Financial Performance and Position of the Company - Assignment Example

Business two question Contents Contents 2 Answer 3 Part A. 3 Financial Performance and Position of the Company 3 Profitability Ratio 3 EfficiencyRatios 6 Liquidity Ratio 8 Gearing Ratios 9 Investment Ratios 10 Part B. 12 Analysis of the working capital problem faced by the company and recommendations to the Directors to improve the company’s financial position 12 References 13 Mittal, R., 2011. Management Accounting and Financial Management. New Delhi: Vaibhav Printers. 13 Sinha., 2009. Financial Statement Analysis. New Delhi: PHI Learning Pvt Ltd. 13 Bibliography 14 Gallagher, T., 1968. Financial Management; Principles and Practice. USA : Freeload Press. 14 Bose. D., 2010. Fundamentals of Financial Management. New Delhi: PHI Learning Pvt Ltd. 14 Robinson, T., 2012. International Financial Statement Analysis. New Jersey: John Wiley& Sons. 14 Rajasekaran, V., 2012. Accounting for Managers: For VTU. India: Pearson Education India. 14 Troy, L., 2008. Almanac of Business and Industrial Financial Ratio. USA: CCH 14 Wahlen, J., 2011. Financial Reporting, Financial Statement Analysis and Valuation: A Strategic Perspective: A Strategic Perspective. USA : Cengage Learning. 14 Appendices 15 Answer 1. Part A. Financial Performance and Position of the Company Profitability Ratio Profitability Ratio can be defined as financial a tool which is used to justify a company’s ability to generate revenue which is compared to the business’s expenses and other operational costs which are incurred during a specific time period. Ratios which are coming under profitability ratio can be judged by its higher value as compared to a competitor’s ratio or same ratio for previous period of time. If the ratios are higher then it indicates that the company is doing well (Thukaram, 2007, p.99). Gross Profit Margin Gross profit margin is derived from the ratio of gross profit to sales or revenue. Gross profit margin shows the percentage by which gross profit has exceeded cost of production. It measures that how well a business can control its costs. Investors also use this ratio and compare with different companies in same industry and in different industry to decide which one is most profitable to invest. Higher gross profit means that the company is more efficient than its competitors (Barry, 2010, p. 135). Particulars 2012 2011 Gross Profit margin 35.85 36.55 From the above table it can be seen that the gross profit margin of the company has declined over the years from 2011 to 2012. It indicates that the efficiency of the company has decreased in controlling it cost and cost of production has increased compare to the year 2011. Net Profit Margin It is a ratio under profitability ratios which can be calculated as net profit before interest and tax divide by sales. This ratio indicates the amount of sales is remaining after paying all expenses. It is very necessary to while comparing with other companies. Higher net profit indicates that a company is more competent than other companies at converting sales into profit. Particulars 2012 2011 Net Profit Margin 4.05 3.60 From the above table it can be seen that net profit margin of the company has increased over the years from 2011 to 2012. It indicates that efficiency of the company has increased in the year 2012 in converting it sales revenue into net profit after paying all the expenses. Thus the company has performed more efficiently in 2012. Operating Profit Margin Operating profit margin ratio shows the relationship between the operating profit earned by the company and the total sales revenue of the company. It indicates that how much the company is efficient in earning profit before interest and tax from the sales revenue. Particulars 2012 2011 Operating Profit margin 9.26 8.16 From the above table it can be seen that operating profit margin of the company ha increased from the year 2011 to 2012. It shows that the company is more efficient in 2012 in earning operating profit before interest and tax out of its sales revenue. Return on Shareholder’s Fund It shows that how much amount the company is paying to the shareholder’s excluding the dividend. Particulars 2012 2011 Return on Shareholders fund 8526.06 6037.74 From the above table it can be seen that return on shareholders’ fund has increased from 2011 to 2012. It shows that the shareholders are getting more return from investing in the company. It indicates return on investment of the shareholders has increased. Return on Capital Employed ROCE helps to measure the return of a business earned by capital employed. It measures the profitability and effectiveness of the company to generate revenues over the amount of capital invested. Particulars 2012 2011 Return on Capital Employed 18.12 16.46 From the above table it can be seen that the return on capital employed ratio has improved over the years in 2012 from 2011. It indicates rather the company has earned more out of the capital invested in the company as compare to the year 2011. It shows that the profitability and effectiveness of the company has increased in generating revenues over the amount of capital invested. Efficiency Ratios It can also be called as operating ratio. It measures the company’s efficiency with which it uses its different assets like inventories, fixed assets etc. Some of the examples of activity ratios are shown below (Sinha, 2009, p.133). Average Inventory Turnover Period This ratio shows the number of times the inventory of