PRACTICE QUESTIONS FINANCIAL

STATEMENT ANALYSIS

. Financial statement analysis

Ratio Formula Deduction
Current Ratio CA/CL Measure short term liquidity
CR of 2 usually acceptable, depends
on industry
To a lender or supplier, the higher the
ratio the better
To the co – may indicate inefficient use
of cash and other short-term assets
Quick Ratio CA – inventory/CL Measure short term liquidity
Compensate for slow moving inventory
QR of 1 acceptable, but depends on
industry
Better ratio if inventory cannot be easily
converted in cash
Cash Ratio Cash/Current liabilities Of importance for a very short-term
creditor
Net working capital NWC/Total assets A relative low value indicates low levels
to total assets of liquidity
Interval measure CA/average daily Determine how long a company can
operating costs survive without any economic activity
Total Debt Ratio (Total Assets – Total Measure financial leverage
Equity)/Total Assets The higher this ratio, the greater the
firm’s degree of indebtedness and the
more financial leverage
Debt Ratio Total Interest-bearing Measure financial leverage
debt/Total Assets The higher this ratio, the greater the
firm’s degree of indebtedness and the
more financial leverage
Debt/Equity ratio Total Interest-bearing How much ‘foreign’ money is used by
debt/Total equity or the company
Interest-Bearing debt / The greater the debt, the greater the
Total Equity risk
Equity Multiplier Total assets/Total equity
Long term debt Long term debt/ (Total Measure of financial leverage
ratio Assets)
(Use Interest Bearing
debt)
Times interest PBIT/Interest paid Measure how well a company can
earned cover its interest obligations
 Also called: interest coverage ratio
The higher the ratio, the better the
company can cover its interest
obligations
Cash Coverage (PBIT+Depreciation) Measure the company’s ability to
/Interest generate cash from operations
Frequently used as a measure of cash
flow available to meet financial
obligations.
The higher the ratio the better
Inventory turnover Cost of goods Measure the activity of liquidity of a
sold/Inventory company’s inventory
Only meaningful if it is compared with
other companies in the same industry
or with the company’s past inventory
turnover
The higher this ratio, the more
efficiently the inventory is managed
Days’ sales in InventoryX365/Cost of How long will it take to sell the inventory
inventory goods sold
Receivables Sales/Accounts If all the sales are not on credit, use
Turnover receivable only credit sales.

Days’ sales in Accounts receivable X How long to collect outstanding credit?

receivables 365 / Credit sales The ratio is meaningful only in relation
to its credit terms
Net working capital Sales/Net working Measure how much ‘work’ a company
turnover capital is getting out of working capital
Non-current asset Sales/Non-current Indicate the efficiency with which the
turnover assets company uses its non-current assets to
generate sales
Total asset Sales/Total assets Indicate the efficiency with which the
turnover company uses its assets to generate
sales
The higher this ratio, the more efficient
the company use its assets to generate
sales.
Of great importance to management
Profit margin NPAT/Sales The higher the profit margin, the better
It is seen as a measure of success with
respect of earnings on sales
Return on Assets EBIAT/Total assets Also called Return on Investment (ROI)
(ROA) Measure the firm’s overall effectiveness
in generating profits with its available
assets
Return on Equity NPAT/Total equity Measure the return earned of the
owners’ investment in the company.
The higher this return, the better off are
the owners
Price/Earnings Price per share/Earnings Use to assess the owners’ appraisal of
ratio per share share value.
The ratio measures the amount
investors are willing to pay for each
rand of the company’s earnings
Measure the degree of confidence that
investors have in the company’s future
performance.
The higher the P/E ratio, the greater the
investors’ confidence.
Market to Book Market value per share/ Compare the market value of the
value ratio Book value per share company’s investments to their cost.
A value of less than 1 could mean the
company has not been successful
overall in creating value for its
shareholders
 QUESTION 1 (40 marks)

Mr. Quick Rich recently won an amount of US$ 25 million in the US Lottery. His financial
advisor informed him that South Africa will soon have the fastest growing economy in the
world. In light of this he is considering to buy a controlling interest in a South African listed
company. His financial advisor recommended Shop-a-lot Limited as a potential target for a
take-over.

Shop-a-lot Limited, a public company listed on the JSE Securities Exchange, has been
engaged in the mass retailing of food and other consumer goods for twenty years. During this
period the company has displayed consistent growth as evidenced by the increase in its total
assets and earnings.

Shop-a-lot Limited is unique in the sense that there are no similar listed companies of its size
in South Africa. All their competitors are much smaller and are aimed at the convenience
market.

Mr. Quick Rich considers himself to be a risk-averse investor. He has approached you to
analyse the company’s financial results over the past two years to determine whether this
would be an appropriate investment.
The abridged financial statements are attached as Appendix 1.

Additional information:

1. Deferred tax is considered to be part of debt.

2. Management considers all interest bearing current liabilities to form part of total debt. Non-
interest bearing current liabilities form part of assets.

3. The company sells its products strictly on a cash basis, except for one of its branches, which
is situated in an extremely poor area. This branch was acquired as a result of a take-over
from a general dealer five years ago. The owner of the general dealership applied a policy of
extending 30 days credit to a select number of customers to assist them with their cash flow
problems. A clause in the take-over agreement stipulated that this practice must continue for
the next 10 years, after which it will gradually be phased out. Credit sales in this branch
amount to 2% of total sales.

4. All purchases are made on credit. Purchases include fixed costs. The opening balance of
inventory on 1 July 2006 was R115 628.

4. At 30 June 2008 the shares had a Price Earnings ratio of 15.

5. The company’s tax rate is 28%.

6. You may assume that the year-end balance of a balance sheet item is representative of the
average balance of that item during the year.

