Importance and Types of Ratios - Assignment Example

Student’s Name Professor’s Name Course Name Date Integrated Case Study Analysis: D’Leon Inc Question a: Importance and Types of Ratios Ratios are considered to be important in any business operations since they provide management with sufficient information needed to make effective decisions at any given time. Management, as internal users of financial information, requires ratio analysis to make top-notch judgments about the viability of conducting given processes or not. Notably, ratios have, in a longer period, been used as a mode of simplifying accounting figures that otherwise would be deemed challenging to interpret. Third, ratios are used extensively to conduct informed level of judgment especially in matters regarding the performance of business operations efficiently. Retrospectively, ratios provide information to such stakeholders as creditors and bankers about the viability of relationship held by the company. Bankers apply ratios to formulate credit viability of a given firm. The five major categories of ratios include; 1. Profitability ratios 2. Liquidity ratios 3. Efficiency ratios 4. Gearing ratios 5. Investment ratios Question b Current ratio = current assets/ current liabilities For 2009=2,680,112/1,144,800= 2.34 Quick Ratio = current assets less inventories/current liabilities For 2009= (2,680,112-1,716,480)/1,144,800= 0.84 In the period between 2007 and 2008, the liquidity position of the company was subsiding even deeper. This means that its ability to meet its short-term obligations was incapacitated. Subsequently, these ratios were below the industry average despite the fact that they had increased insignificantly in 2009. It will not be safe to assume that stated users of ratios; bankers, stockholders and managers, will have an equal ground on the usage of ratio because their needs are different. However, it is important to understand that they will all need to figure the liquidity ratio for their own use. For instance, managers will use these liquidity ratios to determine whether the firm was in better position to meet its short-term obligations and thus, seek for additional funds. Bankers will use these ratios to distinguish the viability of the firm to be able to repay its loans and other obligations in case credit is availed to them. On the other hand, stockholders will likely apply these ratios in determining the whether it was possible to enjoy such benefits as yearly dividends as attributed to the company’s ability to meet its long-term objective of maximizing shareholders wealth for that matter. Question C Inventory turnover= Sales/ Inventory of Finished goods For 2009= 7,035,600/ 1,716,480 = 4.1X Fixed Assets Turnover= Sales/ Fixed Assets For 2009=7,035,600/ 817,040 = 8.6X Total Assets Turnover= Sales/ Total Assets For 2009 =7,035,600/ 3,497,152 = 2.0 Days Sales Outstanding = Accounts receivables*365/Sales For 2009= (878,000*365)/ 7,035,600 = 45 days In 2009, the inventory turnover ratio was 4.1X while the industry average stood at 6.1X. This was way below the industry average meaning that the company is holding excessive amounts of inventories at any given time and also, the firm is selling this stock slowly in comparison to the industry’s average. The fixed assets turnover for 2009 stood at 8.6X while the industry’s average stood at 7.0X. It can be seen that this ratio stood way and above the industry’s average meaning that company had devised effective ways of increasing production of sales in respect to the usage of its immediate fixed assets. The total assets turnover ratio stands at 2.0X while the industry’s average is placed at 2.6X. This is way below the industry’s average ratio hence meaning that the firm is not generating satisfactory levels of businesses for the immediate size of its assets investments. The 2009 days sales outstanding ratio stands at 45 days while the industry’s average stands at 32 days. This is way above the industry’s average meaning that the firm has not devised effective ways of collecting monies for goods sold on credit at an adequate time as reflected by other firms within the industry. In an overall perspective, it can be noted that D’Leon Inc utilization of assets to generate sufficient volumes of sales is not at par with the industry’s average. This means that there is inefficiency in the way operations are conducted at any given time. Question d Debt-to-total-assets- ratio= total debt/total assets For 2009 =400,000 /3,497,152 =0.11 Debt-to-equity-ratio= total debt/total stockholder’s equity For 2009= 400,000/ 1,952,352 =0.2 Times-interest-earned ratio= profits before interest and taxes/total interest charges For 2009= 492,648/70008 =7.04 In comparison to the industry average, it can be ascertained that D’Leon Inc leverage ratios are way above. This means that the firm’s has not effectively struck a balance between funds provided by creditors and owners of the firm. It might also mean that D’Leon Inc will likely not be able to pay its interest costs in the event that there is an impending decline the level of revenues. In this regards, it is safe to postulate that the company has not been able to devise its financial capital structure in the best way possible in order to reflect a balance between the equity and debt funds. Question