The Elite Service Company having operated for month, and the financial statement for the period of operation prepared, it is important to analyze the figures and statistics presented in order to be able to determine the adjustment necessary and the appropriate measures that need to be taken in order to be able to improve the performance of the firm. The financial statements also provide a quite clear position of the business and the analysis such statement together with the consideration of the decision and measure taken by the management could provide more informative and fundamental information in propelling the business to continue operating.
Interpreting the Financial Statement
The Income statement is a critical financial tool that measures how much a company earns in revenue over a certain time period and the expenses related to the revenue earned. The success of the company, therefore, can be measured by establishing the financial ratios relating to the data provided in the statement. First, the Return on Asset (ROA) test the ability of the company to make the profit, it measures the ratios of the total assets vis-à-vis the total assets. For Elite service company, therefore;
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ROA = Net income ÷ Total assets
3800 ÷ 37000 = 0.102 (100)
ROA = 10.2%
The return on asset can be used to assess the performance of the company against their competitor in the market such that if it the same or higher than their rival company, the business is on a good course. However, dummies.com further notes that “Return on assets indicates the number of cents earned on each dollar of assets, thus higher values of return on assets shows that business is more profitable.” And therefore, compared to other places in the industry, the Elite Service company seems to be on the right trajectory of success.
The success of the company can also be determined by its ability to generate income to its owners. To assess this, the Return on Equity becomes a good weighing scale.
ROE = Net income ÷ Shareholders’ or owners’ equity
= 3800 ÷ 24500 (%) 15.51%
A high return therefore, is indicator of the success of the business, the fact that “for most of the twentieth century, the S&P 500, a measure of the biggest and best public companies in America, averaged ROEs of 10% to 15%” (thebalance.com) suggest that the Elite service is within the class of the other successful business as its ROE is within the range.
Another key aspect of determining the success of a company is the analysis the extent to which it relies on the debt for supplement its operations. The leverage ratios, therefore, becomes a succinct tool for measuring the health of the business.
Debt-equity ratio = Total Debt / Total Equity
= 12500 / 24500 = 0.51
This ratio suggests that for the Elite company, the chances of future operations are guaranteed as the usually the ratio less than one usually indicates that the creditors are satisfied and have the full trust and confidence in the operation of the business.
From the analysis of the income statement, net income a basic necessity while considering the success of any business. The fact that Elite Service is able to register an income of note just after a month of operation indicates that the company is on course toward achieving its set objects. After deductions, a net income of $ 3800 was posted at the end of the period. While the profit has been registered, understanding the profitability of the business is also critical in determining whether the company is trending on the same path as its competitors, therefore, the net profit margin provides a ratio in which a comparison can be made.
Net profit Margin = Net Income / Net Sales
3800 / 7500 = 0.506
The ratio suggests that the company is averaging making progress and the chances of success are better for the business. A higher net profit margin means that a company is more efficient at converting sales into actual profit. The advantage of ratios is that the net profit margin ratio puts into account all costs in finding the final benefit of the income of a business. It, therefore, minimizes chances of biases and misinformation. Furthermore, the success and profitability can be gauged efficiently using this means as Net margin includes all the factors that influence profitability whether under management control or not. Furthermore, the fact the company was able to share dividends to its shareholders proves its ability to achieve greater heights. Usually, sharing dividend comes after all the deductions have been made and the net profit established.
Analyzing the decision on dividend distribution
Dividends are the pro rata claims enjoyed by shareholders at the end of a given trading period, they are important as salary is to the employees. The process of sharing dividends is usually rigorous and involves a lot of evaluation of the financial position of the business. The decision to share dividend, therefore, is quite complex and thus involves a lot of consideration. For the Elite Service Company, the decision to share dividends just a month in operation suggest quite a lot in the tray for the management. Paying the dividend also remains a goal that every company aspires to achieve either immediately or sometime in the future, this because it serves as means of attracting investment and increasing the confidence in business for sharing dividend is one of the measures of success. And based on that the decision was justified. However, such decision seems to quite an informed considering the infancy level of the business, while the shareholders may be lusting for profits, the stability of the business should be having given priority.
First, developing or improving the asset of the company would be instrumental in stabilizing the profitability of the business. To underscore this thought, thebalance.com argues that in many cases, “especially those where a company has a good opportunity to plow earnings back into the asset to expand at high returns on capital, it may be decades before the first dividend is declared.” This indicates that the management might hurriedly rush to share the dividend. The decision, therefore, was quite untimely and though its advantages could be short term. Drawing a comparison against other well-performing companies in the across different industries, the standard practice is usually prolonged, a salient example in point is that “for almost a generation, Microsoft didn't pay a dime in dividends as its dividend policy was to retain all earnings to grow the core engine” (thebalance.com).
Another reason that makes the decision on dividends quite misinformed is that the management did not factor in the fact that the business environment is always unstable and is characterized by period of economic stresses and in the most unfortunate situation, the financial statements show that the company lacks adequate financial reserves that cushion them in the event of harsh economic situation.
Reference
Kennon, J. (n.d.). Determining a Company's Dividend Payout Policy. Retrieved January 17, 2018, from https://www.thebalance.com/determining-a-company-s-dividend-payout-policy-356100
Kennon, J. (n.d.). Return on Equity (ROE) Is Key When Analyzing Financial Statements. Retrieved January 17, 2018, from https://www.thebalance.com/return-on-equity-roe-357601
Using an Income Statement to Test a Business's Profitability. (n.d.). Retrieved January 17, 2018, from http://www.dummies.com/business/accounting/using-an-income-statement-to-test-a-businesss-profitability
