Regency Blue Ribbon Restaurant Ratio Analysis - Example

Regency Blue Ribbon Restaurant Ratio Analysis Customer Inserts His/her Name Customer Inserts Grade Course Customer Inserts Tutor’s Name 20, 11, 2011 Executive summary Financial management has a critical role in development of an organisation strategy that will ensure low cost production and increased revenues. Regency Blue Ribbon Restaurant competitiveness will depend on how well the management will utilise the existing information from its accounting information systems and other operational systems. The role of the financial manager is to provide timely financial information mainly on the trends and relationships of the accounting elements. Ratio analysis will therefore play a very important role in proving critical information for improvement of sales revenue, operations management and cost management consequently becoming an indirect critical input for strategic management. For Regency Blue Ribbon Restaurant to change its current financial performance, this financial ratio analysis will provide the necessary statistics for management to use in development the necessary tactical and strategic resolutions that will see the restaurants turnaround. Introduction Financial reports analysis is one of the critical information processing tasks in an organisation that will help discover the trend and relationships of accounting items therefore assisting management in decision making. This analysis for Regency Blue Ribbon Restaurant will enable the finance management provide management information on the performance of the organisation over the four years, 2007 to 2009 and also provide projections for the years 2011 and 2012. The analysis will be based on the income and expenditure reports and balance sheet for the last five years and also income projections for year 2011 and 2012. Ratios comparison against industry averages Historical ratios analysis Income statement analysis Gross Profit Ratio This ratio measures the Regency Blue Ribbon Restaurant’s profitability and also efficiency in their food and beverage production processes over the four year period from 2007 to 2010. The ratio is relates the gross profit after deduction of cost of foods and beverages used in the period to the revenues for the same period. In 2007 Food sales revenues were above industrial average and hard a figure of 71% therefore 6% above the industrial average while its Food cost of sales increased from 30% in 2007 to 32.5% in 2007 and the worst period was 42% in 2010. In the same period beverage sales were below the industrial average by almost 6% and decreasing and in the year 2010 and 2011 it increased to 33% and 34% respectively but still below the industrial average. On the contrary and over the same period of time the beverage cost of sales has been always higher than the industrial average and in some cases like 2009 higher by 10%. Regency Blue Ribbon Restaurant gross profit margin ratio had been higher than the industrial average in 2007 to 2009 but declined below it in 2010. This can be attributed to either increased cost of beverages which has always been above 8% except for the year 2011 as indicated in the analysis table and also can be attributed to reduced sales revenue for the same product. The profitability of restaurant therefore has been based on the profitability of food stuff but due to poor performance on the part of the beverage sales hence declined from 67% in 2007 to 58% in 2010 which can also be partly be attributed to the drastic increase in food cost of sales. The management of Regency Blue Ribbon Restaurant should therefore find ways of improving profitability of beverages as a product through strategies aimed at increasing its revenues and reducing its cost of sales. Reducing cost of sales requires that the management purchases its beverages from cheaper vendors or manufacturers. In order to increase beverage revenue, the management should consider having some strategic marketing initiatives that may boost sales like having a combined product of both food and beverage or any other method of boosting sales. Net profit ratio This ratio measures the net profit as percentage of sales revenue and is a measure of the firm’s capacity to withstand bad economic times as it measures the ultimate profitability after all the operating and non-operating costs have been deducted (Helfert, 2001). For the case of Regency Blue Ribbon Restaurant the net profit ratio has been always below the industrial average indicated a great level of inefficiency in management of non-production expenditures. In 2007 to 2011, the figures for net profit are; 6.24% in 2007, 5.5% in 2008, 2.72% in 2009, (0.53%) in 2009, 17.5% in 2010 and finally 1.34% in 2012. The underlying expenses especially salaries and wages have been above the industrial average for all the 5 years by 17% in 2007, 2009 and 2010, 18% in 2012, 16% in 2008 and finally 10% in 2011 due to increased sales. Other expenditures like energy cost have also been higher than the industrial average by more than 3% for each of years from 2007 to 2012 but have been reducing from approximately 7% for the years 2007 to 2009 to 4.7% in 2010 and 4% in 2011 due increased sales and 4.59% in 2012. This expenses being higher than the industrial average has been the major cause of decline in net profit margin apart from the increased cost of beverages coupled with its declining sales. In order to improve on the net profit margin necessary management of expenses like salaries and wages and also energy costs have to be checked since both expenses are more