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Critical examination of the business and finance strategy adopted by Fenland to date:
Business strategy adopted by Fenland to date:
Fenland Electronics Ltd. (FEL) is a U.K. based company and is a world leader in the field of radio communications. Their secret to success has been to get the backing from the venture capitalists once the management buy-out happened. To do this, a non-executive chairman and two non- executive directors were appointed to look into the interests of the venture capitalists. However the managing director and the technical director controlled all the management shares. This helped them to double their turnover between the years 1991-1994. The operating profit increased to a peak in 1993 before decreasing in 1994 due to a failed attempt in acquiring a company in Spain. For the current year the operating profit is again set to decrease due to tough trading conditions although the turnover is set to increase. Under these circumstances FEL thought it is important to take a closer look at its financial position and hence have appointed a Finance Director. In order to increase its presence globally, a person has been appointed to lead the company’s sales team in Eastern Europe. Hence re-structuring its Board of Directors and getting the full backing from the Venture Capitalists has been the business strategy hitherto for FEL to grow.
Finance strategy adopted by Fenland to date:
The finance strategy hitherto was to fully utilise the cash flow in the aftermath of the buyout. This helped FEL to make the deferred payments and make the bank payments. The management initially controlled all the management shares but in order to get better control the strategy was to purchase ordinary shares. Hence the management purchased 273, 333 A ordinary shares of £0.75 each. The managers injected £205,000 of their own funds in exchange for the ordinary shares. The venture capitalists meanwhile had acquired 820,001 Ordinary B shares and 5,856,000 preference shares. The dividends on the preference shares however was not paid to the venture capitalists in 1991 and 1992 due to pressure on cash flow. In order to tackle this situation, the finance strategy adopted by the venture fund managers was to exercise their option to convert some of their preference shares into ordinary shares. This strategy paid off fairly well with £380,000 being paid. However a sum of £848,000 was still outstanding at the end of 1994.
Description of the likely business and finance strategy of Fenland going forward:
Business strategy of Fenland going forward:
FEL has a positive outlook on its future. They are optimistic about their business prospects in the years to come. This is because there is a great demand among governments and military organizations to revamp and upgrade their current systems and equipments. Hence FEL is optimistic that it can increase its market share. In order to maintain a good market share, it first has to preserve its reputation as a supplier of technically advanced products at a competitive price. Competition in business can be kept in check by carefully considering the Porter’s Five Forces and coming up with a sound working strategy. One of the top priorities of FEL is to improve the turnaround time on basic business products. FEL is implementing procedures to achieve this aim. FEL also strives to be a “one-stop shop” in fulfilling complex contracts by increasing the sale of added value services from initial site surveys through to maintenance agreements. Any strategy in the field of civilian and military air traffic control equipment would be incomplete without a strong research and development programme. FEL is aware of this and is already working on a new series of products. This is a key strategic objective for FEL in order to meet the projected turnover and operating profit for the next three years. A major U.K. Ministry of Defence contract has an 80% chance of being obtained by FEL. This would also mean that FEL has to increase its employee headcount. A lesson FEL has learnt from the failed attempt t acquire a company in Spain is to stop growing through acquisitions. Instead the new strategy for FEL would be to grow through joint ventures- most likely in the United States. FEL is happy with their current banking arrangements with the National Trading Bank. FEL is convinced that the present bank facilities will support future expansion plans. The major U.K. ministry of defence contract that is in the offing forecasts the turnover to increase by a massive 70% in 1996. Projected growth thereafter is set at a challenging 20% per annum, with operating profits rising to 17% of turnover by 1998. In the wake of all these FEL recognises the importance of a sound business plan and an organised approach to strategic planning. FEL has reviewed its past and current performance. This has helped them in identifying the loopholes and re-shaping their business strategy.
