Topic Overview BAFS Elective Part - Accounting Module Financial Accounting A04: Financial Analysis S5 / S6 2 lessons (40 minutes per lesson)

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1 : Topic Overview P.1 Topic Level Duration Topic Overview - Accounting Module Financial Accounting A04: S5 / S6 2 lessons (40 minutes per lesson) Learning Objectives: 1. To understand the major types of accounting ratios; 2. To calculate different accounting ratios; 3. To evaluate financial performance through accounting ratios; 4. To improve the financial performance; and 5. To describe the limitations on using accounting ratios. Overview of Contents: Lesson 1 Lesson 2 Major Types of Accounting Ratios and Their Calculations Evaluation of Financial Performance through Accounting Ratios Prior Knowledge: Students should have basic understanding on the Income Statement and the Balance Sheet. Resources: Topic Overview and Teaching Plan PowerPoint Presentation Student Worksheet Suggested Activities: Case Study Matching Game Problem Solving BAFS As at April 2009

2 : Topic Overview P.2 Theme Duration Lesson 1 Major Types of Accounting Ratios and Their Calculations 40 minutes Expected Learning Outcomes: Upon completion of this lesson, students will be able to: 1. Have basic understanding of the major types of accounting ratios; and 2. Understand how to calculate different accounting ratios. Teaching Sequence and Time Allocation: Activities Part I: Introduction Brief revision of the 8 accounting ratios, including Profitability Ratios (Gross Profit Ratio & Net Profit Ratio) Liquidity Ratios (Current Ratio & Quick Ratio) Management Efficiency Ratios (Stock Turnover Rate, Credit Period Allowed to Debtors, Credit Period Received from Creditors & Return on Capital Employed) Part II: Content Activity 1: Matching Matching game of 8 accounting ratios with formulas will be assigned for revision and as a warm-up for the following activities. Reference PPT #1-5 PPT #6-7 Student Worksheet p.1 Time Allocation 10 minutes 5 minutes Activity 2: Problem Solving Students will be provided with the financial statements of two companies of a similar scale and industry. They will calculate the eight accounting ratios mentioned in Part I of the two companies. Students fill in the two columns of Company A and B with calculations of the 8 accounting ratios for the preparation of Activity 3 and 4 in Lesson 2. Financial statements of the two companies will be provided. PPT #8-9 Student Worksheet pp minutes BAFS As at April 2009

3 : Topic Overview P.3 Activity 3: Case Study Students will conduct a comparison between their own company and its competitors with accounting ratios provided, and will state whether their company is performing better or not according to data provided. The answer slides have animations and chops of WIN/LOSE/DRAW in order to indicate the performance of their company with different ratios compared with competitors. At activity end, teachers suggest and explain which company is doing better in various aspects. Part III: Conclusion Teacher concludes lesson by highlighting the classification of accounting ratios. Students are required to consider the usefulness of accounting ratios and its limitations at home. PPT #10-17 Student Worksheet p.4 12 minutes PPT # minutes BAFS As at April 2009

4 : Topic Overview P.4 Theme Duration Lesson 2 Evaluation of Financial Performance through Accounting Ratios 40 minutes Expected Learning Outcomes: Upon completion of this lesson, students will be able to: 1. Evaluate the financial performance using accounting ratios; 2. Find out how to improve financial performance; and 3. Describe the benefits and limitations using accounting ratios. Teaching Sequence and Time Allocations: Activities Time Reference Allocation Part I - Introduction Teacher begins lesson by asking students their opinions on the usefulness of accounting ratios and limitations of ratios analysis. 3 minutes Teacher asks students to apply calculated ratios in Activity 2 to interpret performance of companies compared to industry average and competitors. Part II Content Activity 4: Group Discussion and Presentation Students are divided into 6 groups to discuss the PPT # minutes level of performance of North Ltd and South Ltd to compare Industry averages (given) and offer improvement suggestions. Students present their own views and listen to Student Worksheet pp.5-8 feedback from other groups. 8 minutes will be given to students to discuss among themselves and formulate their arguments. Each group will nominate one representative to present their ideas. Each representative will have 2 minutes (maximum) to present their performance and improvement methods. Activity 5: Debate Teacher asks students to conduct a debate on the topic of Ratios analysis is the best method to evaluate financial performance! Students are divided into 2 groups. One group PPT #25-27 Student Worksheet 18 minutes BAFS As at April 2009

