You are Professional Accountant (SA) for registered accountants. A client of yours in the SME
sector is speculating shares on listed company on the JSE. The detail and name of the listed
company is confidential at this stage and this is the information that you have been provided
with
1. The company was founded some years ago and operates as a chain of specialist stores
selling stationery, clothing and crockery and home ware on credit.
2. From January 2008 to present date, the shares have doubled in price and the market
in general appears to be most impressed with the performance of the economy.
3. The growth in the share price has been accompanied by growth in the number of
stores that have been opened or acquired through the take over of SMEs operating in
the same market.
4. Extractsfrom the annual financial statements of the are as follows:
Statement of Financial Position at 31 December
2012 2011
R'000 R'000
EQUITY AND LIABILITIES
Issued share capital 147834 147834
Retained Income 100192 82275
Equity attributable to ordinary shares 248026 230109
Non-Current Liabilities
Long Term Loans 237652 108297
Current Liabilities 148141 56390
Creditors 130732 44784
Shareholdersfor dividends 17409 11606
Bank Overdraft 0 0
TOTAL EQUITY AND LIABILITIES 633819 394796
ASSETS
Non-Current Assets
Property, Plant and Equipment 16069 14696
Current Assets 617750 380100
Inventory 192085 149002
Trade and other receivables 425665 229633
Cash and bank balances 0 1465
TOTAL ASSETS 633819 394796
Statement of Profit and Loss and Other Comprehensive Income for the years
ended 31 December
2024 2023
R'000 R'000
Turnover 1287052 934052
Operating Profit 137342 81768
Net Finance Cost 39264 20862
Operating Profit before taxation 98078 60906
Income tax expense 7027 3048
Profit for the Year 91051 57858
3502 2237
Operating profit includes Depreciation
and loss on sale of fixed asset
Required:
a) Prepare the cash flows from operating activities for the company for 2024
using the available information (10 Marks)
b) Perform a financial review of the company based on calculating the following
financial ratios and explain how it may be interpreted.
Debt equity ratio
Timesinterest earned
Current ratio
Debtors average collection period
Inventory turnover
Your answer should include an overall assessment of the company (25 Marks)
c) List the audit steps to verify the existence of inventory (10 Marks
a) Cash flows from operating activities for the company for 2024:
Operating Profit before taxation 98,078
Add: Depreciation 3,502
Less: Loss on sale of fixed asset 2,237
Changes in working capital:
Increase in inventory (192,085-149,002) (43,083)
Increase in trade and other receivables (425,665-229,633) (196,032)
Increase in creditors (130,732-44,784) 85,948
Increase in shareholders for dividends (17,409-11,606) (5,803)
Net cash flows from operating activities (60,639)
b) Financial ratios calculation and interpretation:
Debt equity ratio = Total liabilities / Equity attributable to ordinary shares
= (237,652 + 148,141) / 248,026
= 1.75
Interpretation: The company has a debt equity ratio of 1.75, indicating that it relies more on debt financing compared to equity. This may pose a risk in terms of financial stability and solvency.
Times interest earned = Operating Profit / Net Finance Cost
= 137,342 / 39,264
= 3.5
Interpretation: The times interest earned ratio of 3.5 shows that the company is able to cover its interest payments 3.5 times with its operating profit. A higher ratio is generally more favorable.
Current ratio = Current Assets / Current Liabilities
= 617,750 / 148,141
= 4.17
Interpretation: The current ratio of 4.17 indicates that the company has sufficient current assets to cover its current liabilities, suggesting good liquidity and ability to meet short-term obligations.
Debtors average collection period = (Trade and other receivables / Turnover) x 365
= (425,665 / 1,287,052) x 365
= 120.77 days
Interpretation: The debtors average collection period of 120.77 days suggests that the company takes an average of around 4 months to collect its receivables, which may impact cash flow and liquidity.
Inventory turnover = Cost of Goods Sold / Average Inventory
= 1,287,052 / [(192,085 + 149,002) / 2]
= 8.44
Interpretation: The inventory turnover of 8.44 indicates that the company sells and replaces its inventory approximately 8.44 times in a year, showing efficient management of inventory.
Overall assessment: The company appears to have strong growth potential based on the increase in share price and number of stores. However, the high debt equity ratio raises concerns about financial risk and leverage. The current ratio and times interest earned ratio are satisfactory, indicating liquidity and ability to cover interest payments. The debtors collection period is slightly high, potentially impacting cash flow, while the inventory turnover ratio shows efficient inventory management.
c) Audit steps to verify the existence of inventory:
1. Confirm the existence of inventory physically by conducting comprehensive stock counts.
2. Confirm the ownership of inventory by reviewing ownership documents such as purchase invoices and delivery notes.
3. Check the inventory locations and perform spot checks to ensure accuracy.
4. Verify the valuation of inventory by reconciling physical counts with the accounting records.
5. Trace inventory transactions to supporting documentation such as sales orders, purchase orders, and inventory reports.
6. Investigate any discrepancies or inconsistencies found during the inventory verification process.
7. Obtain third-party confirmation of inventory held at external warehouses or locations.
8. Review internal controls and procedures related to inventory management to assess reliability of inventory records.
9. Perform analytical procedures to assess reasonableness of inventory balances and movements.
10. Document all audit procedures performed and findings in the audit working papers.