A subsidiary of Viago, Lip Smackers Ltd., deals in baked goods. In recent months
ID: 2454515 • Letter: A
Question
A subsidiary of Viago, Lip Smackers Ltd., deals in baked goods. In recent months, the business has been under pressure from its suppliers to reduce the average credit period taken from three months to one month. As a result, the directors approached the Oscar bank to ask for an increase in the existing overdraft for one year, to be able to comply with the suppliers’ demands. The most recent financial statements of the business are as follows:
Statement of Financial Position as of May 31.
ASSETS $
Noncurrent Assets
Property, plant, and equipment 74,000
Current Assets
Inevtories at cost 198,000
Trade Receivables 3,000
201,000
Total Assets 275,000
EQUITY AND LIABILITIES
Equity
$1 ordinary shares 20,000
General reserve 4,000
Retained earnings 17,000
41,000
Noncurrent Liabilities
Borrowings: Loan notes 40,000
repayable in just over
one years time.
Current Liabilities 162,000
Trade payables 10,000
Accrued Expenses 17,000
Borrowings: Bank overdraft 5,000
Taxation 194,000
Total Equity and Liabilities 275,000
Abbreviated Income Statement for the Year
Ended May 31
Sales Revenue $740,000
Operating Profit 38,000
Interest Charges (5000)
Profit before taxation 33,000
Taxation (10,000)
Profit for the year 23,000
A dividend of $23,000 was paid for the year.
Additioanl Information:
The loan notes are secured by personal gurantees from the directors.
The current overdraft bears an interest rate of 12 percent a year.
Task:
1. Calculate relevant Ratios.
a. Current Ratio= Current Asstes/Current Liabilities. Solvent or Insolvent? How do you know?
b. Operating Profit Ratio= Operating Profit/Sales Revenue x 100%
c. Average Settlement Accounts Payabel=
2. Given: The required reduction to achieve 30 day balance would be $108,000 or a loan for that amount. How do you know this?
3. Provide your Analysis: Fill in blanks
The annual sales level of $ is approximately $ per month. The banker would be concerned about any baker or baking company carrying days sales in inventory; especially since suger, flour, and other confectionery products can be purchased in much lower quantities and eggs, dairy products must be purchased in lesse amount due to the freshness requirements. Possibly stale goods are being carried as saleable items, and as such are part of the inventory. The banker would ask for a detailed inventory report, perhaps an audit of the inventory to ascertain that $ of actual raw material (inventories ot cost), in fact, actually exists.
The accounts payable balance of $162,000 that is 90 days past due suggest that total purchases are $657,000.
The banker would likely suggest that all purchases of raw material (supply one answer) continue or cease except for baking elements not on hand and use the cash generated by reducing the inventory levels to pay down the accounts payable creditors. This assumes that the business is on the up and that the inventory exists and is ready to be converted into saleable product.
4. Provide your opinion: The financial analysis that I have performed, dictates that granting addional averdraft or a loan to Lip Smackers (supply one answer) will or will not be wise.
Explanation / Answer
a. Current Ratio= Current Asstes/Current Liabilities
= 201000/ 226000 = .889
Company is Insolvent as Standard Current ratio is 2:1
he required reduction to achieve 30 day balance would be $108,000 or a loan for that amount.
b) Operating Profit Ratio= Operating Profit/Sales Revenue x 100%
= 38,000/740000 * 100= 5.14
c. Average Settlement Accounts Payable= 10000
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