Problem – FS -2015 **

The following data relate to Navana Ltd. A trading company as at 31st December. 2014.

Capital and liabilities Amount Assets Amount

Paid-up capital 15,00,000 Cash 40,000
Reserves 3,50,000 Debtors 6,40,000
Retained earnings 2,50,000 Inventory 9.10,000
Debenture –Long term 5,00,000 Bills receivable 3,50,000
Bills payable 5,00,000 Prepaid expenses 2,50,000
Sundry creditors 5,10,000 Investment –short-term 1,60,000
Bank overdraft 2,00,000 Land and Building 7,00,000
Accrued expenses 1,90,000 Goodwill 3,50,000
Provision for taxation 2,50,000 Plant and Machinery 6,00,000
Total 40,00,000 Total 40,00,000

Annual sales Tk.74,40,000 . Cost of goods sold Tk.66,96,000, Tax rate 30%
You are required to calculate the following ratios for the year and comment on the
following position as revealed by these ratios :

a) Current ratio
b) Acid-test ratio
c) Profitability ratio
d) Inventory Turnover ratio
e) Debtor Turnover ratio
f) Debt Equity ratio
g) Proprietary ratio

Bank overdraft is payable on demand

Solution : FS -2015

Calculation of current assets Current liabilities

Cash 40,000 Bills payable 5,00,000
Debtor 6,40,000 Sundry creditors 5,10,000
Inventory 9,10,000 Bank overdraft 2,00,000
Bills receivable 3,50,000 Accrued expenses 1,90,000
Prepaid expenses 2,50,000 Total 14,00,000
Investment- short term 1,60,000
Total current assets 23,50,000

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 23,50,000

a) Current Ratio = = = 1.68
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 14,00,000

𝑸𝒖𝒊𝒄𝒌 𝒂𝒔𝒔𝒆𝒕𝒔 14,40,000

b) Quick Ratio = = = 1.03
𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝒍𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒊𝒆𝒔 14,00,000
Quick assets = Current assets - Inventory
Calculation of profit :
Sales 74,40,000
Cost of goods sold 66,96,000
Gross profit 7,44,000
Less income tax 30% 2,32,200
Net profit after tax 5,11,800
 c) Profitability Ratio :

𝐺𝑟𝑜𝑠𝑠 𝑝𝑟𝑜𝑓𝑖𝑡 7,44,000

1. Gross profit Ratio = x100 = x 100 = 10%
𝑆𝑎𝑙𝑒𝑠 74,40,000

𝑁𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡 5,11,800

2. Net profit Ratio = x 100 = x 100 = 6.88 %
𝑆𝑎𝑙𝑒𝑠 74,40,000

𝐶𝑜𝑠𝑡 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠 𝑠𝑜𝑙𝑑 66,96,000

d) Inventory turnover Ratio = = = 7.36 times
𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 9,10,000

𝑆𝑎𝑙𝑒𝑠 74,00,000
e) Debtors’ Turnover ratio = = = 11.56 times
𝐷𝑒𝑏𝑡𝑜𝑟𝑠 6,40,000

f) Debt- Equity Ratio =

𝐿𝑜𝑛𝑔 𝑡𝑒𝑟𝑚 𝐷𝑒𝑏𝑡 5,00,000

i. = 0.24
𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟𝑠 𝐹𝑢𝑛𝑑𝑠 21,00,000

𝐿𝑜𝑛𝑔−𝑡𝑒𝑟𝑚 𝐷𝑒𝑏𝑡+𝑆ℎ𝑜𝑟𝑡−𝑡𝑒𝑟𝑚 𝐷𝑒𝑏𝑡 19,00,000

ii. = 0.90
𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟𝑠 𝐹𝑢𝑛𝑑𝑠 21,00,000

Shareholders fund :
Paid-up capital 15,00,000
Reserves 3,50,000
Retained earnings 2,50,000
Total 21,00,000
Total liabilities – Shareholders fund = Long and Short- term debt
40,00,000 - 21,00,000 = 19,00,000
𝑃𝑟𝑜𝑝𝑟𝑖𝑒𝑡𝑜𝑟𝑠 𝐹𝑢𝑛𝑑𝑠 21,00,000
g) Proprietary Ratio = = 40,00,000 = 0.53
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
Comments on Financial Position :

Liquidity. A current ratio of 2 is considered ideal under normal condition.

