Page 27 - CIMA MCS Workbook February 2019 - Day 1 Suggested Solutions

SUGGESTED SOLUTIONS

Smilebrite’s return on capital employed (ROCE) fell from 87.5% in 2017 to 83.7 in 2018. Although
there was a reduction in operating profit from 2017 to 2018, there was also a small increase in
capital employed, combining to reduce the ROCE. There was an increase in long‐term loan finance
from V$1.2m to V$1.5m, with total equity falling slightly from V$5.342m to V$5.199m, with share
capital and share premium remaining unchanged. The reduction in equity was due to the dividend
paid in the year exceeding the retained profit after tax for 2018.

From 2017 to 2018, there was a fall in non‐current asset utilisation (based upon PPE), which fell
from 3.16 times to 3.04 times. In a similar manner to ROCE, growth in revenue was more than
offset by an increase in PPE during the period under review.

However, there is evidence that new assets have been acquired during the year as the carrying
amount of PPE has increased from V$5.652m to V$6.113m, representing an increase of just over
8%. It is unclear whether this represents an increase in capacity, or a replacement for older items
of PPE.

A calculation of the dividend paid in 2018 identifies that a dividend of V$4.207m was paid by
Smilebrite, which exceeded the profit after tax for the year of V$3.884m. There may be an issue
relating to the source of pressure upon Smilebrite to pay such a dividend based upon the profit
after tax for the year.

Financial position
The liquidity position of Smilebrite deteriorated during 2018, with a current ratio of 0.95:1 for
2017, compared with 0.84:1 in 2018. . The quick ratio showed a similar picture, falling from 0.8:1
to 0.7:1 during the same period. Whilst Smilebrite’s (in a similar manner to Crowncare) working
capital management is a consequence of its operating activities, liquidity may become an issue if
any significant cash outflows are necessary, such as payment of income tax, loan repayments or
investment in new PPE. At 31 December 2018, trade receivables accounted for 8.3% of revenue
for the year.

Based upon the available information for Smilebrite, the inventory holding period increased from
10 days in 2017 to 11 days in 2018, with the trade receivables’ collection period remaining
consistent at 30 days over the same period. The trade payables credit period increased slightly
from 17 days in 2017 to 19 days for 2018. There was a slight improvement in the operating cycle
of Smilebrite from (10+30‐17) 23 days in 2017, compared to (11+30‐19) 22 days in 2018

Long‐term loans outstanding increased by V$0.3m from V$1.2m to V$1.5m in 2018, with a
consequent increase in the gearing ratio from 18.3% in 2017 to 22.4% in 2018. There was also a
fall in interest cover to 46.7 times in 2018 from 59.6 times in the preceding year. The increase in
gearing would seem to indicate an increase in financial risk, particularly now that it exceeds 20%.
However, the level of interest cover appears adequate, but may suffer if additional loan finance is
taken out and/or interest rates associated with the loan increase over time and/or there is
continued downward pressure on profitability.

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