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Ratio Analysis

Ratio Analysis:

Ratio Analysis is a form of Financial Statement Analysis that is used to obtain a quick indication of a firm's financial performance in several key areas. The ratios are categorized as Short-term Solvency Ratios, Debt Management Ratios, Asset Management Ratios, Profitability Ratios, Liquidity Ratios, and Market Value Ratios. What are the uses of ratio analysis? Financial ratio analysis helps a business in a number of ways. The uses of financial ratios are given below: 1.

Ratios help in analyzing the performance trends over a long period of time. 1

Ratio Analysis 2.

They also help a business to compare the financial results to those of competitors.

Importance and Advantages of Ratio Analysis: Ratio analysis is an important tool for analyzing the company's financial performance. The following are the important advantages of the accounting ratios. 1. Analyzing Financial Statements: Ratio analysis is an important technique of financial statement analysis. Accounting ratios are useful for understanding the financial position of the company. Different users such as investors, management. Bankers and creditors use the ratio to analyze the financial situation of the company for their decision making purpose. 2. Judging Efficiency: Accounting ratios are important for judging the company's efficiency in terms of its operations and management. They help judge how well the company has been able to utilize its assets and earn profits. 3. Locating Weakness: Accounting ratios can also be used in locating weakness of the company's operations even though its overall performance may be quite good. Management can then pay attention to the weakness and take remedial measures to overcome them. 4. Formulating Plans: Although accounting ratios are used to analyze the company's past financial performance, they can also be used to establish future trends of its financial performance. As a result, they help formulate the company's future plans.

5. Comparing Performance: It is essential for a company to know how well it is performing over the years and as compared to the other firms of the similar nature. Besides, it is also important to know how well its different divisions are performing among themselves in different years. Ratio analysis facilitates such comparison.

Limitations of Ratio Analysis:

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Ratio Analysis While ratios are very important tools of financial analysis, they’d have some limitations, such as 

The firm can make some year-end changes to their financial statements, to improve their ratios. Then the ratios end up being nothing but window dressing.

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Ratios ignore the price level changes due to inflation. Many ratios are calculated using historical costs, and they overlook the changes in price level between the periods. This does not reflect the correct financial situation.

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Accounting ratios completely ignore the qualitative aspects of the firm. They only take into consideration the monetary aspects (quantitative)

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There are no standard definitions of the ratios. So firms may be using different formulas for the ratios. One such example is Current Ratio, where some firms take into consideration all current liabilities but others ignore bank overdrafts from current liabilities while calculating current ratio

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And finally, accounting ratios do not resolve any financial problems of the company. They are a means to the end, not the actual solution.

What Are Liquidity Ratios? Liquidity ratios are an important class of financial metrics used to determine a debtor's ability to pay off current debt obligations without raising external capital. Liquidity ratios measure a company's ability to pay debt obligations and its margin of safety through the calculation of metrics including the current ratio, quick ratio, and operating cash flow ratio. Current liabilities are analyzed in relation to liquid assets to evaluate the coverage of short-term debts in an emergency. A company’s liquidity is its ability to meet its short-term financial obligations. Liquidity ratios attempt to measure a company's ability to pay off its short-term debt obligations. This is done by comparing a company's most liquid assets , those that can be easily converted to cash, with its short-term liabilities. Key Takeaways:  In general, the greater the level of coverage of liquid assets to short-term liabilities the better. A company with a low coverage rate should raise a red flag for investors as it may be a sign that the company will have difficulty meeting its short-term financial obligations, and consequently in running its day-to-day operations.

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Ratio Analysis  During hard times for the business or the economy, a company with insufficient liquidity might be forced to make tough choices to meet their obligations. These could include liquidating productive assets, selling inventory or even a business unit. These moves could prove detrimental to both the company’s short-term viability and their long-term financial health.  Liquidity ratios are a key part of fundamental analysis since they help determine a company's ability to service its debts. If a company fails to pay its debts, it could face bankruptcy or restructuring activity that could be detrimental to shareholder value.  Liquidity ratios are based on different portions of the company’s current assets and current liabilities taken from the firm’s balance sheet.  We will look at the current ratio, quick ratios, the cash ratio and the cash conversion cycle as key measurements of a company’s liquidity.

