Gaborone Hardware: Ratios That Do Not Compare
Gaborone Hardware's summarised results for the year ended 31 December 2024 were: revenue P840,000, gross profit P252,000, profit for the year P58,800, inventory P96,000, trade receivables P140,000, trade payables P84,000, bank P24,000 and current liabilities P130,000. At 31 December 2023 inventory was P60,000. In 2023 the gross profit margin was 33%, inventory was held for 40 days, receivables were collected in 45 days and payables were paid in 48 days. During 2024 the firm changed from the weighted average method to FIFO for valuing inventory; this increased the closing inventory figure by P18,000 and the gross profit by the same amount. The owner is pleased that sales have grown and cannot understand why the bank balance is falling.
1. Calculate for 2024: the gross profit margin, inventory turnover in days, the receivables collection period, the payables payment period and the current ratio. Show your workings.
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Workings
- Cost of sales = 840,000 − 252,000 = P588,000
- Average inventory = (60,000 + 96,000) ÷ 2 = P78,000
- Current assets = 96,000 + 140,000 + 24,000 = P260,000
| Ratio | Working | 2024 |
|---|---|---|
| Gross profit margin | 252,000 ÷ 840,000 × 100 | 30% |
| Mark-up (for reference) | 252,000 ÷ 588,000 × 100 | 42.9% |
| Inventory turnover | 588,000 ÷ 78,000 = 7.54 times; 365 ÷ 7.54 | 48.4 days |
| Receivables collection period | 140,000 ÷ 840,000 × 365 | 60.8 days |
| Payables payment period | 84,000 ÷ 588,000 × 365 | 52.1 days |
| Current ratio | 260,000 ÷ 130,000 | 2:1 |
Note: some candidates use closing inventory only for turnover (588,000 ÷ 96,000 = 6.13 times, 59.6 days). Either is acceptable if stated and applied consistently; the average-inventory version is preferred because it matches the stock held through the year.
2. Comment on what has happened to the working capital cycle between 2023 and 2024, and explain how this helps explain the falling bank balance.
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The cash operating cycle = inventory days + receivables days − payables days.
| 2023 | 2024 | Change | |
|---|---|---|---|
| Inventory days | 40 | 48.4 | +8.4 |
| Receivables days | 45 | 60.8 | +15.8 |
| Payables days | 48 | 52.1 | +4.1 |
| Cash cycle | 37 days | 57.2 days | +20.2 days |
The cycle has lengthened by about 20 days. The firm now waits far longer to be paid by customers (from 45 to about 61 days) and holds stock for longer. Taking about four extra days of supplier credit partly offsets this, but nowhere near enough.
This is precisely why the bank balance is falling while sales rise: profit is not cash. Each extra day of the cycle locks up roughly 840,000 ÷ 365 ≈ P2,300 of cash, so 20 days represents well over P40,000 tied up in stock and debtors rather than sitting in the bank. Growth itself absorbs cash - higher sales require higher stock and higher receivables, and the firm must also pay its suppliers in cash. The owner should tighten credit control, chase overdue accounts, review slow-moving stock and consider whether the gross margin can bear the extra financing cost.
3. Explain why the 2024 ratios are not strictly comparable with 2023, and show how one key ratio changes if the effect of the accounting policy change is removed.
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Why comparability is broken Ratios are only meaningful if the figures behind them are prepared on the same basis (the consistency convention). The firm switched from weighted average to FIFO during 2024, and FIFO raised closing inventory by P18,000 and gross profit by P18,000. That single policy change flatters both the gross profit margin and the inventory days, for two reasons:
- Profit includes an P18,000 gain that arises purely from the valuation method, not from trading.
- The 2024 closing inventory is measured on a different basis from the 2023 closing inventory, so the average inventory figure mixes two methods.
Restating for the policy change
- Restated gross profit = 252,000 − 18,000 = P234,000 → margin = 234,000 ÷ 840,000 = 27.9%, i.e. about 5 points below the reported 30% and well below the 2023 figure of 33%. The apparent resilience of the margin is largely an accounting artefact.
- Restated cost of sales = 588,000 + 18,000 = P606,000.
- Restated closing inventory = 96,000 − 18,000 = P78,000; average inventory = (60,000 + 78,000) ÷ 2 = P69,000; turnover = 606,000 ÷ 69,000 = 8.78 times → 41.6 days, close to the 2023 figure of 40 days. On a like-for-like basis, stock control has barely changed - the deterioration is in receivables, not inventory.
What the owner should do Before drawing conclusions: restate prior-year figures on the new basis (or both years on the old basis), disclose the change and its effect in the notes, and then compare. Additional information would also help - a break-down of receivables by age, the credit terms offered, the split between cash and credit sales, and a cash flow statement, since a profit figure alone cannot explain the falling bank balance.