7. Assume 365 days per year.

 REQUIRED:

a) Analyse the company’s financial results in 2008 and 2007 specifically in each of the following
areas:
• Liquidity
• Management of current assets
• Long-term solvency
• Profitability
Indicate, where appropriate, whether the performance is in line with your expectation for this
type of business. (34)

b) Suggest to Mr. Rich how he can find a suitable benchmark to compare Shop-a-lot Limited’s
results with. (2)

c) Make a recommendation to Mr. Rich regarding the takeover of Shop-a-lot Limited,

considering his risk preference. Consider any other issues which you may deem relevant.
(4)
APPENDIX 1
Income statement for the year ending 30 2008 2007
June R’000 R’000
Sales revenue 1 824 888 1 500 914
Variable costs (1 765 (1 448
270) 937)
Fixed costs (5 414) (5 080)
Gross profit 54 204 46 897
Interest income 6 954 4 651
Other income (unlisted investments) 4 373 5 149
Finance costs (1 967) (1 823)
Profit before tax 63 564 54 874
Income tax expense (30 061) (23 405)
Profit for the period 33 503 31 469
Earnings per share (cents) 171.2 160.8

Balance sheet at 30 June 2008 2007

R’000 R’000
ASSETS
Non-current assets
Property, plant and equipment 143 516 117 147
Investments 36 633 25 456
Total non-current assets 180 149 142 603

Current assets
Inventories 120 403 120 702
Receivables 6 990 7 052
Taxation 0 147
Cash assets 64 103 23 423
Total current assets 191 496 151 324
TOTAL ASSETS 371 645 293 927

EQUITY AND LIABILITIES

Equity
Share capital 1 956 1 956
Share premium 10 842 10 842
Retained earnings 107 959 90 777
Total equity 120 757 103 575

Non-current liabilities
Long-term borrowings 12 400 12 720
Deferred tax 2 712 2 313
Total non-current liabilities 15 112 15 033

Current liabilities
Trade and other payables 215 305 164 460
Shareholders for dividends 12 620 10 859
Current tax payable 7 851 0
 Total current liabilities 235 776 175 319
TOTAL EQUITY AND LIABILITIES 371 645 293 927

QUESTION 1 (SUGGESTED SOLUTION)

a) Ratio analysis
2008 2007
Liquidity ratios

Current ratio 191 496 151 324

235 776 175 319
= 0.81:1 ✓ = 0.86:1 ✓

Quick ratio 191 496 – 120 403 151 324 – 120 702
235 776 175 319
=0.30:1 ✓ =0.17:1 ✓

• Both the current ratio and quick ratio would appear to be significantly below that of an
average company. ✓ However, considering the nature of the business, this is expected.
Shop-a-lot would want to take maximum advantage of the positive cash cycle for 98% of
their sales ✓. The industry they are in (consumer goods = necessities) allows this. 98%
are for cash and this will hence stretch credit terms to the absolute maximum to optimize
the situation. ✓
• The quick ratio being lower than 1, implies that current liabilities are not only used to
finance current assets, but also a large portion of non-current assets. ✓
• Since the major part of current assets is made up of inventory, the numbers weaken even
more when the quick ratio is calculated. ✓
• In this type of industry current assets are usually very liquid (consisting of grocery items),
therefore I am not too concerned about the liquidity position at this point in time. If the
current asset management ratios are good, the company should be able to pay its current
liabilities when they fall due. ✓ This will be discussed next.

2008 2007
Current asset
management

Inventory turnover 1 765 270 + 5 414 1 448 937 + 5 080

120 403 120 702
= 14.71 times ✓ = 12.05 times ✓
OR 24.82 days OR 30.30 days

Receivables
collection period 6 990 x 365 7 052 x 365
(1 824 888 x 0.02) (1 500 914 x
0.02)
=69.90 days ✓ = 85.75 days ✓
Creditors payment
period 215 305 x 365 164 460 x 365
*C1* 1 770 385 *C1* 1 459 091
= 44.39 days ✓ = 41.14 days ✓

C1 = Variable Costs + Fixed costs – Opening inventory + Closing inventory

2008 = 1 765 270 + 5 414 – 120 403 + 120 702 = 1 770 385
2007 = 1 448 937 + 5 080 – 115 628 + 120 702 = 1 459 091

• The inventory turnover period improved from 2007 to 2008. Inventory only stayed on the
shelves for an average of 24.82 days in 2008. ✓
• Looking at the creditors payment period, the company has taken slightly longer to pay
creditors in 2008. ✓ When this is compared to the number of days inventory, it can be
seen that in both years the company sells inventory faster than it takes to pay their
creditors. ✓ This is good, since cash is received from sale of inventory (which is 98%
cash) 19.57 days before creditors need to be paid (44.39 – 24.82). ✓
• The debtors collection period improved in 2008, but at 69.9 days it is still much higher
than the credit terms of 30 days. ✓ The company probably also write off a large portion of
these debtors as irrecoverable. ✓ Since the balance of trade receivables is so low in
relation to current assets, this is not too concerning. ✓
• Debtors are only 2% of sales, thus there is more than sufficient cash to cover short term
liabilities. ✓

2008 2007
Long-term solvency

Debt ratio 15 112 15 033

*C2* 135 869 *C2* 118 608
= 11.12% ✓ =12.67% ✓

Or 15 112 – 2 712 15 033 – 2 313

135 869 118 608
= 9.13% ✓ = 10.72% ✓

Debt: Equity ratio 15 112 15 033

120 757 103 575
= 12.51% ✓ =14.51% ✓
OR 0.125:1 OR 0.145:1

Or 15 112 – 2 712 15 033 – 2 313

120 757 + 2 712 103 575 + 2 313
✓ ✓
= 10.04% = 12.01%

Times interest earned 63 564 + 1 967 54 874 + 1 823

1 967 1 823
= 33.32 times ✓ = 31.10 times ✓
C2 = Total Assets – current Liabilities
2008 = 371 645 – 235 776 = 135 869
2007 = 293 927 – 175 319 = 118 608

• The company financed only 11.12% of its assets with debt in 2008. ✓ The advantage of
low debt is that financial risk is kept at a minimum. ✓ The disadvantage is, however, that
the company does not get the maximum financial leverage from fixed cost, tax deductible
debt. ✓
• Return on equity will be improved if more debt is introduced to the capital structure, but
with this move financial risk will increase. ✓
• Since the business risk of the company is low (being a well-established company that
supplies necessities), it can afford to take on a higher financial risk. ✓
• Another indicator that financial risk is low, is the very high interest cover ✓

2008 2007
Profitability

Gross profit 54 204 46 897

1 824 888 1 500 914
= 2.97% ✓ = 3.12% ✓

Net profit 33 503 31 469

1 824 888 1 500 914
= 1.84% ✓ =2.10% ✓

Return on assets 33 503 + (1 967 x 0.72) 31 469 + (1 823 x 0.72)

