Premium Electronics Pty Ltd Ratio Analysis - Example

Premium Electronics Pty Ltd Ratio Analysis Date Name: Professor: Course: Date Executive summary The financial ratios assist the management of a company in planning and decisions making. They include profitability ratios, financial stability ratios and business activity ratios. Ratio analysis help a company to compare it financial statements for different period to identify problems facing it. In that regard, this report will analyze Premium Electronics Pty Ltd financial statements for the years 2010, 2011, 2012, and 2013 and calculate profitability ratios, liquidity ratios, efficiency ratios, and financial gearing ratios for each period. The calculated ratios will then be used to assess various problems facing Premium Electronics Pty Ltd and later outline some recommendations that can help the company overcome the issues its facing. Table of Content Executive Summary……………………………………………………………………………….2 1.0 Introduction…………………………………………………………………………………....4 2.0 Calculation of Ratios…………………………………………………………………………..5 3.0 Ratio Analysis………………………………………………………………………………....5 3.1 Profitability…………………………………………………………………………....5 3.2 Efficiency……………………………………………………………………………...6 3.3 Liquidity……………………………………………………………………………….8 3.4 Financial Gearing……………………………………………………………………...9 4.0 Recommendations……………………………………………………………………………10 Conclusion……………………………………………………………………………………….10 References……………………………………………………………………………………….12 Appendix 1……………………………………………………………………………………….13 1.0 Introduction Ratio analysis is a comparison of financial statements of different financial periods or of different companies to help analyze the financial position of a business (Keršuliene et al 2010). Moreover, ratio analysis helps to simplify the understanding of different components of financial statements of a company which would otherwise make no sense. For example, one is able to understand the relationship between level of sale and the Net profit by calculating the Net Profit Margin ratio. It helps in comparing performance of different companies by comparing their ratios for same periods. Ratio analysis also helps in trend analysis by comparing ratios of a company in different periods to determine whether or not performance is improving. An investor can determine whether or not to invest in a company by looking at a few ratios instead of going through the complete financial statement (Petzke et al 2010). This report will calculate and analyze Premium Electronics Pty Ltd ratios from 2010 to 2013 to identify the problems facing the company and later give recommendations on how to solve these issues. Ratio Premium Electronics Pty Ltd Ratios 2010 2011 2013 Profitability Ratios Return on Assets (%) Asset turnover (times) Gross profit margin (%) Net profit margin (%) Return on Equity (%) Efficiency Ratios Accounts Receivable turnover (days) Inventory Turnover (days) Accounts payable turnover (days) Liquidity Ratios Current ratio (times) Quick Ratio (times) Finance Gearing Ratios Interest coverage ratio (times) Gearing ratio 25.18 2.05 66.67 12.26 26.51 44.63 80.80 38.55 3.25 2.09 6.68 36.72 25.88 2.27 65.66 11.41 25.50 42.21 75.14 36.81 2.76 1.73 4.35 42.82 23.58 2.30 63.37 10.26 22.42 40.78 78.47 39.54 2.31 1.31 3.29 42.82 21.14 2.33 61.34 9.08 17.01 37.42 82.52 42.17 1.89 1.0 2.37 45.70 3.0 Ratio analysis 3.1 Profitability Profitability is the ability of a company to earn profit. It can be measured using profitability ratios that uses margin analysis and shows the return on sales and capital employed. These ratios give the company good understanding of how well company utilizes its resources in generating profit and value to shareholders. Long -term profitability of the company is vital for both company’s survival and the shareholder’s wealth (Peavler, 2010). Profitability ratios includes, gross profit ratio, profit margin ratio and return on owners equity (Investment) (ROI) (Peavler, 2010). Premium Electronics Pty Ltd profitability levels have been decreasing as shown by the profitability ratios above. The company gross profit margin has decreased from 66.67% in 2010 to 61.34% in 2013. Moreover, its net profit margin ratio has also decreased from 12.26% in 2010 to 9.08% in 2013. The decrease in these two ratios indicates that Premium Electronics Pty Ltd cost of goods and expenses have increased without a corresponding increase in revenue hence a decline in profit. In addition, the company has not used it assets efficiently to generate revenue. Premium Electronics Pty Ltd return on asset ratio has been decreasing from 25.18% in 2010 to 21.14% in 2013, which indicate that the company has not efficiently used it additional assets it has acquired during this period to generate extra revenue. Therefore, due to declining level of profit as a result of high cost of production and inefficiency in the company’s operation, the company’s return on equity ratio has also decreased from 26.51% in 2010 to 17.01%. The company risk losing potential investors since the returns offered by company are decreasing. 