The Profitability of a Company - Case Study Example

Financial Analysis Core Ratios Under this heading four key ratios will be analyzed. Please that the data analyzed is of five years i.e. from 1963 to 1967. The four key ratios are discussed below: Return on sales ratio is achieved by dividing Net Profit after tax with sales to assess the profitability of the company. The five years data suggest that the net margin remained in the band from 5.95% to 6.74% suggesting not a better performance as for as the profitability is concerned. The asset turnover ratios seem to be ok as the company has been able to generate the current level of sales by effectively utilizing its asset base. Asset leverage is quite low and has decreased over the period of time suggesting higher reliance on the external financing to finance the overall assets of the company. This can be due to the fact that Inventories, over the period of time has shown considerable increase hence necessitating the obtainment of external financing to fund the inventory purchase. Return on equity has greatly dipped as the company despite increasing its equity base has not been able to generate more return on its equity. From the strategic management point of view, the return on equity ratios are more critical since managers has the primary responsibility of creating value for its shareholders which company seem to have failed to achieve for the period under review. The corporate performance specially the return on the equity is a strong indicator to the investors in the capital market signaling the overall future direction of the company. This is also evident from the fact that the share price of the stock of the company has constantly dipped in the period under review and hit a low price of $62 in year 1962. Strategically dwindling confidence of the investors may not help achieve company its proposed objectives as it progresses in the future. Profitability Ratios A closer look at the gross margins earned by the company suggest that the core costs are well under the control of the company however over the period of time, its operating margins are decreasing showing the lack of control over the increase in the general and administrative overheads. Though organization seems to managing its assets in better way however this may also due to the fact of higher accumulated depreciation. Strategically the decreasing profitability of the company can be a difficult problem to handle with as the outside investors keep a very keen eye on the bottom lines of the organization’s income statements. However it must also be note that the return on the overall capital employed and Return on invested capital, both have shown an abnormal dip as mainly due to constant profitability. The almost constant level of profitability also suggest that the company has either reached its maturity stage or in the process of reaching it. Organizations reaching their maturity levels require a lot of reshuffling in its strategic management practices as in order to create a long term viable future for the organization, it is necessary that it keeps on innovating in its approach in strategic management since change competitive dynamics necessitate that it must keep making innovative strategic decisions. It is also imperative that the introduction of Super to the current production line will contribute to the profitability of the company as the supposed introduction will not only include the synergies within the production processes resulting in more effective and efficient production with less costs and higher profit margins. Financial Structure The working capital management of the company seems to be excellent as it has constantly being able to keep its current as well as quick ratio under great control and it’s above the 1:1 level which is considered as the best level to maintain. The gearing of the company is decreasing mainly due to the introduction of the fresh equity by the company. Strategically, it can be interpreted on two counts. It can be either seen as a negative sign as the outside investor may perceive that the company is finding it hard to raise the funding from external sources thus investing its own funds to fund the business whereas on the other hand it can be interpreted as the positive signal as the existing shareholders of the company has so much trust in the company that they are investing more of their money as the future expectations are high. However, it also must be noted that low level of gearing will not allow company to create value through its EPS as the low level of debt will be reflected in the lower EPS levels. It is therefore really challenging for the company to strike a right balance between the capital structure of the company since too much reliance on the equity not only make the company a potential target for leveraged buyout but will not help them to improve their share price through magnified EPS due to the higher debt levels. Conclusion The historical analysis of the available financial data suggests that the company is faltering on many grounds. The reducing margins coupled with lesser degree of leverage seem to be the bottlenecks for the company. It must be noted that from the return on asset ratios, it is very clear that the plant of the company is surely aging and there is an acute need for making investment by doing capital expenditures. Since due to constant profits and increasing equity, the return on equity is showing a declining thus to gain the confidence of the external investors, it is very important that the company take some strategic decisions in order to revive the confidence of investors. Besides the proposed capital expenditure must be executed as it is very clear that the low level of leverage clearly provide the company an opportunity to look for external financing given the fact that the proposed capital expenditure plans are in-line with the overall strategic direction of the company and upon their execution, the new project will surely help add value to the shareholders wealth by improving on the production capacity of the company thus providing it more leverage and room to cater the consumer demands. Appendix 1) Core Ratios Return on Sales (NPAT/Sales %) 6.74 6.20 5.95 5.98 5.87 Asset Turnover (Sales / Total Assets) 1.89 1.91 2.03 1.62 1.98 Asset Leverage (Total Assets/Equity) 1.31 0.63 0.43 0.30 0.22 Return on Equity (NPAT/Equity %) 16.70 7.52 5.16 2.94 2.52 2) Profitability Ratios Gross Profit / Sales (%) 36.76 37.37 36.60 37.94 38.74 Net Operating Profit / Sales (%) 14.23 13.30 12.11 11.83 11.56 Profit before Tax / Sales (%) 14.23 13.30 12.11 11.83 11.56 Return on Capital Employed (ROCE) 32.95 15.79 10.28 5.71 4.89 Return on Invested Capital (ROIC) 38.43 20.54 14.10 8.00 6.88 Return on Assets (ROA) 26.86 25.43 24.62 19.17 22.87 Financial Structure Current Ratio 2.54 2.16 2.57 2.98 2.21 Quick Ratio (Acid Test) 1.27 0.89 1.33 1.21 1.12 Working Capital (Thousands) 249 234 271 433 289 Gross Gearing (%) 39.92 20.38 12.32 8.62 7.77 Net Gearing (%) 39.92 20.38 12.32 8.62 7.77 Read More