5 : Topic Overview P.5 assumes the affirmative (benefits of ratios analysis) side and the other as the negative (limitations of ratios analysis) side. 8 minutes will be given to students to discuss among themselves and formulate their arguments. Each group will nominate two representatives to debate. Each representative has 1 minute to present their views and arguments. After all 4 representatives have presented, each group will have a representative to give a 1.5- minute concluding remark. Part III - Conclusion Teacher concludes lesson by highlighting key points to students. pp.9-10 PPT # minutes BAFS As at April 2009

6 Accounting Module - Financial Accounting Accounting Ratios : Profitability Ratios Liquidity Ratios Management Efficiency Ratio Technology Education Section Curriculum Development Institute Education Bureau, HKSARG April Introduction This session aims to help students understand major types of accounting ratios, calculate different accounting ratios and evaluate financial performance through these accounting ratios. Students will finally suggest ways to improve company s financial performance. Knowing the limitations when using accounting ratios is also a must. Prior knowledge Students should have basic understanding on the income statement and the balance sheet. Duration Two 40-minute lessons Lesson 1 Teacher starts the lesson by briefing students the 8 accounting ratios. Users of financial statements evaluate the financial position, financial performance and creditworthiness by analysing and interpreting the financial statements with ratios. Generally, accounting ratios are grouped into the following categories: a.profitability ratios b.liquidity ratios c.management efficiency ratios Contents Lesson 1 Major Types of Accounting Ratios and Their Calculations Lesson 2 Evaluation of Financial Performance through Accounting Ratios 1 2

7 Profitability Ratios Liquidity Ratios Gross Profit Ratio Net Profit Ratio Current Ratio Liquid Ratio (Quick Ratio / Acid Test Ratio) Gross Profit Sales X 100% Net Profit Sales X 100% Current Assets Current Liabilities X 100% Current Assets - Inventory Current Liabilities X 100% 3 4 Profitability ratios measure a company s overall financial performance in terms of profits and return on investment. Liquidity ratios measure a company s relative liquidity --- a firm s ability to pay its current debts. Investors would not be interested to invest in a company with poor earnings potential since the market share price and dividend potential will be adversely affected. Creditors will avoid companies with deficient profitability since the amounts owed to them may not be paid. The major ratios that measure profitability are Gross Profit Ratio and Net Profit Ratio. Liquidity is essential to maintaining business activities. It is particularly important in times of adversity such as when the business is shut down by a strike. The company would be required to satisfy current liabilities before current assets could be realised. In times of recession, operating losses may ensue. If liquidity is insufficient to cover such losses, the company may be forced to wind up. The major ratios that measure liquidity are Current Ratio and Liquid Ratio. 3 4

8 Management Efficiency Ratios Credit Period Allowed to Debtors Credit Period Received from Creditors Activity 1: Matching (Refer to Student Worksheet P.1) Stock Turnover Rate Average Accounts Receivable X 365 days Sales Average Accounts Payable X 365 days Purchases Return on Capital Employed Cost of goods sold Average Stock Profit before interest and tax Owners equity + preference shares + long term liabilities X 100% 5 6 Management efficiency ratios measure management s efficiency in employing assets to generate income. A matching game of the 8 accounting ratios with its formulas will be assigned for revision and as a warm-up for the following activities. The major ratios that measure management efficiency are 1.Stock Turnover Rate 2.Credit Period Allowed to Debtors 3.Credit Period Received from Creditors 4.Return on Capital Employed (there are several equations to measure ROCE e.g. Profit before interest/owners equity or Profit after interest and tax/owners equity ) 5 6

