1. Managing Finance & Budgets Lecture 4 Follow-Up Activities and Solutions

2. 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.

3. 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!

4. Activity Two Calculate and comment on profitability ratios for the two years shown: YEAR 1 YEAR 2 SALES2,240,0002,681,200 COST OF SALES1,745,4002,072,000 OVERHEADS 252,000 362,800 INTEREST 24,000 6,200 TAX 60,200 76,000 DIVIDENDS 40,200 60,000 SHARE CAPITAL 300,000 334,100 RESERVES 198,300 302,500 LONG TERM LOANS 200,000 60,000

5. Activity Two Solution: Gross Margin% The P & L Account Shows:  Sales£2,240,000  Gross Profit£494,600 (NBGross Profit = Turnover – Cost of Sales) Gross Margin%= 494600 x 100= 22.1% 2240000 The company makes 22p for every £1 it brings in. This can be used to pay overheads etc.

6. 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% 2240000 After paying all outstanding costs, the company makes 11p for every £1 it brings in.

7. 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% 497500 The company is making 32p for every £1 invested by shareholders.

8. 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.

9. Activity Three Calculate and comment on liquidity ratios for the two years shown: YEAR 1YEAR 2 DEBTORS240,800210,200 BANK ACCOUNT 33,500 41,000 OPENING STOCK 241,000300,000 CLOSING STOCK300,000370,800 TRADE CREDITORS 221,400228,800 DIVIDENDS OWING 40,200 60,000 CORPORATION TAX OWING 60,200 76,000 CASHFLOW FROM OPERATIONS 231,000251,400

10. Activity Three Solution: Current Ratio Current Assets :  Trade Debtors£240,800  Bank Account £33,500  Closing Stock Value£300,000 £574,300 Current 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

11. Activity Three Solution: Acid Test Ratio Current Assets excluding Stock :  Trade Debtors£240,800  Bank Account £33,500 £274,300 Current 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..

12. 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 Ratio321800 The currently available cash in circulation is about three-quarters of what is needed to pay current debts

13. Activity Four Use the figures shown in Activity Two to calculate and comment on financing ratios for the two years shown.

14. 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% 697500 Just over a quarter of the company’s financing comes through loans

15. 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

16. 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 1YEAR 2 CREDIT PURCHASES1,804,4002,142,800 NUMBER OF EMPLOYEES 14 18

17. 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 days Stock is held on average for 57 days

18. 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 days Debtors take 39 days on average to pay the money.

19. 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 days The company takes 45 days on average to pay its bills.

20. 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 = 3.2 The turnover of the business is three times the total capital invested in it.

21. 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.

22. 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 1YEAR 2 Number of Ordinary Shares600,000668,200 Preference Dividends/Shares NIL NIL Market Price Per Share 2.50 3.50

23. Activity Six Solution: Dividend per Share  Dividends Announced £40,200  Number of Shares 600,000 Dividend per Share = 40200 600000 = £0.067 Each shareholder gets 6.7p for each share they own.

24. 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.

25. Activity Six Solution: Dividend Yield  Dividend per share £0.067  Market Price per Share £2.50  Tax Rate20% Dividend Yield = 0.067/(1 – 0.2) x 100 2.50 = 3.35% NB: 20% = 0.2 Shareholders are currently getting a rate of return of 3.35% on their investment at market value (compare Inflation ~ 2%)

26. 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.

27. Activity Six Solution: Cash-Flow per Share  Operating Cash-Flow £231,000  Number of shares issued: 600,000 Cash-Flow per Share: = 231000 600000 = £0.385 There is about 40p for every share in current circulation within the company.

28. Activity Six Solution: Price/Earnings Ratio  Market Price per share: £2.50  Earnings per share: £0.264 Price/Earnings Ratio: = 2.50 0.264 = 9.45 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)

29. 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

30. 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) orLower (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)