ANALYSIS RATIOS FOR FINANCIAL STATEMENT

Table of Contents

Introduction. 4
Calculations and Ration Analysis. 5
Liquidity Ratios. 5
Current Ratio. 5
Quick Ratio. 6

Profitability Ratios. 7
Gross Profit Ratio. 7
Net Profit Ratio. 7

iii. Return on Assets Ratio. 8

Return on the Capital Employed Ratio. 8
Efficiency Ratios. 9
Inventory Turnover Ratio. 9
Inventory Turnover Period. 9
Z-Score. 10
Conclusion. 10
References. 12
Appendix. 14

Analysis Ratios for Financial Statement

A. Introduction

Ration analysis is a tool in finance that helps the users of financial information to understand more in-depth the financial health of organizations. It allows management and investors to assess the current situation of a company and the probable future. Understanding economic trends allow management to predict the future of the organization to solve business problems that could lead to losses. For example, profitability ratios will enable the company to reduce expenses when it realizes that the company is making losses. Different financial ratios allow users to create different judgments. There are five financial ratios: profitability ratios, efficiency ratios, solvency, ratios, liquidity ratios, and earnings ratios.

Profitability ratios help management and investors to determine the profitability of a company. Examples of profitability ratios include Gross profit margin ratio, net profit margin ratio, return on assets, and return on capital employed. It allows users to determine the number of various components of balance that forms part of the profit. Understanding this allows a company to manage its financial operations to reduce expenses and increase profit. Liquidity ratios measure the ability of the company to meet its short term financial obligations when they fall due. Liquidity ratios include cash ratio quick ratio and current ratio. They are essential in understanding the ability of a company to repay short term debts when they fall due.

Efficiency ratios help to understand how efficient a company uses assets and liabilities to make a profit. They include inventory turnover and inventory turnover ratio. Solvency ratios are ratios that measure whether a company can pay off its debt (Amanda, 2019). They include the debt-equity ratio and Interest coverage ratio. Further, the earnings ratio analyses the returns the shareholders obtain from the investment. They include the P/E ratio, Earnings per Share, and Return on Net worth. In Muscat Securities Market (MSM), this report will analyze the financial statements of Al Buraimi Hotel Saog (ABHS) and Dhofar Beverage and Food Stuff Company Saog (DBCI) using various financial ratios.

B. Calculations and Ration Analysis

1. Liquidity Ratios

i. Current Ratio

The current ratio refers to a ratio that determines the ability of a company to meet its short term financial obligations using existing assets. It is obtained by dividing existing assets by current liabilities. A current ratio of more than one means that a company can meet its short term liabilities using existing assets, while a current ratio is less than one that means that the company cannot meet its financial obligations using current assets (Hantono, 2018). The current ration of ABHS in 2019 and 2018 is 0.346 and 0.168, respectively, while that of DBCI is 1.085 and 1.067, respectively. Going by the current ratios, DBCI can meet its current obligations using current assets while more than ABHS.

ii. Quick Ratio

Quick ratio tests the liquidity of a company by focusing on all noncurrent liabilities other than inventory to meet obligations falling due within a financial period. It helps investors and analysts to determine if a company can efficiently meet its business requirements (Hantono, 2018). The importance of this ratio is the fact that the company retains its existing stock to pay for its financial obligations within the period. A higher quick ratio means that the company is in a better position. The quick ratio of less than 1 is a good sign to investors and partners. The quick ratios of ABHS are 0.34 and 0.15 in 2019 and 2018, respectively, while DBCI had a ratio was 0.61 in the two years. Both companies do not show positive value to investors and partners.

iii. Cash Ratio

Cash ratio is a liquidity ratio that measures the ability of a company to meet its short term liabilities using only cash and cash equivalents. The current rate is essential because only money can be used to pay the existing debt (Amanda, 2019). When determining whether to lend to a company, creditors look at the cash ratio to assess whether a company can manage cash to settle short term debts as they fall due. It is preferred because, at times during liquidation of a company, the company may not be having accounts receivables or inventories, or it would take time to collect all receivables or sell stocks. The cash ratios of ABHS for 2019 and 2018 are 0.03 and 0.08 and 0.12 for DBCI in the two years, respectively. A cash ratio of less than one indicates that a company cannot pay its short term debts using cash and cash equivalents only.

