Non-Financial Performance Measures - Essay Example

Ratio analysis of Anaeco Limited Introduction Ratio analysis is used by the management, the shareholders or the potential investors to interpret the financial statements of a particular company, with the aim of evaluating its strengths and weaknesses. This report seeks to explain why the company under the analysis needs to refurbish its strategies on areas of liquidity, profitability and capital structure. The tools used in ratio analysis include financial statements and comparison of the past and industry firms. The purposes of ratio analysis is to evaluate current bank operations, compare its present performance to past performances, analyze the effectiveness and efficiency of operations, evaluate risk operations and standardize most financial information for the purposes of comparison. A clear ratio analysis, therefore, becomes useful in the evaluation of customer creditworthiness, evaluation of loan applications, analysis investment opportunities and evaluating potential merger candidates. It also helps in analyzing internal management control. Ratio analyses are of different types. The report will only analyze the key financial ratios that indicate the performance of Anaeco Limited. Essentially, the ratio analysis will be based on the trend in three years, including 2009, 2010 and 2011 financial years. In the analysis, the report will highlight some limitations of relying on particular ratios. Finally, the report will wrap up with a summary of the key findings and make a brief recommendation, to the management, on the way forward, and also to the shareholders and the potential investors regarding the prevailing performance of the company. 1.0 Profitability ratios Profitability ratios shed light upon the overall effectiveness of management regarding the returns generated on sales and investment. 1.1 Net profit margin The net profit margin is not very good because the company is yet to make profits. The situation has actually worsened after 2010, though there are some positive indications as the figure could be heading towards a positive end. The management should investigate the reason why the company has been performing poorly, and chart out strategies to ensure the shareholders get better returns from their investment. The results of the net profit margin are shown in appendix 1.1. 1.2 Dividends per share The dividend per share has been zero since 2009, as shown in appendix 1.2. This is attributed to the persistent losses that the company has been incurring, leaving nothing for the shareholders to claim as dividends. This trend has a cause for alarm and it is the high time that the management unravels new strategies to make sure the company starts making profits so the shareholders can enjoy dividends. 1.3 Earnings (loss) per share Due to the persistent losses that the company has incurred since 2009, the shareholders can only share losses rather than earnings. The worst affected year is 2011, with the shareholders sharing a loss of 6.2 per share as shown in appendix 1.3. As discussed above, this trend needs concerted efforts by the management to rescue the company. If the trend persists, the shares of the company will continue losing value. 1.4 Return on investment (ROI) The return on investment (ROI) for the last three years can be calculated using the Dupont Model as shown in appendix 1.4 (Marshall et al. 2002). The company’s ROI dropped drastically in 2010, before increasing by more than 70 percent in 2011. This recovery is remarkable as it reveals that the company is increasing its sales while at the same time optimizing the utilization of assets to generate these sales. To attain such results, it means that the average assets, the operating income, as well as the sales have to increase at the same rate. However, the 2010-2011 trends is only attractive in the short-term, because if it persists, it will be an indication that Anaeco Limited is not investing well in assets. In other words, in the long-term, such a trend will be an indication that the company is undergoing increased operations at the expense of asset efficiency improvement. 2.0 Liquidity ratios The liquidity rations are used to show the ability of the firm to pay its debts in the short-term (Manzler 2004). 2.1 Inventory turnover ratio The inventory turnover ratio for Anaeco Limited exhibits mixed trend. Essentially, a high turnover ratio is better than a low turnover ratio. The ratio declined slightly in 2010, but increased significantly in 2011 as indicated in appendix 2.1. The recent increase is remarkable because it shows that the management of inventory is efficient. It is also an indication that the inventory is selling fast; therefore, less fund is tied in it. The low inventory turnover ratio registered in 2010 could be an indication that there were some slow moving goods, which is risky because it could eat into the entity’s earnings. However, it is important to note that a very high value could be an indication that the inventories are underinvested (Manzler 2004). 2.2 Current Ratio The ability of the company to pay off its short-term liabilities by the current assets is measured by the current ratio. A value of 1 to 2 is considered to be the acceptable range. Anaeco Limited current ratios for 2009, 2010 and 2011 financial years are calculated as shown in appendix 2.2. In 2009, the company’s current assets surpassed its current liabilities by 1.22 times. In 2010, it was 0.42 times and in 2011 it was 0.05 times. This means the current assets in comparison with the current liabilities has been dropping drastically since 2009. The values for 2010 and 2011 are not acceptable, and this calls for the management to take some action to avoid problems that emanates from the company not being positioned to repay its short-term dues. The management may want to finance the company’s operating cycles through other means such as long-term debt or equity. Also, the management can try to increase the rate of current assets faster than the rate of current liabilities, though, this should not be done at the detriment of the business- the company should continue collecting debts in timely manner. At the same time, the management should avoid very high current ratio as this may reflect redundant jamming of liquid assets in the business. 