X82 - Threads Ltd.

Threads Ltd manufactures nuts and bolts, which are sold to industrial users. The
abbreviated financial statements for 2006 and 2007 are as set out below.
Calculate the financial ratios as required in the yellow cells.

Print out this sheet when completed (use landscape and fit to 1 page). Use this printout
and the ratios you have calculated to answer the questions in worksheet Supplier
Questions.

Threads Ltd
Income statements for the year ended 30th June

2006 2007 2006 2007

£000 £000 Profitability ratios
Revenue 1,180 1,200 Operating profit margin 19.8% 13.9%
Cost of sales (680) (750)
Gross profit 500 450 Gross profit margin 42.4% 37.5%
Operating Expenses (200) (208)
Depreciation (66) (75) ROCE 31.0% 19.8%
Interest (8)
Profit before tax 234 159 Efficiency ratios
Taxation (80) (48) Inventory turnover period 79 115
Profit for the year 154 111
Receivables settlement period 32 47
Dividends paid 70 72
Payables settlement period 32 37

Balance sheets as at 30th June 2006 and 2007 Liquidity ratios

2006 2007 Current ratio 1.27 1.66
£000 £000
Non current assets 702 687 Acid test ratio 0.53 0.67
###
Current assets
Inventories 148 236
Trade receivables 102 156
Cash 3 4
253 396

Total assets 955 1,083

Equity
Ordinary share capital of £1 (fullypaid) 500 500
Retained earnings 256 295
756 795

Non-current liabilities
Bank loan 50

Current liabilities
Trade payables 60 76
Other payables and accruals 18 16
Taxation 40 24
Bank overdraft 81 122
199 238

Total equity and liabilities 955 1,083

X82 - Threads Ltd.
Threads Ltd manufactures nuts and bolts, which are sold to industrial users. The
abbreviated financial statements for 2006 and 2007 are as set out below.
Calculate the financial ratios as required in the yellow cells.

Print out this sheet when completed (use landscape and fit to 1 page). Use this printout
and the ratios you have calculated to answer the questions in worksheet Supplier
Questions.

Threads Ltd
Income statements for the year ended 30th June

2006 2007 2006 2007

£000 £000 Profitability ratios
Revenue 1,180 1,200 Operating profit margin 19.8% 13.9%
Cost of sales (680) (750)
Gross profit 500 450 Gross profit margin 42.4% 37.5%
Operating Expenses (200) (208)
Depreciation (66) (75) ROCE 31.0% 19.8%
Interest (8)
Profit before tax 234 159 Efficiency ratios
Taxation (80) (48) Inventory turnover period 79 115
Profit for the year 154 111
Receivables settlement period 32 47
Dividends paid 70 72
Payables settlement period 32 37

Balance sheets as at 30th June 2006 and 2007 Liquidity ratios

2006 2007 Current ratio 1.27 1.66
£000 £000
Non current assets 702 687 Acid test ratio 0.53 0.67
###
Current assets
Inventories 148 236
Trade receivables 102 156
Cash 3 4
253 396

Total assets 955 1,083

Equity
Ordinary share capital of £1 (fullypaid) 500 500
Retained earnings 256 295
756 795

Non-current liabilities
Bank loan 50

Current liabilities
Trade payables 60 76
Other payables and accruals 18 16
Taxation 40 24
Bank overdraft 81 122
199 238

Total equity and liabilities 955 1,083

X82 - Threads Ltd.
Threads Ltd manufactures nuts and bolts, which are sold to industrial users.

Comment on the performance of Threads Ltd from the viewpoint of a business considering
supplying a substantial amount of goods to Threads Ltd on usual trade credit terms.

Copy your calculation values into the yellow cells.

Answer the questions below in worksheet Supplier Questions.

