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)