Here the current ratio is 1.68 which indicates that the company is not so much
liquid. However the quick ratio i.e. 1.03 (Ideal is 1:1) indicates that the
liquidity position of the company is satisfactory.
A inventory turnover ratio of 7.36 per year indicates that the stock holding
period is 50 days which may be considered satisfactory.
Debtors turnover is 11.56 times per year, indicating thatdebtors are taking 31
days to pay. This seems very reasonable.
Profitability. A gross profit ratio of 10% and net profit ratio of 6.88%
indicates that the company’s profit earnings capacity is not at all satisfactory.
Management look into the matter and must take proper steps to increase the
profitability of the company.
Capital Gearing/ Financial Leverage. Capital gearing or financial
leverage of the company (showing the relationship between finance supplied
by shareholders and finance supplied by outsiders) is good. The debt equity
shows that against every Tk1 financed by shareholders , long -term borrowing
is only Tk.0.24 and total borrowing is Tk.0.90. The proprietary ratio of 0.53
indicates that more than 50% of the book value of total assets has been
financed by the shareholders. Thus, the company has a satisfactory capital
structure . It does not depend much on external finance, either from short-term
sources or from long-term sources. The problems of high gearing or low
gearing are not faced by the company.
Exercise: IBBL-2014
The information below is taken from the records of two companies in the same industry:

(Amount in ,000)

P. Ltd. Q. Ltd.
Tk. Tk.
Cash 210 320
Debtors-net 330 630
Stock 1,230 950
Plant and equipments 1,695 2,400

Total Assets 3,465 4,300

Sundry creditors 900 1,050

8% Debentures 500 1,000
Equity Share capital 1,100 1,750
Retained earnings 965 500

3,465 4,300

Sales 5,600 8,200

Cost of goods sold 4,000 6,480
Other operating expense 800 860
Interest expenses 40 80
Income taxes 380 390
Dividends 100 180

Answer each of the following questions by making a comparison of one or more relevant ratios:

a) Which company is using the shareholders' money more profitably?

b) Which company is better able to meet its current debts?
c) If you were to purchase the debentures of one company, which company's debentures would you
buy?
d) Which company collects its receivable faster assuming all sales to be credit sales?
e) Which company retains the larger proportion of income in the business?
Solution : IBBL-2014

Income Statement

P. Ltd. Q. Ltd.
Tk. Tk.
Sales 5,600 8,200
Cost of goods sold 4,000 6,480
Gross Profit 1,600 1,720
Less: other operating expense 800 860
Net profit before interest & tax 800 860
Les: Interest expense 40 80
Net profit before tax 760 780
Income tax 380 390
Net profit after tax 380 390

Calculation of shareholders Fund.

P. Ltd. Q. Ltd.
Tk. Tk.
Equity share capital 1,100 1,750
retained earnings 965 500
2,065 2,250
a) i) Rate of return on stockholders fund

𝑁𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡 𝑎𝑓𝑡𝑒𝑟 𝑡𝑎𝑥 𝑇𝑘. 380 𝑇𝑘. 390

×100 = ×100 ×100
𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟𝑠 𝐹𝑢𝑛𝑑 𝑇𝑘. 2065 𝑇𝑘. 2,250

=18.40% =17.33%

Comment: Company P. Ltd is making more Profitable use of shareholders Money.

