Question

Ratio analysis can be used for identifying some of the issues of a firm. Indeed, Ratios draw the management’s attention towards issues needing attention by evaluating a broad range of financial aspects of an entity, such as its liquidity, efficiency of operations, and profitability.

You are required to select a company listed in Bursa Malaysia

Download the latest FOUR (4) years Financial Statements of the selected company. The selected company must be from the manufacturing, industrial, oil and gas, trading or services sector. Do NOT select a company in banking or financial services industry. Using ratio analysis, analyze the selected company’s current position. The outcome of your analysis should be identifying some strengths and weaknesses of the company, highilighting the issues you find and providing some recommendations to the company’s management.

In your report include the followings.

a) Describe the selected company’s background.

b) Analyse and critically comment the company performance and trend based on the financial ratios of the selected company for the past FOUR years (Note: Please use at least THREE financial ratios for each group of ratios as mentioned below). Highlight the strengths and weaknesses of the company based on your analysis.

i) Liquidity

ii) Assets management

iii) Financial Leverage

iv) Profitability

c) Formulate relevant recommendations to the company’s management based on the results of your analysis.

Answer 1

KEY TAKEAWAYS

• Ratio analysis compares line-item data from a company's financial statements to reveal insights regarding profitability, liquidity, operational efficiency, and solvency.
• Ratio analysis can mark how a company is performing over time, while comparing a company to another within the same industry or sector.
• While ratios offer useful insight into a company, they should be paired with other metrics, to obtain a broader picture of a company's financial health.

• What Does Ratio Analysis Tell You?

  Investors and analysts employ ratio analysis to evaluate the financial health of companies by scrutinizing past and current financial statements. Comparative data can demonstrate how a company is performing over time and can be used to estimate likely future performance. This data can also compare a company's financial standing with industry averages while measuring how a company stacks up against others within the same sector.

  Investors can use ratio analysis easily, and every figure needed to calculate the ratios is found on a company's financial statements.

  Ratios are comparison points for companies. They evaluate stocks within an industry. Likewise, they measure a company today against its historical numbers. In most cases, it is also important to understand the variables driving ratios as management has the flexibility to, at times, alter its strategy to make its stock and company ratios more attractive. Generally, ratios are typically not used in isolation but rather in combination with other ratios. Having a good idea of the ratios in each of the four previously mentioned categories will give you a comprehensive view of the company from different angles and help you spot potential red flags.

  Examples of Ratio Analysis Categories

  The various kinds of financial ratios available may be broadly grouped into the following six silos, based on the sets of data they provide:

  1. Liquidity Ratios

  Liquidity ratios measure a company's ability to pay off its short-term debts as they become due, using the company's current or quick assets. Liquidity ratios include the current ratio, quick ratio, and working capital ratio.

  2. Solvency Ratios

  Also called financial leverage ratios, solvency ratios compare a company's debt levels with its assets, equity, and earnings, to evaluate the likelihood of a company staying afloat over the long haul, by paying off its long-term debt as well as the interest on its debt. Examples of solvency ratios include: debt-equity ratios, debt-assets ratios, and interest coverage ratios.

  3. Profitability Ratios

  These ratios convey how well a company can generate profits from its operations. Profit margin, return on assets, return on equity, return on capital employed, and gross margin ratios are all examples of profitability ratios.

  4. Efficiency Ratios

  Also called activity ratios, efficiency ratios evaluate how efficiently a company uses its assets and liabilities to generate sales and maximize profits. Key efficiency ratios include: turnover ratio, inventory turnover, and days' sales in inventory.

  5. Coverage Ratios

  Coverage ratios measure a company's ability to make the interest payments and other obligations associated with its debts. Examples include the times interest earned ratio and the debt-service coverage ratio.

  6. Market Prospect Ratios

  These are the most commonly used ratios in fundamental analysis. They include dividend yield, P/E ratio, earnings per share (EPS), and dividend payout ratio. Investors use these metrics to predict earnings and future performance.

  For example, if the average P/E ratio of all companies in the S&P 500 index is 20, and the majority of companies have P/Es between 15 and 25, a stock with a P/E ratio of seven would be considered undervalued. In contrast, one with a P/E ratio of 50 would be considered overvalued. The former may trend upwards in the future, while the latter may trend downwards until each aligns with its intrinsic value.

  Examples of Ratio Analysis in Use

  Ratio analysis can predict a company's future performance—for better or worse.Successful companies generally boast solid ratios in all areas, where any sudden hint of weakness in one area may spark a significant stock sell-off. Let's look at a few simple examples

  Net profit margin, often referred to simply as profit margin or the bottom line, is a ratio that investors use to compare the profitability of companies within the same sector. It's calculated by dividing a company's net income by its revenues. Instead of dissecting financial statements to compare how profitable companies are, an investor can use this ratio instead. For example, suppose company ABC and company DEF are in the same sector with profit margins of 50% and 10%, respectively. An investor can easily compare the two companies and conclude that ABC converted 50% of its revenues into profits, while DEF only converted 10%.

  Using the companies from the above example, suppose ABC has a P/E ratio of 100, while DEF has a P/E ratio of 10. An average investor concludes that investors are willing to pay $100 per $1 of earnings ABC generates and only $10 per $1 of earnings DEF generates.