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Business Survival:
There are two key factors for business survival: Profitability Solvency Profitability is important if the business is to generate revenue (income) in excess of the expenses incurred in operating that business. The solvency of a business is important because it looks at the ability of the
To apply analytical tools and techniques to financial statements to obtain useful information to aid decision making.
Profitability Ratios
3 elements of the profitability analysis: Analysing on sales and trading margin
focus on gross profit
Profitability Ratios
Gross Profit % = Gross Profit * 100 Net Sales Net Profit % = Net Profit after tax * 100 Net Sales Or in some cases, firms use the net profit before tax figure. Firms have no control over tax expense as they would have over other expenses.
Net Profit % = Net Profit before tax *100 Net Sales
Return on Assets =
* 100
Quick Ratio = Current Assets Inventory Prepayments Current Liabilities Bank Overdraft
*100
Dividends
Dividend payout ratio = Dividends per share *100 Earnings per share Price Earnings ratio = Market price per
Walker Ltd Statement of Cash Flows for the year ended 31 March
2005 $000 Cash flow from operations Receipts from customers Payments to suppliers & employees Interest paid Tax paid Net cash flow from operating activities Investing activities Purchase of non-current assets Net cash used in investing activities Financing activities Dividends paid Issue of ordinary shares Repayment of loan capital Net cash outflow from financing activities Increase in cash & cash equivalents 2,281 (2,050) (24) (46.4) 160.6 (121.2) (121.2) (32.0) 20.0 -__ (12) 27.4 (40.2) 34.1 (140.0) (146.1) 7.5 (31.4) (31.4) $000 $000 2,711.8 (2,460.4) (6.2) (60.2) 185 2006 $000
Additional information:
Credit purchases for the year 2006 were $2,142,800. General prospects for the major industries in which Walker is involved look good with a forecast glut of oil set to reduce the cost of production and world demand for plastic remaining strong. Benchmarks: There are no exact benchmarks for Walker Ltd because it is a diversified company. The following are average indicators that relate to the plastic retailing and manufacturing industries for the year 2006.
Gross profit margin Net profit margin Inventory turnover Debt/equity ratio Return on Assets Return on Equity 25% 7% 6 times 0.6 : 1 12% 20%
Relevant ratios
Important note: The calculations of the ratios in this illustration did not use averages for total assets, equity and inventory. The 2005 and 2006 year end figures were used and this is a slight variation to the formulas provided.
Benchmarks
2005
2006
22%
22.7%
7.1%
6.1%
15.6%
15.5%
Industry 20%
32%
26%
Benchmarks
2005
2006
5.8 times
5.58 times
2.2
2.53
2005 1.78:1
2006 1.70:1
Quick Ratio
0.85:1
0.69:1
Days Payable
Standard 30 days
49.19 days
Benchmarks
2005
2006
Industry 0.6:1 Standard benchmark 1:1 Standard benchmark: Between 3 and 5. Below 3 risky. Above 5 very favourable
1.05: 1
0.67:1
TIE
10.14 times
39.74 times
Report
For the investor considering the purchase of shares in the company, the return they will earn is the key financial factor but an overall evaluation of the companys performance and position is also important to get a better picture of how well the company is actually doing. ROE in 2006 is 26%. Whether or not this is attractive depends on the perceived riskiness of this investment and other alternatives available but this return is certainly more attractive than current bank interest rates. ROE has decreased by 4% but the companys ROE at 26% is still better than the industry average of 20% Riskiness of business is being reduced by the significant repayment of loan in 2006.
Profitability The NP% and ROA ratios show a small downward trend in % over the 2 year period. ROE% ratio show a more significant decrease but is still better than the industry average. Gross Profit Margin is slightly unfavourable at about 2.3% below the industry benchmark of 25%. The horizontal analysis information show that Sales have increased by 20%. However operating costs have increased by 34%. Asset Management IT has gone down slightly from 5.8 to 5.58 times. IT is still close to the industry benchmark of 6 times. AT has increased showing more sales being
Liquidity Current ratios of 1.78:1 (2005) and 1.70: 1 are at above acceptable levels but below ideal level. Quick ratios appear more of a concern being below acceptable levels in both years and even more so in 2006 (0.69:1). Raises some concerns over the liquidity of the business and inventory management (although IT ratio only shows a slight decline in 2006). Days Payable is a concern as there may
Financial Structure Although slightly higher than D/E industry benchmark (0.67:1), business has become less risky due to the significant repayment of loan in 2006. TIE is extremely good for the business at 39.74 times (well above 5 the standard benchmark). Cash flow situation Strong cash flow from operating activities (increased from 160,600 to 185,000). Spending under investing activities suggest more growth. Repayment of debt under financing activities imply restructuring of business
Recommendation
Given: 1) the strong forecast for the industry (ie general prospects looking good and world demand for plastic products remaining strong), 2) the sales growth in this business, 3) acceptable ratios as they are quite close to the industry averages, 4) good cash flows from operating activities and 5) favourable ROE, although it has decreased, it is still better than the industry average ROE.