Assignment – Accounting Report

Accounting Assignment Question

The Bujang Lapok Berhad manufactures and sells a line of exclusive sportswear. The company
was started by Miss Sizuka just 10 years ago and has been profitable every year since its
inception. The chief financial officer for the firm, Mr. Nobitha, has decided to seek a line of
credit form the firm’s bank. In the past, the company has relied on its suppliers to finance a
large part of its needs for inventory. However, in recent months tight money conditions have
led the firm’s suppliers to offer sizable cash discounts to speed up payments for purchases. Mr.
Nobitha wants to use the line of credit to supplant a large portion of the firm’s payable during
the summer, which is the firm’s peak seasonal sales period.

The firm’s two most recent statement of financial position were presented to the bank in
support of its loan request. In addition, the firm’s income statement for the year just ended was
provided. These statements are found in the following:
Income Statement
for the year ending December 31, (in RM millions)

This year Last year

Sales revenue 53,195 52,235
Less: Cost of goods sold 41,304 38,032

Gross profits 11,891 14,203

Less: Operating expenses

Selling & administration 4,064 3,933

Pension 405 714

Non-pension post retirement 758 834

Depreciation 1,100 994

Amortization of tools 1,120 961

Total operating expenses 7,447 7,436

Operating profits 4,444 6,767

Less: Interest expenses 995 937

Net profit before taxes 3,449 5,830

Less: Taxes (40%) 1,380 2,332

Net profit after taxes 2,069 3,498

Statement of Financial Position

for the year ending December 31 (in RM millions)

This
year Last year
Current Assets
Cash and cash equivalents 5,543 5,145

Marketable securities 2,582 3,226

Account receivables 2,003 1,695

Inventories 4,448 3,356

Prepaid taxes 985 1,330

Other receivables 13,623 12,433

Total Current Assets 29,184 27,185
Property & equipment 20,468 18,281
Less: Accumulated Depreciation 7,873 7,208

Net Plant & Equipment 12,595 11,073

Other Assets

Special tools 3,566 3,643

Intangible assets 2,082 2,162

Deferred tax assets 490 395

Total Other Assets 6,138 6,200
Total Assets 47,917 44,458

Current Liabilities
Account payables 8,290 7,826
Short-term debt 2,674 4,645
Accrued liabilities 7,032 5,582
Other payments 1,661 811
Total Current Liabilities 19,657 18,864
Non-Current Liabilities
Long-term debt 9,858 7,650
Accrued employee benefits 3,378 3,514
Other non-current liabilities 4,065 3,736
Total Non-Current Liabilities 17,301 14,900
Total Liabilities 36,958 33,764

Shareholder's Equity
Preferred stock 0 2
Common stock (at RM1 par) 408 364
Additional paid-in capital 5,506 5,536
Retained earnings 5,045 4,792
Total Shareholder's Equity 10,959 10,694

Total Liabilities and Shareholder's Equity 47,917 44,458

Industry Average Ratio this year

Current Ratio 1.78

Acid Test Ratio 1.55

Inventory Turnover 7.41
Average Collection Period 22.8
 Non-Current Asset Turnover 1.54

Total Asset Turnover 0.89

Debt 75%

Times Interest Earned 6.4

Net Profit Margin 4.70%

Return on Assets 4.60%

Return on Common Equity 20.70%

You were assigned the task of analysing Mr Nobitha’s loan request.

Based on the given information, answer the following questions.

a. Which of the ratios reported in the average industry do you feel should be most crucial in
determining whether the bank should extend the line of credit?

b. Compute the financial ratios for both years, and using the average industry evaluate the
firm in the following areas:

i. Liquidity
ii. Operating profitability
iii. Financing policies
iv. Return on the shareholders’ investment

c. How does your finding support of fail to support what you would conclude using ratio
analysis to evaluate the firm’s performance?
ANSWERS :
a. Which of the ratios reported in the average industry do you feel should be most
crucial in determining whether the bank should extend the line of credit?

