Interpretation

Type of Questions:
i) Normal Position and Performance:
Compare entity to sector/industry or previous year results, to
analyse position and performance.

Question Example: Mowair. Bun Co. Treats Co.

ii) Compare 2 companies to see which the better investment is.

Question Example: Xpand. Pastry.

iii) Effect of acquiring Subsidiary:

Exclude/ Include subsidiary result and then calculate and analyse
for Principal.
Question Examples: Woodbank. Parul Co. Duke Co.

iv) Effect of disposing Subsidiary:

Exclude/Include subsidiary result and then calculate and analyse
for Principal.
Question Examples: Pitcarn. Perkins. Pirlo. Marvell.

*IMPORTANT: READ THROUGH CHAPTER 22 OF STUDY TEXT.

INTERPRETATION OF EACH BALANCE AS WELL AS APPROACH
FOR CONSOLIDATED QUESTIONS ARE EXPLAINED THERE.

Some Important Points:

 Don’t use Bullet points, use paragraphs.
 For commenting on Ratios: What exactly does the ratio mean? What
does the change in the ratio mean? Why has the ratio changed?
 Wherever possible, use percentages. Example: Total Assets has
increased 12% compared to last year instead of saying increased by
2 million.
  A question may ask what additional information you require. Make
scenario-specific requests and give reasons. Examples of
Information:
Budgeted Figures, Industry Averages, Non-Financial Information like
product range information or long-term plans of management
 You can mention that primary measure of profitability is ROCE. And
when analysing ROCE you can separately look at both factors, OPM
and Net Asset Turnover and their effects on ROCE.

APPROACH FOR SOLVING QUESTIONS:

Type 1: Comparing 2 entities for investment opportunities.
 First compare revenues. If one is significantly higher, could mean
larger market share which may be due to lower profit margins.

 Mainly compare ROCE of both and split into OPM and Net Asset
Turnover Component.

 For this, compare the ‘capital employed’ part of Net Asset Turnover.
For example: 1 entity owns premises, other rents. In this case the first
one will show high capital employed and low ROCE. One could use
revaluation model while other uses cost model. Again the first one will
show higher capital employed and will be tougher to compare.

 As P is looking to acquire an entity, ROE or ROI needs to be

calculated.
This is (Profit for the year) / Purchase Price.
But this could be due to differences in finance costs rate or tax rate
which could again harm comparability. Differences in finance cost
rate does show difference in credit-worthiness though,

 For comparing Liquidity:

Don’t make general statements. Different industry have different
current asset requirements like retail can operate comfortably at low
 current ratio as inventory directly turns to cash. Service Industry has
very little inventory but large receivables balances.
Compare differences in holding periods, collection periods and what
this means. (poor credit terms or credit control, cash flow
problems.etc)
See if NCA of any entity are near ends of life which means further
investment required. See how entities finance their assets.

 For comparing Gearing:

Compare both but remember different companies may have different
financing strategies. High gearing may mean high risks, see interest
cover to validate this
.
 End with summary.

 Summary: Both would represent similar/different investments.

Summarise the differences in companies like high level of debt
financing, different revenues. Etc.

 WRITE THIS LINE AT END OF SUMMARY:

Ultimately P’s decision may be determined by its attitude to risk
is and what its purpose for acquisition is (gaining market share,
higher profits). P needs to consider how well each investment
would fit in with the existing activities and management
structure.

 Overall Approach:
I) Compare Revenue, discuss reasons. Compare profitability
ratios, particularly ROCE after splitting into two components.
II) Calculate ROI/ROE for both and compare.
III) Compare liquidity but keep in mind that different industries
have different current asset requirements. Compare holding/
collection periods and say what it means.
IV) See if further investment required soon to replace old NCA.
V) Compare gearing to find out risk profile.
 VI) ALWAYS SEE WHAT ITEMS HARM COMPARABILITY and
see if results without them can be calculated.
VII) End with summary by saying both are similar/different and
the major differences.
VIII) Finish the answer with the line about how investment
decision depends on risk attitude and purpose of acquisition.
How well the investment fits in with existing activities and
management structure.

PROFITABILITY
First, compare revenue. Kovert much higher. Possible reason is geining
market share by selling at lower margins as shown by the profit margin
calculations.
ROCE is the primary measure of profitability. Kandid’s ROCE is 62.5%
which is significantly higher than Kovert which is 31.0%.
ROCE can be split into two components, Profit Margin and Net Assets
Turnover. Both measures are agan much higher for Kandid.
Comparaility issues in comparing ROCE which leads to differences in
capital employed. Isssues are government grant treatment by Kandid which
reduces capital employed. It seems that Kandid is renting its properties
while Kovert purchased them leading to higher capital employed for Kovert.
Kovert also has adopted revaluation which again increases capital
employed. Overall, Kandid has a lower total assets figure which gives
higher ROCE and may be misleading.
Compare ROE instead which would be more relevant.
ROE is 30% for Kandid and 25% for Kovert.
Still, Kandid has higher. Kovert has 10% interest rate, Kandid has only 5%
which may suggest differences in creditworthiness. Tax rates also much
higher for Kovert. If similar level of finance cost and tax rate, ROE would be
much closer.
LIQUIDITY:
Both have healthy liquidity. Kandid has much higher cash which it could
have used to invest instead Kandid has better inventory and receivables
collection period. High receivables collection period may be due to poor
credit control.

GEARING
Both similar level. High gearing. Compare interest cover. Both hve low
equity. Kovert has high gearing due to using leases to acquire assets. Both
have loans due soon which would require further cash flow.

Kovert plants almost end of life requiring replacement soon which means
more cash outflow.

SUMMARY:
Both operating in similar industry, have similar profit figures and purchase
price but very different investment. Kovert has higher revenue, financed
using loans and leases. Kandid rents property. And other differences
summarised.
Ultimately investment decision depends on Xpand’s attitude to risk and how
well each investment would fit in with existing activities and management
structure.