Financial Performance of Pace Leisurewear Ltd through Appropriate Theory and Relevant Techniques - Research Proposal Example

Report on: Evaluation Of Financial Performance of Pace Leisurewear Ltd Through Appropriate Theory And Relevant Techniques Terms of Reference: Managing director, Pace Leisurewear Ltd From: Mr. XXX , Financial Analyst, XXX Management Consultants. Abstract: Firm's liquidity is in a worst condition and is a menace to pay for current obligations. The profitability is quite satisfactory but quality of debtors is quite poor. Sales rate of the firm is not satisfactory. Adding more debt than previous year heighten its greater degree of risk as fixed obligation is imposed. Rate of return is quite lower than investing its asset. Return on equity is high as operating profit margin as high. Internal finance should be conducted through factoring of debtors, selling of unsold stock at a cheaper rate, taking operating lease. Content page: Terms of Reference: 1 Abstract: 1 Content page: 2 Introduction: 2 Methodology: 3 Financial techniques to evaluating The Company: 3 Ratio Analysis: 4 Liquidity Ratio: Short-term Solvency 4 Activity ratios: Asset liquidity, Asset management efficiency 5 Leverage ratios: Debt financing and coverage 6 Profitability ratios: Overall efficiency 6 Du Pont system: 7 Ways of financing: 7 Conclusion: 8 Bibliography: 8 Appendix 9 Table 1 10 Ratio outcome 10 Table 2 10 Cash flow statement 10 Graphs 11 Calculation of factoring: 14 Introduction: To wear out weakness and strengthening the advantages financial analysis is done by the firms. Financial statement analysis involves, comparing the performance with that of other firms in the same industry and evaluating trends in the firm's financial position over time. These studies help management identify deficiencies and then take actions to improve performance. Methodology: For evaluating the financial performance of the firm ratio analysis and Du Pont system are used. According to Fraser, L. (2001) & Ormiston, A. (2001) the subordinate classifications of ratio analysis are: Liquidity ratio: Short term solvency Activity ratios: Asset liquidity, Asset management efficiency Leverage ratios: Debt financing and coverage Profitability ratios: Overall efficiency Financial techniques to evaluating The Company: According to Fraser, L. (2001) & Ormiston, A. (2001) The available cash resources to satisfy the current obligations must come primarily from cash or the conversation to cash from of other current asset. For interpreting the liquidity of the firm, several types of ratios have been depicted. Current ratio, quick ratio, cash flow liquidity measures the firm's short-term solvency. Firm's ability to meet the current obligations can be judged. Liquidity position or effects of using debt can be evaluated. The available cash resources to satisfy the current obligations must come primarily from cash or the conversation to cash from of other current asset. To judge the long-term financial position of the firm, financial leverage ratios are used. Brigham, E. (2007) & Houston, J. (2007) mentioned that these ratios indicate mix of funds provided by owner and lender. According to Fraser, L. (2001) & Ormiston, A. (2001) the amount and proportion of debt in a company's capital structure is extremely important because of the trade off between risk and return. Gross profit margin, operating profit margin, and net profit margin represent the firm's ability to translate sales dollars into profits as different stages of measurement. Administrative efficiency can be judged through this. Brigham, E. (2007) & Houston, J. (2007) assessed the fixed asset turnover ratio measures how effectively the firm uses its fixed assets and total asset turnover measures the turnover of the entire firm's asset. So, Debt ratio, debt to equity ratio, long tem debt to total capitalization ratio have been drawn. Ratio Analysis: Liquidity Ratio: Short-term Solvency Year before last Last year Current 1.76 1.13 Quick 1.10 0.47 Cash flow liquidity 0.30 The current ratio of the firm indicates that at the end of year current asset covered current liabilities 1.13 times down form the previous year. The low liquidity indicates increase of creditors and decrease of cash position of the firm. The firm will face trouble, as proportion of current asset to current liability is lower. The quick ratio is in a worst condition. So, the firm cannot meet its current obligations unless the stock turnover is increased. Activity ratios: Asset liquidity, Asset management efficiency Year before last Last year Average collection period (Days) 42.06 60.99 Accounts receivable turnover (times) 8.68 5.99 Inventory turnover (Times) 3.10 2.00 From the average collection period it is seen that firm's credit policies is becoming lenient from previous year which is indicating credit policy is too lenient, quality of debtors is poor. As average collection period is increased by 45% from previous year it is a harbinger of becoming bad debts. It is indicating the poor quality of debtors. Inventory turnover is decreased to 2 times. It is happened for several reasons; poor quality of goods, increased in price, quality of advertisement campaign is poor and etc. Year before last Last year Fixed asset turnover 1.63 1.55 Total asset turnover 1.08 0.92 Fixed and total asset turnover is becoming worse compare with previous year indicating management inefficiencies in generating sales from investment asset. As lower the ratios, the bigger in the