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1 1 The Balance Sheet of Harry Stotl is given below with some words and figures missing. (a) Enter the missing words and figures in the boxes (i) to (v) on the Balance Sheet. Balance Sheet as at 30 September 2002 (b) Calculate, showing your workings, (i) Harry s current ratio (ii) Harry s quick ratio (c) (i) Calculate Harry s working capital. Show your workings. (ii) Explain two effects if a business does not have enough working capital. Ans: (a) (i) $ 86000; (ii) $ 20000; (iii) Assets; (iv) Drawings; (v) $ 5500 (b) (i) 2.2 : 1 (ii) 0.6 : 1 (c) $ (c) if working capital inadequate, may result in * Loss of discounts for prompt payment * Inability to pay creditors, wages, day - -to day expenses * Interruption of supplies and production, leading to loss of sales * use of costly additional finance, e.g, overdraft

2 2. Khalid Ahmed started business on 1 September He rented premises and opened a food store. Khalid did not wish to take any part in the day-to-day running of the business so he appointed a manager. Goods are sold on cash terms to the public, and local restaurants and hotels are supplied on credit terms. All goods are collected by the customers from Khalid s shop. Omar and Sara Moussa are friends of Khalid. They formed a partnership on 1 September 1997, when they purchased premises, fixtures and a motor vehicle and opened a furniture store. All goods are sold on credit terms and are delivered free of charge to customers. Both Omar and Sara work full time in the business and do not employ any staff. The following information relates to the year ended 31 August (a) Calculate the following ratios for each business. Place your answers in the table below. Show clearly all your workings in the space provided. (i) Ratio Khalid Ahmed Omar and Sara Moussa Percentage of gross profit to sales (ii) Percentage of net profit to sales (iii) Collection period for debtors (iv) Payment period for creditors (b) State four differences between the two businesses which would make it wrong to compare their results. Ans : (a) Ratio Khalid Ahmed Omar and Sara Moussa (i) Percentage of gross profit to sales % % (ii) Percentage of net profit to sales % % (iii) Collection period for debtors days days (iv) Payment period for creditors days days 72800

3 (b) different type of business (sole trader/partnership), different type of trade (food story / furniture store), one run by manager one run by owners, one is a new business one is 5 years old. Different types f expenses one has rent other has costs of premises; one has no delivery costs other has motor expenses. Different volume of sales. 3 Martha Adebuyo owns a retail shop. Her financial year ends on 31 August. Her Trading and Profit and Loss Account for the year ended 31 August 2004 is shown below. Some words and figures are missing. (a) In each of the boxes (i) to (vii) enter the missing word(s) or figures. Trading and Profit and Loss Account for the year ended 31 August 2004 (b) Calculate, showing your workings, Martha s (i) gross profit as a percentage of her sales for the year; (ii) net profit as a percentage of her sales for the year. (c) In her next financial year (ending on 31 August 2005), Martha plans to reduce her total expenses in the Profit and Loss account by 10%. Assuming her sales remain unchanged, state the effect this reduction would have on her gross and net profit to sales percentages. 1. Effect on gross profit to sales percentage 2. Effect on net profit to sales percentage Ans:(a)(i) $6000 (ii) Stock (iii) $ (iv) Inwards (v) $ (vi) Received (vii)$ 7000 (b)(i) % (ii) % (c) 1. No effect 2. Reduction in expenses would increase NP: sales percentage only

4 4 Sarah makes children s toys. She rented premises and started business on 1 August The toys are sold on credit to large retail shops and wholesalers. Sarah works in the business and does not employ any staff. She supplied the following information on 31 July $ Capital Cash 100 Bank 1000 Bank loan repayable 31 December Bank loan repayable 31 December Stock Debtors 6100 Creditors 7250 Expenses prepaid 200 Expenses accrued 150 Machinery and equipment (a) Select the relevant figures and calculate Sarah s working capital on 31 July (b) Calculate, correct to two decimal places, Sarah s current ratio and quick ratio at 31 July (c) State two ways in which Sarah could improve her working capital. (d) Sarah decides to compare the results of her first year of trading with those of another business. She obtains the final accounts for the last financial year of the business owned by her two brothers. Sarah s two brothers formed a partnership on 1 January They purchased four food stores in local towns. All the goods are sold on cash terms. The brothers did not wish to take any part in the day-to-day running of the business, so appointed a manager for each store. State and explain four reasons why Sarah should not compare her results with those of her brothers business. Ans: 4(a) Current assets (18400) Current liabilities (12400) = Working capital (6000) (b) Current ratio = = 1.48: 1 Quick ratio = = 0.6: 1 (c) Ways to improve working capital: Injection of more capital; more long-term loans; sale of surplus fixed assets; reduction of drawing (d) Reasons why should not compare with other business: Different type of business (sole trader/partnership) Different type of trade (manufacturing/food store) One run by managers, one run by owner One in its first year of trading, one in its fifth year Different type of sales (cash/credit) Different types of expenses (rent/cost of maintaining premises) Different type of fixed assets (machinery/premises, fixtures).

