The Ratio Analysis - Assignment Example

Case Studies # 2 Why are ratios useful? Who uses the ratio analysis and for what reasons? Every company’s performance needs to be appraised to identify the areas of problems and improvement for the company. Performance measurement is a part of the system of financial control of an enterprise as well as being important to investors. There are many different ways in which performance of a company can be measured. One way of appraising such financial performance is through the use of the Ratio Analysis technique. Ratio Analysis is ‘a tool used by individuals to conduct a quantitative analysis of information in a companys financial statements. Ratios are calculated from current year numbers and are then compared to previous years, other companies, the industry, or even the economy to judge the performance of the company. Ratio analysis is predominately used by proponents of fundamental analysis’. (Investopedia.com) This technique is of great help and assistance for different stakeholders of a company. Each stakeholder has its own purpose of using this technique. The key stakeholders who use ratio analysis are: Shareholders; use this technique to appraise the performance of the company. By the use of this technique they analyze and predict the share price and the proposed return from their investment in the company. Potential Investors; use this technique to analyze the trend of dividend payment and the future share price of the company. They use this technique to analyze the potential returns from investing in a company. Besides the returns, ratio analysis technique is also used by potential investors to ascertain the long-term survival of a company. Directors/Employees; use this technique to identify areas of concern such as slow payments by debtors. Such areas are identified first and later fixed accordingly. 2. Calculate Rockies Breweries’ 2010 current and quick ratios based on the projected financial statements. What are your comments on the company’s liquidity position for 2008, 2009, and 2010 projection over time and against industry norm? Ratio Formula Calculation Year 2010 Current Ratio Current Asset ÷ Current Liabilities 2,680,112 ÷ 1,039,800 2.6 Quick Ratio Current Assets – Inventory ÷ Current Liabilities 2,680,112 – 1,716,480 ÷ 1,039,800 0.93 According to the ratios calculated, the liquidity position for Rockies Breweries’ seems to be quiet strong, the company has a very low chance of going bankrupt and it enjoys a very healthy liquidity position. The company’s liquidity position for the company has been improving over the last three years and as compared to its downward liquidity position in the year 2009, it has improved heavily. As compared to the industry averages, the company has been performing just under the industry averages but this does not show that the company is performing adversely. 3. Calculate Rockies Breweries’ 2010 inventory turnover, days sales outstanding, fixed assets turnover, and total assets turnover based on the projected financial statements. What are your comments on the company’s asset utilization for 2008, 2009, and 2010 projection over time and against industry norm? Ratio Formula Calculation Year 2010 Inventory turnover Cost of Goods Sold ÷ Average Inventory 5,800,000 ÷ 1,501,920 3.9 Days Sales Outstanding Accounts Receivable ÷ Total Credit Sales * No. of Days 878,000 ÷ 7,035,600 * 365 45.6 Fixed Assets Turnover Fixed Assets ÷ Sales * 100 836,840 ÷ 7,035,600 * 100 11.9 Total Asset Turnover Total Assets ÷ Sales * 100 Net Sales ÷ Total Assets 2.0 Inventory turnover determines the rate at which the company is able to sell off its products. Rockies Breweries inventory turnover has deteriorated as compared to the year 2008, 2009 and the industry average. This shows that the company is having problems in selling off its products quickly. Days Sales outstanding for the company suggests that the company has been facing problem in recovering their sales amount from its debtors as this figure has deteriorated from the year 2008 and is also not in line with the industry average. Fixed Asset Turnover has improved for the company as compared to the preceding years and the industry averages whilst the Total Asset Turnover has remained the same as that of 2009 and is below the industry average. 