The Gross Profit Margin of Mark Equipment Pty Ltd - Essay Example

Table of Contents Question 1 (a) 2 Question 1 (b) 4 Question 2 11 Question 3 12 Question 4 13 Question 4 (a) 13 Question 4 (b) 14 Question 5 15 References 17 Bibliography 18 Appendices 19 Loan Amortization Schedule 19 Question 1 (a) The Gross Income Margin is a financial measure to evaluate an organization’s financial wellbeing by disclosing the percentage of cash left after considering the cost of goods sold into account. The gross income value of an organization serves as the basis for the payment of further expenses and future reserves. The gross income margin of an organization can be calculated as the ratio of its revenue less its cost of sales to its revenue value. i.e., Gross Income Margin = (Revenue – Cost of Sales)/ Revenue The cost of sales refers to the direct expenses involved in the manufacturing of the products sold by the organization. The cost of sales value includes the cost of resources utilized in the manufacturing of the products along with the labor expenses utilized in the production of the products. Thus, the cost of sales can be computed as, Cost of Sales = Opening Stock + Purchases – Closing Stock The computation of the cost of sales of a company does not comprise of any indirect costs involved in the process of sale of the products. Thus, the repair and maintenance charges, costs of depreciation of tools and equipments, rent expenditure, wages and charges of water and electricity have been excluded from the calculation of the cost of sales and hence from the computation of the gross profit of the company1. Therefore, the cost of sales of Mark Equipment Pty Ltd for the present year and the previous year would be, Cost of Sales (Present Year) = 7,476,900 + 89,881,400 – 9,291,100 = $ 88,067,200 Cost of Sales (Past Year) = 6,486,900 + 56,820,100 – 7,476,900 = $ 55,830,100 The Revenue values of Mark Equipment Pty Ltd for the present and the previous year were 159,697,500 and 107,043,200 respectively. Hence, the Gross Income of Mark Equipment Pty Ltd for the same period would be 71,630,300 and 51,213,100. Consequently, the gross income margin of Mark Equipment Pty Ltd for present year would be, = 71,630,300/ 159,697,500 = 0.44 = 44% While, the gross income margin of Mark Equipment Pty Ltd for previous year would be, = 51,213,100/107,043,200 = 0.478 = 47.8% Accordingly, gross income earned by Mark Equipment Pty Ltd for the present year was equivalent to 44% of its revenue generated for the same period, while the gross income of the company for the previous year was 47.8% of its revenue for the identical period. As a result, the restructures income statement of Mark Equipment would be as follows: Question 1 (b) Analysis of the Financial Position of Mark Equipment Pty Ltd For the analysis, the financial performances of Mark Equipment Pty Ltd have been reviewed and evaluated in certain key aspects, such as, Short-Term Liquidity; Long-Term Solvency; Asset Management; and Profitability for the present and the previous year. The short-term liquidity of the company and its ability to disburse of its immediate compulsions can be evaluated from the current ratio, the quick ratio and the cash ratio of the company. The current ratio of a company signifies its capability to pay off the short-term commitments in a prompt way and is hence helpful to understand the short-term solvency or liquidity of a company2. Current Ratio= Current Assets/ Current Liabilities Thus, for the previous year, Current Ratio of Mark Equipment Pty Ltd = 13119000/10237700 = 1.28 And for the present year, Current Ratio of Mark Equipment Pty Ltd = 36733500/27323300 = =1.34 The quick ratio of an organization shows the ability of the organization to meet its pressing obligations. Quick Ratio= Quick Assets/ Current Liabilities Thus, for the previous year, Quick Ratio of Mark Equipment Pty Ltd = 5642100/10237700 = 0.55 And for the present year, Quick Ratio of Mark Equipment Pty Ltd = 27442400/27323300 = =1.004 The cash ratio can be calculated as the ratio of summation of cash and short-term marketable investments divided by current liabilities of the organization. It is advantageous in finding out how swiftly the organization can repay its short-term liability to its creditors. Cash Ratio= Cash Assets/ Current Liabilities Thus, for the previous year, Cash Ratio of Mark Equipment Pty Ltd = 42400/10237700 = 0.004 And for the present year, Cash Ratio of Mark Equipment Pty Ltd = 53200/27323300 = =0.002 The long-term solvency aspect of a company can be evaluated with the help of ratios like debt ratio and debt to equity ratio among others. These ratios signify the association of the