5 5 Anvil has prepared the following trial balance (after calculating net profit) for the year ended 31 August Anvil Trial Balance at 31 August 2005 $ $ Plant and equipment Motor cars Provision for depreciation Plant and equipment Motor cars Accruals Bank and cash Bank loan repayable Creditors Debtors Prepayments Stock at 31 August Capital Drawings Net profit (a) Prepare Anvil s Balance Sheet at 31 August (b) From Anvil s Balance Sheet, calculate the following ratios to two decimal places. (i) Current ratio (ii) Quick ratio Ans: (a) working capital: $ 56900; balance sheet $ (b) (i) 2.61: 1 (ii) 2.16:1 6 Maria Mafule is a sole trader. She sells leather goods to retail shops. Her financial year ends on 30 September. She provided the following information: For the year ended 30 September 2006 $ $ Sales cash credit Purchases cash credit At 30 September 2006 $ Stock Debtors Creditors Bank overdraft Maria decides to compare her liquidity position on 30 September 2006 with that on 30 September (a) Complete the table on the following page to show the ratios for Maria s business for the year ended 30 September You may use the space below for your workings. Calculations should be correct to two decimal places for (i) and (ii) and should be rounded up to the next whole day for (iii) and (iv). Place the ratios you have calculated into the box below.

6 Ratios (i) Current ratio (ii) Quick ratio (iii) Collection period for debtors (iv) Payment period for creditors Year ended 30 September : : 1 34 days 26 days Year ended 30 September 2006 (b) For each of the following ratios suggest one possible reason which could account for the change in the ratio between 30 September 2005 and 30 September Current ratio Quick Ratio (c) For each of the following ratios suggest two possible reasons which could account for the change in the ratio between 30 September 2005 and 30 September Collection period for debtors (i) (ii) Payment period for creditors (i) (ii) Maria Mafula is interested in comparing her results with those of another business and has obtained the final accounts of some other businesses in the same city. (d) Explain three factors which Maria should bear in mind when attempting to compare her results with the accounts she has obtained relating to other businesses. (i) (ii) (iii) Ans: (a)(i) Current ratio 1.3 : 1 (ii) Quick ratio 0.74:1 (iii) Collection period for debtors 41 days (iv) Payment period for creditors 40 days (b) Current ratio: Increase in current liabilities greater than the increase in current assets. Increase in bank overdraft Increase in creditors. Decrease in stock. Decrease in debtors Quick ratio: Greater proportion of current assets in form of stock. Increase in bank overdraft. Increase in creditors. Decrease in debtors (c) All responses to be based on own figure calculations in (a) Collection period for debtors: Less efficient credit control. Allowing longer credit to encourage sales. Not allowing cash discounts Payment period for creditors: Shortage of liquid funds; Knock-on effect of debtors taking longer to pay; Suppliers not allowing cash discounts. (d) Problems of inter-firm comparison

7 Should compare with a business in same trade Should compare with a business of approximately the same size Should compare with a business of the same type (sole trader/partnership etc) The accounts may be for 1 year only which will not show trends and may not be a typical year The financial year may end on different dates and the period of time covered may be different The businesses may operate different accounting policies There may be differences which affect profitability and the items on the Balance Sheet The accounts do not show non-monetary items, but these are important in the success of a business It is not always possible to obtain all the information about a business in order to make a true comparison 7 Jones Shilango is a trader. He provides the following information for the year ended 31 July $ Sales Purchases Stock 1 August Stock 31 July Expenses were 15 % of sales. (a) (i) Calculate to two decimal places, the percentage of gross profit to sales. Show your workings. (ii) State two ways in which the percentage of gross profit to sales could be improved. (b) (i) Calculate to two decimal places the percentage of net profit to sales. Show your workings. (ii) State two ways in which the percentage of net profit to sales could be improved. Jones Shilango s accountant advises him that it is necessary to make decisions in relation to accounting policies. (c) (i) State which accounting policy is described in the following statement. It must be recognised that a financial report can only be compared with reports for other periods if similarities and differences can be identified. (ii) Explain the meaning of the accounting term reliability. In addition to Jones Shilango, the owner, other people are also interested in the final accounts of Jones Shilango s business. (d) List three business people (excluding the owner) who would be interested in Jones Shilango s final accounts. In each case state one reason why the person would be interested in the accounts. (i) Business person Reason for their interest (ii) Business person Reason for their interest (iii) Business person Reason for their interest

