To understand the value of a firm, interested parties have to look at its financial condition. This is the status of the assets, liabilities and equity position of a firm at a given time and this is often described in the financial statement. To determine the financial condition one needs to look at the financial ratios which are retrieved from the financial statements. These ratios are classified into liquidity, efficiency, leverage, and coverage and profitability ratio. Considering the data given let us report the financial condition of this organization using the ratios.
Liquidity Ratios
The current ratio is the ratio of total current assets to current liabilities. It indicates its ability to pay off its short term liabilities by liquidating its current assets. According to Siad (2018) Low current ratio indicates the firm has difficulties in paying current liabilities, for example, the ratio that is below one indicates that even if the firm liquidates all its current assets, it will not be enough to pay its current liabilities. The organization with the current ratio of more than one is considered to have a good financial condition this is because of high liquidity. From the data, the entity has a ratio that is more than one for all years which implies it can pay all its current liabilities using current assets for a given time
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Acid test also called quick ratio measures the ability of the business to pay its current obligation using the quick assets. It’s similar to the current ratio except that it includes inventories. This ratio is a good measure of liquidity in the case when inventories are not easily convertible to cash. From the data for years 2013 and 2014 the financial condition was poor because the acid test ratio is below one hence it not able to pay its current liabilities by selling current assets but for the years between 2015 and 2018 the financial condition was good since the ratio was more than one which implies its ability to settle its current obligations by selling its current assets.
The efficiency Ratios
Inventory turnover is a measure of how efficient an organization can control its merchandise. It indicates the times the company inventory is sold and replaced over a given period of time. Higher ratios are considered better because it shows how the company is efficiently selling the inventory it buys. Also, it shows how the liquid is the inventory. From the data, the ratio was below six in all the years indicating the efficiency was not better except in the year 2014 which more. In those years the efficiency in managing warehousing, distribution of goods based on sales was not better but 2014 had the better management of this.
Another ratio is the account receivable turnover. This measures the rate of how credit sales are turned to cash. A high ratio is considered good as it implies that the company is collecting its accounts receivables efficiently and it has a good number of quality customers furthermore it shows that the company is operating on a cash basis. A low ratio indicates a lack of efficiency in the collection of the accounts receivables (Mensah, 2016). From the data, the ratio is fluctuating slightly and it is higher indicating efficiency of the entity in the collection of accounts receivables
The average collection period is another indicator of efficiency which is the period it takes for a company to receive accounts receivables payments. In this case, the lower ratio is considered favorable because it implies the firm’s ability to collects debts faster. From the data, the average collection period of the entity can be considered to be favorable because of the lower ratio for every year. Therefore it collects its accounts receivables faster.
Fixed asset turnover also is used to measure efficiency. It shows the company’s ability to generate net sales from its fixed assets investments the higher ratio is considered favorable as it indicates that the company has more effectively utilized fixed assets investments to generate revenue. From the data, the turnover is fluctuating up and down which mean also that sales generated from fixed assets are fluctuating in the same manner
Finally, another ratio of efficiency is the total asset turnover.it is the measure of the revenue relative to the value of the assets of the company. Also, it measures the efficiency in which the firm is generating revenue from its assets. In this case, a higher ratio is considered favorable as it implies that the company is performing better and it’s generating more income from the assets. From the data, it’s clear that from every one dollar of an asset above one sale are generated that is in 2013 is1.36,2014 is 1.21, 2015 is 1.32,2016 is 1.26, 2017 is 1.11 and 2018 is 1.26 which is favorable and hence good financial position.
Leverage Ratios
Total debt ratio is the ratio of debt to total assets that is, it is the proportion of the assets financed by debt. The ratio more than one simply means the company is financed more with debt hence more liabilities. Also, high ratio implies the company is at risk of defaulting its loans in case of increase on interest rates. The ratio below one indicates a large portion is financed by equity. Therefore, the higher the ratio the more leverage hence greater financial risk. From the data, it is clear that the ratio is bellow one from all the years thus implying low leverage from the company.
Long-term debt ratio is a ratio that shows the proportion of the company’s assets financed by long term debts. It outlines the long term financial position and the ability of the firm to settle its financial obligations. A decreasing ratio shows the firms reducing dependency on debt but a ratio below 0.5 is considered good. In the data, the ratio through the years was below 0.5 thus favorable but also, it was increasing over the years hence increasing dependency on debt.