3.0 Capital structure ratios The capital structure ratios are used to show the level at which the company capital is balanced between debts and equity (Bagehot 1971). 3.1 Debt equity ratio The debtor’s ratio for the company increased significantly in 2010, which was a positive trend because the company lessened its reliance on equity rather than borrowed capital, to finance its assets. However, in 2011, the shareholders net worth is a deficit, which leaves the company with no option, but relies on debts alone to finance its assets. The situation that is occurring in 2011 needs a speedy action because overreliance on debts could increase the burden on the company in terms of more interest expenses that debts attract (Marshall et al 2002). 4.0 Conclusion The financial ratios are very useful in analysis of performance of a company. Depending on different interest and uses of financial ratios by their readers, their usefulness and value varies. For example, aggressive investors will mostly want to evaluate the results of ROI, while an investor who is assessing the risk of the company, in respect to its ability to continue operating in the foreseeable future, will want to assess the acid test or the debt ratio. The ratios analyzed in this report are very useful to different classes of users, including the management, the shareholders and the potential investors. For those who want to get a proper interpretation of the rations, they should use the analysis in conjunction with the company’s annual reports so they can make elaborate clarification. The potential investors will highly benefit from this analysis as they will understand the performance of the company and, therefore, make more informed choices when deciding to invest in this particular company. The shareholders will also benefit because they can be able to assess whether the management has invested their funds well, and take the necessary action if they deem that something is not going the right way. The ratios analyzed in this report should also be compared with those of similar companies in the industry so that the interpretation can be more informed (Ittner & Larcker 2000), The analysis of Anaeco Limited has shown that the performance of the company has not been very well since 2007. Indeed, the trend shows that the situation has been worsening. To rescue the situation, the management needs to chart out a way of uplifting the company from its losses. The issues of loss making are the most critical, as other problems are either directly or indirectly connected to it. The management may want to assess the root cause of the problem. If the business is dealing in goods or services that have become out of taste, diversification option may come in handy. The shareholders have a genuine cause for concern, and they need to investigate the performance of the members of the management team. If need be, the shareholders can pass a vote of no confidence to the current management so they can give room to some new team, who could come up with ways of revamping the company. Finally, the results of these ratios act as a red flag for any potential investor who could be willing to invest in Anaeco Limited. This is not the best time to invest in this company as its future in terms of liquidity and profitability is not very promising. May be in future, if the company starts generating profits and management enact good policies that will enhance its financial performance, it will become a good company to invest with. Reference Bagehot, W, 1971, ‘The Only Game in Town’ Financial Analyst Journal, pp. 12- 14. Ittner, C & Larcker, D 2000, ‘Non Financial Performance Measures: What Works and What Doesn’t’, Financial Times, Mastering Management Series.  Manzler, D 2004, Liquidity, liquidity risk and the closed-end fund discount, University of Cincinnation, New York. Marshall, DH, McManus, WW, Viele, DF, Anthony, RN., Hawkins, DF, & Merchant, KA 2002, Accounting: What the Numbers Mean, Fifth Edition with Selected Material from Accounting: Text and Cases, Tenth Edition, University of Phoenix Edition, McGraw-Hill Primus, Boston. Appendix Appendix 1.1 2011 2010 2009 Net profit(loss) (11,824) (7,097) (6,506) Net sales 191,225 74,739 387,374 Net profit margin -6.2% -9.5% -1.7% Appendixx1.2 2011 2010 2009 Dividend to ordinary shareholders 0 0 0 No. of shares outstanding 198,540,247 177,811,913 156,911,302 Dividend per share 0 0 0 Appendix 1.3 2011 2010 2009 Net profit (loss) for equity holders (11,824,250) (7,097,258) 6,506,321 Loss per share (6.2) (4.4) (5.2) Appendix 1.4 ROI 2011 2010 2009 Operating income ÷ average total assets 191,225/4,613,696 =4.1% 74,739/6,784,379 =1.1% 387,374/8,745,083 =4.42% Appendix 2.1 Inventory turnover ratio 2011 2010 2009 Sales 191,225 74,739 387,374 Closing inventory 13,799 16,301 43,877 ratio 13.8 4.58 8.82 Appendix 2.2 2011 £ 2010 £ 2009 £ Current assets/current liabilities 214,275/4,353,178 =0.05 1,839,668/4,372,561 =0.42 5,004,072/4,086,943 =1.22 Appendix 3.1 2011 2010 2009 Debt 8,108,950 4,720,547 4,334,530 Net worth(deficit) (3,507,056) 2,139,641 4,506,599 -2.3 2.2 0.96 Read More