3.2 Efficiency It focuses on how well a company utilizes its assets to generate revenue. To measure Premium Electronics Pty Ltd efficiency, there are various efficiency ratios that can be used which look at the time it takes for the company to convert inventory into cash or the time it take to collect cash from customer (Myaccountingcourse.com, 2014). These ratios include accounts receivable turnover ratio, inventory turnover ratio, and accounts payable turnover ratio. Account receivable turnover ratio is a ratio that measures how many times a company turns its accounts receivable into cash in one financial period. It shows how efficiently a company is collecting its credit sales from customers. As shown in the table above, there have been consistent declines in days taken by Premium Electronics Pty Ltd to collect its credit sales from its customer from 44.63 days in 2010, 42.21 days in 2011, 40.78 days in 2012, and 37.42 days in 2013. This indicates that the company is becoming more efficient in collecting its credit sales since fewer days are now required to do so. This will increase the company liquidity levels as debt is collected faster. Inventory turnover ratio measures a company’s effectiveness in managing its inventory. It shows how many times average inventory is sold in one financial period. Therefore, this ratio helps a company not to tie up capital by buying too much stock and waste resources by storing obsolete stock (Myaccountingcourse.com, 2014). Premium Electronics Pty Ltd inventory turnover ratio had initially declined from 80.80 days in 2010 to 75.14 days in 2011. However, the ratio has increased to 78.47 days in 2012 and 82.52 days in 2013. The decrease which was experienced in 2011 was a good sign that the company is becoming more effective in selling its inventory. However, Premium Electronics Pty Ltd was not that effective in selling its inventory in 2012 and 2013, since the inventory turnover ratio increased and this can affect the company’s liquidity level as the company may end up holding up capital by buying too much stock and waste resources by storing obsolete stock. Accounts payable turnover ratio shows how quickly a company pays off its creditors. Suppliers use this ratio to decide whether or not to grant credit to a company (Myaccountingcourse.com, 2014). Premium Electronics Pty Ltd account payable ratio has increased from 38.55 days in 2010 to 42.17days in 2013. Even though the days taken to pay suppliers by the company have increased, vendors will be willing to grant credit to Premium Electronics Pty Ltd since it has a high turnover ratio than the average industry ratio. 3.3 Liquidity This is the company’s ability to pay its current liability. There are two ratios that can be used to assess the liquidity level of a company namely: acid test ratio and current ratio (Myaccountingcourse.com, 2014). Acid test ratio or quick ratio measures the company’s ability to pay its short term liquidity without having to sell its inventory. Current ratio is a balance sheet financial performance measure of a company’s liquidity whereby it indicates the company’s ability to meet its short term debts and obligations. Generally, the higher current and acid test ratios, the larger the margin of safety that the company possesses to pay off its current liabilities when they fall due (Myaccountingcourse.com, 2014). When the liquidity ratios are greater than 1, this shows that a company is in good financial health but when it’s less than 1 it is very likely that it will fall into financial difficulties. Premium Electronics Pty Ltd current and acid test ratios have been declining from 2010. The current ratio has decreased from 3.25 in 2010 to 1.89 in 2013 while the quick ratio has decreased from 2.09 in 2013 to 1.0 in 2014. Although the company’s liquidity ratios are greater than 1 indicating good financial health, the margin of safety that it possesses to pay off it short term obligation is reducing and this will make Premium Electronics Pty Ltd less attractive to suppliers who supply goods on credit to the company. The decrease of current and quick ratios can be attributed to an increase in current liabilities without a corresponding increase in current assets. 