Question

ABC company specialized in food industry has selected the following information from its most recent annual report to be the subject of an immediate press release.

• Net income this year was $4.4 million. Last year's net income had been $4.0 million.
• The current ratio has changed to 2.5 from last year's 2.
• The debt/total assets ratio has changed to 4 from last year's 3.
• The receivable turnover has changed to 7 from last year’s 5 times.
• The Return on Assets has changed to 13% from last year’s 14.8%.
• The company purchased 2 new machines.

Required: As a financial analyst, you are required to think carefully about what information above is good news for the business and what information is bad news. Justify your answer.

Answer 1

Good news for the business are as under:

1. Defination of Net income: Net income (NI), also called net earnings, is calculated as sales minus cost of goods sold, selling, general and administrative expenses, operating expenses, depreciation, interest, taxes, and other expenses.

In our case Net income increased from 4 to 4.4 million when compared to prior year. It is a positive news for the company as the company's profit after deducting all the expenses has increased by $ 4,00,000. So it is a good news.

2. Defination of current ratio: Indicator of a firm's ability to meet short-term financial obligations, it is the ratio of current assets to current liabilities.Though every industry has its range of acceptable current-ratios, a ratio of 2:1 is considered desirable in most sectors.

In our case current ratio is 2.5 times when compared to prior year which was 2 times so it is a good news for business as the company as more short term current assets to meet its short term financial obligations.

3. Defination of receivable turnover ratio:The accounts receivable turnover ratio is an accounting measure used to quantify a company's effectiveness in collecting its receivables or money owed by clients. The ratio shows how well a company uses and manages the credit it extends to customers and how quickly that short-term debt is collected or is paid

In our case receivable ratio has increased to 7 times when compared to 5 times in prior year which indicates  that a company’s collection of accounts receivable is efficient and that the company has a high proportion of quality customers that pay their debts quickly. So it is a good news for company.

Bad news for the business are as under:

Defination of Return on Assets: Return on assets (ROA) is an indicator of how profitable a company is relative to its total assets. ROA gives a manager, investor, or analyst an idea as to how efficient a company's management is at using its assets to generate earnings. Return on assets is displayed as a percentage.

In our case ROA decreased to 13 % from 14.8% in prior year which is a bad indication as the business net income is decreased to its total assets when compared to the prior year so it is bad news.

Defination of Debt/ Total asset ratio: Total-debt-to-total-assets is a leverage ratio that defines the total amount of debt relative to assets owned by a company. The higher the ratio, the higher the degree of leverage (DoL) and, consequently, the higher the risk of investing in that company.

In our case Debt/total asset ratio has increased to 4 from 3 when compared to prior year which there is a high degree of leverage & which ultimatly amounts to high risk. So it is a bad news for business/company.