Financial Ratio Analysis of Elm Bank Ltd - Case Study Example

FINANCIAL RATIO ANALYSIS Name: Professor: Institution: Course: Date: 1.0 Financial Ratio Analysis. 1.1 Introduction Ratio analysis is a comparison of relationship between financial statements to help analyze the financial position of a business (Keršuliene et al 2010). Ratio analysis needs careful analysis to prevent a company from going out of business. Ratio analysis helps to simplify the financial statements of a company. It helps in comparing different companies. Ratio analysis helps in trend analysis by comparing a particular company in a period. It makes financial statement easy to understand. An investor can judge a company by looking at a few numbers instead of the complete financial statement. Ratio analysis helps the government in making policies (Petzke et al 2010). The government do this by collecting data from different to help them make policies the policies. Ratio analysis is an important tool in a company because it helps in making various decisions. For instance, shareholders interested in investing in the company can use the information for example, looking at return on investment ratios to make the decision. Creditors can also use the ratios to decide on whether to provide services to the company (Cui & Ryan 2011). For instance, by looking at current ratio analysis a creditor will know whether the company is in a position to pay its debt or not. The information also helps the employees to know whether the company is in a position to give salary increments and incentives through profitability ratios. An analysis will show ratio analysis of Elm bank Ltd between the years 2012-2013 and whether it is worth to invest in the company or not (Petzke et al 2010). 1.2 Profitability Ratios Profitability refers to business performance in making profit with minimal costs. 1.2.1 Return on total assets (ROTA%) Return on total assets = Profit Before Interest Payable and Tax × 100 Total Assets (excluding Intangibles) 2012 2013 ROTA= 3500 × 100= 14.7% ROTA= 3780 × 100 = 14.87% 23808 25418 Interpretation: 1. This ratio measures how the company is managing and efficiently using its assets to generate its profit (Peavler 2010) 2. The ratio increased from 14.7% in 2012 to 14.87% in 2013. 3. This was an increase of 0.17%. This increase implies that the company its assets efficiently to generate revenue (Peavler 2010) 1.2.2 Profit Margin Profit before Interest Payable and Tax × 100 Profit Margin= Sales 2012 2013 Profit Margin% 3500 × 100=14% 3780 × 100= 9% 25000 42000 Interpretation: 1. It indicate how much earning is kept by the company for each dollar of sales it makes 2. The ratio reduced from 14% in 2012 to 9% in 2013. 3. This was a decrease of 5%. This decrease implies that the company has no better control of its cost compared to the previous year (Peavler 2010) 1.2.3 Gross Profit Ratio Gross profit Margin = Gross profit Sales 2012 2013 12000 ×100 = 48% 18900 × 100 = 45% 25000 42000 Interpretation This ratio shows the sales available to help to offset expenses leading to net profit. The gross profit decreased from 48 % in 2012 to 45% in 2013.A decrease of 3% indicates that the company sales are not sufficient (Petzke et al 2010). 1.3 Liquidity Ratios Liquidity ratios the ability of a company to get funds for it daily operations 1.3.1 Current Ratio Current ratio = Current Assets Current Liabilities 2012 2103 Current Ratio 4470 =1.86 times 7752 = 2.41times 2407 3213 Interpretation: 1. This ratio is used to gauge the company’s quantity of its current assets to its current liability. (Peavler 2010) 2. The ratio has increased from 1.86 in 2012 to 2.41 in 2013. 3. This is an improvement of 0.55 which implies that the company is in a better position to meet its obligations as and when they fall due. 1.3.2 Acid Test Ratio A company’s ability to meet short-term financial liabilities is determined by an acid test Acid test = Current assets –inventory Current liabilities 2012 2013 Acid test Ratio 4470-2470 = 0.83 7752-2772 =1.55 2407 3213 Interpretation: 1. Liquid ratio measures the quality of the company’s current assets vis-à-vis its current liability. 2. The ratio increased from 0.83 in 2012 to 1.55 in 2013. The ratio improved by 0.72 3. A current ratio of greater than one is good for the company as it implies that the company can meet its debt without having to sell its inventory. 1.3.3 Stock Turnover Cost of Sales Stock Turn = Stock 2012 2013 Stock turnover 13000 =5.26 23100 =8.33 2470 2772 Interpretation: 1. This ratio indicates the efficiency with which a company manages its inventory. 2. This ratio has increased from 5.26 in 2012 to 8.33 in 2013. 3. The ratio improved with 3.07 indicating that the company is managing its inventory efficiently and hence signifying higher profits. 1.4 Solvency Ratios Solvency refers to how a company meets its financial commitment in the end. It helps to show the risk an investor or a creditor faces. 1.4.1 Debt to Equity Ratio Debt to equity ratio = Total liabilities Owners’ equity Debt to equity ratio 2012 = 15407 = 1.19 Debt to equity ratio 2013 = 11213 = 0.51 12871 21957 Interpretation: 1. It measures the extent to which the company is financed by the owners (shareholders) in comparison with external creditor (Steffy, Zealey & Strunk 1974). 2. The ratio has decreased from 1.19 in 2012 to 0.51 in 2013. 3. There was decline of 0.68 indicating that the company is in a better position to be financed internally. The higher the gearing ratio, the riskier it is for the company. 1.4.2 Debt to assets ratio Debt to assets ratio = Total assets Total liabilities 2012 2013 28278 = 1.83 33170 = 2.96 15407 11213 Interpretation 1. Debt to assets ratio indicates company assets not managed by equity but instead the assets are managed with debt 2. There has been an increase of 1.13 in 2013 as compared to 2012. 1.5. Investor Ratios 1.5.0 Return on Equity Return on Equity = profit attributable to shareholders X100 Book value equity 2012 2013 Return on Equity 1788 × 100= 13.89% 2086 × 100 =9.5% 12,871 21,957 Interpretation: 1. This ratio measures the returns of a company on the shareholders investments. 