TOPIC 7 S AX a ANALYSING FINANCIAL STATEMENTS QUESTION 1 August 2023 Question One B Citing TWO practical examples, explain the meaning and application.of “predictive analytics”, in the context of financial analysis. (6 marks) ANSWER Meaning and application of “predictive analytic” in the context of financial analysis ¢ Predictive analytics is the use of data to predict future trends and events. It uses historical data to forecast potential scenarios that can help drive strategic decisions ¢ The predictions could be for the- She ruture for instance, predicting the malfunction of a piece of mabhinery later that day or the more distant future, such as predicting your company’s cash flow for the upcoming year. * Predictive analytigs’Gan be conducted manually or using machine ~ Learning algorithms, BitheWay, historical data is used to make assumptions about the future ) ¢ One predictive analytics tools in regression analysis Examples of application of predictive analytics 1. Cash flow projections 2. Profitability forecast 3. Predicting future cost patterns 4, Cost patternTOPIC 7 So & o ANALYSING FINANCIA STATEMENTS, nN 98 QUESTION 1 April 2023 Question One C Summarise FIVE limitations of ratios in analysing financial performance. (S marks) ANSWER Limitation of ratio analysis © It ignores qualitative aspect © Ratios are not rigidly defined © Based on historical information © Ratio’s do not take into account effect of inflation ¢ It uses accounting data which are prone to manipulation © Changes in accounting policies from one yéar to another affects comparabililty * Seasonal factors affecting performanc¢-trom one period to another AE QUESTION 2 1o December 2022 Question Four<\~ (a) Ratio analysis has over titné-proven to be a useful financial tool for decision making. However, reliance on ratios for decision making has inherent limitations. Required: Citing SIX limitations, justify the above statement. (6 marks) (b) The following draft financial statements were extracted from the books of Mrima Limited as at 31 December: Statement of profit or loss for the year ended 31 December: 2021 2020 Sh.*000” Sh.*000” Sales 1,167,800 972,600 Operating profit 41,340, 34,476 Finance cost 3,968 3.968 Profit before tax 37,372 30,508 Taxation 14,052) 11.468 Profit for the period 20 19,040Dividends paid (4,800) (4,480) Retained profit for the year 18,520 14,560 Retained profit brought forward 61,640 47,080 Retained profit brought forward 80,160 61,640 Statement of financial position as at 31 December: 2021 2020 Non-current assets: Sh.“000” Sh.“000” Equipment 25,400 9,990 Current assets: Inventory 100,910. 80,290 Trade receivables 86,740 80,420 Bank balances 11,580 24.184 199.230 184.894 Total assets 224,630 194,884 Equity and liabilities: Capital and reserves: Shares of Sh.20 each 19,840 19840 Retained earnings 80.160 & 640 100,000 2 81.480 Non-current liabilities: 10% debentures 39,680 39,680 Current liabilities: Trade payables 14,460 65,208 Taxation @ 6,520 4,946 Accruals S 3.970 3,570 > 84,950 73.724 Required: Calculate for each year, TWO ratios for each of the following user groups, which are of particular significance to them: (i) Shareholders. (4 marks) (ii) Trade payables. (2 marks) (iii) Internal management. (2 marks) (c) Comment on the changes between the two years as reflected in the ratios calculated in (b) above. (6 marks)ANSWER a) Limitations of ratio analysis = Ratio ignores inflation/ fluctuation in values = Interpretation of ratio changes according to the circumstances of each tase, = Ratios are based on historical data. = Adoption of different accounting policies from company to company hindes comparisons. = Ratio analysis do not consider time value of money. = Accounting data can be manipulated. = It ignores the qualitative aspect of the firm. “A a> 8 b) Sayari Ltd 2021 020 No of shares 19,840 _ 20 nA EPS = Total Earning 23,320 ~ No of shares 992 Total Dividends 4,800 Be iB ——— = 4.52 DES No of shares 992>, a 992 ee PS GZ, 19.19 = y51 eae i: Dividend Cover DPS c} ee Ay aren 4527 4.25 times 4.52 DPR = 2-8 x 1009 484 100 = 20.56 1s19 aie Se EPSane: 23510 suum cue = 