Accounting and Control, Business Accounting, Financial Accounting - Assignment Example

Accounting and Control, Business Accounting, Financial Accounting Name: Tutor: Course: Institution: Date: Contents Introduction 3 Groups of financial ratios 3 Liquidity ratios 4 Profitability ratios 4 Debt ratios 4 Operating performance ratios 4 Analysis /discussion 5 Current ratio 5 Quick ratio 5 Stock turnover ratio 6 Debtor’s ratio 7 Conclusion 8 Introduction Over time, businesses accumulate massive amounts of information regarding its financial performance. As a result, it becomes very hard for an individual or the management team to be able to make proper sense of the financial performance of the organization. Ratio analysis is the analysis of the current year’s figures and comparing them with the previous year’s figures and or industry competitors to establish how the business is faring financially. Ratio analysis helps to draw a clear road map of the business’s financial journey and can therefore be used to determine how the business will be managed in the future. The following is a ratio analysis for the year ending 2009 for Domino’s Pizza, a NYSE traded company. As Joel (2009) illustrates, financial analysis allows the business management team to be able to make wise and prudent business decisions with regard to financial management. This is because the quality of the decisions made depend on optimum values rather than extremes (Maxwell, 2009). For instance, businesses need to use financial leverage for them to be financially healthy, yet, too much financial leverage can harm the financial health of the business. The question is; how does a manger identify the optimum? That is where financial analysis comes. Groups of financial ratios There are many types of financial analysis that can be done on a businesses’ financial information. Liquidity ratios Liquidity ratio, just as the name suggests measures the liquidity of the business. Liquidity ratios offer an insight of the businesses’ ability to meet the various liabilities. As such, current ratio is a comparison of the business’ current assets to its current liabilities. Quick ratio on the other hand looks at the available cash in the business’s vault and compares this with the liabilities that the business has to meet in the near future. Profitability ratios Profitability ratios try to show how the business is using its assets to generate money for the owners (stock holders). Thee ratios measure how efficiently, or otherwise the business’s assets are being used to generate profit. They include the Profit Margin Analysis, Effective Tax Rate, Return On Assets, Return On Equity and Return On Capital Employed. Debt ratios Debt ratios are important in indicating the efficiency with which the business is settling its liabilities. A business has many liabilities arising from supplier debts (debt purchases) and from short, mid term and long term bank loans and bank overdrafts. These debts offer a business the opportunity to use financial leverage. These ratios include the overview of debt, debt ratio, debt equity ratio, capitalization ratio, interest coverage ratio and the cash flow to debt ratio. Operating performance ratios These ratios show the efficiency of the business in terms of the way it is converting its stock into revenue. They also measure the efficiency in which the business is turning its potential sales into actual sales. These ratios include the fixed assets turnover, the sales per employee rate and the operating cycle. Analysis /discussion Current ratio Domino’s ratios do indicate that the company may be headed for a financial mess is it was to meet a situation that would interrupt its cash flow even for a short time. However, the needs of the level of the current ratio differ from industry to industry and therefore it might be different for Domino due to the nature of their industry. A comparison with Pizza Hut, a competitor, shows that this could be an industry average. Pizza Hut has a current ratio of less than one unit of current assets for every unit of current liability. This can be explained by the fact that the operations of a pizza hut are much more dynamic as compared to other industries such as manufacturing. However, Domino’s current assets are diminishing as evidenced from the transition between years 2008 and 2009. This trend should therefore be addressed carefully to make sure that it does not lead to a financial black hole (Gibson, 2009). Quick ratio Quick ratio indicates the firm’s ability to meet its liabilities in the immediate future. A ratio indicating that the current assets are less than one unit for every unit of debt is a clear indication of poor financial health for the organization. In contrast, Pizza Hut’s quick ratio, although poorer than the Domino’s ratios shows an improvement from year 2008 to year 2009, increasing from 2008 to 2009. This is an indication that Pizza Hut management realizes the need to increase the ration of current assets to current liabilities and is therefore applying all effort to make sure this is increased. Quick ratio can also me measure by comparing the available liquid cash (instead of all the current assets) to the current liabilities to indicate how much the firm is ready to pay off its current debts without having to convert any assets to cash. It is advisable that this kind of quick ratio called the acid test ratio be enough to settle short term liabilities such as credit purchases to