Who Uses the Ratio Analysis and for What Reasons - Assignment Example

Rockies Breweries’ Q1. Why are ratios useful? Who uses the ratio analysis and for what reasons? A company’s performance and Financial Analysis is done using ratio analysis. Ratio analysis is a procedure where an item of financial data is compared with another item of financial data so as to interpret the relationship between the two so that an understanding can be developed about the information and hence conclusions could be drawn. “Ratio analysis is one of the most common types of financial analysis and is thought to be the most important method of financial analysis of an enterprise. It is a more advanced approach to analysis of structure and dynamics of the balance sheet and profit and loss account than the initial analysis. It was introduced by banks which use it to examine solvency of businesses which they credit. The ratio analysis enables examination of various aspects of business operations.” (Business-explained, 2008) The common users of the ratio analysis technique are the shareholders of that company, investors willing to lend or invest in that company. The shareholders use ratio analysis technique to ascertain the value of their shareholding in that company. As they are the owners of that company they want to have a look at the performance of that company, hence the ratio analysis technique helps them to evaluate and judge the performance of the company. Investors on the other hand only use this technique when they have a stake or a probable future stake in that company e.g. a bank uses ratio analysis technique along with many other technique to evaluate the performance and after such evaluation, the bank lends any money to that company. Q2. Calculate Rockies Breweries’ 2010 current and quick ratios based on the projected financial statements. What are your comments on the company’s liquidity position for 2008, 2009, and 2010 projection over time and against industry norm? Ratio Ratio Calculated 2010 Current Ratio 2,680,112/1,039,800 2.6 Acid Test Ratio 2,680,112 – 1,716,480/1,039,800 0.93 The company’s current ratio has improved from the preceding years and is almost reflecting the industry average result. The Acid Test Ratio on the other hand has improved but just need s a bit more improvement to reach the industry average. These ratios clearly suggest a strong liquidity position for Rockies Breweries’. Q3. Calculate Rockies Breweries’ 2010 inventory turnover, days sales outstanding, fixed assets turnover, and total assets turnover based on the projected financial statements. What are your comments on the company’s asset utilization for 2008, 2009, and 2010 projection over time and against industry norm? Ratio Ratio Calculated 2010 Inventory turnover 5,800,000/1,501,920 3.8 Days Sales Outstanding 878,000/7,035,600 * 365 45.6 Fixed Assets Turnover 836,840/7,035,600 * 100 11.8 Total Asset Turnover Net Sales/Total Assets 2.0 The ratios calculated above suggest that the company needs some efforts to rotate their inventory and cash. The inventory turnover ratio is way below the industry average and it clearly suggests a slow conversion of stock into revenue. The day sales outstanding ratio is also way below the industry standard reflecting the cash to be stuck up between the debtors of the company. The fixed asset turnover and the total asset turnover ratios are also below the industry average and need a lot of effort to get an improvement. Q4. Calculate Rockies Breweries’ 2010 debt ratio, TIE, and EBITDA coverage. What are your comments on the company’s financial leverage for 2008, 2009, and 2010 projection over time and against industry norm? Ratios Ratio Calculated 2010 Debt Ratio 1,539,800/3,516,952 * 100 43.8 Times Interest Earned 502,640/80,000 6.3 EBITDA 622,640 + 40,000/ 80,000 + 40,000 5.5 The ratios suggest that the company’s leverage has improved since last year but is below the industry standard. If the leverage is not improved, the company may face problems in acquiring future debt as a source of finance. The company has enough earnings to pay off the interest on it long term obligations and this almost in accordance with the industry average as well. The EBITDA coverage has improved as compared to 2008 and 2009 but is below the industry average. The EBITDA is a measure that determines the company’s ability to pay off its interest, principal and lease obligations. Q5. Calculate Rockies Breweries’ 2010 profit margin, basic earnings power, ROA, and ROE. What are your comments on the company’s profitability position for 2008, 2009, and 2010 projection over time and against industry norm? Ratios Ratio Calculated Year 2010 Profit Margin 253,584/7,035,600 * 100 3.6% Basic Earnings Power 502,640/3,516,952 * 100 14.3% ROA 253,584/7,035,600 * 100 3.6% ROE 253,584/1,977,152 * 100 12.8% The company’s