Question 1.

Ratio Market AV 2008 2009

Current ratio 1.8 1.84 1.04
Quick ratio 0.7 0.78 0.38
Inventory turnover 2.5 2.59
Av collection period 37.5 36.5 57 days
Debt ratio 65% 67% 61.3%
Times interest earned 3.8 4.0 2.79
G-profit margin 38% 40% 33.75%
N-profit margin 3.5% 3.6% 4.09%
Return on total assets 4% 4.0%
Return on shareholders 9.5% 8.0% 11.27%
equity
Book ratio 1.1 1.2

Question 2.
INTRODUCTION
This report has been prepared on the basis of the most recent income statement and Balance sheet of
Puppet industries for the year ending 31 December 20X9. The objective being to analyse the
financial performance and position of the said entity with reference to the table of ratios generated
above.

Profitability and Performance

The entity made profit in 20X9, However it experienced a decline in the gross profit margin from
40% in 20X8 to 33.75% in 20X9. This gross profit margin is significantly lower than the industry
average. This reduction might have resulted from, a reduction in the selling price, increase in the
cost of sales. In contrast the net profit margin increased from 3.6% in20X8 to 4.09% 1n 20X9. This
indicates that the company is able to minimise its operating expenses as compared to other entities
in general which yield a net profit margin of 3.5% on average.

The return on total asset indicates whether the company is making better use and efficient in the
utilisation of its non current assets in operations to generate profit.

Debt and Liquidity

The debt ratio measures the ratio of a company's total liabilities to its total assets. It is apparent that
almost all companies operating in the same industry with Puppet experience a debt ratio of about
65%, considering the industrial norm puppet has made a reasonable improvement on its debt ratio
from 67% in 20X8 to 61.3% in 20X9

When reviewing the liquidity of puppet, the situation has worsened. The current ratio measures the
company's ability to meet its current liabilities out of its current assets. A ratio of at least one should
be accepted, puppet met this expectation in both years although the ratio is declining. It should be
noted that there might a significant increase in current liabilities.

The current ratio can be misleading, therefore a reliable ratio which exclude inventory should be
used, this is the quick ratio. The quick ratio of puppet is low and declining and this shows that
current liabilities cannot be met from current assets excluding inventory. A major part of the current
liabilities is the bank overdraft, the entity is obviously relying on the banks continuing support for
short term funding. It would be appropriate to look for alternative sources of finance in the future to
avoid cashflow problems. When compared to the industry as a whole, the ability of puppet to meets
its short term debts is significantly low and uncompetitive with it having 0.38 while the average
should be 0.7.

Efficiency and Activity

The efficiency ratios, receivables ratios and inventory turnover give useful indication of how the
company is managing its current assets.

As it can be seen from the table, the average collection period increased from 36.5days to 57 days.
This may indicate that the company is failing to follow up its debts efficiently or that it has given
increased credit terms to some or all of its customers. Whatever the case might be the company
fares badly with its rivals, who are capable of collecting on average in 37.5 days.

Looking at inventory turnover there may be an indication of overstocking, stocking up on the

expectation of substantial sales increase or the holding of obsolete or slow moving items which
should be written down or the opposite.

Investigation should be carried out in both inventory and receivables.

Investment an Market Ratios

The profit earned in 20x8 was enough to cover the interest expense 4 times as compared to that in
20X9 which can only cover that 2.79 times. This might result in reduced dividends and retained
earnings. And also this might indicate in the interest charge due to increased long term interest
bearing loans. In the industry other companies seem to offer better investment packages with
sufficient profits to cover their interest charges 3.8 times However puppet improved the return to its
shareholders from 8% to 11.27%, as compared to the industry which stands at 9.5%. The market
ratio will reveal the confidence that the investors have on puppet.

Conclusion and summary

Although Puppet is still solvent and profitable, activity and efficiency have declined significantly,
the company is vulnerable to experiencing cash flow problems and/or difficulties in maitaining
competition in the industry