Ratios for Inter-Company Comparisons - Case Study Example

Finance Case Study 1) Ratios are very useful for inter-company and time based comparisons of a company over the years. They are better than absolute figures as they provide basis for comparison and we can safely predict whether the performance of the company is improving or declining. Therefore, Rockies Breweries can use ratio analysis to determine the performance of the company both as compared to other companies and different years. This is extremely important for the managers of concerned departments to see the reasons behind any variances that appeared and to take the corrective action as needed to improve the performance and profitability of the company in long-run. 2) Current Ratio for 2010 = Current Assets/Current Liabilities = 2680112/1039800 = 2.57 Quick Ratio for 2010 = Current Assets – Inventory/Current Liabilities = 2680112-1716180/1039800 = 0.92 The company’s liquidity position was 2 .3 in the year 2008. This means that for every $1 of liability, the company had $2.3. This is an extremely good ratio indicating that the company can easily payoff of it short-term debts without having to suffer any liquidity problems. Similarly, this ratio is close to the ideal current ratio and indicates that cash not lying idle. In the year 2009, this ratio worsened and came down 1.5 indicating that the company has $1.5 of assets to pay off every $1 of liability. The company can still payoff of its debts easily without having to go through much trouble, given that the large portion of current assets in not tied-up in the form of inventory. In the year 2010, the ratio again improved and came at par with the ratio in the year 2008, showing that there will be no liquidity problems in paying off current liabilities. Going deeper into the analysis and checking the Quick Ratio, we can see that like the current ratio it declined in the year 2009 from 0.8 in 2008 to 0.5 in 2009. However, it again improved in the year 2010 and came to 0.92. However, this ratio remained really bad during the three years indicating that a large chunk of company’s current resources are tied into inventory and they will have problems in clearing its current debts and liquidity problems look imminent. The ratio remained lower the industry average, but since the company’s ratio is more close to the ideal ratio, we can say that the company is managing its resources better than other companies in the same industry. 3) Inventory Turnover: COGS/ Average Stock = 3.86 Fixed assets Turnover = Sales/Fixed Assets = 8.4 Total Assets Turnover = Sales/Total Assets = 2.0 Inventory Turnover is constantly decreasing from what it was in the year 2008. It was 4.8 in the year 2008 and came down to 4.5 in the year 2009 and 3.86 in the year 2010. This shows that the company’s performance is deteriorating. Similarly, it is not performing to well as compared to the industry average which is around 6.1. Hence, the company needs to improve its sales strategy in order to sell its product well and bring it on par with the industry average. Fixed Assets Turnover follows to different trends. It decreased from 10 to 6.2 from the year 2008 to 2009; it rose again to 8.2 in 2010. Hence, we can say that the company is improving its performance from the year 2009 to 2010. We can say that the company is doing really well in managing its fixed assets well as its fixed assets turnover is bigger than industry average. The company’s total assets turnover remained constant during the three years at around 2. This shows that the company is following consistent policy and its performance is also consistent. However, this ratio is lower than the industry average and hence the company needs to improve its revenue generating potential of assets employed. 4) Debt Ratio = 43.7% TIE = 3.17 Times EBTIDA Ratio = 0.071 Debt Ratio of the company was 54.7% in the year 2008. In 2009, it rose to around 80.7% which meant that most of the company’s assets were financed by debts. However, the company was able to bring this ratio down to 43.7% in the year 2010. This means that the company is low-geared. As compared to industry average, it is better off as it has a lower debt ratio than industry average and lower debt means lower interest expenses than other companies. The company’s TIE ratio follows the same trend. It declined in the year 2009 and rose again in the year 2010 to 3.17. It is much lower than industry average which means that it is worse off against other companies in terms of covering interest expenses against its profits. Similarly, EBTIDA coverage is declining meaning that the company’s sales are not converted into profit effectively. It is much lower than industry average and hence signifies that the company needs to control their expenses and try to turn more sales into profits or increase their profit margins. 5) Profit Margin = 3.6% Basic earning power: 14% ROA = 12% ROE = 25.54% Profit margin decreased in the year 2009 as compared to 2008. However, it rose to the highest in these years in the year 2010. This means that the company has been able to adjust its selling price and costs in order to make more profit. The new margin is at par with the industry showing that the company is doing as well as its competitors. Earning power declined massively in the year 2009. However, it came back to 14% in the year 2009. Again it is much lower than industry’s average showing that the company needs to improve its policies to improve basic earning power. As far as the return on assets is concerned it was 6% in the year 2008, after which it declined. However it rose to 12% in the year 2010 which is greater than the industry’s average and shows that the company is doing really well. The company’s return on equity followed the same trend. It decreased in the year 2009 before increasing in the year 2010. It is also higher than the industry average signifying the fact the company’s return are better than other firms in the industry. 6) P/E = 12.00 Market/book = 1.53 This again shows that the company showed massive recovery in the year 2010 from the condition in the previous years. However, the company is lagging behind other companies in the same industry in terms of market value of share and needs to further improve to be at par with its competitors. 7) Assets T/O * Profit Margin * Asset/Equity 2 * 3.6 * 0.57 = 4.104% The major strength of the company is that it is utilizing its assets better than other companies and is low on debt ratio. The weakness is that its Assets Turnover is lower than other companies in the industry. 8) This will improve the liquidity of the company by improving the cash cycle. However, it implies loss of customers, but the company will be ok if it bring its DSO in line with the industry average. This will improve the profitability and improve stock price. 9) Company should decrease its stock purchases as too much cash is lying idle that can be put to better uses to increase profitability and stock price. 10) Pros will be timely payments and good reputation and possible cash discount. However, this is not a good option considering the net cash cycle and loss of customer because the company will try to sell on cash. This will lead to a reduction in stock price. 11) It should try to bring DSO down to industry average and increase profit margins and selling price to bring it in line with what the competitors are doing to increase profits and hence stock prices. 12) The external factors such as economic outlook, what accounting policies other industry members are using and that the company’s accounting policies are consistent from one year to another should be considered in conjunction with ratio analysis. References: Harold Randall. (2006). Accounting. Letts Educational Read More