23.55% (ii) Trade payable 199,230 184,894 CA SV eee = 2.51: Current ratio Zr 84,950 73,724 rae 98,320 104,604 CA- te = 1.16: say 142: Acid test ratio = ———TSOTY 34950 +16 aeiii) Internal management OS Return on capital employed 23,230 19,040 Nv =—“7_ x 100% Tsee0 aes 121,116 162 wet asset < ar 199,230 164,690 Current ratio=— 34950 7 2.34:1 73,724 ~ 2.51:1 98,320 104,604 Acid ti el ee Ape pe ae 739,680 ~ 'ol4 73,724 c) i) Shareholders * EPS has increased by 4.32. This is due to increase in profit after tax without any increase in share capital. © Dividend cover increased by 0.61 times due to ee in profit. oO ii) Trade payables o Current ratio has reduced but only marginally and-is still appears to be quite sound. Acid test ratio has also reduced but it’s still hn the required margin. iii) Internal management Return on capital employed has incre by 1% as a result of increased PAT. S oO QUESTION 3 S August 2022 Question Five B Dragon Limited is a public entity which has grown in recent years by acquiring established business entities. The directors of Dragon Limited have identified two potential entities targeted for a takeover. The directors believe that the shareholders of the two target companies would be receptive to a takeover. As a pre-requisite to the takeover decision, the directors have tasked a firm of consultants to carry out a cross-sectional analysis of the financial statements of the two potential target companies which operate in the same industry sector. The financial statements of the two entities as at 30 April 2022 are shown below: Statement of profit or loss for the year ended 30 April 2022: Able Limited Ceda Limited Sh.“000” Sh.“000” Revenue 87,500 140,000Cost of sales 66,500) 114,800) Gross profit 21,000 25,200 Distribution costs (1,495) (2,710) Administrative expenses (2,880) (5,340) Operating profit 16,625 17,150 Finance costs 875 (3,150) Profit before tax 15,750 14,000 Income tax expense G,150) (3,500) Profit for the year 12,600 10,500 Statement of financial position as at 30 April 2022: Able Ceda Limited Limited Sh.*000”, Sh.“000” Assets: G. Non-current assets: iG Property 9,800 10,500 Owned plant ao 7,000 8,050 Right-of-use asset ce s 17,500 @ 16,800 36,050 Current assets: NG Inventory of 5,600 11,900 Trade receivables SS 7,350 17,850 Bank O 3,850 200 Total assets 9 33,600 66,500 Equity and liabilities: Equity: Ordinary share capital (Sh.10 par value) 3,500 7,000 Revaluation surplus 1,750 3,150 Retained earnings 5,600 9.450 Total equity 10,850 19,600 Non-current liabilities: Lease liability - 14,700 10% loan notes 15,750 17,500 Current liabilities: Trade payables 4,375 7,350 Lease liability - 2,450 Current tax 2,625 4,900 Total equity and liabilities 33,600 66,500Required: op i) Common size statements of profit or loss for the two entities for the year ended x April 2022. a marks) (ii) Common size statements of financial position as at 30 April 2022. A Ns marks) (iii) Advise the directors of Dragon Limited on the best company for takeOver, (2 marks) ANSWER (i) Common size statement P&L i) Common size statements of profit or loss for the two entities for the year ended 30 April 2022 Able Itd Ceda Itd Revenue 87,500 100% ak 100% Cost of sales (66,500) 76% 00) 82% Gross profit 21,000 24% ee 5,200 18% Distribution cost (1,495) 1.71% (2,710) 1.94% Administrative expenses (2,880) ° (6,340) 3.8% Operating profit 16,625 1,750 12.25% Finance cost (875) (3,150) 2.25% PBT 15, 14,000 10% Income tax 3. i (3.500) 2.5% Profit for the year oa 14.4% 10,500 7.5% ii) Common size statements of financial position as at 30 April 2022 Asset Able Itd Ceda Itd Non-current asset Property 9,800 29.17% 10,500 15.79% Owned plant 7,000 20.83% 8,050 12.11% Right to use asset = 26.32% Total NCA 16,800 50% 54.21% Current asset Inventory 5,600 16.67% 11,900 17.89% Receivables 7,350 21.875% 17,850 26.84% Bank 3,850 11.46% 700 1.05% Total CA 16,800 50% 30.450 45.79% Total assets 33,600 100% 66,500 100% Equity &liabilities Ordinary share capital 3,500 10.42% 7,000 10.53%Revaluation 1,750 5.21% 3,150 4.74% S Retained earnings 5,600 16.67% 9.450 14.21% ® Total equity 10,850 32.29% 19,600 