994 Accounting Ratios Return on Capital Employed Return on Shareholders Fund Gearing Ratio Price-earnings ratio Orange Ltd.

10% 21% 55% 12 times Industry Average 10% 15% 35% 16 times

As Orange Ltd has a high gearing ratio, the market perceives the risky position of Orange Ltd as it has a higher proportion of debt financing. A low price-earnings ratio of Orange Ltd indicates a weak market confidence in the company. The higher return on capital employed may indicate that Orange Ltd may have some risky investments which lead to a higher return. However, the market may worry about the long term insolvency of Orange Ltd and has doubt over its profitability in the long run and therefore the share price is relatively low. A higher return on shareholders fund may imply a higher earnings per share. Due to the risky position of Orange Ltd, a higher earnings per share does not justify a higher level of share price and therefore the price-earnings ratio of Orange Ltd is lower than the industry average.

963 Accounting Ratios Current Ratio Acid Test Ratio Gross Profit Margin Return on Capital Employed (Owners Equity) Earnings Per Share Market Price Per Share Dividend Cover Capital Gearing Ratio A Ltd 1.61:1 1.04:1 51.7% 28.9% 33 cents per share $1.98 1.7 times 19.3% B Ltd 1.39:1 0.81:1 58.1% 47.3% 66 cents per share $5.81 2.8 times 57.3%

Liquidity The current ratio and acid test ratio of A Ltd were 1.61:1 and 1.04:1 respectively. The corresponding ratios of B Ltd were 1.39:1 and 0.81:1 respectively. A Ltd was operating more efficient than B Ltd. It may be due to the lower level of cash and trade debtors and / or higher level of trade creditors in B Ltd. B Ltd was operating in poor liquidity position to meet its future current liabilities. Profitability The gross profit margin and net profit margin of A Ltd were 51.7% and 21.8% respectively. The corresponding ratios of B Ltd were 58.1% and 26.5% respectively. B Ltd was operating more profitability then A Ltd. It may be due to the lower of cost of sales and / or the higher of profit margin setting in B Ltd. The return on capital employed based on owners equity of A Ltd and B Ltd were 28.9% and 47.3% respectively. Once again, B Ltd was operating more efficient in using its capital.

Investment The earnings per share of A Ltd and B Ltd were 33 cents per share and 66 cents per share respectively. The market price per ordinary share of A Ltd and B Ltd were $1.98 and $5.81 respectively. Therefore, the price / earnings ratio of B Ltd was higher than A Ltd. B Ltd provided a higher dividends payable per share to their shareholders. The dividend cover of A Ltd and B Ltd reflected that the total actual amount dividend payable to shareholders of A Ltd was higher than B Ltd in relation to the net profit after taxation and preference dividends. Furthermore, B Ltd was operating in a higher level of gearing level than A Ltd.

955 Accounting Ratios Gross profit margin Vicky Limited 25%

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Flora Limited 20%

Net profit margin Stock turnover rate Return on capital employed Current ratio Acid test ratio Debtors turnover Creditors turnover

12.5% 3 times 25% 9:1 6:1 3.2 times 10 times

12.5% 4.8 times 37.5% 4:1 2.25:1 6 times 9.2 times

Profitability Flora Limited was operating more profitability than Vicky Limited. The gross profit margin of Flora Limited was 20% and it was 5% lower than Vicky Limited. It may be due to the lower price setting of the goods or the higher of cost of goods sold. Nevertheless, the net profit margin of Flora Limited remained the same as Vicky Limited in 12.5%. It highlighted that Flora Limited was more efficient in minimizing the operating expenses. The return on capital employed of Vicky Limited and Flora Limited were 25% and 37.5% respectively. Flora Limited was operating more profitability than Vicky Limited.