8 Ans 7 (a) (i) Gross profit = ( ) = Gross profit as % of sales= 24.03% (ii) Look for cheaper supplies Increase selling prices Change proportions of different types of goods sold (b) (i) Net profit = (15% x ) = 6500 Net profit as % of sales = 9.03% (ii) Increase gross profit e.g. increase profit margin, increase selling prices etc. Increase sales Reduce expenses e.g. reduce staffing levels, reduce advertising etc. Increase other income e.g. rent out part of premises, earn more discount (c) (i) Comparability (ii) Information provided in financial statements must be reliable Either It must be capable of being depended upon as a faithful representation of the underlying transactions and events it represents Or It must be capable of being independently verified Or It must be free from bias Or It must be free from significant errors Or It must be prepared with suitable caution being applied to any judgements and estimates. (d) (i)bank manager Assessment of prospects of any requested loan/overdraft repaid when due Assessment of prospects of any interest on loan/overdraft being paid when due Assessment of the security available to cover any loan/overdraft (ii) Lenders Assessment of prospects of any requested loan when due Assessment of prospects of any interest on loan being paid when due Assessment of the security available to cover any loan (iii) Creditor for goods Assessment of the liquidity position Identifying how long the business takes to pay creditors Identifying future prospects of the business Identifying what credit limit is reasonable (iv) Managers Assessment of past performance Basis of future planning Control the activities of the business Identifying areas where corrective action is required

9 8 Andy Mann owns a general store. His Trading and Profit and Loss Account for the year ended 31 March 2003 is shown below. Some words and figures are missing. (a) In each of the boxes (i) to (vi) enter the missing word(s) or figure. Andy Mann Trading and Profit and Loss Account for the year ended 31 March 2003 $ $ $ Sales Less Cost of goods sold Opening stock (i) Purchases Less (ii) (2000) Less (iii) (120000) Gross Profit Add Rent received (iv) Discount (v) Less Wages Insurance 3000 General expenses Depreciation (vi) Net Profit (b) Calculate Andy s net profit as a percentage of his sales for the year. Show your workings. (c) On 31 March 2003 Andy s capital was $ He also had a long-term loan from his bank of $ Calculate Andy s net profit as a percentage of the capital employed in his business. (d) Give two reasons why it is important for Andy to know his net profit as a percentage of the capital employed. Ans 8: (a) (i) $12000 (ii) Purchase returns (accept returns ) (iii) Closing stock (accept Stock at 31 March 2003 ) (iv) $5000 (v) received (vi) (b) 15% (c) Capital employed: $ = ( $ x 100 = 12% ) (d) N.P. as percentage of capital employed: - measures overall profitability of the business in relation to resources used - indicates adequacy of return on owner s investment - enables comparisons to be made, e.g. against other investments, earlier years, similar firms - assists decision-making, e.g. in production, cost of borrowing or other acceptable points

10 9 The following balances were extracted from the books of Mary on 31 January 2003 $ Machinery Fixtures 8500 Stock 6600 Debtors 5400 Creditors 4620 Insurance prepaid 120 Rent received in advance 160 Bank overdraft 1780 Cash 240 General expenses accrued 700 Long term loan Capital (a) (i) Select the relevant figures and calculate Mary s working capital on 31 January (ii) Calculate, correct to two decimal places, Mary s current ratio and quick ratio at 31 January Show your workings. 1. Current ratio 2. Quick ratio (b) (i) State and explain two disadvantages to a business of having insufficient working capital. (ii) State two ways in which a business could increase its working capital. Ans: (a) (i) Working capital $5100 (ii) 1. Current ratio 1.70:1 2. Quick ratio 0.79:1 (c) (i) May have problems paying debts as they fall due May not be able to take advantage of cash discounts Cannot make the most of opportunities as they occur Difficulties in obtaining further supplies (ii) Injection of more capital Long-term loans Sale of surplus fixed assets Reduce drawings

