Additional Solved Sums, Financial Management, Prassanna Chandra

As a rule of thumb, real rates of interest are calculated by subtracting the inflation rate from the nominal rate.

What is the error from using this rule of thumb for calculating real rates of return in the following cases?

At the end of March, 20X6 the balances in the various accounts of Dhoni & Company are as follows: Rs. in million Accounts Balance Equity capital 120 Preference capital 30 Fixed assets (net) 217 Reserves and surplus 200 Cash and bank 35 Debentures (secured) 100 Marketable securities 18 Term loans (secured) 90 Receivables 200 Short-term bank borrowing (unsecured) 70 Inventories210 Trade creditors 60 Provisions 20 Pre-paid expenses 10

Required: Prepare the balance sheet of Dhoni & Company as per the format specified by the Companies Act.

Solution

Balance Sheet of Dhoni & Company As on March 31, 20 X 6 Liabilities

• Assets
• Share capital
• Fixed assets
• Equity |120 |
• Net fixed assets |217 | |
• Preference |30 |
• Reserve & surplus |200 |
• Investments |  | |
• Marketable securities |18 |
• Secured loans
• Current assets, loans & advances
• Debentures |100 | |
• Term loans |90 | | |
• Pre-paid expenses |10 |
• Unsecured loans |
• Inventories |210 | |
• Short term borrowing |70 |
• Receivables |200 | |
• Current liabilities & provisions | |
• Cash & Bank |35 | |
• Trade creditors |60 | |  |
• Provisions |20 | |

The comparative balance sheets of Evergreen Company are given below: (Rs. in million)

• Owners’ Equity and Liabilities As on 31. 3. 20X6 As on 31. 3. 20X7
• Share capital 70 70
• Reserves and surplus 40 80
• Long-term debt 80 90
• Short-term bank borrowings 80 85
• Trade creditors 40 70
• Provisions 10 20
• Total320415
• Assets Fixed assets (net)120210
• Inventories 90 95
• Debtors 60 65
• Cash 25 30
• Other assets 25 15
• Total320415

The profit and loss account of Evergreen Company for the year ending 31st March 2007 is given below:

• Net sales 750
• Cost of goods sold 505
• Stocks 290
• Wages and salaries 105
• Other manufacturing expenses 110
• Gross profit 245
• Operating expenses135
• Selling, administration and general120
• Depreciation 15
• Operating profit110
• Non-operating surplus or deficit(20)
• EBIT 90
• Interest 25
• Profit before tax 65
• Tax 15
• Profit after tax 50
• Dividends 10
• Retained earnings 40

How rapidly (in how many days) must accounts receivable be collected if management wants to reduce the accounts receivable to 300,000?

Solution:

1,200,000 Average daily credit sales = = 3287. 67 365 If the accounts receivable has to be reduced to 300,000 the ACP must be: 300,000 = 91. 3 days 3287. 67 15. A firm has total annual sales (all credit) of 100,000,000 and accounts receivable of 20,000,000.

How rapidly (in how many days) must accounts receivable be collected if management wants to reduce the accounts receivable to 15,000,000? Solution: 100,000,000 Average daily credit sales = = 273,972. 6 365 If the accounts receivable has to be reduced to 15,000,000 the ACP must be: 15,000,000 = 54. 8 days 273,972. 6 16. The financial ratios of a firm are as follows. Current ratio = 1. 25 Acid-test ratio = 1. 10 Current liabilities=2000 Inventory turnover ratio=10 What is the sales of the firm? Solution: Current assets = Current liabilities x Current ratio = 2000 x 1. 25 = 2500 Current assets – Inventories = Current liabilities x Acid test ratio 2000 x 1. 10 = 2200 Inventories = 300 Sales = Inventories x Inventory turnover ratio = 300 x 10 = 3000 17. The financial ratios of a firm are as follows. Current ratio = 1. 33 Acid-test ratio = 0. 80 Current liabilities=40,000 Inventory turnover ratio=6 What is the sales of the firm? Solution: Current assets = Current liabilities x Current ratio = 40,000 x 1. 33 = 53,200 Current assets – Inventories = Current liabilities x Acid test ratio = 40,000 x 0. 80 = 32,000 Inventories = 21,200

Sales = Inventories x Inventory turnover ratio = 21,200 x 6 = 127,200 18. The financial ratios of a firm are as follows. Current ratio = 1. 6 Acid-test ratio = 1. 2 Current liabilities=2,000,000 Inventory turnover ratio=5

What is the sales of the firm?

