Financial Statement Analysis

Ithemba Engineering $($Pty$)$ Ltd $($Ithemba$)$ manufactures and distributes specialised products to customers in the construction industry. Every year, Ithemba invests significantly in research and development to improve existing product designs and to develop new products. Many of its products and designs have been patented to protect the company$$s intellectual property. Ithemba focuses on supplying South African customers. It has supported customers$$ expansion into the rest of Africa and the Middle East and exports represent approximately $10\%$ of annual revenue. Foreign subsidiaries of South African groups are invoiced in US dollar. The construction industry in South Africa has been under significant pressure in recent years due to the slowdown in the global economy and limited infrastructure spend by the government. As a result, Ithemba has struggled to grow revenue during the past three financial years. Steel is the major raw material used by Ithemba in its manufacturing processes. The volatility of this commodity$$s price in recent years has placed additional pressure on the company$$s gross profit margin. Because of this situation working capital management has become increasingly important for Ithemba. More and more customers are placing orders at the last moment, which is forcing Ithemba to hold larger inventories. Customers are also delaying payment of accounts because of cash flow pressures. All sales are on credit and Ithemba allows customers $60$ days from invoice to pay amounts due. The result is that Ithemba$$s overdraft balance has steadily increased in recent years, to the extent that this has become a permanent source of finance. Ithemba currently pays interest on its overdraft at $10\%$ per annum, compounded monthly.

Apart from the overdraft, Ithemba has had no other debt facilities since $20$X$9.$ Bankers are reluctant to grant Ithemba longer term finance due to concerns about the company$$s cash flow generation and the negative outlook for the construction industry in general. The following are extracts from the annual financial statements of Ithemba for the year ended $30$ November $20$Y$2$:

EXTRACT FROM THE STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE YEAR ENDED $30$ NOVEMBER $20$Y$2$

$20$Y$220$Y$1$

R$000$ R$000$

Revenue $248230241000$

Cost of sales $(157580)(144400)$

Gross profit $9065096600$

Bad debts $(5100)(4500)$

Depreciation $(19800)(20100)$

Research and development cost $(10200)(11100)$

Other operating cost $(28750)(26700)$

Operating profit $2680034200$

Finance charges $(12750)(10800)$

Profit before tax R$14505$ R$23400$

EXTRACTS FROM THE STATEMENT OF FINANCIAL POSITION AS AT $30$ NOVEMBER $20$Y$2$

$20$Y$120$Y$2$

R$000$ R$000$

Trade receivables $5100042900$

Total assets $279900264900$

Shareholders$$ equity $152200142100$

Bank overdraft $127500102800$

Inventory $2806021750$

Required:

Analyse and discuss the profitability and working capital management of Ithemba during the financial years ended $30$ November $20$Y$1$ and $20$Y$2.$ Support your answer with relevant calculations and ratios.

Note:

Bank overdraft must be incleded in your analysis and discussion as it normally forms part of working capital. Assume $365$ days in a year and round all days up to the next whole day