Problem – FS -2015 **

The following data relate to Navana Ltd. A trading company as at 31st December. 2014.

Capital and liabilities Amount Assets Amount

Paid-up capital 15,00,000 Cash 40,000

Reserves 3,50,000 Debtors 6,40,000

Retained earnings 2,50,000 Inventory 9.10,000

Debenture –Long term 5,00,000 Bills receivable 3,50,000

Bills payable 5,00,000 Prepaid expenses 2,50,000

Sundry creditors 5,10,000 Investment –short-term 1,60,000

Bank overdraft 2,00,000 Land and Building 7,00,000

Accrued expenses 1,90,000 Goodwill 3,50,000

Provision for taxation 2,50,000 Plant and Machinery 6,00,000

Total 40,00,000 Total 40,00,000

Annual sales Tk.74,40,000 . Cost of goods sold Tk.66,96,000, Tax rate 30%

You are required to calculate the following ratios for the year and comment on the

following position as revealed by these ratios :

a) Current ratio

b) Acid-test ratio

c) Profitability ratio

d) Inventory Turnover ratio

e) Debtor Turnover ratio

f) Debt Equity ratio

g) Proprietary ratio

Bank overdraft is payable on demand

Solution : FS -2015

Calculation of current assets Current liabilities

Cash 40,000 Bills payable 5,00,000

Debtor 6,40,000 Sundry creditors 5,10,000

Inventory 9,10,000 Bank overdraft 2,00,000

Bills receivable 3,50,000 Accrued expenses 1,90,000

Prepaid expenses 2,50,000 Total 14,00,000

Investment- short term 1,60,000

Total current assets 23,50,000

a) Current Ratio = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 =

23,50,000

14,00,000 = 1.68

b) Quick Ratio = 𝑸𝒖𝒊𝒄𝒌 𝒂𝒔𝒔𝒆𝒕𝒔

𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝒍𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒊𝒆𝒔 =

14,40,000

14,00,000 = 1.03

Quick assets = Current assets - Inventory

Calculation of profit :

Sales 74,40,000

Cost of goods sold 66,96,000

Gross profit 7,44,000

Less income tax 30% 2,32,200

Net profit after tax 5,11,800

c) Profitability Ratio :

1. Gross profit Ratio = 𝐺𝑟𝑜𝑠𝑠 𝑝𝑟𝑜𝑓𝑖𝑡

𝑆𝑎𝑙𝑒𝑠 x100 =

7,44,000

74,40,000 x 100 = 10%

2. Net profit Ratio = 𝑁𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡

𝑆𝑎𝑙𝑒𝑠 x 100 =

5,11,800

74,40,000 x 100 = 6.88 %

d) Inventory turnover Ratio = 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠 𝑠𝑜𝑙𝑑

𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 =

66,96,000

9,10,000 = 7.36 times

e) Debtors’ Turnover ratio =𝑆𝑎𝑙𝑒𝑠

𝐷𝑒𝑏𝑡𝑜𝑟𝑠 =

74,00,000

6,40,000 = 11.56 times

f) Debt- Equity Ratio =

i. 𝐿𝑜𝑛𝑔 𝑡𝑒𝑟𝑚 𝐷𝑒𝑏𝑡

𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟𝑠 𝐹𝑢𝑛𝑑𝑠

5,00,000

21,00,000 = 0.24

ii. 𝐿𝑜𝑛𝑔−𝑡𝑒𝑟𝑚 𝐷𝑒𝑏𝑡+𝑆ℎ𝑜𝑟𝑡−𝑡𝑒𝑟𝑚 𝐷𝑒𝑏𝑡

𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟𝑠 𝐹𝑢𝑛𝑑𝑠

19,00,000

21,00,000 = 0.90

Shareholders fund :

Paid-up capital 15,00,000

Reserves 3,50,000

Retained earnings 2,50,000

Total 21,00,000

Total liabilities – Shareholders fund = Long and Short- term debt

40,00,000 - 21,00,000 = 19,00,000

g) Proprietary Ratio = 𝑃𝑟𝑜𝑝𝑟𝑖𝑒𝑡𝑜𝑟𝑠 𝐹𝑢𝑛𝑑𝑠

𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 =

21,00,000

40,00,000 = 0.53

Comments on Financial Position :

Liquidity. A current ratio of 2 is considered ideal under normal condition.