Finance strategy of Fenland going forward:
FEL has to take a re-look at its financial strategy for the coming years. This would mean that the new financial strategy to be formulated would be able to completely pay off the dividends on the preference shares that are due to the venture capitalists in time. A sum of £848,000 was still outstanding at the end of 1994. In order to avoid similar situations from occurring in the future, the Director of Finance recently appointed must formulate appropriate policies that take care of the interests of the venture capitalists. Since long term expansion of FEL may involve joint ventures, the role played by these venture capitalists becomes all the more important. The venture capitalists must invest more in the company. They must buy more shares. The finance strategy must convince the venture capitalists that it takes care of their dividends and sees to it that there is no outstanding liability. The potential defence contract that is in the offing from the U.K. Ministry of Defence projects a high turnover for the years 1996 to 1998. The operating profit is set to rise as well. The projections also show that more employees are to be recruited. In order to meet these ends there must be good liquidity in the finance sector. Stocks must move fast out of the inventory in order and debtors have to make their payments on time. Healthy quick ratio and current ratio has to be maintained at all times. The finance strategy here is to define a range for the quick ratio and the current ratio and the ratios must lie within this range at all times. This provides financial control and stability and sees to it there is sufficient working capital on a day-to-day basis. The new finance strategy must take care of the interests of all the stakeholders concerned. The holders of the ordinary shares must receive their dividends on time and the new finance strategy must take care of this aspect. The new finance strategy must take care of the bank policies so that bank re-payments are made on time. A good financial relationship with the bank would help them secure higher loan amounts in the future. The directors of FEL could also consider purchasing preference shares as this would provide them more control.
“Some preference shares have special voting rights to approve certain extraordinary events (such as the issuance of new shares or the approval of the acquisition of a company) or to elect directors.” (en.wikipedia.org, 2006).
This would give the Directors more control over the business in the years to come.
Financial analysis and financial summary of Fenland:
Financial analysis:
Here we analyse the Return on capital employed, Return on total assets, Debt/Equity, Interest Cover, Gross Margin/Sales, Liquidity, and Working Capital for the years 1991, 1992, 1993, and 1994.
[The detailed calculations for these entities are provided in Appendix 1 of this report.]
Return on capital employed:
We can see that the Return on capital employed suddenly decreases during 1994 after continuously increasing from 1991 to 1993. This is because during 1994 the Operating profit decreased due to the higher administrative overheads and marketing costs. The Return on capital employed has the lowest value during 1991 primarily due to the very high value of the Share premium which substantially increased the value of the Capital employed. It must also be noted that the Operating profit was at the lowest during this year.
Return on total assets:
During the year 1991 the Return on total assets was lowest. This is because the Total assets were maximum during 1991. This was because of the Goodwill that amounted to £3721000 during this year. It must also be noted that the Operating profit was the lowest during 1991. Between 1992 and 1994 the Return on total assets has only shown small fluctuations in its value. This tells us that Fenland has had a fairly stable hand in generating profits using its assets during this period.
Debt/Equity:
We can see that the Debt/Equity ratio reached a maximum value during 1992 and decreased since then. This is because during 1992 the sum of the current liabilities and long term liabilities reached a maximum value of £2402000. Fenland owed more at this period. However it must also be observed that the Net assets were at a minimum during this year. This also increased the risk of not being able to clear the liabilities. However after 1992 this situation eased for Fenland as the Debt/Equity ratio was controlled primarily through the increase in the net assets. The Debt/Equity was lowest during 1991 primarily due to the very high value of the Net assets of Fenland.
Interest cover:
We can see that Interest cover has continuously increased from 1991 till 1994. This is a good healthy sign for Fenland and this is because the Interest payable has continuously decreased from 1991 till 1994. The very low value Interest payable during 1994 significantly increased the Interest cover during this year. Hence we can observe that the interest paying ability of Fenland continuously got better and better since 1991.
Gross Margin/ Sales:
In this context it is interesting to observe that this ratio has almost remained constant between 1991 and 1993. This is due to the proportionate changes in the magnitudes of the Gross profit and Turnover for these years. The slight dip during 1994 is because the Gross profit could not measure up in proportion to the high turnover unlike the previous years. The Turnover in 1994 exceeded the Gross profit by a maximum value of £2680000 when compared with other years.