Solution

Current assets = Current liabilities x Current ratio = 2,000,000 x 1. 6 = 3,200,000 Current assets – Inventories = Current liabilities x Acid test ratio = 2,000,000 x 1. 2 = 2,400,000 Inventories = 800,000 Sales = Inventories x Inventory turnover ratio = 800,000 x 5 = 4,000,000 19.

• Accounts receivable= 25 days
• Gross profit margin= 28 percent
• Inventory turnover ratio = 7
• Equity = 600,000 + 100,000 = 700,000
• Debt = Short-term bank borrowings =1. 5 x 700,000 = 1050,000
• Hence Total assets = 700,000+1050,000 = 1,750,000
• Total assets turnover ratio = 1. 9
• Sales = 1. 9 x 1,750,000 = 3,325,000
• Gross profit margin = 28 per cent
• Cost of goods sold = 0. 2 x 3,325,000 = 2,394,000
• Day’s sales outstanding in accounts receivable = 25 days Sales
• Accounts receivable = x 25 360 3,325,000 = x 25 = 230,903 360
• Cost of goods sold 2,394,000
• Inventory turnover ratio === 7
• Inventory = 342,000

As short-term bank borrowings is a current liability , Cash + Accounts receivable Acid-test ratio = Current liabilities Cash + 230,903 = = 0. 3 1050 ,000 So Cash = 84,097 Plant and equipment = Total assets – Inventories – Accounts receivable – Cash = 1,750,000 – 342,000 – 230,903 – 84,097 = 1,093,000 Putting together everything we get Balance Sheet

Comparative Profit and Loss Accounts

• Nalvar Limited (Rs. in million) | | |20X4 |20X5 |20X6 |20X7 | | |20X3
• Net sales |3. 8 |4. 2 |5. 3 |6. 5 |7. 8 | |
• Cost of goods sold |2. 6 |3. |3. 9 |4 |4. 8 | |
• Gross profit |1. 2 |1. 1 |1. 4 |2. 5 |3 | |
• Operating expenses |0. 3 |0. 3 |0. 4 |0. 6 |0. 6 | |
• Operating profit |0. 9 |0. 8 |1 |1. 9 |2. 4 | |
• Non-operating surplus deficit |0. 1 |0. 2 |0. 1 |0. 3 |0. 3 | |
• Profit before interest and tax |1 |1 |1. |2. 2 |2. 7 | |
• Interest |0. 1 |0. 1 |0. 2 |0. 1 |0. 1 | |
• Profit before tax |0. 9 |0. 9 |0. 9 |2. 1 |2. 6 | |
• Tax |0. 05 |0. 08 |1 |1. 2 |1. 2 | |
• Profit after tax |0. 85 |0. 82 |-0. 1 |0. 9 |1. 4 |

Required: Compute the important ratios for Nalvar Limited for the years 20X3-20X7.

You may assume that other assets in the balance sheet represent other current assets.

• Current ratio
• Debt-equity ratio
• Total assets turnover ratio
• Net profit margin
• Earning power
• Return on equity

Solution

We will rearrange the balance sheets as under for ratio analysis. It is assumed that ‘Other assets’ are other current assets

• Current ratio |2. 2 |2. 2 |2. 3 |2. 3 |2. 5 | |
• Debt-equity ratio |1. 0 |0. 9 |0. 8 |0. 8 |0.
• Total assets turnover ratio |0. 7 |0. 7 |0. 7 |0. 9 |1. 0 | |
• Net profit margin(%) |22. 4 |19. 5 |-1. 9 |13. 8 |17. 9 | |
• Earning power (%) |18. 9 |16. 1 |14. 3 |30. 6 |35. 5 | |
• Return on equity (%) |32. 7 |25. 6 |-2. 4 |22. 0 |28. 0 | 26.

