Financial Ratio Analysis And Budget Preparation For Loan Application Of Mary Norton

Financial Ratio Analysis for Mary Norton’s Loan Application

As per the case study Mary Norton who has applied for a loan for a period of 8 years has provided financial ratios as a proof of the businesses worthiness to acquire such a loan. The financial ratios which are shown by Mary Norton some of which are considered to be financial indicators of the businesses performance. The current ratio of the business is shown to be 2.1 which has reduced from the previous year. There has been a fall in the current assets of the business even though the ratio is still ideal. The quick ratio of the business has improved from the previous year which shows that the firms liquidity position has further improved and the same is depicted as 1.4. The asset turnover ratio of the business has fallen from the previous year which is not a favorable sign for the business. The cash debt ratio has improved slightly which shows improvement in debt servicing of the company. The profit of the business has decreased from previous year by 8% which is a significant fall as compared to 2016 which shows that the profit has increased by 32%. As the profit of the business has decreased therefore the earning per share of the business has also fallen which is shown as 2.5 per share in 2017.

The ratios which are provided by Mary Norton shows mixed results. In terms of liquidity condition, the business is very much favorable as it has a perfect current ratio and a near perfect liquid ratio. The current ratio and quick ratio which is considered to be ideal is 2:1 and 1.5: 1 respectively. The current ratio of the business shows the company’s ability to meet the current obligations of the business effectively. In addition to this, the acid test ratio of the business shows the current obligations of the business which is similar to current assets of the business. The only difference which lies between current ratio and acid test ratio is that inventory is not included in acid test ratio of the company. This suggest that the business will be reliable if they are granted the debt amount. However, the asset turnover ratio has fallen and the profit which is generated by the business during the year has also fallen which suggest that the current performance of the business is not good. The asset turnover ratio of the business represents how much profit the business can earn employing the assets of the company and the return which is earned on the assets are financial indicators of the strength of the company. Therefore, the analysis of profitability does not paint the business as favorable. The ratios which are provided by Mary Norton are somewhat important for decision making but some other ratios like interest coverage ratio, debt service ratio, debt equity ratio are also important and provides a great deal of information which will be required before the loan amount can be granted to Mary Norton.

Sales Budget

The three other ratios which needs to be calculated for Borrowers ltd are Debt servicing ratio, interest coverage ratio and debt equity ratio. The debt service ratio reveals the ability of the company to manage and maintain the debt capital which the business has taken. The ratio reveals a great deal about the company’s capability to meet the obligations which are related to debt capital of the business (Rasoolpur 2014). The interest coverage ratio of the business reflects the company’s ability to pay the interest charges which are associated with the borrowings of the business. The interest coverage ratio is used often by financial institution to judge whether the business is able to meet the interest payments for existing loans (Baños-Caballero, García-Teruel & Martínez-Solano, 2014). Debt equity ratio is considered to be one of the financial indicators of the business’s performance. It also reveals the capital structure of the business and also the nature of the capital which the business uses that is it can tell whether a business is leveraged firm or not. Moreover, the debt equity ratio also shows the dependency of the business on the equity and debt capital for financing the activities of the business. The debt capital in the business represents the leverage of the business. However, too much leverage would increase the financial leverage of the business which is not a favorable sign and therefore the leverage conditions and business stability is reflected by debt equity ratio which is to be considered before loan can be granted to Mary Norton.

The limitations which ratio analysis faces in case of credit or investment decisions are given below in point form:

• The calculations of ratios does not considers the effect of inflations in the computation process than bring out unrealistic results.
• The data which is presented in the Profit and loss account are at current cost where as the items which appear in the balance sheet is reported at historical costs which some time produces unusual results (Smith & Smith 2014).
• The ratios are based on formulas which are set but it is seen for calculating ratio sometimes two separate formulas are available which might give approximately same or different results so there arises a confusion which formula is genuine (Vogel 2014).

The above table shows the trend of net profit and sales of the business. The trend and the changes in sales figure of the business is shown in the diagram above. The maximum net sales which is achieved by the business is in the year of 2017 itself and the maximum amount of profit which is generated by the business is in the year 1166.2 in the year 2016.

The question has taken the 2013 as the base year on the basis of which trend is to be analyzed for each period. If the base is taken 2013, the trend shows that in 2014 there has been a fall in the sales of the business but the profit of the business has significantly increased which signifies that the company has effectively managed the cost of the business. In 2015 and 2016 both the figures of sales and profits have significantly increased which suggest that the business is developing and growing. The net sales of the business has increase from previous year and is shown as 4555.2, however the profit of the business has reduced which can be attributed to cost of the product or even other factors are also possible.

Purchase Budget

The profitability ratio of the business consists of operating profit ratio, return on assets, return on equity and net profit margin of the business (Parsian & Shams Koloukhi 2013). The operating profit ratio of the company shows that the ratio has significantly improved from 2016 estimates. The returns on assets of the business also shows a similar result which suggest that the utilization if assets by the business has improved considerably.  The net profit margin of the business has also increased from previous year which suggest that the business has improved their operations and generated more profit (Agha 2014). The return on equity of the business has reduced from previous year which suggest that the business needs to focus on the needs of the shareholders of the business.

