Ayawaso Ltd operates a hotel in Accra and the following are its results for the last three years with its year end being 31 December.
Required:
a) Using all of the above information, comment on the Gearing, Liquidity and Profitability of Ayawaso Ltd from 2016 to 2018. (12 marks)
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Profitability of Ayawaso
- Revenue increase / (decrease)
The decrease and increase in Ayawaso limited revenue appears to be in line with how the hotel sector has performed in the recession and coming out of the recession in 2017. The hotel sector in Accra has shown a noticeable improvement in revenue in 2018 so Ayawaso limited has displayed a decent performance with its revenue over the period.
- Non-Current Assets increase / (decrease)
Ayawaso limited appears to have carried out a sizeable capital improvement programme in 2016 with some residue of this spend rolling over to 2017. The 2018 spend is small and is consistent with the hotel not needing much capital spend given the refurbishment in 2016 and 2017.
- Gross Profit Percentage
A good performance by Ayawaso limited in capitalising on improving market conditions in 2018 by increasing its rates and thereby increasing its gross margin. Again the results are in line with the hotel sector in Accra.
- Net Profit Percentage
Ayawaso limited performed poorly in this ratio. As Accra gradually came out of recession in 2017, Ayawaso limited net profit percentage increased and showed the hotel was performing well. However, there has been a sizeable decrease in the net profit percentage from 2017 to 2018 which is very disappointing especially in light of the increase in the gross profit percentage. This is an area that the hotel management and shareholders needs to examine closely to identify and correct the reasons for the decrease in net profit percentage from 2017 to 2018.
- Return on Capital Employed
Again a disappointing return and the decrease in profit is the significant reason for the decrease in the ratio. Underneath the line, the capital employed would have increased year on year which would also help to decrease the ratio but the change in profit from 2017 to 2018 has been the main driver for the decrease in the ratio from 2017 to 2018. (4 points @1.5 marks each= 6 marks)
Liquidity of Ayawaso Ltd
- Current Ratio
The company has struggled with this ratio particularly in 2016 and 2017 but it is improving and 2018 is getting closer to the norm of 2:1. Overall, the result from 2016 to 2018 has been decent and continued focus on this ratio can ensure that it gets to a satisfactory level in the years ahead.
- Acid Ratio
Again this ratio has improved from 2016 to 2018 but it is disappointing to see that it decreased from the 2017 level. Therefore, management need to find the reasons for the decrease and work to ensure that it gets back to the norm of 1:1 at a minimum. The 2016 ratio shows that the hotel was carrying a sizeable quantity of inventory which then decreased in 2017 and increased again in 2018. This is surprisingly high for a hotel and needs serious investigation as normally inventory would not be at this level in a hotel. (2 points @ 2 marks each = 4 marks)
Gearing of Ayawaso Ltd
- Debt to Equity Ratio
It is pleasing to note the improvement in this ratio from 2016 to 2018 as the company has paid down its debt and improved its reserves. The decrease has slowed down in 2018 which is probably due to decreased profits leading to decreased cash flow to pay back debt as well as the company trying to improve its current ratio by holding on to more of its cash.
- Dividend Cover
This ratio is going in the right direction as increased profits due to higher revenue are helping to increase the cover. It also appears as if a decision was made to reduce the amount of the dividend and leave more of the profit in the hotel to be used for future investment. Management need to ensure that the shareholders are happy with the decrease in the level of the dividend given the increased profits despite lower profit margins, the hotel is enjoying. Overall, the hotel is performing well with management’s main focus to ensure that inventory levels are reduced to hotel norms and to remedy the decrease in net profits for 2018 while ensuring that the hotel improves its ratios overall due to a more buoyant hotel market existing in Accra.
(2 points @ 2 marks each = 4 marks)
b) Identify and explain FIVE (5) advantages of ratio analysis as a means of assessing the financial performance of a business. (5 marks)
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- Comparison
Financial ratios provide a standardised method with which to compare companies and industries. Ratios can put all companies on a relatively equal playing field in the eyes of analysts; companies are judged on their performance rather than their size, sales volume or market share.
- Industry Analysis
Ratios can reveal trends in particular industries, creating benchmarks against which the performance of all industry players can be measured thus providing valuable information to users, shareholders, trade payables, banks.
- Stock/ Shares Valuation
Ratios help investors and analysts to evaluate the strengths and weaknesses of individual companies or industries and allow them to highlight companies to invest in or to avoid investing in.
- Planning and Performance
Ratios can provide guidance to entrepreneurs when creating business plans or preparing presentations for lenders and investors. Ratios can also serve as an impetus for strategic change within an organisation, providing management with relevant guidance and feedback as ratio valuations shift in response to organisational changes. Ratios help to ensure managers perform by revealing financial weaknesses and opportunities.
- Simplicity
It highlights important information in simple formats. A user can judge a company by just looking at a small amount of numbers instead of reading the whole financial statements.
c) State THREE (3) likely reasons for the significant change in non-current assets in 2016 and 2017. (3 marks)
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- Revaluation of fixed assets.
- Additional investment in fixed assets.
- Non-replacement of existing assets.
- Non-disposal of existing assets.