Ratio Analysis

Question 1

Critically analyse

Answer 1

Calculations and discussions

• overly reliant on two clients (Bring in x%)
• All costs are fixed resulting in a high degree of operating leverage.
• The allocated overheads represent 51% of total divisional costs and are likely to be the reason for the adverse operating profit variance. These need to be investigated urgently.
• These costs are not within the control of the division and are likely to be unavoidable and therefore distort the performance of the division.
• The mark-up %’s appear reasonable and one would expect the trainees to have the highest.
• Despite an improvement on total budgeted revenue, the increase in operating costs have eroded planned operating profit margins
• A detailed budget would have enabled a more meaningful evaluation of performance

Question 2

How to improve profitability

Answer 2

-Diversify revenue streams
-Consider entering into insurance-type contracts (e.g. residual value guarantee contracts) to reduce the losses
-Reduce fixed cost component of the cost-structure
-Outsource/Sub lease
-Reduce variable costs
-Reduce the high gearing levels as these place pressure on profits and cash flows.
-Consider a rights issue / raising equity capital
-Losses incurred on disposal of trucks can be eliminated by hedging on the currency
-Benchmark prices to industry / consider price sensitivity / adjust in line with inflation.
- Consider target costing
-Increase revenue by changing pricing structure of contracts.
-Consider factoring or invoice discounting its debtors’ book to raise capital.
- This is likely to be expensive; affect profitability.
-Improve cash inflow by reducing the high trade debtors days (increasing in 2010 – 64.9 days, from 2009 – 59.9 days), by offering payment discounts / improved debt collecting measures
-Enter into sale-and-leaseback agreements wrt vehicle fleet,
-Delay paying accounts payable up to a point that would not damage relationships with suppliers
-Collect working capital faster, debtors collect earlier, or reduce inventory holdings (1). Both of these seem to already have been decreased, so scope here may be limited
-Extend creditors terms, or overdraft facilities to free up space for the liabilities
For short term debt, try and push this out to at least a year longer with the providers.
-Improve revenue generation by offering discounts or having specials.
-Attempt to reduce costs by retrenching or negotiating with suppliers (1). The company has already embarked on cost saving exercises already, therefore the scope to reduce costs may be limited (1).
-Institute share option remuneration for shareholders instead, to try retain cash.
-Ask employees to take temporary pay cuts now, rather than facing retrenchment later.

Question 3

Guidance on ratio analyse:

Answer 3

• Specific ratios
• Balanced scorecard
• Compare
• Customers
• Internal
• Growth