How accounting ratios monitor the financial performance

Question

Question 1: Interpret the contents of a given profit and loss account and balance sheet and explaining how accounting ratios can be used to monitor the financial performance of Debenhams.

Profit & Loss Account:

	2007		2008
Sales		80,000		120,000
Less COGS:
Opening Stock	25,000		22,500
Add Purchases	50,000		91,000
Less Closing Stock	(15,000)	60,000	(17,500)	96,000
Gross Profit		20,000		24,000
Less Depreciation	1,000		3,000
Other Expenses	9,000	10,000	6,000	9,000
Net Profit		10,000		15,000

Balance Sheet:

	2007		2008
Fixed Assets:
Equipment	10,000		20,000
Less Depreciation	(8,000)	2,000	(6,000)	14,000
Current Assets:
Stock	15,000		17,500
Debtors	25,000		20,000
Bank	5,000		2,500
Total	45,000		40,000
Creditors	5,000		(10,000)
Net Assets		42,000		44,000
Financed By:
Capital		38,000		36,000
Add Net Profit		10,000		15,000
Less Drawings		(6,000)		(7,000)
Capital Employed		42,000		44,000

Interpret the contents of a given profit and loss account and balance sheet and explaining how accounting ratios can be used to monitor the financial performance of Debenhams

2007	Formulae	Workings	Answer
Gross Profit Margin
Net Profit Margin
Return On Capital Employed (ROCE)
Current Ratio
Acid Test
Debtors Days
Creditors Days

Interpret the contents of a given profit and loss account and balance sheet and explaining how accounting ratios can be used to monitor the financial performance of Debenhams

2008	Formulae	Workings	Answer
Gross Profit Margin
Net Profit Margin
Return On Capital Employed (ROCE)
Current Ratio
Acid Test
Debtors Days
Creditors Days

Interpret the contents of a given profit and loss account and balance sheet and explaining how accounting ratios can be used to monitor the financial performance of Debenhams

How do the following ratios help to monitor Debenham's financial performance:

Benefit	Relate to Figures		Impact on Debenhams
	2007	2008	Improved	Worsened
Gross Profit
	2007	2008	Improved	Worsened
Return on Capital employed (ROCE)
	2007	2008	Improved	Worsened
Current Ratio
	2007	2008	Improved	Worsened
Debtor Days

Question 2: Analyse the reasons why costs need to be controlled to budget

1. From the above information, identify two problems that Debenhams are facing:

2. What would you advise Debenhams to do in order to improve their budget position? (Give two points with explanations).

3. Analyse the reasons why costs need to be controlled to budget

4. The advantages of controlling costs are:

5. The disadvantages of not controlling costs are

6. Potential problems of not controlling costs on the Budgets of Debenhams are:

7. Evaluate the adequacy of accounting ratios

8. Evaluate the problems they have identified from unmonitored costs and budgets 

9. Explain three advantages & three disadvantages of budgets:

10. What are the potential problems for Debenhams if budgets are left unmonitored?

11. Evaluate the problems they have identified from unmonitored costs and budgets

12. For Budgets & Costs, provide two recommendations for each to Debenhams on how to improve their position, with explanations:

Question 3: Describe sources of internal & external finance for Debenhams.

1. If Debenhams made £10 million profit in the last financial year, what would they do with this profit?

2. Can you think about another source of finance that Debenhams could potential use?

3. Write a paragraph to answer each of the following:

a. Why may a bank overdraft be more beneficial than a bank loan for Debenhams?

b. Why might investors be more willing to invest into a company, like Debenhams, than save their money in a bank account?

c. Why are shares considered a long-term investment?

d. Why are banks currently very reluctant to lend a small business money?

e. Why may banks be more likely to lend money to a large company, such as Debenhams?

Question 4: Illustrate the use of budgets as a means of exercising financial control of Debenhams

	February	March	April
Receipts - Debtors	21,000	28,000	30,000
Payments:
Purchases	12,000	9,000	10,000
Expenses	20,000	22,000	18,000
Office machinery	24,000
	56,000	31,000	28,000
Balance B/fwd	3,200	-31,800	-34,800
Receipts	21,000	28,000	30,000
	24,200	-3,800	-4,800
Payments	56,000	31,000	28,000
Balance c/fwd	-31,800	-34,800	-32,800

1. From the above budget, identify three problems and for each of your problems, identify a solution:

2. Interpret the contents of a given profit and loss account and balance sheet

a. What does the Trading, Profit & Loss Account show?

b. What does the Gross Profit show?

c. Make a comment about the expenses.

d. What does the Net Profit show?

e. What might Debenhams do with this Net Profit?

f. How do Fixed & Current Assets differ?

g. Why are Current Assets so important?

h. Why is it important to have more Current Assets than Current Liabilities?

i. What does the Net Asset figure show?

j. Why must the last section of the Balance Sheet match the Net Asset figure?

3. Interpret the contents of a given profit and loss account and balance sheet

a. From the trading, profit & loss account, how might Debenhams improve their sales?

b. From the trading, profit & loss account, how might Debenhams reduce their costs?

c. From the balance sheet, how do the current assets cover the current liabilities, in Debenham's day-to-day operations?

d. Why is the balance sheet important to an investor?

4. Illustrate the financial state of Debenhams

What does each of the ratios mean?

• The Gross Profit margin shows .....
• The Net Profit margin shows .....
• The return on capital employed (ROCE) shows .....
• The current ratio shows....
• The acid test ratio shows....
• The debtor days shows....
• The creditor days shows....