Let us now consider the Liquidity ratios for all the years.
For this we calculate the Stock holding period, Debtors collection period, Current ratio, and Quick ratio.
Stock holding period (in days):
It is a healthy sign that the Stock holding period keeps decreasing from 1991 till 1994. This means that since 1991 the shelf life of the products got lessened and the products moved faster out of the inventory. Good for the company!
Debtors collection period (in days):
We can observe that the Debtors collection period decreases from 1991 to 1994. This is a good sign for Fenland as money can be collected faster from the Debtors. Good for the company!
Current ratio:
We can observe that the Current ratio decreases from 1991 to 1993 and then increases during 1994. The reason is the Current liabilities increased from 1991 and 1993 which made the Current ratio to get weakened. But the Current liabilities decreased during 1994 which made the Current ratio stronger for that year. Since the Current assets exceed the Current liabilities for all the years, we can see healthy Current ratios for all the years, and this in turn indicates that Fenland is able to meet the current obligations during these years.
Quick ratio:
We can observe that the Quick ratio decreases from 1991 till 1993 and then increases in 1994. This is because the Current liabilities increased from 1991 to 1993. The increase in the Quick ratio during 1994 is due to the decrease in the Current liabilities during 1994. Since the Quick ratio does not go below 0.8:1 for all the year, it shows that Fenland has stood the true test of liquidity.
Working Capital:
We can observe that the Working capital decreases from 1991 till 1993 and then increases during 1994. Working capital was lowest during 1993 as the Current liabilities were at a maximum value during that period. We can observe that Fenland had good liquidity during these years.
Financial Summary:
The liquid ratios provide a very positive picture of Fenland. The Current ratio and the Quick ratio show the strength of Fenland with respect to liquidity and both these ratios decrease from 1991 to 1993 before increasing in 1994. This behaviour exhibited by these two ratios is also shown in the Working capital which follows a similar graph pattern. Overall Fenland has shown strength in liquidity aspect. The Stock holding period and the Debtors collection period follow a similar graph pattern of decreasing from 1991 to 1994. This is good for Fenland as Debtors pay Fenland more quickly just as the Stock moves out quickly. Ability to pay the interest increased over the years as shown by Interest cover; however the Debt/Equity ratio followed a different graph pattern showing a peak during 1992 indicating risk. The Gross Margin/Sales was almost constant over the years but the Return on capital employed and Return on total assets plunged in 1994.
Description and justification of the treatment of goodwill and outstanding liability and the impact of the choices made:
In the previous section we have included Goodwill for calculating ratios.
In the event of Goodwill not being included for the purpose of our calculations, the situation would be as follows:
[See Appendix1 for detailed Goodwill calculations]
Return on capital employed during 1992 = 2.3792(increased by 2.3792-1.3299 = 1.0493)
Return on capital employed during 1993 = 2.5459(increased by 2.5459-1.4620 = 1.0839)
Return on capital employed during 1994 = 0.9170(increased by 0.9170-0.6466 = 0.2704)
Return on total assets during 1991 = 0.1871(increased by 0.1871-0.0731 = 0.1140)
Debt/Equity during 1991 = 16.9548(increased by 16.9548-0.5851 = 16.3697)
It is good that Return on capital employed and the Return on total assets have increased by not including Goodwill in our calculations. But it is also to be observed that the Debt/Equity ratio has alarmingly increased to 16.3697. This indicates very high risk. This situation is definitely not desirable.
“Some debt is good, but too much is dangerous. The debt-to-equity ratio is an indicator of whether a company is using debt prudently or is overburdened with debt that could cause problems. Most industrial businesses stay below a 1 to 1 debt-to-equity ratio. They don’t want to take on too much debt, or they cannot convince lenders to put up more than one-half of their assets.” (Tracy, 2002, p.57)
Hence we justify the inclusion of Goodwill in our ratio calculations.
