Financial Ratios for Digital Solutions - Case Study Example

Name Institution Tutor Date Financial ratios for Digital Solutions Associated plc (DSA) Introduction Companies need to evaluate their financial health and stability of their operations. Other than the top management level, financial calculation and evaluation is important for the overall company and its continuity. Managers need information from the finance unit in the resource allocation process and facilitate the routine operations of the company. According to McLaney (2011), financial ratio analysis aids in instilling confidence among managers while they manage the business resources. Given the financial reports and statements, related contents of the statement can be evaluated to identify business’ performance. Through this, managers can gauge the market performance, liquidity, efficiency, gearing and profitability of the company. The usefulness of ratio analysis is attained by comparing Company ratios over different financial periods or against same ratios of other Companies in the industry. This paper calculates financial ratios for Digital Solutions Associated plc (DSA). This information is used to recommend to the management on which of the company’s UK division they will close as part of the solution. DSA UK divisions include Leicester, Nottingham and Kettering. Accounting ratios for Leicester, Nottingham and Kettering divisions (2012) Current ratios Current ratio = Current assets/Current liabilities Leicester Current ratio = 27,500/11000 = 2.5 Nottingham Current ratio = 57000/37000 = 1.54 Kettering Current ratio = 19000/17000 = 1.12 Acid test ratios (Quick ratio) Leicester Acid-Test ratio = 27000 – 14000 - 11500/11000 = 0.14 Nottingham Acid-Test ratio = 57000 – 37000 – 20000/37000 = 0 Kettering Acid-Test ratio = 19000 – 8000- 10000/17000 = 0.06 Return on Capital employed (ROCE) Return on Capital employed = Earnings Before interest and tax (EBIT) * 100% Total assets - Current liabilities Leicester ROCE = 13500/ (60500 - 11000) * 100% = 27.2727 = 27.27% Nottingham ROCE = 23000/ (95000 - 37000) * 100% = 39.6552 = 39.66% Kettering ROCE = 15000/ (81000 - 17000) * 100% = 23.4375 = 23.44% Gross Profit Margin Gross profit margin = Gross profit/sales Revenue * 100% Sales revenue = Turnover Leicester Gross profit margin =23000/65000 * 100% = 35.3846 = 35.38% Nottingham Gross profit margin = 70000/300000 * 100% = 23.3333 = 23.33% Kettering Gross profit margin = 70000/135000 * 100% = 51.8519 = 51.85% Operating profit margin Operating profit margin = Operating profit (Before interest and tax) * 100% Sales revenue Sales revenue = Turnover Leicester Operating profit margin = 13500/65000* 100%= 20.7692 = 20.77% Nottingham Operating profit margin = 23000/ 300000 * 100% = 7.6666 = 7.67% Kettering Operating profit margin = 15000/ 135000 * 100% = 11.1111 = 11.11% Retained profit ratio Retained profit ratio = (Net income – dividends)/ Net income Leicester Net income = retained profits Retained profit ratio= (9500 – 0)/9500 = 1 Nottingham Retained profit ratio= (18000 - 0)/18000 = 1 Kettering Retained profit ratio= (14000-0)/14000 = 1 Assets turnover Net asset turn over = Sales Revenue/Total assets less current liabilities Leicester Net assets turnover = 65000/ (60500 - 11000) = 1.3131 = 1.31 Nottingham Net assets turnover = 300000/ (95000 - 37000) = 5.1724 = 5.17 Kettering Net assets turnover = 135000/ (81000-17000) = 2.1094 = 2.11 The Company has low asset turnover, indicating a higher profit margin. Net asset turnover is following a decreasing trend comparing 2011 and 2012. Inventory turnover (in days) Inventory turnover = Sales/inventory Leicester Inventory turnover = 65000/14000 = 4.643 = 5 days Nottingham Inventory turnover = 300,000/37000 = 8.108 = 9 days Kettering Inventory turnover = 135000/8,000 = 16.875 = 17 days The Company is indicating an improving trend in inventory management efficiency by increasing value of inventory turnover ratio. However, if this is due to overstocking, the business is susceptible to increased inventory holding costs. Debtor collection period Debtors collection period = debtors/ sales revenue- cash sales * 365 days Leicester Debtors collection period = 11500/ 65000 * 365days = 64.576 = 65 days Nottingham Debtors collection period = 20000/300000 * 365days = 24.333 = 25 days Kettering Debtors collection period = 10000/135000 * 365days = 27.037 = 28 days The Company has experienced reducing debtor collection period ratio indicating improved efficiency in Company’s debt management. The decreasing ratio indicates that lesser money is being held by debtors and therefore a reducing risk for default by debtors. 