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Unit 02 The Financial Environment-2
Unit 02 The Financial Environment-2
UNIT
(2)
(3)
The money market channel wholesale funds, usually less than one year, from
lenders to borrowers. The market is largely dominated by the major banks and
other financial institutions. Referring to short-term lending and borrowing
purposes
The securities or capital market deals with long-dated securities such as
shares and loan stock
The foreign exchange market is a market for buying and selling one currency
against another. Deals are either on a spot basis (for immediate delivery) or on
a forward basis (for future delivery).
The financial markets provide mechanisms through which the corporate financial
manager has access to a wide range of source of finance and instruments.
Capital markets have two important functions:
Primary Market
- providing new capital for
business and other activities.
Example share issuing, or
loans.
Secondary Market
trading existing securities
Business Finance/4ACC0812/Chandran/1006
The semi-strong
form of the EMH
states that current
market prices
reflect not only all
past price
movements, but
ALL publicly
available
information. In
other words, there
is no benefit in
analyzing existing
information, such
as that given in
published
accounts, dividend
and profits
announcement,
appointment of a
new chief
executive or
product
breakthrough, after
the information has
been released. The
stock market has
already captured
this information in
the current share
price
Business Finance/4ACC0812/Chandran/1006
Dividend yield
Raising Finance. There are clear tax benefits in raising finance by issuing
debt rather than capital. Interest on borrowings attracts tax relief, thereby
reducing the companys tax bill, while a dividend payment on equity capital
does not attract tax relief. The tax system is thereby biased in favour of debt
finance.
(2)
[b]
Profit margin
(i) Gross profit margin
(ii Net profit margin
)
Return on Capital employed
Asset turnover
Debtor days
Stockholding period
Supplier credit days
Current ratio
Quick ratio
Gearing ratio
Profitability
Ratios
(2)
Activity Ratios
(a)
(b)
(c)
(d)
(3)
Liquidity and
Financing
Ratios
(a)
(b)
(c)
Business Finance/4ACC0812/Chandran/1006
(4)
Investors Ratios
(d)
Interest cover
(a)
(b)
(c)
(d)
(e)
(f)
What is Sufficient?
Not too much of money but just nice to meet payment, not too little
of money but some of them are used to do other investment (to earn
more money)
The ideal current ratio is generally accepted to be 2:1 (that is, out of all of the
current assets, half is financed by current liabilities and the other half from
long-term liabilities)
The ideal quick ratio is 1:1, these liquidity ratios are a guide to the risk of cash
flow problems and insolvency
Business Finance/4ACC0812/Chandran/1006
However, these ratios also vary according to the nature of the companys
business. For example, does service company have lots of inventory? What
about manufacturing company?
Two situations that should not happen:
(1)
Overcapitalisation
Too much current assets funds are held to carry current assets, should
have invested elsewhere to get better return
(2)
Overtrading
Where a business tries to do too much too quickly with little long-term
capital
Dangerous will have liquidity problem, does not have enough capital to
provide cash to pay its debts as they fall due
Business Finance/4ACC0812/Chandran/1006
CCC = Stock Turnover in days + Debtors collection period Creditors payment period
If the turnover period for stocks and debtors lengthen, or the payment period to
creditors shorten:
The operating cycle will lengthen
The investment in working capital will increase
TUTORIAL
U N I T
QUESTION 1
(a)
Sales
Cost of Sales
Purchases
Debtors
2003
(RM000)
300
240
160
38
Business Finance/4ACC0812/Chandran/1006
2004
(RM000)
350
288
194
43
24
40
22
48
35
75
39
53
Required:
Calculate the projected change in working capital cycle between 2003 and 2004
positions.
(b)
You are the company secretary of Paper Malaysia Bhd a large manufacturing company.
The financial director has recently resigned following the disclosure of same financial
irregularities and you are temporarily helping to sort out the company finances.
Your examination of the financial position reveals that some 30% of the total net assets
of RM10 million comprise debtors. You consider from cash flow projections that the
company is likely to be short of funds in the next three months. You also consider that
the management of debtors has been neglected such that too much cash is locked up in
the debtors accounts.