✓ ✓
135 869 118 608
= 25.70% ✓ = 27.64% ✓

Return on equity 33 503 31 469

120 757 103 575
= 27.74% ✓ =30.38% ✓

• Both the gross profit% and net profit% decreased slightly in 2008. ✓
• ROA and ROE decreased as well in the 2008 year. ✓ This is possibly due to the fact that
no credit is allowed is decreasing sales, however from the sales figure this is clearly not
the case ✓
• Looking at profit margins it would appear that the decrease in earnings is as a result of an
increase in the costs of the entity ✓
• Interest rates appear to have increased when looking at the increase in finance costs (I/S)
despite the fact that LT borrowings decreased ✓
• There is a decrease in income from unlisted investments. This is despite the increase in
these investments. They may possibly be making bad investment decisions ✓
• The cash balance increase by approximately 3 times. They are earning little or no interest
returns on this cash ✓
• In both years the ROE exceeded ROA, which implies positive financial leverage. ✓
• Even though the company did not make use of a lot of debt, it used the debt that was
employed to magnify the return to its shareholders. ✓
Total (53)
Max (33)

b) He can use the industry numbers of the smaller companies, but must take account of
the increased risk to which such companies are subject. ✓
Alternatively he can benchmark Shop-a-lot against a similar company in the USA market, e.g.
Wallmart, bearing in mind that different political risks, interest rates, inflation rates and the
exchange rate can have an effect on the results. ✓
Any other valid comment. ✓ Max (3)

c) Mr. Rich should take over Shop-a-lot Limited. ✓ Overall the company is profitable,
manages its assets well, is liquid and not exposed to excessive financial risk. ✓ Once
he has taken over the company he can consider to increase the debt slightly in order
to benefit from the advantages of financial leverage, however depending on his risk
adversity he might be skeptical about it. ✓ Mr. Rich is risk averse. Shop-a-lot is hence
a good investment for him considering the low business and financial risk. ✓
Any other valid comment. ✓
QUESTION 2 (50 MARKS)

The Sasol group of companies specialises in diversified fuel products and chemical
manufacturing, which is also complemented by interests in technology development as well as
oil and gas exploration and production.

As a listed company, Sasol interacts on an ongoing basis with the investment community to
ensure that Sasol's strategy, operations, performance and future prospects are understood.

Sasol, together with Uzbekneftegaz (the National Oil and Gas Company of Uzbekistan) has
marked a significant milestone with the signing of a Heads of Agreement for the development
and implementation of a Gas to Liquids (GTL) project, as well as a Memorandum of
Understanding for mutual cooperation in the oil and gas industry, in the Republic of Uzbekistan.
Sasol management is excited by the prospects of this agreement, because this is a region that
is relatively new to Sasol.

Oil production has become very technologically advanced and due to a shortage of skills in the
local market, Uzbekneftegaz will be required to obtain highly skilled technicians from India and
China to comply with requirements of the agreement to be able to compete both locally and
globally.

The new project would require Sasol to install a 200km cross-border pipeline running from a
new oil site in Urgench to an old processing site in Navoi. It is cheaper to move the oil to the
old processing plant than to build a new one at Urgench.

As part of the agreement, Sasol is also negotiating with the Uzbekistan government regarding
the enablers required for the project, which includes, amongst others, the involvement of a
local entity. Sasol would be expected to purchase a small oil division (Uzi Oil) owned by the
Uzbekistan government. As there is strong competition in the region, the Uzbekistan
government is of the opinion that a take-over from Sasol is required in order to enhance Uzi
Oil’s ability to compete in the oil industry. Sasol’s management hired a team of consultants to
perform a due diligence and risk assessment on Uzi Oil. The results from the consultants are
as follows:
• Uzbekistan is a very small economy where difficulties exist in obtaining reliable suppliers.
The acquisition by Sasol of Uzi Oil is set to enhance the performance of Uzi Oil. Sasol will
also benefit from the additional capacity built by the acquisition.
• Uzi Oil’s technology is less advanced than Sasol’s and as a result input from Sasol will
greatly improve Uzi Oil’s operations.
• Uzi Oil is exposed to high inflation levels in Uzbekistan, which over the past year has
resulted in high costs in general. The synergies from the Sasol merger would result in
economies of scale that could reduce these effects.
• Uzi Oil had already started taking action to prepare for the possible take-over from Sasol.

Extracts of the financial statements of Uzi Oil were supplied to Sasol management for analysis:
UZI OIL
Statement of financial position as at 30 June 2010
2010 2009
Notes €m €m
Property, plant and equipment 1 70,370 66,273
Assets under construction 1 14,496 11,693
Other intangible assets 1,068 964
Other non-current assets 6,920 6,359
92,854 85,289

Trade accounts receivable 25,126 23,082

Cash and cash equivalents 12,186 21,396
Inventory 15,672 10,345
52,984 54,823
Total assets 145,838 140,112

Equity and liabilities

Total equity 86,217 78,995
Non-current liabilities 17,814 19,455
Current liabilities 36,519 34,308
Current portion of interest bearing liability 5,288 7,354
Total equity and liabilities 145,838 140,112
 UZI OIL
Statement of Comprehensive Income
for the year ended 30 June 2010
2010 2009
Notes €m €m

Turnover 137,836 129,943

Cost of sales and services (88,508) (74,634)

Gross profit 49,328 55,309

Other operating income 2,811 1,370

52,139 56,679

Marketing and distribution expenditure (7,583) (6,931)

Administrative expenditure 2 (9,050) (6,697)

Other operating expenditure (13,942) (9,100)

Competition related fines 3 (3,947) _

Effect of crude oil hedges 4 (289) (2,201)

Depreciation (3,325) (1,782)

Change in accouting estimates (1,469) (698)

Translation (losses)/gains (166) (300)

Other expenditure (4,746) (4,119)

Earnings before Interest and Tax 21,564 33,951

Finance expenses (2,531) (1,148)

Profit before tax 19,033 32,803

Taxation (5,254) (10,129)

Profit for the period 13,779 22,674

Dividend Declared 6,557 3,528

Notes:
Note 1
Uzi Oil made a series of capital acquisitions and began to build a new plant in preparation of
the new project in Uzbekistan. The capital expenditure was funded with a mixture of cash, debt
and equity. Substantial profits are expected to arise as a result of this expenditure as the project
grows and matures.
Note 2
The administrative costs increased due to additional administrative staff who were appointed
to help the company to prepare for the new project.
Note 3
Uzi Oil and another similar entity were found guilty of anti-competitive behaviour by the
competition commission of Uzbekistan. The two companies had allegedly colluded in fixing oil
prices in Uzbekistan. Management have realised that this type of action has a negative impact
on the reputation of the business and have declared their intention to never engage in similar
actions again.
Note 4
Global oil prices decreased which led to lower hedge losses for Uzi Oil.

