Financing Decisions Acme Inc. is a wholesaler and distributor of electrical comp
ID: 2641303 • Letter: F
Question
Financing Decisions
Acme Inc. is a wholesaler and distributor of electrical components. The most recent draft financial statements of the business revealed the following:
Income statement for the year (in millions)
Sales revenue 14.2
Opening inventories 3.2
Purchases 8.4
Goods Available for Sale 11.6
Closing inventories (3.8)
Cost of Goods Sold (7.8)
Gross profit 6.4
Administration expenses (3.0)
Distribution expenses (2.1)
Operating profit 1.3
Finance costs (0.8)
Profit before taxation 0.5
Tax (0.2)
Profit for the period 0.3
Statement of financial position as at the end of the year (in millions)
ASSETS
Non-current assets
Property, plant and equipment
Land and buildings 4.0
Equipment 1.1
Motor vehicles 4
5.5
Current assets
Inventories 3.8
Trade receivables 2.9
Cash at bank .2
6.9
Total assets 12.4
EQUITY AND LIABILITIES
Equity
Share capital 2.1
Retained earnings 1.6
3.7
Non-current liabilities
Loan notes (secured on property) 3.9
Current liabilities
Trade payables 2.2
Short-term borrowings 2.6
4.8
Total equity and liabilities 12.4
1. Land and buildings are shown at their current market value. Equipment and motor vehicles are shown at their carrying amount (that is, cost less accumulated depreciation).
2. No dividends have been paid to ordinary shareholders for the past three years.
In recent months, suppliers (trade payables) have been pressing for payment. The chief executive has therefore decided to reduce their level to an average of 40 days outstanding. To achieve this, she has decided to approach the bank with a view to increasing the overdraft (the short-term borrowings comprise only a bank overdraft). The business is currently paying 10 per cent a year interest on the overdraft.
Required:
1) State, with reasons, how you consider the bank would react to the proposal to grant an additional overdraft facility.
Explanation / Answer
Answer:
The point that a bank shall consider are as under:
1. Lower Net Profit ratio: Profit 0.3 for revenue 14.2 is just 2.11% (BAD)
2. Debt to equity ratio = 3.9/3.7 = 1.05 (Good)
3. Loan notes (secured on property) 3.9: The biggest assets of the con is given on security already.
4. Short-term borrowings 2.6; The Co. is already under a short term debt. (BAD)
5. Net worth of the co. is just $3.7 million (BAD)
6. No dividends have been paid to ordinary shareholders for the past three years (BAD)
7. The chief executive has therefore decided to reduce their level to an average of 40 days outstanding. (BAD)
Hence overall bank is most likely to deny for overdraft facility.
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