The financial stability ratio is made up of debt ratio, debt equity and interest cover ratio. The debt ratio has reduced which means that the business has reduced the debt capital which was used by the business (Baum, Checherita-Westphal & Rother 2013). The debt to equity ratio reflects the capital structure of the business which has reduced significantly as shown in the table above. The asset turnover ratio of the business has increased which is a positive sign for the business (Delen, Kuzey & Uyar 2013).

As per the question, Peter is of the opinion that the operating cash flows is one of the important decision which helps in the decision-making process. The argument of Peter is correct as the cash from operation reveals the operational efficiency of the business and also reveals the ability of the business to reduce the costs which are related to operations and such is considered to be a financial indicator of the business performance (Biddle, Ma and Song 2013). Therefore, it helps investors in making investment decisions as almost all investors consider such a ratio.

Hamilton Manufacturer had previously taken a loan for which the installment is due and therefore the installment needs to be paid in February. The business will be able to pay off their loan as the closing cash balance of the business is sufficient to meet the obligation which is related to the loan amount. The amount which is to be paid as installment amounts to $ 80.000. The cash balance which the business has is shown in the cash flow statement for thee year 2016 is shown to be $ 1,13,000.

Sales Budget:
Particulars	October	November	December	TOTAL
Budgeted Sales Volume	22000	27000	32000	81000
Selling Price per unit	$5.50	$5.50	$5.50	$5.50
Budgeted Sales Revenue	$1,21,000	$1,48,500	$1,76,000	$4,45,500

Part b

Purchase Budget:
Particulars	October	November	December	TOTAL	January
Budgeted Sales Volume	22000	27000	32000	81000	30000
Add: Closing Inventory	8100	9600	9000	9000
	30100	36600	41000	90000
Less: Opening Inventory	6600	8100	9600	6600
Budgeted Purchase Volume	23500	28500	31400	83400
Purchase Price per unit	$4.00	$4.00	$4.00	$4.00
Budgeted Cost of Purchase	$94,000	$1,14,000	$1,25,600	$3,33,600

Part c

Cash Budget:
Particulars	October	November	December	TOTAL
Cash Sales	$1,08,900	$1,33,650	$1,58,400	$4,00,950
Receipts from Debtors	$9,900	$12,100	$14,850	$36,850
Payment to Suppliers	-$72,000	-$76,800	-$94,000	-$2,42,800
Net Increase/(Decrease) in Cash Flow	$46,800	$68,950	$79,250	$1,95,000
Add: Opening Cash Balance	$17,000	$63,800	$1,32,750	$17,000
Closing Cash Balance	$63,800	$1,32,750	$2,12,000	$2,12,000

Part d

Variances refers to the deviation which arises between the standard which is et by the management and the actual performance of the business (Chen, Weikart & Williams 2014). The main purpose and use of variances comes in budgets as it helps budgets to monitor activities of the business. In addition to this, variances are useful to identify the faults in the management and take corrective actions so that such variances do not occur.

A common limitation which variance analysis faces is that the applicability of such a approach is not very much wide and therefore it is only applicable.

Reference

Agha, H., 2014. Impact of working capital management on profitability. European Scientific Journal, ESJ, 10(1).

Baños-Caballero, S., García-Teruel, P.J. & Martínez-Solano, P., 2014. Working capital management, corporate performance, and financial constraints. Journal of Business Research, 67(3), pp.332-338.

Baum, A., Checherita-Westphal, C. & Rother, P., 2013. Debt and growth: New evidence for the euro area. Journal of International Money and Finance, 32, pp.809-821.

Biddle, G.C., Ma, M.L. & Song, F.M., 2013. The risk management role of accounting conservatism for operating cash flows.

Chen, G.G., Weikart, L.A. and Williams, D.W., 2014. Budget tools: Financial methods in the public sector. CQ Press.

Delen, D., Kuzey, C. & Uyar, A., 2013. Measuring firm performance using financial ratios: A decision tree approach. Expert Systems with Applications, 40(10), pp.3970-3983.

Parsian, H. & Shams Koloukhi, A., 2013. A study on the effect of free cash flow and profitability current ratio on dividend payout ratio: Evidence from Tehran Stock Exchange.

Rasoolpur, G.S., 2014. Impact of Cash Flow Coverage, Debt Service & Current Ratio on Capital Structure Decisions: Empirical Evidence from the Indian Corporate Sector. Journal of Research in Marketing, 3(1), pp.232-238.

Smith, S.R. & Smith, K.R., 2014. The journey from historical cost accounting to fair value accounting: The case of acquisition costs. Journal of Business and Accounting, 7(1), p.3.

Vogel, H.L., 2014. Entertainment industry economics: A guide for financial analysis. Cambridge University Press.