Credit analysis ratios are tools that assist the credit analysis process. These ratios help
analysts and investors determine whether individuals or corporations are capable of fulfilling
financial obligations. The credit analysis process also will help the bank to determine if
Bujang Lapok Berhad can fulfill the financial obligation when the loan request is approved.

Credit analysis involves both qualitative and quantitative aspects. Ratios cover the
quantitative part of the analysis. Although there are many financial ratios to access the credit
rating of a company, banks basically have to look at a company’s debt ratios when deciding
its credit line. The debt ratio is a measure of how much liabilities are held among the
company’s assets and is a representative indicator of its financial structure, particularly
dependence on other capital. This ratio, which indicates how much equity is prepared for
other capital to be repaid (total debt), is an important indicator for assessing the soundness of
a company because this ratio allows us to determine whether companies can settle its entire
debt with their equity in times of a crisis. Besides debt ratio, other most important ratio is the
Liquidity ratio, Current ratio and Acid test ratio including time interest earned.

Key ratios can be roughly separated into four groups:

(1) Profitability

(2) Leverage

(3) Coverage

(4) Liquidity

Profitability – the net profit margin evaluates the net income earned from each unit of sale
made in percentage. It considers the leftover of the company after covering the company
expenses. The bank must consider the net profit margin to evaluate how effectively the
company can convert revenues into sufficient net income to pay back the loan (Brigham &
Houston, 2021). Hence, it is a good efficiency metric to evaluate the performance of the
management in spending expenses from revenue generated.

Leverage ratios - the leverage ratios evaluate the company debt against the balance sheet
assets, cash flow, or income statement to evaluate the company's ability to meet its debt

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obligations. The average industry metrics listed include the debt ratio that evaluates the
company's total debt compared to the total asset. A low debt ratio is favorable to the company
as it increases the asset claim of the bank to the company in case of liquidation. An analysis
of a higher ratio may indicate debt is aggressive in financing its operation and may result in
high default risk.

The coverage ratio - The coverage ratios are a crucial ion determination of cash, interest, or
asset that covers the interest expense on debt. The bank will prefer to accept the company
loan request if the coverage ratio is higher than the industry average or sufficiently high
enough to cover the debt obligation (Brigham & Houston, 2021). Among the coverage ratios
to consider in the industry average is the times interest earned that evaluates the ability of the
company to meet debt obligation from the current income. It evaluates the number of
earnings before interest and taxes against interest and bond payable during the accounting
period.

Liquidity - the bank would consider the liquidity analysis based on the company's ability to
convert assets into cash that can repay the current loan (Brigham & Houston, 2021). Higher
leverage would indicate that the company can convert the asset to cash (more liquid) to pay
the current debt easily. The ratio to evaluate includes the current ratio and the acid test ratio
(Corporate Finance Institute, 2020).

b. Compute the financial ratios for both years, and using the average industry
evaluate the firm in the following areas:
o Liquidity
o Operating profitability
o Financing policies
o Return on the shareholders’ investment

Current Ratio
The current ratio measures the company's ability to generate cash to meet the short-term
financial commitments. Also called the working capital ratio, it is calculated by dividing the
current assets—such as cash, inventory and receivables—by the current liabilities, such as
line of credit balance, payables and current portion of long-term debts.

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The current ratio is a liquidity ratio that measures a company's ability to pay short-term
obligations or those due within one year. It tells investors and analysts how a company can
maximize the current assets on its balance sheet to satisfy its current debt and other payables.

This Year = RM29,184mil / RM19,657mil = 1.48

Last Year = RM27,185mil / RM18,864mil = 1.44
Industry Average Ratio this year for Current Ratio is 1.78

A current ratio that is in line with the industry average or slightly higher is generally
considered acceptable. If a company has a very high current ratio compared to its peer group,
it indicates that management may not be using its assets efficiently.
For Bujang Lapok Berhad, the current ratio is lower than the industry average. It may
indicate a higher risk of distress or default compared to the peer in the same industry. The
asset utilization efficiency may be low compared to the industry (Brigham &Houston, 2021).
However, the ratio is above one, which means the company can cover the current liabilities
using its current liabilities (Corporate Finance Institute, 2020).

