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The following is an extract from financial reports for Andrew’s Discount Tyres as at 30 May 2015 - HSC - SSCE Business Studies - Question 24 - 2015 - Paper 1
Question 24
The following is an extract from financial reports for Andrew’s Discount Tyres as at 30 May 2015. Current assets Accounts receivable 1 000 Inventory ... show full transcript
Worked Solution & Example Answer:The following is an extract from financial reports for Andrew’s Discount Tyres as at 30 May 2015 - HSC - SSCE Business Studies - Question 24 - 2015 - Paper 1
Step 1
Explain ONE possible limitation of this financial report.
Answer
One limitation of this financial report may be that it capitalizes expenses. For example, research and development costs could be recorded as an asset rather than an expense, which might distort the financial picture. This practice can mislead stakeholders regarding the actual profitability and financial health of the business, as it may present inflated asset values while concealing relevant ongoing costs.
Step 2
Discuss the gearing of Andrew’s Discount Tyres.
Answer
The gearing ratio measures the proportion of debt in relation to equity within a business's capital structure. For Andrew's Discount Tyres, we can calculate the total liabilities and total equity to assess their gearing.
Total liabilities:
- Current liabilities (Overdraft + Accounts payable): 1,000 = $3,000
- Non-current liabilities (Mortgage): $5,000
Total liabilities = 5,000 = $8,000
Total equity: $16,000
Gearing ratio formula: ext{Gearing Ratio} = rac{ ext{Total Liabilities}}{ ext{Total Liabilities} + ext{Total Equity}}
Substituting the values gives: ext{Gearing Ratio} = rac{8,000}{8,000 + 16,000} = rac{8,000}{24,000} = rac{1}{3} ext{ or } 33.33\%
This indicates that Andrew’s Discount Tyres has a relatively low gearing ratio compared to the industry average of 80%. A lower gearing suggests that the company is less reliant on debt for financing its operations, which can be considered a safer position in terms of financial stability. However, this might also imply that there could be potential underutilization of borrowing capacity to leverage growth opportunities.