Calculation of current assets:

P. Ltd. Q. Ltd.
Tk. Tk.
Cash 210 320
Debtors-net 330 630
Stock 1,230 950
Total 1,770 1,900

b) i) Current Ratio :

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 𝑇𝑘. 1,770 𝑇𝑘. 1,900

=
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 𝑇𝑘. 900 𝑇𝑘. 1,050

=1.97 =1.81

ii) Acid-Test-Ratio :

𝑄𝑢𝑖𝑐𝑘 𝐴𝑠𝑠𝑒𝑡𝑠 𝑇𝑘. 540 𝑇𝑘. 950

=
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 𝑇𝑘. 900 𝑇𝑘. 1,050
Or
𝐶𝑢𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠−𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 =0.60 =0.90

Comment: Company Q. Ltd is able to meet its current debts in a better way, since its quick ratio is
higher than company P. Ltd.

c) i) Debt Equity Ratio :

𝐷𝑒𝑏𝑡𝑠 𝑇𝑘. 500 𝑇𝑘. 1000

×100 = ×100 ×100
𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟𝑠 𝐹𝑢𝑛𝑑 𝑇𝑘. 2,060 𝑇𝑘. 2,250

=24.27% =44.44%
ii) Debt Service Ratio:

𝑛𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡 𝑏𝑒𝑓𝑜𝑟𝑒 𝑡𝑎𝑥 𝑎𝑛𝑑 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑇𝑘. 800 𝑇𝑘. 860
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑒𝑥𝑝𝑒𝑛𝑠𝑒 𝑇𝑘. 40 𝑇𝑘. 80

= 20 Times = 10.75 times

Comment: I would prefer to buy the debenture of P. Ltd. because its debt-Equity ratio is less and
debt service ratio is higher.

d) Debt Collection period :

𝐷𝑒𝑏𝑡𝑜𝑟𝑠×𝐷𝑎𝑦𝑠 𝑖𝑛 𝑎 𝑦𝑒𝑎𝑟 𝑇𝑘. 330 × 365 𝑇𝑘. 830 × 365

=
𝐶𝑟𝑒𝑑𝑖𝑡 𝑠𝑎𝑙𝑒𝑠 𝑇𝑘. 5,600 𝑇𝑘. 8,200

= 21.5 days or = 36.95 days or

say 22 days say 37 days

Comment: Company P. Ltd. collects its receivable faster as its debts collection period is lower than
Q. Ltd.

e) Dividend payout Ratio :

𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑓𝑢𝑛𝑑 𝑇𝑘. 100 𝑇𝑘. 180

×100 = ×100 ×100
𝑝𝑟𝑜𝑓𝑖𝑡𝑎𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 𝑇𝑘. 380 𝑇𝑘. 390

=26.32% =46.15%

Retain Ratio

P. Ltd= 100%-26.32% =73.68%

Q. Ltd= 100%-46.15% =53.85%

Comment: Company P. Ltd retains larger Proportion of profit in the business.

 COST VOLUME PROFIT ANALYSIS

The basic objectives of running any business organization is to earn profit. Profits
determine the financial position ,liquidity and solvency of the company. Profit serves
as yardstick for judging the competence and efficiency of the management.Profit
planning ,is therefore, a fundamental part of the overall management function.

Cost Volume Profit (CVP) Analysis is an important tool of profit planning. Cost
volume profit analysis helps the management in profit planning. The most significant
single factor in profit planning of the average business is the relationship between the
volume of business, cost and profit . An analysis of the effects of various factors on
profit is an essential step in financial planning and decision making.

The analytical technique used to study the behavior of profit in response to the
changes in volume , cost and prices is called the Cost – Volume – profit(CVP)
analysis.

It provides information about the following matters:

1) The behavior of cost in relation to volume.

2) Volume of production or sales, where the business will break-even.

3) Sensitivity of profit due to variation of output.

4) Amount of Profit for a projected sales volume.

5) Quantity of production and sales for a target profit level.

CVP Analysis may therefore be defined as a managerial tool showing the

relationship between various ingredients of profit planning; viz. cost (both fixed and
variable), selling price and volume of activity.

Such an analysis is useful to the management accountant in the

following respects:

(i) It helps him in forecasting the profit fairly accurately.