All the other ratios, namely, Interest cover, Gross margin/Sales, Stock holding period, Debtors collection period, Current ratio, and Quick ratio are not at all impacted by Goodwill as they are not determined by the Fixed assets or the Share premium. In either case of Goodwill being amortised or being written off to share premium they remain unaffected. The Working capital is also not impacted by Goodwill as it does not depend on the Fixed assets or the Share premium.
[See Appendix1 for the treatment of outstanding liability of £0.848m with respect to the preference share dividends]
Valuation of Fenland using a range of methodologies and the full workings behind each valuation:
Valuation using Earnings multiple approach (P/E):
In this method the company value is determined using the formula:
Company value = P/E * Earnings
We choose the most recent year for the purpose of valuation. Therefore we take the year 1994 into consideration. Next we need to select a suitable P/E ratio from the first table of Exhibit 3. We choose the P/E value of company A as it is the lowest. Lower P/E values are most practical to use for valuation purposes.
“One reason to calculate P/Es is for investors to compare the value of stocks, one stock with another. If one stock has a P/E twice that of another stock, it is probably a less attractive investment.” (en.wikipedia.org, 2006)
Hence we choose company A with P/E value of 9.1 for our calculation purposes. All other companies have higher P/E values for the year 1994.
Next we find determine the Earnings. We obtain this value from Table 1 profit and loss accounts. The Earnings is the Net profit after interest and tax for the year 1994. This value is £484000 which is shown after the row for Taxation.
Hence we determine the company value as
Company value = 9.1 * £484000 = £4404400
Valuation using Acquisition multiple approach (A/M):
In this method the company value is determined using the formula:
Company value = A/M * Earnings
We choose the most recent year for the purpose of valuation. Therefore we take the year 1994 into consideration.
In order to determine the A/M ratio, we select the last table mentioned in the Exhibit 3.
We have to select the ratio from among the companies A, B, and D as the ratio is not applicable to company C. We select company A for our purpose as it has the highest A/M ratio of 20.0.
We already know the Earnings value as taken for the year 1994 as £484000.
Therefore we get the company value as:
20*£484000 = £9680000
Valuation using Book value – NET ASSET BACKING (NTA) approach:
In this method the company valuation is done using the formula:
Company value = (Market price to Book value) * Net assets
We choose the most recent year for the purpose of valuation. Therefore we take the year 1994 into consideration.
In order to obtain the value for Market price to Book value we choose the year 1994 and the value of 2.8 for company B from the second table of Exhibit 3
This method “is a valuation metric that sets the floor for stock price under a worst-case scenario. When a business is liquidated, the book value is what may be left over for the owners after all the debts are paid. Paying only a price/book = 1 means the investor will get all his investment back. Share of capital intensive industries trade at lower price/book ratios because they generate lower earnings per dollar of assets.” (en.wikipedia.org, 2006)
Hence our justification for choosing company B which has a market price to book value ratio as 2.8.
We get the value of Net assets from table 2 which is the balance sheet. We take the value for 1994 which is £1180000.
Hence we calculate the Book value as
2.8 *£1180000 = £3304000
Return on capital employed:
Return on capital employed shows “how well the firm is using its resources to generate profits.” (Hansen, 2005, p.83)
Return on capital employed for the years 1991 to 1994 is calculated using the formula:
Return on capital employed = (Net profit before tax and interest)/ (Capital employed)
Net profit before tax and interest is the Operating profit of the company and this can be obtained from Table 1 which gives the profit and loss accounts for Fenland.
Capital employed is the Capital and Reserves and this can be obtained from Table 2 which gives the balance sheet for Fenland.
For year 1991: Return on capital employed = £447000/£3854000 = 0.1159
For year 1992: Return on capital employed = £778000/£585000 = 1.3299
For year 1993: Return on capital employed = £886000/£606000 = 1.4620
For year 1994: Return on capital employed = £763000/£1180000 = 0.6466
Return on total assets:
Return on total assets tells how well the firm is using its assets to generate profits.
Return on total assets for the years 1991 to 1994 is calculated using the formula:
Return on total assets = (Net profit before tax and interest)/ (Total assets)
= (Net profit before tax and interest)/ (Fixed assets+ Current assets)
Total assets here are obtained by adding the Fixed assets and the Current assets for each of the years 1991-1994. The Fixed assets and the Current assets are as obtained from Table 2 which gives the balance sheet for Fenland.