assets and the liabilities of a company3. Debt Ratio = Total Liabilities/ Total Assets For the previous year, Debt Ratio of Mark Equipment Pty Ltd = 11787700/ 20456000 = 0.57 And for the present year, Debt Ratio of Mark Equipment Pty Ltd = 30284500/ 43991300 = 0.69 Debt to Equity (D/E) Ratio = Long Term Debt/ Total Stockholders’ Equity For previous year, the D/E Ratio of Mark Equipment Pty Ltd = 1550000/8668300 = 0.178 And for present year, the D/E Ratio of Mark Equipment Pty Ltd = 2961200/13706800 = 0.216 The turnover ratios determine the asset management measures of a company. The ratios indicate how effectively the company utilizes its assets to generate revenue. The asset turnover ratios look at how well a company is generating revenue in relation to its assets. These ratios do not consider the net profit earned, the way return on asset does. Fixed Asset Turnover Ratio = Sales revenue/ Net fixed Assets For the previous year Fixed Asset Turnover Ratio of Mark Equipment Pty Ltd = 107043200/5921600 = 18.07 And for present year, Fixed Asset Turnover Ratio of Mark Equipment Pty Ltd = 159697500/7093500 = 22.51 Total asset Turnover ratio = Sales Revenue/ Total Assets For the previous year, Total Asset Turnover Ratio of Mark Equipment Pty Ltd = 107043200/20456000= 5.23 And for present year, Total Asset Turnover Ratio of Mark Equipment Pty Ltd = 159697500/43991300 = 3.63 The profitability aspect of Mark Equipment Pty Ltd can be analyzed with the help of the profit margin ratios in addition to the return on asset and the return on equity of the company. The gross profit margin indicates the gross or basic profitability of a company; the operating profit margin is an indicator of the operating performance of the company whereas the net profit margin is an indicator of the overall profitability of the business4. Gross Profit Margin = Gross Profit/ Sales Revenue For previous year, Gross Profit Margin of Mark Equipment Pty Ltd = 51213100/107043200 = 0.051 = 47.8% For present year, the Gross Profit Margin of Mark Equipment Pty Ltd = 71630300/159697500 = 0.063 = 44% Operating Profit Margin = Operating Profit/ Sales Revenue For previous year, Operating Profit Margin of Mark Equipment Pty Ltd = 1500100/107043200 = 1.40% For the present year, the Operating Profit Margin of Mark Equipment Pty Ltd = 22152100/159697500 = 13.87% Net Profit Margin = Net Profit/ Sales Revenue For previous year, Net Profit Margin of Mark Equipment Pty Ltd = 24300/107043200 = 0.02% For 2011, the Net Profit Margin of Mark Equipment Pty Ltd = 183000/159697500 = 0.17% Return on Total Asset (ROA) = Profit after Tax/ Total Assets For the previous year, Return on Total Asset of Mark Equipment Pty Ltd = 183000/ 20456000= 0.0337 = 0.06% And for 2011, ROA of Mark Equipment Pty Ltd = 24300/ 43991300= 0.0725= 0.89% Return on Equity (ROE) = Profit after Tax/ Total Stockholders’ Equity For previous year, the ROE of Mark Equipment Pty Ltd = 183000/8668300= 2.11% And for 2011, the ROE of Mark Equipment Pty Ltd =24300/13706800= 0.18% The assessment of the financial health of Mark Equipment Pty Ltd can be carried out by the examination of the financial ratios of the company. The analysis of the current ratio shows that it has increased from 1.28 in the previous year to 1.34 in the present year. Ideally, the company should have current assets by current liabilities ratio of 2:1, in order to be in a position to comfortably repay their short-term liabilities. Thus, though the percentage of current assets of the company is a little higher than that of the current liabilities, the company should try to improve its current ratio in order to enhance its liquidity. The company also needs to focus on its cash assets so as to improve its creditworthiness. The debt ratio and the debt to equity ratio indicate the financial leverage of the organization. Debt ratio signifies the relationship between the total liabilities and the total assets. The debt ratio of Mark Equipment Pty Ltd has slightly increased from 0.57 to 0.69 during the period. The debt to equity ratio helps in deriving a reasonable relationship between the debt and the equity value of a company5. The present value of the debt to equity ratio also increased a little from 0.17 in the previous year to 0.21. Since the values of the mentioned ratios are moderately low, it can be implied that the company is in a position to raise long-term debts, in case it wants to, considering the moderately low interest rate. The fixed asset turnover ratio of Mark Equipment is 22.51 in the present year, whereas the fixed asset turnover of the company for the previous year has been 18.07. The total asset turnover for the previous year was 5.23, whereas