Financial ratios

[Abdelghaffar Abouelghait]

 

Financial ratios                

Financial ratios ,contain a convenient way to summarize a large amount of accounting and financial information were to compare the performance of companies ,which can be expressed as a percentage or number of times , as one of the most common analysis tool .

 Explain the types of financial ratios depending on the balance sheet and income statement in the  financial statement material .

                                                                   liquidity ratios

 It cares creditors , especially short term debt holder financial position of the company and it’s ability to repay it is debt in the short term and the ability of the company to transfer non-monetary assets into cash .

What do you mean good liquidity ??

1-    Increase company ability to settlement its obligations in maturity date.

2-    Increase company ability to faced financial crisis.

3-    Increase the confidence supplier of funds.

4-    Take the advantages cash discount .

*** current ratio = current assets /current liability

The ratio show the amount covered by current assets dinars for each of the current liability .

2007=1195/500

=2.39

2006=2.26

The result give as clear picture , the current ratio are increase so the  financial risk decrease and this lead to increase the confidence  suppliers.

 Recommendations    

1-    Maybe the reason for this ratio increase , increase in account receivable ; so the top management must improve the collection policy .

2-    Increase in cash ,that mean the top management failure to finding investment opportunities .

3-    high the inventory , so the top management must improve the sale policy by :

a-    making training to salesman

b-   using gift and decline the price without losses

c-    increase in advertising and promotion

d-   improve the quality of product and performance .

 

Acid-test ratio

= (current assets – inventory  /(current liability

This ratio show the company is ability to repay short term obligation from assets easy conversion into cash .

2007=(1195-696)/500

=1.00

2006=1.04

The  ratio decrease ,that mean  the company facing difficulty to settlement  short –term obligation from assets easy conversion into cash .

Recommendation

The result  give us a  clear picture  high inventory

So, the top management must  improve the sale policy by :

A-   making training to salesman

B-using gift and decline the price without losses

C-increase in advertising and promotion.

D- improve the quality of  product and performance

e-    search for new markets .

 

Leverage Ratio

This ratio measures  the company is dependence on third-party funds to finance its assets .

 Debt –To-Equity

=total debt / shareholder equity

This ratio shows degree company is reliance on third party funds to finance its assets compared to proprietary  funds.

2007= 1030/1139=.90

2006=.88

The result give us clear picture increase company reliance on third party fund to finance its assets compared with property fund , that is lead to decrease in confidence supplier .

Recommendation

The company must achieve a balance in this ratio because the increase lead to higher finance risk and the company becomes unable to pay its obligation in the long term .

·       the lower  ratio lead to higher liquidity , lower profit and reduced financing risk .

***

 

 

Debt-to-total Assets

=total debt/total assets

This ratio measures the degree to reliance the company on third party funds to finance its assets.

2007=1030/2169

=.47

2006=.45

The result give us clear  picture the company facing difficulty to settlement obligation and increase in financing risk.

Recommendation

The company must search in reason of increase in this ratio . maybe potential problem in inventory or account receivable lead to increase assets so the company must determine the proportion of account receivable and inventory from current assets.

 

Total capitalization

= total debt/ (L.t-debt+equity)

Show the relative importance of long term debt to the long term financing of the firm.

2007=1030/ (530+1139)

=.62

2006=.67

The result indicate that the ratio is decrease ,they are two reason *-the company settlement long term debt or convert from long term debt to short term debt , but you should note other financial leverage increase so , that mean the company convert from long term debt to short term debt .

coverage ratio 

 =EBIT/interest charges

This ratio shows the extent to which the company is profits (operation  income)  to fall and still able covered  interest expense.

2007=210/ 95

=3.56 ones

2006=4.35 ones

I can't comment in on the denominator ,but we can discover increase reliance of the company is  debt to capitalization ratio ,  this result  give indicate  that the coverage  ratio is decrease , that mean declining the company is ability to cover interest expense of EBIT.

Recommendation

What should a company do to increase profit ?? 

(processing item of income)

1-    purchase : the company should looking  a new supplier at a lower price .

2-    purchasing expense : delivery of good buyer .

3-    selling  and administrative expense : A- decrease commission salesman B- delivery goods seller C-  the expulsion of employees who don’t provide added value .