A supplier seeking to sell a substantial amount of goods to Threads limited will be concerned with Copy your calculation values into these cells.
both the liquidity of the company and its longer term viability. Where a customer contributes a
significant proportion of sales revenue, a supplier will want to be confident that the customer will 2006 2007
continue to be in business and will continue to pay its suppliers. Profitability ratios
Operating profit margin

Gross profit margin

Q1. Consider the liquidity ratios of Threads Ltd. What conclusions might a supplier make
when looking at these figures? ROCE

Efficiency ratios
Inventory turnover period

Receivables settlement period

Payables settlement period

Q2. What implications might a supplier make from reviewing Threads Ltd's receiveables
and payables settlement period ratios? Liquidity ratios
Current ratio

Acid test ratio

Q3. What implications might a supplier make from reviewing Threads Ltd's inventory
turnover period?

Q4. What implications might a supplier make from reviewing Threads Ltd's profitability
ratios?

Q5. What should be the attitude of the supplying company to its future business with
Threads Ltd?
X82 - Threads Ltd.
Threads Ltd manufactures nuts and bolts, which are sold to industrial users.

Comment on the performance of Threads Ltd from the viewpoint of a business considering
supplying a substantial amount of goods to Threads Ltd on usual trade credit terms.

Answer the questions below in worksheet Supplier Questions.

A supplier seeking to sell a substantial amount of goods to Threads limited will be concerned with Copy your calculation values into these cells.
both the liquidity of the company and its longer term viability. Where a customer contributes a
significant proportion of sales revenue, a supplier will want to be confident that the customer will 2004 2005
continue to be in business and will continue to pay its suppliers. Profitability ratios
Operating profit margin 19.8% 13.9%

Gross profit margin 42.4% 37.5%

Q1. Consider the liquidity ratios of Threads Ltd. What conclusions might a supplier make
when looking at these figures? ROCE 31.0% 19.8%

The liquidity ratios reveal an apparent improvement over the two years. For a manufacturing Efficiency ratios
business the liquidity ratios seem low and the supplier may be concerned. Increase in inventory
Inventory turnover period 79 115
over the period has led to a greater improvement in the current ratio than in the acid test ratio. The
improvement in the acid test ratio has not been very great and some concern over the businesses
liquidity position would be appropriate. Receivables settlement period 32 47

Payables settlement period 32 37

Q2. What implications might a supplier make from reviewing Threads Ltd's receiveables Liquidity ratios
and payables settlement period ratios? Current ratio 1.27 1.66

The average credit period allowed to debtors (receivables) has increased substantially in 2007 Acid test ratio 0.53 0.67
from 32 days to 47 days. This increase may be due to factors such as poor credit control or
particular customers experiencing financial difficulties. The supplier should note this change in
receivables settlement period as this increase in outstanding receivables seems to have been
partly financed by an increase in payables settlement period. In other words Threads Ltd is taking
longer to pay its suppliers than it did previously. That said, 37 days is not particularly outrageous.

Q3. What implications might a supplier make from reviewing Threads Ltd's inventory
turnover period?

Inventory turnover period has increased significantly from 79 days to 115 days in 2005. This might
be due to stockbuilding in anticipation of future sales revenue. However it might also indicate that
certain products are not selling as well as expected and are therefore remaining in stock.

Q4. What implications might a supplier make from reviewing Threads Ltd's profitability
ratios?

Gross profit margin and operating profit margins are both lower in 2007. Low-margins have in turn
led to a lower ROCE. The lower profit margins, the increase in receivables settlement period, and
the increase in inventory turnover period might suggest that the business has an ageing product
range which is becoming more difficult to sell. It might also suggest that the business environment
is more competitive.

Q5. What should be the attitude of the supplying company to its future business with
Threads Ltd?

The ratios calculated above do not indicate any serious problems for the business. However it is
clear that 2007 was a more difficult year than 2006. Although things may improve in the future, the
supplier should be cautious about their dealings with Threads Ltd. It would be advisable not to rely
too heavily on Threads Ltd for future sales revenue.

These answers are more detailed than would be expected in the exam. They should be read
carefully and thought about in order to understand the significance or meaning of changes
in financial ratios.