e50 Ways in we prove its gross proti Yolume and or reduce cost of goods sold. (c) valuation of inventories is crucial in determining cost of goods sold for a period and thus the gross profit (4) An unexpected reduction in the gross profit ratio should be taken seriously. It may be the sign of any or all of the following situations on which action should be taken: (a) Careless inventories control leading to losses and pilferage of inventories; (b) An error in the inventories taking records, (c) Defalcation of cash received from sales. (d) Rising costs which have not been passed on to customers in higher prices. (5) Insofar as gross profit ratio is regarded as a measure of the effectiveness of the basic profit earning process, an increase is a good thing. The question is whether this is a genuine improvement or whether it represents a recovery from a setback. This could be determined by examining accounts over a series of years from the past. The gross profit ratio should also be considered in the context of the absolute value of gross profit. A gross profit ratio could be considerably improved by increasing prices to the final customer. If, in a competitive situation, however, this will indicate a more than proportionate decline in sales. In effect, total profitability might be reduced. Illustration 79 K Ltd manufactures auto parts. The company sells its products to a number of independent distributors who resell the goods to garages and other retail outlets in their areas. K ltd has a policy of having only one distributor in any given geographical area. Distributors are selected mainly on the basis of financial viability. K Lid is keen to avoid the disruption of sales and loss of credibility associated with the collapse of a distributor. The company is currently trying to choose between two companies which have applied to be its sole distributor in Noida U.P., a new sales area. The applicants have supplied the following information: Particulars Company A Ltd Company B LA 2015 2016 2017 2015 2016 2017 Sales Rin Lakhs) 12,80 16,00 20,00 18.05 19,00 20,00 Gross Profit (%) 22 20 18 23 22 24 Return on Capital Employed (%) 8 12 16 14 15 Current Ratio 1.7:1 19:1 21:1 17:1 1.65:1 17:1 Liquid Ratio 14:1 1.1:1 0.9:1 0.9:1 0.9:1 0.9:1 Gearing (%) 21 28 29 30 Requirement: Using the information provided above, explain which of the companies appears to be the safer choice for the rate of distributors. 16 15 27