avoid law suits from suppliers who may feel like their services are not being taken seriously if they are not paid well (Wilson J. , 2010). For Domino and any other such business that deals with highly perishable goods and also depends highly on suppliers for these goods, it is increasingly important that the quick ratio be well maintained. This is important because doing this will help Domino to avoid instances where it may end up incurring too many unnecessary losses. Stock turnover ratio Domino has an improvement in its sales. Stock turnover rates are important because they show how well the firm is doing in the market. Although Domino’s stock turnover is increasing, there is a notable different between Domino’s rate of stock turn over and that of the Pizza Hut. With a stock turnover rate of over fifty times, Pizza Hut seems to be doing well in the market in terms of sales. Pizza Hut’s rate of turnover is not only higher than that of Domino by almost as much twice but also growing at a higher rate. This is something that the management of the Pizza Hut will need to check. However, of importance is the fact that the rate of stock turnover is affected by so many other factors and therefore there is no way to determine whether the rates or turnover for the two companies are comparable. For instance, as McGregor (2009) puts it, the rate of turnover is also affected by the ordering system of the firm. As (Stephen, 2009)If a firms needs to order small portions of stock to avoid stock pile up and dead stock, a firm may decide to schedule its ordering to have many deliveries of smaller portions, leading to higher rates of stock turn over. If Domino on the other hand decides to order larger stock piles to take advantage of economies of scales, its stock turnover will definitely be lower. This is a crucial aspect of stock management and cost management because one has to forego one for the other (manuel, 2009). The nature of the business that Domino is in is sensitive in that it requires that the firm be careful due to the perish ability of the products (David, 2010). Because the firm doesn’t want to have dead stock in its store, it may need to reorganize its stocking schedules. Doing this, as James (2009) asserts, will make sure that there is no dead stock and that the firm is always able to deliver the best products to its customers since such products as mild and vegetables used in the production of pizza are highly perishable. Debtor’s ratio Debtor’s ratio is also another important financial ratio that helps to understand the rate at which debts are being paid (Wilson, 2009). Again, this is also another intricate area because the manager has to identify an optimum. A ratio that is too low indicates that the firm is not taking enough advantage of debts to leverage on its finance. According to McAtthur (2009) in his article, among the principles of business economics, one states that a business should delay paying its debts for as long as it is legal, in order to fully take advantage of the financial leverage those debts of any kind offer. The debtor’s ratio for Pizza hut is significantly low but seems to be improving. On the other hand, Dominos debtor’s ratio is significantly high but seems to be diminishing with time. From the data, it is prudent to conclude that the optimum for debtor’s ratio in the industry should be about 2 weeks. Dominos Pizza should than find a way to manage its debtor’s ratio and put a rein on it before it causes a nightmare for them. Conclusion Domino’s Pizza’s ratio analysis for its financial analysis shows that there is a need to adjust their financial scheme in order to be able to be able to reach the industry optimum and thereby making sure that the organization will not be plunged into a financial mess. For example, a closer look shows that the organizations ability to pay off its short term liabilities is not that good and their debt turnover is a area of concern. This means that these two ratios, and since they are related in many endeavors, need to be reconciled and made right. This should be done while at the same time putting in mind that the financial analysis does not necessarily have to affect all decisions but has to leave room for other things such as the prudence of the decisions maker and other tacit knowledge about the industry and the current economic factors. Bibliography David, J. (2010). Management in the New Century. Intwrnational Jouranl of Commerce , 17-25. Gibson, J. (2009). Express Utilization of Portifolio Management. Journal of Managememt , 66-69. James, K. (2009). Driving Strategy in Competitive Businesses. Jouranl of Strategic Managemnt , 22-28. Joel, J. (2009). Alertness in Financial Managemnt. Hoboken, NJ: Guill Books. manuel, K. (2009). Managemnt and Business Strategy in Finanacial Prudence. London,: Penguin Books. Maxwell, J. (2009). Well managed Finance and the Strategic Approach. International Journal of Commerce , 13-14. McAtthur, M. (2009). Delivering Business Economics. International Jouranl of Management , 20-29. McGregor, J. (2009). Identifying Invisible Strategy values in Financial Management. Journal of Managemnt Sciences , 20-25. Stephen, K. (2009). Developing Portifolio Delivery and Management. Oxford, : Oxford Publishers. Wilson, J. (2009). Financial management nad the Prudent Manager. new York, NY.: Business Books Publishers. Wilson, J. (2010). understanding Financail Management. International Jouranal of managemnt , 12-16. Read More