Syarikat Vista Berhad: Profit Fell While Revenue Grew
Syarikat Vista Berhad supplies laboratory equipment and has 500,000 ordinary shares of RM1 in issue. The board is negotiating a new term loan, and the managing director has circulated the summary below, describing 20X5 as 'a year of strong growth'.
| RM'000 | 20X5 | 20X4 |
|---|---|---|
| Revenue | 1,200 | 1,000 |
| Gross profit | 360 | 330 |
| Profit from operations | 150 | 140 |
| Finance cost | 40 | 25 |
| Profit after tax | 80 | 90 |
| Non-current assets | 900 | 700 |
| Inventory | 180 | 150 |
| Receivables | 200 | 160 |
| Cash | 20 | 40 |
| Ordinary shares of RM1 | 500 | 500 |
| Retained earnings | 250 | 190 |
| 10% loan notes | 400 | 250 |
| Current liabilities | 150 | 110 |
The finance director has proposed a dividend of 8 sen per share, arguing that it is affordable because 'there is RM250,000 of retained earnings and the bank balance is positive'.
1. Calculate, for both years, the gross profit margin, operating profit margin, ROCE, gearing, interest cover, current ratio and receivables collection period. State the formula used.
Read the worked answer
Cost of sales: 20X5 = 1,200 − 360 = 840; 20X4 = 1,000 − 330 = 670. Capital employed = equity + loan notes.
| Ratio | Formula | 20X5 | 20X4 |
|---|---|---|---|
| Gross profit margin | GP / revenue | 30.0% | 33.0% |
| Operating profit margin | operating profit / revenue | 12.5% | 14.0% |
| ROCE | operating profit / (equity + loan notes) | 150/1,150 = 13.0% | 140/940 = 14.9% |
| Gearing | loan notes / (equity + loan notes) | 400/1,150 = 34.8% | 250/940 = 26.6% |
| Interest cover | operating profit / finance cost | 3.75 times | 5.6 times |
| Current ratio | current assets / current liabilities | 400/150 = 2.67 | 350/110 = 3.18 |
| Receivables days | receivables / revenue x 365 | 60.8 days | 58.4 days |
Other useful figures: inventory days 78.2 (20X5) vs 81.7 (20X4); payables days 52.1 vs 59.9; EPS 16 sen vs 18 sen.
Check the arithmetic carefully: gearing uses total capital employed in the denominator, not equity alone (400/750 = 53% is a different, debt-to-equity measure - state which one you are using). ROCE must use operating profit, before finance cost and tax, otherwise the comparison is distorted by the change in borrowing.
2. Evaluate the managing director's claim that 20X5 was 'a year of strong growth'.
Read the worked answer
Revenue grew 20% (1,000 to 1,200) - that part is true - but almost every measure of quality fell.
- The margin squeeze, not the interest, is the main story. Gross margin fell from 33.0% to 30.0%. Cost of sales rose 25.4% (670 to 840) against revenue growth of 20%, so RM1 of sales now generates 30 sen of gross profit instead of 33 sen. Administration and distribution costs were actually well controlled (210 vs 190, i.e. 17.5% of revenue vs 19.0%), so the fall in the operating margin from 14.0% to 12.5% is driven by gross margin, not overheads.
- ROCE fell from 14.9% to 13.0% even though the asset base grew by RM200,000. The new assets are not yet earning their keep.
- Risk has risen sharply. Gearing rose from 26.6% to 34.8% and interest cover collapsed from 5.6 times to 3.75 times. A 3.75-times cover is thin for a capital-intensive supplier; a further fall in operating profit of about 73% of the current finance cost would wipe out cover entirely.
- Liquidity weakened: the current ratio fell from 3.18 to 2.67, cash fell from RM40,000 to RM20,000, and receivables days lengthened to 60.8, even though payables were paid faster (52.1 days vs 59.9). That combination explains the cash outflow.
- Only inventory days improved (81.7 to 78.2) and EPS fell from 18 sen to 16 sen.
Conclusion: growth in volume, deterioration in profitability, efficiency and solvency. The phrase 'strong growth' describes revenue only and would not survive scrutiny by a lender.
3. Advise the board on the proposed 8 sen dividend, and state the limitations of your analysis.
Read the worked answer
The dividend. 8 sen x 500,000 shares = RM40,000, which is 50% of the RM80,000 profit after tax and is legal - the company has RM250,000 of retained earnings, so it is distributable. Affordability is a different question:
- Cash at the year end is only RM20,000, and RM150,000 of current liabilities (including tax) fall due shortly; receivables have stretched to 61 days. Paying RM40,000 would require the overdraft or delay of creditor payments.
- Interest cover is 3.75 times and a new term loan is being negotiated; a lender will expect cash to be retained, and a covenant may restrict distributions.
- The dividend would reduce retained earnings to RM210,000, weakening the equity base against gearing already at 34.8%.
Recommendation: declare a smaller dividend (for example 3 sen, RM15,000), or defer the decision until the loan is agreed and receivables are collected. Ensure the dividend is not paid out of capital.
Limitations of the analysis:
- No industry averages or competitor figures, so we cannot say whether a 30% gross margin is good or poor for laboratory equipment supply.
- Only two years are compared, and both are historical cost; ROCE is distorted if the 20X4 assets are older and more depreciated than the new 20X5 assets.
- No statement of cash flows, so the cash movement is inferred rather than analysed.
- Accounting policies (revenue recognition, inventory valuation, depreciation) are not given, and a policy change could explain part of the movement.
- Ratios are a starting point for questions, not conclusions.