11 10 (a) Explain the meaning of the following accounting terms. (i) Margin (ii) Mark-up (b) Zakari is a trader. He provides the following information for the year ended 31 January $ $ $ Sales cash credit Cost of sales Opening stock Purchases cash credit Closing stock Running expenses Debtors at 31 January Creditors at 31 January Zakari decides to compare his results with those for the previous financial year. (i) Complete the following table to show the ratios for Zakari s business for the year ended 31 January Place the ratios you have calculated into the box below. Ratios Gross profit as a percentage of sales Net profit as a percentage of sales Collection period for debtors Payment period for creditors Year ended 31 January % 10% 28 days 35 days Year ended 31 January 2004 % % Days Days (ii) For each ratio suggest two possible reasons which could account for the change in the ratio between 31 January 2003 and 31 January Gross profit as a percentage of sales Net profit as a percentage of sales Collection period for debtors Payment period for creditors [8] (c) Name three business people who would be interested in the final accounts of Zakari. In each case state one reason why that person would be interested in Zakari s final accounts. (i)... (ii)... (iii)...

12 Ans (a) (i) Margin when the gross profit is expressed as a percentage of the selling price. (ii) Mark-up when the gross profit is expressed as a percentage of the cost price (b) (ii) All responses to be based on own figure calculations in (b) (i) Gross profit as a percentage of sales Purchasing goods more cheaply Reducing trade discounts to customers Increasing selling prices Net profit as a percentage of sales- Increase in gross profit percentage Reduction in expenses Differences in types of expenses (fixed/variable) Collection period for debtors Less efficient credit control Allowing longer credit to maintain sales Not allowing cash discounts to debtors Payment period for creditors Shortage of liquid funds Knock-on effect of debtors taking longer to pay Suppliers not allowing cash discounts (c) Interested parties Zaraki (Proprietor) - Assessment of past performance Planning for the future Identifying areas where corrective action is required Manager (if any) Assessment of past performance Planning for the future Identifying areas where corrective action is required Bank manager Assessment of prospects of any requested loan/overdraft being repaid when due Assessment of prospects of any interest on loan/overdraft being paid when due Assessment of the security available to cover any loan/overdraft Lenders Assessment of prospects of any requested loan being repaid when due Assessment of prospects of interest on loan being paid when due Assessment of the security available to cover the loan Creditors for goods Assessment of the liquidity position Identifying how long the business normally takes to pay creditors Identifying future trading prospects of the business

13 11 David Hoon is a sole trader. He prepared the following Balance Sheet at 28 February David Hoon Balance Sheet at 28 February 2005 $ $ $ Fixed Assets at book value Current Assets Stock Debtors Cash Current Liabilities Creditors Bank overdraft Capital (a) (i) Calculate, correct to two decimal places, David s current ratio and quick ratio at 28 February Show your workings. 1 Current ratio 2 Quick ratio (ii) State and explain which of the above ratios gives a better indication of the liquidity position of David s business. Name of ratio... Explanation... David Hoon s net profit for the year ended 28 February 2005 was $4950. (b) Calculate, correct to two decimal places, David s return on capital employed (ROCE). Base your calculation on the capital at 28 February Show your workings. All David Hoon s sales are made on credit. His debtors are allowed a period of 30 days in which to pay their accounts. For the year ended 28 February 2005 his sales were $ (c) (i) Calculate David s collection period for debtors. Show your workings. (ii) State and explain whether you think David will regard this ratio as satisfactory. Will David be satisfied?... Explanation... David Hoon purchases all his goods on credit. He is allowed a period of 60 days in which to pay his accounts. For the year ended 28 February 2005 his purchases were $ (d) (i) Calculate David s payment period for creditors. Show your workings. (ii) State one possible advantage to David of paying his creditors before the due date. (iii) State one possible disadvantage to David of paying his creditors before the due date.

14 Ans:

Prepared by D. El-Hoss. Business Ratios. All questions are the copyright of Cambridge International Examination Board.

Prepared by D. El-Hoss. Business Ratios. All questions are the copyright of Cambridge International Examination Board. Business Ratios 14 5 (a) Explain the meaning of the following accounting terms. Examiner s (i) Margin......... Mark-up.........[4] (b) Zakari is a trader. He provides the following information for the