Financial Performance for Sparklin Automotive Company - Case Study Example

Financial Performance for Sparklin Automotive Company – and General Manager Finance From: Manager Finance Date: Subject: Financial Performance for Sparklin Automotive Company – 2010 and 2011 Overview of Report This report presents a brief analysis of the performance of Sparklin Automotive Company during the financial year 2010 and 2011. The report includes an overview of the ratio analysis, its use and importance with respect to financial analysts. In addition to this, the report also presents a ratio analysis for Sparklin Automotive Company and an evaluation of the performance based on such ratios. Moreover, the report also discusses other possible methods for financial performance analysis, which could have been used to analyze the performance of Sparklin Automotive Company. At the end, recommendations are presented for Sparklin Automotive Company on the basis of performance evaluation presented in the report. Ratio Analysis, Its Use and Significance Ratio analysis refers to the financial analysis tool through which financial analysts carry out the analysis of a company’s financial performance by conducting a quantitative analysis. For the purpose of determining different ratios for the company, its financial statements are considered, which include comparative information, i.e. information pertaining to more than one financial year (Albrecht, Stice, & Stice, 2008; Eugene F. Brigham, 2012; Needles & Powers, 2010). Following are the ratios which have been considered in the analysis of Sparklin Automotive Company’s financial performance during the past 2 years: Current Ratio Current ratio is a measure of liquidity position of a company, which determines the amount of liquid assets possessed by a company in comparison with the amounts owed by it in short run. The ratio is determined by dividing current assets with current liabilities of the company (Needles & Powers, 2010). Debt to Equity Ratio The debt to equity ratio for a company shows that how far a company’s finance is obtained through borrowing with reference to the total equity of the company. This ratio, as the name suggests, is determined by dividing the total debt of the company with total equity (Needles & Powers, 2010). Inventory Turnover The inventory turnover ratio shows the frequency with which a company’s inventory is sold over a period of time. The ratio is determined by dividing the total sales revenue with the average inventory level or ending inventory, as the case may be (Needles & Powers, 2010). Accounts Receivable Turnover This ratio signifies the efficiency of a company with respect to the collection of its amounts owed to debtors. When accounts receivable turnover is high, it is considered favorable because the company is able to maintain a lower level of receivables with respect to total revenues earned on credit. The ratio is determined by dividing the total revenues earned with accounts receivables (Needles & Powers, 2010). Gross Margin Percentage The gross margin percentage is a ratio which shows gross margin as a percent of total revenues earned by a company. The ratio is helpful in understanding the efficiency of a company over time by comparing the gross margins for more than years and analyzing the trends observed therein. The ratio is determined by dividing the gross profit with total revenues earned by the company (Needles & Powers, 2010). Use and Significance of Financial Ratios Ratio analysis are used to determine changes (which may be positive or negative) in the financial performance of a given business enterprise. The analysis presents a historical review of the performance of a company as it takes into account financial information which is historic (Albrecht, Stice, & Stice, 2008). On the basis of conclusions reached through ratio analysis, financial analysts can devise appropriate measures or recommendations for the company to improve in areas which require attention. Since ratio analysis also depicts any inefficiency in the performance of the company, therefore it is possible to determine the efficiency with which a business enterprise has carried out its operations in a given period of time (Albrecht, Stice, & Stice, 2008; Eugene F. Brigham, 2012). Ratio Calculation for Sparklin Automotive Company (2010 and 2011) Considering the financial information presented in the consolidated financial statements of Sparklin Automotive Company, following is the ratio analysis: Current Ratio The formula used in determining the current ratio for Sparklin Automotive Company is as follows: Current Ratio = Current Assets / Current Liabilities (Needles & Powers, 2010) Inserting the values for the respective variables in the formula, following value is obtained: Year Calculation Ratio 2010 Current Ratio = 72,300 / 49,000 1.48 2011 Current Ratio = 67,350 / 48,000 1.40 Debt to Equity Ratio