Introduction to Financial Management - Research Paper Example

Introduction to financial management Student’s name: Instructor’s name: Subject code: Date of submission: Table of contents Table of Contents Introduction to financial management 1 Table of contents 2 Table of Contents 2 Executive summary 3 Acknowledgements 3 Dana gas PJS financial analysis 3 Interpretation of the results of the analysis 7 Conclusion 10 References: 11 Executive summary Financial ratios analysis is one of the methods used in analyzing the performance of the firm in different financial periods and hence establishes how well the firm is performing financially. In other words, its one of the investment decision making tools that investors use to gauge investment opportunities and hence choose the best opportunity. As such, this paper performs a financial ratios analysis of Dana Gas PJS for the years 2011 and 2012. The aim of the analysis is to establish whether the company is financially sound or not and hence recommend areas of improvement that can be undertaken. The financial ratios analysis covers areas such as liquidity, asset management, profitability, debt management and leverage. It is concluded that the company is financially sound based on the analysis and hence the company provides a good investment opportunity for potential investors. However, it is recommended that investors consider other factors such as the state of economy in conjunction with the financial ratio analysis so as to make sound and informed investment decisions. Acknowledgements I wish to acknowledge the invaluable support provided by my parents and my lecturers. I appreciate your support for without it, I would not have been able to come thus far. I am ever grateful. Dana gas PJS financial analysis Liquidity Ratios Current Ratio = Current Assets/Current Liabilities 2012= 1,154/1060= 1.089 2011= 902/1041 =0.866 Quick Ratio = (Current Assets-Inventories)/ Current Liabilities 2012= (1154-54)/1060 =1.038 2011= (902-53)/1041=0.816 Cash Ratio = Cash and cash equivalents / current liabilities 2012= 165/1060 = 0.156 2011= 112/1041 =0.108 Asset management Ratios Inventory Turnover =COGS/Inventory 2012 = 54 /54 = 1 2011 = 47 /53 = 0.887 Day’s Inventory = 365/ Inventory Turnover 2012 = 365× (54/54) = 365 days 2011 = 365× (53/47) = 411.596 days Fixed Assets turnover =Sales/ Net Fixed Assets 2012 = 500/ 2,366 = 23.13% 2011 = 521/ 2,405 = 21.66% Total Assets Turnover = Sales /Total Assets 2012 = 500/3,520 =14.20% 2011 = 521/3,307 = 15.75% Accounts receivable turnover ratio =net credit sales/average accounts receivables 2012 = 500/670 = 0.746 2011 = 521/501 = 1.04 Profitability Ratios Gross margin = Gross profit /Sales 2012 = 357/500 = 71.4% 2011 = 364/ 521 = 69.87% Operating margin = Operating income /Sales 2012 = 228/500 = 45.6% 2011 = 222/521 = 42.61% Return on Assets = Net income + after tax interest expense/ Average total assets 2012 = (228+86)/3,520 = 8.92% 2011 = (222+87)/ 3,307 = 9.34% Return on Equity = Net income /Average shareholders equity 2012 = 228/ 2,413 = 9.45% 2011 = 222/2,220 = 10% Debt management Ratios Debt Ratio =Total debt/total Assets 2012 =1103 /3,520 = 33.22% 2011 =1083 /3,307 = 32.75% Debt to equity ratio = Total debt /Total owner’s Equity 2012 = 1103/2413 = 45.71% 2011 =1083/2220 = 48.78% Equity multiplier = Total Assets / Total owners’ equity 2012 = 3520/2413 = 1.459 2011 =3307/2220 =1.49 Leverage Ratios Interest coverage = Operating income /Interest expense 2012 = 228/86 = 2.65 times 2011 = 222/87 =2.55 times Efficiency Ratios Accounts payable turnover = COGS /Average accounts payable 2012 = 54/138 = 0.39 2011 = 47/134 =0.35 Interpretation of the results of the analysis Liquidity Liquidity ratios seek to establish whether the company has enough cash on an ongoing basis to meet its operational obligations whenever they fall due. a) Current ratio - Dana gas PJS had a current ratio of 0.866 in 2011 which improved to 1.089 in 2012. However, this level of current ratio does not show adequate financial health for the company since it is very low despite the improvement. The company needs to ensure its ability to pay salaries and other short-term expenses on time. However, with this level of current ratio may lead to liquidity issues in the company and the company may be unable to meet its short-term financial obligations as well as difficulties in accessing credit which may be a threat to growth and leverage operations. b) Quick ratio – the company had a quick ratio of 1.038 in 2012 which is an improvement from 0.816 recorded in 2011. Although the firm’s quick ratio has improved, it still not strong enough. The firm would need more short-term assets to cover immediate liabilities whenever they fall due. In other words, the firm would need to sell some of its inventories to cover the short-term liabilities. This is a pointer towards liquidity problems for the firm. Asset management Asset management ratios seek o establish how efficient the firm is in managing its assets to generate income. a) Inventory turnover – the company’s inventory turnover improved from 0.887 in 2011 to 1 in 2012. This means that inventory was turned into sales only once during the year. Although the company’s purchasing and production efficiency is improving, the rate of conversion of inventory into