Quick Ratio (acid-test ratio)

The acid-test ratio, commonly known as the quick ratio, uses a firm's balance sheet data as an
indicator of whether it has sufficient short-term assets to cover its short-term liabilities.

This Year = (RM29,184mil – RM4,448mil – RM985mil) / RM19,657mil = 1.20

Last Year = (RM27,185mil – RM3,356mil – RM1,330mil ) / RM18,864mil = 1.19
Industry Average Ratio this year for Acid Test Ratio is 1.55

If the acid-test ratio is much lower than the current ratio, it means that a company's current
assets are highly dependent on inventory.
For Bujang Lapok Berhad, this is not a bad sign in all cases, however, as some business
models are inherently dependent on inventory. Retail stores, for example, may have very low

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acid-test ratios without necessarily being in danger. However, the company has a ratio higher
than one indicating it can cover the current liabilities using the most liquid assets.
The acid-test ratio is not significantly lower than its current ratio of 1.44, indicating the
company is not dependent on its inventory. Therefore, the company's overall liquidity
outlook is lower than the industry average but stable enough to meet its current liability
obligations. Further analysis is required to indicate if the company can qualify for the bank
loan request.

Inventory Turnover
Inventory turnover is a financial ratio showing how many times a company has sold and
replaced inventory during a given period. A company can then divide the days in the period
by the inventory turnover formula to calculate the days it takes to sell the inventory on hand.

This Year = RM41,304mil / RM4,448mil = 9.28

Last Year = RM38,032mil / RM3,356mil = 11.33
Industry Average Ratio this year for Inventory Turnover is 7.41

A low turnover implies weak sales and possibly excess inventory, also known as
overstocking. It may indicate a problem with the goods being offered for sale or be a result of
too little marketing. A high ratio, on the other hand, implies either strong sales or insufficient
inventory. The former is desirable while the latter could lead to lost business.
For Bujang Lapok Berhad, a high inventory turnover reduces the amount of capital they have
tied up in their inventory, thereby improving their liquidity and financial strength. Moreover,
keeping a high inventory turnover reduces the risk that their inventory will become unsellable
due to spoilage, damage, theft, or technological obsolescence.

Average Collection Period

The average collection period ratio measures the average number of days clients take to pay
their bills, indicating the effectiveness of the business's credit and collection policies. This
ratio also determines if the credit terms are realistic.

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This Year : = RM2,003mil / (RM53,195mil / 365)= 13.74
Last Year : = RM1,695mil / (RM52,235mil / 365) = 11.84
Industry Average Ratio this year for Inventory Average Collection Period is 22.8

For Bujang Lapok Berhad, Average Collection Period is lower than Industry Average Ratio.
A lower average collection period is generally more favorable than a higher average
collection period, as it indicates the organization is more efficient in collecting payments.
However, there is a downside to this, as it may indicate that its credit terms are too strict,
which could cause it to lose customers to competitors with more lenient payment terms.

Non-Current Asset Turnover

Non-current asset turnover is a management efficiency ratio. It measures the annual revenue
generated per unit of non-current assets. Non-current assets are a company's long-term
investments for which the full value will not be realized within the accounting year. They are
typically highly illiquid, meaning these assets cannot easily be converted into cash. Examples
of noncurrent assets include investments, intellectual property, real estate, and equipment.

This Year = RM53,195mil / RM18,733mil = 2.83

Last Year = RM52,235mil / RM17,273mil = 3.02
Industry Average Ratio this year for Non-Current Asset Turnover is 1.54

For Bujang Lapok Berhad, their Non-Current Asset Turnover is higher than Industry Average
Ratio.The higher the asset turnover ratio, the more efficient a company is at generating
revenue from its assets.

