Financial Ratios - Case Study Example

RUNNING HEAD: Financial Ratios . Financial Ratios of Introduction This paper seeks to present a position paper comparing the effectiveness and reliability of suing financial measures as opposed to non-financial measures. This paper is making the initial position that financial measures are more effective and more reliable than financial ones but importance of the second type of measures have their unique roles to play that will make their effectiveness and reliable very important in relation to financial measures. This paper will use the case of Quick Connectors (QC) with its financial statements and compare them with another competitor in the industry as basis of making any conclusion for the purpose of the position paper. 2. Analysis and Discussion 2.1 An analysis of the utilization of assets in terms of efficiency (or inefficiency). What are measurements associated with returns and activity ratios? Explanation why each specific measurement is selected. The utilization of assets in terms of efficiency or inefficiency can be measured using the return on assets (ROA). Quick Connecters had ROA of in 2009 as compared to that of 2008. This means that QC is better in terms of how its uses in assets in the management of companys resources. The measurements associated with returns and activity ratios include aside from ROA include the return on equity (ROE), gross margin, net operating margin and net profit margin (Meigs, Meigs, & Meigs, 1995). The selection of each measurement is made because it allows comparison of the comparison within the company for purposes of evaluation where the company is strong or weak. Comparison can be made with prior periods and if the company has done not well, assuming all other things are equal, there appears to be a problem. Since companies normally grow over time in terms of revenues and expenses and it is normal that inflation rates exist every year, a company that does not grow in revenues would indicate some problem. A company is expected to become efficient overtime as it acquires better knowledge. Thus measuring how much income is gained in relation total assets using ROA, would provide the information from year to year. The same expectation could be made in relating net income to revenues, thus net margin measure s the same. The gross margin and operating margin have their purpose of measuring how the company has improved also in relation to revenues. 2.2. Assess the operating performance of QC using financial ratios. Quick connector may be assessed as profitable, liquid and efficient in 2009 compared to that of 2008. This is based on the its net profit margin, ROE, ROA, quick ratio and current ratio (Meigs, Meigs, & Meigs, 1995). See Gross margin grew to 30% in 2009 from 25% in 2008. Operating margin grew from 2% to 9%, while return on assets grew by more than 4 times to 37% from 7% in 2008. ROE also grew heftily by more than 4 times from 11% to 63% in 2009.Appendix A. 2.3. Comparison of QC with competitors in another retail company. A competitor named Pendragon plc, which is engaged in retail business had the financial ratios on profitability and efficiency as that used with QC and this will comparison possible. However the explanation or underlying reasons for the differences could utmost be only speculative in the absence of the other information like the non-financial ones to explain the relative superior or less superior performance of a company compared to competitors. See Appendix A. To illustrate, it can be observed that QC has higher average ROA, ROE, net profit margin, gross margin and operating margin than Pendragon. Although Pendragon is a bigger company, QC was doing better in terms of efficiency and profitability. What could explain its better performance may be its size in terms of revenues or the attitude of its people but these could only be speculative without further details on non-financial information to validate the comparison of the two companies. 2.4. How the information presented on the companies support position taken? This paper has used the financial statements of two companies dealing in retailing of for evaluating the effectiveness and reliability of financial measures in comparison with financial measures. In support to the initial position taken that financial measures are more effective and more reliable than financial, this paper has indeed proven the same by finding financial measures more readily available than the non-financial measures. Thus comparisons were made between the two companies and on after doing financial measures that the non-financial ones become very relevant. This makes the initial position correct that the importance of the second type of measures have their unique roles to play that will make them effective and reliable in relation to financial measures. It was found that to get a better a better picture of the firm comparing their financial measures would not be enough so that analysis could not stop there. Decision makers want to know the underlying reasons so that they could decide accordingly. Knowing the underlying reason would cause the decision maker to act more responsibly to the information. The non-financial measure makes the overall value of information complete and this makes the measure effective. The reliability of non-financial measures will depend also on the logical relationship with the financial measures and their verifiability across industries. Since it is harder to have access to non-financial information, it can be considered as less reliable. 3. Conclusion The uses of financial information was found easier to make between QC and Pendragon. However, non financial information was lacking from QC to make the comparison except the data on head count or number of employees during the year. Financial and nonfinancial information can be found to actually complement each other. One understands more financial information with the presence of non-financial or better an understanding of both information would be allow better comparative analysis and eventually better judgement. To compare their effectiveness however concerned, it the financial information should be given more weight since it functions first in the forefront by causing to bring out the non-financial measures as explanation for the variance. It is only when the variance or lack of it has been determined that non-financial information would become very relevant. It was deduced that possibly the more profitable position of QC may be due to smaller size or number of employees in terms of revenues or attitude its people. However to argue that simply because Pendragon had more employees than QC that could explain the lower profitability and efficiency of the former would be to invite oversimplification. If the argument is sustained , it would amount to having just small number of employees and one could just be profitable. Such would become absurd, as it would contradict the aspiration to grow and become bigger as company. The presence of therefore of other non-financial information is not only important but they should be considered as indispensable in making comparison or benchmarking across companies. In a capitalistic economy as many of the countries around the world have, comparison is inevitable if they have to attain efficient capital market. This should be the reason why companies are regulated where they do not only financial information in their annual report but also other relevant information including non-financial ones, which regulator-governments may impose as requirement like the US Securities and Exchange Commission. In terms of reliability, this paper also gives to financial measures due to verifiability of the information across a number of companies on a wider scale not only nationally but also even internationally. This should explain internationalization of accounting standards which essentially refer to financial information. Appendices Appendix A - Summary of Comparative Financial Ratios; Sources: Quick Connectors (n.d.); Pendragon (2010) References: Meigs, R,. Meigs, W., & Meigs, M. (1995). Financial Accounting. New York: McGraw-Hill Pendragon (2010). Financial Statements for the year 2009 and 2009. Retrieved from http://www.reuters.com/finance/stocks/incomeStatement/detail?stmtType=BAL&perType=ANN&symbol=PDG.L Quick Connectors (n.d.) Case Study – given Streetdirectory (2010). Non Financial Measures - Making Them Meaningful. Retrieved 28 November 2010 from http://www.streetdirectory.com/travel_guide/20396/corporate_matters/non_financial_measures___making_them_meaningful.html Read More