Bright Retail: ratio analysis and interpretation

Tick each point that your answer made clearly and only once. Points here are this site's own. A real examiner may accept other valid points.

• Gross profit margin: 20X5 35.0%, 20X4 38.6%.
• Return on capital employed: 20X5 21.6% (1,100 / 5,100), 20X4 23.3% (1,050 / 4,500).
• Current ratio: 20X5 1.50, 20X4 1.46.
• Quick ratio: 20X5 1.00, 20X4 1.08.
• Inventory holding period: 20X5 49 days, 20X4 42 days.
• Gearing: 20X5 41.0%, 20X4 37.0%.
• Capital employed is calculated correctly as total assets less current liabilities for each year.
• Each ratio is calculated with the formula given and the workings are shown.

Marks counted: 0 of 8

Tick each point that your answer made clearly and only once. Points here are this site's own. A real examiner may accept other valid points.

• Gross margin fell from 38.6% to 35.0%, which is consistent with the price cuts to protect market share against the new competitor.
• Revenue grew by 14.3 percent (from 7,000 to 8,000), which shows that the price cuts and the strategy may have protected volume.
• Operating profit rose only slightly (1,050 to 1,100), so the operating margin fell from 15.0% to 13.8%.
• ROCE fell from 23.3% to 21.6%, because capital employed grew faster than profit, partly due to the new distribution centre, which has not yet had time to produce returns.
• The inventory holding period rose from 42 to 49 days, which is consistent with carrying more inventory, and risks obsolescence and the cost of holding it.
• The current ratio is little changed (1.46 to 1.50), but the quick ratio fell (1.08 to 1.00), because the rise in current assets is mostly inventory, so liquidity is weaker than the current ratio suggests.
• Receivables days rose (20X4 36, 20X5 41), which is unusual for a retailer and should be investigated.
• Gearing rose from 37.0% to 41.0%, and interest cover fell from 8.8 times to 7.3 times, so a further loan would increase financial risk.
• The bank would consider the ability to service more debt, the fall in margins, the uncertainty about the competitor, and the security available.
• A balanced conclusion: the entity has grown, but profitability and liquidity are under pressure, so the bank is likely to want more information, security or a smaller loan, or to delay until the distribution centre produces benefits.
• Limitations: the analysis uses year-end figures and only two years, and the entity should be compared with competitors and industry averages.
• Recommendation for the directors: improve inventory control, review pricing and consider phasing the new stores.

Marks counted: 0 of 12