9 Activity 1: Matching ANSWER Match the following ratios with the correct formulas: Current Asset Gross Profit Ratio Net Profit Ratio Current Ratio Liquid Ratio Stock Turnover Rate Current Liabilities Profit before interest & tax Equity, Preference shares & LT Liabilities Net Profit X 100% Sales Average Accounts Receivable Sales Gross Profit X 100% Sales X 100% X 365 days Activity 2: Problem Solving Refer to Student Worksheet P.2-3 Calculation of the accounting ratios Debtors collection period Cost of goods sold Average Stock Creditors repayment period Current Assets - Inventory Current Liabilities Return on capital employed 7 Average Accounts Payable X 365 Purchase days 8 Students will match ratios with the related formulas to strengthen their understanding of each ratio. Students read the financial statements on Student Worksheet P.2 ---then calculate the ratios on P.3. Before calculation, students should beware about the formula of each ratio to ensure correctness of the calculation. Students calculate the accounting ratios in this Activity with the data to be used in upcoming activities. 7 8

10 Activity 2: Suggested ANSWER Calculate the following ratios of two companies: Profitability Ratios North Ltd South Ltd Gross Profit Ratio 65% 57.4% Net Profit Ratio 8.6% 14.6% Liquidity Current Ratio 6.0:1 2.7:1 Quick Ratio 4.8:1 2.2:1 Management Efficiency Stock Turnover Rate 4.0 times 4.5 times Credit Period Allowed to Debtors 113 days 73 days Credit Period Received from Creditors 79 days 169 days Topic Return A04 on Capital Employed 9 10% BAFS 6.7% Elective Part Activity 3: Case Study You are the financial manager of ME Video Game Company Limited. Your staff has calculated accounting ratios of the company and its competitor, PlayGame Company Limited. Based on her workings, please advise your boss which one is better by putting a chop (WIN/LOSE/DRAW) next to that ratio. 10 Students will calculate the accounting ratios and present their answers. Teacher introduces the case to students and ask them to complete the answers to discuss. Formulas: Gross profit ratio: 1677/2580 (North) / 1148/2000 (South) Net profit ratio: 223/2580 (North) / 292/2000 (South) Current ratio: 1250/207 (North) / 950/358 (South) Quick ratio: ( )/207 (North) / ( )/358 (South) Stock turnover ratio: 903/[( )/2] (North) / 852/[( )/2] (South) Credit period allowed to debtors: 800/2580*365days (North) / 400/2000*365days (South) Credit period received from creditors: 207/953*365days (North) / 358/772*365days (South) Return on capital employed: ( )/( ) (North) / ( )/( ) (South) 9 10

11 You are the financial manager of ME Video Game Company Limited. Your staff has calculated accounting ratios of the company and its competitor, PlayGame Company Limited. Based on her workings, please advise your boss which one is better by putting a chop (WIN/LOSE/DRAW) next Possibly to that ratio. ME Video Game Co Ltd sells video games at a higher price! Or the purchase price of video game is Activity 3: Case Study Ratios ME Video Game Co Ltd PlayGame Co Ltd lower than that of PlayGame Company! Profitability Gross Profit Ratio 25% 20% Net Profit Ratio 12.5% 12.5% Liquidity Current Ratio 9:1 4:1 Quick Ratio 4:1 1:1 11 Profitability Activity 3: Case Study It is rarely to have an equivalent NP ratio for You are the financial manager of ME Video Game Company different Limited. Your companies. staff has calculated accounting ratios of the company and its competitor, They PlayGame have Company the same Limited. Based on her workings, please advise your boss which one is better by putting a proportion between the chop (WIN/LOSE/DRAW) next to that ratio. net profit figure and the sales figure for Ratios ME Video Game Co Ltd both PlayGame companies. Co Ltd Gross Profit Ratio 25% 20% Net Profit Ratio 12.5% 12.5% Liquidity Current Ratio 9:1 4:1 Quick Ratio 4:1 1:1 12 Teacher discusses with students which company is performing better and possible reasons and implications of the ratios Same NP ratio means they have the same proportion for the net profit figure and sales figure. Higher GP ratio may result from high selling price (high profit margin) or lower cost of good sold (cost control policy). Higher NP ratio due to tight control on expenses