3.4 Financial Gearing Financial gearing refers to a company’s debts related to its equity capital. To measure financial gearing of a company, these two ratios can be used; interest coverage ratio and gearing ratio. Interest coverage ratio is used to assess how easily a company can pay interest on its outstanding debts. The lower the ratio, the more the company is burdened to pay interest since an interest coverage ratio of 1.5 or lower raises questions on the company’s ability to meet interest expenses while if the ratio is below 1 it indicates that a company is not generating sufficient revenues to satisfy interest expenses (Myaccountingcourse.com, 2014). On the other hand, gearing ratio focuses on the capital structure of a company, i.e. proportion of capital that is provided by debt compared to capital contributed by shareholders. This ratio measures the proportion of assets invested in a company that are financed by long-term debts. The higher the gearing ratio, the higher the risk to a company since payment of interest is not optional as compared to payment of dividends. It is important to note that a gearing level of less than 50% is healthy for a company (Myaccountingcourse.com, 2014). Interest coverage ratio and gearing ratio have been used to measure Premium Electronics Pty financial gearing level. Premium Electronics interest coverage ratio has been consistently declining for the past four years i.e. from 6.68 times in 2010 to 2.37 times in 2013. This can be attributed to an increase in long term liabilities and as a result, the company’s interest expenses have also increased. Although, the ratio is greater than 1.5 which means company is not burdened to pay the interest expenses, the rate at which the ratio is decreasing is alarming. On the other hand, Premium Electronics Pty gearing ratio has increased from 36.72% in 2010 to 45.70% in 2013. This means the proportion of assets invested in Premium Electronics Pty Ltd that are financed by long-term debts have been increasing hence increasing the risk faced by the company since payment of interest is mandatory as compared to payment of dividends. However, this risk is not that high to worry investors and the management of Premium Electronics Pty Ltd since it’s less than 50%. 4.0 Recommendations For Premium Electronics Pty Ltd to prosper in this industry, first, it should ensure that it employs more marketing strategies in order to reach a wider market. This means that their demand for their products will increase and hence their sales. This will in turn increase the profitability level of the company. Moreover, the company should at least retain 40% of its net profit which will be used to acquire latest technologies that can help reduce cost of production and expenses hence increase profit. These measures will help Premium Electronics Pty Ltd improve its profitability ratios. To increase stock turnover, Premium Electronics Pty Ltd should stock goods which can easily move and are inexpensive. Marketing should be done thoroughly and they should avoid stocking unnecessary goods. In conclusion the Premium Electronics Pty Ltd should measure the actual performance with the planned one, identify the variances, determine cause of variances and develop course of action to rectify these variances. Conclusion From the analysis above, we can conclude that Premium Electronics Pty Ltd profitability levels have decreased from 2010 to 2013. This has been as a result of increasing cost of goods and expenses without a corresponding increase in revenue generated. However, the company’s liquidity and financial gearing levels are favourable. Although most of the company’s operations such as account receivable turnover and account payable turnover are efficient, the company is becoming less effective in managing its inventory. To overcome identified problems, it is recommended that the company implements more marketing strategies to increase sales and invest in latest technology to increase efficiency and reduce cost of goods and expenses. This will help the company to be more profitable. Moreover, for the company to manage it inventory effectively, Premium Electronics Pty Ltd should stock goods which can easily move and are inexpensive References Keršuliene, V., Zavadskas, E. K., & Turskis, Z. (2010). Selection of rational dispute resolution method by applying new step‐wise weight assessment ratio analysis (Swara). Journal of Business Economics and Management, 11(2), 243-258. Myaccountingcourse.com (2014), Financial Ratio Retrieved on 7th January 7, 2015 from http://www.myaccountingcourse.com/financial-ratios/ Peavler, R (2010). Use profitability ratios in Financial Ratio Analysis. Retrieved on 7th January 2015 from http://bizfinance.about.com/od/financialratios/a/Profitability_Ratios.htm Steffy, W.Zearley, T.,Strunk J.(2005). Financial Ratio Analysis: an effective Management Tool. 4th Edition: USA Appendix 1: Premium Electronics Pty Ltd Ratios 2012 2013 Return on asset = Net Profit before interest and tax ×100 Average total Assets Asset turnover = Sales Average Total Assets Net Profit margin= Net profit before interest and tax ×100 Sales Return on Equity = profit attributable to shareholder ×100 Book value of equity Accounts Receivable turnover = Net credit Sales Average Accounts receivable Inventory turnover = cost of goods sold Average Inventory Accounts Payable turnover = Total Purchases Average Accounts payable Read More