The aim of this report is to analyse the financial ratios of the Super Cheap Auto Group Ltd and ARB Corporation Ltd from 2008-2009. This would help to give a better understanding of both company’s financial health and performance. This report has analysed the financial ratios of both companies and discovered that both companies are profitable. ARB Corporation is more efficient than Super Cheap Auto Group. All its efficiency ratios suggest that the company is efficient in its operations. The weakest results came from its inventory turnover which remained constant over the two years period. Super Cheap Auto Group needs to improve on its inventory and debtors turnover so as to achieve optimum efficiency. Stability ratios suggest that ARB Corporation is more stable than Super Cheap Auto Group. The report as gives recommendations that can help both companies to perform better.
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Introduction:
The performance and interpretation of financial ratios are one of the most frequently used ways to analyse a company’s financial performance. This report would examine the financial data provided in the financial reports of two companies, namely; Super Cheap Auto Group Ltd and ARB Corporation Ltd. The report would analyse some of the data reported by both companies in their financial statements. At the end of this report, readers would be able to tell a number of things about the above companies. For example, it would be possible to tell if whether the companies are operating in excess debt or inventory and what corrective actions can be put in place so as to keep the business moving in the right direction. These financial ratios would help to throw more light on some salient business issues such as whether the customers are paying their debts on time, or if the company’s operating expenses are too much to make it generate maximum profits. Ratio calculations can also help to make financial analysts to better understand whether the company is making the best use of its assets. It is possible for a business to either over or under utilise its assets in its quest to maximise profits. Ratio analysis can guide a company to know whether it is making good use of its assets and when it is not the case; the outcome of the calculations can guide the financial analyst to recommend management to take the appropriate corrective measure. In order to ensure that the best decision is made, businesses compare their ratios to the general industry ratios compiled by the industry in which they operate. A business can compare its individual ratios to the average ratios compiled for industry to understand whether it is moving in the right or wrong direction.
Profitability Ratios:
Profitability ratios are used to measure the ability of a business to yield returns on the capital invested into the venture. The fact that a company is making profit is not sufficient to classify it as a successful business (Epstein & Jermakowicz, 2007). This is because some businesses make less profit than they would have made if the factors of production were combined differently. Profitability ratios are not just there to tell whether a business is making profit or not (Wild, 2007). In addition to the above; profitability ratios tell if a business is as profitable as it ought to be. A rise in profitability ratios is a possible sign for any business (Wild, 2007). The profitability ratios of both Super Cheap Auto Group Ltd and ARB Corporation Ltd are all positive. They ratios suggest that the companies are making profits and are worth the investment of investors. The table (Appendix A) depicts the performance of the various profitability ratios. Positive implies that the profitability ratios were good. Both businesses had positive outcomes on all the ratios performed. Below is an explanation about the various ratios and how to calculate them.
Gross Profit Margin:
The gross profit margin can enable the management of a business to assess the ability of the business to yield returns on investment at the gross profits level. This ratio covers three issues which include pricing, production and inventory. This ratio can be calculated by using the formula below (Epstein & Jermakowicz, 2007):-
Gross Profit
Total Sales
Net Profit Margin:
The net profit margin can quickly enable a business to know how much net profit it generates from each dollar received in sales revenue. It is an indicator that management can use to assess whether it has well managed its operating expenses so as to ensure that the business generates the best possible returns on investment. This ratio also indicates whether the organisation is making the right volume of sales that can enable it to meet up with fixed costs while making some reasonable profits. Net profit margin can be calculated by using the formula listed below:-
Net Profit
Total Sales
Return on Assets:
This ratio can be used by management to measure the level of efficiency with which the company makes use of its assets to make profits. This ratio is used to measure a company’s level of efficiency in the use of its assets.
Net Profit Before Taxes
Total Assets
Efficiency Ratios:
Efficiency has to do with the evaluation of the various ways in which companies manage their assets. Financial analysts are always interested in evaluating the value of a company’s assets as well as the how the company manages these assets. There are many ratios that can be used by financial analysts to evaluate the level of efficiency within a business (Wild, 2007). The efficiency ratios analysed in the table titled Appendix A depicts that both companies are efficiently run even though there is need for some minor improvements that can only go to improve on the level of efficiency (Williams, 2008). ARB needs to improve on inventory turnover as it had a flat trend from 2008-2009. Creditors’ turnover was also negative as creditors seemed to mount more pressure to get loans repaid faster over the same period. Super Cheap Cars had even worse efficiency performance. The ratios performed suggest that the company had negative trends on both inventory turnover and debtors’ turnover. This means the company has to improve on both areas in order to attain optimum efficiency. Debts need to be collected faster to ensure liquidity (Williams, 2008).
Accounts Receivable Turnover:
This ratio is interested in analysing how many times accounts receivable are paid within a specified accounting period. When turnover is high, the business collects cash faster and this makes the business to have a higher level of cash in hand (Williams, 2008). The formula used to calculate this ratio is:
Total Net Sales
Accounts Receivable
Accounts Receivable Collection Period:
This refers to how much time it takes a business to collect its accounts receivable from its clients. The shorter the period the better for the business just like with turnover discussed above. And when a company has a shorter collection period; the more likely it is that it would have more money in hand. The formula used to calculate this ratio is below:
365 Days
Accounts Receivable Turnover
Accounts Payable Turnover:
This ratio depicts the number of times that a business repays its creditors within an accounting period. When the number is high, it implies that the business might have decided to pay its creditor on a later date or it could simply have problems in paying back its creditors (Weston, 1990).