Assume a tax rate of 28% in Uzbekistan.

REQUIRED:

(a) Analyse and interpret the financial results of Uzi Oil to advise Sasol management as to
whether the acquisition of Uzi Oil would be a good investment or not. Analyse the ratios
under the headings of the following major categories showing relevant calculations (Use
365 days per year in all your calculations.):

• Liquidity (6)
• Debt Management (12)
• Profitability (22)

(b) List any other relevant considerations that the management of Sasol should consider
before acquiring Uzi Oil. (10)
QUESTION 2 SUGGESTED SOLUTION

a)

Liquidity 2009 2008

Current Ratio (CA/CL - excl int
bearing liab) 1.45 ½ 1.60 ½
Quick Ratio 1.02 ½ 1.30 ½
Inventory days 64.63 ½ 50.59 ½
The liquidity of Uzi Oil has decreased in the current year due to a
decrease in cash due to the funding of the capex for the upcoming
project. 1
The quick ratio may have decreased also due to an increase in
inventory in preparation for the project 1
Cash has decreased with 43% from 09 to 2010. Current assets in total
are largely unchanged, despite huge drop in cash balance – this is due
to significant increase in inventory (51.5%). 2
Inventory days increased from 50,59 days to 64,63 days: could be due
to limited demand due to price fixing scandal, obsolescence
(technologically outdated), holding higher quantities to offset limited
supplier problems, high competition levels, or difficulty to move oil in
countries with political uncertainty / instability. 2
Current liabilities decreased from 167.78 days to 150.6 days: may be
pressurised by suppliers in strong negotiating position (difficult to get
supplies) to pay more quickly. 2
Available 11
Max 6

Debt Management
Debt to Equity 26.80% ½ 33.94% ½
Interest bearing liab(incl current portion)/Total
Equity
The debt to equity ratio has decreased in the current year. This is due to
a decrease in the level of long term liabilities and an increase in equity 1
It appears that the capex was financed using more equity than debt
thereby reducing the financial risk of the entity 2
However, note that interest doubled, even though LT loan lower. May be
that less debt is at a higher interest rate (or debt was initially incurred
halfway through 2009). 2

Debt Ratio 37.26% ½ 38.37% ½

Total liab/Total Assets
The debt ratio has decreased in the current year due to a decrease in
the level of long term debt (8.43%) and the increase in fixed assets
(8.87%) 1

Solvency Ratio 2.45 ½ 2.29 ½

Total assets/Total Liabilities
The solvency ratio has increased due to an increase in total assets and
a decrease in liabilities 1

Interest Cover 8.52 ½ 29.57 ½

The interest cover has reduced
significantly 1
This is due to a large decrease in the profitability of Uzi Oil resulting
from an inflationary environment, competition related fines and
depreciation increase 1
Available 13
Max 12

Profitability
ROE (add back fine) 20.56% ½ 28.70% ½
The return on equity has decreased in the current year mainly to the
decreased in profitability of Uzi Oil as a result of the increase in COS,
fines and depreciation 1

ROA 13.40% 1 16.77% 1

(EBIAT/Total Assets) - add
back fine
The decrease in ROA is due to an increase in assets acquired in
preparation of the new project which has not begun to make a return yet 1
The profit also decreased due to the competition related fines and an
increase in depreciation from the acquisitions 1
The ROE is greater than the ROA which shows positive
financial leverage 1

Gross Margin 35.79% ½ 42.56% ½

The decrease in gross margin was as a result of the inflationary
environment which increased the costs of purchasing goods , and due
to possible lower revenue through price fixing: the inflationary increases
were NOT carried over to clients! 1

Net Margin (add back fine) 12.86% ½ 17.45% ½

The net margin has decreased significantly in the current year 1
Overall the company’s profitability was affected by the competition
related fines, and the increased depreciation from the capex in
preparation for the project 2
New admin staff was also hired to prepare for the project 1
Management needs to stop engaging in anti-competitive behavior as
this has affected the analysis of their entity significantly 2
 Conclusion and Advice
Uzi Oil has not performed well in the current year. This was mainly due
to the inflation in the country and the once off expenses (competitive
related fines) they incurred. 1
They also invested in assets which have not started bringing in return,
however, are expected to as soon as the project grows and matures. 1
I would advise management to continue to purchase Uzi Oil as it is a
leading division and the purchase would result in synergies, economies
of scale and would enhance the performance of Uzi Oil. 2
However, Sasol should consider building in further controls 1
Max 22

2. Other considerations

• Sasol is investing in an area that is new to Sasol. Does Sasol have the necessary
expertise and skill to be able to perform well? (1)
• Sasol should consider that they would be entering into a new country and they do not
have knowledge of the local laws and customs (1)
• Sasol should consider exchange rate risk for entering into a foreign country (1)
• Sasol should consider their reputation if they enter into a transaction with an entity
known for anti-competitive behaviour (1)
• The investment would require technological skills. Does Sasol have the skills required
or the funding to obtain the required skills from India and China? (1)
• The 200km pipeline that is required is a cross-border pipeline. Does Sasol has the
necessary documentation or authorisation from the relevant countries that the pipeline
would be going through? (1)
• Sasol must consider the rehabilitation of the country and drill sites at the end of the
project (1)
• Unethical behaviour: consider who will manage the company in future (management
may be replaced in company bought 100%) / consider building in suitable controls;
(1)
• Political risk/risk of war/risk of instability/risk of theft in Uzbekistan? (1)
• High competition should be considered: how will Sasol compete? Marketing initiatives /
distribution channels? (1)
• Risk of 200km pipe-line: oil may be tapped illegally. How will pipeline be secured? What
about the threat of bombs etc? Cost of security? (1)
• Management has jumped the gun in preparing for the venture before the agreements
have been finalised: what is Sasol’s reputational risk if it decides not to deal with the
Uzbekistan govt? (1)
• Is the additional capacity acquired through the merger needed by Sasol and how will it
be used? (1)
• Has the cost implications of bringing Uzi Oil up to required technological standards been
taken into account? (1)
• What are the long-term effects of operating in a high-inflation environment? Is the project
still worthwhile? (1)
• How socially responsible (e.g. relating to sustainability / damage to the environment /
employment of additional staff / job creation etc) is this project? (1)

Available: 16

Max: 10
QUESTION 3 (45 MARKS)

There are many types of investments that will let you generate a high income. One of these is
getting your own fast food franchise. You can also invest in a clothing shop. However, one of
the most highly profitable investments is buying a fuel station.