Here the current ratio is 1.68 which indicates that the company is not so much

liquid. However the quick ratio i.e. 1.03 (Ideal is 1:1) indicates that the

liquidity position of the company is satisfactory.

A inventory turnover ratio of 7.36 per year indicates that the stock holding

period is 50 days which may be considered satisfactory.

Debtors turnover is 11.56 times per year, indicating thatdebtors are taking 31

days to pay. This seems very reasonable.

Profitability. A gross profit ratio of 10% and net profit ratio of 6.88%

indicates that the company’s profit earnings capacity is not at all satisfactory.

Management look into the matter and must take proper steps to increase the

profitability of the company.

Capital Gearing/ Financial Leverage. Capital gearing or financial

leverage of the company (showing the relationship between finance supplied

by shareholders and finance supplied by outsiders) is good. The debt equity

shows that against every Tk1 financed by shareholders , long -term borrowing

is only Tk.0.24 and total borrowing is Tk.0.90. The proprietary ratio of 0.53

indicates that more than 50% of the book value of total assets has been

financed by the shareholders. Thus, the company has a satisfactory capital

structure . It does not depend much on external finance, either from short-term

sources or from long-term sources. The problems of high gearing or low

gearing are not faced by the company.

Exercise: IBBL-2014

The information below is taken from the records of two companies in the same industry:

(Amount in ,000)

P. Ltd. Q. Ltd.

Tk. Tk.

Cash 210 320

Debtors-net 330 630

Stock 1,230 950

Plant and equipments 1,695 2,400

Total Assets 3,465 4,300

Sundry creditors 900 1,050

8% Debentures 500 1,000

Equity Share capital 1,100 1,750

Retained earnings 965 500

3,465 4,300

Sales 5,600 8,200

Cost of goods sold 4,000 6,480

Other operating expense 800 860

Interest expenses 40 80

Income taxes 380 390

Dividends 100 180

Answer each of the following questions by making a comparison of one or more relevant ratios:

a) Which company is using the shareholders' money more profitably?

b) Which company is better able to meet its current debts?

c) If you were to purchase the debentures of one company, which company's debentures would you

buy?

d) Which company collects its receivable faster assuming all sales to be credit sales?

e) Which company retains the larger proportion of income in the business?

Solution : IBBL-2014

Income Statement

P. Ltd. Q. Ltd.

Tk. Tk.

Sales 5,600 8,200

Cost of goods sold 4,000 6,480

Gross Profit 1,600 1,720

Less: other operating expense 800 860

Net profit before interest & tax 800 860

Les: Interest expense 40 80

Net profit before tax 760 780

Income tax 380 390

Net profit after tax 380 390

Calculation of shareholders Fund.

P. Ltd. Q. Ltd.

Tk. Tk.

Equity share capital 1,100 1,750

retained earnings 965 500

2,065 2,250

a) i) Rate of return on stockholders fund

𝑁𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡 𝑎𝑓𝑡𝑒𝑟 𝑡𝑎𝑥

𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟𝑠 𝐹𝑢𝑛𝑑 ×100 =

𝑇𝑘. 380

𝑇𝑘. 2065×100

𝑇𝑘. 390

𝑇𝑘. 2,250×100

=18.40% =17.33%

Comment: Company P. Ltd is making more Profitable use of shareholders Money.

Calculation of current assets:

P. Ltd. Q. Ltd.

Tk. Tk.

