The Large Volumes of Financial Information - Term Paper Example

Financial management Table of Contents Executive summary 3 Financial statement analysis 3 Horizontal analysis 3 Vertical analysis 4 Financial ratios analysis 4 1 Liquidity ratio 5 1.1 Current ratio 5 2.A profitability ratio 6 2.1 Gross profit margin ratios 6 2.2 Operating profit before tax margin 6 3 An activity ratio 7 3.1 Asset turnover (times per year) 7 3.2 Inventory turnover (times per year) 7 4A financial leverage ratio 8 4.2 Equity ratio 8 5. Solvency ratios 8 5.1 The debt-worth ratio 8 5.2 Working capital 9 5.3 Net sales to working capital 9 Recommendation 10 Discussion of the limitations and other action 11 Executive summary The assessment of the operation performance of the company is aimed at understanding the level of efficiency and profitability in the application of the assets. The assessment of the financial condition of the company is aimed at finding out if the company is able to meet its obligations. Financial analysis also called quantitative analysis is a very crucial element when it comes to investing. It is a fundamental process that one should undertake to understand the perceptive of the company. It is essential that to know which financial information to analyze because there is massive financial information for a company. The large volumes of financial information intimidate most the investors because they do not know what to analyze. However, analysis of financial ratios will enable the investors to understand the status of the business. The analysis is based on the financial statement and ratios of JoBe Company. The recommendation for Ben about the company is that he should not go ahead and buy JoBe. The company has shown signs of recovery from poor performance of the previous years based on 2011 financial data however, it has not reached the levels of the previous year performance hence it is on a decline financial performance. Financial statement analysis Horizontal analysis Horizontal analysis is the investigation of the net sales performance of the company across the years. It shows how the company is performing each year. Net sales are one of the figures that are to be used in the evaluation of the company. According to the comparative income statement for JoBe, the Net sales for the projection of 2015 is 4,878,000 while that for others years is 4,998,000 and 5,398,000 for 2014 and 2011 respectively. According to the actual net sales from 2011 to 2014, there is a decline in the company net sales. The 2015 projections are also lower in value than the previous year. The reduction in net sales may be as a result of ‘reserve for allowance of returns’ which the sales that are returned by the customers. Vertical analysis This is an investigation of the relationship between each account, it shows the investor the relationship between the assets and liabilities together with income and expenditure. Cost of sales this is the cost that JoBe incurred in the process of selling its products. The cost of goods or cost of sales is essential for the investor because it will indicate the cost that one will invest in the product include the raw materials and the process f turning it into the final product. The cost of sale for JoBe is 3,268,260, 3,712,000 3,448,000 for 2015 (projections), 2014, and 2011 respectively. There is a decline in the cost of sales from 2012 to the projections of 2015. Gross profit this is the amount of profit that the company would have made if it could not have paid expenses such as salaries, electricity among others. Operating expenses operating expenses are important figures to the investor because they tell the investor on the amount of investment paid out in order to get the profits indicated. Knowing how to control expenses will ensure that the investor has maximum profits. Financial ratios analysis Financial analysis also called quantitative analysis is a very crucial element when it comes to investing. It is a fundamental process that one should undertake to understand the perceptive of the company. It is essential that to know which financial information to analyze because there is massive financial information for a company. The large volumes of financial information intimidate most the investors because they do not know what to analyze. However, analysis of financial ratios will enable the investors to understand the status of the business. A ratio is a relation between one quantity and another expressed mathematically. It is a comparison between one financial information and another. Ratios are classified according to the way they are constructed and their basic characteristics, ratios can be classified as; return ratio, a turnover ratio, coverage ratio or a competent percentage. Coverage ratio is a measure of the ability of the company to meet particular obligations. The return ratio is about the net benefit that is relative to the resources expended. The turnover ratio is a measure of the gross benefit of the resources expended while component percentage is the ratio of the component of an item to the item. A shareholder ratio explains JoBe’s financial condition in terms of the amounts per share of stock. The return on investment ratio is the information about the amount of profit, relative to the assets used to produce that profit. The measures of the operating performance and financial condition of the company ratios; 1 Liquidity ratio It gives us the information about the ability of JoBe to meet its short-term, immediate obligations. 