1 CASE STUDY – Ratio analysis You have been approached by a shareholder in XYZ plc to provide him/her with a thorough evaluation of the company: XYZ plc. The shareholder is going to a shareholders’ meeting with the company’s directors in two weeks time. The information provided by the shareholder is limited to the attached set of financial statements. Using this information you are required to write a report to the shareholder that: analyses the financial statements In particular the shareholder would like you to: 1. 2. 3. 4. 5. 6. Explain the analysis technique – ratio analysis; Highlight the limitations of ratio analysis; Analyse the company in terms of its solvency/liquidity; Analyse the company in terms of its working capital management; Analyse the company in terms of its financial performance; and Analyse the company in terms of its investment potential 2 FINANCIAL STATEMENTS FOR XYZ PLC FOR THE YEAR ENDED 30 SEPTEMBER 20X1 3 XYZ plc Income statement for the year ended 30 September: Revenue Cost of goods sold Gross profit Other income Administration expenses Material item (exceptional) Finance charges Profit before taxation Income tax charge Profit for the year 20X1 £'000 7,746 (2,254) 5,492 213 (4,321) (250) (30) 1,104 (276) 828 All income and profits are derived from continuing activities. The notes on pages 4 to 7 form part of these financial statements. 20X2 £'000 6,481 (2,262) 4,219 163 (4,174) (20) 188 188 4 XYZ plc Statement of financial position as at 30 September: ASSETS Non-current assets Property, plant and equipment Available-for-sale investments 20X1 20X0 £'000 £'000 592 1,948 2,540 482 1,243 1,725 594 600 482 1,676 500 528 503 421 1,952 Total assets 4,216 3,677 EQUITY AND LIABILITIES Equity and reserves Equity share capital Reserves Total equity 100 1,101 1,201 100 1,023 1,123 1,174 10 1,184 1,200 10 1,210 791 1,040 1,831 3,015 4,216 337 1,007 1,344 Current assets Trade receivables Inventories Cash at bank Available-for-sale investments Non-current liabilities Long-term loan Preference share capital Current liabilities Trade payables and accruals Payments made in advance Total liabilities Total equity and liabilities 3,677 The notes on pages 5 to 7 form part of these financial statements. The financial statements set out on pages 3 to 7 where approved by the board on 12 October 20X1 and signed of its behalf by: A Director B Director 5 XYZ plc 1. STATEMENT OF SIGNIFICANT ACCOUNTING POLICIES The following accounting policies have been used consistently in dealing with items which are material in relation to the company's financial statements. BASIS OF PREPARATION The financial statements are prepared in accordance with generally accepted accounting principles under the historical cost convention and comply with the financial reporting standards of the international accounting standards board. PROPERTY, PLANT AND EQUIPMENT AND DEPRECIATION Property, plant and equipment are stated at cost less accumulated depreciation. The charge for depreciation is calculated to write down the cost of the assets to their estimated residual values by annual instalments over their expected useful lives, on the following bases: Leasehold premises Motor Vehicles Fixtures and fittings 10% 20% 20% Straight line Straight line Reducing balance AVAILABLE FOR SALE INVESTMENTS Investments are shown at cost less provision for permanent diminutions in value and in the case of Government Securities the investments are shown at book value by amortising the premium or discount of redemption value over costs on investment by reference to the remaining life to redemption and includes interest accrued to the reporting period date. Income from investments, together with any related tax credits, is recognised in the income statement in the financial year in which it is receivable. Investments are accounted for as non-current assets except investments with one year or less to redemption which are accounted for as current assets. INVENTORIES Inventories are stated at the lower of cost or net realisable value. REVENUE Revenue is credited to the income statement in the year to which it relates. 6 XYZ plc NOTES TO THE FINANCIAL STATEMENTS 2. PROPERTY, PLANT AND EQUIPMENT Property £’000 500 100 600 Motor vehicles £’000 100 80 (30) 150 80 20 100 38 40 (20) 58 118 60 (20) 158 Closing net book value 500 92 592 Opening net book value 420 62 482 Cost Opening balance Additions Disposals Closing balance Depreciation Opening balance Charge for year Released on disposal Total £’000 600 180 (30) 750 3. SHARE CAPITAL 20X1 Number 20X0 Number Authorised share capital Equity shares of £0.10 each 10% Preference shares of £1 each 200,000 50,000 200,000 50,000 Allotted, issued and fully paid up Equity share capital of £0.10 each 10 % Preference shares of £1 each 100,000 10,000 100,000 10,000 7 XYZ plc NOTES TO THE FINANCIAL STATEMENTS 4. STATEMENT OF CHANGES IN EQUITY (20X1) Share capital £’000 Balance at 1 October 20X0 100 Changes in equity for 20X1 Profit for the period Dividends paid Balance at 30 September 20X1 100 STATEMENT OF CHANGES IN EQUITY (20X0) Share capital £’000 Balance at 1 October 20W9 100 Changes in equity for 20X0 Profit for the period Dividends paid Balance at 30 September 20X0 100 Retained earnings £’000 1,023 828 (750) 1,101 Retained earnings £’000 935 188 (100) 1,023 Total £’000 1,123 828 (750) 1,021 Total £’000 1,035 188 (100) 1,123 5. TAXATION Taxation is charged at the current rate of taxation 20X1: 25% (20X0: 25%) 6. TURNOVER 20% of turnover is by way of cash sales. 7. SHARE PRICE The stock market price of the equity shares at the year end was £8.00. (20X0: £2.00) 8. ASSUMPTIONS Where limited information is given use your initiative.