Question

Once you have completed the calculations, write a memo to the organization's senior management and board of directors explaining the financial strengths and weaknesses based upon your analysis. The liquidity, profitability, and capital structure will be assessed and communicated to the leaders of the organization. Your memo should be no more than 250 words in length and should be written in plain English for a lay audience.

I need assistsnce interpreting the ratio analysis table i have completed.

Answer 1

Ratio Analysis - In the order of ratios provided in excel:

1- Current Ratio: This is one of the key measure of liquidity to find out if a firm can meet it's short term obligation. As compared to the benchmark ratio of 2.00, current ratio in both the years is favourable meaning the firm has more short term assets available to meet obligations and therefore has good liquidity.

2. Days Cash on Hand: It reflects the no of days company can keep performing operations without making any sales. Benchmark is 15 days but the companies ratios both the years are better at approx 18 and 28 days. Compared to the previous year, current year is showing a better ratio.

3. Days in AR: This ratio reflects average collection period. As per benchmark it should be taking 45 days or less to convert credit sales to cash by cash collection. Both the year's ratio is showing greater than 70 days period which is an indicator of poor collection. It would also imply customers are unwilling to pay for purchases and some of these may even get converted to bad debts. The lower the ratio the better it is and therefore the firm needs to work on increasing efficiency in cash collection.

4. Operating Margin: Operating margin reflects operational profitability. It reflects the profit after cost of good sold and operating expenses are considered. It also states how efficiently operations are run. The ratios of 3.07 % and 2.20 % are below the benchmark 4%. This implies low operating profitability. This is even before considering other non ops expenses. This requires further analysis if there is downward trend due to increasing cost of purchase/raw materials or other operating expenses. Also need to check if this ratio is highly variable. Such further analysis will help understand the operational/business risk and efficiency of operations management.

5. Return on Total Assets: This ratio is calculated based on the earnings before interest and taxes. Base is Total assets. It is an indicator of efficienty utilising assets to generate earnings for a firm.It is after deducting depreciation but before considering the impact of Finance charges (interest) and Taxation. Ratio for the firm is favorable as compared to bechmark- 7.13% and 5.07% as compared to 4%. However as compared to the last year, it has decreased and should be looked at for the cause.

6.Return on Net Assets: It is calculated by dividing Net income with sum of Fixed assets and Working Capital. It is a measure of financial performance. Compared to benchmark of 10% this ratio is higher for both the years at approx 18% and 15%. It reflects that company is efficiently using fixed assets and working capital to generate income. However the decline in the % during current year is concerning.

7. Debt to capitalisation: This is calculated by dividing the total interest bearing debt by total capital of the firm. Benchmark is 50% meaning for each 50$ debt there are 100$ assets. It measure the solvency and a higher ratio is unfavorable as can be seen from the ratio for both the years. It reflects that company has increase debt from the previous year.

8. Times interest earned: This is interest coverage ratio and reflects a firms ability to meet its interest expenses on its debts. As can be seen ratios are low compared to benchmark for both the years. It means company has fewer earnings/income to meet its interest obligations. This can be concerning specially if we look at increased debt. failure to meet this obligation could have severe consequences leading upto bankruptcy.

9. Debt service coverage: It is a measurement of the cashflow that is available to meet a firms current debt obligation. As we can see the ratio is low compared to the benchmark which is not optimal and is just reinstating what lower TIMES INTEREST EARNED implies - company has lower earnings/cash available to meet the interest obligation.

10. Fixed asset turnover: This ratio tells how efficiently a firms business uses fixed assets to generate revenue. Higher ratio indicates higher efficiency. The firm's ratio was unfavorable in the previous year but has become favorable in the current year as compared to bechmark. this indicates improvement in efficiency.

11. Salary and benefit/NPSR: This ratio has been favorable as compared to benchmark over both the years.

Key highlights:

While company has good liquidity by way of Current Ratio and higher no of days cash in hand, Company needs to work on improving its cash collection. It needs to work towards efficient operations by looking at operational costs. Increasing debt and lower available earnings/cash to service interest could have severe impact from long term sustainability and solvency.