This decision of yours was supported by the following research conducted

The reasons for buying a fuel station are infinite. Firstly a lot of people use fuel. Most individuals
own vehicles now. With huge numbers running on the streets everyday, you will surely have
hundreds of customers filling up in your station. Secondly, no matter the price of the fuel, the
people cannot do anything but refill their tanks. Whether the value goes up or down, they need
fuel to make their cars or trucks run.

Thirdly, fuel is one of the main critical global commodities. So, it is only fitting that you invest in
something that people need the most. Fourthly, there are already a handful of other
entrepreneurs that are putting their money in fuel stations. So, you might want to start your own
investment and get into the trend.

You are currently investigating the option of buying a BP fuel station including the property for
the value of R8 million. This fuel station also has a convenience store on the premises. You
expect that the net profit after tax will increase by 5% per year.

The business broker that you have consulted with has provided you with the following
information:
Statement of Financial Position as at 31 December

Notes 2010 2009

Assets
Non-current assets 1,961,705 1,821,387
Property & equipment 1,634,296 1,634,296
Operating lease asset 327,409 187,091

Current assets 2,355,538 1,187,784

Trade and other receivables 8 297,846 24,678
Inventory 7 800,000 700,000
Cash and cash equivalents 1,257,692 463,106

TOTAL ASSETS 4,317,243 3,009,171

Equity and liabilities

Equity 1,395,663 1,349,577
Ordinary shares 100 100
Retained earnings 1,395,563 1,349,477

Non-current liabilities 2,591,118 1,279,011

Interest bearing shareholder's loan 236,413 124,012
Interest bearing long term loans 2,150,191 961,652
Deferred tax 204,514 193,347

Current liabilities 330,462 380,683

Taxation 48,333 31,279
Trade and other payables - non interest bearing 282,129 349,404

TOTAL ASSETS & LIABILITIES 4,317,243 3,009,271

Note 1: Revenue

The price of petroleum products is regulated. Terms and Conditions set by government limits
the gross profit on petroleum to 3.5 cents per liter. However the price of diesel is not regulated
and fuel station owners can determine the price of diesel. The convenience store is also a
source of additional revenue as motorists prefers to purchase refreshments from there.

Note 2: Interest Received

Investments in cash & cash equivalents will continue to yield a 5% return per annum.

Note 3: Accounting fees & Administration fees

The current accountant of this BP fuel station increased the accounting and administration fees
during the current year under review due the fact that he had to submit tax returns on behalf of
this enterprise for the past 5 years, which was never submitted by the company before. It is not
expected that accounting fees will exceed the prior year expense in the future as you, as the
future owner, will be able to draft the financial statements and administrate the tax affairs of
the entity.

Note 4: Auditor’s remuneration & Client relationship fees

Due to changes in the new companies act, it is not expected that this company will require an
audit in the future as it will be classified as owner managed company with only one shareholder.

Audit remuneration increased in the current financial year due to additional audit work required
on a reportable irregularity whereby the company paid client relationship fees to the
management team of a logistics company to only buy fuel from this BP fuel station.

It is expected that client relationship fees will not be paid in the future.

Note 5: Interest payable

Interest will be charged on long term debt at a floating rate of 10% per annum.

Note 6: Inflation

Ignore the impact of inflation in your calculations.

Note 7: Inventory

Due to a recent strike by the petroleum workers union, the owner of this fuel station decided
that it may be prudent to increase fuel reserve levels.

Note 8: Accounts receivable

30% of all sales are credit sales.

Note 9: Accounts payable

All purchases are on credit.

Note 10: Cost of Sales

Depreciation has been included in the cost of sales as well as the operating lease asset
expense.
REQUIRED MARKS

Analyse and discuss the financial statements of this BP fuel station by

focusing on the following ratios:
3
• Gross Profit Margin 6
• Net Profit Margin
• Return on Equity using sustainable earnings 8
8
• Working capital cycle (or cash conversion cycle)
(a) 5
• Earnings Yield based on sustainable earnings
• Debt to Equity 4
• Interest Cover 3

In conclusion, advise management, with reasons, whether or not you

believe that this BP fueling station will be a good investment or not?
3

From a treasury perspective, explain what an option is as well as the

(b) characteristics and types of option contracts?
5
TOTAL MARKS 45
Question 3 SUGGESTED SOLUTION

2010 2009 Marks

Gross Profit Margin 2.52% 2.27% 1
The gross profit margin increased by 11% during the 2010 financial year. 1
The gross profit amount increased by 12% 1
Margins grew as more market share was obtained due to the elimination of competitors
who did not survive the economic crisis. 1
This increase can be caused by the increase in the gross profit margin of diesel & margin
from the convenience store 1

Net Profit Margin 1.06% 1.29% 1

The net profit margin decreased by 17.83% during the 2010 financial year 1
The Rand amount of net profit decreased by 15.54% 1
The decrease was due to the following factors:
- Accounting & administration fees increased due to tax return submissions 1
- Auditors remuneration increased due to reportable irregularity 1
- Client relationship fees increased due to bribery 1
- Interest bearing debt increased causing interest paid to increase 1
- An operating lease asset was noted on the statement of financial position, yet a
corresponding expense item was not noted in the statement of comprehensive
income. This raises questions about the completeness of expenses 2
Errors that may need attention are:
- the lease expense item
- lack of depreciation on equipment
- the deferred tax adjustment 2

