The report consists of an analysis of the financial ratios for the company’s reports on 2014 FY. Financial ratio analysis is essential in providing relevant information about a firm’s performance. Analyzing ratios assist the executives, managers, creditors, and investors to make financial decisions. Therefore, the managers, creditors, and investors of Yellow Leaf Company will make sound financial decisions after assessing the results of the ratios. There were four kinds of ratios assessed in the company’s reports which include liquidity, coverage, profitability, and activity.
The liquidity ratio focuses on the assessment of the short-term potential of the company to meet the current obligations. One of the common liquidity ratios is the current proportion. The current ratio assesses the organization’s capability on fulfilling the present obligation using the available finances derived from the current assets. Thus the current ratio is computed using the formula:
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Current ratio=CA/CL
Where CA-Current assets
CL-Current liabilities
The financial reports for 2014 indicate that the CA amounted to $ 2,960,278. However, the short-term liabilities were valued at $ 612,792. Thus the current ratio was computed as follows.
Current ratio=2,960,278/612,792=4.83
The current ratio for Yellow Leaf Corporation was more than one. Thus, the company meets the set standards for the proportion of current assets to liabilities in the industry. A ratio below than one indicates that a firm has more liabilities than assets which is a threat to financial performance. A high value for the current ratio indicates that a company can meet its short-term financial needs. The acceptable ranges of current ratios in the business sector are from 1.5% to 3% (Basu, 2018). A business that attains a current ratio of the set range is perceived to be healthy. Yellow Leaf attained a ratio of 4.83 which demonstrates that it can meet its financial requirements in the short-term.
The acid-test ratio was also computed to determine the financial strength of Yellow Leaf Corporation. The ratio focuses on establishing the solvency of an organization in a short period. The formula consists of three elements including cash, securities, and total receivable. Thus, the acid-test ratio as calculated as:
(Cash + Securities + Receivables)/CL
(1,162,333 + 1,218,048+0)/612,792
=3.88
Companies have a lower quick ratio value than the result of the current ratio. It indicates that the firm company has accruals in stock and deferred tax that are more than the current assets. However, the case of Yellow Leaf Company is different. The firm has a high quick ratio value which demonstrates that it can overcome liquidity problems.
The second category is the activity ratios which focus on assessing the organization’s ability to utilizing the assets. The first type of ratio computed in the case was the receivables turnover. The ratio helps the investors and managers determine the frequency of collecting receivables in a particular period. The receivables turnover proportion provides essential data on the quality of unpaid cash in the company. Further, the ratio indicates the performance and ability of the company providing credit to other organizations.
The formula of accounts receivables focuses on dividing the total collectibles by the gross sales. The numerators should comprise the total credit purchases. The financial reports of the company do not provide specific credit sales. Thus, it is assumed that all purchases are similar to credit sales. The average collectibles were computed by adding the opening and closing balances for the year. The value of the two balances of collectibles was divided by two. The value of the receivables turnover for Yellow Leaf firm was 3.02. The results of receivable turnover proportion vary because they rely on a company’s regulations and the industry measures. Thus, a low value of receivables turnover ratio indicates that a corporation does not collect the debts appropriately (Quick Books Canada Team, 2017). The results of the ratio indicate that Yellow Leaf collects the receivables 3.02 times a year. Thus, the corporation takes 121 (365/ 3.02) days to receive cash from credit sale transactions. The collection period is less than the industry standards. Yellow Leaf can improve the outcome by amending the credit laws.
The next type of activity ratio is inventory turnover. The ratio assesses the time taken to sell the stock. Also, the ratio examines the management of the company’s inventory. The stock turnover is computed as follows:
=COGS/ Average Stock
=756, 000/ 497, 800
=1.52
Average days to sell stock=365/1.52
=240.34
A low stock turnover illustrates that a firm spends more cash increasing goods volumes or purchasing products that are not sold in the market.
Profitability ratios assess a firm’s ability to gain profits to meet operating expenses and providing returns to the investors. The profitability ratios assessed in the company include profit margin on sales and payout. The profit margin on sales is computed as follows:
=Total income/ Total sales
= 819, 218/ 2, 919, 800
=0.28
It indicates that the company made 28% returns on the sold stock. Corporations try to gain a high-profit margin sales ratio by increasing the revenue and decreasing the expenses. The external and internal elements that affect the firm influence the value of the ratio. The standard profit margins in the industry are between 4 to 13%. Thus, Yellow is in a good position in the sector. The second ratio is the payout ratio which involves the amount of income paid to stakeholders in the form of dividends. The payout earnings of the company are below one which demonstrates that earnings are retained to enhance growth.