Liquidity ratio of unilate Textiles Items Required in Liquidity Ratio:  Current Assets  Current Liabilities  Inventory  Cash  Marketable Securities Current Ratio: Current Asset/ Current Liabilities 2005: 465/130 = 3.57 (unfavorable) 2004: 400/105 = 3.80 (Favorable) Significance of Current Ratio: We can determine the short term liquidity of a business concern using the Current ratio. An increase in the current ratio represents improvement in the liquidity position of a business concern and wise versa. 4

Ratio Analysis

Interpretation: Current ratio is an overall measure of how liquid the company is. Liquidity measures how quickly a company can turn assets into cash. If the company had to pay off all of its current liabilities, does it have enough current assets to cover the liabilities? This means that the company has exactly enough assets to cover their liabilities, so they can cover any emergencies. Unilate textiles has a current ratio 3.80 in 2004 and it is Favorable for company. A higher current ratio is always more favorable than a lower current ratio because it shows the company can more easily make current debt payments.so they have enough assets to cover themselves if they have to. As an investor, and a company that does business with unilate Textiles, this is a good sign just in case anything comes up, the company can pay what they owe. There was a slight decline in the current ratio in 2005 which was caused due to a larger increase in liabilities. The company does not disclose what the issuance of this debt is for, but it looks like the company could be looking to invest in something.

Quick Ratio: Current Assets - Inventory

2005: (465-270)/130 = 2004: (400-200)/105 =

1.5(unfavorable)

Current Liabilities

1.90(Favorable)

Significance of Quick Ratio: The quick ratio is very useful in measuring the liquidity position of a firm. It measures the firm’s capacity to pay off current obligations immediately and Is a more rigorous test of liquidity than the current ratio? It is used as a complementary ratio to the current ratio. Interpretation: The quick ratio is similar to the current ratio, but looks at more short-term current assets. This ratio looks at liquidity, like the current ratio. The quick ratio eliminates some of the current assets that take longer to turn into cash. An example of this is inventory. This ratio would be useful if the company had only a couple of weeks to pay off all of their liabilities, so they need to have cash quickly. Ideally, a company wants to have a quick ratio of above 1, which means that they can cover all of their liabilities quickly. Most companies do not have a quick ratio above one because rarely will a company have to pay off liabilities quickly. For a more established company, like Unilate, they will probably have a quick ratio a little bit under 1. Having a lower quick ratio means that they can utilize better cash management by putting cash into more long5

Ratio Analysis term assets or investments to help the growth of the company. Unilate Textiles quick ratio being at 1.90 in 2004 is a healthy number for the size of their company.

Asset Management Ratios Asset management ratios are the key to analyzing how effectively and efficiently your small business is managing its assets to produce sales. Asset management ratios are also called turnover ratios or efficiency ratios. If you have too much invested in your company's assets, your operating capital will be too high. If you don't have enough invested in assets, you will lose sales and that will hurt your profitability, free cash flow, and stock price.

Receivable Activities: Annual sales/ Average Account receivables Significance: The accounts receivable turnover ratio is an accounting measure used to quantify a company's effectiveness in collecting its receivables or money owed by clients. The ratio shows how well a company uses and manages the credit it extends to customers and how quickly that short-term debt is collected or is paid. 2005: 1500/180 = 8.33 (Unfavorable) 2004: 1435/160 = 8.96 (Favorable) Interpretation: A higher ratio indicates that the being paid by the customers on time which helps to maintain the cash flow and payment of the business’s debts, employee salaries, etc. on time. It is a good sign when the accounts receivables turnover ratio is on the higher side since the debts are being paid on time instead of writing them off. It shows a healthy business model. In 2004 Unilate textiles have 8.96 receivable activities and it is favorable for company than 2005 Day’s sale outstanding Significance: Determining the day’s sales outstanding is an important tool for measuring the liquidity of a company’s current assets. Due to the high importance of cash in operating a business, it is in the best interests of the company to collect receivable balances as quickly as possible. (Rec. * Days in year)/ Annual Sales 2005: (180*360)/1500 = 43.2 (unfavorable)