2. The ratio decreased from 13.89% in 2012 to 9.5% in 2010 3. There was a decrease of 4.39%. This is a bad indication that the company is not getting high return on the shareholders investments (Steffy, Zealey & Strunk 1974). Important Additional Information for Elm bank Ltd Comparing performance Comparing the company’s ratio with the ratios of the industry it is operating in. this is a good indicator on whether a company was worth investing as it is compared with its main competitors. Finance and transparency An investor is able to know whether the financial statement of companies is released in a timely manner. Transparency ensure that the investor is can clearly understand the past and current financial status Rights of the stakeholders The investor is able to understand how well the policies protect the benefit the stakeholders and shareholders. Companies with good policies give stakeholders a chance to have some ownership by allowing them to vote and help in decision-making (Liao et al 2012) Board of directors The composition of the board of directors will help a n investor to decide whether to invest in company. Good board of directors ensures that the rights of the shareholders are well protected in the company. A well-structured board ensures that the management of the company respects the view of the shareholders (Liao et al 2012). The rate of employee turnover The investor can compare the company’s tenure with other companies. The company may not be in a position to run a long-term business if the average tenure is less than one year. Management Approval The investor need to consider which percentage of employees approves the leader of the company. Additionally, conducting a promoter score help an investor to know how the employees view the company and decide on whether to invest (Liao et al 2012) Employee diversity This helps the investor to know the composition of employee in the organization. A good company has highly qualified and innovative employees. This helps the investor to know whether the company has the right people with problem solving skills (Petzke et al 2010). Organization structure An investor need to consider a structure that is results oriented and allows the employees to take part in decision making of the company Competitive advantage Competitive advantage drives the ability of a business to maintain long-term business. The company needs to have a competitive advantage over its competitors. Competitive advantage ensure that shareholders are rewarded well. Corporate governance This refers to the rule that that govern the companies’ relationships and duties between the management, directors, and stakeholders. Every company has a company constitution that investors need to consider before making investment plan (Petzke et al 2010). The company rules and regulation should be a key consideration to any investor. Corporate governance makes sure that company laws are followed and eliminate any unethical business in the company. Corporate Governance helps an investor in to understand the following; Reasons to invest to invest There are various reasons that make the company a viable business for an investor. Looking at the financial statement of the company the following were the reasons that made me advise a friend not to invest in Elm bank Ltd. Firstly, the profitability ratios has shown how the company is not managing and efficiently using its assets to generate its profit and this can be supported by the decline in the profit margin ratio. Moreover, Elm back revenue is becoming less sufficient to offset expenses and is shown by the decline of the gross profit ratio. Only liquidity and solvency ratios have shown a positive sigh since the Current ratio has increased and this makes it viable to invest in the company for it shows the company can survive even in changing market trends and he reduction on debt on equity ratio shows the company is becoming less dependent on external funding thus making it stable financially. However, this is no enough since it is not maximizing shareholders wealth as show by the investors’ ratios. This is indicate by a decline in return in equity which is a bad indication that the company is not getting high return on the shareholders investments. References Keršuliene, V., Zavadskas, E. K., & Turskis, Z. (2010). Selection of rational dispute resolution method by applying new step‐wise weight assessment ratio analysis (Swara). Journal of Business Economics and Management, 11(2), 243-258. Cui, X., & Ryan, C. (2011). Perceptions of place, modernity and the impacts of tourism–Differences among rural and urban residents of Ankang, China: A likelihood ratio analysis. Tourism Management, 32(3), 604-615. Liao, G. J., Chan, K. A., Jiang, P., Sun, H., Leung, T. Y., Chiu, R. W., & Lo, Y. D. (2012). Noninvasive prenatal diagnosis of fetal trisomy 21 by allelic ratio analysis using targeted massively parallel sequencing of maternal plasma DNA.PLoS One, 7(5), e38154. Rana, M. M., Islam, M. S., & Kouzani, A. Z. (2010, February). Peak to average power ratio analysis for LTE systems. In Communication Software and Networks, 2010. ICCSN'10. Second International Conference on (pp. 516-520). IEEE. Petzke, K. J., Fuller, B. T., & Metges, C. C. (2010). Advances in natural stable isotope ratio analysis of human hair to determine nutritional and metabolic status. Current Opinion in Clinical Nutrition & Metabolic Care, 13(5), 532-540. Groves, B. A., & Allen, M. G. (2010). ITERA: IDL tool for emission-line ratio analysis. New Astronomy, 15(7), 614-620 Steffy, W.Zearley, T.,Strunk J.(1974). Financial Ratio Analysis: an effective Management Tool. Retrieved on 13th January 2011 from http://books.google.com/books?id=f0ZPAAAAMAAJ&q=financial+ratio+analysis&dq=financial+ratio+analysis&hl=en&ei=AMUvTZGCI4XKhAf8iOmzCw&sa=X&oi=book_result&ct=result&resnum=1&ved=0CCYQ6AEwAA Peavler, R(2010). Use profitability ratios in Financial Ratio Analysis. Retrieved on 13th January 2011 from http://bizfinance.about.com/od/financialratios/a/Profitability_Ratios.htm Read More