Cash 210 320

Debtors-net 330 630

Stock 1,230 950

Total 1,770 1,900

b) i) Current Ratio :

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 =

𝑇𝑘. 1,770

𝑇𝑘. 900

𝑇𝑘. 1,900

𝑇𝑘. 1,050

=1.97 =1.81

ii) Acid-Test-Ratio :

𝑄𝑢𝑖𝑐𝑘 𝐴𝑠𝑠𝑒𝑡𝑠

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 =

Or

𝑇𝑘. 540

𝑇𝑘. 900

𝑇𝑘. 950

𝑇𝑘. 1,050

𝐶𝑢𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠−𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

=0.60 =0.90

Comment: Company Q. Ltd is able to meet its current debts in a better way, since its quick ratio is

higher than company P. Ltd.

c) i) Debt Equity Ratio :

𝐷𝑒𝑏𝑡𝑠

𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟𝑠 𝐹𝑢𝑛𝑑 ×100 =

𝑇𝑘. 500

𝑇𝑘. 2,060×100

𝑇𝑘. 1000

𝑇𝑘. 2,250×100

=24.27% =44.44%

ii) Debt Service Ratio:

𝑛𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡 𝑏𝑒𝑓𝑜𝑟𝑒 𝑡𝑎𝑥 𝑎𝑛𝑑 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡

𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑒𝑥𝑝𝑒𝑛𝑠𝑒

𝑇𝑘. 800

𝑇𝑘. 40

𝑇𝑘. 860

𝑇𝑘. 80

= 20 Times = 10.75 times

Comment: I would prefer to buy the debenture of P. Ltd. because its debt-Equity ratio is less and

debt service ratio is higher.

d) Debt Collection period :

𝐷𝑒𝑏𝑡𝑜𝑟𝑠×𝐷𝑎𝑦𝑠 𝑖𝑛 𝑎 𝑦𝑒𝑎𝑟

𝐶𝑟𝑒𝑑𝑖𝑡 𝑠𝑎𝑙𝑒𝑠 =

𝑇𝑘. 330 × 365

𝑇𝑘. 5,600

𝑇𝑘. 830 × 365

𝑇𝑘. 8,200

= 21.5 days or

say 22 days

= 36.95 days or

say 37 days

Comment: Company P. Ltd. collects its receivable faster as its debts collection period is lower than

Q. Ltd.

e) Dividend payout Ratio :

𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑓𝑢𝑛𝑑

𝑝𝑟𝑜𝑓𝑖𝑡𝑎𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 ×100 =

𝑇𝑘. 100

𝑇𝑘. 380×100

𝑇𝑘. 180

𝑇𝑘. 390×100

=26.32% =46.15%

Retain Ratio

P. Ltd= 100%-26.32% =73.68%

Q. Ltd= 100%-46.15% =53.85%

Comment: Company P. Ltd retains larger Proportion of profit in the business.

COST VOLUME PROFIT ANALYSIS

The basic objectives of running any business organization is to earn profit. Profits

determine the financial position ,liquidity and solvency of the company. Profit serves

as yardstick for judging the competence and efficiency of the management.Profit

planning ,is therefore, a fundamental part of the overall management function.

Cost Volume Profit (CVP) Analysis is an important tool of profit planning. Cost

volume profit analysis helps the management in profit planning. The most significant

single factor in profit planning of the average business is the relationship between the

volume of business, cost and profit . An analysis of the effects of various factors on

profit is an essential step in financial planning and decision making.

The analytical technique used to study the behavior of profit in response to the

changes in volume , cost and prices is called the Cost – Volume – profit(CVP)

analysis.

It provides information about the following matters:

1) The behavior of cost in relation to volume.

2) Volume of production or sales, where the business will break-even.

3) Sensitivity of profit due to variation of output.

4) Amount of Profit for a projected sales volume.

5) Quantity of production and sales for a target profit level.

CVP Analysis may therefore be defined as a managerial tool showing the

relationship between various ingredients of profit planning; viz. cost (both fixed and

variable), selling price and volume of activity.

Such an analysis is useful to the management accountant in the

following respects:

(i) It helps him in forecasting the profit fairly accurately.