Total Asset Turnover

The asset turnover ratio measures the value of a company's sales or revenues relative to the
value of its assets. The asset turnover ratio can be used as an indicator of the efficiency with

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which a company is using its assets to generate revenue. Asset turnover is the ratio of total
sales or revenue to average assets.

This Year = RM53,195mil / RM47,917mil = 1.11

Last Year = RM52,235mil / RM44,458mil = 1.17
Industry Average Ratio this year for Total Asset Turnover is 0.89

For Bujang Lapok Berhad, their Total Asset Turnover is higher than Industry Average Ratio.
The higher the asset turnover ratio, the more efficient a company is at generating revenue
from its assets.
Conversely, if a company has a low asset turnover ratio, it indicates it is not efficiently using
its assets to generate sales.

Debt
Debt ratio is a solvency ratio that determines the total number of a company’s liabilities as
compared to its total assets in percentage form. In simple terms, it showcases a company’s
ability to use its assets in order to pay off any and all liabilities it has.

This Year = RM36,958mil / RM47,917mil = 0.771 (77.1%)

Last Year = RM33,764mil / RM44,458mil = 0.759 (75.9%)
Industry Average Ratio this year for Debt is 75%.

A ratio greater than 1.0 (>100%) shows that a considerable portion of debt is funded by
assets. In other words, the company has more liabilities than assets. A high ratio also
indicates that a company may be putting itself at risk of default on its loans if interest rates
were to rise suddenly.
For Bujang Lapok Berhad, their debt ratio is slightly higher than Industry Average Ratio
which implies the business has a higher default risk if the interest expenses or rates increase.
The debt funds a greater proportionate of the company assets compared to peers in the
industry.

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Their debt ratio of less than 100% indicates that this company has more assets than debt. A
ratio below 1.0 (<100%) translates to the fact that a greater portion of a company's assets is
funded by equity.

Times Interest Earned

The times interest earned (TIE) ratio is a measure of a company's ability to meet its debt
obligations based on its current income. The formula for a company's TIE number is
earnings before interest and taxes (EBIT) divided by the total interest payable on bonds and
other debt. The result is a number that shows how many times a company could cover its
interest charges with its pretax earnings. TIE is also referred to as the interest coverage ratio.

This Year = RM4,444mil / RM995mil = 4.46

Last Year = RM6,767mil / RM937mil = 7.22
Industry Average Ratio this year for Times Interest Earned is 6.4

A high ratio means that a company is able to meet its interest obligations because earnings
are significantly greater than annual interest obligations. However, a high ratio can also mean
that a company has an undesirably low level of leverage or pays down too much debt with
earnings that could be used for other investment opportunities to get higher rate of return.
For Bujang Lapok Berhad, their Times Interest Earned is lower this year compared to last
year. A lower times interest earned ratio means fewer earnings are available to meet interest
payments. Failing to meet these obligations could force a company into bankruptcy. It is used
by both lenders and borrowers in determining a company’s debt capacity.
Further, the current year Times Interest Earned is lower than the industry average of 6.4
times. The result may indicate the company's ability to pay outstanding debt compared to the
industry average and, therefore, the high-interest risk of the company's current debt relating
to future borrowing.

Net Profit Margin

The net profit margin, or simply net margin, measures how much net income or profit is
generated as a percentage of revenue. It is the ratio of net profits to revenues for a company
or business segment. Net profit margin is typically expressed as a percentage but can also be

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represented in decimal form. The net profit margin illustrates how much of each dollar in
revenue collected by a company translates into profit.

This Year = RM2,069mil / RM53,195mil = 3.88%

Last Year = RM3,498mil / RM52,235mil = 6.69%
Industry Average Ratio this year for Net Profit Margin is 4.70%.

The Bujang Lapok Berhad net profit margin has decreased from last year's ratio of 6.69% to
the current year's ratio of 3.88% against the industry average of 4.70%. The company is
operating below the industry average in its profit generation.

