Liquidity, Profitability and Financial Stability of Jitterbug Pty Ltd - Assignment Example

Save this file under a name unique to you. Preferably start the file name with your family name and first name and the relevant year and study period. Highlight and delete this message. [ENTER THE TITLE OF THE REPORT INCLUDING THE NAME OF THE BUSINESS BEING INVESTIGATED] for [Enter the name of the client] [Enter the date of submission] prepared by [Enter your name] Executive Summary The idea of this essay is to evaluate liquidity, profitability and financial stability of Jitterbug Pty Ltd for the purpose of making recommendations to the bank as to whether the company qualifies for the loan or not. To determine whether the company qualifies for the loan, the paper analysis different ratios. To determine the profitability, we use gross profit margin ratio, operating profits margin, return on assets, and return on equity. In determining the liquidity position of the firm, we use current ratios, quick ratios, accounts receivable ratios and inventory turnover ratios. In determining financial stability, we use the debt ratios, equity ratios, times interest earned ratios. We also use percentage analysis and compare them with the ratios to acquire an apparent understanding of how the company has been performing over the three year period. After analysing the company, it is clear that it has good liquidity, profitability and financial stability. This paper also looks at the shortcomings of using ratio analysis to determine the performance of the company. Is also gives recommendations of the additional information needed to make clear judgments of the performance of the company. Contents To update the page numbers in the contents table below, when you have completed your report: - left click on the table below - right click and select Update Field - ensure “Update page numbers only” is selected - click OK Highlight and delete this message. Introduction Mr. Shane Long purchased Jitterbug Pty Ltd, a Jazz and Jive club. Since he acquired it, he has introduced major efficiency measures, aimed at cutting costs and improving profitability. He has also undertaken a major upgrade project to improve the outlook of the building. Mr. Shane has requested for a $600,000 loan. The thought of this essay is to assess the profitability, liquidity and financial stability of the company. This paper is limited to evaluating the position of the company using financial statements for three years only. Profitability These are ratios used to measure a firm's effectiveness and performance, in relation to how a firm generates returns from sales and investments. They measure the firm's ability to generate revenue as compared to expenses and other cost incurred over the accounting period. This is average; the percentages do not change with a high margin. This means that the firm is profitable. High operating returns margin indicates that the firm is relatively liquid. Interesting to note that the firm has improved over the period 2008 to 2009 by a big margin. This means that the profitability of the firm has been improving and the firm is managing to keep the costs of operation under control. 2. Price-earning ratios and dividend ratios. Price earnings ratio measures the price of shares relative to net profits of the company. It compares the current market price with the share price. The dividends payout ratio calculates the rate at which companies reward the shareholders in the form of dividends. When a firm has a high dividend payout ratio, then shareholders get higher dividends. In this case, Jitterbug Pty Ltd has a P/E ratio of more than one meaning that the market can pay more for the shares. In addition, the company is capable of paying high dividends to the investors, meaning that the company is performing profitably (Accounting for management, 2011). 3. Conclusion and sub-conclusion on the profitability of the firm. From the above analysis, the Jitterbug Pty Ltd is profitable. It is capable of meeting its current obligations and payout dividends to shareholders. Liquidity 1. The firm can be said to be in good liquidity conditions. This is because, over the three years, the company has been able to have enough assets to pay the current liabilities. The reduction in the current ratios over the years indicates the firm is utilizing the cash more efficiently instead of holding it in the company. 2. From the percentage analysis of assets and liabilities, the current ratios are reducing as a result of decrease in a number of the assets over the years, like cash and prepaid expenses and the increase of currents liabilities at a higher margin. 3. Accounts receivable ratio- accounts receivable turnover ratios are used to find out the how many times the debts/ accounts receivables will be collected in a year. The higher the ratio, the higher the number of times credit is collected indicating a tight credit policy. The figures for Jitterbug Pty Ltd indicate that the firm has a good collection policy (Siddiqui, 2006, p.89). 