2. Profitability Ratios

i. Gross Profit Ratio

The gross profit ratio is a profitability ratio that shows the amount of profit that a company generates after deducting its cost of revenues. Net sales calculate it, then multiply the result by a hundred. The ratio measures the amount the company earns more than the price of sales. It can be used to compare the profitability of more companies (Ariyani, Anatasya, and Simanjuntak, 2019). The gross profit trend can be used to forecast the company’s financial performance or compare the pattern with the other company. The gross profit margin ration for ABHS 38% in 2019 and 48% in 2018, while for DBCI is 40% in 2019 and 39% in 2018. In both companies, the profit margin ratio trend is decreasing. The values also indicate that the DBCI was more profitable in 2019, while ABHS was more profitable in 2018. It would mean that the importance of the closing stock has been understated while the value of the opening stock has been overstated in both companies. There would be a general decrease in prices in the two companies without a corresponding reduction in the cost of revenues. Similarly, the loss of revenue could have increased without an increase in selling prices.

ii. Net Profit Ratio

Gross profit Ratio would not be a final measure of determining profitability without a Net Profit Ratio. The net profit ratio accounts for all expenses incurred during a business period. It measures the amount of net profit earned in the amount received from sales. It is measured by dividing net income by net sales (Ariyani, Anatasya, and Simanjuntak, 2019). It is used to assess how well a company can convert sales into income. The ratio is essential for both investors and creditors to evaluate the ability to pay dividends and the earning of enough profits to pay loans, respectively.

A low net profit ratio requires management to cut budget and expenses because the company could be having a lot of costs. The net profit ratio of ABHS is 49% in 2019 and 15% in 2018, while the net profit ratio for DBCI is -4% in 2019 and -7% in 2018. DBCI made losses while ABHS made a profit. According to the Income statement, DBCI reported selling and distribution expenses $1,080,264, general, and administrative expenses of $771,583, among others. ABHS reported general and administrative costs of $116,916 and no distribution expenses. While ABHS reported only two items in the expenses section, DBCI reported four things. It would be recommended that DBCI should manage its costs to earn a profit.

iii. Return on Assets Ratio

Return on assets (ROA) is a profitability ratio that measures the amount of net income earned from assets. It measures the efficiency of a company to deliver net income using its assets. The ratio is important to investors and management in assessing the ability of the company to utilize its assets to generate profits. It is obtained by dividing Net Income by total assets. The ROA of ABHS in 2019 in 6%, while that of DBCI is -3%. It indicates that ABHS has an upward profit trend while DBCI makes losses. It would mean that ABHS uses its assets effectively to generate profits more than DBCI. Companies would desire to invest in ABHS than DBCI.

iv. Return on the Capital Employed Ratio

Return on capital (ROCE) measures how efficient a company can generate profits using money employed. It is obtained by dividing net operating profit by employed capital. It is used to measure the long term effectiveness of a company by considering long term financing. It measures whether a company can stay longer in operation. Like ROA, ROCE shows the amount of profit earned from capital employed (Ariyani, Anatasya, and Simanjuntak, 2019). Management of an organization requires higher ROCE. ABHS’s ROCE was 0.08 in 2019 and 0.03 in 2018, while DBCI’s was -0.04 in 2019 and -0.08 in 2018. It would, therefore, indicate that ABHS generates a higher percentage of profit using capital employed than DBCI. Investors use ROCE to assess how the long term financial strategies of company work. The company should always generate more profit to enable them to repay loans or pay investors dividends. It could also be deduced that the asset value of DBCI has hindered its profitability since the more significant amount of assets can affect the company’s return.

3. Efficiency Ratios

i. Inventory Turnover Ratio

Inventory turnover ratio is an efficiency ratio that compares the cost of sold with average inventory to measure the efficiency of the company. It measures the number of times inventory sold its catalogs. The ratio is important because it indicates how lists were purchased as well as how sales were made to ensure that turnover is achieved. It is obtained by dividing the cost of goods sold by average inventory (Odelia and Wibowo, 2020). ABHS’s inventory turnover is 27times while DBCI’s are four times. It means that ABHS replenished its inventory for 27 times while DBCI replenished its stocks for only three times. In other words, ABHS will replenish its inventories for 6.75 times in the 1-time replenishment of DBCI. It would be easy for ABHS to secure a loan from creditors than DBCI because creditors will use this ratio as collateral.

ii. Inventory Turnover Period

This indicates the number of days that a company uses to sell its entire inventory. It is obtained by dividing 360 days by inventory turnover ratio. ABHS will take takes 13 days while the DBCI tool 94 days. Less number of days means that a company is making more sales, while more days indicate that sales are slow.

