales per Employee
Total Sales £2,240,000
Number of Employees 14
Sales per Employee = 2240000 14
= £160,000
Each employee brings in £160,000 worth of business.
Each employee brings in £160,000 worth of business.
Activity Six
Using the figures given in Activities 2 and 3, and the additional figures below, calculate and comment on shareholder value for the two years shown:
YEAR 1 YEAR 2
Number of Ordinary Shares 600,000 668,200
Preference Dividends/Shares NIL NIL
Market Price Per Share 2.50 3.50
Activity Six Solution: Dividend per Share
Dividends Announced £40,200
Number of Shares 600,000
Dividend per Share = 40200600000
= £0.067
Each shareholder gets 6.7p for each share they own.
Each shareholder gets 6.7p for each share they own.
Activity Six Solution: Dividend Payout
Net Profit £242,600 Interest - £24,000 Tax - £60,200 Net profit after interest/tax £158,400
Dividends Announced £40,200 Dividend Payout = 40200 x 100 158400
= 25.4%One quarter of the total profit is paid out in dividends to shareholders.
One quarter of the total profit is paid out in dividends to shareholders.
Activity Six Solution: Dividend Yield
Dividend per share £0.067 Market Price per Share £2.50 Tax Rate 20%
Dividend Yield = 0.067/(1 – 0.2) x 100 2.50
= 3.35%
NB: 20% = 0.2NB: 20% = 0.2
Shareholders are currently getting a rate of return of 3.35% on their investment at market value (compare Inflation ~ 2%)
Shareholders are currently getting a rate of return of 3.35% on their investment at market value (compare Inflation ~ 2%)
Activity Six Solution: Earnings per Share
Net Profit £242,600 Interest - £24,000 Tax - £60,200 Net profit after interest/tax £158,400
Number of shares issued: 600,000 Earnings per Share: = 158400 600000
= £0.264
The company is making about 26p for every share that is held.
The company is making about 26p for every share that is held.
Activity Six Solution: Cash-Flow per Share
Operating Cash-Flow £231,000 Number of shares issued:
600,000
Cash-Flow per Share: = 231000 600000
= £0.385There is about 40p for every share in current circulation within the company.
There is about 40p for every share in current circulation within the company.
Activity Six Solution: Price/Earnings Ratio
Market Price per share: £2.50 Earnings per share: £0.264
Price/Earnings Ratio: = 2.50 0.264
= 9.45The market price of a share is about 10 times the profit made by the share. (may be better the other way round – each share earns about one-tenth of its current market value in a year)
The market price of a share is about 10 times the profit made by the share. (may be better the other way round – each share earns about one-tenth of its current market value in a year)
Activity Seven
Discuss the following:
If a business is “overtrading”, do you think the following ratios would be higher or lower than normally expected?
(a) Current ratio
(b) Average stock turnover period
(c) Average settlement period for debtors
(d) Average settlement period for creditors
Activity Seven Solution
In an ‘overtrading’ position, these ratios would be:
(a)Current ratio:
Lower (Liabilities would increase)
(b)Average stock turnover period
Lower (Stock run-outs occur)
(c) Average settlement period for debtors
Higher (if inability to supply means total sales lower)
or Lower (if business chases debt due to shortage of cash)
(d)Average settlement period for creditors
Higher (shortage of cash makes it difficult to pay creditors)