For the year 1991: Return on total assets = £447000/ (£3913000+£2196000)
= £447000/£6109000 = 0.0731
For the year 1992: Return on total assets = £778000/ (£182000+£2805000)
= £778000/£2987000 = 0.2604
For the year 1993: Return on total assets = £886000/ (£254000+£2686000)
= £886000/£2940000 = 0.3013
For the year 1994: Return on total assets = £763000/ (£421000+£2263000)
= £763000/£2684000 = 0.2842
Debt/Equity ratio:
“Higher the Debt/Equity ratio, bigger is the risk as you owe more.” (Prebble, 2006)
Debt/Equity for the years 1991 to 1994 is calculated using the formula:
Debt/Equity = (Current liabilities + Long term liabilities)/ (Net assets)
Looking into the balance sheet for Fenland from Table 2, we can see that the Current liabilities is the value for the Creditors due within one year and Long term liabilities is the value for the Creditors due after one year. The values for the Creditors due within one year is as given in the balance sheet for Fenland in Table 2. However to get the values for the Creditors due after one year, we need to add the Bank loan with the Deferred consideration. The Net assets can be found in the balance sheet for Fenland from Table 2.
For the year 1991: Debt/Equity = (£1159000+£1096000)/ £3854000 = £2255000/£3854000 = 0.5851
For the year 1992: Debt/Equity = (£1902000+£500000)/ £585000 = £2402000/£585000 = 4.1059
For the year 1993: Debt/Equity = (£2334000+0)/ £606000 = £2334000/£606000 = 3.8514
For the year 1994: Debt/Equity = (£1504000+0)/ £1180000 = £1504000/£1180000 = 1.2745
Interest cover:
“The Interest cover tells how much we are able to pay the interest bill.” (Prebble, 2006)
Let us calculate the Interest cover for the years 1991 to 1994 using the formula:
Interest cover = (EBIT)/ Interest = (Operating profit)/ (Interest payable)
Where EBIT stands for Earnings Before Interest and Tax.
Looking into the profit and loss accounts for Fenland in Table 1, we can see that EBIT is the Operating profit and the Interest payable is as stated in the same table.
For the year 1991: Interest cover = £447000/£223000 = 2.0044
For the year 1992: Interest cover = £778000/£182000 = 4.2747
For the year 1993: Interest cover = £886000/£120000 = 7.3833
For the year 1994: Interest cover = £763000/£43000 = 17.7441
Gross Margin/Sales:
“Gross Margin/Sales indicates how much profit you make by selling.” (Prebble, 2006)
Gross Margin/ Sales for the years 1991 to 1994 is calculated using the formula:
Gross Margin/ Sales = (Gross profit)/ (Sales) = (Gross profit)/ (Turnover)
Looking into the profit and loss accounts for Fenland in Table 1, we can see that the Sales value can be obtained by looking into the Turnover value. The Gross profit is as given in Table 1.
For the year 1991: Gross Margin/ Sales = £1168000/£2453000 = 0.4761
For the year 1992: Gross Margin/ Sales = £1627000/£3417000 = 0.4761
For the year 1993: Gross Margin/ Sales = £2123000/£4463000 = 0.4756
For the year 1994: Gross Margin/Sales = £2245000/£4925000 = 0.4558
Stock holding period:
“The higher the value of the Stock holding period, greater is the shelf life of the product and this is not good.” (Prebble, 2006)
Stock holding period is calculated using the formula:
Stock holding period = (Stock)/ (Cost of sales per day)
The values for the Stock can be found from Table 2 which gives the balance sheet for Fenland. Cost of sales per day is calculated by dividing the Cost of sales (which can be obtained from Table 1- profit and loss accounts for Fenland) by the total number of days in the year. It must be observed that 1992 is a leap year and has 366 days.
