UNIVERSITY OF SALFORD SALFORD BUSINESS SCHOOL

COURSE MANAGING FINANCE

TITLE OF PAPER

TOBERMORAY LTD RATIO ANALYSIS

ROLL NUMBER @00315325

TABLE OF CONTENTS PAGE 1. Comments

.................1
c) Liquidity......................................................................................................

b) Profitability..................................................................................................

..................3
d) Efficiency....................................................................................................

..................4 e) Investments................................................................................................ ..................6

f) Conclusions.................................................................................................

..................8

2. Making ratios more meaningful...................................................................8 3. Limitations of ratio analysis........................................................................... 9 Appendix

Table of charts PAGE

Tobermoray financial performance................................................................. 1 Tobermoray liquidity chart............................................................................. 3 Tobermoray asset utilisation.......................................................................... 4 Tobermoray investment................................................................................. 6

COMMENTS: PROFITABILITY:
Financial performance Sales turnover index Gross profit margin Net profit margin (operating profit) Return on capital employed (ROCE) 2004 100 25% 10% 18.48% 2005 105 25% 10% 19.29 % 2006 158 20% 7.94% 18.17% 2007 100 18% 5.77% 14.21%

The measures taken by the Tobermoray Ltd appears not to have been favourable as the ROCE dropped by 7% from 15% in 2004 to 9% in 2007. On the surface this performance appears to be due to the expansion program i.e. opening additional retail outlets with a view to increasing its market share price. The decision to expand showed signs of overtrading i.e. expanding sales outside the limit of resources (Atrill Peter, 2006) in 2006 and 2007 but remained within limit in 2004 and 2005. The expansion program increased inventory by 39%, receivables increased by 41%, trade payables increased by 37%, cash declined at a fairly alarming rate leading to a bank overdraft. We also see that profitability declined after the expansion, gross profit dropping from 25% in to 20% in 2006. Also the operating profit margin fell by 2.06% in 2006 and a further 0.11% in 2007. Overtrading often occurs when companies expand its own operations too quickly (aggressively)Overtraded companies enter a negative cycle, where increase in interest expenses negatively impact net profit leads to lesser working capital leads
4

to increase borrowings leads to more interest expense and the cycles continues. Overtraded companies eventually face liquidity problems and/or running out of working capital (Finance Wales, CIMA 2004). Tobermoray Ltd expansion program has left it trading beyond a level its financing can support. Due to this it has formed a reliance on bank overdrafts and trade payables. Consequently it will get to the point where banks will refuse lend the company money or suppliers will withhold further supplies until borrowings are paid or reduced. It is advisable that Tobermoray ltd operate within the level of finance available to it and if it is unable to get new financing due to its position operations should be reduced in line with available finance even if this may lead to a loss in sales and profits in the long term it is necessary for to ensure sustainability in the long term. Additional solutions are:

Invoice discounting Encouraging automated payments Negotiating payments with suppliers Improve stock control Offering discounts on prompt payments (ICA 2011)

LIQUIDITY
SOLVENCY RATIOS Current ratio Acid ratio Interest cover ratio 2004 2005 2.03:1 1.39:1 6 times 2006 1.05:1 0.70: 1 3.33 times 2007 1.36:1 0.85:1 2.67 times

1.78: 1 1.16: 1
5 times

The liquidity ratio is a measure of the companys ability to meet its liabilities as at when due (Brigham E, Houston J 2011). Regarding liquidity the companys position has fallen during the period of 2006 and 2007 due to its current liabilities rising higher than its current assets.. A figure of 1.5:1 is regarded as the norm which was met in 2004 and 2005. In 2006 however the current ratio dipped by 0.98 percent but it picked up in 2007 by 0.31 percent. The same dip is noticeable in the acid test ratio in 2006 which fell by 0.69% but picked up in 2007 by 0.78% . This shows an unavailability of cash to settle its liabilities. According to this analysis it is clear that the company is unable to meet its liabilities as of the year 2006 but if the upward trend from 2007 continues.