29.47%. NCL Lease liability “ 14,700 251196 10% loan note 15,750 46.875% 17,500 6.32% Current liabilities Trade payables 4,375 13.02% 7,350 11.05% Lease liability - - 2,450 3.68% Current tax 2,625 —-7.8125% 4.900 7.37% Total equity liability 33,600 100% 66,500 100% iii) Advise to the directors of Dragon Limited on the best company for take over In terms of profit, Able Itd is more profitable than Ceda Itd & QUESTION 4 C2 April 2022 Question Two * Super Cars Limited deals in car accessories. Reaighly 75% of sales are on credit while the balance are on cash sales. Cy Super Cars Limited engaged an analyst-yh(/extracted the following summary of industry ratios: ef Return on year end ca ployed 28.1% Net asset (equal to oes turnover 4 times Gross profit margin 17% Net profit (before tax) margin 6.30% Current ratio 1.6:1 Closing inventory holding period 46 days Trade receivables collection period 45 days Trade payables’ payment period 55 days Dividend yield 3.75% Dividend cover 2 times Super Cars Limited summarised financial statements for the year ended 31 December 2021 are as provided below: Statement of profit or loss for the year ended 31 December 2021 Sh."'000" Revenue 20,000 Cost of sales 17,250) Gross profit 2,750 Operating expenses (1.850)Profit on disposal of plant 2 e Finance cost (00), oN Profit before tax 1, Income tax expense Profit for the period 9 Statement of financial position as at 30 December 2021 Non-current assets: Property, plant and equipment 2,750 Current assets: Inventory 1,250 Trade receivables 1,800 Total assets Equity and liabilities: Capital and reserves: Ordinary shares of Sh.100 each 500 Retained earnings 1,900 2,400 Non-current liabili 8% debentures 1,000 Current liabilities: Trade payables Current tax Bank overdraft 2,400 Total equity and liabiliti 5,800 S Additional information: 1. Super Cars Limited received Sh.600,000 from the sale of plant that had a carrying amount of Sh.400,000 at the date of its sale. 2. The market price of Super Cars Limited's shares throughout the year averaged Sh.375 each. 3. There were no issues or redemption of shares or loans during the year. 4. Dividends paid during the year ended 31 December 2021 amounted to Sh.450,000, maintaining the same dividend paid in the year ended 31 December 2020. Required: (a) With reference to the industry ratios, compute the equivalent ratios for Super Cars Limited for the year ended 31 December 2021. (12 marks) (b) Using the ratios computed in (a) above, analyse the financial performance and position of Super Cars Limited for the year ended 31 December 2021 compared to the industry. (8 marks)a RU Sot OO) REE ES HST SIA ie RS Oe a a ccc (Total: 20 maygs) o ANSWER oo a) Computation of equivalent ratios “a |Formula Super Car Ltd Industry | ji) Return on capital employed (ROCE) | PAT 750 oe = 28. Capital Employed * °° 2400 eae Bes ji) Net Asset Turnover Sales a = 5.9 times 4 times. Capital Employed & liii) Gross profit margin 0 Gross profit x 100 x 100 = 13.75% 17% sales eet ,000 liv) Net Profit(before tax) margin 000 x 100 =5% PBIT 20,000 6.3% = x 100 Sales vy) Current ratio 3,050 Current Assets ae =1.27:1 1.6:1 Current Liabilities fi \vi) Inventory holding Period 1,250 t = s Closing Inventory x 365 days 17,250 sa5nn X 365 = 26 days 46 days Cost of sales vii) Receivable collection period Trade recievabl SO ese 45 days x = S ees x365days —_ |75% x 20,000 ays y Credit sales\viii) Trade Payables Payment period eS 2,150 = Trade Payable x 365 days 7 750 x 365 = 45 days >| 55 days Credit Purchases/Costofsales * A se ix) Dividend yield DPS 450,000 + 5,000 a 90 =24% | 3.75% MPS 375 375 ix) Dividend cover 750 . Profit _ EPS 375 = 1.67 times 2 times Dividend DPS b) Analysis of financial performance Profitability ratio © Gross profit margin is lower than the average 13.75% compared to industry 17%. the company is thus underperforthing © Net profit margin is 5% compofifid to the industry 6.3 9%. the decrease in depreciation in super car Ithis because of sale of plant worth 400,000. Its clear that super cars ltd is notes profitable as the industry Liquidity ratio «In terms of liquidity position, super