Acme Inc. is a wholesaler and distributor of electrical components. The most rec
ID: 2629980 • Letter: A
Question
Acme Inc. is a wholesaler and distributor of electrical components. The most recent draft financial statements of the business revealed the following:
Income statement for the year (in millions)
Sales revenue 14.2
Opening inventories 3.2
Purchases 8.4
Goods Available for Sale 11.6
Closing inventories (3.8)
Cost of Goods Sold (7.8)
Gross profit 6.4
Administration expenses (3.0)
Distribution expenses (2.1)
Operating profit 1.3
Finance costs (0.8)
Profit before taxation 0.5
Tax (0.2)
Profit for the period 0.3
Statement of financial position as at the end of the year (in millions)
ASSETS
Non-current assets
Property, plant and equipment
Land and buildings 4.0
Equipment 1.1
Motor vehicles 4
5.5
Current assets
Inventories 3.8
Trade receivables 2.9
Cash at bank .2
6.9
Total assets 12.4
EQUITY AND LIABILITIES
Equity
Share capital 2.1
Retained earnings 1.6
3.7
Non-current liabilities
Loan notes (secured on property) 3.9
Current liabilities
Trade payables 2.2
Short-term borrowings 2.6
4.8
Total equity and liabilities 12.4
Notes
1. Land and buildings are shown at their current market value. Equipment and motor vehicles are shown at their carrying amount (that is, cost less accumulated depreciation).
2. No dividends have been paid to ordinary shareholders for the past three years.
In recent months, suppliers (trade payables) have been pressing for payment. The chief executive has therefore decided to reduce their level to an average of 40 days outstanding. To achieve this, she has decided to approach the bank with a view to increasing the overdraft (the short-term borrowings comprise only a bank overdraft). The business is currently paying 10 per cent a year interest on the overdraft.
Required:
1. Comment on the liquidity position of the business.
2. Calculate the amount of finance required to reduce trade payables, from the level shown on the statement of financial position, to an average of 40 days outstanding.
3. State, with reasons, how you consider the bank would react to the proposal to grant an additional overdraft facility.
4. Identify four sources of finance (internal or external, but excluding a bank overdraft) that may be suitable to finance the reduction in trade payables, and state, with reasons, which of these you consider the most appropriate
Explanation / Answer
1 Liquidity Position:
Current Ratio: Current Assets/Current Liabilities
=6.9/4.8
=1.4375
Quick Ratio = (Current Assets-Inventories)/Current Liabilities
=(6.9-3.8)/4.8
=0.645
Cash ratio = Cash/Current Liabilities
=0.2/4.8
=0.041667
The current ratio of the firm is 1.4375 which implies that that the current assets of the firm have sufficient current assets to take care of its short term liabilities.
The Quick ratio is also good. The cash ratio of 0.041667 is on a lower end but still decent enough.
CONCLUSION: The firm
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