EFFICIENCY

RATIOS Stock turnover Debtor collection period Creditor repayment period Working capital cycle Fixed asset turnover Total assets turnover Working capital turnover

2004 31.94 days 40.15 days 36.20 days 35.98 days 2.20 times 1.54 times 11.6 times

2005 33.31 days 40.19 days 34.5 days 39.01 days 2.48 times 1.59 times 8.7 times

2006 23.54 days 39.98days 34.78 days 28.74 days 2.33 times 1.68 times 120 times

2007 25.69days 39.50 days 29.98 days 35.21 days 2.77 times 1.87 times 22 times

The companys has been more efficient in paying back its creditors in 2007 reducing the payment period from 34.78 days to 29.98 days. It has also been able to steadily
7

controlling its debtor position from 2006 2007. This could be because more resources have been applied to credit control. The fixed asset turnover shows that the company has become 0.44 times more efficient in 2007 from 2006. This means that for every 1 of its fixed assets generated 0.44p of its sales. This may not be a major improvement but it has been a steady improvement over the years. Creditor repayment period has gone down by 4.8dyas meaning the company is able to pay its trade creditors faster in 2007 than it did in 2006 this shows a consideration for its suppliers and responsibility in improving and keeping business ties, The period for stock turnover went up in 2007 by 2.5 days. This should pose a concern for management as it is taking longer to sell available stock, though it might not be a significant change the expansion program means an availability of more stock and more shops. If the stock increased from 700, 000 in 2006 to 900,000 in 2007 a significant change in volume should dictate an increase in efficiency in turning over the stock.

INVESTMENT
INVESTOR RATIOS Return on shareholders equity Earnings per share Price earnings ratio Dividend per share Earning yield Dividend yield Dividend cover 0.24p 6.25 0.20p 16% 13.3% 1.2 0.23p 6.52 0.22p 15% 14.7% 1.05 0.21p 7.14 0.15p 14% 10% 1.4 0.15 10 0.10p 10% 6.7% 1.4 24% 2004 2005 23.33% 21% 2006 15% 2007

The investment ratios for 2007 and 2007 do not look impressive. The earnings per share dropped from 24p in 2006 to 15 p in 2007. Additionally there is a general decline in the investment ratios from 2006 to 2007. Another worrying decline is in the dividend per share ratio which can result in the fall in the market value of its shares but that clearly was no the case as the price of shares has remained stable. Company profits remained level from the previous years (2005- 2006) this however declined in 2007 by 97%. There is an increase in the price earnings ratio of 2.86% this was probably caused by the market considering that the companys future is reasonably promising notwithstanding the reduction in the company profits.

Conclusion
9

Although the companys profitablilty isnt impressive this may be due to the expansion programme undertaken by management which has affected its liquidity position. This analysis has revealed signs of overtrading and an unfavourable liquidityposition but it seem that investors have understood the underlying financial problems and can see the small improvement in performance from 2006 to 2007 because the market share price has remained constant. It is advisable however that the expansion programme be scaled down to match the companys financial capacity such that it can regain a favourable liquidity standing for sustainable long term growth.

3) MAKING RATIOS MORE MEANINGFUL Ratio analysis are useful to an extent but to fully interprete their usefulness it is advisable that other information should be used to complement its findings. Further Information I will need to make my analysis more meaning full are: 1.Budget figures for Tobermoray Ltd 2.Industry averages 3.Other non financial information i.e Sales mix , product range, long term management plans,
market share details

4) LIMITATIONS OF RATIO ANALYSIS

An investor must understand that although ratio analyses are attractive because of their simplicity they also come with limitations. Ratios are only as good as the data they are based on and the information with which they are compared. Thus a ratio analysis will usually inherit the limitations of the information on which it is based.
10