(ii) It is helpful in setting up flexible budgets, since on the basis

of this relationship, he can ascertain the costs, sales and

profits at different levels of activity.

(iii) It also assists him in performance evaluation for the

purposes of management control.

(iv) It helps in formulating price policy by projecting the effect

which different price structures will have on cost and

profits.

(v) It helps in determining the amount of overhead cost to be charged at various

levels of operations, since overhead rates are generally pre-determined on the basis of

a selected volume of production.

Thus, cost-volume profit analysis is an important media through which the

management can have an insight into effects on profit on account of variations in costs

(both fixed and variable) and sales (both volume and value) and take appropriate

decisions.

A widely used technique to study Cost –volume –profit relationships is break –even

analysis.

Assumptions in CVP analysis

• The behavior of both costs and revenues is linear throughout the relevant

range of the activity index.

• All costs can be classified with reasonable accuracy as either variable or

fixed .

• Changes in the activity are the only factors that affect costs.

• All units produced are sold.

• Selling price remains the same at different level of activity

• There is no change in the product mix

• There is no change in the level of efficiency

• Policies of management do not change

• As the number of units produced and sold are the same , there is no

closing or opening stock

Break-Even Analysis

A Break-even analysis shows the relationship between the costs

and profits with sales volume. The sales volume which equates

total revenue with related costs and results is neither profit nor

loss is called break –even point(BEP) . It can be expressed

either in sales units or Sales Taka amount.

- The process of finding the break- even point is called break-

even analysis

Knowledge of break-even point is useful to management

when it decides –

whether to introduce new product lines,

Change sales prices on established products, or

Enter new market areas.

Three appraoches to “break –even analysis”

1. Contribution Margin Approach ,

2. Equation technique

3. Graphic presentation: a) Break-even chart , and

b) Profit volume chart

Contribution Margin: The excess of unit selling price over unit

variable cost is called Contribution Margin. Suppose, Unit

selling price Tk. 500 and Unit variable cost Tk300, now

Contribution Margin pet unit is –

a) Unit selling price – Unit Variable cost = Unit Contribution

Margin

= Tk 500 - Tk 300 = Tk 200

b) Contribution = Fixed cost + profit

c) Contribution = Sales x P/V Ratio or C/M Ratio

• Contribution Margin Ratio : The Contribution margin ratio is the

contribution margin per unit divided by the unit selling price.

C/ M Ratio = Unit contribution

Unit selling price × 10

ii) Total contribution ÷ Total sales x 100

Contribution Margin Ratio is also called P/V ratio

The expression of contribution margin is very helpful in determining the

effect of changes in sales on net income.

For example , net income will increase by Tk40,000 (40%x Tk1,00,000)

if sales increase Tk 1,00,000. Thus by using contribution margin ratio,

managers can quickly determine increase in net income from any

changes in sales. Let us see this effect through a CVP income statement.

Assume that M/S Havana Ltd. current sales are Tk5,00,000 and it wants to

the effect of a Tk. 1,00,000 increase in sales. It could prepare a comparative

CVP statement analysis as follows.

No changes With Changes

Total Per Unit Total Per Unit

Sales Tk 5,00,000 Tk500 Tk6,00,000 Tk.500

- Variable cost Tk 3,00,000 Tk300 TK3,60,000 Tk.300

Contribution margin Tk. 2,00,000 Tk 200 Tk 2,40,000 Tk. 200

- Fixed cost TK. 2,00,000 - Tk. 2,00,000 -

Net income Tk- 0 - Tk. 40,000

======== ========

Margin of safety

Margin of Safety: The excess of actual sales over the break -even sales is

called Margin of safety .The margin of safety is another relationship that may

be calculated from CVP analysis.CVP analysis also help managers assess risk

by providing a measure of the margin of safety. It shows how far sales can fall

below the planned level of sales before loss occur. It compares the level of

planned sales with the break-even point. The larger the margin of safety, the

less likely it is that the company will have an operating loss, that is, operate

below break-\even point. A small margin of safety indicate a more risky

situation.