2012 indicates inefficiency in credit management since money is not being received soon as indicated by the increased value of collection period. Financial report Profitability ratios   DSA Industry Average Leicester Nottingham Kettering   2012 2011 2012 2012 2012 2012 Profitability ratios Gross Profit Margin 34.50% 32.00% 40.00% 35.38% 23.33% 51.85% Operating Profit Margin 16.20% 15.00% 17.00% 20.77% 7.67% 11.11% Retained profit 9.00% 10.00% 8.00% 1.00% 1.00% 1.00% ROCE 37.50% 38.00% 25.00% 27.27% 39.66% 23.44% Liquidity ratios Current ratio 1.3 1.35 5 2.5 1.54 1.12 Acid test ratio 1.1 1.10 1 0.14 0 0.06 Leverage ratios Inventory turnover (in days) 70 75.00 50 5 9 17 Debtor collection period 50 55.00 40 65 days 25 days 28 days Asset turnover 1.25 1.44 1.2 1.31 5.17 2.11 Profitability ratios of the DSA include gross profit margin, operating profit, Returns of capital employed and retained earnings ratio. Gross profit margin for Kettering and Leicester divisions indicate an increase from 40% to 51.85% and from 30.00% to 35.38% respectively. However, Nottingham profits drop as indicated by a reduction in the ratio from 25.00% to 23.33%. Operating profits have also changed in the same way from 2011. Leister and Kettering mark an increase in operating profit from 20.00% in 2011 to 20.77% in 2012 and 10.00% in 2011 to 11.11% in 2012 respectively. However, Nottingham indicates a drop in the profitability ration from 10.00% in 2011 to 7.67% in 2012. A decrease in profitability ratios indicates that the ability of the company management to generate earnings from capital is reducing. Retained earnings ratio reduces in both cases since the company statements do not indicate any payments of dividends. They are however no indication of bankruptcy since the ratios are 1%. Based on the profitability ratios, the management should consider closing the company’s Nottingham division against is other two divisions. This is because, despite the fall in is profitability ratings, the company’s average performance is catching up with its competitors in the market as indicated by the industry average. Increase in profitability of Leister and Kettering divisions reflect in the increase in average gross profit margin and operating profit margin from 32.00% in 2011 to 34.50% in 2012 and 15.00% in 2011 to 16.20% in 2012 respectively. Return on capital ratio is reducing in 2012 as compared to 2011. Leister division of DSA Company indicates a 2.73 decrease from 30.00% in 2011 to 27.275 in 2012. Nottingham division also indicates a decrease in capital return ratio of 10.34% from 50.00% to 39.66%. Kettering division records the highest decrease in the ratio by16.56% from 40.00% to 23.44%. The company’s financial position is not safe and there is less assurance for sustainability in growth and continuity. DSA Company liquidity ratios (current ratio and acid test ratio) indicate mixed reports of both increases and reductions in liquidity. Current ratios for Leicester and Nottingham divisions have increased from 1.80 in 2011 to 2.5 in 2012 and 1.00 in 2011 to 1.54 in 2012 respectively. However, Kettering division in this case records a reduction in ratio from 1.20 in 2011 to 1.12% in 2012. Acid test ratio records a drop for both divisions in 2012 as compared to 2011. It is however catching up with its competitors according to the average ratio as compared to industry average for 2012. This indicates that the company can comfortably settle its current obligations using it current resources. Leverage ratios indicate a positive movement. Both divisions indicate an upward movement of company’s general performance. As compared to the industry, there is an increase in competitive ness for example in asset turnover; industry average is at 1.2 while DSA company turnover is at 1.25. It is the highest performing ratio in 2012. Recommendation Leister division indicates high performances as indicated by both ratios. It contributes majorly to the DSA company business progress. Nottingham other end is not stable as reported by the ratios, however, it is better as compared to Kettering. This is noted especially by the return on capital ratio current ratio and inventory turnover ratio. The management should therefore consider closing down Kettering as compared to the other two divisions. Conclusion DSA Company is generally competitive as indicated by its average ratios as compared to the average industry ratios. The company performance in 2011 varies from its performance in 2012 as indicated by their ratios. General performance has dropped from the previous year’s performance. However, if the management is considering closing one of the company’s UK divisions, that should be Kettering division since its performance is lower compared to the other two divisions. Work cited Digital Solutions Associated plc (DSA). (2012). Accouning statements 2011-2012. Digital Solutions Associated plc Read More