e Operating margin = Earnings before interest and taxes/Sales For 2009 = 492,648/7,035,600 =0.07 Profit Margin= sales less cost of goods sold/sales For 2009= (7,035,600- 5,875,992)/ 7,035,600 =0.16 Basic Earning Power=EBIT/ total assets For 2009=492,648/3,497,152 =0.14 Return on Assets=net income/ total assets For 2009= 253,584/3,497,152 =0.07 Return on Equity= net income/ total stockholder’s equity For 2009 =253,584/1,952,352 = 0.13 In comparison to their respective industry averages, these ratios are way below. This can be taken to mean that the firm is not placed at a fair position to effectively utilize its, stockholders, equity and assets in order to post recommendable amounts of profits at any given day of operations. It also means that the company cannot, at any particular time, meet its operational expenses and at the same time make profits. Question f Price/ Earnings ratio = Market price per share/Earnings per share For 2009 =12.17/1.014 = 11.7 For 2009= Market/Book Ratio = 7.809/12.17 = 0.6 These ratios indicate that the stocks of the firm have been over-valued in the financial period starting in 2009. Due to this over-valuing of securities in the securities market might make the investors have a low opinion of the firm given that there are insignificant amounts of earnings available for common stockholders. Question g DuPont Identity= (profits/sales)* total asset turnover* (assets/equity) = (253,584/7,035,600)*2*(3,497,152/1,952,352) = 0.13 From the ratio value above, it can be noted that the company’s major strengths rests with the effective utilization of the respective assets in order to come up with substantial sales. It is also evident that the company has devised rigorous advertising campaigns. However, on the other hand, the company’s leverage base is not balanced at all. This is likely to trigger financial mis-interpretation between funds provided by owner’s visa-vis debt structures. Question h In the case that the company improves on its DSO thereby improving the period upon which debts are collected, means that the accounts receivable will increase substantively. This, in turn, has the effect of catapulting the total revenues and assets at any given times hence portraying a stable company’s operations. In respect, the stability will likely attract potential investors into purchasing stock of the company due to higher demand. In return, the capital structure will change greatly as the debt value will be offset with equities hence striking a formidable balance for the capital structure (Halabi, Barrett & Dyt 163-170). Question i Looking at the company’s level of operations there is a possibility that inventories can be adjusted accordingly and thus, affects the current standings of the firm’s profit levels. In the case that the firm adopts effective pricing strategies and offer goods on discount terms, the level might be reduced significantly hence catapulting the level of sales at any given time. Higher sales volume would likely translates to higher profit margins. Retrospectively, higher profit margins mean that there would enough amount of money to be allocated to pay dividends to common stockholders (Halabi, Barrett & Dyt 163-170). The ability of the firm to constant dividends will likely attract more potential investors hence creating huge demands for the company’s stocks. With the huge demands, the stock price will increase substantively. Question j Even with the slightly higher levels of operations for the firm as projected, there is insufficient evidence that it will be able to meet the ratios favorable for offering loans. However, as a potential supplier, I might continue to supply goods on credit but introduce discount terms as a way of enticing D’Leon into paying dues on time. Question k In 2007, the company in a bid to increase its operations presence and also attract more sales volumes should have done either all or some of the following; first, it could adopt lower pricing strategies in order to attract more sales volume that could have translated to more profits. Second, the company could have invested in rigorous advertising campaigns in order to create a substantial awareness of their products to untapped markets. Question l The first limitation of ratio rests with the fact that the evaluation is based on give financial statements meaning that in the event that these statements are wrong, the value of ratios will be mis-interpreted in due course. Secondly, ratio analysis does not consider the ever-changing positions of stock prices there creating errors while calculating some of the ratios like EPS. Third, ratio analysis might also be challenging to interpret to the immediate user since different terms are used to mean similar positions (Halabi, Barrett & Dyt 163-173). Question m Some of the qualitative factors analysts can use to gauge future performance of a firm might include; the ability of the management to make effective decisions for the firm, the immediate skill capacity of the firm’s employment base as well as the ability of the firm to engage in positive CSR projects in the environment for which it operates. Works Cited Halabi, A. K., Barrett, R., Dyt, R. Understanding Financial Information Used to Assess Small Firm Performance. Qualitative Research in Accounting & Management, 2010, 7(2), p. 163-179 Read More