Question

Question 4                                                                                                                         

Using the information provided below for Breville Group Limited (sells home appliances) and Globe International Limited (skating and footwear apparel):

1. Review each ratio briefly stating what is tells you about the company and which company, if either, is better.                                                                                         (7.5 marks)
2. Based on your findings justify which company you would seriously consider for an investment.

   (0.5 mark)

Answer 1

1) Net Profit Margin

Formula -    Net profit/Revenue*100

Interpreatation

• Net profit margin is equal to how much net income is generated as a percentage of revenue.
• Net profit margin helps investors assess if a company's management is generating enough profit from its sales and whether operating costs and overhead costs are being contained.
• Net profit margin is one of the most important indicators of a company's financial health.

2)Return on equity(ROE)

Formula- ROE= Net Income/Average Shareholder’s Equity*100

Interpretation

• Return on equity (ROE) measures how effectively management is using a company’s assets to create profits.
• Whether an ROE is considered satisfactory will depend on what is normal for the industry or company peers.

3)Return on assets (ROA)

Formula-   ROA= Net Income/Total assets

Interpretation

• Return on Assets (ROA) is an indicator of how well a company utilizes its assets, by determining how profitable a company is relative to its total assets.
• ROA is best used when comparing similar companies or comparing a company to its previous performance.

4) Days inventory or Days sales of Inventory(DSI)

Formula- Average inventory/Cost of goods sold * 365

Interpretation

• Days sales of inventory (DSI) is the average number of days it takes for a firm to sell off inventory.
• DSI is a metric that analysts use to determine the efficiency of sales.
• A high DSI can indicate that a firm is not properly managing its inventory or that it has inventory that is difficult to sell.

5) Days Receivables

Formula- Accounts receivable/Annual revenue * 365

Interpretation

Accounts receivable days is the number of days that a customer invoice is outstanding before it is collected. The point of the measurement is to determine the effectiveness of a company's credit and collection efforts in allowing credit to reputable customers, as well as its ability to collect cash from them in a timely manner. The measurement is usually applied to the entire set of invoices that a company has outstanding at any point in time, rather than to a single invoice. When measured at the individual customer level, the measurement can indicate when a customer is having cash flow troubles, since it will attempt to stretch out the amount of time before it pays invoices.

6) Days Payable

Formula- Average account payable/cost of goods sold * 365

Interpretation

The accounts payable days formula measures the number of days that a company takes to pay its suppliers. If the number of days increases from one period to the next, this indicates that the company is paying its suppliers more slowly, and may be an indicator of worsening financial condition. A change in the number of payable days can also indicate altered payment terms with suppliers, though this rarely has more than a slight impact on the total number of days, since the terms must be altered for many suppliers to alter the ratio to a meaningful extent.If a company is paying its suppliers very quickly, it may mean that the suppliers are demanding fast payment terms, either because short terms are part of their business models or because they feel the company is too high a credit risk to allow longer payment terms.

7) Liquidity Ratios

Current ratios

Formula = Current assets/Current Liabilities

Interpretation

• The current ratio compares all of a company’s current assets to its current liabilities. These are usually defined as assets that are cash or will be turned into cash in a year or less, and liabilities that will be paid in a year or less.
• The current ratio is sometimes referred to as the “working capital” ratio and helps investors understand more about a company’s ability to cover its short-term debt with its current assets.

8) Quick ratio

Formula = (Current assets – Inventory – Prepaid expenses)/ Current Liabilities

Interpretation

• The quick ratio indicates a company's capacity to pay its current liabilities without needing to sell its inventory or get additional financing.
• The quick ratio is considered a more conservative measure than the current ratio, which includes all current assets as coverage for current liabilities.
• The higher the ratio result, the better a company's liquidity and financial health; the lower the ratio, the more likely the company will struggle with paying debts.

Capital Structure Ratios

Gross Gearing

Gross Gearing ratio, is the Total Debt (short-term and long-term) as a percentage of the Total of Shareholders' funds and Debt funds. The calculation is the following:

= [(creditors,short + creditors,long + creditors,other + subordinated loans + insurance funds) / (ord cap,reserves + prefs,minorities + creditors,short + creditors,long + creditors,other + subordinated loans + insurance funds)] * 100

= [TOTAL LIABILITIES / TOTAL ASSETS] * 100

Interpretation      

• Gearing ratios are a group of financial metrics that compare shareholders' equity to company debt in various ways to assess the company's amount of leverage and financial stability.
• Gearing is a measure of how much of a company's operations are funded using debt versus the funding received from shareholders as equity.
• Gearing ratios have more meaning when they are compared against the gearing ratios of other companies in the same industry.

Net Interest coverage ratio

Formula = EBIT/ Interest Expense

Interpretation

• The interest coverage ratio is used to see how well a firm can pay the interest on outstanding debt.
• Also called the times-interest-earned ratio, this ratio is used by creditors and prospective lenders to assess the risk of lending capital to a firm.
• A higher coverage ratio is better, although the ideal ratio may vary by industry.

Market Performance ratio

Price earning ratio=   Market value per share/ Earning per share

Interpretation

• The price-earnings ratio (P/E ratio) relates a company's share price to its earnings per share.
• A high P/E ratio could mean that a company's stock is over-valued, or else that investors are expecting high growth rates in the future.
• Companies that have no earnings or that are losing money do not have a P/E ratio since there is nothing to put in the denominator.

Note: If we have the figures, from the above we can conclude which company is good for investment.

All the best

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