12 Activity 3: Case Study You are the financial manager of ME Video Game Company Limited. Your staff has calculated the accounting ratios and its competitor, PlayGame Company Limited. Based on the calculations, please advise management which company is better by chopping (WIN/LOSE/DRAW) the ratio. Profitability Ratios ME Video Game Co Ltd PlayGame Co Ltd Ratios Management Efficiency Activity 3: Case Study ME Video Game Co PlayGame Co Ltd Too much Ltd stock is lying idle! Beware of obsolete stock! Stock Turnover Rate 3 times 4.8 times Gross Profit RatioME Video Game 25% Co Ltd s current ratio of 20% 9 is far greater than required. It could be because too much money is lying idle or inventory levels are Net Profit Ratio 12.5% 12.5% high. Quick Ratios for ME is also higher than Liquidity necessary! ME may encounter bankruptcy risk! Current Ratio 9:1 4:1 Quick Ratio 4:1 1:1 13 Credit Period Allowed to Debtors Credit Period Received from Creditors Return on Capital Employed 114 days 61 days 60 days 40 days 24% 34% 14 Benchmark for current and quick ratios are 2:1 and 1:1 respectively. Greater than the benchmark rate means the company is holding excess cash or idle resources. Conversely, the lower than benchmark rate causes liquidity problems and company may not have adequate resources to meet its short-term debt. The greater the stock turnover rate, the shorter the period between purchase and sale. If ratios are too low, it means the company is holding too much stock and risking obsolescence and potential damage

13 Activity 3: Case Study Activity 3: Case Study Ratios ME Not Video efficient Game in debt Co collection! PlayGame Co Ltd Poor credit controls Ltd may result in bad debts! Management Efficiency Ratios Management Efficiency ME Video Game Co Ltd PlayGame Co Ltd Stock Turnover Rate 3 times 4.8 times Credit Period Allowed to Debtors Credit Period Received from Creditors Return on Capital Employed 114 days 61 days 60 days 40 days 24% 34% Stock Turnover Rate 3 times 4.8 times ME settles accounts payable slowly and can have more $$$ (working capital) for daily Credit Period Allowed to 114 operations! days 61 days Debtors Credit Period Received 60 days 40 days from Creditors Return on Capital Employed 24% 34% The shorter the credit period allowed to debtors, the greater the company s efficiency. Lower ratios mean the company is capable of collecting debts quicker and reduces the chance of bad debts and increases company cash flow. Contrary to the credit period allowed to debtors, longer credit periods offered from creditors is suggested. It means that the company is capable of maintaining good supplier relationships and a longer period is being allowed. However, credit periods should not be too long as it indicates the company may be risking liquidity problems and thus unable to repay debts. Moreover, delaying payments may have a negative effect on the company s image and reputation

14 Activity 3: Case Study Summary of Lesson 1 Ratios Management Efficiency ME Video Game Co Ltd 17 PlayGame Co Ltd Stock Turnover Rate 3 times 4.8 times Credit Period Allowed to 114 days 61 days Debtors ME has managed a lower return! Unable to make efficient use of resources to Credit Period Received 60 generate days income! 40 days from Creditors Return on Capital Employed 24% 34% Profitability Ratios Net Profit Ratio Gross Profit Ratio Accounting Ratios Current Ratio Liquidity Ratios Stock Turnover Rate 18 Liquid Ratio Credit Period Allowed to Debtors Management Efficiency Ratio Credit Period Return on Received Capital from Employed Creditors The higher the ROCE, the better the performance of the company. It means that the company is able to use its funds efficiently. Teacher concludes lesson and highlights major accounting ratios discussed lesson