the company has been converted into total sales revenue during the financial period. Thus it determines the effectiveness and efficiency of the company in managing its inventory. Particulars 2012 2011 Average inventory turnover period 189.67 93.86 From the above table it can be seen that the inventory turnover period of the company has increased over the years. It indicates that the effectiveness and efficiency of the company has improved in managing its inventory. Average Settlement period for Debtors This ratio shows the number of times average trade receivables have been converted into liquid cash during a financial year. Particulars 2012 2011 Average settlement period for trade receivables 115.91 98.07 From the above table it can be seen that the settlement period for trade receivables has increased over the years from 2011 to 2012. It shows that company is efficient enough in collecting its receivables. Average Settlement period for Creditors This ratio indicates the number of times the trade payables have been set off during a financial year. It needs to be calculated to evaluate the requirements of liquid cash for paying the trade payables. Particulars 2012 2011 Average settlement period for trade payables 147.16 150.85 From the above table it can be seen that the settlement period for trade payables has decreased over the years from 2011 to 2012. It shows that the company is taking time in paying off its creditors. But it should be improved in order to improve the brand image of the company among the creditors. Net Asset Turnover Period It shows the relationship between net assets and sales revenue thus it is known as the net assets turnover ratio. Particulars 2012 2011 Net asset turnover ratio 1.96 2.02 From the above table it can be seen that the net asset turnover ratio has decreased over the years from 2011 to 2012. Sales Revenue per Employee It measures the sales amount generated by one employee. Particulars 2012 2011 Sales revenue per employee 293.48 247.83 From the above table it can be seen that the sales revenue per employee has increased over the years. It indicates that the employees are more efficient now in generating total sales revenue as compared to the year 2011. Liquidity Ratio Liquidity ratios measures the efficiency and ability of the company in meeting its short-term financial obligations, it indicates the capacity of the company in paying its current liabilities whenever needed. Thus these types of ratios show the short-term financial position of an organization. An organization should guarantee that it is not suffering from lack of liquidity to pay any sudden liquidity crisis. The failure to meet the liquidity obligations in the time period may result into loss of creditors’ confidence, bad credit image, and even in legal actions taken against the company. But on the other side very high degree of liquidity is also not suitable for a company as it would imply that funds are kept as idle and not generating revenue. Thus it is essential to keep an appropriate balance between lack of liquidity and liquidity. Current Ratio It can also be called as working capital ratio. It can be determined by current assets over current liabilities. It shows the financial performance of company’s liquidity ( Mittal,2011,p.53). Particulars 2012 2011 current ratio 1.28 1.09 From the above table it can be seen that the current ratio of the company has increased over the years. The ideal current ratio is 2:1. But it should be at least 1.5 depending on the industry. Although the current ratio of the company has increased in 2012 but it is less than 1.5 thus it can be said that the company is not enough liquidity in its hand to pay off any sudden liquidity crisis. Acid Test Ratio It is also known as acid test ratio. It can be calculated as (current assets- inventory)/ current liabilities. It defines the short term liquidity capacity of a company (Public.asu, No Date). Particulars 2012 2011 Acid test ratio 0.63 0.69 From the above table it can be seen that the acid test ratio of the company has decreased over the years from 2011 to 2012. It shows that short term liquidity capacity of the company has decreased over the years. Gearing Ratios Gearing Ratio It measures the financial leverage of the company. It shows the degree to which the company’s operations are funded by the owner’s funds versus the borrowed funds. Particulars 2012 2011 gearing ratio 0.58 0.53 From the above table it can be seen that the gearing ratio of the company has increased over the years from 2011 to 2012. It indicates that the company is depending more on the borrowed funds rather the owner’s fund. It was less depending on the debt capital in 2011 but it is more depending on debt capital in 2012. Interest Coverage Ratio It shows the amount interest which is payable by the company. Particulars 2012 2011 Interest coverage ratio 2.05 2.10 From the above table it can be seen that the interest coverage ratio has decreased over the years from 2011 to 2012. It indicates that the company is less able to pay its fixed interest liability in the recent year as compared to the year 2011. Investment Ratios Dividend Payout Ratio It analyzes the relationship between the earnings of the company which belongs to the shareholders and the amount dividends paid to the equity shareholders in a financial year. It Indicates the percentage shares of the earnings of the company is available for the equity shareholders are paid out by the company as dividend to the equity shareholders. Particulars 