sales for the company is certainly not desirable given that the company had 365 days in inventory in 2012 which was actually an improvement from the previous year. As such, there is need for the company to strategize on how to better convert its inventory into sales which means improved profitability in future. b) Fixed assets turnover – The Company’s fixed assets turnover improved to 23.13% in 2012 from 21.66% in 2011. This indicates that the company is now using its fixed assets more productively to generate revenue and hence profits which is desirable c) Total assets turnover – the company’s total assets turnover declined from 15.75% in 2011 to 14.20% in 2012. This was occasioned by an increase in the level of total assets despite the sales having declined during the year. As such, there is need for the company to use its total assets more effectively in generating sales which will make the company more profitable. d) Accounts receivable turnover ratio – The Company’s accounts receivable turnover ratio declined significantly from 1.04 in 2011 to 0.746 in 2012. This is an indication of the company’s declining efficiency in collecting cash once goods are sold on credit. Therefore, there is need for the company to improve its terms with its customers to ensure cash is collected on time in a bid to ensure that the company does not run into liquidity problems. Profitability Profitability ratios help in determining how well the company is performing so that it has the required financial resources so as to continue in operation. a) Gross margin – the company’s gross margin improved from 69.87% in 2011 to 71.4% in 2012. This is desirable as it shows that the company is able to generate enough profits to cover its direct costs. b) Net margin – the company’s net margin improved from 42.61% in 2011 to 45.6 in 2012. This is a desirable level of return as it implies the company is able to generate enough money to cater for all its expenses while still generating some income for the shareholders. c) Return on assets –the company’s return on assets declined from 9.34 in 2011 to 8.92 in 2012. This was occasioned by an increase in assets that was not proportionate to the increase in income. As such, there is need to use the increasing assets more efficiently to generate income for the company. d) Return on equity – the company’s return on equity declined from 10% in 2011 to 9.45% in 2012 due to an increase in the owner’s equity that was not matched with a proportionate increase in the level of income. As such, there is need to use the increased equity more efficiently to generate income for the equity owners. Debt management Debt management ratios show how effective the company is in managing borrowed funds as well as the associated level of risk. a) Debt ratio –the company’s debt ratio increased from 32.75% in 2011 to 33.22% in 2012. This is not desirable as it shows an increasing level of risk. b) Debt to equity ratio – the company’s debt to equity ratio declined from 48.78% in 2011 to 45.71% in 2012 owing to an increase in the level of equity. This is desirable for the company as it shows declining risk. c) Interest coverage – the company’s interest coverage improved from 2.55 in 2011 times to 2.65 times in 2012. This is desirable as it shows the company is more prepared to meet its interest obligations. Efficiency Efficiency ratios show how efficient the company is in managing its liabilities. a) Accounts payable turnover -The Company’s accounts payable turnover improved from 0.35 in 2011 to 0.39 in 2012. This is desirable as it shows the company does not have liquidity problems and its ability to make payments has improved. Conclusion As has been established above, the company’s performance greatly improved in all aspects analysed above in the year 2012 as compared to 2011. The company’s liquidity and hence ability to meet its short-term obligations improved. The company has also been highly profitable with its net margin being 45%. This is desirable as it shows that the company is able to generate enough funds to meet its financial obligations while being able to provide adequate returns for equity holders. It has also been established that the company’s level of equity increased while debts declined. This is desirable in that the risk posed to the company incase its unable to meet its obligations to creditors is declining. Similarly, the company’s ability to pay its interest obligation also slightly improved. This being the case, the company can provide a good investment opportunity for potential investors given its good levels of returns. In addition, the company can easily source for funds from financiers and hence has the ability to expand which can improve its profitability even further for the benefit of equity holders. It should however be noted that investment decisions should not be solely based on financial analysis but other factors such as the state of the industry and the general economic conditions prevailing in the country should also be considered to enable one make sound and informed investment decisions. However, based on the two years performance, the company offers a good investment opportunity to potential investors. References: Johansen, B2012, Fundamental principles of financial management, London, Rutledge. Read More