Why Tulip Refractory Is Making a Continuous Loss for a Span of Consecutive Five Years - Research Paper Example

?Financial Management Table of Contents Introduction 3 Main activities of the Organization 3 Financial Analysis 3 Liquidity Analysis 4 Solvency Analysis 5 Profitability Analysis 6 Operating Activity Analysis 7 Investment Activity Analysis 8 Recommendation 8 Conclusion 9 Reference 10 Introduction The main aim of the project is to draw a financial analysis of the two catering services namely, Tulip Refractory and Cafe 88 on the basis of the profit and loss statement and the balance sheet thus provided. Both Tulip Refractory and Cafe 88 provide catering services, but the former has been appointed by our organization to provide the canteen facilities to the office staff with a loan of 60000 pound has also been granted with an interest chargeable on the loan. Through the recent observations made by the organization it had been observed that Tulip Refractory is making a continuous loss for a span of consecutive five years but while the sister concern of the organization working with Cafe 88 is earning a year on year profit on a similar basis, i.e. no commercial price is to be charged from the office staff. From this study we have to analyze the reason for the loss of Tulip Refractory under the mentioned organization and how the sister concern of the main organization is earning profits working with Cafe 88(Analysis of Financial statement, n.d., and pp.1-10). Main activities of the Organization The main activities of Tulip Refractory are to provide meals, snacks and refreshment on working days to various staff of the organization. During the weekends the staffs of the Tulip Refractory are allowed to do some catering in private functions and ceremonies. Similar is the function of the Cafe 88 but we can observe a remarkable difference in the operation of both the catering services. This has put the main organization to take adequate steps based on the financial analysis thus conducted as follows. Financial Analysis When we talk of financial analysis it is generally conducted on the basis a few ratios through which we can provide proper recommendations or steps to be taken by the organization to avoid any further losses in the near future. However, the main tools behind the financial analysis of a company are its financial statements (profit and loss statement and the balance sheet). The main function of making an effective financial analysis of the company is to draw conclusion to arrive at a decision which will be in the best interest of the company. For achieving this purpose we employ the tool of ratio analysis under which three main aspects of a company are analyzed on the basis of its profitability, liquidity and efficiency/solvency. Liquidity Analysis The liquidity of the company means the repayable factor of a firm generally in cash form. The company which has assets which can be easily turned into cash for the purpose of meeting with the obligations of a company is called the liquidity analysis of the company. The liquidity of the firm has thus been found with the help of current ratio, quick ratio and cash ratio (Brigham, et. al., 2010, pp.93-110). Particulars (All values in pound) Tulip Refractory Cafe 88 Year 2011 2011 Current Assets 9000 16000 Current Liabilities 6000 4000 Current Ratio 1.50 4.00 Current Ratio mainly gives us an idea regarding the shot-term liability capacity of a firm. Higher the current ration more is its ability to repay its obligations. From the recent findings we can analyze that the repayment capacity of Tulip Refractory is much less in comparison to Cafe 88. This is because the liability of Cafe 88 is less with respect to the assets acquired by the catering firm. Particulars (All values in pound) Tulip Refractory Cafe 88 Year 2011 2011 Bank and cash 1000 14000 Debtors 5000 0 Total quick Assets 6000 14000 Current Liabilities 6000 4000 Quick Ratio 1.00 3.50 Quick ratio is known to be a much more conventional with respect to the current ratio; thus considered a better liquidity measure. Inventory in most of the companies is considered to be the most illiquid form of asset hence it is deducted from the total current assets. Thus it does not overestimate the company’s repayment capacity unlike current ratio. Since the current assets irrespective of the stock is more in Cafe 88 so it has a better short term obligation repayment capacity than Tulip Refractory. Particulars (All values in pound) Tulip Refractory Cafe 88 Year 2011 2011 Bank and cash 1000 14000 Current Liabilities 6000 4000 Cash Ratio 0.17 3.50 Cash is considered to be the most liquid assets in any company. Though this is an important liquidity ratio yet it should be seldom used as it deducts the two main important assets of the company namely, debtors and inventory. The cash balance being more in Cafe 88 its repayment capacity also becomes more in comparison to the Tulip Refractory. Solvency Analysis The solvency position of the company helps us determine the repayment capacity of a firm in the short term duration of the firm. This is extremely important for the canteen as its operation is generally on a short term basis. Following are the few ratios used for the determination of the solvency of a firm. Particulars (All values in pound) Tulip Refractory Cafe 88 Year 2011 2011 Current Liability 6000 4000 Non-current interest bearing liabilities 25000 13000 Total debt 31000 17000 Equity attributable to owners -17000 55000 Debt to Equity -1.82 0.31 The ratio between debt and equity is known as the debt equity ratio. Higher the debt equity ratio more is the interest bearing burden on the company. The above calculations shows us that the debt of Tulip Refractory is more than that of Cafe 88 but the equity is negative in case of Tulip Refractory which is a matter of great concern for the firm. This means that Tulip Refractory has borrowed a lot in the market whereas it does not have any savings in case the company goes sick. Particulars (All values in pound) Tulip Refractory Cafe 88 Year 2011 2011 Revenue 160000 80000 Cost of Goods sold 80000 10000 Operating Expenses 99500 49900 EBIT -19500 20100 Interest on borrowing 500 100 Interest Coverage Ratio -39.00 201.00 Through interest coverage ratio we can repay the obligation of interest calculated on loan though the profit earned from the company. Lower interest coverage ratio can pose a threat to the concerned company in the coming future. Interest coverage ratio