BUSF_A01.qxd

Appendix 4 • Suggested answers to selected problem questions

General comments

This business has experienced a major expansion in activities over the two years. This has led

to an increase in the ROCE ratio, but an ROCE in excess of the interest rate caused a greater

increase in ROSF, an effective use of gearing. Despite the benefits of gearing, its level is now

very high, and much of it is short term and represents a distinct risk to the business.

The gross profit ratio increased significantly. This was accompanied by an increase in

the operating profit margin.

The liquidity position has weakened considerably from a healthy position to one that

looks distinctly unhealthy. The inventories turnover period is now rather long compared

with last year. Attention needs to be paid to liquidity and gearing, which are linked since

part of the gearing comes from the overdraft.

(a) An equity investor’s perspective

This person will probably be pleased with the expansion in revenue and profit, also with

the effective use of gearing. The high level of gearing and the significant deterioration in

liquidity are major causes of concern.

(b) The bank’s perspective

The bank will be concerned at the very weak liquidity position and the security for the

overdraft. The latter should not pose a problem: there seem to be plenty of assets, though

we do not know what quality they are as security, in terms of marketability.

Current ratio

1.76 : 1

1.02 : 1

Acid test ratio

0.78 : 1

0.40 : 1

Gearing ratio

0.34 : 1

7,600 +3,250 0.54 : 1

9,000 +7,600 +3,250

3,600

6,875 +3,600

Non-current liabilities +overdraft

Share capital +reserves +non-current

liabilities +overdraft

7,974 −4,820

7,844

4,356 −2,418

2,482

Current assets less inventories

Current liabilities

7,974

7,844

4,356

2,482

Current assets

Current liabilities

Last year This year

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