Section A Answer: The following comments are about the financial performance and positionof Capetright plc. Profitability: ROCE is a primary measure of profitability. The comparison betweencapital invested and profit implies the effectiveness with which capitalinvested have been deployed. ROCE increased significantly from 60.62% in 2003to 99.74% in 2004. ROSF also increased significantly from 67.1% in 2003 to 121.5% in 2004.The figure represents the amount of profit that is left for the owners. Normally,the owners seek to get as high a value as possible for ROSF. Based on the view,the 2004 ROSF ratio is very good. The gross profit ratio increased slightly from 57.4% in 2003 to 59.6% in2004, accompanied by an increase in the net profit margin from 11.94% in 2003to 15.19% in 2004. The gross profit ratio is a measure of profitability inbuying (or producing) and selling goods before considering any other expenses.Therefore, the cost of sales is a major expense for the businesses and anychange about this ratio can have a significant effect on the net profit for theyear. (Atrill and Mclaney, 2005) Theincrease about this ratio means that gross profit ( Obviously, part of the increase about the net profit margin ratio islinked to the increase about the gross profit margin ratio. The net profitmargin is regarded as the most appropriate measure of operational performance,however, the ratio can vary considerably between types of business. (Atrill andMclaney, 2005) Carpetright plc was lookingfor growing profit margins to stimulate sales (from Efficiency: The sales to capital employed ratio shows how effectively the assets ofthe business are used to get sales revenue. (Atrill and Mclaney, 2005) Sales tocapital employed ratio increased slightly from 5.08 times in 2003 to 6.57 timesin 2004. Normally, the higher sales to capital employed ratio are preferred toa lower one. 6.57 times in 2004 represents that assets are used moreproductively for the generation of revenue than that in 2003. However, it isnecessary to notice that a very high ratio may represent that the business is‘overtrading on its assets’, namely, it will have insufficient assets to keepthe level of sales revenue achieved. (Atrill and Mclaney, 2005) Stock turnover decreased from 79.47 days in 2003 to 68.86 days in 2004.The figure shows the products bought by Carpetright plc would have been soldabout 10 weeks later in 2004, compared with 11 weeks in 2003. Generallyspeaking, a business will prefer a short stock turnover period to a long one. Debtorsturnover increased from 3.06 days in 2003 to 4.23 days in 2004. Normally, abusiness prefers a shorter debtors turnover to a long one. The increase ofdebtors turnover means more cash was tied up in debtors. It is not good for abusiness to collect its cash and large increase of debtors will have an effecton the cash flow of a business. Creditors turnover increased from 90.81 days in2003 to 99.36 days in 2004. It is good for Carpetright plc to attempt toincrease its creditors turnover because the increase of creditors turnover willprovide a free source of finance for Carpetright plc. However, the increase ofcreditors turnover between 2003 and 2004 will lead to a loss of suppliergoodwill for Carpetright plc. It could bring some adverse results toCarpetright plc although this is beneficial to use free finance provided bysuppliers. Liquidity: Usually 2 times or 2:1 for all businesses is an ‘ideal’ current ratio,however, it needs to consider the fact that different types of business requiredifferent current ratios. (Atrill and Mclaney, 2005)Carpetright plc will prefer having a relatively low ratio because it isbeneficial to hold fast-moving stocks and will grow mostly cash sales revenue. Currentratio decreased from 0.52 times in 2003 to 0.48 times in 2004. The highercurrent ratio, the more liquid the business is. However, current ratio ofCarpetright plc is sharp below 2times. It means Carpetright plc has weakliquidity. On the other hand, acid test ratio slightly increased from 0.23times in 2003 to 0.24 times in 2004. It also means Carpetright plc has weakliquidity because the minimum level for this ratio is often 1 times. It is notunusual for this ratio to be below 1.0, however, the acid test ratio ofCarpetright plc is too lower than 1.0. It means current assets do not quitecover the current liabilities so that Carpetright plc is experiencing someliquidity problems. Gearing: Gearing ratio increased from 37.05% in 2003 to 41.6% in 2004. The morehighly geared business has produced a better ROSF in 2004 than in 2003. Namely,high gearing ratio can be used to increase the returns to owners. It isnecessary to notice that