- Margin of Safety Ratio = Actual sales - Break-even sales

Actual sales

- Symbolically, M/S ratio = (AS – BES) ÷ AS

Variable and Fixed cost

• Variable cost: Variable costs are costs that vary in total directly and

proportionately with changes in the activity level. If the level increase by

5% , total variable costs will increase 5%. If the level of activity

decreases by 20% , variable costs will decrease 20%. A variable cost

may also be defined as a cost that remains the same per unit at every

level of activity.

• Fixed costs: Fixed costs are costs that remain the same in total

regardless of changes in the activity level. As total fixed costs remain

constant as activity changes, it follows that fixed costs per unit vary

inversely with activity. As volume increases, unit cost declines and

vice versa.

Cost Volume profit Analysis

Sales

Variable cost

Fixed cost

Profit

Sales =Variable cost + Fixed cost + profit or loss.

Contribution = Sales - Variable cost.

Contribution = Fixed cost + Profit or loss.

Contribution = Sales x C/M Ratio or P/V ratio.

Contribution (per unit) = Unit selling price – Unit variable cost.

Total contribution := Total sales –Total variable cost.

a) C/M or P/V ratio:

i) Unitcontribution

Unit saling price x 100

i) Total cntribution

Total sales x100

Break Ever point :

i) BEP(Unit) = Total Fixed cost

Contribution Margin Per Unit

ii) BEP (sales) = Total Fixed cost

C/M Ratio or P/V Ratio

iii) BEP (sales) = Total fixed cost

1-variable cost / sales

c) Margin safety:

i) Margin of safety (unit) = Total sales unit –BEP units

ii) Margin of safety (Taka) = Total sales –BEP sales

iii) Margin of safety = Profit ÷ contribution

sales

d) Margin of safety Ratio: = Margin of safety

sales x100

Problem : CVP – 01( 2015)*

Shirin International Ltd. is the distributor of a certain product . The product is sold in the

market for Tk. 300 per unit with a variable procurement cost of Tk. 210 and a variable

selling expenses of Tk. 25. The Company’s other variable cost is Tk. 15. Fixed selling

and administrative expenses are Tk. 2,00,000 per year.

Required :

(i) What is the break-even point in unit and Taka ?

(ii) What sales level in unit is required to earn an annual before- tax profit of

Tk. 1,50,000 ?

(iii) What sales level must be achieved to have after- tax profit of Tk. 2,00,000 ,

if tax rate is 50 % ?

(iv) What sales level must be achieved to have the after tax target profit of

Tk.2,40,000 if tax rate is 40 %?

(v) What is the Margin of Safety(MS) and after tax- profit for sales level of

10,000 units , if tax rate is 40 % ?

Problem : CVP –02( 2015)

The Paradise Company is the exclusive distributor for an automotive product. The

product sells for Tk.50 per unit and has a CM ratio 40%. The company’s fixed

expenses are Tk.3,00,000 per year.

Required:

i. What is the variable expenses per unit ?

ii. What is the break – even point in units and sales taka ?

iii. What sales level in units and in sales taka is required to earn annual

profit of Tk. 90,000 ?

iv. Assume that by using efficiency and technology, the company is able to

reduce its variable expenses by Tk. 5 per unit. What is the company’s new

break- even point in units and sales taka ?

Problem : CVP- 03 (2015)**

The following data are obtained from the records of a factory :

Sales: 4,000 units @ Tk. 25 each Tk. 1,00,000

Materials consumed Tk. 40,000

Variable overheads Tk.10,000

Labour charges Tk. 20,000

Fixed overheads Tk. 18,000 Tk. 88,000

Net profit Tk. 12,000

======

Calculate :

i. The number of units by selling which the company will neither lose nor gain

anything .

ii. The sales needed to earn net profit of 20% on sales.

iii. The extra units which should be sold to obtain the present profit if it

proposed to reduce the selling price by 20% and 25% .

iv. The selling price to be fixed to bring down its break-even points to 500

units under present condition.