Section C

1 Treat Co

(a) Ratio Workings Treats Co Sector average

per question
Return on year-end capital 7,466/ (25,968 + 33,621) 12·5% 28.8%
employed (ROCE)
Net asset turnover 214,553/ (25,968 + 33,621) 3·6 times 2.4 times
Gross profit margin 106,544/214,553 49·7% 55%
Operating profit margin 7,466/214,553 3·5% 12%
Current ratio 47,996/50,391 0·95:1 1.8:1
Inventory turnover period (30,393/108,009) x 365 103 days 25 days
Gearing (debt/equity) 33,621/25,968 129% 43%
Receivables collection period 17,603/214,553 30 days 15 days

(b) Performance

Treats Co’s gross profit margin is slightly below the market average. This is not surprising as
Treats Co sells goods to supermarkets which are likely at lower margins than goods sold directly
to the public.

However, Treats Co’s operating profit margin is significantly below the industry average. It is
unclear what the cause of this is but it does suggest cost control issues as this is much worse
than the sector average, compared to the difference in gross profit margin.

The fact that the assets held by the company are old and may need replacing may mean there
have been large repairs and maintenance expenses in the year or have had impairment charges
applied to them.

ROCE is much lower than the industry average. This is as a direct result of the low operating
profit margin as the net asset turnover is above the sector average.

The fact that the ROCE is low in comparison to the industry average is concerning as this figure
would drop further following an investment in property, plant and equipment (PPE). Currently
Treats Co does not have the cash to acquire assets, so replacements are likely to lead to an
increase in debt (whether due to loans or leasing assets), which would further reduce the ROCE.

The net asset turnover is higher than the industry average. Again, it must be noted that once the
PPE is replaced, this figure will be significantly reduced
Position

The current ratio is significantly lower than the industry average. This is likely to be due to the
significant overdraft which Treats Co uses for working capital management.

It appears that a lot of cash is tied up in inventories. This could be due to the need to hold large
volumes of goods to meet the supermarket contracts but could also signify issues over demand
for Treats Co’s products.

The inventory holding period is more than four times longer than the industry average.
Considering that Treats Co sells perishable food products, this is of concern as items may require
to be written down/off.

Treats Co’s receivables collection period is not particularly high at 30 days but is still twice that
of the industry average. This is likely to be due to the supermarket contract which will demand
much longer payment terms.

Most of the sector sells goods solely through their own stores and so these are likely to be cash
sales. As a result, the receivables days ratio is not comparable with many companies in the
sector.

The gearing ratio is significantly higher than the industry average, which is a significant concern,
particularly in the light of Treats Co’s cash position. Treats Co is likely to need investment in non-
current assets; it is doubtful whether it will be possible to raise debt finance to do this.
The large dividend payment is questionable as $7·14m has been paid despite the entity being
overdrawn and in need of investment

Conclusion
Overall, the results are mixed and further information is required to fully investigate the
performance and financial position of Treats Co. Further investigation is required of the
composition of operating expenses. Neither the inventory nor the cash position looks very
strong in comparison to the industry averages; however, the receivables is reasonable – further
aged analysis of inventory and the classification of receivables would also be useful to explain
these positions. Finally, gearing is high and so more information relating to the terms of
borrowings would also be useful.
 Other points which could be made:
- Gross margin – Treats Co still makes a 50% margin. This may be because Treats Co is a larger
company (as shown in the supermarket contract) and can exercise economies of scale in
managing costs or negotiating purchase discounts.

- Gross margin – It is unclear what proportion of goods are sold to the supermarkets versus
direct to the public. More information on this would help to further understand Treats Co’s
margin compared to the sector average.

- Operating margin – This may get worse if assets are replaced or if impairments are needed.
New assets are likely to have higher depreciation, which will further reduce the margin (as will
impairment charges).

Section C

Perd Co

(a) Consolidated statement of profit or loss and other comprehensive income for Perd Co for the
2 year ended 31 March 20X8

$’000

Revenue (58,200 + 34,300 – 83,500

9,000 intra-group)

Cost of sales (34,340 + 20,400 – (46,340)

9,000 + 600 unrealised
profit)

Gross profit 37,160

Operating expenses (w1) (28,270)

Profit from operations 8,890

Investment income (3,000 – 800 dividends 2,200

from S [$1m x 80%])

Finance costs (3,240 + 1,600 + 453 (5,923)

unwinding (w2))
 Profit before tax 5,797

Tax (1,560 + 1,480) (3,040)

Profit for the year 2,757

Other comprehensive
income

Gain on revaluation (4,100 + 700) 4,800

Total comprehensive 7,557

income

Profit attributable to: 2,639

Shareholders of Perd 118

Co

Non-controlling (w3) 2,757

interests

Total comprehensive
income attributable to:

Shareholders of Perd 7,299

Co

Non-controlling (w3) 258

interests

7,557

(b)Total assets:
 $’000
Perd Co 287,310
Sebastian Co 110,540
Goodwill 3,200
Impairment (400 + 300) (700)
Unrealized profit (600)
Intra-group balance (7,000)
Revaluation gain 4,800

407,550

Working 1 – Operating expenses

$’000
Perd Co 18,040
Sebastian Co 7,130
Impairment 300
Fair value depreciation 100
Removal of Sebastian Profit on disposal (see below) 5,100
Group profit on disposal (see below) (2,400)

28,270

Sebastian Co would have recorded a profit on disposal based on historical cost. At 30 September
20X7, the property would have had a carrying amount of $9,900, being $11m less 1·5 years’
depreciation ($11m/15 x 1·5 = $1·1m). Therefore, the profit on disposal would have been
$5·1m, being $15m less $9·9m.

The group profit on disposal would be based on the carrying amount to the group. The carrying
amount of the property in the consolidated financial statements at 30 September 20X7 would
have been $12·6m ($14m less 1·5 years’ depreciation). Therefore, the profit on disposal will be
$2·4m ($15m less $12·6m)
 Working 2 – Unwinding discount
$’000
$7.547m x 6% = $0·453m 453

Working 3 – Non-controlling interest

$’000
Profit for the year 3,690
Adjusted profit on disposal ($5·1m – $2·4m) (2,700)
Fair value depreciation (100)
Goodwill impairment (300)
NCI share of profit at 20% 118
Total comprehensive income
Profit (from above) 118
20% x 700 revaluation gain 140
Total comprehensive income 258

Marks
Treat Co
(a) Ratio analysis 5

(b) Performance 6
Position/conclusion 9

15

20

Perd Co Marks
(a) Revenue/COS 3.5

Other income expenses 8

Profit/OCI appropriation 3.5

15

(b) Total assets 5

20