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The following is an extract from financial reports for Andrew’s Discount Tyres as at 30 May 2015 - HSC - SSCE Business Studies - Question 24 - 2015 - Paper 1
Question 24
The following is an extract from financial reports for Andrew’s Discount Tyres as at 30 May 2015. Current assets Accounts receivable 1 000 Inventory 2 000 Cash 2... show full transcript
Worked Solution & Example Answer:The following is an extract from financial reports for Andrew’s Discount Tyres as at 30 May 2015 - HSC - SSCE Business Studies - Question 24 - 2015 - Paper 1
Step 1
Explain ONE possible limitation of this financial report.
Answer
One limitation of this financial report may be that it capitalises research and development expenses. This means that instead of expensing these costs in the current period, they are treated as assets on the balance sheet. This can lead to an inflated asset value, making the company's financial position appear stronger than it may really be. Such an approach could mislead stakeholders, as it does not accurately reflect the company’s immediate financial situation.
Step 2
Discuss the gearing of Andrew’s Discount Tyres.
Answer
Gearing refers to the ratio of a company's debt to its equity. In the case of Andrew’s Discount Tyres, we first need to calculate total liabilities and total equity:
- Total Liabilities = Current Liabilities + Non-Current Liabilities = (Overdraft + Accounts Payable + Mortgage) = (2000 + 1000 + 5000) = 8000
- Total Equity = Owner’s Equity = 16000
The gearing ratio can be calculated using the formula:
Substituting the values, we get:
This indicates that only 33.33% of the company’s capital is financed through debt, which is significantly below the industry average gearing ratio of 80%. This suggests that Andrew’s Discount Tyres is conservatively financed and may have lower financial risk compared to its peers in the industry. However, it may also mean that they are not leveraging debt effectively to grow the business.