Financial Performance of Dareen Merchandizing - Research Paper Example

?RATIO ANALYSIS INTRODUCTION This report is aimed at analyzing the financial performance of Dareen Merchandizing. Analysis will be conducted using financial ratios and these ratios will be compared over the period of two years. Performance analysis will also be conducted based on the comparison of company performance with industry performance and trend. On the arrived results, comment will be made on factors driving results in positive or negative directions. Each ratio comparison and analysis will also be followed by recommendations for future improvement prospects of Dareen Merchandizing. RATIO ANALYSIS OF DAREEN MANUFACTURING Ratios are relative measures and provide information in comparison with similar ratio over period of time or with other company or industry average (McLaney, 2009). Comparison using ratios over two financial years of Dareen Merchandizing and with industry would provide considerable insight regarding Dareen Merchandizing business performance. 1- PROFIT MARGIN FORMULA = NET INCOME     SALES   (McLaney, 2009) A- RATIO: Ratio DM 2011 Industry 2011 DM 2010 Industry 2010 PROFIT MARGIN =219,030/815000 26.87% 26.00% =136,990/645,000 21.24% 22.00% B- COMMENT ON COMPANY PERFORMANCE AND INDUSTRY TREND 2011- PM-Favorable over industry 2010- PM- Favorable over industry Profit margin in the year 2011 has increased as compared to year 2010. Main reason driving this increase appears to increase in prices as well as sales of the product. Income statement shows sales increased from AED 645,000 in year 2010 to AED 815,000 in year 2011. Increase in price is also clued from comparatively minimal increase in cost goods sold than increase in sales. Increase in sales can be attributed to heavy advertising expenditure incurred from AED 2200 in year 2010 to AED 25000 in 2011. Also this increase in sales can be attributed to increase in fixed asset from AED 179,121 in year 2010 to AED 242,067 in year 2011 assuming company has undergone some expansion plan in year 2011. DM is performing very much similar to the industry as the profit margin of the overall industry has also increased in the recent year as compare to previous year. Hence, it appears that prices have increased in the industry so does of DM product and to maintain and increase the sales momentum DM spent considerable amount in advertising, which seems to be paying off. C- RECOMMENDATION Increase in sales without similar increase in cost refers that firm has strong control over cost components. However, this increase in sales has a push from high advertising expenditure and hence, firm has room for improvement in this respect. Control over advertising expenses has additional capacity to improve this profitability ratio. Moreover, control over utilities expenses that have increased almost near to double, can also improve net income which will ultimately improve DM’s profitability and will take it ahead of industry profitability margin. Control over these would give some room to decrease price (for instance, seasonal discounts etc) which will further increase sales and would promote profitability positively. 2- INVENTORY TURNOVER FORMULA = SALES     INVENTORY   (McLaney, 2009) A- RATIO: Ratio DM 2011 Industry 2011 DM 2010 Industry 2010 INVENTORY TURNOVER 815,000/170,700 10.00X 645,000/32,470 9.00X 4.77X 19.86X B- COMMENT ON COMPANY PERFORMANCE AND INDUSTRY TREND 2011- IO- Unfavorable over industry 2010- IO- Favorable over industry Inventory turnover ratio of DM doesn’t reflect some healthy picture. In the year 2010 DM had a very minimal inventory in reference to the amount of sales. In the following year of 2011, the amount of retained inventory increased to large extent. It reflects that in both years company had inefficient inventory management. In the former year it must be constantly involved in the buying inventory every few day i.e. every 18 day (360/19.86) which resulted extra exercise, cost and time which could have been invested in other productive exercise. In the year 2011, firm purchased sizeable inventory each time in anticipation increasing sales. Decline in inventory turnover, tough reflects the sizeable investment in asset that pays no return. Nevertheless, Inventory turnover of 4.77X is close to industry average that assets DM following industry trend of buying inventory every 72 days (360/5). C- RECOMMENDATION DM needs to develop some consistent plan for inventory buying. It had ample variations in trend in comparison within its own performance as well as with industry. Also in an attempt to bring Inventory turnover close to industry, company bought excess inventory that drove Inventory turnover of company down than industry, though being very close to it. Hence, it reflects the aggressive in pattern. 