2012 2011 Dividend payout ratio 120.00 100.00 From the above table it can be seen that the dividend payout ratio of the company has increased over the years from 2011 to 2012. Earning Per Share This ratio measures the amount of profit available to the shareholders on the basis of per share. Particulars 2012 2011 Earning per share 98.80 64.00 From the above table it can be seen that the EPS has increased over the years from 2011 to 2012. It indicates that more amount of profit is available to the shareholders on per share basis as compared to 2011. Price Earning Ratio It shows the relationship between the market price of the share and earning per share available to equity shareholders. Particulars 2012 2011 Price earning ratio 0.0101 0.0156 From the above table it can be seen that the price earning ratio of the company has decreased over the years from 2011 to 2012. Part B. Analysis of the working capital problem faced by the company and recommendations to the Directors to improve the company’s financial position From the above study it can be seen that the company is facing the problem in managing its working capital as the current ratio and acid test ratio of the company are not good. Working capital is essential for a company to conduct its day to day activities. It is also useful for paying short term liquidity needs. It needs to improve its working capital position to pay off any sudden liquidity crunches. Apart from the working capital problem, overall profitability of the company has increased over the years except the gross profit margin. But the creditor’s turnover period of the company has decreased. It can act on the image of the company among the creditors and suppliers. Thus the directors need to improve its settlement period for trade payables. Gearing ratio has shown that the company is depending more on the debt capital in current as compared to the previous year. But on the other side, dividend payout ratio and EPS of the company has improved over the years which indicate that shareholders’ will more invest in the company. Thus from the above study it can be recommended to the directors that they need to improve the liquidity position of the company to resolve its problem of working capital and they also need to increase the settlement period of creditors. Apart from this, the overall profitability and efficiency ratio of the company is good. References Thukaram, R., 2007. Management Accounting. New Delhi: New Age International. Mittal, R., 2011. Management Accounting and Financial Management. New Delhi: Vaibhav Printers. Public.asu., No Date. Ratio Analysis. [Pdf]. Available at: http://www.public.asu.edu/~bac524/liquidity_ratios.pdf. [Accessed on 6/30/2014]. Sinha., 2009. Financial Statement Analysis. New Delhi: PHI Learning Pvt Ltd. Barry., 2010. Introductory Financial Accounting And Reporting. USA : McGraw-Hill International. Bibliography Gallagher, T., 1968. Financial Management; Principles and Practice. USA : Freeload Press. Bose. D., 2010. Fundamentals of Financial Management. New Delhi: PHI Learning Pvt Ltd. Robinson, T., 2012. International Financial Statement Analysis. New Jersey: John Wiley& Sons. Rajasekaran, V., 2012. Accounting for Managers: For VTU. India: Pearson Education India. Troy, L., 2008. Almanac of Business and Industrial Financial Ratio. USA: CCH Sheeba, K., 2011. Financial Management. New Delhi: Dorling Kindersley. Wahlen, J., 2011. Financial Reporting, Financial Statement Analysis and Valuation: A Strategic Perspective: A Strategic Perspective. USA : Cengage Learning. Appendices Income Statement for the years ended 30 September Particulars 2012 (amount in thousands of pounds) 2011 (amount in thousands of pounds) Sales Revenue   13500   11400 Cost of Sales         Opening Inventory 1860   1200   Purchase 11300   7893     13160   9093   Closing Inventory 4500 8660 1860 7233 Gross Profit   4840   4167 Selling and Distributrion expenses 1580   1725   Administration Expenses 1360   1225   Bad Debts writtren off 650   287   Operating Profit before interest and taxation   1250   930 Interest Payable   610   442 Profit before tax   640   488 Tax   93   78 Profit for the year   547   410 Statement of Financial Position as at 30 September Particulars 2012 (amount in thousands of pounds) 2011 (amount in thousands of pounds) Non-current assets     Land and Buildings 4250 4375 Equipment 438 500 Motor Vehicles 275 350   4963 5225 Current Assets     Inventory 4500 1860 Trade Receivables 4287 3063 Other Receivables 38 100 Cash 12 25   8837 5048 Total Assets 13800 10273 Equity     Ordinary Shares of 1 pound each 2500 2500 Retained profit 397 150   2897 2650 Non-current liabilities     Loan notes 4000 3000 Current liabilities     Trade payables 4556 3262 Other payables including taxation 810 511 Bank Overdraft 1537 850   6903 4623 Total equity and liabilities 13800 10273 Particulars 2012 2011 Gross Profit margin 35.85 36.55 Net Profit Margin 4.05 3.60 Operating Profit marrgin 9.26 8.16 Return on Shareholders fund 8526.06 6037.74 Return on Capital Employed 18.12 16.46 Average inventory turnover period 189.67 93.86 Average settlemernt period for trade receivables 115.91 98.07 Average settlemernt period for trade payables 147.16 150.85 Net asset turnover ratio 1.96 2.02 Sales revenue per employee 293.48 247.83 current ratio 1.28 1.09 Acid test ratio 0.63 0.69 gearing ratio 0.58 0.53 Interest coverage ratio 2.05 2.10 Dividend payout ratio 120.00 100.00 Earning per share 98.80 64.00 Price earning ratio 0.0101 0.0156 Read More