15 Preparation for next lesson 19 Activity 4: Group Discussion and Presentation You are the financial controller of North Ltd or South Ltd. Your boss would like you to comment on the performance of the company with industry level and bring out the improvement directions and methods. Here are the industry ratios: Profitability Ratios Toy Industry Gross Profit Ratio 50% Net Profit Ratio 10% Liquidity Current Ratio 3:1 Quick Ratio 1.5:1 Management Efficiency Stock Turnover Rate Credit Period Allowed to Debtors Credit Period Received from Creditors 5 times 2 months 2 months 20 Topic Return A04 on Capital Employed 10% Preparation for next lesson Teacher asks students to consider the usefulness of accounting ratios and the limitation of the ratio analysis. End of Lesson 1 Lesson 2 Teacher starts the lesson by asking students to use the ratios calculated in Activity 2, to interpret the performance of companies compared with the industry average level and his competitor. Students are required to divide into 6 groups and their role were assigned as follows: Gp1: You are North Ltd financial controller and is responsible for calculating and evaluating the profitability ratio Gp2: You are North Ltd financial controller and is responsible for calculating and evaluating the liquidity ratio Gp3: You are North Ltd financial controller and is responsible for calculating and evaluating the management efficiency ratio Gp4: You are South Ltd financial controller and is responsible for calculating and evaluating the profitability ratio Gp5: You are South Ltd financial controller and is responsible for calculating and evaluating the liquidity ratio Gp6 You are South Ltd financial controller and is responsible for calculating and evaluating the management efficiency ratio Students are given 8 minutes to discuss among themselves and formulate their arguments. Representative from each group will present their ideas. 2 minutes will be given to present their performance and improvement methods

16 Activity 4: Group Discussion and Presentation Here are the background of two companies: North Ltd: Target Customers: Teenager/infant/baby Price range: $200 - $500 Products: Basketball & football sportswear, Sports equipment, Trendy sports clothes Remarks: strong marketing strategies, invites Stars as spokespersons, advertises in different channels, good in design History: about 5 years South Ltd: Target customers: Adult/Elderly Price Range: above $800 Products: Golf/Tennis/Casual sportswear, Golf/Tennis Equipment Remarks: many loyal high-class customers, good quality, suppliers give longer credit payment periods History: long history Activity 4: Group Discussion and Presentation North Ltd: Group 1: Profitability Group 2: Liquidity Group 3: Management Efficiency Before discussion, teacher covers the background of the two companies. Teacher should also highlight that although the ratio calculations are important, students should also consider other issues, such as target customers history and product range, etc. when doing evaluations. Teacher asks students to start their presentations. Some suggested arguments: (numerical answer is in Slide 9) Profitability of North Ltd (Group 1) Company maintains higher GP (65%) ratio than the industry (50%) benchmark Possibly due to high price strategy adopted by North Ltd compared to the industry benchmark NP ratio is (8.6%). It is below industry average (10%) Spends too much on marketing and advertising, e.g. invite Stars as spokespersons Suggestion: more effective internal cost controls and investigate methods to reduce expenses Liquidity of North Ltd (Group 2) Both Current (6.0:1) and Quick Ratios (4.8:1) are far above industry averages (3:1 and 1.5:1) No problem in meeting short-term debts However, too much money is idle and the company is not making efficient use of its financial resources Suggestion: review financial resources and formulate a strategy to make better use of capital Management Efficiency of North Ltd (Group 3) Stock Turnover Rate (4 times) Lower than industry average (5 times) Lower efficiency with risk of obsolete stock Suggestion: reduce selling price to speed up outdated stock sales Credit period allowed to debtors: Debtors on average take 3.7 months to pay Too long compared with industry averages (2 months) and risk of bad debts increase Suggestion: Reduce the credit period allowed to debtors; strengthen and tighten debt collection policies Credit period received from creditors: On average creditors pay within 2.6 months Similar to industry average (2 months) Able to use its short-term financing to fund activities and make efficient use of funds Return on capital employed Same as industrial average (10%) Efficient use of funds to generate income 21 22