than 50% of Regency Blue Ribbon Restaurant total expenditure yet in the industrial average both expenditures are supposed to be 29.5% indicating that these two expenditures requires management action. Optimal staffing level should be established so the excess staff costs can be reduced. With regards to energy costs, alternative energy sources that are cheap should be analysed and sourced for use within the restaurant. Return on Investment- ROI This is the ultimate measure on the efficiency of the investment made on Regency Blue Ribbon Restaurant but the investor. It is ratio of net income to average equity employed. For the case of Regency Blue Ribbon Restaurant this ratio has been above the industrial average for the three years from 2007 to 2009 but drop to the worst case situation in 2010 indicating that there’s need investigate the business environment on which Regency Blue Ribbon Restaurant operates or its management policy changes. Working capital ratio This is a ratio of current assets to current liabilities hence a measure of firms liquidity and the ability of its current assets to meet its immediate current liabilities. This is ratios indicates the firm’s financial security which core to its operations. For the case of Regency Blue Ribbon Restaurant, this ratio has always been above industrial average indicating that the company performing better and is capable of settling its obligations. It should be noted this ration has been on the decline and on 2010 it was slightly below the industrial average indicating a necessary check and correction to its working capital management policy. Debt ratio This is a ratio of total liabilities to total assets and therefore is a measure of Regency Blue Ribbon Restaurant’s solvency and consequently indicating the proportion of its assets financed by debt. The ratio has been below the industrial average consequently indicating that Regency Blue Ribbon Restaurant’s assets have been substantially been financed by owners’ equity. Regency Blue Ribbon Restaurant therefore is not heavily geared compared to its peers in the industry. In 2007 the debt equity ratio has been 0.48, 0.47 in 2008, 0.39 in 2009 and 0.35 in 2010. The continuous decline in this ratio is a clear indicator of limited working capital as compared to peers in the industry where the ratio is 0.75%. Limited working capital also leads to reduced business activity therefore reduced profitability. Inventory turnover This ratio indicates the liquidity of the inventory in days. It is a function of management purchasing process and hence low inventory turnover days may be an indicator of over-stocking of inventory and the contrary is also true. For the case of Regency Blue Ribbon Restaurant the ratio has been way very high as compared to the industrial average but over the four years there has been a consistent decline towards it indicating that the purchasing process management has been on a consistent improvement. Accounts Receivable turnover This is an indicator of the liquidity of Regency Blue Ribbon Restaurant’s receivables and over the four years, this ratio has been way above the industrial average. This ratio also has been above the accepted credit limit of 30 days for Regency Blue Ribbon Restaurant indicating that customers take long before settling their accounts. The industrial average is 26days while the accepted credit period is a 30 days, this means that the average collection period over the four years for Regency Blue Ribbon Restaurant has been much below any accepted standards; internal credit period and the external industrial average. Regency Blue Ribbon Restaurant needs to re look implementation and management of their debtors since this may increase the risk exposure for the Restaurant. Findings Over the four year period under analysis most of the profitability ratios have been declining indicating some laxity in the part of management in managing the operations and production cost of the restaurant. Gross profit ratio was 68% in 2007 but it dropped to approximately 58% in 2010, this was explained by the drop in revenues in 2009 and increased cost of food and beverages for 2010. This ratio should be an indicator that management should be able to management production cost and find avenues for increasing production (Fabozzi & Peterson, 2003). With the continuous drop in profitability ratios of gross profit margin and net profit ratios, the drop on return on investment ration was foreseeable since the major component of this ratio is Net profit. ROI indicates that the benefit of investing in Regency Blue Ribbon Restaurant is declining and is a signal to the investor that things aren’t going very well therefore he should investigate whether it is as a result of internal management factors or external and economic factors. Financial stability ratios; working capital and debt over the four years to 2007 have indicated decline. For the case of working capital ratio, this is not order since it indicates tendencies towards financial instability due to increased leverage on the part of Regency Blue Ribbon Restaurant. On the other hand decreased debt ratio over the four year period is a healthy for Regency Blue Ribbon Restaurant since it is an indicator that the proportion of assets funded by debt is declining hence reduced risk of not settling external debts in case of winding up. On the other hand the business activity and efficiency ratios have over the four year period 2007 to 2009 been decline for the case of inventory turnover but fluctuating for the accounts receivable turnover. The decrease in the