1.1 Current ratio Current ratio is a measure of liquidity of the company. It measures the ability of the company to generate cash that meets its immediate needs. It is an indicator of the ability of the company to satisfy the current liabilities using its current assets. It is a ratio that gives the relationship between current assets and current liabilities. For JoBe company, the current ratio is; 1.41 for 2014, and 2.14 for 2011 with the industry average of 2.01 for 2014. The ratios show a decreasing trend from 2011 to 2014. The larger the liquidity ratio, the better for the company to meet its immediate obligation. The ability of the company to meet its obligations is reducing every year with the industry average for 2014 being 2.01 while JoBe has a current ratio of 1.41 which is below the industry ratio. 2. A profitability ratio It offers information about the amount of income from each dollar of sales. 2.1 Gross profit margin ratios Gross margin ratio is part of the profitability ratios that compare the income with the sales. It is the ratios that give information of what makes up the income of JoBe, and they are expressed as a portion of the dollars. The gross profit margin is the ratio of income or profit to sales. It is a ratio that shows how much each dollar of sales is left after cost of goods sold. It is a comparison between gross income over sales. The profit margin ratios for JoBe are; 34.0%, 36.1% and 34% for 2014, 2011 and the industry average for 2014 respectively. The current year profit margin ratio (2014) is equal to the industry average profit margin. There was a decline in the profit margin in the previous 2 years to 2014 but the company has realized an increase in the profit margin. It means that there is 34 percent of every dollar left after cost of goods sold. 2.2 Operating profit before tax margin This is also a profitability ratio that indicates the components of income with sales. It is the operating income before tax or interest to sales. It gives the company information about how much of each dollar of sales is left over after operating expenses. It is a comparison between operating income and sales. The ratios for JoBe are; 9%, 12% and 9.50% for 2014, 2011 and the industry average for 2014 respectively. In 2011, the company recorded a high ratio in terms of percentage of what was left for every dollar of sales after operating expenses. There is a decline in the subsequent years up to 2014 where the company realizes an increase by 2%. The industry average for operating profit before tax margin is 9.50% while the current ratio for JoBe is 9.0% which is slightly below the industry average. 3 An activity ratio It gives information related on the ability of JoBe to manage the resources efficiently. 3.1 Asset turnover (times per year) Asset turnover is a group of activity ratios which measure how assets are utilized by the company. Turnover ratios are used to indicate how much benefit has been realized by specific assets like inventory. The ratios are 2.9, 3.4 and 3.0 for 2014, 2011 and the industry average for 2014. There is a decline after constant value in 2011 and 2012. 3.2 Inventory turnover (times per year) The inventory turnover is the ratio of cost of goods sold to inventory. It is an indicator of how many times inventory is created and sold during the period. The inventory turnover for JoBe are; 11.0, 13.4 and10.5 for 2014, 2011 and the industry average for 2014 respectively. The ratios show that there is a decline between 2011 and 2013 on the number of times the inventory was created and sold during the period. However, there was an increase in the number of times it was created in 2014 and sold during the period which went above the average industry inventory turnover ratio. 4 A financial leverage ratio It is about the degree of JoBe’s fixed financing obligations and the ability to satisfy these financing obligations. 4.2 Equity ratio This is a measure of the financial leverage of a company and it is the ratio of total liabilities over the stockholders equity. The values for JoBe company are; 1.07, 0.92 and 2.78 for 2014, 2011 and the industry average for 2014 respectively. 5. Solvency ratios This is the measure of the stability of the company and the ability of the company to settle its debt. This is ratios that are of interest to the bank loan officers. They are also of interest to the investor because they give him a strong indication of the financial health and viability of the business. There are four ratios that are commonly used for solvency ratios: 1. Debt-to-worth ratio 2. Working capital 3. Net sales to working capital 4. Z-score 5.1 The debt-worth ratio It is given by total liabilities/ net worth Net worth is total assets- total liabilities (equals to net assets) = 825000 Total assets = 1,705,000 debt-worth ratio = 1705000/ 825000 = 2.07 5.2 Working capital It is the measure of cash flow. It is an indicator of the capital invested in the resources such as cash that are relatively rapid turnover. It always a positive number and its used to understand the ability of the company to weather during hard times. = total current assets – total current liabilities 5.3 Net sales to working capital Net sales to working capital are the relationship between net sales and working capital which measures the efficiency of the working capital as being utilized by the company. It shows the support of the working capital to the sales. = net sales/ net working capital Low ratios indicate the inability to use working capital. It means that there is a lot being done such as investment in the equipment. If the ratios are too high, it is dangerous because any drop in sales causes a cash shortage that may expose the company’s vulnerability to the creditors. 