Financial Ratio Analysis and Recommendations - Assignment Example

Creativity and Decision-Making in Business Financial Ratio Analysis and Recommendations [Name of the Student] [Name of the institution] [Name of the Professor] [Course] Creativity and Decision-Making in Business Activity 1 Analyse the History of the previous six months trading and identify exactly whathas gone wrong and when. Graphs and tables will be useful in pinpointing this evidence. 3. Formulate clear recommendations into an action plan for improving the situation. You should submit a formal Consultancy Report in which you explain 1, 2, and 3 in an attractive, easy-to-follow way. Note that 1 & 2 are about evidence, so you will need to include ratios, graphs, and tables, but that your explanation and interpretation is just as important. In 3, you action plan should be as clear as possible. Accounting Ratios Gross margin- It is profit realised after accounting for cost of sales. It reflects the ability of the business to increase sales by either increasing the volume or price as well as reduce cost. Gross margin = = = 45% A figure of 45%, is an indication of huge profit. The ratio of gross margin on sales varies widely from industry to industry, so that it should be used solely for comparing the sales performance of the same company over a period of time. Net margin- This is the second component of the formula for calculating the R.O.C.E. it seeks to assess the profitability of sales that is the efficiency of sales as a critical event in generating income. It shows the prudence in the management of expenses. Net margin % (or Return on Sales) = = = 22.5% The figure of 22.5% large it shows the company huge profits from its activities. The ratio of net margin on sales varies widely from industry to industry, so that it should be used solely for comparing the performance of the same company over a period of time. Some companies may operate In an industry which is characterized by low profit margins and high levels of turnover. ROCE- The return on capital employed ratio is an indicator of how effective a company’s assets are at generating earnings. In other words, the ratio indicates the amount of earnings a company is able to generate from invested capital, thus enabling investors to forecast the company’s profitability in an industry. Expressed as a percentage, ROA is calculated by dividing a company’s net earnings by its total assets, thus establishing the percentage of income generated from invested capital. ROCE (%) = = = 9.375% ROCE based on the month of August is 9.375% . This indicates that although the company is not currently generating optimal earnings from its investments, it has the potential to utilize its assets to boost profitability. In this regard, ROCE is impressive considering the high degree of competition and this makes the company an attractive investment. Return on Shareholders Funds (ROSF)- A company’s Return on Shareholders Funds ratio is used to measure its ability to reinvest resources for income generation. The ratio is calculated by dividing net income by total equity, enabling investors to know the efficiency with which company assets are being used to generate revenue. As such, the higher the ROSF the better a company is at utilizing resources for revenue generation, hence the more profitable the company is likely to become. ROSF (%) = = = 10.28% ROSF ratio, based on August results, is 10.28%. Although this is within the range of 10% to 30% that is considered desirable for companies to provide dividends and retain funds for growth, the company’s ROSF indicates potential for revenue creation, making it an attractive investment option. Current ratio - the current ratio is used to measure a company’s ability to meet its short-term financial obligations without threatening its financial stability. The ratio relies on the company’s current assets and current liabilities, since it is believed that a company should use its short-term assets to meet short-term liabilities. As such, a current ratio of less than 1 is a bad sign for the company’s survival, since it indicates that the company may not be able to meet its current liabilities. Current ratio = = = 1.117 current ratio based on consolidated statements for the month of August is 1.1117. This implies that the company is able to meet its short-term financial obligations without going bankrupt since its current assets are more than its current liabilities. As such, the company would be a good investment option since its survival in terms of paying current obligations is secure. Acid test - The acid test ratio takes only those current assets that are readily convertible to cash i.e. it excludes inventory. The Quick (or Acid Test) Ratio is a more effective indicator of liquidity as it only takes into account the most liquid assets (cash and net accounts receivables in this case) and does not take into consideration current assets that are considered as less liquid including inventory and office supplies. Acid test = = = 0.922 If we look at the Quick Ratio, it is equal to 0.922. Asset turnover- This is the first component of the formula for calculating the ROCE is an asset utilization ratio. It is intended. Thus, if the firm has a low ratio of sales to assets, it is implied that some substantial under-utilization of assets is occurring, or alternatively that assets are not being efficiently employed. This ratio focuses therefore, on the use of assets made by the management. Because it is a measure of past managerial efficiency in this respect, it is thought to provide a reasonable basis for forecasting management’s future efficiency. It is considered to be a prime determinant of the level of future income flows. Asset turnover = = = 0.417 times Asset turnover is low ratio which means it has over invested in its assets. This indicates that company uses more assets which are being used for its sales. Debtor payment time - average time taken by debtors to pay for their debts Asset turnover = = = 37.23 days This means that a lower receivable turnover ratio in which it has not strengthen its credit policies and it also finds difficult in collecting from its customers. This shows that receivable turnover is higher rate showing that its credit policies are strong enough. Creditor payment time - the Creditor payment time gives us how number of days taken before payments are made to creditors. Creditor payment time = = = 37.23 days An average payment period of 49 days when we divide 365 by the payable turnover ratio. But it is a sign of worry also as the normal credit terms are 30 days. Gearing ratio – Gearing ratios are referred to as a measure of the organization’s ability to service its debts that are eventually expressed as a percentage. Gearing ratios are arrived at by adding the organization's post-tax net profit and its depreciation, and dividing the sum achieved by the quantity of liabilities both long-term and short-term; the resultant amount is ultimately expressed in terms of percentage. A high gearing ratio indicates a healthy situation of the company, while a low ratio indicates quite opposite of the above. A low solvency ratio furthermore indicates probability of default. Different industries do have different standards as to what can be stated as an acceptable gearing ratio, however, as a general rule, a ratio of 20% or higher is considered to be healthy. Investors take in to account the solvency ratio while taking decisions about making further loans. Gearing ratio = = = 2.198% Activity 2 four months trading, from August to December.Graphs and tables will be useful in pinpointing this evidence. 