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Ratio Analysis 2004: (160*360)/1435 = 40.139 (Favorable) Interpretation: Days Sales Outstanding is a company's average collection period. A low figure indicates that the company collects its outstanding receivables quickly. Typically it is looked at either quarterly or yearly (90 or 365 days). Unilate have 40.139 DSO in 2004 than 2005 and it is Favorable for company

Payable turnover in days: (Account payable* Days in year)/ Annual 2005: (30*360)/1230 = 8.78 (unfavorable) 2004: (15*360)/ 1176.7 = 4.58 (Favorable) Significance: Payables turnover is an important activity ratio, and provides a measure of how effectively a business is managing its payables. The payables turnover ratio measures the number of times the company pays off all its creditors in one year. Interpretation: A low payables turnover ratio (or high days payables) is in favor of the company. However, it could also mean that the company is finding it difficult to make payments. ). Unilate have 4.48 payable turnover in 2004 than 2005 and it is Favorable for company. If a company has a high payables turnover ratio, it indicates that the company has very lenient payment policy, and it is probably not taking advantage of credit facilities. It can also mean that the company is using the discounts offered by the suppliers for early payments Inventory Turnover in days: (Inventory*Days in year)/CGS 2005: (270*360)/1230 = 79.02 (Favorable) 2004: (200*360)/ 176.7 = 61.18 (unfavorable) Significance: An activity ratio measuring the efficiency of the company's inventories management. It indicates how many days the firm averagely needs to turn its inventory into sales. Interpretation: Companies that have low inventory turnover are not moving product through the marketplace quickly. Companies that have high inventory turnover have excellent sales, and are moving 7

Ratio Analysis inventory quickly. Ultimately, the turnover rate with the highest return is the best rate for any business. The higher the inventory turnover, the better since a high inventory turnover typically means a company is selling goods very quickly and that demand for their product exists. In 2005 unilate have high inventory turnover 79.02 than 2004.

Fixed Asset Turnover: Sales/ Net fixed Assets 2005: 1500/ 380 = 3.94 (unfavorable) 2004: 1435/350= 4.1 (Favorable) Significance: Fixed Asset Turnover (FAT) is an efficiency ratio that indicates how well or efficiently a business uses fixed assets to generate sales. This ratio divides net sales by net fixed assets, calculated over an annual period. The net fixed assets include the amount of property, plant, and equipment. Interpretation: A high asset turnover ratio indicates greater efficiency. A low asset turnover ratio indicates inefficiency, or high capital-intensive nature of the business. A low fixed asset turnover ratio could also mean that the company’s assets are new (less depreciation). Unilate have high asset turnover ratio in 2004 and it is favorable for company

Total Asset Turnover: Annual sales/ Total Assets 2005: 1500/845= 1.775 (Unfavorable) 2004: 1435/750 = 1.913 (Favorable) Significance: The asset turnover ratio measures a company's efficiency and productivity. A company can increase a low asset turnover ratio by continuously using assets, limiting purchases of inventory and increasing sales without purchasing new assets. It is calculated by dividing a company's sales by its total assets. Interpretation: The ratio measures the efficiency of how well a company uses assets to produce sales. A higher ratio is favorable, as it indicates a more efficient use of assets. Conversely, a lower ratio indicates the company is not using its assets as efficiently. Unilate have 1.913 asset turnover ratio in 2004 and it is favorable for company. 8

Ratio Analysis Debt management ratio Debt Equity Ratio Total Debt/ Shareholders Equity 2005: 410/435 = 0.94 (unfavorable) 2004: 360/390 = 0.92 (Favorable) Significance: This ratio is calculated to know the extent of debt used in the business concern. The outsiders are calculating this ratio to know the liquidity position of the company. Interpretation: The debt to equity ratio is a financial, liquidity ratio that compares a company’s total debt to total equity. The debt to equity ratio shows the percentage of company financing that comes from creditors and investors. A higher debt to equity ratio indicates that more creditor financing (bank loans) is used than investor financing (shareholders). Lower values of debt-toequity ratio are favorable indicating less risk. Higher debt-to-equity ratio is unfavorable because it means that the business relies more on external lenders thus it is at higher risk, especially at higher interest rates. Unilate have low Debt equity in 2004 that is 0.92 and it is favorable for company than 2005

