Ratio Analysis: A Detailed Study Of Watley Financial Condition

Types of Ratio

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Ratio analysis is also known as the financial statement analysis. This analysis helps a management accountant to study and analyze the financial statements of an organization. The detailed analysis helps the accountant to analyze the financial condition of the firm and its position in the competitive market. Therefore, the ratio analysis is considered as a quantitative analysis. The financial statements are analyzed based on all the financial statements of an organization. These include – the balance sheet of the firm, the cash flow statement and the income statement. The analysis of the financial statements helps in evaluating the various aspects of the financial and operating performances of an organization. These include – liquidity, efficiency, profitability and profitability. The data and information available from the financial statements of an organization vary from one firm to another. Thus, depending on the availability of the financial data and information the types of ratios are calculated for a particular firm in order to analyze its financial position and condition in the competitive market.

As per the case study of the organization named Watley, the ratio analysis has been performed in order to determine its financial condition and financial position in the market. The financial data and information has been gathered from the balance sheet, income statement and cash flow statement of the organization. Based on the provided data, the liquidity ratio, profitability ratio, activity ratio and gearing ratio of the firm has been calculated. Depending on the availability of the financial information and data, the current ratio has been calculated under the liquidity ratio, total assets turnover ratio has been calculated under activity ratio, return on equity ratio has been calculated under profitability ratio and equity ratio has been calculated under gearing ratio. The calculations and the formulae of each ratio have been provided in the following calculation table.     

The ratio analysis has been performed for the organization Watley for two years i.e. 2014 and 2015.

Liquidity Ratio – The liquidity ratio indicates the liquidity of a firm that is it indicates the ability of an organization to pay off both the long-term liabilities and current liabilities of the organization. It can also be said that the particular kind of ratio indicates the cash levels of an organization and also its ability to payback its debt and obligations on time. Therefore, it indicates that the higher will be the liquidity ratio, it will be better for the firm. For the company Watley, current ratio has been calculated in order to analyze the financial condition of the firm. The current ratio is defined as a type of liquidity ratio that also indicates the efficiency of a company which measures the ability of the firm to pay off the short-term liabilities along with its current assets. Therefore, the current ratio is also termed as an efficiency ratio that indicates the efficiency of an organization. This particular ratio is considered as a most important measure for liquidity as the short-term liabilities remain due within the next year. In this case study, the current ratio of the organization Watley has been calculated in order to determine its liquidity as well as efficiency for the future prospect.  From the calculation it has been found that the current ratio of the firm has increased from 1.11 in the year 2014 to 2.28 in the year 2015 due to the increase in the current assets of the firm in comparison to the current liabilities. This indicates that the firm has a strong financial condition as the capability of the particular firm of paying back the money has increased with the passage of time.   

Liquidity Ratio

Activity Ratio – The activity ratio helps to measure the ability of an organization to convert the various accounts within the balance sheet into sales or cash. This ratio measures the firm’s efficiency on the basis of the usage of its leverage, assets or other items of balance sheet. This ratio is considered as one of the most important ratios as it helps to determine whether the management of an organization is doing well or not in generating cash and revenue from its resources. For the company Watley, total assets turnover ratio has been calculated in order to analyze the financial condition of the firm. The total assets turnover ratio is an activity ratio that indicates the efficiency of the firm and measures the ability of an organization in order to generate the sales of the company from its assets by comparing the net sales along with the average total assets. It can also be said that this particular ratio helps an organization to show its efficiency in generating sales. For the firm Watley, the assets turnover ratio has been calculated in order to calculate the net sales as a percentage of assets in order to represent the process of generating sales from every dollar of the assets of the firm. The above calculation shows that the total assets turnover ratio of the firm Watley has increased from the year 2014 to 2015. The value of the particular ration in the year 2014 was 2.12 and it then increased to 2.21 in the year 2015 due to the increase in the net sales of the firm with the passage of time compared to the average total assets. This indicates that the particular firm has a strong financial condition.    

Profitability Ratio – The profitability ratio helps in measuring the total amount of profit earned by an organization. In other words it can also be said that the profitability ratios are used in order to assess the ability of an organization to generate the earnings in comparison to its various relevant costs and expenses that incurred during the particular time period. Thus, it can be said that the higher will be the ratio, it will be better for the firm. For the company Watley, return on equity ratio has been calculated in order to analyze the financial condition of the firm. The return on equity ratio also measures the ability of an organization in order to generate profits from the investment of the shareholders. It can also be said that the ROE indicates the amount of profit the company earns from every dollar of the equity of the common stockholders. Here, for the company Watley the ROE has been calculated in order to determine ability of the firm in generating profits.   It has been found that the profitability ratio of the firm has decreased with the passage of time. The return on equity ratio was 3.65 in the year 2014 but it decreased to 3.25 in the year 2015. This indicates that the shareholder’s equity has been decreased slightly with the passage of time. Thus, it represents that the firm has a weak financial condition.      

Gearing Ratio – The gearing ratio is defined as terminology that describes the financial ratio and compares the equity of the owner with the borrowed funds. In other words it can also be said that the gearing ratio helps to measure the financial leverage and demonstrates degree to which the activities of an organization are funded by the funds of the owner versus the funds creditors. For the company Watley, equity ratio has been calculated in order to analyze the financial condition of the firm. The equity ratio is defined as a solvency or leverage ratio that helps in measuring the quantity of assets that are financed by the investments of the owners by relating the total equity of the firm to its total assets. For Watley, this particular ratio has been calculated in order to determine the solvency of the firm. It can be said from the above calculation that the equity ratio of the firm Watley increased from 0.69 in the year 2014 to 0.74 in the year 2015 due to the increase in equity compared to the assets of the firm. This indicates that the firm Watley had a strong financial condition and thus has a strong financial position in the market.     

Therefore, it can be concluded that the company Watley has a strong financial condition as all the ratios like liquidity ratio, activity ratio and gearing ratio except the profitability ratio of the firm have increased with the passage of time from the year 2014 to 2015. Thus, it can be suggested that the profitability ratio of the firm Watley should increase in order to run the business effectively and efficiently in future. The profitability ratio of the firm can be increased with the increase in the sales or revenues of the firm, by reducing the cost of production and by increasing the net income of the firm in order to run the organization successfully.