Return on Equity Rand Rand

Calculation
Net Profit before tax 817,897 988,347 1
Add Back:
Additional Accounting fees 100,096 1
Additional Administration fees 61,204 1
Auditors remuneration 81,050 39,750 2
Client relationship fees 82,265 72,000 2
1,142,512 1,100,097
Less: Tax @ 28% (319,903) (308,027) 2 Principle
822,609 792,070 1 Principle

Equity 1,395,663 1,349,577

ROE 58.94% 58.69% 2 Principle

The return on equity increase slightly during the year under review (also accept that ROE
remained the same) 1 Principle
This increase is mostly due to an increase in profit after tax 1
Based on the movement in equity, there is a possibility that R542,800 was paid out as a
dividend insulting in a decrease in equity. 2
Note to markers: Alternative to Net profit before tax
If students use net profit of R588,886 & R711,610 allocate 2 marks. This represents profit after
tax

Note to marker: Please allocate half of the indicated marks if their amounts are
correct in one year but not in the other
Working Capital cycle
Inventory days 5.4 4.7 2
Debtors days 6.5 0.5 2
Accounts Payable 1.9 2.4 2
Working capital cycle 10.0 2.9 2 Principle

The working capital cycle increased dramatically during the current financial year 1
This increase is mainly due to a rapid increase in accounts receivable 1
The increased working capital cycle will put the entity under cash flow pressure, hence
the need for additional funding 1
There may be a risk of bad debts as a result of the increase in trade debtors 1
The problem here is that the increase in cash is not due to improved trading condictions.
The increase in cash is as a result of the the R1m increase in long term loans. 2

Earnings Yield
Market Price 8,000,000 1
Sustainable Profits 822,609 1 Principle
Growth adjusted @ 5 % 863,739 1 Principle
Earnings Yield 10.80% 1 Principle

The market price may be high as the earning yield only reflects a rate of 10% 1 Principle
Similar investments may yield a much higher return 1
This investment may be over priced 1 Principle
This investment may be low risk at a PE Ratio of 9.1 1
This could be as a result of low growth 1

Debt: Equity ratio 171% 80% 2

This ratio increased with 114% (113.75%) during the year under review 1
This increase is mostly due to an increase in long term debt 1
This was further exacerbated by the fact that most of the net income was paid out as a
dividend to shareholders. 2
This ratio indicates that this company is highly geared and that financial risk is high 1
Although this level looks high, it is based on book values. The value of equity has been
given as R8m - therefore debt of R2m to equity of R8m is only 25%. This is not high at all.
The historic / accounting value of equity may very well be meaningless. 2

Interest Cover 4.43 10.10 1

Interest cover decreased during the year under review 1
This decreased was caused by an increase in debt levels 1
This company should be in a position to settle interest 1

Concerns
- High cash balance as a result of long term debt 1
- Auditors remuneration increased due to reportable irregularity 1
- Client relationship fees increased due to bribery 1
- Any other valid point 1

Max: 40 Marks
Available: 73 Marks
Part B
An option is the right (but not the obligation) to buy or sell at some date in the future at
a predetermined price. 2
Call option = right to buy from the writer of the call option (seller) at a set price 1
Put option = right to sell to the writer of the put option (buyer) at a set price 1
The option premium is payable at the date of the commencement of the agreement but the
exercise price is payable on the option expiry date for a CALL option and the exercise price
is receivable on the option expiry date for a PUT option. 1
American = option holder can exercise at any time up to expiry date 1
European = option holder can only exercise on the expiry date and not at any time before. 1
Exercise or Strike Price = the contract price payable by CALL option holder on expiry and
the contract price receivable by the PUT option holder on expiry. 1

Max: 5 Marks
Available: 10 Marks
QUESTION 4 (55 MARKS)
From the 17th to the 20th Century, Robben Island served as a place of banishment, isolation
and imprisonment. Today it is a World Heritage Site and museum, a poignant reminder to the
newly democratic South Africa of the price paid for freedom. Robben Island Museum (“RIM” or
“the Museum”) operates as a site and living museum. It aims to develop the Island as a national
and international heritage and conservation institution. In managing its resources and activities,
RIM will strive to maintain the unique and universal symbolism of the Island, nurture creativity
and innovation as well as to contribute to the socio-economic development and transformation
of the South African society and enrich humanity.
Robben Island Museum generates revenue through selling tickets to national and international
visitors to the island. A guided tour of the prison and island as well as a return boat trip to and
from Robben Island to Cape Town, are all included as part of the services provided to visitors
to the island. RIM can also be booked for private functions which may include weddings as well
as corporate functions. However, most visitors are not aware that RIM can be utilised for
conferences and private functions, on request. The Department of Arts & Culture also allocates
government grants to RIM in order to assist with the operational management and maintenance
of the Museum. RIM performed better during the 2012 financial year in comparison to the
previous year. This was mainly due to the strengthening of the internal control environment
and the smooth running of the ferry operations.
Visitor figures for the 2011/2012 financial year stood at 352,229 against a corresponding figure
of 348,229 during the 2010/2011 financial year. This moderate increase means that the
museum has to exercise fiscal discipline because the visitor numbers are not growing
significantly. The Museum has not done anything to diversify its offerings or income streams.

The Museum is not expected to be a going concern in the near future due to the fact that
employee expenses are expected to far exceed the grant allocation received from the
Department of Arts & Culture in the future. The museum’s number of employees increased
from 120 in 2011 to 240 in 2012. This increase in the number of employees was needed in
order to assist with non-core functions at the museum. The increase mostly relates to the
appointment of administrative clerks. The increase in the number of employees is of concern
to management, as it was noted that there is lack of a performance driven culture at RIM and
the newly appointed staff will not be able to assist with the provision of core services (Core
services include the provision of guided tours as well as research conducted into the history of
the Island) at RIM. The museum also experienced two industrial actions due to management
plans to re-structure the staff profile of the museum to include more tourist guides,
educationalists and historians and less administrative employees. This may have impacted
negatively on the operations and public image of the museum.

Maintenance has been identified by the Management of the museum as an area for particular
concern. Experts are required in order to restore the historic buildings on the island, however
inadequate co-ordination between various government departments have resulted in delays in
the maintenance and restoration of the heritage assets and infrastructure on the island.