Return on Assets
Return on assets (ROA) is an indicator of how profitable a company is relative to its total
assets. ROA gives a manager, investor, or analyst an idea as to how efficient a company's
management is at using its assets to generate earnings.
ROA is displayed as a percentage; the higher the ROA is, the better. Higher ROA indicates
more asset efficiency. ROA is calculated by dividing a company’s net income by total assets.
As a formula, it would be expressed as:

This Year = RM2,069mil / RM47,917mil = 4.31%

Last Year = RM3,498mil / RM44,458mil = 7.86%
Industry Average Ratio this year for Return on Assets is 4.60%.

The Bujang Lapok Berhad ROA shows a decreasing trend from 7.86% last year to 4.31% this
year. This year's ratio is lower than the industry average of 4.60%, indicating that the
company performs poorly against the other companies in the same industry.

Return on Common Equity

The return on common equity ratio measures how much money common shareholders receive
from a company compared with how much they invested originally. It is one of five

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calculations used to measure profitability. The others are: return on shareholders’ equity, net
profit margin ratio, gross profit margin and return on total assets.
This is a ratio that determines the ability of a company to generate profits as a result of its
shareholder investments. In simpler terms, it shows how much profit is made from every
dollar of stockholder equity.
The higher the percentage, the greater the return shareholders are seeing on their investment.
For this reason, the ratio is very important in helping business owners and financing
professionals determine a company’s financial health.

This Year = RM2,069mil / RM10,959mil = 18.87%

Last Year = RM3,498mil / RM10,694mil = 32.70%
Industry Average Ratio this year for Return on Common Equity is 20.70%.

The Bujang Lapok Berhad return on equity reduced from 32.70% last year to the current
18.87% this year. Comparing the current company return on common equity with the
industry average indicates that a company is earning less from each unit of equity capital
invested (18.89%) than the industry average of 20.70%. Hence, the company is inefficient in
its use of the shareholders' funds in generating sufficient profit.

c. How does your finding support or fail to support what you would conclude using
ratio analysis to evaluate the firm’s performance?

The decision for evaluation of the loan request requires an extensive analysis of the
transaction's risk by ascertaining the borrower's ability to repay the loan (Calxa, 2020). The
financial ratio is a vital consideration in ascertaining the prospective borrower's ability,
among other variables such as the managerial ability, the technical and operational risk, and
the productive use of the loan to generate earnings (Brigham & Houston, 2021). The Bujang
Lapok Berhad ratio computation enables the evaluation of the relationship in the financial
statement by evaluating the comparative analysis in the last two years and the industry
compared with other peers within the industry (Corporate Finance Institute, 2020).

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Table below is the comparative analysis in the last two years vs Industry Average Ratio this
year.

Industry Average
This year Last year
Ratio this year
Current Ratio 1.48 1.44 1.78
Acid Test Ratio 1.20 1.19 1.55
Inventory Turnover 9.28 11.33 7.41
Average Collection Period 13.74 11.84 22.8
Non-Current Asset
2.83 3.02 1.54
Turnover
Total Asset Turnover 1.11 1.17 0.89
Debt 77.10% 75.90% 75%
Times Interest Earned 4.46 7.22 6.4
Net Profit Margin 3.88% 6.69% 4.70%
Return on Assets 4.31% 7.86% 4.60%
Return on Common Equity 18.87% 32.70% 20.70%

The findings from the Bujang Lapok Berhad indicates the company is performing below
industry average in all important metrics of credit analysis ratios such as liquidity ratios,
financing policies, profitability, and coverage ratios. The level of risk associated with
advancing the loan request is higher in Bujang Lapok Berhad than the peers in the same
industry. For instance, the debt level is high, indicating the default level in case of increase in
interest rate. However, the company remains profitable in the last ten years and generates to
sustain the business operations. The company's Times Interest Earned ratio also shows
positive results, although less than the industry average. The level of risk associated with the
Bujang Lapok Berhad is therefore high compared to the industry average. However, it is
within an accommodative risk if the company advances a small loan request as the company
is still profitable and has multiple interest coverage ratios.

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