Reviving Perabot Sinar Kayu's Position

Analysis and Interpretation of Financial Statements for Decision Making

Skill: Create

Stimulus

Question

(a) Based on the table, identify TWO main financial problems faced by Perabot Sinar Kayu Enterprise in 2023 and use the ratio figures as evidence.

(b) Propose THREE improvement measures Encik Zulhilmi could take. For each proposal, explain the cause-and-effect link, that is, how the action restores the related ratio.

(c) Explain why taking a short-term loan to finance assets is NOT a good solution to this business's liquidity problem.

Thinking steps

1. Read each ratio and compare the 2022 value with 2023. Decide the direction of change (up/down) and whether it signals improvement or deterioration.
2. Group the ratios by aspect: liquidity (current, quick), efficiency (inventory turnover, debtors collection period) and profitability (gross and net profit margin).
3. Identify the most critical problems (quick ratio below 1:1 and cash tied up in inventory and debtors), because these are the source of cash-flow risk.
4. Find the cause behind each problem, not just the symptom: e.g. net profit falling while gross profit is stable means rising operating expenses.
5. Propose a specific improvement for each cause and state the expected effect on the related ratio (link cause → action → effect).
6. Check that the proposals do not conflict, e.g. taking short-term loans would worsen the current ratio, so avoid it.

Model answer

PROBLEM IDENTIFICATION (analysing the evidence):

1) Liquidity has deteriorated sharply: the current ratio fell from 2.5:1 to 1.2:1 and the acid-test (quick) ratio from 1.5:1 to 0.5:1. A quick ratio below 1:1 means that, without selling inventory, the business cannot meet its current liabilities; there is a cash-flow risk.

2) Operating efficiency and profitability have fallen: inventory turnover dropped from 6 times to 3 times (stock is piling up / slow-moving), the debtors collection period lengthened from 30 to 60 days (slow collection), and net profit margin fell from 15% to 7% even though gross profit margin fell only slightly, showing operating expenses rose relative to sales.

PROPOSED IMPROVEMENTS (creating; each linked from cause to effect):

a) Tighten credit and collection policy: set a maximum 30-day credit term and offer a cash discount for early payment. Cause-effect: shortens the debtors collection period → cash comes in faster → raises the quick ratio and liquidity.

b) Manage inventory actively: clear/promote slow-moving goods and buy according to actual demand. Cause-effect: raises inventory turnover → less capital tied up in stock → more cash and lower risk of obsolete stock.

c) Control operating expenses: review fixed costs (e.g. rent, wages, utilities) and cut waste. Cause-effect: lowers total expenses → restores the net profit margin even if sales stay the same.

SHORT-TERM LOAN (part c): A short-term loan is a current liability. Using it to buy assets adds to current liabilities without adding current assets, so the current and quick ratios fall further, and the loan must be repaid within a year from cash the business is already short of. Assets should be financed with capital or a long-term loan so the current ratio can recover to a safe level (around 2:1).

CONCLUSION: The root cause is cash tied up in slow-moving inventory and late-paying debtors, plus rising operating expenses. The measures above tackle these causes directly and restore both liquidity and profitability.