Photo AI
LMX Ltd has provided the information in the table as at 30 June 2010: | | LMX Ltd | Industry average | |------------------------|---------|------------------| | Debt to equity | 0.5 : 1| 0.7 : 1 | | Accounts receivable turnover ratio | 52 days | 26 days | | Return on owners’ equity | 12% | 40% | | Gross profit ratio | 60% | 55% | (a) Outline ONE advantage for LMX Ltd of using comparative ratio analysis - HSC - SSCE Business Studies - Question 25 - 2010 - Paper 1
Question 25
LMX Ltd has provided the information in the table as at 30 June 2010: | | LMX Ltd | Industry average | |------------------------|---------|--... show full transcript
Worked Solution & Example Answer:LMX Ltd has provided the information in the table as at 30 June 2010: | | LMX Ltd | Industry average | |------------------------|---------|------------------| | Debt to equity | 0.5 : 1| 0.7 : 1 | | Accounts receivable turnover ratio | 52 days | 26 days | | Return on owners’ equity | 12% | 40% | | Gross profit ratio | 60% | 55% | (a) Outline ONE advantage for LMX Ltd of using comparative ratio analysis - HSC - SSCE Business Studies - Question 25 - 2010 - Paper 1
Step 1
Outline ONE advantage for LMX Ltd of using comparative ratio analysis.
Answer
One advantage of using comparative ratio analysis for LMX Ltd is that it allows the company to benchmark its financial performance against industry standards. This comparison can highlight areas of strength, such as the gross profit ratio of 60% which is higher than the industry average of 55%. Such insights can guide management in making informed decisions to enhance financial strategies and operational efficiencies.
Step 2
Explain the effect of the proposed extension on LMX Ltd’s efficiency.
Answer
Extending credit terms from 30 days to 90 days can significantly impact LMX Ltd's cash flow and accounts receivable turnover ratio. Currently, LMX Ltd has a turnover ratio of 52 days, which indicates that it takes longer than the industry average of 26 days to collect debts.
With the proposed extension, the collection period will increase, potentially further extending the 52-day turnover period. This may lead to delayed cash inflows, affecting the company's liquidity. Consequently, LMX Ltd might struggle to meet its short-term obligations, impacting its overall efficiency and increasing the risk of bad debts.
Moreover, the extension could reduce the company's competitive edge if it struggles to manage its cash flow effectively compared to competitors. It's essential for LMX Ltd to weigh these potential risks against the benefits of securing a significant customer.