profitability position is good and the profit margin has improved from being negative 1.6% to positive 3.6%, this shows great improvement. The profit margin ratio is in accordance with the industry average as well. Besides the profit margin ratio the company’s other profitability ratios have decline as compared to the industry averages. Q6. Calculate Rockies Breweries’ 2010 P/E and market/book. What are your comments on the company’s market value position for 2008, 2009, and 2010 projection over time and against industry norm? Ratios Ratio Calculated 2010 P/E ratio 12.17/1.014 12.0 Market/Book Ratio 12.17/7.909 1.5 The company’s P/E ratio has deteriorated compared to the 2008 figure. Besides that the figure is also not in line with the industry average as well. Market/Book ratio on the other hand has improved as compared to previous years but still does not match the industry average. Q7. Use the DuPont equation to provide a summary and overview of Rockies Breweries’ financial condition as projected for 2010. What are the company’s major strengths and weaknesses? DuPont Analysis for 2010 ROE = (Net profit margin)* (Asset Turnover) * (Equity multiplier) ROE = 3.6*2*(3,516,952/1,977,152) ROE = 3.6*2*1.8 ROE = 8.64 The company’s major strength lies in the Net profit margin ratio and the equity multiplier ratio. The net profit margin is totally in line with the industry average, suggesting a good profitability result for the company and the equity multiplier suggest an increase in the asset with respect to the equity of the shareholders. The company has more than enough to keep its shareholders happy. Q8. Suppose if the company can reduce its days sales outstanding to the industry average level, how this reduction in DSO can help the company’s financial conditions and thus the stock price? Examining the past and projected DSOs for the company, would it be possible to improve its DSO position? If so, is it a good idea to go ahead with the earlier COO’s suggestion to offer 60-day credit terms rather than 30-day term? If the company reduces its DSO to the industry average of 32, it would be considered as a great achievement, this way the company would be able to generate and keep its cash rolling. This rolling of cash would help in generating a powerful liquidity position for the company. The company can improve its DSO position by reducing the credit term offered to the debtors or it can offer cash discounts on prompt or earlier payments from its debtors. Hence it would be a better option to offer a 30-day term rather than a 60 day term. Q9. Does it appear that the company can adjust its inventory level? If it does indeed improve its inventory, how should this affect the company’s profitability and stock price? Improving the inventory level would be a tough job for the company because its current inventory level is way below the industry average of 6.1. If the company somehow improves its inventory level, it would be able to enjoy greater profits by reducing its costs of warehousing. This would reduce the cost of goods sold and hence increase the profits and the stock price of the company. Q10. Late payments to suppliers have been an issue as the financial conditions have worsened. Should the company only sells on cash? What would be the pros and cons? If the company sells on cash it might lose some existing customers who prefer credit rather than cash. On the other hand selling on cash would enable the company to improve the company’s liquidity and profitability position; hence the company would have enough liquid cash to meet its daily obligation much more easily with no cash stuck up in debtors Q11. In hindsight, what should Rockies Breweries have done in 2008? The company should have reduced it DSO from 2008 and should have given its debtors the option of cash discounts. Such cash discounts help in better rolling of cash hence improving the liquidity of a company. Besides this the company should not have stuck too much in the inventory. It would have kept a high inventory turnover to increase its profitability. Q12. While the ratios analysis is meaningful, what are some qualitative factors that you should consider when evaluating a company’s likely future financial performance in conjunction with the ratios? Some qualitative issues for a brewery besides ratio analysis would be to address to the complaints of any customers. Besides this, the other issue would be of quality, the company should keep a good quality standard to increase its goodwill. The number of defected products produced in a batch should be looked upon and properly handled. This can be done by having a proper quality control and quality assurance department within the company. References Business-Explained.com, Ratio Analysis, 2008 http://www.business-explained.com/courses/finance/financial_analysis/ratio_analysis/ Read More