17 Activity 4: Group Discussion and Presentation Activity 4: Group Discussion and Presentation Conclusion South Ltd: Group 4: Profitability Profitability North Ltd South Ltd Liquidity North Ltd South Ltd Group 5: Liquidity Management Efficiency North Ltd South Ltd Group 6: Management Efficiency Some suggested arguments: Profitability of South Ltd (Group 4) Both GP ratio (57.4%) and NP ratio (14.6%) are a bit higher than industry averages (50% and 10% respectively) Able to maintain effective internal company cost controls on materials purchases and expenses Suggestion: company can investigate other methods to further control costs to increase profit margins Liquidity of South Ltd (Group 5) Both Current Ratio (2.7:1) and Quick Ratio (2.2:1) are better than industry averages (3:1 and 1.5:1 respectively) No problem in meeting its short-term debts Suggestion: Ratios are above normal requirements (current 2:1; Liquid 1:1), to increase returns, the company can invest its financial resources in bonds and shares to maximise profits Management Efficiency of South Ltd (Group 6) Stock Turnover Rate: (4.5 times) similar to industrial average (5 times) able to maintain inventory control levels Credit period allowed to debtors: Debtors on average take 2.4 months to pay Similar to industry level (2 months) Able to collect quickly from debtors and have more funds available for short-term investments Credit period received from creditors: On average repay creditors within 5.6 months Much higher than industry average (2 months) Slow payments could result in damage to image and reputation making it difficult to find suppliers; or call for bankruptcy by its creditors However, as it is a long established company, suppliers are most likely confident in granting a longer credit period Suggestion: speed up repayment periods Return on capital employed A bit lower than industry average (10%) Less efficient in utilising funds to generate revenue Suggestion: investigate methods on efficient use of funds e.g. investment opportunities with higher returns Students can refer to Students Worksheet P.8 and complete the table during discussions. Teacher should comment upon students view. Teacher should state that there is no definite answer as to how a company can have an absolute advantage over competitors. In reality, it also holds true. Teacher should also mention that financial ratios are useful tools in evaluating different companies performance, however, one should consider that different interpretations can be reached if they are supported with reasonable information

18 Activity 5: Debate Ratios analysis is the best method to evaluate financial performance! Activity 5: Debate Ratios analysis is the best method to evaluate financial performance! Teacher asks students to conduct a debate on the statement: Ratios analysis is the best method to evaluate company performance! Divide students into 5 groups. Each group will divide into half, as the affirmative (benefits of ratios analysis) side and the negative (limitations of ratios analysis) side. 8 minutes is granted to discuss the statement. Both sides need to formulate arguments and present their views within the group. Teacher should use the last 5 minutes to make conclusions regarding the debate topics Some suggested arguments for the proposition (Benefits of ratios analysis): Helpful to review trends between periods for the same company Useful to compare a company with industry competitors, especially with companies in different countries because figures are stated in terms of standard units e.g. %, times etc. Provides a complete picture of an entity compared to financial statements Provides pointers towards interest areas of a company Overtrading can be financially disastrous and ratios can be used to identify it

19 Activity 5: Debate Ratios analysis is the best method to evaluate financial performance! Summary of Lesson 2 Ratio analysis has benefits and limitations. However, without ratios, comparisons are difficult to make between different financial statements and stakeholders do not have enough information for decision-making. With ratios, financial statements can be interpreted and applied to satisfy user requirements. So, ratio analysis is still the common method to effectively evaluate companies Some suggested arguments against the proposition (Limitations of ratios analysis): Teacher concludes the lesson by highlighting the key points. Companies may adopt different accounting policies/standards and resulting figures are difficult to compare Different definitions of accounting ratios for different analysts e.g. Earnings before interest and tax, Earnings before tax, Earnings after interest and tax etc Ratios are calculated using averages or ending values and difficult to identify seasonal business fluctuations Not applicable for different industries and different size comparisons Use of misleading ratios may result in poor quality decision making 27 28

20 The End 29 End of Lesson 2

21 : Student Worksheet P.1 Accounting Module Financial Accounting : Activity 1: Matching Match the following ratios with the correct formulas: Gross Profit Ratio Current assets Current Liabilities Net Profit Ratio Profit before interest & tax Equity, Preference shares + LT Liabilities x 100% Current Ratio Net profit Sales x 100% Liquid Ratio Average Accounts Receivable Sales x 365 days Stock Turnover Rate Gross Profit Sales x 100% Debtors Collection Period Cost of goods sold Average Stock Creditors Repayment Period Current Assets Inventory Current Liabilities Return on Capital Employed Average Accounts Payable Purchases x 365 days BAFS As at April 2009