Comparative Balance Sheets, Somani Limited (Rs. in million) | | | 20X5 | 20X6 | 20X7 | | | |20X4 | | | | | |20X3 | | | | | |

• Share capital |41 |50 |50 |50 |55 | |
• Reserves and surplus |16 |36 |72 |118 |150 | |
• Long-term debt |28 |25 |30 |29 |22 | |
• Short-term bank borrowing |35 |30 |36 |38 |38 | |
• Current liabilities |24 |28 |30 |30 |25 | |
• Total |144 |169 |218 |265 |290 | |
• Assets | | | | | | |
• Net fixed assets |72 |80 |75 |102 |103 | |
• Current assets | | | | | | |
• Cash and bank |8 |9 |15 |12 |11 | |
• Receivables |24 |30 |59 |62 |85 | |
• Inventories |35 |42 |55 |75 |79 | |
• Other Assets |5 |8 |14 |14 |12 | |
• Total |144 |169 |218 |265 |290 | | | | | | | | |

Compute the following ratios for years 20X3-20X7:

• Current ratio
• Debt-equity ratio
• Total assets turnover ratio
• Net profit margin
• Earning power
• Return on equity

For ratio analysis purpose, we will rearrange the balance sheet as under. It is assumed that ‘Other assets’ are other current assets 20X3 20X4 20X5 20X6 20X7

• Share capital | |41 | |50 | | |
• Current ratio |1. 2 |1. 5 |2. 2 |2. 4 |3. 0 | |
• Debt-equity ratio |1. 1 |0. 6 |0. 5 |0. 4 |0. | |
• Total assets turnover ratio |2. 4 |2. 3 |1. 9 |1. 5 |1. 3 | |
• Net profit margin (%) |13. 0 |23. 8 |23. 9 |20. 6 |22. 3 | |
• Earning power (%) |50. 0 |76. 6 |67. 0 |46. 8 |45. 3 | |
• Return on equity (%) |64. 9 |88. 4 |70. 5 |42. 9 |38. 5 | 26.

The profit and loss account of Sasi Industires

Limited for years 1 and 2 is given below:

Using the percent of sales method, prepare the pro forma profit and loss account for year 3. Assume that the sales will be 3500 in year 3. If dividends are raised to 40, what amount of retained earnings can be expected for year 3?

• Year | | |1 |2 | |
• Net sales |2300 |2700 | |
• Cost of goods sold |1760 |2000 | |
• Gross profit |540 |700 | |
• Selling expenses |150 |180 | |
• General and administration expenses |120 |124 | |
• Depreciation |94 |84 | |
• Operating profit |176 |312 | |
• Non-operating surplus deficit |12 |10 | |
• Earnings before interest and tax |188 |322 | |
• Interest |30 |38 | |
• Earnings before tax |158 |284 | |
• Tax |56 |96 | |
• Earnings after tax |102 |188 | |
• Dividends |35 |35 | |
• Retained earnings |67 |153 |

Solution

Year | | | | |1 |2 |

Average percent |Proforma Profit & Loss of sales account for year 3 assuming sales of 3500| |

• Net sales |2300 |2700 |100 |3500 | |
• Cost of goods sold |1760 |2000 |75. 30 |2635. 43 | |
• Gross profit |540 |700 |24. 70 |864. 57 | |
• Selling expenses |150 |180 |6. 59 |230. 80 | |
• General and administration expenses |120 |124 |4. 90 |171. 7 | |
• Depreciation |94 |84 |3. 60 |125. 97 | |
• Operating profit |176 |312 |9. 60 |336. 14 | |
• Non-operating surplus deficit |12 |10 |0. 45 |15. 61 | |
• Earnings before interest and tax |188 |322 |10. 05 |351. 75 | |
• Interest |30 |38 |1. 36 |47. 46 | |
• Earnings before tax |158 |284 |8. 69 |304. 29 | |
• Tax |56 |96 |3. 00 |104. 3 | |
• Earnings after tax |102 |188 |5. 70 |199. 46 | |
• Dividends(given) |35 |35 | |40 | |
• Retained earnings |67 |153 | |159. 46 |

The profit and loss account of KG Electronics

Limited for years 1 and 2 is given below:

Using the percent of sales method, prepare the pro forma profit and loss account for year 3. Assume that the sales will be 26,000 in year 3. If dividends are raised to 500, what amount of retained earnings can be expected for year 3

• Year | | |1 |2 |
• Net sales |18,230 |22,460 | |
• Cost of goods sold |13,210 |16100 | |
• Gross profit |5020 |6360 | |
• Selling expenses |820 |890 | |
• General and administration expenses