Written Assignment - Unit 7 ( Financial ratio trend analysis) PDF

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Written Assignment - Unit 7

Financial ratio & trend analysis Ratio analysis is a tool for evaluating financial statements but also relies on the numbers in the reported financial statements being put into order to be used as ratios for comparison over time or across companies. Financial statements are used as a way to discover the financial position and financial results of a business. With a few exceptions, such as ratios involving stock price, the majority of the data used in ratio analysis comes from the financial statements. Ratios put this financial statement information in context. (Lumen learning n.d.)

Although ratios are very helpful but caution must be exercise when comparing companies that not in the same industry against others in outside of that industry. Narratives 1 Profit margin ration - Is the degree to which a company's business activities make profit. It is calculated as a percentage of sales; net income divide by net sales. It is the amount that has been generatd as profit as a proposition of sales. 2 Return on Assets - This is the rate at which the assets of the business is capable of generating profits. that indicates how profitable a company is in relation to its total (Marshall, 2021).

Current ratio - This is a liquidity ratio that measures the ability of a company to pay short-term obligations. 3 4 Quick ratio - This is an extension of the current ratio. It is a liquidity ratio that measures the ability of a company to pay its short-term obligations without having to use its non-cash assets or using its most liquid assets. (Shobhit, 2021). 5 Accounts receivable ratios (AR Turnover Ratios) - There are indicators of a company’s ability to efficiently collect accounts receivable and the rate at which their customers pay off their debts. Higher ratios are often preferable as they suggest faster turnover and healthier cash flow. Businesses that get paid faster tend to be in a better financial position. This ratio is otherwise known as “receivable turnover” or “debtors turnover” ratio, the accounts receivable turnover ratio is an efficiency ratio — specifically an activity financial ratio — used in financial statement analysis. It purpose is to measure how efficiently and quickly a company converts its account receivables into cash within a given accounting period of time. (Scott, 2020).

6 Average collection period - Iis the average number of days between the dates that credit sales were made, and when that money was received/collected from the customers. The average collection period is also referred to as the days' sales in accounts receivable. 7 Inventory Turnover Ration - Thi is the amount of time that passes from the day an item is purchased and when it is sold. One complete turnover of inventory means the company sold the stock that i purchased, less any items lost to damage or shrinkage. Inventory includes all goods, raw or finished, that a company has in stock with the intent to sell. (Abbey, 2020). 8 Average sale period - Is the period from the moment a product is purchased and stored until the sale occurs. The average sale period (PMV) is the period it takes to sell a product since its purchase or production. It is an economic indicator that allows us to have an idea of the time it takes to sell. The mathematical formula to determine average collection ratio requires you to multiply the days in the period by the average accounts receivable in that period and divide the result by net credit sales during the period. 9 Debt-to-equity ratio (debt/equity ratio, D/E) indicates the relative proportion of entity's equity and debt used to finance an entity's assets.It is otherwise called financial leverage ratio and it is the key financial ratio used as a standard for judging a company's financial standing. It is also a measure of a company's ability to repay its obligations. (Readyratios.com, n.d.) Page 1

Revenue Revenue Percentage (%)

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Summary of calculations

2,500,000 100%

5,400,000 100%

44%

40%

Profit margin is relative to sales and calculated as a percentage of same. Profit margin of Fashion Forward is more by 4% when compared to Dream Designs

1 Profit Margin Ratio

GP/Net Sales

Income statement (IS)

2 Return on Assets 3 Current Ratio 4 Quick Ratio

Net income/ Total assets CA/CL (CA-Inventory)/CL

IS & BS Balance sheet (BS) Balance sheet (BS)

5 AR Turnover Ratio

Net credit sales/Average accounts rec. IS & BS

6 Average Collection Period

365days / AR Turnover Ratio

IS & BS

32

7 Inventory Turnover Ratio

COGS / Average inventory

IS & BS

12.9

15.7 DD is better placed with FF here

8 Average Sale Period

365days* Average acct. rec./Net credit IS & BS

31.9

22.2 Calculated in number of days, the shorter the better.

9 Debt to Equity Ratio

Total liabilities / shareholders fund

0.96

0.77 Financial leverage benchmark is usually 1:1

Balance sheet (BS)

4.97% 1.11 1.01 11.43

4.85% The 1.40 Both companies surpassed the ratio 1:1 1.28 Both companies surpassed the ratio 1:1 Number of times. The higher the number of times, 16.46 the better. This is in number of days and shorter the period, the better. DD is better placed 22

RECOMMENDAATIONS In conclusion, ratio analysis and trend should not be the only bases for concluding and accepting a company over the other, the other quatitatives factors and all important quanlitative factors should, a well, be considered. Fashion Forward seems very likely to be selected based of profitability but the Dream Designs is equally good in terms of liquidity and inventory turnover. There may be other factors to really consider before a final decision is made, on this. Example of those other factors are the integrity of the owners and directors - qulitative factor and other factors that could be tied to the going concern of the business - availability of raw materials to continue production in the long-run etc. Comparing FF & DD, as mentioned earlier, FF has a better profitability, return on assets and deb to-equity ratio while DD has a better liquidity, receivable turnover ratio, better debt collection period, inventory ratio and average sale period. So, it is absolutely difficult to choose a company over the other in this scenario, other parameters may then be helpful. Page 2

REFERENCES

Abby, J. (2020, November 16). Inventory Turnover Ratio Defined: Formula, Tips & Examples. Retrieved from https://www.netsuite.com/portal/resource/articles/inventory-management/inventoryturnover-ratio.shtml Fresh desk by freskwork. (n.d.) What is average collection period? Retrieved from https://www.thebalancesmb.com/average-collection-period-ratio393191#:~:text=The%20formula%20for%20calculating%20the%20average%20collection%20period,the%20period%2C%20then%20divide%20that%20by%202.%20 Heisinger, K., & Hoyle, J. B. (n.d.). Accounting for Managers . https://2012books.lardbucket.org/books/accounting-for-managers/index.html Jeff, G., & Moore, S. (n.d.). Financial statements and ratio analysis. FAPPO. Marshall, H. (2021, April 08). What is return on assets (ROA): Investopedia . Retrieved from https://www.investopedia.com/terms/r/returnonassets.asp Scott, B. (2020, August 24). Accounts Receivables Turnover Ratio: Definition, Formula & Examples . Retrieved from https://www.netsuite.com/portal/resource/articles/accounting/accountsreceivable-turnoverratio.shtml#:~:text=The%20formula%20for%20calculating%20the%20AR%20turnover%20rate,credit.%20The%20shop%20totaled%20%24100%2C000%20in%20gross%20sales. Shobhit, S. (2021, October 20). Quick ratio: Investopedia. Retrieved from https://www.investopedia.com/terms/q/quickratio.asp The Finance Storyteller. (2019, January 290). Financial Ratio Analysis. [Video]. YouTube .

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