First and the most important limitation to ratio analysis is that it is based on historical costs thus in most cases it is an unclear measurement on performance. It fails to consider inflation i.e. changes in prices which can lead to inaccurate valuation of the companys profitability and is not a good basis for future forecasting. Secondly an investor should remember that income ratios lose credibility where estimated costs such as depreciation on fixed assets which affect operating expenses and profit. Also since there are many other factors which do not form part of the financial reporting ratios can only show the position of financial accounting of the company and not the true financial condition. Reliance on ratios usually makes the user ignore the underlying financial statements which might contain information fundamental to evaluating a companys performance and profitability. Thirdly there lies a difficulty in industry comparisons with ratio analysis. For proper accurate comparison and analysis disparity in accounting policies, financial gearing methods etc should be taken into consideration .No two companies will be alike and the greater the differences between the companies the harder it is to achieve a comparison adding more limitations to the use of ratio analysis. Fourthly ratio analysis can give a window dressing effect where the company will make deliberate attempts to make their financial position look more attractive to potential investors. This is a problem with creative accounting and is very misleading. Fifthly there is no industry oe universally accepted standard ratio. This makes the interpretation of ratios more difficult. The strength or weakness of a ratio cannot be generalised. Where a strong or high current ratio can point to a solid liquidity position which is good it could also mean excessive cash with is bad (Bodie, Z; Kane A and Alan J. Marcus(2004).

11

References

Atrill Peter (2006). Financial management for decision makers. 4th ed. London: Pearson Education. 91. Bodie, Zane; Alex Kane and Alan J. Marcus (2004).Essentials of Investments, 5th ed. McGraw-Hill Irwin. pp. 459 Brigham E, Houston J (2011). Fundamentals of financial management. United Kingdom: Cengage Learning. 99.
12

Finance Wales: "A practical guide to cash-flow management", page 28. CIMA, 2004 http://www.highpeak.gov.uk/business/econdev/General/Cash_flow_management_ 17_08_04.pdf Retrieved on 2010-11-10 Institute of chartered accountants, England. (2011). Avoid the problems of overtrading: Debts. Available: http://www.businesslink.gov.uk/bdotg/action/detail? itemId=1073791134&r.i=1073791135&r.l1=1073858790&r.l2=1073858944&r.l3=107 3925094&r.s=sc&r.t=RESOURCES&type=RESOURCES. Last accessed 16/11/2011

APPENDIX A) FINANCIAL PERFORMANCE (PROFITABLILITY) Sales turnover index 2004 2005 2006 Formula: Next year x base 8400 x 100 = 105 12600 x 100 = 158 number 8000 8000 Base year Assuming an index number of 100 and a base year is 2004
13

2007 13860 x 100 =100 8000

Gross profit margin Formula: Gross profit x 100 Sales Turnover

2004 2000 x 100 = 25% 8000

2005 2100 x 100 = 25% 8400

2006 2520 x 100 = 20% 12600

2007 2495 x 100 = 18% 13860

Net profit margin Formula: Operating profit x 100 Sales Turnover ROCE Formula: Operating profit x 100 *Capital employed *Assuming capital employed is Fixed assets +current assets+ current liabilities

2004 800x 100 = 10% 8000

2005 840 x 100 = 10% 8400

2006

2007

1000x 100 = 7.94% 800 x 100 = 5.77% 12600 13860

2004 800 x 100 = 18.48% 4330

2005 840 x 100 = 19.29% 4355

2006 1000x 100 = 18.17% 5505

2007 800 x 100 = 14.21% 5630

B) SOLVENCY (LIQUIDITY) Current Ratio 2004 Formula: Current Assets : 1 Current Liabilities 1570 : 1 = 1.78: 1 880

2005 1905 : 1 = 2.03:1 940

2006 2080 : 1 = 1.05:1 1975

2007 2400 :1= 1.36:1 1770

Acid test ratio

2004

2005

2006

2007

14

Formula: Current assets Inventory Current Liabilities

1570-550 = 1.16: 1 880

1905-600 = 1.39:1 2080-700 = 0.70:1 940 1975

2400-900 = 0.85:1 1770

Interest cover ratio Formula: Operating profit or EBIT Interest payable

2004 800 = 5 times 160

2005 840 = 6 times 140

2006 1000 =3.33 times 300

2007 800 =2.67 times 300

C) CAPITAL (FINANCIAL) GEARING Debt/Total capital 2004 2005 employed Formula: 2000 = 1750 = Debt 0.83 0.67 *Total capital employed 2000+330+80 2250+355+25 *Assuming total capital is Equity share capital + Free reserves+ profit and loss account credit balance Debt/Equity Formula: Debt Equity 2004 2000 = 0.86 2330 2005 1750 = 0.67 2605