the returns to shareholders will sharp decline if theprofits have a small decrease for a high gearing ratio in 2004. The reason isthat the loan interest is relatively low. However, net profit margin in 2004 isbetter than that in 2003. Gearing ratio in 2004 is higher than before.Generally speaking, the level of gearing would not be very high although theeffect of gearing is beneficial to shareholders. However, it could increase therisk of the business. Interest cover ratio: The interest cover ratio has increased dramatically from a positionwhich profit covered interest 29.46 times in 2003 to one which profit coveredinterest 41.57 times in 2004. The main reason is that the profit in 2004 isbetter than that in 2003. The part reason is that long-term liabilities decreasedin 2004 (from Dividend payout ratio sharp dropped from 75.7% in 2003 to 62.2% in 2004.The main reason is that the dividend in 2004 has been increased although it isaccompanied by the increase of profits. It means Carpetright plc tends toexpand its new markets through keeping more profits rather than payingdividends. The detailed numerical analysis is based on the following calculation ofratio and formula. 1. ROCE 68,755/ (28,647+40,289)*100=99.74% (Year 2004) 52,091/ (31,836+54,093)*100=60.62%(Year2003) 2. ROSF 48,937/40,289*100=121.5%(Year 2004) 36,285/54,093*100=67.1%(Year 2003) 3. Sales to capital employed 452,721/ (40,289+28,647)=6.57times (Year 2004) 436,433/ (54,093+31,836) =5.08times (Year 2003) 4. Gross profit margin 269,880/452,721*100=59.6% (Year 2004) 250,632/436,433*100=57.4%(Year 2003) 5. Net profit margin 68,755/452,721*100=15.19% (Year 2004) 52,091/436,433*100=11.94%(Year 2003) 6. Stock turnover in days 34,492/182,841*365=68.86days (Year 2004) 40,453/185,801*365=79.47days (Year 2003) 7. Debtors turnover in days 5,249/452,721*365=4.23days (Year 2004) 3,659/436,433*365=3.06days (Year 2003) 8. Creditors turnover in days 49,771/182,841*365=99.36days (Year 2004) 46,225/185,801*365=90.81days (Year 2003) 9. Current ratio 67,909/141,765=0.48:1 73,520/140,982=0.52:1 10. Acid test ratio (67,909-34,492)/141,765=0.24 times (Year 2004) (73,520-40,453)/140,982=0.23 times (Year 2003) 11. Gearing 28,647/(40,289+28,647)*100=41.6% (Year 2004) 31,836/(54,093+31,836)*100=37.05%(Year 2003) 12. Interest cover 68,755/1,654=41.57times (Year 2004) 52,091/1,768=29.46times (Year 2003) 13. Dividend payout 30,434/48,937*100=62.2%(Year 2004) 27,461/36,285*100=75.7%(Year 2003) Formula: 1. ROCE=Net profit before interest & taxation/Sharecapital+Reserves+Long-term loans 2. ROSF= Net profit after interest & taxation/Sharecapital+Reserves 3. Sales to capital employed=Sales/ Sharecapital+Reserves+Non-current liabilities 4. Gross profit margin=Gross profit/Sales 5. Net profit margin=Profit before interest &taxation/Sales 6. Stock turnover in days=Stock held/Cost of sales *365 7. Debtors turnover in days=Trade debtors/Credit Sales*365 8. Creditors turnover in days=Trade creditors/Cost ofsales *365 9. Current ratio=Current assets/Current liabilities 10. Acid test ratio=Currentassets-stock/Current liabilities 11. Gearing=Long termliabilities/Equity +Long term liabilities 12. Interest cover=Profitbefore interest & taxation/interest payable 13. Dividend payout=Dividendsannounced for the year/Earnings for the year available for dividends Section B Answer: Enron collapse is a typical example of corporate governance failure. Themain reason of Enron collapse focuses on the criminal acts of the company’sfinance organisation, specifically its chief financial officer. It is necessaryto notice that creating accounting of Enron manipulated the financialstatements so that chief financial officer did not valuate the real positionand performance of Enron correctly. Enron’s energy-trading operations were hugely profitable until itscollapse. Enron’s North American trading operations were $2.9 billion in thefirst eight months of 2001. (Peterson, 2003) Normally,these huge profits from energy trading were much more than huge losses inrecent businesses. However, Enron’s traders made use of creating accountingmethods to hide their energy-trading profits so as to avoid being accused ofgetting profiting from the Enron’s traders took advantage of creating accounting methods to hidetheir profits so that the financial statement can not show Enron’s realposition and performance. The financial statement provided wrong informationfor its investors, management level and shareholders. Therefore, Enron collapsewas due to a sudden loss of confidence among investors, bankers so that Enronwas plunged into a liquidity crisis. (Words count: 274)
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