4. Z-Score

Z-score predicts the likelihood “that a company will be bankruptcy.” Dr. Edward Altman used the formula; 1.2A+1.4B+3.3C+0.6D+1.0E. Where; A is the ratio of working capital to total assets, B the ratio of retained earnings to total assets, C represents the ratio of market value to equity to book value total liabilities. E is the ratio of sales to total assets A Z-score of scale 0 -1.8 shows that the company will declare bankruptcy in future, “1.8 -3 shows that a company has a possibility of declaring bankruptcy while the scale of above three indicates that the company will not declare bankruptcy” (Range, Njeru and Waititu (Jkuat), 2018). Applying this formula, the Z-Score of ABHS is 3.45, while that of DBCI is 2.11. Therefore, ABHS will not declare bankruptcy in the future, while DBCI is likely to declare bankruptcy in the future.

C. Conclusion

Financial ratios are essential in understanding the health of an organization. Every financial ratio is essential in its way, either to the investors, creditors, or any other person interested in understanding the financial situation of a company. Without financial analysis, it would be difficult for everyone to read financial information to understand the contents. Instead, numbers in the financial statement should be explained to be meaningful. The meaningfulness of the financial information is achieved by providing a thorough analysis of the financial report. The significant financial statements in the calculation of economic analysis are the income statement and balance sheet. It is because users would always want to know the profitability of a company and how well the company can use different components to earn revenue and profit.

Liquidity ratios measure the ability of the company to meet its short term financial obligations when they fall due. Liquidity ratios include cash ratio quick ratio and current ratio. Going by the current ratios, DBCI can meet its current requirements using current assets while more than ABHS. Even though the DBCI has the potential to repay its debt using current liabilities, the current ratio is almost one, and there would be no enough current assets to run the business after paying the obligations. It is wise for a business to have enough net current assets to cushion it when it has to use its current assets to pay debts. Consequently, the two companies had a quick ratio and cash ratio of less than one; this would mean that investors and creditors would not be willing to invest and lend money to these businesses.

Profitability ratios help management and investors to determine the profitability of a company. The profitability ratios indicated that ABHS is profitable than DBCI. Although DBCI had a gross profit margin of 40% in 2019 and 39% in 2018, this profitability is not maintained in the net profit ratio; perhaps the company could be having a lot of expenses. Return of asset and return on capital employed also showed that the two companies had not done manage to convert their resources to profit. ABHS is better than DBCI inefficiency as it can sell its inventories 27 times, while DBCI can sell only four times. Creditors could use the inventory turnover ratio as collateral for lone. The Z-score indicates that ABHS will not be going to bankruptcy in the future, while DBCI has a likelihood of going to bankruptcy. Therefore, in most ratios and Z-score, ABHS is financially healthier than DBCI.

D. References

Amanda, R., 2019. The Impact of Cash Turnover, Receivable Turnover, Inventory Turnover, Current Ratio, And Debt To Equity Ratio On Profitability. Journal Of Research In Management, 2(2).

Ariyani, R., Anatasya, F. And Simanjuntak, M., 2019. Liquidity, Net Profit Margin, Growth Of Company Terhadap Dividend Payout Ratio Pada Perusahaan Manufaktur. Jesya (Jurnal Ekonomi & Ekonomi Syariah), 2(2), Pp.118-130.

Hartono, H., 2018. The Effect Of Current Ratio, Debt To Equity Ratio, Toward Return On Assets (Case Study On Consumer Goods Company). Accountability, 7(02), P.64.

Odelia, T. And Wibowo, B., 2020. Pengaruh Current Ratio, Debt To Equity Ratio, Inventory Turnover Dan Return On Equity Terhadap Price Earning Ratio. Jemap, 2(2), P.238.

Range, M., Njeru, A., And Waititu (Jkuat), G., 2018. Using Altman’s Z Score (Book Value Of Equity/Total Liabilities) Ratio Model In Assessing Likelihood Of Bankruptcy For Sugar Companies In Kenya. International Journal Of Academic Research In Business And Social Sciences, 8(6).