The managing director has asked you to prepare a brief report for the next Board
meeting. The current return on capital is 12%.
QUESTION 2
XY Sdn Bhd
Profit and Loss Account for the year ended 31 December 2002
RM
Sales
less: Cost of Sales
Opening Inventory
add: Purchases
RM
452,000
125,000
341,000
466,000
143,000
323,000
Gross Profit
129,000
Net Loss
3,000
RM
163,000
143.000
306,000
52,000
25,000
280,000
257,000
663,000
Total Assets
Capital and Reserves
Ordinary Share Capital
Retained Profits
100,000
158,000
258,000
Business Finance/4ACC0812/Chandran/1006
120,000
Current Liabilities
Trade Creditors
Bank Overdraft
145,000
140,000
285,000
663,000
Bank Overdraft
Required:
(a) Calculate the current ratio and quick ratio an explain why the management of this
company should be concerned about its liquidity position
(b) Explain the term Operating Cash Cycle
(c) Calculate the Operating Cash Cycle for this company (assume a 360 days year).
QUESTION 3
The following are extracts of Balance Sheet and Income Statement of Big Shop Sdn Bhd:
2002
RM
2003
RM
Current Assets:
Stocks
Debtors
Balance at Bank
1,200
1,000
1,800
1,400
600
1,000
Current Liabilities
3,400
2,300
Owners Equity
4,500
3,500
14,000
8,000
4,200
10,000
6,000
2,800
Sales
Cost of Goods Sold
Net Profit
(a)
Calculate the following ratios for each year (assuming a 365 day year):
(i) Current ratio
(ii) Quick ratio
(iii) Gross profit margin
(iv) Net profit margin
(v) Debtors collection period (in days)
(15 marks)
(b)
Using the above calculated ratios, comment on the profitability and liquidity of
Big Shop Sdn Bhd.
(5 marks)
TOTAL 20 MARKS
QUESTION 4
The following details have been extracted from the accounts of EmEnO Sdn Bhd for the last
three years.
Turnover (Sales)
Gross Profit
Net Profit
Fixed Assets
Stock
Debtors
Creditors
Cash at Bank
Bank Overdraft
2002
(RM000)
100
33
15
64
4
8
5
5
-
2002
(RM000)
103
34
15
72
4
11
6
6
2004
(RM000)
108
35.6
15
68
4
15
6
5
Required:
Business Finance/4ACC0812/Chandran/1006
(b)
Comment briefly on the ratios given and those that you have calculated in (a) above.
(6 marks)
(14 marks)
TOTAL 20 MARKS
QUESTION 5
Deron Sdn Bhd makes a range of products, all of which follow a similar production process
and have the same cost structure. The products are made in batches that are started at the
beginning of the month and are completed and taken into finished goods stock at the end of
the month. There is no work-in-progress at the end of any month.
Currently sales are RM0.3 million a month and produce a contribution of 40 sen per RM1 of
sales. Variable raw material costs account for 20 sen per RM1 of sales. Fixed costs are
RM120,000 per month of which RM30,000 is depreciation. The companys only variable
costs are production costs.
Currently trade debtors take one month to pay, trade creditors for raw materials are paid one
month after purchase and the other variable costs are paid during the month of production. At
the end of each month the company has sufficient raw material stock to meet the following
months production and enough finished goods stock to meet the following months sales.
The company has decided to expand its production and sales volumes by 50%. To generate
the increased demand, the selling price will be reduced by 10% and trade debtors will be
allowed to pay two months after the sale. Since neither the usage, nor the cost per product of
raw materials and other variable costs will be affected by the proposed expansion, the
contribution per RM1 of sales will fall to 30 sen. The changes to sales volume, price and
payment period will commence with sales made from 1st December 2004.
The companys balance at bank at 1st October 2004 is expected to be RM70,000.
Required:
Prepare the companys cash budgets for each of the months of October 2004, November
2004, December 2004. January 2005 and February 2005.
[Note: To have the necessary finished stock in place fore 1st December, it will be necessary
to increase production during November, and to have the required raw material stock in place
for 1st November it will be necessary to increase purchases during October.
TOTAL 25 MARKS
Business Finance/4ACC0812/Chandran/1006