Question

Ratio Analysis

The comparative statements of financial position of IKEA Furniture Outlay Retail Shop in Sydney for the current year and previous year are given below. Calculate the ratios necessary to evaluate the shop’s performance

IKEA Furniture Outlay Profit & Loss Statement

For the year ended 30^th June 2012 & 2013

	2012	2013
Sales( all credit)	220 000	250 000
Less Cost of Sales:	76 500	124 000
Opening Inventory	65 000	85 000
Purchases	99 500	144 000
Goods available for sale	164 500	229 000
Closing Inventory	(88 000)       76 500	(105 000)     124 000
Gross Profit	143 500	126 000
Operating Expenses	39 700	71 060
Net Profit	103 800	54 940

IKEA Furniture Outlay Balance Sheet as at 30^th June 2012/2013

	2012	2013
Assets:
Current Assets:
Cash	75 700	87 000
Accounts Receivable	69 000	68 500
Inventory	88 000	105 000
Total Current Assets	232 700	260 500
Non-Current Assets:
Plant and Equipment	295 000	208 500
Total Assets:	527 700	469 000
Liabilities

Current Liabilities
Accounts Payable	51 500	59 950
Bank overdraft	15 200	20 500
Total Current Liabilities	66 700	80 450
Noncurrent Liabilities:
6.5% Bank Loan	333 000	243 070
Total non-current liabilities:	333 000	243 070
Total liabilities	399 700	323 520
Owner’s Equity
Ordinary shares of $2 each	95 000	100 100
Retained profit	33 000	45 380
Total Owner’s Equity	128 000	145 480

Required:

Prepare Ratio Analysis based on the formula distributed to you

Make comments about how to improve the business performance.

Note:

All sales are on credit. Accounts receivable balance on 1/07/2011 was $66 800 and Business works 5 days a week.

Retained Profit = Net Profit – Dividend paid

Formula:

Current ratio = Current assets/Current liabilities

Liquid ratio = Current assets — Inventory (Closing Stocks)/Current liabilities — Bank overdraft

Gross profit ratio = Gross profit/Sales

Net profit ratio = Net profit after tax/Sales

Accounts receivable rate = Credit sales/Average accounts receivable Collection days = 365 days / Accounts receivable rate

Return on equity = Net profit after tax/Owners equity Debt to Equity = Total debt/Equity

Total asset turnover = Total sales/Total assets

Return on investment (ROI) = Net profit after tax/Total assets Inventory turnover = Cost of Goods sold/Average Inventories Times Interest cover = Net Profit before Interest & tax / Interest

Earnings per share = (Net profit before tax – Preference Dividend) / Number of Ordinary shares

Ratio (Formula)	2012	2013	Interpretation

Ratio (Formula)	2012	2013	Interpretation

Ratio (Formula)	2012	2013	Interpretation

Ratio (Formula)	2012	2013	Interpretation

Answer 1

Current Assets	3.49	3.24
Liquid Ratio	2.17	1.93
GP Ratio	0.65	0.50
NP Ratio	0.47	0.22
AR Rate	3.19	3.64
ROE	0.81	0.38
Debt to Equity	3.12	2.22
Total Asset Turnover	0.42	0.53
ROI	0.20	0.12
Times interest cover	4.80	3.48
EPS	2.19	1.10

Current assets ratio: This ratio is a measure of liquidity. It indicates whether the business would be able to repay the current liabilities out of current assets within a year. Current asset ratio of 3.49 indicates that we have $3.49 of current assets to repay $1 of current liabilities. As it can be seen that current ratio has been reduced from 3.49 to 3.24 which indicates that the current assets have declined.

Liquid ratio: This ratio indicates ability to meet short term liabilities with most liquid assets like cash and it excludes inventories. Decline in liquid ratio from 2.17 to 1.93 indicates that liquid assets are declining.

GP ratio: It stands for gross profit ratio. The formula for calculating gross profit ratio is: Gross profit/ Sales. It measures trading profitability of a company. Declining gross profit of 0.50 from previous level of 0.65 indicates that trading expenses have increased due to reduction in profit or the value of closing inventory has eroded or the opening stocks were overvalued.

NP ratio: It stands for net profit ratio. The formula for calculating net profit ratio is: Net profit/ Sales. Decline in net profit ratio from 0.47 to 0.22 may indicate decline in sales with no decline in operating expenses or increase in operating expenses leading to a decline in net profit.

AR Rate: It stands for accounts receivable rate. It means how many times the company can convert its accounts receivable into cash. The formula to calculate the same is: Net credit sales/ Average accounts receivable. An increase in accounts receivable rate from 3.19 to 3.64 indicates that the company is able to realise it debtors faster than earlier and thus is a positive sign.

Return on Equity: return on equity measures profitability. It is a measure of shareholders return. It is calculated by way of the following formula: Net income/ shareholders equity. A decline in ROE from 0.81 to 0.38 indicates that preference dividends have incresed thus resulting in a decline in income available for distribution to equity shareholders or it may also be due to decline in profits of a company.

Debt to Equity: Debt to equity ratio is calculated by the formula debt/equity. It indicates whether the company is financed by debt or equity. If this ratio is less than 1 then it means that capital/ equity is more and debt is less. A declining debt to equity from 3.12 to 2.22 is a good indicator which shows that either debt has been paid or more equity financing has been done.

Total Assets Turnover Ratio: It indicates how efficiently a company is able to generate sales from its assets. It is calculated by the formula: Net Sales/ Total Assets. Increase in this ratio from 0.42 to 0.53 indicates that sales have increased without increase in the assets employed.

ROI: It stands for return on investment. It is calculated by using the following formula: Net profit/ Total Assets. It indicates return on assets employed. Decrease in ROI means decrease in income or increase in total assets without increase income.

TImes interest cover: Times interest coverage ratio calculates the sufficiency/ adequacy of operating income before interest (EBIT) in order to pay interest on loan for a certain number of times. The formula to calculate times interest coverage ratio is EBIT/ interest on loan. Decline in this ratio from 4.80 to 3.48 indicates that either the operating income has declined or the loan amount has increased resulting into increase in the interest amount.

EPS: It stands for earning per share. It means that the profit made by the company if distributed fully, then a shareholder might earn an amount equivalent to the EPS calculated. Decline in EPS from 2.19 to 1.10 may be due to various factorss such as increase in the no of shares due to increase in share capital or bonus issue of shares or rights issue of shares or due to decline in profits of the company.