that is below one indicates that the company is not generating enough profit to cover up the expense of the interest which as we can observe is the case with Tulip Refractory. Profitability Analysis Profitability analysis is the process through which we can analyze the criteria which helps us determine the revenue earned from the company is more in respect to the cost incurred in the production process. This we have found with the help of a few formulas namely, operating profit margin, net operating margin and return on assets. Particulars (All values in pound) Tulip Refractory Cafe 88 Year 2011 2011 Operating profit margin -12.50% 25.00% Net profit margin -12.50% 25.00% ROA -142.86% 27.78% Operating margin gives a vivid idea to the about the profit earning capacity of a company from its sales on every dollar. Operating margin can be best judged when compared on a periodic basis with that of another company for similar period of time. The massive loss made by Tulip Refractory is the reason behind the negative operating margin in comparison to Cafe 88 which gives a positive operating margin because its interest expense is much lower than that of Tulip Refractory. Net Profit Margin is a more effective way of controlling cost thereby helping the company actual the net profit of the company. This is another way of making a comparative study between two or more companies in the same business under similar conditions. We can see that both net profit margin and operating margin are the same due to the absence of the tax factor. Here as we can estimate that Cafe 88 is in a better position than Tulip Refractory. The return that is generated from the assets of the company is termed as return on assets. Assets comprises of both equity as well as debt. This is a tool for estimating how effectively the company is able to convert its assets into income. Again here we see that Cafe 88 earns a positive return on assets in comparison to Tulip Refractory which generates a high negative return on assets. Operating Activity Analysis Through the word operations activity what we understand is the way the day to day activities are carried out. The expense that goes for carrying out these operating activities calculating which we can make an estimate of the inventory turnover ratio, payables ratio and working capital turnover ratio to name a few. Particulars (All values in pound) Tulip Refractory Cafe 88 Year 2011 2011 Cost of Goods Sold 80000 10000 Average inventories 3000 2000 Inventory Turnover 53.33 40.00 The income that is earned from inventory is called the inventory turnover ratio which is higher in the case of Tulip Refractory helping in the reduction of its holding cost. Particulars (All values in pound) Tulip Refractory Cafe 88 Year 2011 2011 Revenue 160000 80000 Trade creditors 6000 4000 Payables turnover 26.67 20.00 This ratio gives us an idea as to the time that a company is taking to repay its debt. Cafe 88 takes more time in order to pay off its debt in comparison to Tulip Refractory. Particulars (All values in pound) Tulip Refractory Cafe 88 Year 2011 2011 Revenue 160000 80000 Working capital 3000 12000 Working capital Turnover 53.33 6.67 Working capital is generally used for funding the operations of the company to make sales proceed. The income thus generated when it is more than the funding operations of the company it gives us the working capital turnover ratio. Since Tulip Refractory’s working capital turnover ratio is more because the revenue generated is more but the working capital is less. Investment Activity Analysis Long term investment positions of the company is assessed on the basis of some formulas like the net fixed asset turnover ratio and total asset turnover ratio based on which the investment criteria of a company can be analyzed. Through the following calculations made we can make an estimate as to whether to invest in Tulip Refractory or Cafe 88. Particulars Tulip Refractory Cafe 88 Year 2011 2011 Revenue 160000 80000 Equipment 50000 62000 Net Fixed Asset Turnover 3.20 1.29 The investment made in the fixed assets of the company for further operations in order to generate high revenue. The revenue generated in case of Cafe 88 is low against the investment made in fixed assets as compared to Tulip Refractory. Particulars Tulip Refractory Cafe 88 Year 2011 2011 Revenue 160000 80000 Total assets 14000 72000 Total asset turnover 11.43 1.11 The Revenue earned from investment of the total assets of the company which is again high in the case of Tulip Refractory as the income that it is generating from total assets investment is more than Cafe 88. Recommendation By analyzing the financial statements, it is concluded by the researcher, that the company should invest in the company generating positive return. The solvency position of Tulip Refractory is not attractable for the organization. The liquidity ratio of Tulip Refractory has decreased, when the liquidity position of the Cafe 88 has improved. However, when the researcher analyzes the return on assets it has found that Cafe 88 is efficient in managing the investments they got from the investors. They are also utilizing the assets at the best. The net profit margin of the company has also improved during the year, which implicates the operating efficiency of the company. The net profit margin of Cafe 88 is better than Tulip Refractory. Analyzing the strategies and financial condition of both the catering concern the researcher can recommend that the investor should invest in Cafe 88, thus outsourcing its canteen service to them (Brigham et. al, 2009, pp.256-286) Conclusion The above analysis it can be said that if the canteen service can be sub-contracted to Cafe 88 it will be beneficial for the organisation as we can observe from the given data that financial condition of Cafe 88 is much better than Tulip Refractory in most cases. Furthermore Cafe 88 concentrates only on canteen service whereas Tulip Refractory also has some extra source of income which deviates its focus from the main line of business as it is more concerned with commercial pricing of services. Reference Analysis of Financial Statement, n.d. Financial Statement Analysis. [Pdf] Available at: http://www.nos.org/srsec320newe/320el27.pdf [Accessed on May 15, 2012] Brigham E. F., et al., 2009. Phillip R. Daves, Intermediate Financial Management. Canada: Cengage Learning Brigham E. F., et al., 2010. Financial Management Theory and Practice. Canada: Cengage Learning Read More