For the year 1991: Stock holding period = £720000/ (£1285000/365) = 204.5136 days
For the year 1992: Stock holding period = £687000/ (£1790000/366) = 140.4703 days
For the year 1993: Stock holding period = £754000/ (£2340000/365) = 117.6111 days
For the year 1994: Stock holding period = £848000/ (£2680000/365) = 115.4925 days
Debtors collection period:
Debtors collection period is calculated using the formula:
Debtors collection period = (Debtors)/ (Sales per day)
The value for Debtors can be obtained from Table 2 which gives the balance sheet for Fenland and the Sales per day is Turnover (from Table 1- profit and loss accounts for Fenland) divided by the number of days in the year. Once again it must be remembered that 1992 is a leap year and therefore it has one extra day.
For the year 1991: Debtors collection period = £874000/ (£2453000/365) = 130.0489 days
For the year 1992: Debtors collection period = £1134000/ (£3417000/366) = 121.4644 days
For the year 1993: Debtors collection period = £1327000/ (£4463000/365) = 108.5267 days
For the year 1994: Debtors collection period = £1397000/ (£4925000/365) = 103.5340 days
Current ratio:
“The Current ratio indicates how strong is the ability of the company to meet the current obligations.” (Prebble, 2006)
Current ratio is calculated using the formula:
Current ratio = (Current assets)/ (Current liabilities)
The Current assets and the Current liabilities are obtainable from Table 2 which gives the balance sheet for Fenland.
For the year 1991: Current ratio = £2196000/£1159000 = 1.8947
For the year 1992: Current ratio = £2805000/£1902000 = 1.4747
For the year 1993: Current ratio = £2686000/ £2334000 = 1.1508
For the year 1994: Current ratio = £2263000/ £1504000 = 1.5046
Quick ratio:
“Quick ratio looks at Stock. If you can remove Stock from Current assets, it is a real test of liquidity- especially if the Stockholding period is more.” (Prebble, 2006)
Quick ratio is calculated using the formula:
Quick ratio = (Current assets – Stock)/ (Current liabilities)
The values for Current assets, Stock, and Current liabilities are obtainable from Table 2 which gives the balance sheet for Fenland.
For the year 1991: Quick ratio = (£2196000-£720000)/ £1159000 = £1476000/£1159000 = 1.2735
For the year 1992: Quick ratio = (£2805000-£687000)/ £1902000 = £2118000/£1902000 = 1.1135
For the year 1993: Quick ratio = (£2686000-£754000)/ £2334000 = £1932000/£2334000 = 0.8277
For the year 1994: Quick ratio = (£2263000-£848000)/ £1504000 = £1415000/£1504000 = 0.9408
“The Acid-test or Quick ratio measures the ability of the company to use its “near cash” or quick assets to immediately extinguish its current liabilities. Ideally the acid test ratio will be 1:1, but 0.8:1 is acceptable, any less and the business could suffer financial difficulties.” (en.wikipedia.org, 2006)
Working capital:
“Working capital represents the amount of day-by-day operating liquidity available to a business.” (en.wikipedia.com, 2006)
Working capital is calculated using the formula:
Working Capital = Current assets – Current liabilities
The values for Current assets and Current liabilities are obtainable from Table 2 which gives the balance sheet for Fenland.