Liquidity The stock turnover rate of Vicky Limited and Flora Limited were 3 times and 4.8 times respectively. The higher ratio of Flora Limited may be due to the lower of average stock held or the higher of cost of sales. The lower level of average stock held by Flora Limited may lead to the lower of insurance premium, warehouse rental charges etc. Furthermore, the higher level of average stock held by Vicky Limited may be a factor of its high current ratio in 9:1. Other than stock, the acid test ratio of Vicky Limited and Flora Limited were 6:1 and 2.25:1 respectively. It may be due to too much idle current assets held by Vicky Limited. Flora Limited was more efficient in liquidity position than Vicky Limited. In the area of credit control, the average collection period from credit customers of Vicky Limited and Flora Limited were four months and two months respectively. Flora Limited was more efficient to collect the debts. Furthermore, Flora Limited could paid its creditors a little bit later than the other company.

Flora Limited was more efficient in credit control than Vicky Limited. 942 Accounting Ratios Current Ratio Acid Test Ratio Collection Period for Debtors Stock Turnover Net Profit Margin Assets Turnover Return on Owners Equity Dividend Yield Price/Earnings Ratio 1992/93 1.39:1 0.56:1 5.29 weeks 3.62 times 12.56% 0.93 times 9.49% 5.88% 16.78 times 1993/94 1.07:1 0.23:1 3.68 weeks 3.26 times 12.41% 0.96 times 10.87% 5.56% 15.38 times

The liquidity position of the company was not very satisfactory since the current ratio dropped from 1.39:1 in 1992/93 to 1.07:1 in 1993/94. Too much stock was being tied up and the acid test ratio fell from 0.56:1 in 1992/93 to 0.23:1 in 1993/94. The improvements of 1.61 weeks in debtors collection period was partly offset by the lower stock turnover ratio in 1993/94. The larger stock holding and the lower stock turnover could be the reasons for the deteriorating liquidity position. In terms of profitability, the company was not showing improvement and there was a slight drop in the net profit margin. However, the company was able to utilize its assets more efficiently in generating more sales in 1993/94. In addition, the return on owners equity has increased from 9.49% to 10.87%. According to the statement of changes in financial position, the companys main sources of funds came from operating profits and issue of ordinary shares. Large amount of funds has been used up to purchase fixed assets and repayment of loan. Since long-term applications of funds exceeded long-term sources by $27150, working capital and liquid funds have been used to finance these long-term applications. The company should try to improve its liquidity by reducing it stock holding. The substantial increase in purchase of fixed assets suggested expansion and the company should try to utilize its fixed assets more efficiently in generating more revenue. The company should borrow more long-term loans to finance its expansion.

892 Accounting Ratios Liquid Ratio Average Stock Turnover Rate Capital Gearing Ratio Earning as a Percentage of Average Capital Employed Ratio of Sales to Average Capital Employed 1987 1:1 4 times Nil 22.2% 2.96 times 1988 1.19:1 4.4 times 59% 19.7% 2.12 times

Liquidity Hop Woo Limited has improved its liquidity position by increase its liquid ratio from 1:1 in 1987 to 1.19:1 in 1988. The balance of bank account has also been changed from overdraft balance in 1987 to debit balance in 1988. Meanwhile, Hop Woo Limited issued $500,000 12% Debentures in 1988 in order to provide the funds for the above changes and invest the additional source of funds in fixed fixed assets. Furthermore, the average stock turnover rate has been increased from 4 times in 1987 to 4.4 times in 1988.

Profitability The earnings as a percentage of average capital employed of Hop Woo Limited has been decreased from 22.2% in 1987 to 19.7% in 1988. Furthermore, the ratio of sales to average capital employed has also been decreased from 2.96 times in 1987 to 2.12 times in 1988. Both ratios highlighted that the sales and the earnings were not in proportion to the increase in the average capital employed in 1988. The average capital employed has been increased by 92%in 1988, however, the sales and the profit before interest and tax could only be increased by 70%and 38% respectively. Gearing Position The issue of 12% debentures during the year has the effect of taking advantage of gearing. This is considered by the investors as a better source of funds than the issue of additional ordinary shares since the profits of the Hop Woo Limited has
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shown improvements in 1988. In the long run the objective of the company should try to improve its utilization of capital employed, by achieving a higher level of sales in relation to the capital base. This will result in an improvement in the return of capital employed.