IntroductionOver time, businesses accumulate massive amounts of information regarding its financial performance. As a result, it becomes very hard for an individual or the management team to be able to make proper sense of the financial performance of the organization. Ratio analysis is the analysis of the current year’s figures and comparing them with the previous year’s figures and or industry competitors to establish how the business is faring financially. Ratio analysis helps to draw a clear road map of the business’s financial journey and can therefore be used to determine how the business will be managed in the future.
The following is a ratio analysis for the year ending 2009 for Domino’s Pizza, a NYSE traded company. As Joel (2009) illustrates, financial analysis allows the business management team to be able to make wise and prudent business decisions with regard to financial management. This is because the quality of the decisions made depend on optimum values rather than extremes (Maxwell, 2009). For instance, businesses need to use financial leverage for them to be financially healthy, yet, too much financial leverage can harm the financial health of the business.
The question is; how does a manger identify the optimum? That is where financial analysis comes. Groups of financial ratiosThere are many types of financial analysis that can be done on a businesses’ financial information. Liquidity ratios Liquidity ratio, just as the name suggests measures the liquidity of the business. Liquidity ratios offer an insight of the businesses’ ability to meet the various liabilities. As such, current ratio is a comparison of the business’ current assets to its current liabilities. Quick ratio on the other hand looks at the available cash in the business’s vault and compares this with the liabilities that the business has to meet in the near future.
Profitability ratiosProfitability ratios try to show how the business is using its assets to generate money for the owners (stock holders). Thee ratios measure how efficiently, or otherwise the business’s assets are being used to generate profit. They include the Profit Margin Analysis, Effective Tax Rate, Return On Assets, Return On Equity and Return On Capital Employed. Debt ratios Debt ratios are important in indicating the efficiency with which the business is settling its liabilities.
A business has many liabilities arising from supplier debts (debt purchases) and from short, mid term and long term bank loans and bank overdrafts. These debts offer a business the opportunity to use financial leverage. These ratios include the overview of debt, debt ratio, debt equity ratio, capitalization ratio, interest coverage ratio and the cash flow to debt ratio. Operating performance ratiosThese ratios show the efficiency of the business in terms of the way it is converting its stock into revenue.
They also measure the efficiency in which the business is turning its potential sales into actual sales. These ratios include the fixed assets turnover, the sales per employee rate and the operating cycle. Analysis /discussionCurrent ratioDomino’s ratios do indicate that the company may be headed for a financial mess is it was to meet a situation that would interrupt its cash flow even for a short time. However, the needs of the level of the current ratio differ from industry to industry and therefore it might be different for Domino due to the nature of their industry.
A comparison with Pizza Hut, a competitor, shows that this could be an industry average. Pizza Hut has a current ratio of less than one unit of current assets for every unit of current liability. This can be explained by the fact that the operations of a pizza hut are much more dynamic as compared to other industries such as manufacturing. However, Domino’s current assets are diminishing as evidenced from the transition between years 2008 and 2009. This trend should therefore be addressed carefully to make sure that it does not lead to a financial black hole (Gibson, 2009).