An extract from the Annual Financial Statements are attached below based on The Standards
Of Generally Recognised Accounting Practice (GRAP) as this is one of the recognised
accounting frameworks utilised in the public sector in South Africa.
Statement of Financial Performance

Notes 2012 2011

R R
Grants recognised 55 037 922 52 234 784
Donations and bequests 6 500 -
Robben Island Musuem tour sales 65 041 426 57 198 341
Other income 1 068 732 1 019 303
Total Revenue 121 154 580 110 452 428
Operating Expenses 4 -96 565 519 -102 584 342
Administrative expenses 5 -13 865 720 -12 578 980

Operating Surplus / (Deficit) 10 723 341 -4 710 894

Net finance income 3 425 968 3 094 404

Surplus / (Deficit) for the period 14 149 309 -1 616 490

Statement of Financial Position

Notes 2012 2011

R R
ASSETS
Non current assets
Property, Plant & Equipment 1 52 439 362 61 367 162
Intangible assets 1 53 467 120 889
Non-current assets held for sale: Vehicles - 303 124
Deposits held for leased property 88 684 -
52 581 513 61 791 175

Current assets
Inventories 2 1 116 942 1 990 420
Trade and other receivables 3 1 716 247 1 368 068
Cash & Cash Equivalents: Current account balance 87 254 507 60 730 377
90 087 696 64 088 865

Total Assets 142 669 209 125 880 040

NET ASSETS AND LIABILITIES

Accumulated surplus 118 677 939 104 528 630

LIABILITIES
Non current liabilities
Finance lease obligation - 11 857
- 11 857

Current liabilities
Government grant: Deferred revenue 13 217 893 13 274 815
Finance lease obligation - 27 746
Trade and Other Payables 10 773 377 8 036 992
23 991 270 21 339 553

Total liabilities 23 991 270 21 351 410

Total net assets and liabilities 142 669 209 125 880 040
Note 1
Reconciliation of Tangible Assets - 2012
Opening Balance Additions Impairment Disposal Depreciation Total
Buildings 25 362 530 - - - -863 991 24 498 539
Office furniture 4 103 328 9 563 -378 753 - -1 563 822 2 170 316
Motor vehicles 6 056 439 389 623 -64 674 -68 232 -2 038 093 4 275 063
Computer Equipment 2 611 927 221 153 -128 369 - -1 612 500 1 092 211
Boats 22 807 111 7 892 - - -2 685 126 20 129 877
Cell phones 38 270 - -33 605 - -2 799 1 866
Plant, machinery & tools 387 557 - -5 062 - -111 005 271 490
61 367 162 628 231 -610 463 -68 232 -8 877 336 52 439 362

Reconciliation of Intangible Assets - 2012

Computer software 120 889 33 400 -64 582 -36 240 - 53 467

Impairment of office furniture: The assets were written off based on the results of an asset verification performed during year end. Assets to the
value of R336 597 were written off as a result of impairment. Assets to the value of R273 866 were written off as the museum were not able to verify
these assets.

Note 2
Inventory 2012 2011
Village Shop inventory 24 474 47 399
Inventory on boat 5 658 13 579
Books & Posters 904 125 1 454 817
Other 118 264 85 116
Diesel & Petrol 64 421 389 509
1 116 942 1 990 420

Inventory had been written off in both years due to the inability to verify these assets.
Note 3
The aging of trade and other receivables 2012
Current 664 817
30 Days 538 010
60 Days 4 506
90 Days plus 404 633
Total receivables 1 611 966

Provision for Bad debts -104 281

The current debtors policy states that trade debtors should settle accounts within 60 days.
Note 4
Operational expenditure 2012 2011
Advertising 608 996 576 649
Assets written off 613 099 -
Bad debts written off 26 827 951 998
Inventory written off 599 302 4 227 515
Consultation fees / Professional fees 5 429 471 9 921 610
Depreciation & Amortisation 8 941 918 9 973 588
Personel expenses 58 858 544 50 697 216
Maintenance & renovations - 5 294 740
Other operating expenses 21 487 362 20 941 026
Total 96 565 519 102 584 342
Note 5
Administrative expenditure 2012 2011
Outsourced services 8 590 305 7 536 980
Insurance 1 388 621 1 032 629
Bank charges 1 301 862 1 254 199
Other administrative expenses 2 584 932 2 755 172
13 865 720 12 578 980
Source: http://www.robben-island.org.za
General Information:
1. No provision has been made for SA Income Taxation, as the museum is exempt from
income taxation in terms of section 10(1)(cA)(i) of the Income tax Act,1962.

2. The historic cost basis has been used in preparing the annual financial statements.
Even though the Museum is experiencing financial difficulties, it is likely that the
National Treasury will provide RIM with emergency funding, should it be required.

3. The CPI rate for 2012 was 5.8% as per the Statistics SA database.
REQUIRED MARKS
Analyse and interpret the performance and financial position of 55
the Robben Island Museum from 2011 to 2012. (round ratios to 2
decimal places)
Hint: Focus on analyzing the following components:
No Component Mark allocation
1 Revenue 13 Marks
2 Operating expenditure 16 Marks
(a) 3 Administrative expenditure 6 Marks
4 Margins 3 Marks
5 Effective Interest 2 Marks
6 Return on Assets, Return on 7 Marks
Equity as well as Asset Turnover
7 Debt Management ratios 4 Marks
8 Liquidity ratios 4 Marks
TOTAL MARKS 55
QUESTION 4 - SUGGESTED SOLUTION
Section a Analysis of performance 2012 2011 Total Marks
Revenue
Percentage change in revenue from 2011 to 2012 9.69% 1

Revenue Mix
Grants recognised 45.43% 47.29% 1
Donations and bequests 0.01% 0.00% 1
Robben Island Museum tour sales 53.68% 51.79% 1
Other income 0.88% 0.92% 1