4. Calculate Rockies Breweries’ 2010 debt ratio, TIE, and EBITDA coverage. What are your comments on the company’s financial leverage for 2008, 2009, and 2010 projection over time and against industry norm? Ratios Formula Calculation Year 2010 Debt Ratio Total Liabilities ÷ Total Assets * 100 1,539,800 ÷ 3,516,952 * 100 43.8 Times Interest Earned EBIT ÷ Interest 502,640 ÷ 80,000 6.3 EBITDA EBITDA + Lease Payments ÷ Interest + Lease Payment 622,640 + 40,000 ÷ 80,000 + 40,000 5.5 The company’s leverage has improved from last year but it is not in accordance with the industry average. The TIE ratio has improved since last year and is in line with the industry average. EBITDA is not in good when compared with the industry average. 5. Calculate Rockies Breweries’ 2010 profit margin, basic earnings power, ROA, and ROE. What are your comments on the company’s profitability position for 2008, 2009, and 2010 projection over time and against industry norm? Ratios Formula Calculation Year 2010 Profit Margin Net Income ÷ Revenue * 100 253,584 ÷ 7,035,600 * 100 3.6% Basic Earnings Power EBIT ÷ Total Assets 502,640 ÷ 3,516,952 14.3% ROA Net Income ÷ Total Assets 253,584 ÷ 7,035,600 3.6% ROE Net Income ÷ Shareholder Equity 253,584 ÷ 1,977,152 12.8% The company’s profitability position has improved in comparison to the year 2009. According to the industry average the company lacks behind in all profitability ratios except the Profit Margin Ratio. 6. Calculate Rockies Breweries’ 2010 P/E and market/book. What are your comments on the company’s market value position for 2008, 2009, and 2010 projection over time and against industry norm? Ratios Formula Calculation Year 2010 P/E ratio Share Price ÷ EPS 12.17 ÷ 1.014 12.0 Market/Book Ratio Market Value per share ÷ Book Value per share 12.17 ÷ 7.909 1.5 The market value position has improved as compared to previous years but is not good as compared to the industry averages. 7. Use the DuPont equation to provide a summary and overview of Rockies Breweries’ financial condition as projected for 2010. What are the company’s major strengths and weaknesses? DuPont Equation ROE = (Net Profit Margin) x (Asset Turnover) x (Asset / Equity Ratio) ROE = 3.6 * 2 * 12.8 ROE = 92.16 The company’s major strength is the in Profit margin ratio, where the company has been able to keep up to the industry average. 8. Suppose if the company can reduce its days sales outstanding to the industry average level, how this reduction in DSO can help the company’s financial conditions and thus the stock price? Examining the past and projected DSOs for the company, would it be possible to improve its DSO position? If so, is it a good idea to go ahead with the earlier COO’s suggestion to offer 60-day credit terms rather than 30-day term? If the company’s DSO position is improved in line with the industry average the company is going to improve its liquidity position and it would be able to use the liquid cash in any other profitable venture for the company. Hence it is not a good idea to offer a 60- day credit rather than a 30 day term. 9. Does it appear that the company can adjust its inventory level? If it does indeed improve its inventory, how should this affect the company’s profitability and stock price? The company can improve its inventory level by not holding back its inventory too much and by selling off its inventory quickly. The other way is not to buy excessive new inventory, rather it would be better to sell the existing one to improve the inventory level. This improvement in inventory level would reduce the cost of goods sold; hence it would improve the profit and the stock price as a whole. 10. Late payments to suppliers have been an issue as the financial conditions have worsened. Should the company only sells on cash? What would be the pros and cons? If the company decides to sell on cash terms, it would eventually reduce its revenue as bulk buyers usually prefer credit term rather than cash terms. The benefit on the other hand of selling on cash term would be that the company would improve its liquidity position and would be able to pay its creditor promptly. 11. In hindsight, what should Rockies Breweries have done in 2008? Rockies Breweries should have kept a good inventory turnover form the beginning to keep liquid cash position. Besides that the company should have kept a reduced day debtor policy to keep a liquid position. All of this would have helped the company to avoid the loss in 2009. 12. While the ratios analysis is meaningful, what are some qualitative factors that you should consider when evaluating a company’s likely future financial performance in conjunction with the ratios? Besides the ratio analysis, the qualitative issue to be considered for Rockies Breweries would be; The productivity i.e. how fast is the company in producing an individual product. The number of complaints received and answered by the employees of the company. References Ratio Analysis, Investopedia.com http://www.investopedia.com/terms/r/ratioanalysis.asp Read More