(ii) It is helpful in setting up flexible budgets, since on the basis
 of this relationship, he can ascertain the costs, sales and
profits at different levels of activity.
(iii) It also assists him in performance evaluation for the
purposes of management control.
(iv) It helps in formulating price policy by projecting the effect
which different price structures will have on cost and
profits.

(v) It helps in determining the amount of overhead cost to be charged at various

levels of operations, since overhead rates are generally pre-determined on the basis of
a selected volume of production.
Thus, cost-volume profit analysis is an important media through which the
management can have an insight into effects on profit on account of variations in costs
(both fixed and variable) and sales (both volume and value) and take appropriate
decisions.
A widely used technique to study Cost –volume –profit relationships is break –even
analysis.

Assumptions in CVP analysis

• The behavior of both costs and revenues is linear throughout the relevant
range of the activity index.
• All costs can be classified with reasonable accuracy as either variable or
fixed .
• Changes in the activity are the only factors that affect costs.
• All units produced are sold.
• Selling price remains the same at different level of activity
• There is no change in the product mix
• There is no change in the level of efficiency
• Policies of management do not change
• As the number of units produced and sold are the same , there is no
closing or opening stock

Break-Even Analysis
A Break-even analysis shows the relationship between the costs
and profits with sales volume. The sales volume which equates
total revenue with related costs and results is neither profit nor
loss is called break –even point(BEP) . It can be expressed
either in sales units or Sales Taka amount.
- The process of finding the break- even point is called break-
even analysis
Knowledge of break-even point is useful to management
when it decides –
 whether to introduce new product lines,
 Change sales prices on established products, or
 Enter new market areas.

Three appraoches to “break –even analysis”

1. Contribution Margin Approach ,
2. Equation technique
 3. Graphic presentation: a) Break-even chart , and
b) Profit volume chart
 Contribution Margin: The excess of unit selling price over unit
variable cost is called Contribution Margin. Suppose, Unit
selling price Tk. 500 and Unit variable cost Tk300, now
Contribution Margin pet unit is –
 a) Unit selling price – Unit Variable cost = Unit Contribution
Margin
= Tk 500 - Tk 300 = Tk 200
 b) Contribution = Fixed cost + profit
 c) Contribution = Sales x P/V Ratio or C/M Ratio

• Contribution Margin Ratio : The Contribution margin ratio is the

contribution margin per unit divided by the unit selling price.
Unit contribution
C/ M Ratio = × 10
Unit selling price

ii) Total contribution ÷ Total sales x 100

 Contribution Margin Ratio is also called P/V ratio
 The expression of contribution margin is very helpful in determining the
effect of changes in sales on net income.
 For example , net income will increase by Tk40,000 (40%x Tk1,00,000)
if sales increase Tk 1,00,000. Thus by using contribution margin ratio,
managers can quickly determine increase in net income from any
changes in sales. Let us see this effect through a CVP income statement.
 Assume that M/S Havana Ltd. current sales are Tk5,00,000 and it wants to
the effect of a Tk. 1,00,000 increase in sales. It could prepare a comparative
CVP statement analysis as follows.

No changes With Changes

Total Per Unit Total Per Unit
Sales Tk 5,00,000 Tk500 Tk6,00,000 Tk.500
- Variable cost Tk 3,00,000 Tk300 TK3,60,000 Tk.300
Contribution margin Tk. 2,00,000 Tk 200 Tk 2,40,000 Tk. 200
- Fixed cost TK. 2,00,000 - Tk. 2,00,000 -
Net income Tk- 0 - Tk. 40,000
======== ========

Margin of safety
Margin of Safety: The excess of actual sales over the break -even sales is
called Margin of safety .The margin of safety is another relationship that may
be calculated from CVP analysis.CVP analysis also help managers assess risk
by providing a measure of the margin of safety. It shows how far sales can fall
below the planned level of sales before loss occur. It compares the level of
planned sales with the break-even point. The larger the margin of safety, the
less likely it is that the company will have an operating loss, that is, operate
below break-\even point. A small margin of safety indicate a more risky
situation.
- Margin of Safety Ratio = Actual sales - Break-even sales
Actual sales
- Symbolically, M/S ratio = (AS – BES) ÷ AS
 Variable and Fixed cost
• Variable cost: Variable costs are costs that vary in total directly and
proportionately with changes in the activity level. If the level increase by
5% , total variable costs will increase 5%. If the level of activity
decreases by 20% , variable costs will decrease 20%. A variable cost
may also be defined as a cost that remains the same per unit at every
level of activity.