22 : Student Worksheet P.2 Activity 2: Problem Solving North Ltd and South Ltd are both retailers operating the same market and are very similar. The financial statements of North Ltd and South Ltd for Year 7 are as follows: Income statement for the year ended 31 December Year 7 North Ltd South Ltd $000 $000 $000 $000 Sales 2,580 2,000 Less Cost of goods sold Opening inventories Purchases ,153 1,002 Closing inventories Gross profit 1,677 1,148 Administrative expenses Selling expenses Finance cost Net profit Balance sheets as at 31 December Year 7 ASSETS North Ltd South Ltd Non-current assets $ $ $ $ Property, plant and equipment 3,680 5,300 Current assets Inventories Trade receivables Cash and cash equivalents 200 1, ,930 6,250 CAPITAL AND LIABILITIES Capital Share capital 2,500 2,500 Retained profit 1,223 1,392 3,723 3,892 Non-current liabilities Bank loan 1,000 2,000 Current liabilities Trade payables ,930 6,250 BAFS As at April 2009

23 : Student Worksheet P.3 Calculate the ratios of the two companies: Ratios North Ltd South Ltd Profitability Gross Profit Ratio Net Profit Ratio Liquidity Current Ratio Quick Ratio Management Efficiency Stock Turnover Rate Credit Period Allowed to Debtors Credit Period Received from Creditors Return on Capital BAFS As at April 2009

24 : Student Worksheet P.4 Activity 3: Case Study You are the financial manager of ME Video Game Company Limited. Your staff has calculated accounting ratios for the company and its competitor, PlayGame Company Limited. Based on the calculations, advise management which company is better by chopping (WIN/LOSE/DRAW) next to that ratio. Ratios ME Video Win/Lose/Draw PlayGame Co Game Co Ltd (reasons) Ltd Profitability Gross Profit Ratio 25% 20% Net Profit Ratio 12.5% 12.5% Liquidity Current Ratio 9:1 4:1 Quick Ratio 4:1 1:1 Management Efficiency Stock Turnover Rate 3 times 4.8 times Credit Period Allowed to Debtors 114 days 61 days Credit Period Received from Creditors 36.5 days 40 days Return on Capital 24% 34% BAFS As at April 2009

25 : Student Worksheet P.5 Activity 4: Group Discussion and presentation You are the financial controller of North Ltd or South Ltd. Your boss asks you to comment on the company performance compared to industry levels and show the directions and methods. Here are the industry ratios: Ratios Toy Industry Profitability Gross Profit Ratio 50% Net Profit Ratio 10% Liquidity Current Ratio 3:1 Quick Ratio 1.5:1 Management Efficiency Stock Turnover Rate Credit Period Allowed to Debtors Credit Period Received from Creditors 5 times 2 months 2 months Return on Capital 10% BAFS As at April 2009

26 : Student Worksheet P.6 Here are the two companies backgrounds: North Ltd: Target Customers: Teenager/infant/baby Price range: $200 - $500 Products: Basketball & football sportswear, Sports equipment, Trendy sports clothes Remarks: strong marketing strategies, invites Stars as spokespersons, advertises in different channels, good in design History: about 5 years South Ltd: Target customers: Adult/Elderly Price Range: above $800 Products: Golf/Tennis/Casual sportswear, Golf/Tennis Equipment Remarks: many loyal high-class customers, good quality, suppliers give longer credit payment periods History: long history North Ltd: Profitability Comments: Improvements: North Ltd: Liquidity Comments: BAFS As at April 2009

27 : Student Worksheet P.7 Improvements: North Ltd: Management Efficiency Comments: Improvements: South Ltd: Profitability Comments: Improvements: South Ltd: Liquidity Comments: BAFS As at April 2009

28 : Student Worksheet P.8 Improvements: South Ltd: Management Efficiency Comments: Improvements: Fill in your own answers below: Profitability North Ltd South Ltd Liquidity North Ltd South Ltd Management Efficiency North Ltd South Ltd BAFS As at April 2009

29 : Student Worksheet P.9 Activity 5: Debate Ratios analysis is the best method to evaluate financial performance! Write your arguments For and Against this statement. Arguments FOR the statement: BAFS As at April 2009

30 : Student Worksheet P.10 Arguments AGAINST the statement: BAFS As at April 2009

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