Analysis of the Financial Ratios - Coursework Example

Analysis of the Financial Ratios The return on capital employed ratio is used to analyze the performance of the firm in terms of the profits received against the capital input altogether. It is a ratio that determines the approximate returns of assets deployed by the shareholders of the firm as a whole. In this case Dixon as a company is perceived to be deploying so much capital in order to make profits, it is straining so much on consuming its working capital thus minimizing on its working capital base altogether. The return on capital employed is diminishing as financial years goes (Saleemi 2005). The calculated current ratio depicts the fact that the Company utilizes most of its assets while meeting its financial obligations altogether. The significant change of the ratios depict the fact that as financial years progresses the Company continues to use most of its assets reserves to clear financial obligations it owes its creditors altogether. Profitability ratios like gross profit margin depict the fact that the Company is placed at a better position to convert its sales into profits. In this case the Company’s significant decrease in both its net and gross profit margin depicts the fact that its ability and capacity to convert sales into profits is deteriorating at an alarming rate altogether. The Asset turnover ratio is used to calculate the amount of sales that the Company can make while still consuming its reserved assets. In this case, the calculated ratios depict the fact that the Company is using most of its assets in order to make a single sale which depicts losses on the part of the Company’s operating activities altogether. All in all, the accounting ratios that have been calculated do not depict a favourable trend in that there are significant differences between the 2006-2007 and 2007-2008 periods. The liquidity capability of the firm is deteriorating greatly as the financial years progresses. These trends are not in any way favourable for the Company if it commences for a long period of time altogether. Economic Profits for the Past Two years: Economic Profit= (Total Revenue less Total Expenditure) - Opportunity Cost 2009-2010 Period, Total Revenue-Total Expense= (68.6)-(11.3) = (57.3) M 2010-2011 Period, Total Revenue- Total Expense = 37.4-(207.9) = (170.5) M The main accounting drivers for the firm are based upon the accounting concepts. Therefore there are basically two accounting concepts which Dixon Company decided to implement in the preparation of its financial statements thus minimizing the risks attributed to recording of profits where there was none. The two accounting concepts are the Prudence concept which postulates that a firm is entitled to record revenues and profits in the balance sheet in the manner that only when they are realized or rather there is reasonable probability that they will be realized in the end. But liabilities are realized when and only when they are a clear possibility that there costs value will be incurred at any time altogether. The Company has also embarked on preparing its financial statements in accordance with the going concern driver as a whole. In this concept the operation of the firm and its other activities are expected to be solvent hence possible commence with its operations in the foreseeable future. In this case, Dixon, unlike other companies is perceived to be making losses and thus it could have put an halt to its operations as a whole but because its desire is and continues to be operating at the present economically unviable environment it has persisted to undertaking its activities altogether. The importance and Limitations of breaking the Financial Statements into Bits: By breaking the financial statements into bits it has facilitated the following functions altogether: (I). It has facilitated the analyzing of both the current and future ability of the firm’s to earn revenues (II). It has aided in the determination of both the short –term and long term financial capabilities of firms altogether (III). the breaking down of the statements into bits has facilitated the comparison of financial statements of one firm with another. (IV) Breaking down of the financial statements has also aided in the determination of the possible growth and developments in the future of the Company as a whole. (V). The breaking down of the financial statements into the aforementioned bits has further assisted in the determination of the liquidity positions of the various financial funds which are useful in the future operations of the firm as a whole. However, there are limitations which are attributed with the breaking down of the financial statements into bits. They include: (I). there is no explanations given for the exact reliability of the figures provided altogether. It is difficult to establish the level of dependence of the financial statements being analyzed altogether. Slight manipulations of either incomes or expense will definitely lead to negative analyzing criterion altogether (Saleemi 2005). (II). the overall results attributed to the analyzing of financial statements is faced with the challenge of differences in interpretation process altogether. The bits of the financial statements that have been analyzed may not be detrimental in figuring out the exact solutions required altogether. (III). by breaking the financial statements into bits postulates the fact that they are going to be difficulties especially when choosing the exact tools of analyzing the bits. This is because different analysts use different tools to analyze accounting financial statements altogether. Capital Budgeting: Machine A: Formula, R t / (1+i) t Year NPV of Cash Inflow 10 ($30,000-$8,000)* PIVFA (10%, 10 Years) = 22,000 * {(1-(1/(1+0.1)^10)/0.1=6.1446} = 22,000 * 6.1446 = $ 135,181.2 Machine B, = (60000-12,000)* PVIFA (10 %, 5 Years) = 48,000*(1-(1/(1+0.1)^5)/0.1 = 48,000*(1-(1/1.1^5)/0.1 = 48,000 *(1-1/1.61051)/0.1 = 48,000*(1-0.6209)/0.1 =48,000 *3.791 = $ 181,968 Internal Rate of Return (IRR): IRR=C (n)/ (1+r) n Machine A; Machine B: 115,000/ (1+r) ^10= 0 175,000/ (1+r) ^ 5= 0 115,000 / (1.0r) ^ 10=0 175,000 / (1.0r) ^ 5=0 115,000/ 10 log (1.0r) =0 175,000 / 5log (1.0r) =0 1.0r= antilog 11,500 175,000 /5= log 1.0r 1.0r=4.06 Antilog 35,000= r= 4.54 % r = 4.06 % Payback Period Machine A; Machine B; Year Cash flow Running Total Year Cash flow Running Total 0 30,000 -30,000 0 60,000 -60,000 1 60,000 30,000 1 120,000 60,000 2 90,000 110,000 2 180,000 240,000 3 110,000 210,000 3 240,000 480,000 4 140,000 350,000 4 300,000 780,000 5 170,000 520,000 5 360,000 1,140,000 6 200,000 720,000 7 230, 000 950,000 8 260,000 1,210,000 9 290,000 1,500,000 10 310,000 1,810,000 Recommendation: Considering the calculated figures above, it is safe to indicate that the Company should invest in Machine A since it takes a less amount of time before it break evens and also it breaks-even amount is far much larger than that obtained for Machine B. The fact that the analysis took to analyze the machines using three different techniques stipulates the exactness of the figures obtained altogether. The use of the payback period, NPV and IRR is far much effective and efficient in obtaining a suitable choice of the machines. The analysis facilitates reliable decision making process altogether. It is therefore wise to indicate that the analysis minimizes the level of errors that could be obtained altogether. The major weakness of the analysis comes out of the fact that the processes entail a far much complex calculations of the figures as a whole thus consuming time and resources altogether. References Saleemi, K 2005. Financial Accounting: Financial Ratios, Capital Budgeting, 4th Ed. London, Longhorn Publishers, Read More