• Fixed costs: Fixed costs are costs that remain the same in total
regardless of changes in the activity level. As total fixed costs remain
constant as activity changes, it follows that fixed costs per unit vary
inversely with activity. As volume increases, unit cost declines and
vice versa.

Cost Volume profit Analysis

Sales
Variable cost Sales =Variable cost + Fixed cost + profit or loss.
Fixed cost
Profit

Contribution = Sales - Variable cost.

Contribution = Fixed cost + Profit or loss.
Contribution = Sales x C/M Ratio or P/V ratio.
Contribution (per unit) = Unit selling price – Unit variable cost.
Total contribution := Total sales –Total variable cost.

a) C/M or P/V ratio:

Unitcontribution
i) x 100
Unit saling price
Total cntribution
i) x100
Total sales
Break Ever point :

Total Fixed cost

i) BEP(Unit) =
Contribution Margin Per Unit

Total Fixed cost

ii) BEP (sales) =
C/M Ratio or P/V Ratio

Total fixed cost

iii) BEP (sales) =
1-variable cost / sales
c) Margin safety:

i) Margin of safety (unit) = Total sales unit –BEP units

ii) Margin of safety (Taka) = Total sales –BEP sales

contribution
iii) Margin of safety = Profit ÷
sales
Margin of safety
d) Margin of safety Ratio: = x100
sales

Problem : CVP – 01( 2015)*

Shirin International Ltd. is the distributor of a certain product . The product is sold in the
market for Tk. 300 per unit with a variable procurement cost of Tk. 210 and a variable
selling expenses of Tk. 25. The Company’s other variable cost is Tk. 15. Fixed selling
and administrative expenses are Tk. 2,00,000 per year.

Required :
(i) What is the break-even point in unit and Taka ?
(ii) What sales level in unit is required to earn an annual before- tax profit of
Tk. 1,50,000 ?
(iii) What sales level must be achieved to have after- tax profit of Tk. 2,00,000 ,
if tax rate is 50 % ?
(iv) What sales level must be achieved to have the after tax target profit of
Tk.2,40,000 if tax rate is 40 %?
(v) What is the Margin of Safety(MS) and after tax- profit for sales level of
10,000 units , if tax rate is 40 % ?
Problem : CVP –02( 2015)
The Paradise Company is the exclusive distributor for an automotive product. The
product sells for Tk.50 per unit and has a CM ratio 40%. The company’s fixed
expenses are Tk.3,00,000 per year.
Required:
i. What is the variable expenses per unit ?
ii. What is the break – even point in units and sales taka ?
iii. What sales level in units and in sales taka is required to earn annual
profit of Tk. 90,000 ?
iv. Assume that by using efficiency and technology, the company is able to
reduce its variable expenses by Tk. 5 per unit. What is the company’s new
break- even point in units and sales taka ?

Problem : CVP- 03 (2015)**

The following data are obtained from the records of a factory :
Sales: 4,000 units @ Tk. 25 each Tk. 1,00,000
Materials consumed Tk. 40,000
Variable overheads Tk.10,000
Labour charges Tk. 20,000
Fixed overheads Tk. 18,000 Tk. 88,000
Net profit Tk. 12,000
======

Calculate :

i. The number of units by selling which the company will neither lose nor gain
anything .
ii. The sales needed to earn net profit of 20% on sales.
iii. The extra units which should be sold to obtain the present profit if it
proposed to reduce the selling price by 20% and 25% .
iv. The selling price to be fixed to bring down its break-even points to 500
units under present condition.