2006 2500 = 0.79 2500+505+150

2007 2500 = 0.77 2500+630+125

2006 2500= 0.83 3005

2007 2500= 0.80 3130

D) ASSET UTILISATION Stock Turnover 2004 Formula: Average Stock x 365 (500+550)x365 = Cost of Sales 11365 31.94 days

2005 (550+600)x365 = 6000 33.31 days

15

2006 (600-700) x 365 = 6300 23.54 days

2007 ( 700+900)x365 = 10080 25.69 days

Assuming the 500,000 stock valuation at 1st July 2003 is opening stock and 550,000 is closing stock.

Assuming the 550,000 stock valuation for 2004 is opening stock and 600,000 is closing stock for 2005,

Assuming the 600,000 stock valuation for 2005 is opening stock and 700,000 is closing stock for 2006

Assuming the 700,000 stock valuation for 2006 is opening stock and 900,000 is closing stock for 2007. 2007 1500 x 365 = 13860 39.05 days

Debtor collection period Formula: Closing trade debtors x 365 Credit sales

2004 880 x 365 = 8000 40.15 days

2005 925 x 365 = 8400 40.19 days

2006 1380 x365 = 12600 39.98 days

Creditor repayment period Formula: Closing trade creditors x 365 Cost of sales

2004 600 x 365 = 6050 36.20 days

2005 600 x 365 = 6350 34.5 days

2006 970 x 365 = 10180 34.8 days

2007 950 x 365 = 11565 29.98 days

Working capital cycle Fomula: Stock turnover days + debtors collection period creditors repayment period Fixed assets turnover Formula: Sales Net fixed assets Total assets turnover Formula: Sales *Total assets * total assets =(fixed assets + current assets) Working capital turnover Formula: Sales *Net working capital

2004 31.94+40.15- 36.20 = 35.89 days

2005 33.31+40.19-34.49 = 39.01 days

2006 23.54+39.9834.78= 28.74 days

2007 25.69+39.5029.98= 35.21 days

8000= 2.20 times 3640 8000 = 1.54 times 5210 *(3640 +1570)

8400= 2.48 times 3390 8400 = 1.59 times 5925 *(3390 +1905)

12600= 2.33 times 5400 12600 = 1.68 times 7480 *(5400+2080)

13860 = 2.77 times 5000 13860 =1.87 times 7400 *(5000+2400)

8000 = 11.6 times 690

8400 = 8.7 times 965

16

12600 = 120 times 105

13860 = 22 times 630

* net working capital = (current assets current liabilities) E) INVESTOR RATIOS 2004 000 Return on shareholders 480x100= equity 24% Formula: 2000 Earnings after tax x 100 Ordinary share capital Earnings per share 480 =0.24p Formula: 2000 Earnings after tax or net income Numbers of ordinary shares outstanding Price earnings ratio 150p = 6.25 Formula: 0.24p Current share price Earnings per share Dividend per share 400 = 0.20p Formula: 2000 Annual dividend paid Number of ordinary shares issued Earning Yield 24 x 100= Formula: 16% Earnings per share x 100 150 Market price per share Dividend yield Formula: Dividend per share x 100 Ordinary share market price Dividend cover Formula: Profit after tax Dividend 20x100 =13.3% 150

2005 000 525x100=23.33% 2250

2006 000 525x100= 21% 2500

2007 000 375x100=15% 2500

525 = 0.23p 2250

525 = 0.21p 2500

375= 0.15p 2500

150p= 6.52 0.23p

150p =7.14 0.21p

150p = 10 15p

500= 0.22p 2250

375 = 0.15p 2500

250= 0.10p 2500

23 x 100=15% 150

21x100=14% 150

15x100=10% 150

22x100=14.7% 150

15x100=10% 150

10x100=6.7% 150

480=1.2 400

525 =1.05 500

525 =1.4 375

375= 1.5 250

17