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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 2,000 Cash 2,000 Non-current assets Building 13,000 Fittings 1,000 Research and development 5,000 Current liabilities Overdraft 2,000 Accounts payable 1,000 Non-current liabilities Mortgage 5,000 Owner's Equity 16,000 Other information: Net profit for Andrew's Discount Tyres: $1,000 Industry average gearing ratio (total liabilities + total equity): 80% (a) Explain ONE possible limitation of this financial report - 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 2,000 Cash 2,00... 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: Current assets Accounts receivable 1,000 Inventory 2,000 Cash 2,000 Non-current assets Building 13,000 Fittings 1,000 Research and development 5,000 Current liabilities Overdraft 2,000 Accounts payable 1,000 Non-current liabilities Mortgage 5,000 Owner's Equity 16,000 Other information: Net profit for Andrew's Discount Tyres: $1,000 Industry average gearing ratio (total liabilities + total equity): 80% (a) Explain ONE possible limitation of this financial report - 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 capitalises expenses. For example, research and development is listed as an asset instead of an expense, potentially inflating the balance sheet. This approach could mislead stakeholders regarding the company's financial health.
Step 2
Discuss the gearing of Andrew's Discount Tyres.
Answer
The gearing ratio is essential for understanding a company's financial structure and risk level. For Andrew's Discount Tyres, we calculate total liabilities and compare them to total equity.
Total liabilities:
- Current liabilities: Overdraft (2,000) + Accounts payable (1,000) = 3,000
- Non-current liabilities: Mortgage (5,000)
Total liabilities = 3,000 + 5,000 = 8,000
Total equity = Owner’s equity = 16,000
Gearing ratio = total liabilities / (total liabilities + total equity)
Substituting the values: ext{Gearing Ratio} = rac{8,000}{8,000 + 16,000} = rac{8,000}{24,000} = rac{1}{3} = 33.33\%
This ratio of 33.33% is significantly lower than the industry average of 80%, indicating lower financial risk and less reliance on borrowed funds. However, a lower gearing ratio may also suggest that the company isn't leveraging opportunities for growth through debt, which can be a missed opportunity in a competitive market.