4. Inventory turnover ratio - The inventory turnover ratios determine the number of times the inventory of a company can be replaced and sold over a specific period of time. As the percentage of inventories increases, the inventory turnover ratios decrease. This is because, as more inventories are sold, the need for replacement arises thus the inventory turnover ratios increases. 5. Conclusion - Jitterbug Pty Ltd has good liquidity positions. This is because, it is has enough assets to meet its current obligations and the rate of collecting accounts receivable is good. This means the company is liquid. Financial Stability i. Over the period of the three years, the company's leverage has gone up, meaning that the company is purchasing more inventories in credit. This is confirmed by the equity ratios. Over the years, the total liabilities have increased from 100% in 2008 to 112% in 2009 to 129% in 2010. Total assets on the other hand, have not increased by the same margin, while paid up capital remains constant over the three years. This explains the changes in the ratios (Brigham & Houston, 2008, p.24). ii. By analyzing the percentages of equity and liabilities, there has been an increase trend in the liabilities; they have changed from 100% to 112% to 129%. However, there has been no trend in equity, since it has remained the same from 2008 to 2010. The trend can be interpreted as the firm is purchasing more inventories in credit since the long-term liability remains constant. iii. Times interest earned ratio assesses the solvency of a firm over a long period of time. It measures the ability of the firm to meet the interest expenses. The times interest earned ratio is too high. The generally accepted ratio ranges from 3 to 5. This may mean that the firm is unreasonably cautious in debt to finance its capital or the firm takes a lower risk than the average market risk, which in return, reduces the returns. The liability items that would affect the interest expense are the long-term liabilities. They have not changed offer the three years, meaning that the interest expense goes on reducing year after year. Iv. Asset turnover ratio. This ratio assesses the amount of revenue generated by every unit of a company's asset. These ratios show that the firm is not very efficient in utilizing the fixed assets to generate revenues. In 2008, the ratio was below 1 meaning that the firm was very inefficient. It improved slightly over the next two years but the firm is still inefficient since the industry's' turnover is 4.2 times. The items affecting this ratio are fixed assets and sales. Sales increased slightly in 2009 and then it reduced in 2010. The fixed assets on the other had, dropped in 2009 but the increased in 2010. This explains the fluctuations in the ratio over the three years. v. Conclusion. The company has a good financial stability. Conclusion Jitterbug Pty Ltd is a company which has good liquidity. It has the ability to convert its current assets into cash to pay the current liabilities. Moreover, the company has good inventory turnover, meaning that the company is not storing much inventory in the store. In addition, the collection rate of the accounts receivable is impressive. The company's financial stability is commendable. The company is able to generate enough earnings to pay interest expenses, and can still commit itself to more debt since the times interest earning ratio is high. The market is willing to pay to pay for the share and it is also able to get extra income to pay the shareholders and retain part of earnings for investments. It is also able to invest the assets wisely to produce revenue to pay up the liabilities; this means that the Company is also profitable and can qualify for the loan. Recommendation I recommend that Jitterbug Pty Ltd be awarded the loan of $600000. I have certified that the company good liquidity, profitability and financial stability. It will be possible for the company to raise enough revenues to repay the interests on the bank loan. Moreover, the company is planning to start operating the company during the day, and this will improve the profitability of the company. Appendix – Part C Shortcomings in using financial statements analysis i. Shortcomings of financial statements- most of the analysis is done by analyzing the information in the financial statements. If this information has any limitations, then the analysis will have the same limitations and will not reflect the true status of the business, moreover, personal judgments could be used in preparing the financial statements, meaning the analysis will also be subjective. ii. The analysis is based on analyzing past performance of the company and using them to project the future. However, this projection may not be accurate since the future of the business can be affected by so many factors like changes in market conditions and management. iii. Changes in price levels- price changes take place from period to period. Prices are changing at a very high rate and the price level prevailing today may be very different