The final category was the coverage ratios. The ratios focus on determining the coverage for the entrepreneurs and creditors. The first ratio was the cash debt coverage which provides creditors with data on the firm’s ability to pay debts using cash. The ratio for the company in 2014 FY was 86.53%. The debt to asset for the industry is 50%. Thus, the company has attained a higher value that exceeds the set standards. High cash debt coverage illustrates that the organizations can pay the liabilities using the current cash (Benge, 2018). Thus, Yellow Leaf can repay the liabilities using the available cash. Yellow leaf cannot be declared insolvent because they can settle the obligations on time. The second type is the time-interest earned ratio. The value of the ratio is 263.93 which is beyond the industry standard of 2.5. A high time interest earned outcome demonstrates that a company manages the loan repayments and finances correctly. Also, it illustrates that Yellow Leaf does not use excess finances to invest development and innovation initiatives. Therefore, Yellow Leaf has low solvency risks because it pays the debts on time. However, the high outcome of the ratio is not attractive to investors in the long-term because they do not spend on expansion or new projects.
The following is a summary of the previous analysis of the financial ratios:
The current ratio is 4.83 which indicates that the corporation will have an excellent short-term financial capability
The acid-test ratio is 3.88 which demonstrates that the company has a high cash flow to overcome liquidity challenges
The receivables turnover value is 3.02 that is below the industry’s standards
The stock turnover is 1.52 which portrays that the firm is in a weak position compared to the apparel sector
The value for margin on sales is 28% which shows that the company is in an excellent position in the industry
The payout ratio is zero which indicates that Yellow Leaf uses the earnings to enhance growth
The debt to assets is 21.92% which below the industry value. It demonstrates that the company’s debts are less than the current and fixed assets
The time-interest earned value for the company is 263.93 that show that the company has low solvency risks, but unattractive to investors in the long-term.
The primary financial strengths of the company include high liquidity and adequate assets regarding its overall financial performance. The financial strength is attractive to investors and creditors. The company’s revenue can reduce in the long-term due to the low value of stock and receivable turnover. Thus, Yellow Leaf should develop the metrics for stock and receivable turnover.
The president and store manager need to implement the following recommendation to increase the stock turnover:
Collaborate with the marketers to develop a useful promotional campaign
Establish additional reduction sales and eliminate stock activities to enhance customer access to the stall which can assist the company to sell ordinary priced goods
Host fashion events, appreciation celebrations, and provide assistance t the client. The company will establish relationships and trust with customer due to continuous interactions.
Communicate with customers through emails by sending information about sales, events, or new products
Coordinate with the sales director to identify the external and internal elements that increase the motivation of marketers to increase the sales volume
The president can improve the receivable turnover value by:
Monitoring the account receivables every week and account interest on accrued accounts
Reviewing the procedure for gathering the receivables. Ensuring that the invoices are correct and are delivered on time.
To clarify the credit laws with the employees and clients. The president should incorporate laws on prohibiting loss of credit in the future.
An increase in stock turnover is essential in improving the financial performance of performance of the company. The firm can meet the needs of the target by increasing the stock levels. The sales will increase after the store and marketing department collaborate to promote the products in the market. Improving the accounts receivables increase the cash in the company, but reduce losses due to the elimination of written-off debts. Thus, the company financial performance improves in the long-term.
References
Basu, C. (2018). Four Basic Types of Financial Ratios Used to Measure a Company's Performance . Chron. Hearst Newspapers, 2018. Retrieved from http://smallbusiness.chron.com/four-basic-types-financial-ratios-used-measure-companys-performance-25299.html
Benge, V. A. (2018). What is the good Debt-to-Asset Ratio? Bizfluent . Retrieved from https://bizfluent.com/info-8057096-good-debt-asset-ratio.html
QuickBooks Canada Team. (2017). Accounts Receivable Turnover Ratio. Intuit. Retrieved from https://quickbooks.intuit.com/ca/resources/bookkeeping/accounts-receivable-turnover-ratio/