For the year 1991: Working Capital = £2196000-£1159000 = £1037000
For the year 1992: Working Capital = £2805000-£1902000 = £903000
For the year 1993: Working Capital = £2686000-£2334000 = £352000
For the year 1994: Working Capital = £2263000-£1504000 = £759000
Goodwill calculations:
Goodwill (initially £4026000) has been included for calculating Return on capital employed, Return on total assets, and Debt/Equity ratios. All other ratios have remained unaffected by Goodwill. Goodwill was charged to the Profit and Loss Accounts (amortised) before the company wrote it off by charging it to the share premium. The amortised amount in 1991 was £305000 which made the Goodwill on the balance sheet during 1991 as £4026000-£ 305000 = £3721000. The amortised amount of £304000 in 1992 reduced the Goodwill amount to £3721000-£ 304000 = £3417000. This amount was charged to the share premium (which was £3675000 for 1991 as stated in the balance sheet) in 1992 which reduced the share premium value to £3675000-£ 3417000 = £258000. This amount is what is shown for the share premium value for year 1992 in the balance sheet. Goodwill has impacted the Return on capital employed since it was charged to the share premium during 1992. The share premium is one of the factors that determines the capital employed (Capital and Reserves) as seen from the balance sheet of table2. Hence we can observe that the Goodwill has impacted Return on capital employed during the years 1992, 1993, and 1994. It is important to observe that Goodwill has not impacted Return on capital employed during 1991 although it appears as a fixed asset during that year. This is because the Goodwill was amortised during that year and was not charged to the share premium. Goodwill obviously impacts the Return on total assets during the year 1991 as the total assets is determined by the sum of the fixed assets (which in turn is determined by Goodwill) and current assets. Since Goodwill was written off in 1992 as share premium, it does not impact Return on total assets during the years 1992, 1993, and 1994. The Debt/Equity ratio which depends on the net assets is also impacted during 1991 but not during 1992, 1993, and 1994 as Goodwill was written off in 1992 as share premium.
The Net assets is determined by Goodwill as shown below:
Net assets = Total assets less Current liabilities – Long term liabilities
Total assets less current liability = Total assets – Current liabilities
= Fixed assets + Current assets – Current liabilities
Hence, Net assets = Fixed assets + Current assets – Current liabilities – Long term liabilities.
These calculations are evident in the balance sheet in table2.
Exclusion of Goodwill will result in the following calculations:
Return on capital employed during 1992 = £778000/ (£585000-£258000)
= £778000/£327000 = 2.3792
Return on capital employed during 1993 = £886000/ (£606000-£258000)
= £886000/£348000 = 2.5459
Return on capital employed during 1994 = £763000/ (£1180000-£348000)
= £763000/£832000 = 0.9170
Return on total assets during 1991 = £447000/ (£6109000-£3721000)
= £447000/£2388000 = 0.1871
Debt/Equity during 1991 = (£1159000+£1096000)/ (£3854000-£3721000)
= £2255000/£133000 = 16.9548
Treatment of outstanding liability of £0.848m with respect to the preference share dividends:
The venture capitalists were entitled to a total dividend of £1228000 for the years 1991 to 1994 on the preference shares. However no dividend was paid during 1991 and 1992. An amount of £848000 was still outstanding at the end of 1994.
This means that an amount of £1228000-£848000=£380000 was paid to them between 1993 and 1994. The profit and loss account in table1 shows the amount of £380000 as the dividend paid under the Dividends row of the table. However the balance sheet shows a dividend amount of £183000 as a current liability due within one year for 1993.
The dividend entitled to the venture capitalists for the year 1991 is £197000.
Hence we can see that out of £380000 paid to the venture capitalists,
£380000-£183000=£197000 was paid during the year 1993 and the balance £183000 was paid during 1994.
Hence we can conclude that the dividend for 1991 was fully paid and the dividend for 1992 was only partially paid.
The dividend amount of £183000 shown on the balance sheet as a current liability affects the ratios that depend on current liabilities. This means this amount of £183000 has impacted the ratios: Debt/Equity, Current ratio, and Quick ratio. In fact it has also impacted the Working capital.
Since the dividend amount of £183000 is calculated as:
£1228000-(Outstanding liability of £848000)-dividend entitled for year 1991
we can see clearly that the outstanding liability amount of £848000 has impacted the Debt/Equity, Current ratio, and Quick ratio. The working capital has also been impacted by this outstanding liability amount.
This outstanding liability amount of £848000 needs to be cleared by paying the balance dividend amount due for 1992 and the full dividend amount due for 1993 and 1994.
Since the dividend due for 1992 is £295000, an amount of £295000-£183000=£112000 still needs to be paid in addition to the dividend amounts for 1993 and 1994.
Since the cumulative preference shares are redeemable between 1998 and2000, it is best to clear the outstanding liability of £0.848m during this period.