The debt to equity ratio is a ratio of debt to equity. It compares total debt to total equity. It shows the level to which shareholders equity can pay creditors in case of liquidation. A lower ratio indicates a more stable business is financially and high indicates more risks to creditors. In the data the ratio is less than one for 2013and 2014 this implies high protection for the money. For the year 2015 to 2018, the ratio is more than one which means the greater assets is financed by creditors’ hence it’s associated with more risk. It’s increasing over the years meaning the entity is increasingly depending on debt finance
Long-term debt to equity ratio indicates the level of debt that a company has relative to its worth. It relates the company’s long term debt with its equity. The higher the ratio the higher the degree of risk due to the principle and interest liabilities. From the data, the ration is fluctuating but increasing over the years showing the company is increasingly depending on debt for finance.
Also, coverage ratios can be used in the reporting of the financial condition of an organization. It’s a ratio that shows the company’s ability to service its debt and be able to meet its financial obligations. The high coverage is considered favorable as it implies how easy is it to make interest payments on the debts or pay dividends. From the data, both the time's interest earned and the cash coverage ratio are increasing from 2013 t0 2017 indicating the firm ability to pay its obligation is increasing yearly accept in the year 2018 where it dropped slightly.
Profitability Ratios
Net profit margin measures the company’s after-tax income relative to sales, those with higher ration are considered more efficient and flexible and can take on new opportunities. Considering the data given, the margin is fluctuating but in an increasing manner which means the entity is profitable
Operating profit margin it a measure of the firm's earnings before tax. It’s also called the coverage ratio and its information is useful in assessing the ability of the firm to expand through the addition of debt. The higher the margin the more efficient the firm is and hence more profit. From the data, the margin is increasing from 2013 to2016 indicating increasing profitability of the entity and the starts dropping from 2016 showing the profits have started dropping for the specific years. Despite that, the ratio shows that the company is able to make profits every year.
Return on total asset indicates how good management is utilizing various resources in the organization. It’s a ratio of profit before tax to total assets. It measures how good assets can be put to use to get more profit. In the data given, the ratio is fluctuating over time indicating fluctuation in the use of assets to generate income. Despite this fluctuation, the entity can at least generate income from assets for every year
Return on common equity is the rate of returns that the shareholders receive on their investment. The high ratio is considered favorable since they imply high earnings for the shareholders. For the data given the financial condition is favorable since the trend in the ratios is fluctuating but in an increasing manner implying the shareholders' returns are also fluctuating in an increasing manner for the entity.
In conclusion, having looked at all the financial ratio of the entity, it is clear that the users of the financial institution can now have a general financial condition. This is because they have been able to analyses liquidity, profitability, leverage coverage and the efficiency of the firm
Acid Test Ratio
Also called quick ratio measures, the ration shows the ability of the business to pay its current obligation using the quick assets. Quick assets are assets that can be converted into cash within a short time. According to Laitinen (2018), it shows how good business can quickly convert its current assets into cash so as to pay its current liabilities. Hence, the ratio of quick assets to current liabilities.
Quick ratio= quick assets/current liabilities
In case quick asset breakdown is not given in the financial statement one can just subtract inventory and other prepaid assets from the current total assets. In the analysis, high quick ratios are considered favorable because it indicates that the company can settle all current liabilities without selling any of its fixed assets. Hence higher liquidity of the company.
I selected the acid test ratio because it’s a more conservative measure of liquidity since it does not include all items that are difficult to convert into cash. It focuses only on the company’s more liquid assets. That is assets which are converted into cash faster in less than 90 days. The trend in the ratio is increasing from 2013 to 2015 it the drop in 2016 and increases in 2017 and finally drops slightly in 2018. Despite all the ups and downs in the ratios, they are increasing and are above one as from 2015 meaning the company is able to pay its current liabilities without involving its fixed assets. The change in this ratio was caused by the fluctuation from both the denominators and numerators. The changes in the ratio might have been caused by increased sales in the business, which leads to more cash, increased faster collection of accounts receivables which also contributed to more cash and reduction in the accounts payable because it might have reduced short term liabilities and reduced accrued expenses which reduced current liabilities.
Inventory Turnover
It is an efficiency ratio that indicates how inventory is efficiently managed by comparing sales with the average inventory. It’s the number of times the business has sold and replaced inventory for a given period of time. Low inventory implies week sales and possibly excess in the inventory and a high ratio can either imply a strong sale or few inventories.
Inventory turnover ratio=cost of goods sold/average inventory
The ratio has to be high which indicates that the company is not buying too much inventory and waste resources by keeping an inventory that cannot be sold.