it decreased to 3.63 in the present year. It implies that Mark Equipment had been able to generate more volume of sales in relation to the fixed assets it holds6. Thus, the company had utilized and managed its fixed assets quite fairly, though it needs to improve the utilization of its overall assets. The gross profit margin of Mark Equipment Pty Ltd for the previous year was 47.8% and it decreased to 44% in a year. However, the net profit margin of the company was quite low for both the years. The difference in the company’s gross profit percentage and the net profit percentage is due to the value of operating expense of the company. From the analysis, it can be observed that the profit margins of Mark Equipment Pty Ltd for the present year had decreased from the profit margins for the previous year. The return on total asset indicates the net profit earned per currency of the total asset, whereas the return on equity is an indicator of the net profit earned per unit of shareholder’s equity7. The return on total asset of the Mark Equipment has decreased from 0.89% in the previous year to 0.06 % in the present year. The return on equity of Mark Equipment has also decreased from 2.11% to 0.18% in the present. Such low returns on equity and asset is owing to the small value of net profit of Mark Equipment Pty Ltd, particularly in the present year. Question 2 The selection of the appropriate credit product for Mark Angelo and his company Mark Equipment Pty Ltd can be made based on the credit evaluation of Mark Angelo and Mark Equipment Pty Ltd. The assessment of the financial health of Mark Equipment and the creditworthiness of Mark Angelo is necessary for the determination of the capability of the client to pay back the debt and also the assessment of the assets the client can present to the bank on his or his company’s behalf as collateral against the debt8. The analysis of the financial statements of Mark Equipment of the last two years reveals that the company had generated reasonable values of revenue and gross income, which had also increased in comparison to the previous year. Though the net income of the company had reduced over the period its net asset value had amplified by about 58% in comparison to the previous year. Moreover, the company is not very financially leveraged and had not utilised much credit funds so far. The company holds fixed assets valuing $7093500, which it had so far utilised proficiently to generate revenues. Mark Equipment can present these assets as security to the bank against any type of credit to be obtained from the bank. The assessment of the financial statements of Mark Angelo and his bank statements illustrates he has a reasonable net asset value and owns considerable properties which can act as collaterals in the future. Thus, taking into consideration the financial position of Mark Equipment Pty Ltd and the creditworthiness of Mark Angelo, the bank can offer both fund based and non-fund based credit products to the company. The non-fund based credit products can be beneficial for Mark Equipment Pty Ltd if it is planning to engage in certain projects that might require a bank guarantee. The bank can offer fund based assistance in the form of term loans against appropriate collaterals as well as working capital finance to Mark Equipment Pty Ltd. The bank could also offer asset based loans against the accounts receivable or the inventory of the company9. On the basis of Mark Angelo’s steady financial state, the bank could offer him a credit card, an overdraft facility, a home loan or a personal loan as per his personal or business requirement. The bank could also offer Mark Angelo mortgage bonds in the form of home loans, wherein the credit offered by the bank would be protected by a mortgage on the house 10. Question 3 The key factors in the credit assessment of a client are his capacity to pay back the overdraft, his credit history and profitability, his willingness, collaterals that can be offered as mortgage, and the overall stability11. The financial statement of Mark Angelo discloses that he possesses net asset value of $17,173,400 and properties worth $27,660,000. He also earns a monthly salary of $600,000 from Mark Equipment Pty Ltd, where he is the 50% stakeholder. The three months bank statements from the existing bank of Mark Angelo demonstrate that the prospective client had not faced any occurrence of default till date. Moreover, the credit bureau report also does not illustrate any adverse information. Thus, considering Mark Angelo’s credit history, character and the value of the collaterals he can provide to the bank, the bank could have offered him a secured overdraft