car Itd is performing poor compared with the industry. Efficiency ratio/liquidity © Closing inventory holding period is 26 days compared to 46 days of the industry. it appears that the company is offering quantity rebates more than the industry. « However, there is no change in trade receivable collection period. © The reduction in the trade payable period from 55 days to 45 days as there is no corresponding decrease on the trade receivable collection period. Activity ratios e Net asset turnover is higher (5.9 times) than the industry 4 times, which reflects that super car Itd is managing asset more efficiency than the industry.S QUESTION 5 x 2 December 2021 Question Three A a? ; Various analytical tools are today utilised in financial statements analysis. Some of these tools include: & © Ratio analysis. Trend analysis. © Common size financial statements. Required: In the context of the statement above, describe how each of the above tools is utilised in practice. (6 marks) ANSWER Tools utilized in financial statement analysis oo ¢ Ratio analysis A ratio is an expression of mathematical relationship between quantity and another. Ration analysis can disclose nein which reveals conditions and trends that ofien cannot be noted by inspectiph of the individual component of the ratio e Trend analysis Trend analysis indicat@direction in which a company is headed. Trend analysis involves the collection of information over a given period of time and then compared against previous period eg past few years. e¢ Common size financial statement Financial statements are prepared on the basis of a base index for comparison purposes. There are two major categories i.e vertical analysis and horizontal analysis. For vertical analysis sales and total asset are the base account while for horizontal analysis the base is a specific year (period) QUESTION 6 December 2021 Question Three B Summarise four attributes of good finan statement analy (4 marks)ANSWER Attributes of good financial statement analysis ¢ Timelines Objectivity Precision and brevity Understandability Relevance Reliability QUESTION 7 December 2021 Question Three C The following are extracts of financial statements from the books of Zawadi Ltd.: Extracts of the income statement for the year ended 30 April: 20285 2021 Sh." Sh."000" Sales revenue 476,200 701,800 Cost of sales (approximates purchases) ae (583,898) Gross profit & 103,812 117,902 Administrative expenses (21,962) (30,692) Distribution costs \G~ (23,800) (33,450) Finance costs Oo (7.200) (10,800) Profit before tax we 50,850 42,960 O Extracts of the statement of financial position as at 30 April: 2020 2021 Sh.""000" Sh."'000" Non-current assets: Property, plant and equipment 888,140 1,777,500 Intangible assets 130,000 104,000 1,018,140 1,881,500 Current assets: Inventories 81,000 81,400 Trade receivables 95,240 175,450 Cash and cash equivalents 60,455 78,650 236,695 335,500 Current liabilities: Trade payables 111,715 204,365 Current tax payable 68,120 92,635 122.335 297,000SS SEIS GEOINT Ee ee We oe a cr Assume a 365-day financial year. Required: Analyse and interpret the performance and efficiency of the company for tivo years ended 30 April 2020 and 2021 using: So & “A S s (i) Gross profit margin. (2 marks) (ii) Return on capital employed. (2 marks) (iii) Inventory turnover period. (2 marks) (iv) Trade receivables collection period. (2 marks) (v) Trade payables payment period. (2 marks) ANSWER Financial ratios Formula 2021 ne ; 117,902 00 Toss margin Sarin Gross profit 701,800 sales = 16.8% jii) Return on capital employed 42,960 Net Income eit e (075,000) * 1°° (920,000) * 1°° Net Assets & = 4.73% = 2.24% iii) Inventory Turnover Period 81,000 81,400 = x 365 SEaROR x 365 Average Inventory x 100% 372,388 583, ee ee cee eae ho Cost of sales =79 Days =51 Days liv) Trade receivables collection creer Reem period , tx 36 476,200 * 36° 701,800 * 36° Average Recievables Creueeclesamma es As =73 days =91 days liv) Trade Payables Payment Period 411,715 204,365 aD aaa Oe aRnaa eel 372,388 583,898, Average Payables ——————_x No of days Credit Purchases = 109 days = 128 days