Question

Extracts of the Statement of Comprehensive Income for the year ended 31 December 2018 and
the Statement of Financial Position as at 31 December 2018 are given below for two companies
viz. ABC Limited and XYZ

Extract of the Statement of Comprehensive Income for the year ended 31 December 2018:

	ABC Limited               R	XYZ Limited            R
Sales	6 600 000	2 160 000
Cost of Sales	4 620 000	864 000
Gross profit	1 980 000	1 296 000
Depreciation	270 000	12 000
Other expenses	240 000	45 000
Operating profit	1 470 000	1 239 000
Interest on loan	174 000	75 000
Profit before tax	1 296 000	1 164 000
Income tax	388 800	349 200
Profit after tax	907 200	814 800

Extract of the Statement of Financial Position as at 31 December 2018:

	ABC Limited               R	XYZ Limited            R
Assets
Non-current assets	1 980 000	1 260 000
Inventories	695 000	190 000
Accounts receivable	1 000 000	180 000
Bank	0	20 000
	3 675 000	1 650 000
Equity and Liabilities
Ordinary share capital	2 000 000	1 000 000
Retained earnings	250 000	80 000
Non-current liabilities (18% p.a)	1 020 000	480 000
Accounts payable	360 000	90 000
Bank overdraft	45 000	0
	3 675 000	1 650 000

Additional Information:                                                                                                           

• Inventories as at 31 December 2017 are as follows:                                                

ABC Limited          R800 000                                                                                           

XYZ Limited            R230 000                                                                               

• All sales and purchases of inventories are on credit.

Required:

Compare the performance of ABC Limited and XYZ Limited (both in same industry) with regard to the following ratios and in each case state your observations:

1.      The ability of each company to repay its short term debts without relying on sale of its inventories.

2.      The return earned by shareholders on their investment.   

3.      The operational effectiveness of each company before considering interest income, interest expense and income tax.

4.      The effectiveness with which the goods for sale have been managed.   

5.      An evaluation of each company’s performance with regard to the management of its trade creditors.   

Answer 1

1. ABC has profit after tax of 907200 and account receivable 1000000. This can be utilized for paying of its short term debts of only 405000.

XYZ has net profits of 814800, account receivable of 180000 and bank balance of 20000 which can be utilized for paying of its short tern debts of 90000.

2. Return earned by shareholders of ABC is 45.36% and XYZ is 81.48%.

3. Operating Profit of ABC is 22.27% and that of XYZ is 57.36%. Hence XYZ is operationally more efficient.

4. Cost of sales for ABC is 70% and for XYZ is 40%. Hence XYZ is more effective in managing the goods for sale.

5. Average credit realisation from customers by ABC is 1.82 months sales and by XYZ is 1 month. Hence XYZ manages the creditors better.