Cost of Goods Sold
Accounts Payable
Days Payable:
This ratio depict the number of days it takes the business to pay accounts payable. When the business takes longer to pay; it might lose more money as it might not benefit from a number of discounts associated with the prompt payment of loans. This ratio can be calculated with the use of the formula below (Epstein & Jermakowicz, 2007):-
365 days
Accounts Payable Turnover
Inventory Turnover:
This ratio enables financial analysts and businesses to evaluate the number of times that their inventory is sold within a specific accounting period. Faster turnover is a positive sign which allows a business to increase its cash flow and cash in hand. It is a positive trend that businesses value (Weston, 1990). The ratio is achieved as depicted below:-
Cost of Goods Sold
Inventory
Days Inventory:
This ratio is used to analyse the average duration that each inventory lasts on the average. When it takes fewer days to sell the inventory, it means there is more cash flow and subsequently cash in hand. The goal of most businesses is to use fewer days to sell its inventory. Fewer days means more sales and profits. Days inventory formula ratio can be achieved using the formula below:-
365 Days
Inventory Turnover
Sales to Total Assets:
The aim of this ratio is to demonstrate the level of efficiency with which the company generates sales on its assets. It measures the ability of the company’s assets to generate sales (Weston, 1990). This ratio can be achieved using the formula listed below.
Total Sales
Total Assets
Debt Coverage Ratio:
This ratio is used to analyse the ability of a business to meet up with its debt obligations and the capacity to manage more debt. Debt management is an important part of business as business always involves lending and borrowing.
Net Profit + Any Non-Cash Expenses
Principal on Debt
Stability Ratios
The stability ratios for ARB are good. The company is enjoying good stability as depicted by all the ratios performed. All the ratios resulted in positive outcomes. The same was true for Super Cheap Cars except for the fact that it had negative outcome in its times interest rate ratios. This implies that the company needs to revise its strategy for managing debts. This would help to reduce business risks for the company.
Gearing:
Gearing is used to evaluate the proportion of assets that have been acquired through loans. The more a business depends on loans the higher are its survival risks. This is because the repayment of loans and interest rates are compulsory (Bodie et al, 2004). They are not like dividends that may not be paid when the business performs poorly. However, gearing can be very helpful to some businesses that have strong and predictable cash flow. Gearing can be calculated using the formula below:-
Borrowing
Net Assets
Interest cover:
This ratio is used to measure the ability of a business to meet up with payment of interest rates that are associated with its loans. The question here is whether the profits made from the business are sufficient enough to pay for the interest and other financial expenses associated with loans. The ratio can be achieved by using the formula below:-
Operating profit before interest
Interest
Earnings per share (ESP):
This is a very important ratio that can be used to determine how stable a business is. It is used to measure the profit generated per share over a specified period. Many investors always make their investment decision by looking at the returns per share in order to know whether the business is worth investing into. When a business has high share profits, investors tend to believe that the business has stabilised. As such, they believe investing into such a business would include fewer risks. This ratio can be achieved as described below:-
Ordinary share earnings
Weighted average ordinary shares
Price Earning Ratio:
This ratio is used to gauge the way the market values a particular business. This is used by comparing the market price per share to the earnings per share in a particular business. The level of earnings can tell whether the market highly values that particular business when it has a relatively higher return when compared to shares in similar businesses (Groppelli & Ehsan, 2000). In order to get this ratio, the formula below needs to be applied.
Market price per share
Earnings per share
Dividend Yield:
This is also described as the ratio of pay out. It can help to tell whether a business can maintain the payment of a dividend. It also gives an idea of the level of earnings that the business retains for itself. This proportion is profit that is ploughed back and not distributed as dividends.
Latest dividend per ordinary share X 100
Current market price per share
Limitations and Conclusions:
Although financial ratios have been touted for their ability to enable management to assess the financial performance to analysts and management, these ratio also have limitations as they can some times send wrong signals about the financial health and performance of a business (Helfert, 2001). Financial ratios best explain what have happened in the past and can help management and financial analysts to understand business trends. Even though some trends can help to give an idea of what the future of business might look like, these ratios cannot provide forecasts for businesses (Bodie et al, 2004).
Ratio analysis is mostly based on accounting data. And this data is mostly drawn from the company’s financial statements. The right forecast needs to come from the economy instead. This is a major weak point when it comes using financial ratios to make business decision and analysis. This is especially true when it comes to predicted future trends in business (Groppelli & Ehsan, 2000). These ratios mostly take account of figures drawn from the balance sheet. The balance sheet is drafted during specific periods within the financial year and does not take into consideration some important issues. As such, these figure do not truly reflect the off balance sheet data (Watanabe, 2007). These ratios may also differ from one business to the other based on the accounting policy that the business uses. This makes it possible to have different ratios and interpretation from the same firm based on what accounting principles it uses (Weygandt, 1996).
APPENDIX A: OUTCOME OF RATIOS PERFORMED
Profitability Ratios
ARB Corporation
Super Cheap Auto
Gross profit margin
Positive
Positive
Net profit margin
Positive
Positive
Return on equity
Positive
Positive
Return on Assets
Positive
Positive
Efficiency Ratios
Asset turnover
Positive
Positive
Inventory turnover
Flat
Negative
Debtors turnover
Positive
Negative
Creditors turnover
Negative
Positive
Current ratio
Positive
Positive
Quick ratio
Positive
Positive
Stability Ratios Outcome
Debt asset ratio (interest bearing debt)
Positive
Positive
Debt asset ratio (total debt)
Positive
Positive
Debt equity ratio (total debt)
Positive
Positive
Times interest ratios (times)
Positive
Negative
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