Revenue Price & Volume Variance

Volume Variance 1.15% 2
Price Variance 12.42% 2

Commentary: Revenue
1) Revenue improved by 9.69% from 2011 to 2012, and this increase is 4% more than inflation. 1
2) The largest contributor to revenue was ticket sales to tourists and other visitors to the museum
followed by governments grants received from the Department of Arts & Culture 1
3) Even though visitors numbers remained constant,
RIM tour sales increase from the prior year to the current year by 13.71% due to a 12% increase in ticket prices 1
4) The improvement in revenue is more than expected due to the 2 industrial actions at the museum ,
and fragile labour relations environment, which would have had an impact on the number of tourists visiting 1
the island.
5) Revenue obtained from government grants and other income increased at a slightly lower rate than inflation. 1
6) The impact of donations on revenue was insignificant 1
7) In order to remain a going concern, it is imperative that the Management of RIM should focus on growing
revenue generated from tour sales in order to help subsidise employee costs. 2
8) RIM can perhaps also consider generating additional revenue from hosting conferences and private
functions on the island as well as from venue hire, conferences and special tours 1
9) The improvement in revenue may be due to the fact that the ferry operated smoothly during the year. 1
10) Advertising may also have contributed to the increase in revenue. 1
Operating expenses 2012 2011 Total
Percentage decrease in Operating expenses -5.87% 1
Operating expenses as a % of revenue 80% 93% 1

Commentary: Operating expenses

1) Operating costs were 5.87% lower than in the previous financial year 1
2) It was noted that Management's effort to tighten the internal control environment, may have resulting in
in a decrease in fruitless and wasteful expenditure 2
3) Employee costs is the largest contributor to operating expenditure (61% of operating expenditure) 1
4) It must be noted that employee costs only increased by 16%, even though the staff complement of RIM
doubled from 120 to 240 staff members 1
5) It may be that most of the newly appointed employees may have been appointed close to the end of the
financial year and as such the 2012 employee costs may not be fully reflective on the impact of the increase in 1
the number of employees
6) In order to remain a going concern, it is imperative that RIM should consider restructuring their employees by
retrenching staff who do not add value to the operations of the museum or re-deploy them as tour guides 1
7) Management should also establish a high performance culture at RIM 1
8) The increase in employee costs may have been the result of labour unrest and 2 industrial actions incurred
in 2012 1
9) It is interesting to note that no maintenance expenditure was incurred in 2012. 1
This saving may be driven by management in order to save costs. 1
However, management must consider the impact that lack of maintenance will have on the sustainability of 1
the museum
10) A significant decrease of 45.28% was also noted in consulting fees incurred during the year under review 1
Management may have decided to rather employ their own managers and employees oppose to rely on consultants 2
11) It was also noted that there was a decrease in inventory write-offs during the year. 1
However the decrease in write-offs may be indicative that inventory may be overstated. 1
12) It was also noted that there was a decrease in debtors during the year. 1
However the decrease in write-offs may be indicative that debtors may be overstated. 1
13) The fact that fixed assets and inventory have been written off due to management's inability to verify these assets,
may also point to a lack of internal control in terms of efficient asset management 1
14) The decrease in depreciation may be due to the following reasons:
* The impairment of property, plant & equipment during the year under review 1
* Changes in the accounting estimate of the useful life of assets 1
* Assets held for sale in 2011 were sold during 2012. 1
15) It may be that debtors of 90 days plus may not be recoverable resulting in the provision for bad debts being understated. 1
16) Additional training may be required for new employees, and as such this will influence operating expenditure 1
17) Employment costs increased due to the employment of additional administrative personnel 1
18) Advertising costs increased in line with inflation
Administrative expenditure 2012 2011 Total
Percentage decrease in Administrative expenses 10.23% 1
Admin expenses as a % of revenue 11.44% 11.39% 1

Commentary: Administrative expenditure

1) Administrative expenses increased by 10.23% due to a 13.98% increase in outsource services 1
2) The increase in outsource services is unexpected due to the sharp increase in the number of employees 1
3) It may be that expenditure of Outsource services may decrease next year, due to the employee increases 1
4) Insurance costs have also increased by 34% even though the asset base of the RIM is small in comparison to the
previous year 1
5) The increase in insurance premiums may be driven by the claims lodged against insurance companies for
unaccounted equipment and inventory (referring to write-offs) 1

Margins 2012 2011 Total

Operating Profit Margin 8.85% -4.27% 1
Net Profit Margin 11.68% -1.46% 1

Commentary on Margins
1) Both the operating profit margin and net profit margin improved significantly from the previous year due to 1
stronger internal controls resulting in less expenditure 1
2) The impact of interest earned on the current account have also resulted in the fact that the net profit margin is
higher than the Operating Profit margin 1

Effective Interest rate 2012 2011 Total

Increase in interest 10.71% 1

Commentary on Interest
1) It is interesting to note that interest revenue has increased by 10.71%, even when cash at year end increase by 43.68% 1
2) The increase in cash may not have been sustained throughout the year and as such interest earned may have
fluctuated through out the year 1
3) It is recommended that RIM should rather invest excess cash in fixed deposit accounts and money market accounts
in order to generate more interest earned. 1

Asset Management Ratios 2012 2011 Total

Asset Turnover 84.92% 87.74% 1
Return on Assets 9.92% -1.28% 2
Return on Equity 11.92% -1.55% 2

Commentary on Asset Management

1) The Asset Turnover ratio deteriorated slightly during the year under review. 1
2) Even though revenue increased by 9.69%, the asset base of RIM increased by 13.34%, resulting in a deterioration in 1
asset turnover
3) The increase in the asset base was mainly driven by a 43.68% increase in the value of cash and cash equivalents 1
4) In 2012 ROA<ROE indicating positive financial leverage 1
5) Both the ROA and ROE ratios improved during 2012 due to the fact that RIM has returned back to profitability 1
Debt Management ratios 2012 2011 Total
Total debt ratio 16.82% 16.96% 1
Debt: Equity ratio 20.22% 20.43% 1

1) It appears as though RIM does not have any interest bearing debt and this will result in low financial risk 1
2) Both the debt:equity and total debt ratio remained constant over the last two years 1
3) The levels of debt in RIM is mostly driven by trade payables as well as grants which will result in deferred revenue. 1

Liquidity ratios 2012 2011 Total

Current ratio 3.76 3.00 1
Quick Ratio 3.71 2.91 1

1) The quick ratio inproved during the year due to a 43.68% increase in cash and cash equivalents 1
2) Inventory decreased during the current year due to impairments in the value of posters and books as well as fuel 1
3) Trade payables also increased during the year under review, but not on the same scale as cash & cash equivalents. 1
4) The current ratio inproved during the year due to a 43.68% increase in cash and cash equivalents 1