This shows that the company is having problems in selling off its products quickly. Days Sales outstanding for the company suggests that the company has been facing problem in recovering their sales amount from its debtors as this figure has deteriorated from the year 2008 and is also not in line with the industry average. Fixed Asset Turnover has improved for the company as compared to the preceding years and the industry averages whilst the Total Asset Turnover has remained the same as that of 2009 and is below the industry average. 4. Calculate Rockies Breweries’ 2010 debt ratio, TIE, and EBITDA coverage.

What are your comments on the company’s financial leverage for 2008, 2009, and 2010 projection over time and against industry norm? Ratios Formula Calculation Year 2010 Debt Ratio Total Liabilities ÷ Total Assets * 100 1,539,800 ÷ 3,516,952 * 100 43.8 Times Interest Earned EBIT ÷ Interest 502,640 ÷ 80,000 6.3 EBITDA EBITDA + Lease Payments ÷ Interest + Lease Payment 622,640 + 40,000 ÷ 80,000 + 40,000 5.5 The company’s leverage has improved from last year but it is not in accordance with the industry average.

The TIE ratio has improved since last year and is in line with the industry average. EBITDA is not in good when compared with the industry average. 5. Calculate Rockies Breweries’ 2010 profit margin, basic earnings power, ROA, and ROE. What are your comments on the company’s profitability position for 2008, 2009, and 2010 projection over time and against industry norm? Ratios Formula Calculation Year 2010 Profit Margin Net Income ÷ Revenue * 100 253,584 ÷ 7,035,600 * 100 3.6% Basic Earnings Power EBIT ÷ Total Assets 502,640 ÷ 3,516,952 14.

3% ROA Net Income ÷ Total Assets 253,584 ÷ 7,035,600 3.6% ROE Net Income ÷ Shareholder Equity 253,584 ÷ 1,977,152 12.8% The company’s profitability position has improved in comparison to the year 2009. According to the industry average the company lacks behind in all profitability ratios except the Profit Margin Ratio. 6. Calculate Rockies Breweries’ 2010 P/E and market/book. What are your comments on the company’s market value position for 2008, 2009, and 2010 projection over time and against industry norm?

Ratios Formula Calculation Year 2010 P/E ratio Share Price ÷ EPS 12.17 ÷ 1.014 12.0 Market/Book Ratio Market Value per share ÷ Book Value per share 12.17 ÷ 7.909 1.5 The market value position has improved as compared to previous years but is not good as compared to the industry averages. 7. Use the DuPont equation to provide a summary and overview of Rockies Breweries’ financial condition as projected for 2010. What are the company’s major strengths and weaknesses? DuPont Equation ROE = (Net Profit Margin) x (Asset Turnover) x (Asset / Equity Ratio) ROE = 3.

6 * 2 * 12.8 ROE = 92.16 The company’s major strength is the in Profit margin ratio, where the company has been able to keep up to the industry average. 8. Suppose if the company can reduce its days sales outstanding to the industry average level, how this reduction in DSO can help the company’s financial conditions and thus the stock price? Examining the past and projected DSOs for the company, would it be possible to improve its DSO position? If so, is it a good idea to go ahead with the earlier COO’s suggestion to offer 60-day credit terms rather than 30-day term?

If the company’s DSO position is improved in line with the industry average the company is going to improve its liquidity position and it would be able to use the liquid cash in any other profitable venture for the company. Hence it is not a good idea to offer a 60- day credit rather than a 30 day term. 9. Does it appear that the company can adjust its inventory level? If it does indeed improve its inventory, how should this affect the company’s profitability and stock price? The company can improve its inventory level by not holding back its inventory too much and by selling off its inventory quickly.

The other way is not to buy excessive new inventory, rather it would be better to sell the existing one to improve the inventory level.

Read More