Photo AI
SCI-FI GEEKS LTD The business trades in electronic equipment purchased from China - NSC Accounting - Question 3 - 2020 - Paper 1
Question 3
SCI-FI GEEKS LTD The business trades in electronic equipment purchased from China. The information relates to the past two financial years, ended 31 March. The COVI... show full transcript
Worked Solution & Example Answer:SCI-FI GEEKS LTD The business trades in electronic equipment purchased from China - NSC Accounting - Question 3 - 2020 - Paper 1
Step 1
Liquidity: Explain why you would disagree with the directors' satisfaction.
Answer
While the directors express satisfaction with the current ratio and acid-test ratio, several issues indicate that their contentment may be misplaced. Firstly, the current ratio might not adequately reflect liquidity due to the increase in stock holding, which rose from 32 days to 102 days. This means that funds are tied up in inventory, limiting actual liquid assets available for operational needs. Secondly, the acid-test ratio increased only marginally from 1.2:1 to 1.4:1, which is not significantly reassuring, especially in a crisis like the COVID-19 lockdown, where unexpected liquidity may be required. Hence, these financial indicators raise concerns regarding the company's ability to meet its short-term obligations effectively.
Step 2
Dividends: Comment on the dividend per share over the two years.
Answer
The dividend per share decreased from 90 cents to 72 cents, representing a drop of 20%. This decline highlights a shift in the company's financial strategy in reaction to external business challenges. Additionally, it indicates a potential risk in shareholders' returns, especially when economic conditions are less favorable.
Step 3
Explain the change in the dividend payout ratio.
Answer
The dividend payout ratio decreased from 69% to 136.5% or 72/58 (accepting 124.1%) indicating a substantial shift in policy. This aligns with directors' decisions to retain earnings for bolstering liquidity instead of distributing them as dividends. Such a strategy aims to stabilize the company financially during uncertain times like a pandemic, reflecting prudent management decisions in the face of decreased revenues.
Step 4
A shareholder felt that they should be satisfied.
Answer
While the shareholder feels justified in their satisfaction with the dividends received—claiming they are better than the previous year—this perspective neglects the larger context of declining dividends and overall profitability. The decrease in dividends per share suggests that the financial health of the company is still under strain, and shareholders must look beyond short-term disbursements. Therefore, the rationale for feeling satisfied may not hold when considering the company's long-term viability.
Step 5
Comment on the risk and gearing for both years.
Answer
The debt/equity ratio increased from 0.3:1 to 0.4:1, indicating a higher reliance on debt financing as opposed to equity. This shift suggests increased financial risk as the company becomes more leveraged, notably during a downturn. The Return on Total Capital Employed (ROTCE) decreased from 39% to 23.2%, reflecting diminishing profitability, which further evidences the impact of choosing debt over equity in maintaining financial stability.