investment required generating sales. Leverage ratios: Debt financing and coverage Year before last Last year Debt ratio 0.47 0.63 Long term debt to total capitalization 0.34 0.42 Debt to equity 0.88 1.72 Times interest earned 4.86 5.06 Among total asset the total liabilities is 63%, increasing from previous year by 16%, indicating firm is receiving more debt and increasing the risk as fixed interest charge is increasing. External finance is not possible as higher proportion of debt is using against total shareholder equity. Though the firm increased its debt, it also improved its ability to cover interest payments from operating profit. Profitability ratios: Overall efficiency Year before last Last year Gross profit margin 0.46 0.48 Operating profit margin 0.15 0.21 Net profit margin 0.09 0.13 Cash flow margin 0.12 ROA 0.10 0.12 ROE 0.18 0.33 Cash return on asset 0.11 Gross profit and net profit margin is increased slightly form previous year. The firm can control its cost of sales as gross profit margin is satisfactory and administrative efficiency is comparatively good as net profit margin is increasing. The firm can manage its total investment in asset and return to shareholder is quite satisfactory. Du Pont system: Year Net profit margin Total asset turnover Return on equity Financial leverage Return on equity Year before last 0.09 1.08 0.10 1.88 0.18 Last year 0.13 0.92 0.12 2.71 0.32 Return on equity is increased because of net profit margin has been increased compare with total asset turnover. Financial leverage has been increased indicating higher fixed obligations and higher degree of risk. The firm added more debt by bank overdraft. Though the ROI is increased it threats to unavailability of funds form external sources as fund providers sees greater degree of risk as acid test ratio is below standard. Ways of financing: Factoring: The firm can factoring its debtor and can rise up to $550000. If the factors its debtors the following advantages can be obtained: Factoring provides specialized service in credit management, and thus, help the firm's management to concentrate on manufacturing and marketing Factoring helps the firm to save cost of credit administration due to the scale of economic and specialization Operating lease: The firm can take lease of equipment for short-term basis. This will help to meet current obligation and the cost is comparatively lower. Inventory management should be efficient to sale the current unsold stock. The price of goods can be minimized to a small level of profit. So, the cash can be increased or the credit sale resulting form stock sale can be factored. Conclusion: The firm's net income is high but liquidity position is poor as quality of debtor is not good enough. Administrative efficiency is good. Risk is increased, as debt financing is high. By factoring of debtors new way of financing can be evaluated. Bibliography: Brigham, E. F., & Houseton, J. F. (2004), Fundamentals of Financial Management, 10th Edition, Thomson south-western, Singapore, ISBN: 0-324-17829-8 Fraser, L. & Ormiston, A. (2001), Understanding Financial Statements, 8th ed, New Delhi: Prentice Hall of India private ltd. Kieso, D. Weygandt, J. & Warfield, T. (1993), Intermediate Accounting, 6th ed, London: John Willey & Sons, Inc., Mintz S. M. (1997), Case in Accounting Ethics and Professionalism, Third Edition, New York: McGraw-Hill. Mcconnel, C. R., Brue, S. L. (2005), Economics-Principles, problems & policies, 16th Edition, Mcgraw-Hill International Edition, Singapore, ISBN: 007-124914-1 Pandey, I. M. (2007), Financial Management, 9th Edition, Vikas Publishing House Pvt. Ltd, New Delhi, ISBN: 81-259-1658-X Spiceland, J., Sepe, J., & Tomassini, L. (1949), Intermediate Accounting, 4th ed, London, Irwin Samuelson, P. A., Nordhaus, W. D. (2006), Economics, 18th Edition, Tata Mcgraw-Hill Publishing Company Limited, New Delhi, ISBN: 0-07-059855-X Appendix Table 1 Ratio outcome Year before last Last year Current ratio 1.76 1.13 Quick ratio 1.10 0.47 Cash flow liquidity 0.30 Average collection period 42.06 60.99 Accounts receivable turnover 8.68 5.99 Inventory turnover 3.10 2.00 Fixed asset turnover 1.63 1.55 Total asset turnover 1.08 0.92 Debt ratio 0.47 0.63 Long term debt to total capitalization 0.34 0.42 Debt to equity 0.88 1.72 Times interest earned 4.86 5.06 Gross profit margin 0.46 0.48 Operating profit margin 0.15 0.21 Net profit margin 0.09 0.13 Cash flow margin 0.12 ROA 0.10 0.12 ROE 0.18 0.33 Cash return on asset 0.11 Table 2 Cash flow statement Net Income 2126 Net cash flow from operating activities Increase in A/R -3402 Increase in stock -2130 Increase in other debtors -134 Increase in creditors 1398 Increase in other creditors 154 increase in tax payable 360 Increase in O/D 4250 496 Net cash provided by operating activities 2622 Net cash flow form investing activities Increase in fixed asset -5870 Net cash used by investing activities -5870 net cash flow from financing activities Increase in loan capital 3000 Increase in bond payable 200 Net cash used by financing activities 3200 Decrease in cash -48 Cash (Year before last year) 56 Cash (Last year) 8 Graphs Calculation of factoring: The firm has total debtor $3744. We have assumed that commission will be 2% and reserve will be 10 % by the related credit management firm. So the available finance will be: (3744/365)* average collection periods = (3744/365)*61 =$625 Factoring commission: (625*.02) =$12.5 Reserve 625*.10 =62.5 Advance available (625-12.5-62.5) =$550 Read More