I chose this ratio because firms always buy inventory which they sell to get the money to pay employees, suppliers, etc. also the money can be lost in a case where the demand is less, and inventory becomes obsolete. Also, slow good make the warehouse inefficient
The trend of the ratio is increasing and decreasing. It increase from 2013 to 2014 starts dropping from 2015 to 2018 implying a decrease in the efficiency by which inventories are turning. That is it holding inventory longer than the previously measured time. Hence the firm is incurring increased storage cost, insurance, and maintenance cost
The trend was caused by the changes in the cost of goods sold and the day it takes to sell the inventories. Overstocking due to the minimum or no review of inventory against the maximum limit, over procurement due to poor forecasting, high work in progress due to wrong material movement and fluctuations in customers schedule
Total debt ratio
This is a financial ratio that is used to access the financial leverage of an entity based on the relationship between total debt and total assets. This measures the proportion of the company’s assets that are financed by debt. It can be used in finding the solvency of the business (Tian, 2017). A high ratio implies bulk debt financing of the company’s assets. This is risky since the firm is at risk of paying associated interest rates
Debt ratio= total liabilities/total assets
This is the best ratio because it provides useful information about the leverage of the entity which helps in the deep understanding of the financial condition of an entity. It is easy to understand as results are shown in percentage or ratios, it easy to calculate this because the formula is straightforward and can compare entities with different sizes because they come in ratio or percentages.
In data, the ratio is reducing from 2013 to2014, from there it starts increasing up to 2016 and in 2017 it drops and 2018 increases again. The drop in the ratio implies that the company had a reduced debt financing for the year thus reducing financial risks and increase means it had increased debt finance for the same year thus increased financial risk
The fluctuations in the ratio were due to the fluctuation of the total assets over the years while the liabilities were increasing over the years. This fluctuation is assets may be caused by the entity selling some assets or abandoning them. Assets losing value can also cause a decrease in the total assets. It can also be caused by market fluctuation, becoming obsolete. The increases in the total assets may be due to entity buying more assets and assets gaining value over the respective years.
Cash Coverage Ratio
This is the coverage ratio that measures the amount of cash available to measure payments when are become due. Therefore it’s a measure of solvency of an entity. It determined by adding back non-cash item like depreciation to the profit and dividing it by the payment due for capital expenditure, dividends, etc. It has to be one 1.00 or more for it to be solvent this is because it has some payments to make from its profits.
Cash coverage= (earnings before tax and interest +non-cash expenses)/interest expense
From the data, the ratio is more than one which means it solvent. The trend in the ratio over the years in fluctuating up and down. That is, it increases from 2013 to 2016 and then it starts dropping. When dropping it implies the ability of the entity to pay its interest expense also is dropping and vice vasa.
The trend may be caused by the fluctuation in the numerator which is caused by changes in the sales allowance, product returns, bad debts or inventory obsolescence.
I chose this ratio because the ratio is a forecast of the financial results of an entity. Obtaining this ratio overtime will able to inform the management of the ability of the entity to meet its capital expenditure, dividends, etc. Therefore, it avails guidance on management decisions on capital budgeting expenditure, borrowing or dividend policy.
Net profit margin
This is a profitability ratio that measures the rate income or profit generated by an entity as a percentage of revenue
Net profit margin =net profit/revenue
The trend of the margin is fluctuating in that, high in 2013 and drops in 2014 after which it starts increasing up to the year 2016 after which it again starts dropping. The drop in the margin implies that the profitability of the entity is dropping and increase mean it is increasing for the specific years. It increasing because the current business practices are working well for the business.
I chose the ratio since it the most conclusive profitability ration. The margin is one of the most important indicators of the financial health of an entity. According to Hendri (2015), Tracking decrease or increase will tell whether the company current practices are working and forecast profits based on revenue. It is also possible to compare the profitability of two different entities since it is expressed in percentages and ratios. It can be used to assess whether profit generated from its assets is enough and the costs are being contained
The fluctuation is caused by the changes in both the net profit and revenue of the company. The fluctuations in net profit may be caused by changes in utilities, insurance premiums, labor cost, and sales. Also, fluctuation from the party of revenue might be due to changes in the number of customers, average transaction size, and changes in prices
References
Laitinen, E. K. (2018). Financial Reporting: Long-Term Change of Financial Ratios. American Journal of Industrial and Business Management , 8 (09), 1893.
Mensah, D. (2016). Overriding the financial challenges of state mass transport companies in Ghana: A Case Study of Metro Mass Transit Company Limited (Doctoral dissertation).
Siad, H. A. (2018). The effect of financial reporting on investment decision making at Salam somali bank.
Tian, S., & Yu, Y. (2017). Financial ratios and bankruptcy predictions: An international evidence. International Review of Economics & Finance , 51 , 510-526.