4-    increase  the sales   by  A-   training salesman B- looking anew market  C-  improve quality and performance for product.

 

Activity Ratio

these ratio are used to measure the speed of the conversion of some accounts  in the company to sales or cash .

which is considered complementary to liquidity ratios because they measure the liquidity and efficiency  of the company in the management of accounts receivable and inventory management .

Receivable turnover

= credit sales /  account receivable

(note : assume all sales are credit sales )

this ratio measure the speed of a debt collection company and turn it into cash .

2007=2211/394

=   5.61 ones      365/5.61=65 days

2006=  71.1 days

The result give  us clear picture the top management improve the  debt collection policy .

Note

Types  of debt

1-    good debt

2-    bad debt

3-    doubtful  debt

 

 

payable  turnover

=credit purchase/account payable

(note : assume annual credit sales = 1551$)

This ratio measure the speed of  the company  repay lender .

2007=1551/94      (365/16.5=22.1 days)

=16.5 ones

2006=25.4 day

The result give us clear picture of a company has  become  accelerate repay account payable.

Is this good? No

Recommendation

The best for the  company postpone the payment process to the last day of the maturity this debt .

Because repayment process leading to the decrease in cash and  the possible loss of investment opportunities

The company should change repayment  policy  and purchase on account with  repayment of long term period.

Inventory Turnover

=cost of goods sold /  inventory

This ratio measure the speed of inventory converting into sales .

The higher this ratio was better for lenders which indicates the high liquidity and the efficiency  inventory management .

This low ratio indicates the company is resources disabled and the high storage cost.

2007= 1599/ 696= 2.30

2006 = 2.44

This ratio give us clear picture that  the company facing difficulty converting  the inventory to sales.

Recommendation

1-     Making training to salesman

2-     increase Advertising and promotion

3-    Search  for  new market.

4-    Improve the quality of the product and performance .

5-  using gifts and decline the price without losses.

Total assets turnover

=Net sales / Total assets

This ratio measure the efficiency of the management in the use of assets to generate sales.

*each dinar in assets how much generated sales.

*the extent to which the top management successful .

 

2007= 2211/2169

=1.02

2006= 1.03

This ratio give us clear picture that assets untapped  efficiency.

Profitability Ratios

This ratio measure the  overall performance  of the company  where  examine the company is ability to generate profit from the sales.

Gross profit margin

= Gross profit /net sales

This ratio aims to indicates the efficiency of operations and firm pricing policies.

2007= 612/2211

=.277*100%=27.07

2006= 28.07

Its study relationship between net income related sales and investment on assets .

the result give us clear picture decline in the efficiency of operation and pricing policy.

How to improve this ratio??

Recommendation

1-    Improve sales

A-   Making training to salesman

B-   Search for new market

C-   Increase advertising and promotion.

2-    Decrease sales return

A-   Improve the quality of the product and performance.

B-   Improve the way of packaging

C-   Improve the way to upload and download inventory.

3-    Purchase

A-   The company should looking a new supplier at a lower price.

 

Net profit margin

=Net profit after taxes/  net sales

Which indicate the firm is profitability after taking account of all expense and income taxes 2007= 91/ 2211

= .04     (.04 * 100%= 4.1%)

2006= 4.9%

 The result give us clear picture of the increase in selling and administrative expenses.

*** higher inventory  balance needs to store high costs .

Recommendation

1-    Reduce commission salesman.

2-     the expulsion of employees who don’t provide added value.

 

Return On Investment( ROI ,ROA)

= Net profit after tax /Total assets

 

This ratio measure the relationship between operating profit and Total assets .

The extent of the dinar invested in assets to generated profits.

2007= 91/2169

=.042     (.042 *100%=4.2%)

2006 = 5.00

The result give us a clear picture of the low efficiency in the investment assets .

Recommendation

** the company must reduce selling and administrative expenses.

 

Return On Equity (ROE)

= Net profit After tax / shareholders' equity.

 This ratio  measure  the return on each investor dinars by the ordinary shareholders. 

2007 =91/1149

=.08     (.08 *100%= 8%)

2006 =9.4

This ratio give us a clear picture of the low efficiency of the exploitation of assets and increase expenses .

 Recommendations

The company must provide the resources or the optimal utilization of the available resources .

When ROI=ROE   ???

When there is no debt in the capital structure.