The following financial ratios have been calculated from the financial statement

Question

The following financial ratios have been calculated from the financial statements of Spakfillers Ltd. 2012 2013 2014 13% 3596 | 4096 12% 0.9 24% 4290 9% 1.5 1990 Return on Equi Gross Profit margin Net Profit margin Asset Turnover (times Return on Assets Days Inventor Days Debtors Current Ratio 10% 1.25 1196 | 12.5% | 13.5% 90 days 85 days 80 days 40 days 45 days 50 days 1.1 0.7 uick Ratio Debt (to assets) Ratio Debt to equity Ratio Interest coverage ratio (Times Interest Earned) 2.8 times 1.20 0.9 3096 | 4090 43% 0.95 0.5 45% 82% 4.0 67% 3.5 Required By identifying and using the appropriate ratio calculations above, comment on the company's profitability, efficiency, liquidity and financial stability (short and long term) for the three year period 2012-2014.

Explanation / Answer

Profitability

The companies gross profit ratio is indicating a sound business profitability at 35% during 2012. Again it is also growing year by year to reach 42% in 2014. Within a span of 2 years, a growth of 7% in gross profit indicates growing prospects of the business. But Net profit margin is on a declining trend. When we check the debt equity ratio is increasing, it may that interest expenses were on raise, so net margins are decreasing. Interest coverage ratio should also be verified at this point. This ratio is on increasing trend. Thus in total we can say that even when NP margin is declining, we have good EBIT ( operating income ) for this business. That means leverage ( increase in debt ) is applied profitabily, otherwise, we could have decrease in interest coverage ratio.

Efficiency

Return on assets and Assets turnover shall be verified for this purpose. Assets turnover which is below 1 times in 2012 had gradually improve to 1.5 times in 2014. Thus efficiency had significantly imporoved over past two years, still there is scope for further improvement. Similar interpretation also applies to Return on assets, where a steady improvement in efficiency is identified.

Liquidity

Liquidity can be explained as a firms ability to pay the outstanding obligations ( short - term ) when they arise. For this key ratio that measure this ability are current ratio and quick ratio. A general financial expectation calls for current ratio of 2 times. In this company such ratio is only 1.20 times in 2012 and there is continious decrease in this ratio. Even the quick ratio is not upto standards expected for liquidity at 1:1. In all the years under observation we have a quick ratio lower than 1:1 and again it is on decreasing trend.

An observation of days inventory and days debtors indicates that due to increase in credit allowance, inventory sales were increased, thus the overall operating cycle during all the three years remained same at 130 days. For a better short term liquidity, firm should try to lower its operating cycle year by year.

Financial stability

Also called long term solvency is a measure of firms ability to pay for long term debts. Here Debt ratio and Debt to equity ratio are significant measures. In both these ratios we can see a drastic during the period under study. Currently, with moderate interest coverage ratio and debt financing not exceeding 50% of total assets, financial stability can be concluded as satisfactory.

Kindly comment for any further clarification ........... all the best.

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