3- FIXED ASSET TURNOVER FORMULA = SALES     FIXED ASSETS NET OF DEPRECIATION   (Friedlob, & Plewa, 1996) A- RATIO: Ratio DM 2011 Industry 2011 DM 2010 Industry 2010 FIXED ASSET TURNOVER 815,000/242,067 5.60X 645,000/17,9121 4.70X 3.37X 3.60X B- COMMENT ON COMPANY PERFORMANCE AND INDUSTRY TREND 2011- Unfavorable over industry 2010- Unfavorable over industry Fixed asset turnover of the company has been further deteriorated from 3.60X in the year 2010 to 3.37X in the year 2011. Increased sales component have also increased earning with considerable size, hence, decline in fixed asset turnover is due to increase in fixed asset from AED 179,121 in year 2010 to AED 242,067 in year 2011. This refers that DM has extended its asset such as new outlet etc. This investment at one side increased sales and caused decline in fixed asset turnover. Decline in fixed asset turnover, with increase in fixed asset can be considered justified for the company as taking full benefit from newly made fixed asset requires sometime. However, DM is far below the industry average. To highlight fact, industry has made significant improvement in taking benefits from fixed assets. In comparison with industry, DM in using its already invested assets has some inefficiency. To assume, DM has certain assets that are either not utilized at their optimum level or there are assets which are of no use for the firm. At this situation, further investment in fixed assets is questionable as with increased sales it appears industry is improving its overall efficiency whereas DM is increasing its asset base than focusing on increasing efficiency. C- RECOMMENDATION DM needs to review its investment in fixed assets. DM shall dispose of assets that are not contributing in improving sales, for instances, closing or resizing those outlets that are not generating revenue. These assets may also be certain furniture or fixture that may be in excess to the need of firm. On the other hand, it needs to review assets that are not being utilized to their optimum. Also since, firm has made further investment in fixed asset therefore; it shall focus more to increase sales that improve its fixed assets turnover bringing it closer to industry average. Advertising expense already increased and further increase in advertising expense would cause decline in net income hence, profit margin. Therefore, DM shall incur advertising expense with more considerate approach that increases sales without further increasing advertising expense. 4- QUICK RATIO FORMULA = CURRENT ASSET -INVENTORY     CURRENT LIABILITIES (Gitman, 2003) A- RATIO: Ratio DM 2011 Industry 2011 DM 2010 Industry 2010 QUICK RATIO (291,675-170,700)/ 348,640 1.20X (191,218-32,470)/ 173,400 1.10X 0.35X 0.92X B- COMMENT ON COMPANY PERFORMANCE AND INDUSTRY TREND 2011- Unfavorable over industry 2010- Unfavorable over industry Quick ratio, also known as acid test ratio, is also presenting situation where firm is not in a good position. Over year, its ratio has declined to substantial amount. This calls for firm’s worsening situation as this ratio already doesn’t account for inventory and is quick test of firm’s liquidity. DM’s capacity to pay off its current liability with its quick assets is questionable. Cash and marketable securities have reached near to ground level and firm has also increased its account receivable with heavy amount. Increase in account receivable refers that either the firm has eased its credit policy or have been less successful in recovering its receivables on time, clued from contrast in account receivable of two years though sales have been credit in both years. Firm has alongside increased its current liability by AED 175,240 from 2010 to 2011. View of current liabilities reveals that firm has increased its account payable by substantial amount. Also notes payable to bank has risen from AED 99,200 from 2010 to AED 204000 i.e. by Almost AED 105,000. Moreover, with critical evaluation, to pay off liability of AED 348,640 immediately firm only has AED 120, 275 (as cash and marketable securities with DM are minimal). Hence, DM is highly dependent on the sale of its inventory to pay off its mounting current liability. This is also an important situation to handle as investment has shifted from marketable securities to inventory, where former brings some rate of return on holdings whereas latter is asset investment in an avenue with zero rate of return; while on the other hand expense of interest on notes payable and account payable has been increased. C- RECOMMENDATION