113. Wobnig Co (6/12, amended)
The following financial information relates to Wobnig Co.
|
20X1 |
20X0 |
|
$’000 |
$’000 |
Revenue |
14,525 |
10,375 |
Cost of sales |
(10,458) |
(6,640) |
Profit before interest and tax |
4,067 |
3,735 |
Interest |
355 |
292 |
Profit before tax |
3,712 |
3,443 |
Taxation |
(1,485) |
(1,278) |
Distributable profit |
2,227 |
2,165 |
|
20X1 |
20X0 |
|
$’000 |
$’000 |
$’000 |
$’000 |
Non-current assets |
|
15,284 |
|
14,602 |
Current assets Inventory |
2,149 |
|
1,092 |
|
Trade receivables |
3,200 |
|
1,734 |
|
|
|
5,349 |
|
2,826 |
Total assets |
|
20,633 |
|
17,428 |
Equity |
|
|
|
|
Ordinary shares |
8,000 |
|
8,000 |
|
Reserves |
4,268 |
|
3,541 |
|
|
|
12,268 |
|
11,541 |
Non-current liabilities |
|
|
|
|
7% bonds |
|
4,000 |
|
4,000 |
Current liabilities |
|
|
|
|
Trade payables |
2,865 |
|
1,637 |
|
Overdraft |
1,500 |
|
250 |
|
|
|
4,365 |
|
1,887 |
Total equity and liabilities |
|
20,633 |
|
17,428 |
Average ratios for the last two years for companies with similar business operations to Wobnig Co are as follows:
Current ratio |
1.7 times |
Quick ratio |
1.1 times |
Inventory days |
55 days |
Trade receivables days |
60 days |
Trade payables days |
85 days |
Sales revenue/net working capital |
10 times |
Required
(a) Using suitable working capital ratios and analysis of the financial information provided, evaluate whether Wobnig Co can be described as overtrading (undercapitalised).
Signs of overtrading:
Rapid increase in sales revenue: Wobnig Co’s sales revenue has increased by 40% from $10,375k in 20X0 to $14,525k in 20X1. This rapid growth in revenue is not supported by a similar increase in long-term financing, which has only increased by 4.7% ($16,268k in 20X1 compared to $15,541k in 20X0).
Rapid increase in current assets: Wobnig Co’s current assets have also nearly doubled, increasing from $2,826k in 20X0 to $5,349k in 20X1 (89%). This is striking, given that longterm financing has only increased by 4.7%. Trade receivables have increased by 85% ($1,734k in 20X0 and $3,200k in 20X1), and inventory levels have increased by 97% ($2,149k from $1,092k in 20X0).
Increase in inventory days: Linked to the above, inventory turnover has slowed noticeably, from 60 days in 20X0 to 75 days in 20X1, well above the industry average of 55 days. This may indicate that Wobnig Co is expecting further increases in sales volumes in the future.
Increase in receivable days: Perhaps a matter of greater concern is the fact that trade receivables are being paid much more slowly. Receivable days have increased from 61 days in 20X0 to 80 days in 20X1, again significantly above the industry average. It could be that in order to encourage sales, Wobnig Co has offered more favourable credit terms to its customers. However, the increase in receivable days may also indicate that Wobnig Co is lacking sufficient resources to effectively manage its receivables, and/or that its customers may be unable to settle their debts on time, as they are struggling financially.
Reduction in profitability: Although Wobnig Co’s sales revenue has increased by 40% over the past year, its profit before interest and tax (PBIT) has only increased by 8.9%. The net profit margin has actually decreased, from 36% in 20X0 to 28% in 20X1. This may be due partly to the company selling at lower margins to increase sales volumes, but most likely points to increased costs of sales and operating costs.
With the additional costs associated with holding larger inventories, and increasing financing costs from overdrafts (see below), the company’s profitability is likely to suffer even more in the future.
Increase in current liabilities: Wobnig Co is increasingly financed through current liabilities, which has increased by 131% (from $1,887k in 20X0 to $4,365k in 20X1) while long-term financing has increased only marginally by 4.7%. The sales revenue/net working capital ratio has increased from 11 times to 15 times in 20X1. In particular, overdraft has increased by 500% from 20X0 to 20X1. Payables days have lengthened from 90 days to 100 days, indicating that Wobnig Co is finding it more difficult to settle trade debts.
All of this will put further strain on financing costs, eroding the distributable profits. The company’s interest expense has increased from $292k to $355k.
Reduced liquidity: The cause of Wobnig Co’s increasing dependence on overdrafts and lengthening payables days lies in its reduced liquidity. Wobnig Co’s current ratio has reduced from 1.5 times to 1.2 times, compared to the industry average of 1.7 times. The more sensitive quick ratio has reduced from 0.9 times to 0.7 times, against the average of 1.1 times. Wobnig Co does not yet have a liquid deficit, though, as its current assets still exceed its current liabilities.
Conclusion
From the trends discussed above, we can conclude that Wobnig Co is overtrading.
Workings :
Ratio |
Formula |
20X1 |
20X0 |
Net profit margin |
PBIT/Revenue x 100% |
28% |
36% |
Current ratio |
Current assets/current liabilities |
1.2 times |
1.5 times |
Quick ratio |
(Current assets – inventory)/current liabilities |
0.7 times |
0.9 times |
Inventory days |
Inventory/cost of sales x 365 |
75 days |
60 days |
Receivables days |
Trade receivables/revenue x 365 |
80 days |
61 days |
Payables days |
Trade payables/cost of sales x 365 |
100 days |
90 days |
Net working capital |
Current assets – current liabilities |
$984,000 |
$949,000 |
Revenue/net working capital |
Revenue/net working capital |
15 times |
11 times |
(Note that the Revenue/net working capital ratio can also be calculated excluding cash balances or overdraft.)