this may affect the validity of the ratios used. When this happens, it becomes difficult to clearly predict the trend in profitability and financial stability of the company. The only option would be adjusting the price levels of different period so that the analysis can reveal accurate comparisons. iv. Lack of standards- there are no standards or rules to determine the ideal ratios. Different companies use different ratios to measure the profitability, liquidity and financial stability. In such a case, it becomes difficult to interpret the ratios. v. Several ratios required to make judgments- a single ratio cannot be adequate to make decisions about the performance of the company, therefore, it is important that several ratios be used to enable one to make decisions. When the ratios become so many, they may confuse the analyst, instead of assisting them to make the correct decision. vi. Problem of comparisons- firms operate in different industries and the same ratios cannot be used to compare all companies. Moreover, even firms in the same industry differ in size, structures and the accounting procedures; therefore, it becomes hard to compare even firms in the same industry. Different firms can as well manipulate their operations and accounting information to portray a good performance, which may not be true. vii. The information used in the financial statements maybe out of date. The items of balance sheet are recorded at historical costs, which is not very good for making decisions. The ratios will therefore reveal the past performance, but predicting the future will be difficult since most parameters change with time. Additional information needed. i. To deal with the problem of price changes, it is important to consider the current price levels and converting the historical data into the current price levels. ii. It is to compare the performance of the firm with others is the same industry, with the same structure and accounting policies and of the same size. iii. It is also important to use a variety of ratios so that the analyst will get to a clear analysis and comparison of the company. iv. It is also important to use information from other finance statements like books of original entry so that any problems in the balance sheet and income statement can be addressed. Reference List Siddiqui SA. 2006. Managerial Economics and Financial Analysis 6th edition. New Age International, New York. Brigham, FE. & Houston, JF. 2008. Fundamentals of financial management. Cengage Learning, London. Accounting for management, 2011. Accounting Ratios, Financial Ratios: retrieved from http://www.accountingformanagement.com/financial_statement_analysis_accounting_ratios.htm on 11th may 2011 Appendices Ratios i. Gross profit margin assesses the cost of goods sold with relation to sales. It measures the firms ability to control its inventory and manufacturing costs Gross profit margin is given by gross profit Net sales 2008 2009 2010 254/474=0.53 267/490=0.54 197/396=0.50 =53% =54% =50% ii. Operating profit margin. Is given by EBIT Net sales 2010 2009 2008 286/474=60% 297/490=61% 135/396=34% iii. Return on Assets given by Net income Total assets 2010=214/653=0.33=33% 2009=220/667=0.33=33% 2008=104/694=0.14=33% iv. Return on Equity is given by Net Income Shareholders equity 2010=214/360=0.59=59% 2009=220/360=0.61=61% 2008=104/360=0.29=29% 3. Price earning ratios and dividends ratios Price earning ratio s given by MPS/EPS EPS = Net Profits/ average outstanding shares 2010= 214/180=1.19/share MPS =Market value/average number of share 2010=650/180=3.61 P/E ratio= MPS/EPS= 3.61/1.19=3.03 From the illustrations, dividends= net profits – retained earnings 214-103=111 Dividends/ share= amount of dividends /number of shares =111/180=0.62 Dividends payout Ratio= DPS/EPS =0.62/1.19= 0.52= 52% Liquidity ratios i. Current ratios is given by current assets/current liabilities 2010= 225/110= 2.05 2009= 257/84=3.05 2008=278/67=4.15 Quick ratios is given by total current assets – inventory Current liabilities 2010=225-62/110=1.48 2009= 257-58/84=2.37 2008=278-61/67= 3.24 ii. Accounts receivable ratios = net credit sales accounts receivable. 2010=20%x474/15=6.32 2009=20%x490/11=8.90 2008= 20%x 396/16=4.95 Using 2008 as the base year, the iii. Inventory turnover ratios= net sales/ inventory 2010= 474/62=7.65 2009=490/58=8.45 2008= 396/61=6.49 Financial stability Ratios i. Debt ratios is given by total liabilities/total assets 2010=190/653=0.29=29% 2009=164/667=0.25=25% 2008=147/694=0.21=21% Equity ratios given by shareholders equity/total creditors 2010=360/190=1.89 2009= 360/164=2.10 2008=360/147=2.45 Capitalization ratios given by long term debt/long-term debt= shareholders equity 2010= 80/80+360=0.18 2009=80/80+360=0.18 2008=81/80+360=0.18 ii. Times interest earned ratio- Calculated as IBIT/interest expense. 2010= 286/20=14.3 times 2009=297/18=16.5 times 2008= 135/14=9.6 times iii. Asset turnover ratio - It is given by sales/fixed assets 2010= 474/428=1.11 times 2009= 490/410=1.20 times 2008= 396/416=0.95 times Read More