To improve this critical situation firm needs to improve its investment in marketable securities and account receivable which appear to increase at far higher rate than its increase in sales. Tightening credit policy will increase liquidity available to pay off account payable at a faster rate. This will self reduce need to acquire short term notes payable. Hence, reducing additional interest expense incurred. This will also reduce the credibility risk that increases due to weak paying capacity of current liabilities. Moreover, increase in assets like marketable securities than account receivable is more beneficial as former fetch return on investment without having any chance of bad allowance whereas latter, if gives considerable return, also raises high bad debts risk. 5- DEBT TO TOTAL ASSET FORMULA = TOTAL DEBT     TOTAL ASSETS   (Kaplan, and Atkinson, 1998) A- RATIO: Ratio DM 2011 Industry 2011 DM 2010 Industry 2010 DEBT TO TOTAL ASSET 400,640/533,742 65% 209,400/370,339 60% 75% 57% B- COMMENT ON COMPANY PERFORMANCE AND INDUSTRY TREND 2011- Unfavorable over industry 2010- Favorable over industry DM has increased its debt by ample amount from 57% to 75% in a single year. Total debt has been doubled in the mentioned period whereas total assets have been increased by approx 1.4X. This debt accounting for almost 75% of the asset paying capacity is not a sign of healthy business, though main increase in this debt is from current liabilities. As once firm’s short term paying capacity is questioned, there are least chances for it to get any further leverage from creditors. In comparison with industry, it was in a better position in year 2010. However, it seems as the industry has taken move to increase debt the firm adopted the move more aggressively and increase its debt by an additional 10%. This aggressiveness is reflected in overall constituents of DM’s financial statement. C- RECOMMENDATION As suggested above to reduce level of current liabilities, its ratio will improve considerably. 6- OPERATING LEVERAGE FORMULA = CONTRIBUTION MARGIN     EBIT (Khan, 1993) A- RATIO: Ratio DM 2011 Industry 2011 DM 2010 Industry 2010 OPERATING LEVERAGE (815,000-439,000)/ 315,500 2.0X (645,000-415,000) /197,500 1.9X 1.19X 1.16X B- COMMENT ON COMPANY PERFORMANCE AND INDUSTRY TREND Operating leverage shows how an increase in the sales grows the profits of the company. The higher the value of the operating leverage the higher it would grow the profits (Levy, & Brooks, 1986). However this also means that the company would have more fixed cost and thus riskier. Operating leverage of the company is less than the industry average and therefore an increase in the sales of the company would not grow the profits to the same extends than other companies in the industry in both the years. However this also shows that the riskiness of the company would be less than the industry as the value of the operating leverage is low. So it can be said that it is positive as well as negative for the company as with increasing sales, company would not be able to achieve very high profits. However on the other hand, when the sales of the company will be low then it would have low risk as the fixed cost is low. C- RECOMMENDATION It is important for the company to increase its operating leverage as other companies in the industry would be able to earn more profits than the company and therefore the company needs to take more risk and increase its value of operating leverage so that it can take benefit from increase in sales and achieve more profits. CONLCUSION Overall financial management of firm requires more defined policy. Other than profit margin, DM is performing in with high variation with industry. Also within year, its performance has been reflective of un-considerate decision. For instance, decline of Inventory turnover below industry average or industry improving efficiency of its asset use whereas DM increases investment in fixed assets. Hence, DM requires well thought out strategic planning for its smooth financial operations. References Friedlob, G., & Plewa, J. (1996). Understanding balance sheets. New York: John Wiley & Sons. Gitman, L. (2003). Principles of Managerial Finance. Boston: Addison-Wesley Publishing. Kaplan, R., and Atkinson, A. (1998). Advanced Management Accounting. New Jersey: Prentice-Hall. Khan, M. (1993). Theory & Problems in Financial Management. Boston: McGraw Hill Higher Education. Levy, H., & Brooks, R. (1986). Financial Break-Even Analysis and the Value of the Firm. Financial Management, vol. 15, no. 3, pp. 22-26. McLaney, E. (2009). Business Finance: Theory and Practice, New Jersey, Pearson Education Read More