The managing director of Smart Ltd, a trading company, has just received summary

Question

The managing director of Smart Ltd, a trading company, has just received summary sets of statements for 2014 and 2015.

Smart Ltd

Income statements for years ended 30 September 2014 and 2015

                                                             2014                                   2015

                                               $’000                   $’000          $’000                 $’000

Sales                                                                   1,800                                    1,920

Less cost of sales                 

Opening inventory                     160                                       200

Purchases                              1,120                                      1,175

                                               1,280                                      1,375

Less closing inventory               200                                       250

                                                                            1,080                                    1,125

Gross profit                                                            720                                    795

Less expenses                                                      680                                    750

Net profit                                                                  40                                     45

                                                                            ====                                  ====

Balance sheets as at 30 September 2014 and 2015

                                                           2014                                     2015

                                                    $’000             $’000         $’000                 $’000

Current assets

Bank                                                   4                                            2

Debtors (accounts receivables)    375                                           480

Inventory                                        200                                           250

                                                                               579                                    732

Non-current assets                                                950                                    930

Total assets                                                        1,529                                    1,662

                                                                            =====                                  =====

Current liabilities                                                    195                                     225

Shareholders’ equity

Paid-up ordinary share capital       825                                        883

Retained earnings                          509                                        554      

                                                                            1,334                                    1,437

Total liabilities and shareholders’ equity            1,529                                    1,662

                                                                            =====                                  =====                                                   

The finance director has expressed concern at the increase in inventory and debtor levels.

(a) Show, by using the data given, how you would calculate ratios that could be used to measure inventory and debtor levels in 2014 and 2015 (Note: For measurement of inventory, the average inventory should be calculated; as for debtors, the year end figure is used as the average is not available).

(b) Discuss how the management of Smart Ltd could exercise control over:

1.Inventory levels

2.Debtor levels

Explanation / Answer

1. Inventory level- Manangement can use these ratio to reduce the inventory holding days and increase the inventory turnover ratio. As this data helps the manangement to look into the inventory days, from this they can make the plan to reduce the same.
2. Debtors Level- Manangement can use these ratio to reduce the Debtor collection days and increase the Debtors turnover ratio. As this data helps they can look into the Debtors collection days, from it they can make the plan to reduce it .

a) Ratio calculation for Account receivable and Inventory Account Receivable 2014 2015 Debtors Turnover Ratio Times           4.80           4.00 ( Sales/debtors) Average Collection Period Days               76               91 (365/Debtors Turnover Ratio) * Debtors "000 $ 375 480 Sales "000 $ 1800 1920 Inventory Inventory turnover ratio Times 9.00 7.68 (Sales/inventory) Inventory turnover days days 41 48 (365/inventory turnover ratio) * Inventory "000 $ 200 250 Sales "000 $ 1800 1920

1. Inventory level- Manangement can use these ratio to reduce the inventory holding days and increase the inventory turnover ratio. As this data helps the manangement to look into the inventory days, from this they can make the plan to reduce the same.
2. Debtors Level- Manangement can use these ratio to reduce the Debtor collection days and increase the Debtors turnover ratio. As this data helps they can look into the Debtors collection days, from it they can make the plan to reduce it .

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