of $1500, 000. However, in general a bank offers unsecured overdraft to a client within or a little more than his monthly income12. The monthly income of Mark Angelo in addition to the monthly earnings of his company is considerably less than $1500, 000 and hence cannot justify the condition. Thus, it would not be possible to offer an unsecured overdraft facility of $1500, 000 in the name of Mark Angelo. Question 4 Question 4 (a) The collaterals that a banker can request from Mark Angelo and their realistic values have been listed below: Type of Collateral: Real Estate (Book Values) Residential property at Mill Point Rd, South Perth $15,000,000 Holiday home at Dunsborough $5,160,000 Vineyard farm at Margaret River $7,500,000 Since these collaterals fall under the real estate category, the market values of the properties would be certainly more than their above mentioned book values as the worth of properties usually appreciate with time. Type of Collateral: Marketable Securities Investment in Mark Equipment Pty Ltd - 50% shareholding $1 527 600 Investment in Mark Equipment Pty Ltd - loan account $5 325 800 Fixed deposit $ 750 000 Since these collaterals are investment items, they are worth their above mentioned book values. Question 4 (b) The collaterals that a banker can request from Mark Equipment Pty Ltd and their realistic values have been listed as follows: (Book Values) Fixed Asset (Plant and Equipment) $2,804,700 Stocks $9,291,100 Accounts Receivable $27,389,200 The fixed assets fall under the plant and equipment category of collateral, while stock and accounts receivable fall under the inventory category. The company had depreciated its fixed assets on a straight line basis over the expected life of the assets. Hence, the fixed assets are worth their book value mentioned above. The stocks of the company have been valued at the lesser of their cost or net realisable value on a first in first out basis; hence they are also worth their book values. Question 5 If Mark Equipment Pty Ltd were to take up an additional loan of $10 million spread over a period of ten years, at the annual interest rate of 14.5%, the company will have to pay back the interest and the principal amount of the loan to the bank by means of equated monthly instalments (EMIs) within subsequent 120 months. Amortizing the loan of $10,000,000 into identical instalments, it can be computed that Mark Equipment Pty Ltd would have to pay an EMI of $158,286.76 for the upcoming 120 months13 (Refer Appendices). This implies that the company would have to pay an amount of $18,994,414.8 in total, of which $8,994,414.8 is the interest component of the $10million loan. Taking into consideration that Mark Equipment Pty Ltd would utilize the loan to replace certain redundant equipments; the loan would not essentially result in an increment in the production ability of the company or its sales. The cash flow statement of the company for the present year is as follows: The assessment of the last two years’ balance sheets and the income statements and the cash flow statement of Mark Equipment Pty Ltd illustrate that the net cash flow of the company from the operational, investment and financial activities for the present year is equivalent to $16,370,800. Thus, it can be inferred that the monthly cash flow of the company would be $1,364,233.33. This cash flow value would be enough to accommodate the monthly instalment of the $10 million loan. Thus, Mark Equipment Pty Ltd has the ability to repay a loan of $10 million at 14.5% in 10 years. References Altman, Edward, I. 1968. Financial Ratios, Discriminant Analysis and the Prediction of Corporate Bankruptcy. Journal of Finance, 23(4): 589-609. Damodaran, Aswath, No Date. “Financial Statement Analysis”. “New York University”. http://people.stern.nyu.edu/adamodar/pdfiles/invphiloh/finstatement.pdf Gitman, Lawrence J. Principles of Managerial Finance. India: Pearson Education, 2007. James Madison University, 2010. “Financial Ratio Analysis”. “Financial Analysis”. http://educ.jmu.edu/~drakepp/principles/module2/fin_rat.pdf Koch, Timothy W. & MacDonald, S. Scott. Bank Management. USA: Cengage Learning, 2009. Nikolai, Loren A. & Et. Al. Intermediate Accounting. USA: Cengage Learning, 2009. Rose, Peter S. & Hudgins, Sylvia C. Bank Management & Financial Services. India: Tata McGraw-Hill Education, 2010. Woelfel, C. J. Financial Statement Analysis: The Investor's Self-Study Guide to Interpreting & Analyzing Financial Statements. US: McGraw-Hill Professional, 1994. Bibliography Ross, Stephen. A. & Et. Al. Fundamentals of Corporate Finance. India: Tata McGraw-Hill Education, 2008. Appendices Loan Amortization Schedule Read More