71138781 Avon Products
Financial Ratios
These are the indicators of the financial performance of the company as well as its position. The ratios can also be used to calculate the trends and the performance of the company that can be used for comparison against competitors and industry trends.
Ratios provide different information and are thus classified according to the information they provide
The most common classification is as follows;
I. Liquidity
II. Asset turnover ratios
III. Financial leverage ratios
IV. Profitability ratios
V. Divided policy ratios
Profitability ratios
Gross margin ratio – measures the gross profit on sales and it helps to show the level of sales that can cover the operating expenses of company
Gross profit margin = sales- cost of sales
Sales
2004 2003
7656.2-2911.7 6773.7-2611.8
7656.2 6773.7
=62% =61%
The gross profit margin should be on an increasing trend
Operating profit margin- this ratio shows the profits generated from current operations before subtracting interest expenses and taxes
Operating profit margin= sales- operating expenses or operating income
Sales sales
2004 2003
1229 1042.8
7656.2 =16.1% 6773.7 =15.4%
Higher profit margin ratios are desired
Net profit margin- shows the level of net profits relative to every dollar of sales made
Net profit margin (net return on sales) = profit after taxes
Sales
2004 2003
856.9 674.6
7656.2 =11.25 6773.7 =10%
The higher the net profit margin the better
Return on asset- it measures the effectiveness of the management in utilizing the company’s assets to generate profits
Return assets= net income or profit after + interest
Total assets total assets
2004 2003
846.1 664.8
4148.1 =20.4% 3581.6 =18.6%
The higher the ROA the better the performance of the company
Return on equity- measures the amount / level of profit generated by every dollar invested into the company.
This ratio helps the stockholders gauge the performance of their investments.
Return on equity= profit after taxes or net income
Total equity equity
2004 2003
846.1 664.8
950.2 =89% 331.3 = 179%
Financial leverage ratios
These ratios shows the ability of the company to pay off its debts i.e. indicates the long term solvency of the company. Financial leverage ratios measure the level of long term debt in the company’s books.
Debt-to-equity ratio- it determines the amount of debt that the company can borrow in the long run. It basically shows the level of indebtedness in the company’s financial statements.
Debt-to-equity ratio varies from industry to industry but essentially, a company should not be leveraged so much because too much debt weakens the strength of the balance sheet.
Debt-to-equity ratio= total debt or total liabilities
Total equity total equity
2004 2003
3197.9 3210.3
950.2 =3.37 371.3 =8.65
Times interest earned- it shows the number of times the pretax profit can cover the amount of interest expense on the debt of the company. Times interest earned measures the ability of the company to pay of its debt obligations.
Times interest earned (interest leverage) = operating income
Interest expenses
2004 2003
1229 1042.8
33.8 = 36.4 33.3 = 31.3
Asset turnover ratios/ activity ratios
There ratios determines how efficiently the management of the company is using the assets. It basically evaluates the performance of the management i.e. their ability to efficiently utilize the assets.
Days of inventory- this ratio shows the number of days the company holds inventory. It shows the management efficiency in turning stock in to revenues. The shorter the days in inventory, the better.
Days in inventory= inventory (average) or 365 days
Cost of goods sold ÷ 365 days inventory turnover
2004 2003
740.5 653.4
2911.7/365 = 93 days 2611.8/365 = 91 days
Inventory turnover ratio- this ratio measures the number of times stock is sold in a year. The higher the number of times the better because it indicates that the stock is moving
Inventory turnover ratio = cost of goods sold
Average inventory
2004 2003
2911.7 2611.4
740.5 = 4 times 653.4 = 4 times
Average collection period- it indicates the number of days on average that the receivables take to be collected.
Average collection period = accounts receivable or 365
Total sales/365 receivables turnover
2004 2003
599.1 553.2
7656.2/365 6773.7/365
=29 days =30days
Financial performance of the company
The financial performance of the company is evaluated by establishing the pattern of the calculated financial ratios. The company’s financial position will have improved if this year’s ratios are better than last year’s.
The liquidity ratios of Avon Inc for 2004 indicate that there is an improvement from the 2003 performance. Generally the higher the liquidity ratios the better the performance of the company.
The only profitability ratio that declined is the return on equity which fall from 179% to 89%
The financial leverage ratios for the year 2004 shows an improved performance; the debt-to-equity ratio fell while the times interest earned increased. This indicates that the company is using less debt and therefore paying less interest expenses.
The asset turn over ratios indicates that there is no significant change in the efficient utilization of the company’s assets. All the ratios (days in inventory turnover ratio and average collection period) have not changed much.
The company as improved on its profitability as well as its use of debt but the management should improve on the use of its assets as shown by the asset turnover ratios.
Reference:
NetMBA.com (2007) Financial Ratios. Retrieved on 11/2/2008 from http://www.netmba.com/finance/financial/ratios/
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