Debt to total assets Ratio Total Debts/total Assets 2005: 410/845 =0.485 (unfavorable) 2004: 360/750 = 0.48 (Favorable) Significance: The debt to total assets ratio is an indicator of a company's financial leverage. It tells you the percentage of a company's total assets that were financed by creditors. Interpretation: The debt to asset ratio is very important in determining the financial risk of a company. A ratio greater than 1 indicates that a significant portion of assets is funded with debt and that the company has a higher default risk. Therefore, the lower the ratio, the safer the company. Unilate have 0.48 debt to total asset in 2004 and it is safer for company than 2005 Gearing Ratio: Long term debt/ L.T.D + SH Equity 2005: 280/ 280+435 =0.391 (favorable) 2004: 255/255+390=0.395 (unfavorable) 9

Ratio Analysis Significance: Capital Gearing Ratio is a useful ratio to find out whether a firm’s capital is properly utilized or not. To investors, the importance of capital gearing ratio lies in whether the investment is risky or not. Interpretation: A high gearing ratio means the company has a larger proportion of debt versus equity. Conversely, a low gearing ratio means the company has a small proportion of debt versus equity. The higher the ratio, higher the chances of default and hence more hindrance in the growth of the company. Similarly, the lower the ratio the better it is.unilate have favorable gearing ratio in 2005 than 2004. Profitability Ratios What Are Profitability Ratios? Profitability ratios are a class of financial metrics that are used to assess a business's ability to generate earnings relative to its revenue, operating costs, balance sheet assets, and shareholders' equity over time, using data from a specific point in time. Key Takeaways:  Profitability ratios consist of a group of metrics that assess a company's ability to generate revenue relative to its revenue, operating costs, balance sheet assets, and shareholders' equity.  Profitability ratios also show how well companies use their existing assets to generate profit and value for shareholders.  Higher ratio results are often more favorable, but ratios provide much more information when compared to results from other, similar companies, the company's own historical performance, or the industry average. Net profit margin on sales Net income/ sales 2005: 54/1500= 0.036 (unfavorable) 2004: 59/1435 = 0.0411 (Favorable) Significance: Profitability ratios show a company's overall efficiency and performance. Profitability ratios are divided into two types: margins and returns. Ratios that show margins represent the firm's ability to translate sales dollars into profits at various stages of measurement. Interpretation: Unilate have high profitability in 2004 and it is favorable for company than 2005 A higher value means that the company is doing well and it is good at generating profits, revenues and cash flows. Profitability ratios are of little value in isolation. Gross Profit Margin: Sales - Cost of Goods Sold 10

Ratio Analysis

Sales 2005: 270/1500 = 0.18 (Favorable) 2004: 258.3/ 1435 = 0.18 (Favorable) Significance: Gross profit margin measures the profitability of sales less the direct cost of those sales. The higher the percentage, Gross profit margin shows how well management prices the product, as well as the volume of sales. This margin looks at the efficiency of a firm’s procurement and/or production process. Interpretation: In the case of unilate, the gross profit margin is same in 2004 and 2004 and both are favorable for company. Company’s gross profit margin is equal in both year. Return on investment NI / Total assets 2005: 54/845 = 0.063 (unfavorable) 2004: 59/ 750 = 0.078 (Favorable) Significance: Return on Investment (ROI) is a performance measure used to evaluate the efficiency of an investment or compare the efficiency of a number of different investments. ROI tries to directly measure the amount of return on a particular investment, relative to the investment’s cost. To calculate ROI, the benefit (or return) of an investment is divided by the cost of the investment. The result is expressed as a percentage or a ratio. Interpretation: To interpret the ROI percent results, collect appropriate, comparative data such as trend (time series) or industry data on ROI. The business owner can look at the company's ROI across time and also at industry data to see where the company's return on investment ratio lies. The higher the return on investment ratio, the more efficiently the company is usin...