The formula used in determining the debt to equity ratio for Sparklin Automotive Company is as follows: Debt to Equity = Total Debt / Total Equity (Needles & Powers, 2010) Inserting the values for the respective variables in the formula, following value is obtained: Year Calculation Ratio 2010 Debt to Equity Ratio = 49,100 / 109,200 0.45 2011 Debt to Equity Ratio = 48,150 / 109,200 0.44 Inventory Turnover The formula used in determining the inventory turnover for Sparklin Automotive Company is as follows: Inventory Turnover = Sales / Inventory (Ending Balance) (Needles & Powers, 2010) Inserting the values for the respective variables in the formula, following value is obtained: Year Calculation Ratio 2010 Inventory Turnover = 155,000 / 25,360 3.11 2011 Inventory Turnover = 168,000 / 36,360 2.74 Accounts Receivable Turnover The formula used in determining the accounts receivable turnover for Sparklin Automotive Company is as follows: Accounts Receivable Turnover = Sales / Accounts Receivable (Ending Balance) (Needles & Powers, 2010) Inserting the values for the respective variables in the formula, following value is obtained: Year Calculation Ratio 2010 Accounts Receivables Turnover = 155,000 / 8,500 20.02 2011 Accounts Receivables Turnover = 168,000 / 9,250 20.10 Gross Margin Percentage The formula used in determining the gross margin percentage for Sparklin Automotive Company is as follows: Gross Margin Percentage = (Gross Margin / Sales) * 100 (Needles & Powers, 2010) Inserting the values for the respective variables in the formula, following value is obtained: Year Calculation Ratio 2010 Gross Margin Percentage = (76,250 / 155,000) * 100 49.19 2011 Gross Margin Percentage = (68,380 / 168,000) * 100 40.70 Evaluation of Sparklin Automotive Company’s Performance (2010 and 2011) Based on the ratios determined for Sparklin Automobiles Company for the past two years, it can be stated that the liquidity position of the company is commendable. Although there is a slight decrease in the liquidity position of the company in 2011 as compared to 2010, but it is still quite high to pose any threat in relation to liquidity. Apart from this, the debt to equity ratio has slightly declined in the year 2011 which implies that the company has decreased its reliance on debt for raising finance. As far as inventory turnover for the company is concerned, there has been a decline in the ratio observed in the year 2011 as compared to 2010. This decline is unfavorable for the company, because high level of inventory is in stocks for the company thus implying fewer sales in comparison with the stocks maintained by the company. The accounts receivables turnover for the company has remained on the same level in 2011 as compared to 2010. There is a comparatively equal increase in the accounts receivables and sales of the company in the year 2011, and therefore there has been no significant change resulted in the overall ratio for the company. Gross margin for the company has declined in the year 2011 as compared to 2010. This decline has been due to increase in cost of sales for the company. Other Methods for Financial Performance Analysis In addition to ratio analysis, there are various other methods for evaluating the financial performance of a company. These techniques for financial performance analysis also make use of historical financial information, which is obtained from the financial statements of the company under consideration. These techniques include horizontal analysis, vertical analysis, comparative analysis with industry averages, etc. (Eugene F. Brigham, 2012; Albrecht, Stice, & Stice, 2008). Depending on the nature of analysis required to be carried out and the objectives to be achieved from the analysis, the selection of financial analysis technique is made. Recommendations for Improvement On the basis of financial performance analysis for Sparklin Automotive Company, it has been concluded that the company has been efficient with respect to liquidity and accounts receivables turnover and also with regard to debt to equity ratio. However, there are improvements required in relation to inventory turnover ratio and gross margin ratio. It is recommended on the basis of these findings that the company shall consider maintaining lower levels of inventory stocks because if high levels of stocks are not converted to sales, then they act as investment without any yield. In addition to this, it is also recommended that the company shall consider managing its cost of sales more efficiently, so as to maintain its gross margin. Reference List Albrecht, W. S., Stice, E. K., & Stice, J. D. (2008). Financial Accounting: Cocnepts and Applications. Mason: CENGAGE Learning. Eugene F. Brigham, J. F. (2012). Fundamentals of Financial Managemen. Mason, USA: Joe Sabatino. Needles, B. E., & Powers, M. (2010). Financial Accounting. Mason: Cengage Learning. Read More