3. From the evidence, show how far your action plan has succeeded. Accounting Ratios Gross margin- It is profit realised after accounting for cost of sales. It reflects the ability of the business to increase sales by either increasing the volume or price as well as reduce cost. Gross margin = = = 44.05% A figure of 44%, is an indication of huge profit. The ratio of gross margin on sales varies widely from industry to industry, so that it should be used solely for comparing the sales performance of the same company over a period of time. Net margin- In this it shows that the profit margin is reducing slowly from figure of august in which it shows that the COGS is too high were as when comparing to the industry norm it is high in the beginning which means that COGS is less for the industry but by december it declines at a higher rate in which the industry is not able the meet its goal. Net margin % (or Return on Sales ) = = = 22.02% ROCE- The return on capital employed ratio has exceeded august figure. This means that the they were able to manage its assets in a better way by managing credit policy well is not used properly whereas for the industry the credit policy is much better and it is able to collect ROCE (%) = = = 38.54% ROCE based on the month of August is 38.54% . Return on Shareholders Funds (ROSF)- In this the debt to total assets is declining at a higher rate which means that it is basically financing through is equity but when looking at the august figure it shows that it is increasing which means that they are facing a higher risk even when the interest rate of the market is high. ROSF (%) = = = 51.39% Current ratio - the current ratio is used to measure a company’s ability to meet its short-term financial obligations without threatening its financial stability. The ratio relies on the company’s current assets and current liabilities, since it is believed that a company should use its short-term assets to meet short-term liabilities. As such, a current ratio of less than 1 is a bad sign for the company’s survival, since it indicates that the company may not be able to meet its current liabilities. Current ratio = = = 1.65 . Acid test - The acid test ratio takes only those current assets that are readily convertible to cash i.e. it excludes inventory. The Quick (or Acid Test) Ratio is a more effective indicator of liquidity as it only takes into account the most liquid assets (cash and net accounts receivables in this case) and does not take into consideration current assets that are considered as less liquid including inventory and office supplies. Acid test = = = 1.42 If we look at the Quick Ratio, it is equal to 0.922. Asset turnover- This is the first component of the formula for calculating the ROCE is an asset utilization ratio. Asset turnover = = = 1.75 times This indicates that company uses more assets which are being used for its sales. Debtor payment time - average time taken by debtors to pay for their debts. Asset turnover = = = 8.7 days This means that a lower receivable turnover ratio in which it has not strengthen its credit policies and it also finds difficult in collecting from its customers. This shows that receivable turnover is higher rate showing that its credit policies are strong enough. Creditor payment time - the Creditor payment time gives us how number of days taken before payments are made to creditors. Creditor payment time = = = 13.20 days Gearing ratio – Gearing ratios are referred to as a measure of the organization’s ability to service its debts that are eventually expressed as a percentage. Gearing ratios are arrived at by adding the organization's post-tax net profit and its depreciation, and dividing the sum achieved by the quantity of liabilities both long-term and short-term; the resultant amount is ultimately expressed in terms of percentage. A high gearing ratio indicates a healthy situation of the company, while a low ratio indicates quite opposite of the above. A low solvency ratio furthermore indicates probability of default. Different industries do have different standards as to what can be stated as an acceptable gearing ratio, however, as a general rule, a ratio of 20% or higher is considered to be healthy. Investors take in to account the solvency ratio while taking decisions about making further loans. Gearing ratio = = = 2.198% This shows shows how much protection there is for creditors. The ratio shows the total liabilities divided by total assets, the higher the ratio the higher the risk. The debt to total assets ratios demonstrates that the company has enough Assets to cover for potential insolvency to cover its debt sufficiently. Recommendation The company is facing problems in paying their debts on time, which is a problem of liquidity. If left unattended, this may lead to insolvency. However, the solution is really simple. They need to take a series of steps to increase their performance. Firstly, they need to decrease investment in debtors so that the excess money can be used in paying their creditors on a timelier basis. Secondly, stricter credit terms need to be negotiated with debtors so payments are received earlier. The debt ratio also needs to be decreased that can be achieved by utilizing some of earnings to pay off a portion of their debts and increasing the overall equity share in the business. Another possibility is to sell off some of the assets to pay the long term debts. Furthermore, in order to increase the profit margin, the company needs to increase sales and this can be done by decreasing the prices of their products which are on the higher side as indicated by the Net Sales to Asset Ratio. Reference List Brag, S. 2002. Business Ratios and Formulas: Comprehensive Guide. New Jersey: John Wiley & Sons Inc. Collier, P. 2003. Accounting for Managers: Interpreting Accounting Information for Decision-Making. New York: John Wiley and Sons. Carey, O. & Essayyad, M., 2001. The essentials of financial management. New York: Research & Education Association. Weetman, P. 2006. Financial Accounting: an Introduction. New York: Financial Times Prentice Hall. Read More