The Financial Performance of VDB Limited - Essay Example

Financial ments Interpretation Submitted by: XXXXXX Number: XXXXX of XXXXXXX XXXXXX XXXXXX Code: XXXXXX Date of Submission: XX - XX - 2009 Number of Words: 1061 (Excluding Bibliography) Introduction: This report aims at analyzing the financial performance of VDB Limited for the past two years. The performance of the company can be studied using various techniques, the most common and useful one being the ratio analysis. The ratios of importance are chosen and are computed. The reasons for choosing these ratios are also discussed. Based on the analysis, recommendations are made to improve performance of VDB Limited. Limitations of the analysis and also ratios in general are discussed in the report. Ratio Analysis: One of the most important tools used to interpret financial statements and to understand the company and its financial performance on the whole, is 'Ratio Analysis'. The main reason is that the ratios are simple to calculate. Moreover, they provide a standard for comparison between companies or between the company and the industry in general. They can also be applied to various time periods of the same company and can provide valuable information related to the trend and future prospects (Pendlebury and Groves, 2004). The ratios that are chosen for analyzing VDB Limited include Operating Profit Margin, Return on Assets, Current Ratio, Quick Ratio, Average Collection Period, Stock turnover period. The ratios are computed for VDB Limited based on the financial statements provided for the two years. This will provide a base for comparison of the i. Operating Profit Margin: The profit margin is the measure of the company's ability to earn profit from the generated revenue. This is a very important and crucial ratio as this depicts the earning capacity of the company (Samuels et al, 2000). Profit Margin = (Net Income / Net Sales) * 100 Profitability 2007 2008 Profit Margin 9.31% 6.57% It is clear from the values that the profit margin has declined steeply in 2008 relative to 2007. Though the revenue is much higher in 2008, the purchases and the expenses are relatively higher and hence lesser profits. ii. Return on Assets: This ratio measures the income generating ability of the assets. This ratio is necessary, since the income or the earnings is given higher importance and a company should not only have high revenues, but should also earn the income from it. The return on assets is computed as Return on Assets = (Net Income / Total Assets) * 100 Profitability 2007 2008 Return on Assets 10.53% 7.89% It is evident that the assets are not being utilized at the same level as that of 2007. The income generating ability of the assets has come down in 2008. iii. Current Ratio: The current ratio is a measure of the company's ability to cover its current liabilities using its current assets (Samuels et al, 2000). It is computed as Current Ratio = Current Assets / Current Liabilities Ratio 2007 2008 Current Ratio 3.16 2.96 The current ratio is a measure of liquidity and it indicates that VDB Limited is well positioned in terms of liquidity and will be able to cover its liabilities. Though the ratio has reduced in 2008, it is still very substantial and a healthy value. iv. Quick Ratio: The quick ratio is a measure of the company's ability to cover its current liabilities using its liquid assets. The assets included in this ratio are those which can be easily converted to cash (Samuels et al, 2000). It is computed as Quick Ratio = (Current Assets - Inventories) / Current Liabilities Ratio 2007 2008 Current Ratio 1.5 1.48 VDB Limited has sufficient liquid assets to cover the current liabilities. There is no change in the quick ratio in 2008. v. Average Collection Period: The time period (no. of days) taken to collect the receivables is a crucial measure that illustrates the company's ability to collect the debts (Samuels et al, 2000). It is computed as Average Collection Period = (Average (net) Receivables) / Net Sales) * 365 Ratio 2007 2008 Average Collection Period 61 65 VDB Limited has a very high collection period indicating a low efficiency in collecting funds from its customers. An increase of 4 days in 2008 (from 61 to 65) makes it evident that little or no effort is spent by the management in improving the collection period. vi. Days in Inventory: The time period (no. of days) spent by goods in the inventory indicates the ability of a firm to convert its inventory into sale (Samuels et al, 2000). The days in inventory is measured as Days in Inventory = (Average Inventory / Cost of goods sold) * 365 Ratio 2007 2008 Days in Inventory 86 82 The number of days in inventory in the year 2008 is 82 days whereas it was 86 days in 2007. Hence it is evident that VDB Limited has improved its efficiency in converting stocks to sales. Recommendations: From the analysis, it is evident that the company's overall performance in 2008 is well below that of 2007. VDB Limited has to address a number of issues in order to improve the financial performance. The operating profit margin and the return on assets indicate that the company is lacking in terms of operational efficiency. Hence improvements in the process and optimal utilization of the assets will help increase the profits. The liquidity position of the company is relatively strong and hence it will be able to cover its liabilities effectively. However the management has to focus on improving the effectiveness of collecting funds from the customers, as the average collection period is very high and is increasing. The stock turnover period or the days in inventory, though has decreased in 2008, can still be brought down by employing effective demand forecast and planning. Limitations: The ratio analysis, though a simple and effective tool to analyse performance, it has a number of limitations as well. The changes in money values between various time periods (2007 and 2008) are not taken into account in the calculations (Burkle and Wilks, 2007). Also, it is possible that the changes in the ratios to be caused by environmental and political factors, such as regulatory framework, economic policies, changes in management, etc.., The ratio analysis plays a very negligible role in terms of accurately predicting future performance, as the values are based on historical statements (Pendlebury and Groves, 2004). In spite of these limitations, the ratio analysis can provide a detailed view of the company's performance and its long term and short term growth potential. Bibliography Burke, L. and Wilks, C., (2007), Management Accounting - Decision Management, 4th edn, CIMA Publishing Pendlebury, M. and Groves, R., (2004), Company Accounts - Analysis, Interpretation and Understanding, 6th edn, Thomson Learning, London Samuels, J. M., Wilkes, F. M. and Brayshaw, R. E., (2000), Management of Company Finance, 6th edn, Thomson Learning, London Read More