Question

State few recommendations that addresses the decision making of a stakeholder based on the following financial ratio of a company.( whether to invest or not).

RATIO	2018	2019
Debt ratio	583825/1215816 = 0.48	662649/1488585 =0.44
Return on sales	(43843/1252041)x100 =3.5%	(33611/1419952)x100 =2.3%
PE Ratio	151.6/15.6 = 9.72	217.2/5.7 =38.1
Net profit %	2.30%	0.83%
Return on Equity	4.55%	1.43%
Current Ratio	1.69	1.55

Answer 1

Instead of providing you with some random reccomendations on the above ratios, for each ratios I will be explaining the concept, imporatance and then the recommendation for each ratio.

Debt ratio

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Concept:- It is a measure on degree to which a business has used debt to finance its assets.

Imporatnce:- Higher the ratio, higher the degree of usage, hence higher financial risk.

Reasoning:- Debt ratio has reduced from 0.48 to 0.44 in the year 2019. This means that the company is using less debt to finnace its asset when compared to previous year. This could be due to repayment of a major debt or purchase of assets rather with shares or retained earning.

Reccommendation:- It will be reccommended to keep finnacing assets with lesser debts, which will make the company more attractive to potential investors, as chances of insolvency are lower.

Return on sales

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Concept:- It is a measure on how much profit is the business able to generate per dollar turnover.

Imporatnce:- Higher the ratio, better the efficiency.

Reasoning:- Return on sales ratio has reduced from 3.5 to 2.3 in the year 2019. This means that the company is the company has become less efficient in generating profit from sales. This could be due to lesser efficiency in management of operation costs, or allowance of higher discounts or higher sales returns etc..

Reccommendation:- The company should focus on reducing the operational cost. Mainly the purchases, direct labour and transportation. This can improve the operational profit of the company.

PE Ratio

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Concept:- It is a measure on how attarctive is the companies market price per share when compared to earnings per share

Imporatnce:- Higher the ratio, higher the expected growth persumed by investors.

Reasoning:- PE ratio has almost increase massively. This is due to a decrease in earnings per share and an increase in market price per share. This ratio gives a positive outlook to the company. Eventhough the earnings per share has fallen, the investors are ready to pay higher price for the share. Thus they might be expecting higher growth for the company.

Reccommendation:- It is reccommended to mainatin investors expectation, thereby demanding higher market price per share.

Net Profit

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Concept:-  It is a measure of how much profit the business made on total sales after reducing all the costs to reach such sales.

Imporatnce:- Higher the ratio, better the ability of business to generate profit

Reasoning:- There is a major fall in Net profit ratio. This could be due the fall in sales or increase in costs. May be there is some exceptional transaction during 2019 that has caused huge loss. (Example:- Flood, Fire, Earthquake etc,) Since return on sales have not fallen much, we can conclude that non operating costs are the reason for fall in net profit.

Reccommendation:- It is reccommended to look into the non operating costs that has caused this fall, and manage the same efficiently.

Return on equity

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Concept:-  It is a measure of how much profit the business able to produce from its assets. As you know share holders equity will always be equal to Total assets minus debt.

Imporatnce:- Higher the ratio, better the ability of business to generate profit

Reasoning:- There is a major fall in Return on equity. This could be due the major fall in net profit as we have already discussed. Which we concluded that could be due to the non operating costs.

Reccommendation:- It is reccommended to look into the non operating costs that has caused this fall, and manage the same efficiently. (Reccommendation is same as previous, because the root cause is same)

Current ratio

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Concept:-  It is a measure of liquidity of the business. It reflects business’s ability to meet its current liability with its current assets. Higher the ratio better the ability.

Imporatnce:- Higher the ratio, higher the liquidity of business

Reasoning:- There is a small reduction in current ratio, but the same is not alarming. This could be due to reduction in current assets (example:- increase in bad debts reducing receivables, writedown or dispossal of inventory etc.)

Reccommendation:- It is reccommended to look into the reason behind the fall in current asset value. Receivable should be well managed and followed up regularly to avoid bad debts.