Flora wants to expand and diversify its activities and is considering the acquisition of another entity to help do this. Following extensive research, Flora has identified two potential acquisition targets Nevea and Autz. Both companies operate in the same industry and have the same financial year end. Nevea primarily sells to retail stores whereas Autz sells to internet retailers. Both Nevea and Autz can be purchased at approximately the same amount.

Extracts of the financial statements of Nevea and Autz for the year ended 31 May 2020 are shown below:

Extract from the statements of profit or loss

	Nevea		Autz
	000		000
Revenue	23,975		15,375
Cost of sales	10,662		9,775
Gross profit	13,313		5,600
Operating expenses	7,538		3,346
Profit from operations	5,775		2,254
Finance costs	288		480
Profit before tax	5,487		1,774

Extract from the statements of financial position

	Nevea		Autz
	000		000
Property, plant & equipment	11,700		14,945
Investments	Nil		5,440
Inventory	1,640		874
Receivables	3,700		720
Cash at bank	840		487
Equity	10,575		12,766
Non-current liabilities (loan)	4,200		8,000
Current liabilities	3,800		1,700

The following information is relevant:

1. Nevea has an established, loyal customer base whereas Autz sells to numerous customers on a less regular basis.

2. Nevea accounts for its property using the cost model per IAS 16 Property, Plant & Equipment, whereas Autz uses the revaluation model.

3. Nevea disposed of property during the year resulting in a loss on disposal of 1.2 million (included in the profit or loss extracts above).

4. Included within Autzs non-current liabilities is a 3 million loan note that is due to be repaid in July 2021.

REQUIRED:

1. Calculate the following ratios for both companies:

• Return on capital employed

• Asset turnover

• Gross profit margin

• Operating profit margin

• Current ratio

• Quick ratio

• Inventory turnover period (days)

• Receivables collection period (days)

• Gearing

• Interest cover

(10 marks)

2. Prepare a report for the directors of Flora that analyses the performance and position of Nevea & Autz using the ratios calculated in part (a) and the information available in the scenario.

You should reach a conclusion and make a recommendation to Flora which company it should invest in.

(30 marks)

3. Using relevant research identify and explain the potential limitations in using ratio analysis for comparison purposes between entities.