Question

QUESTION FOUR

You have been provided with the following information for a small private company, Formosa Pty Ltd, whose competitors are predominately large public companies.

	2017	2018	2019	Industry average 2019
Net profit margin	8.2%	7.5%	6.8%	8.0%
Return on equity	13.1%	12.3%	11.1%	13.5%
Current ratio	1.8	2.1	2.4	2.0
Quick ratio	1.2	1.1	0.9	1.2
Receivables turnover	12.2	12.6	13.0	13.0
Inventory turnover	4.7	4.5	4.2	4.8

REQUIRED:

1. Comment on the trend of each of the six ratios for Formosa Pty Ltd in relation to the company’s profitability and liquidity. For each ratio, describe what the ratio measures. (word limit 500).

Explain the difference between liquidity and solvency when analyzing a company’s financial statements. (word limit 150)

Answer 1

1) Net profit margin of the company is showing a decresing trend, it has deresed from 8.2% in 2017 to 6.8% in 2019 and this is also below the industry avreage. The company must take some corrective steps to improve its profitability either by reducing its cost or by improving its revenues.

2) Return on equity is another indicator of profitablilty, which is also showing a reducing trend from 13.15 to 11.15 as that is also linked to the net profit, it will also improve if the company takes the suggested steps to improve the net profit.

3) Current ratio of the company is also 2.4 which is above the industry average of 2 which is also a standard or ideal current ratio.It means the company is having more current assets than the required level so, it must somewhere utilise it's current assets more efficiently.

4) Quick ratio of the company has reduced from 1.2 to .9 which is also lower than the industry average of 1.2. The company should increse its level of liquid assets in comparision to Current liabilities, so that it doesn't have to face any issue of liquidity crunch in near future.

5) Receivable turnover of the company has improved from 12.2 in 2017 to 13 in 2019, which indicates that the company is efficiently recovering its payment from receivables. This ratio is being maintained by the company as equivalent to industry average, the company may increse it by putting some offers to receivables for prompt payment and put the amunt received in improving it's effeciency.

6) Inventory turnover ratio is another indicator of activities of the company which shows a decreasing trend and is below industry average. It means the company is not able to sale its inventory as fast as the competitor companies are doing.

Overall the company should find ways to increase it's sales and profitability as almost in all the ratios its perfonmance is below the average of oher competitor large companies. It's an alarming situation for the company as efforts should be put in to strategise its activities accordingly.

B) liquidity is the short term solvency which indicates the copmpany's ability to pay for its short term liabilities whereas Solency is Long term means the company's ability to pay back its long term debts and the costs associated to that. If a company has sufficient amount of cash is able to pay its short term liabilities its termed as sound liquidity whaereas if it has sufficient Long term flow of cash in future with which it can easily repay it's longer debts and its interest etc, it's termed as Sound solvency position of the comapny.

Hope it helps.