Question

Before you start analysing the firm's financial statements, you will need to obtain industry averages for each of the standard financial statement ratios. They are provided below.

	2019	2020	2021	Industry Averages
Profitability Ratios
Return on equity	21.3%	21.2%	19.6%	22.0%
Return on Capital employed	12.9%	13.5%	13.5%	12.8%
Operating Profit Margin	14.7%	18.2%	23.0%	14.4%
Gross Profit Margin	54.7%	52.0%	49.3%	44.8%
Efficiency Ratios
Average Inventory Turnover period	79.8	83.3	93.0	78.8
Average settlement period for Accounts Receivable	28.0	27.0	28.4	30.0
Average settlement period for Accounts Payable	39.9	48.8	62.4	37.3
Sales Revenue to Capital Employed	87.3%	74.2%	59.0%	87.0%
Liquidity Ratios
Current Ratio	2.82	2.88	2.95	4.60
Acid Test Ratio	2.03	2.14	2.25	2.76
Leverage Ratios
Gearing Ratio	61.7%	58.5%	55.2%	61.4%
Interest Cover Ratio	3.94	4.38	4.65	5.75
Investment Ratios
Dividend Payout Ratio	67.8%	59.9%	57.1%	40.8%
Dividend Yield	6.61%	6.01%	5.08%	4.70%
Earnings Per Share	$0.19	$0.21	$0.20	$0.28
P/E Ratio	10.4	9.8	11.5	11.2

1) Analyse the firm's performance over the last 3 years. You should pay attention to all the 16 ratios shown above. Identify any strengths or weakness, in terms of positive or negative trends.
a. Profitability Ratios
b. Efficiency Ratios
c. Liquidity Ratios
d. Leverage Ratios
e. Investment Ratios

2) Analyse the firm's performance in comparison to Industry averages for each of the ratios. Identify any strengths or weaknesses.
a. Profitability Ratios
b. Efficiency Ratios
c. Liquidity Ratios
d. Leverage Ratios
e. Investment Ratios

3) Summarise the firm's performance in terms of profitability, efficiency, liquidity, leverage & potential for investment.

4) Briefly explain to the client any possible problems with your analysis that client should bear in mind. For example, are there any conclusions you have come to that might be unreliable because of the nature of this analysis, and if so, why?

Answer 1

If we analyse the firms's performance over the three years and compare it with the industry average then the following can be concluded:

a. Profitability ratio - The profitability ratio of the three years is higher then the industry average in all the three years. Return on equity shows the amount of net income returned on the shareholder's equity as a percentage.This ratio shows that the company is in a healthy position in the context of profitability.

b. Efficiency ratio - The efficiencies ratios of a company helps the managers for evaluating the specific targeted performances like receivable turnover ratio. Here, the average settlement period for accounts receivable is lower than the industry average in all the three years it signifies that the customers of the company pays their bill faster and the company has more cash in hand.

c. Liquidity ratios - If the company has lower quick ratio than the industry average means that the company has a relatively lower liquidity than the competitors in the industry. If the company has lower current asset ratio than the competitors it means the company is in a good position from the context of current assets and current liabilities.

d. Leverage ratios - Interest coverage ratio shows that how many times a company can pay off its interest liability, if the leverage ratio is lower than the industry average it means that the company is not in a good position to pay off its interest liabilities. Gearing ratio indicates the company borrowed funds to its internal equity. A gearing ratio more than 50% is considered highly levered or geared.

e. Investment ratios - These ratios are used by companies to assess the performance of company's shares. Earning per share is lower than the industry average in all the three years it means that the company is paying low to their shareholders as compare to the competitors in the average. The dividend payout ratio is higher than the industry average in all the three years it means that the company is distributing more of its earnings to the stockholders. Price earning ratio shows the proportion of earning per share to the market price of the share.

Above analysis draws the following conclusion :

1. Lower interest coverage ratio is not a good sign of a company's growth it shows the number of times a company can pay off its interest liability lower ratio implies that the company can't pay its interest liability often.

2. Sales to capital employed ratio implies the sales revenue as a ratio that is generated by the assets invested in the business. Lower ratio means that the company is insufficient to sustain the high level of revenue generation.