Question 26.Q6: The income statements for Egriff are given below.
The income statements for Egriff are given below.
Egriff issued loan notes during the year to fund the expansion of the business. Non-current assets have increased from $3.8 million in 20X3 to $4.6 million in 20X4.
Required
(a) Calculate the following ratios for Egriff for both years.
(i) Gross profit percentage
(ii) Net profit percentage
(b) Comment on the success of the business expansion using the ratios you have calculated.
| 31 May 20X3 | 31 May 20X4 | |||
| $’000 | $’000 | $’000 | $’000 | |
| Revenue | 20,000 | 26,000 | ||
| Cost of sales | (15,400) | (21,050) | ||
| Gross profit | 4,600 | 4,950 | ||
| Expenses | ||||
| Administrative | 800 | 900 | ||
| Selling and distribution | 1,550 | 1,565 | ||
| Depreciation | 110 | 200 | ||
| Loan note interest | – | 105 | ||
| (2,460) | (2,770) | |||
| Net profit | (2,140) | (2,180) | ||
(a)
(i) Gross profit percentage \frac{\text { Gross profit }}{\text { Sales }} \times 100
20X3 20X4
\frac{4,600}{20,000} \times 100=\quad 23.00 \% \quad \frac{4,950}{26,000} \times 100=19.04 \%(ii) Net profit percentage \frac{\text { Net profit }}{\text { Sales revenue }} \times 100
20X3 20X4
\frac{2,140}{20,000} \times 100=10.70 \% \quad \frac{2,180}{26,000} \times 100=8.38 \%(b) The information given shows an expansion of the business in absolute terms, for example revenue and non-current assets have increased. However, the profitability ratios have deteriorated. Both gross profit percentage and net profit percentage have gone down.
The deterioration in the gross profit percentage may have arisen because margins are being squeezed in order to boost revenue, which has indeed increased. Costs have also increased.
The decrease in net profit percentage arises partly because the gross profit percentage has decreased, but the main component of this is an increase in depreciation, as a result of the investment in non-current assets.