inventory turnover days over the period indicates improved management efficiency with regards to inventory management while the fluctuation on the accounts receivable turnover days is an indicator on the level of inconsistency in the application of the 30 days credit terms by the debtor’s management of Regency Blue Ribbon Restaurant. It is therefore necessary that debt management in Regency Blue Ribbon Restaurant should be improved. Key action points and recommendations for improving the financial performance of the restaurant a) Cost management Decreasing profitability ratios of gross profit and net profit margins is a clear indicator that there are areas of laxity as far as cost management and commodity pricing is concern. The management of Regency Blue Ribbon Restaurant should ensure that proper cost management procedures are instituted so that production cost is clearly captured. This will ensure that will ensure that controllable costs are managed while non-controllable ones are passed onto the buyers. Net profit ratios are in a consistent decline and this is an indicator that non-production expenses have been on increase or that the gross profit margins are lower. For the management to effectively maintain their profitability, it imperative that expenses like salaries and wages have to be managed so that their increase is not related to the sales revenue. The management should therefore change their staffing policies to include permanent staff so that they are paid a fixed amount that will not vary with production. In order to reduce costs, the management should also consider introduction of other products like soft drinks which will also absorb some of the costs of operations while generating additional income. b) Debt collection and purchasing process management The average collection period and inventory turnover ratios indicates that debt management should be improved through radical reconstitution so that average collection period is maintained at lower levels. Sales management should be checked so that unaccounted for sales invoices are captured. Purchasing process also has been improving and the management should further enhance it so that the stockholding costs are reduced. c) Marketing With increased cost over time management should check on their marketing costs which have been increasing over time. As much as the management should increase their sales through marketing, this should be controlled since it is a major contributor to the decline in net profit. d) Employee rewards and terms of employment Employee morale may not be directly be calculated as an asset to the restaurant but this is one of critical aspect in a firm like Regency Blue Ribbon Restaurant which is in hospitality business where service offering is a critical aspect of revenue generation. Having staff with no job security may be viewed as a cost management strategy but its implications on business is major and may have been the major cause of decline in profitability. An analysis of the impact of the forecasted sales for 2011 and 2012 on the net profit of the business Projections for 2011 are increased revenue with constant costs. In reality this assumption will lead to increased profitability but on the other hand costs like salaries and wages being assumed to be constant is unrealistic since it is based on increased work load and sales. The assumption for 2011 is that with all the costs remaining constant and the sales increase realised, the net profit margin will increase to 17%. In order to achieve this thorough cost management by Regency Blue Ribbon Restaurant is necessary. Also the management should not just wait for the opportunity to come but also should position itself strategically anticipating the possibility of new entrants into the market and also stiff competition for their competitors. With regards to 2012 projections, the management should there is anticipated reduction in revenues and some costs increasing especially insurance and salaries and wages. This will increase the overall expenditure of Regency Blue Ribbon Restaurant while at the same time reducing anticipated revues. This will ultimately reduce net profit to a ratio of 1% indicating that the optimal capacity of the restaurant has not been achieved. Actions for improvements The management of Regency Blue Ribbon Restaurant should consider diversification of its products to include both alcoholic and soft beverages so that the capacity of the restaurant can be fully utilised and this may be an avenue to reduce operation costs per unit of production while increasing revenue. Staffing costs; salaries and wages needs immediate attention since this is one cost expense element that has contributed to more that a third of expenditures and almost 17% greater than the industrial average. There is under utilisation of labour therefore optimal staffing requirement should immediately be retained and the excess labour force suspended. The management should develop strategies to cut beverages cost of sales and also improve its sales revenue since this has been the major cause of decline in gross profit margins. Other costs like energy costs should also be managed to acceptable levels by either opting to cheaper energy sources or minimizing energy losses. Appendices Appendix 1: Ratio Analysis Spreadsheet including a Balance sheet and income statement summary References Fabozzi, F., & Peterson, P., 2003. Financial management and analysis. New York: John Wiley and Sons. Helfert, E., 2001. Financial analysis: tools and techniques: a guide for managers. New York: McGraw-Hill. Read More