Interpret basic ratios relating to profitability, efficiency, liquidity, gearing

Question

Interpret basic ratios relating to profitability, efficiency, liquidity, gearing and investment; Required: Which ratios focus on liquidity (short term survival)? Why? How do you compute 'return on assets'? In terms of profitability: What positive trend can be observed (what has improved)? What is causing the return on assets to decline below previous years and the industry average? Should the firm be concerned about the unfavourable trend in the quick ratio and why? What is the average collection period for debtors in 2010? What would be your 'key' recommendation in relation to solvency (long term financial stability)?

Explanation / Answer

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A) Current ratio, quick ratio, cash ratio, sales turnover.

B) Net income/ total assets

C) The company is collecting their receivables more efficiently and has thereby increased their profit margins. However, their increase in assets (cash) has also caused their ROA to decline.

D) Yes, as the year increases, they become less able to pay off their liabilities.

E) 365 / 8 times per year = 45.6 days

F) Their debt to assets ratio is declining which means they are either decreasing their debt or increasing their assets. Either way, increasing their debt will solve this. Therefore, my recommendation is that the company begin to incur more debts instead of using their own funds for operations (this way they can write off the expenses, and keep their assets).

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