2015 2014 2013 2012 2011 debt-worth ratio 2.92 2.07 1.96 1.99 1.92 Working capital 15,000 55,000 156,000 150,000 149,000 Net sales to working capital 325.2 90.87 33.21 36.8 36.23 Recommendation An analysis of the financial statements and ratios has shown the performance of the company together with the actual position in terms of ability of the company to meet its debts. The recommendation for Ben about the company is that he should not go ahead and buy JoBe. The company has shown signs of recovery from poor performance of the previous years based on 2011 financial data however, it has not reached the levels of the previous year performance. The net sales for the company show a declining trend which should not be used to dismiss the ability of the company. The gross profit indicates that the company has improved in 2014 from a lower gross profit in 2013. It means that the amount that the company would have made without paying other expenses is increasing in 2014 with a slight decline in 2015 projections. The gross margin ratios show that the company has recovered its profit margin, and he level of decline from the previous years is not very wide but significant. It indicates that it will be easier to control other factors and improve on gross profit margins. Having 34% of every dollar left after cost of goods sold is a higher figure that is encouraging. However, the this is the only tool that has shown full recovery of the organization to higher levels of 2011. All the ratios show a small margin difference across the years. The ability for the company to meet its debts as indicated by the ratios is very low. Discussion of the limitations and other action The financial ratios were compared with the industry average which may present challenge if JoBe has many divisions. It means that the measure of average performance is not good. Ratio can also be distorted by seasonal factors hence giving a poor measure of the company performance. The use f ‘window dressing’ can make financial statements and ratios look better while they are not good at all hence giving wrong conclusion of the company. The differences in the operating and accounting practices may distort the comparisons. Having different practices means that there is no better way of coming up with the best ratios that are uniform. You cannot tell easily if a ratio is bad or good. There is no right measure of stating when the ratios are good or bad, it means that one cannot give a definite answer of the solution the company status. It is difficult to tell if the company is strong, weak or balanced on its position. There are several features of a financial statement that are analyzed to get the financial performance of the company. It is difficult to compare small business with a larger business in the same industry on financial performance. The financial analysis of the company is only a general guide for the potential buyers of the business. They should not put too much importance to the financial figures or trend in the financial statement. The financial analysis is only based on historical data and projections with constant variables. The future events and the unexpected occurrences can change the conditions of the business performance in the future. The general economic trends are not considered in the financial analysis. It is essential that significant changes in issues such as cost of fuel and interest rates to be considered in the financial statement analysis. There are many accounting principles that are being practiced today. Although most firms use the commonly and universally accepted standards, other firms use different principles which present a challenge in the analysis of the company performance in relation to industry performance. References Cagnazzo, L., Tiacci, L., Cardoni, A., & Brilli, M. (2014). Financial Statement Analysis for Enterprise Network Design. In Collaborative Systems for Smart Networked Environments (pp. 295-303). Springer Berlin Heidelberg. Edwards, A., Schwab, C., & Shevlin, T. (2013, February). Financial constraints and the incentive for tax planning. In 2013 American Taxation Association Midyear Meeting: New Faculty/Doctoral Student Session. Kim, S., Kraft, P., & Ryan, S. G. (2013). Financial statement comparability and credit risk. Review of Accounting Studies, 18(3), 783-823. Quan, Z. (2013). On the Limitations and Improvement Measures of Financial Statement Analysis. Trade Unions' Tribune (Journal of Shandong Institute of Trade Unions' Administration Cadres), 5, 036. Sharma, A., & Panigrahi, P. K. (2013). A review of financial accounting fraud detection based on data mining techniques. arXiv preprint arXiv:1309.3944. Read More