Sapiria Sdn Bhd (SSB) produces dairy products and has seasonal working capital requirements. These have been...

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Sapiria Sdn Bhd (SSB) produces dairy products and has seasonal working capital requirements. These have been financed mainly by a bank loans and overdraft facilities, now totalling RM1.2 million. A limit on dairy product prices and a new contract with the unions, which increased wages, caused a fall in the company's profit during the second half of 2021 and most of financial year 2022. Sales increase over both these years due to an aggressive marketing strategy. In early financial year 2023, the company's bank manager became aware of the deteriorating financial positions of SSB by studying a ratio analysis from the bank's computer system. This showed that certain key ratios, taken from the quarterly management account, were falling below the average for the industry and were moving downwards. The manager sent a copy of the analysis to the SSB's managing director together with a letter expressing his concern, although none of the ratios had fallen below the level specified in the loan agreement. Three months later, the next analysis showed that the current ratio had fallen below 2.0, the limit specified in the agreement. Legally, the bank could take action if the loan was not repaid in full within one month. The bank manager again forwarded the analysis to the managing director. However, this time the accompanying letter said that the bank would insist on immediate repayment of the loan unless the company could show how the financial position could be improved. The managing director said that the present level of sales could not be continued without spending RM500,000 on extra plant and machinery in July 2023. This would need an increase in the loan and overdrafts from RM1.2 million to RM1.7 million. It is now July 2023. The accounts for the year ended 31 December 2022 are as follows: Sapiria Sdn Bhd Statement of Financial Position at 31 December 2022 2022 RM '000 2021 RM '000 2020 RM '000 2019 RM '000 Fixed assets Land and buildings 510 540 200 260 Plant and machinery 430 490 630 740 Fixtures and fittings 20 30 120 200 960 1,060 950 1,200 Current assets Inventories 3,440 2,130 1,280 850 Trade receivables 1,620 1,160 1,020 680 Cash at bank 80 120 260 170 5,140 3,410 2,560 1,700 Current liabilities Trade payables 1,750 1,050 800 620 Bank overdraft 590 130 0 0 2,340 1,180 800 620 Net current assets 2,800 2,230 1,760 1,080 Total assets Less: Current liabilities 3,760 3,290 2,710 2,280 Non-current liabilities Bank loan 600 300 0 3,160 2,990 2,710 2,280 Capital and reserves Issued share capital 850 850 850 850 Accumulated profit 1,630 1,460 1,180 750 Other reserves 680 680 680 680 3,160 2,990 2,710 2,280 Sapiria Sdn Bhd Income Statement for the year ended 31 December 2022 2022 RM '000 2021 RM '000 2020 RM '000 Turnover 11,900 11,470 11,050 Cost of Sales 9,520 9,180 8,840 Gross profit 2,380 2,290 2,210 Distribution cost 140 130 110 Administration expenses 1,780 1,560 1,250 Operating profit 460 600 850 Interest payable 120 30 0 Profit before tax 340 570 850 Tax 100 170 250 Net profit 240 400 600 Note: depreciation 510 430 510 Industry average ratios for 2021-2022 Gearing (debt:equity) 0.5 Quick ratio 1 Current ratio 2.5 Inventory turnover 6 times Debtor asset turnover 33 Fixed asset turnover 13 times Total asset turnover Return on total assets Profit margin 2.6 9.0 % 3.5 % RATIO 2022 2021 2020 Ratio of net income 0.159 0.121 0.088 to assets Gearing debt equity 0.352 0.705 Quick ratio Current 0.73 1.084 1.6 assets Current ratio 2.19 2.889 3.2 Return on equity 282 470 0.705 a) Discuss: i) ii) the strengths and weaknesses that revealed by these ratios and explain the sources of internal funds that are available to pay off the company's bank loan Sapiria Sdn Bhd (SSB) produces dairy products and has seasonal working capital requirements. These have been financed mainly by a bank loans and overdraft facilities, now totalling RM1.2 million. A limit on dairy product prices and a new contract with the unions, which increased wages, caused a fall in the company's profit during the second half of 2021 and most of financial year 2022. Sales increase over both these years due to an aggressive marketing strategy. In early financial year 2023, the company's bank manager became aware of the deteriorating financial positions of SSB by studying a ratio analysis from the bank's computer system. This showed that certain key ratios, taken from the quarterly management account, were falling below the average for the industry and were moving downwards. The manager sent a copy of the analysis to the SSB's managing director together with a letter expressing his concern, although none of the ratios had fallen below the level specified in the loan agreement. Three months later, the next analysis showed that the current ratio had fallen below 2.0, the limit specified in the agreement. Legally, the bank could take action if the loan was not repaid in full within one month. The bank manager again forwarded the analysis to the managing director. However, this time the accompanying letter said that the bank would insist on immediate repayment of the loan unless the company could show how the financial position could be improved. The managing director said that the present level of sales could not be continued without spending RM500,000 on extra plant and machinery in July 2023. This would need an increase in the loan and overdrafts from RM1.2 million to RM1.7 million. It is now July 2023. The accounts for the year ended 31 December 2022 are as follows: Sapiria Sdn Bhd Statement of Financial Position at 31 December 2022 2022 RM '000 2021 RM '000 2020 RM '000 2019 RM '000 Fixed assets Land and buildings 510 540 200 260 Plant and machinery 430 490 630 740 Fixtures and fittings 20 30 120 200 960 1,060 950 1,200 Current assets Inventories 3,440 2,130 1,280 850 Trade receivables 1,620 1,160 1,020 680 Cash at bank 80 120 260 170 5,140 3,410 2,560 1,700 Current liabilities Trade payables 1,750 1,050 800 620 Bank overdraft 590 130 0 0 2,340 1,180 800 620 Net current assets 2,800 2,230 1,760 1,080 Total assets Less: Current liabilities 3,760 3,290 2,710 2,280 Non-current liabilities Bank loan 600 300 0 3,160 2,990 2,710 2,280 Capital and reserves Issued share capital 850 850 850 850 Accumulated profit 1,630 1,460 1,180 750 Other reserves 680 680 680 680 3,160 2,990 2,710 2,280 Sapiria Sdn Bhd Income Statement for the year ended 31 December 2022 2022 RM '000 2021 RM '000 2020 RM '000 Turnover 11,900 11,470 11,050 Cost of Sales 9,520 9,180 8,840 Gross profit 2,380 2,290 2,210 Distribution cost 140 130 110 Administration expenses 1,780 1,560 1,250 Operating profit 460 600 850 Interest payable 120 30 0 Profit before tax 340 570 850 Tax 100 170 250 Net profit 240 400 600 Note: depreciation 510 430 510 Industry average ratios for 2021-2022 Gearing (debt:equity) 0.5 Quick ratio 1 Current ratio 2.5 Inventory turnover 6 times Debtor asset turnover 33 Fixed asset turnover 13 times Total asset turnover Return on total assets Profit margin 2.6 9.0 % 3.5 % RATIO 2022 2021 2020 Ratio of net income 0.159 0.121 0.088 to assets Gearing debt equity 0.352 0.705 Quick ratio Current 0.73 1.084 1.6 assets Current ratio 2.19 2.889 3.2 Return on equity 282 470 0.705 a) Discuss: i) ii) the strengths and weaknesses that revealed by these ratios and explain the sources of internal funds that are available to pay off the company's bank loan