The return on capital employed ratio (ROE) is a fundamental measure of business performance. ROCE in Year1 and Year2 are 20.05 % and 29.60%, respectively. In comparison, the year before last (Year1) and last year (Year2), Year2 had high performance than Year1. It would appear that Year2 is more successful than Year1. It also means Year2 is more profitable than Year1 as Year2 has made better use of company's resources. As a result, Year2 is giving a much greater return on the funds invested in it. This comparison is important in assessing the effectiveness with which funds have been deployed. ROCE is considered by high. Year2 is higher than Year1. What is more, in ROCE, the ratio show PL has success to get the profit. Furthermore, it is also important to compare ROCE with current market borrowing rates as they want to continue to wrangle with the bank over its demands. Here, Year1 and Year 2 can show they didn't have profitability problems, because they get the profit form the value of resources. For example, they have a regular customer, and export to France and Switzerland,the sales also got the order from Arena.
Looking at the return on equity, equity capital in Year2 is more than Year1 meanwhile the profit after
Tax and preference dividend is higher in last year than in the year before last. In compassion, Year2
is earning much higher than Year 1. It means that shareholders can get more profit in Year2 more than Year 1. This is because PL wants to raise the remaining share capital, the directors invest more capital, and friends, family and business contacts were approached. However, company's high return on quality does not present high profitability. It only appears PL has an ability to gain high profit and to return on the shareholders equities. In the future, maybe PL should create the value to attract potential investors. The key point is the return on equity showing debt finance gearing. PL's .overdraft may cause debt problems to affect the return on equity.
The gross profit: there was a slight grow between Year1 and Year2. The gross profit was relative to sales revenue and cost of sales for last two years. The sales revenue in last year is higher than the year before last. In addition, the cost of sales in Year2 is as twice more than Year1. However, to compare these two gross profits ratios, it looks like similar. This could mean that sales price in last year is the same as the year before last or that the purchase cost of goods sold are similar.
Moreover, the sales revenue has increased from 14,006,000 in Year1 to 22,210,000 in Year2. If sales revenue was increased then the gross profit could be increased. It is not difficult to compare for last two years here because it almost the same. There was a slight grow performance in Year2. Clearly, part of increase in the net profit margin ratio is linked to the slight increase in the gross profit margin ratio. They both show in Year 1 and Year 2. To compare the Year 1 and Year 2, the net profit margin in Year2 is more performance that Year 1.
Stock turnover period indicate how quickly goods more through the business. On average, the stock held are being 'turned over' every 118 days in Year1. On the other hand, Year2's stock held are being 'turned over' every 183 days. PL should prepare a short inventories turnover period to a long one. Stock held in Year1 is better than Year2. It means that the goods have been sold about 183 days later in Year2. It could pay more cost to storage the stock or their stocks are more than the demand.
For Year2, the stock turnover has a direct bearing upon gross profit. However, in the year before last, the profit can be increased because of the short stock turnover. In contrast, Year2 may sell the inventories late and get the profit from customer late.
Debtors turnover in days mean funds are being tied up that may be used for more profitable purpose.
This is one of the reasons that PL has less cash in hand. In comparison, the funds can be receivable within 42 days in Year1. On the other hand, the debtors turnover in days has increased in Year 2. it needs 61days, this is not good for PL. Some customers might be slow to pay. If company receives money late, it means that high cash was tied up in trade receivables for sales revenue was occurred.
However, creditors turnover in days was a slight increase between Year1 and Year2. To compare Year 1 and Year2, trade payable 82 days in Year 2 is more benefit than Year1 within 59 days. It means that PL can use free finance provided by supplier in Year 2. Finally, the efficiency ratios here present that Year1 had short-term stock turnover period, receivable is also shorter than Year 2. Year1 may get more profit than Year2. It also means Year1 has more efficiency than Year2. This situation is caused the problem by cash in PL.
There are indications that last year has a significant liquidity problem as shown by both the current and quick ratios. What is more, credit customers seem slow to pay which may be influence on payment to suppliers. Looking at Year1, it seems have the same problem as Year2 because of current and quick ratios. Both of these information show it may have cash flow trouble. We can see that the 'liquid' current assets do not quite cover the current liabilities, so PL may be experiencing some liquidity problems. PL tries to do too much too quickly with too little long term capital, it may cause liquidity troubles because short of money.
For the last two years, we can see both of them are low gearing, the gearing less than 50%. To compare the ROE and gearing in Year 1, gearing is higher than ROE, it may cause liabilities higher than assets. In addition, it's the same as Year2. As a result, the bankruptcy for PL is possible.
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Summary and suggestion:
As the information, PL has more profits in business. They have regular customer to keep business stably. They got a big order so establish their player major in the market. According to profitability ratios, Year1 is more profitable than Year2, thus, the total value of profit was increased than before.
What is more, looking at efficiency ratios, it was not good to PL. Year2 had more bad conditions than Year1. The problem is form here. In Year1, stock turnover period is short and debtors collection period is short, too. But, in Year 2, only creditors payment period is more benefit than Year1. This is not balance to finance position in PL. PL has too inventories and has too slow speed to get the money back from customer, the working capital is becoming less. Moreover, as liquidity ratios show, the cash flow troubles both on last two years. As the liabilities are higher than assets, PL has to face the bankruptcy in the future because they do not have cash to pay the expenses. Apart from this, the gearing shows that the information relative to the ROE, it also points out the liabilities is higher than assets.
To summarize all the ratios analysis, we can find there are some problems in PL. The first one is, they spent a lot of money on employing a young and talented design team. As the money use, it should refer to their profitability and efficiency ratios to see when they can get the money form receivable.
They can set profitability targets as their business basis needs. As they earn more money more than that target, the shareholders will be better off selling the business and putting the money in the bank.
The second one is capital. They are too quickly to collect capital to invest their business. Most capital collect from friends, family and business contacts. The biggest shareholder is Keeble Ltd which is keen to diversify into other areas business. When PL hope Keeble brothers can help by purchasing further share in the company or making a loan, they did not have the money to invest further in PL again. Keeble also want to sell their shares in PL to generate much needed cash for their ailing company. The major shareholders have the same problems causes PL getting worse. PL should recreate the value and profit in order to attract new investors to invest in their business.
Thirdly, PL has increased rapidly, but they do not have staff with financial expertise. This is a serious problem in the company, because no one can quickly to point out the finance problems. The most important thing is to hire a professional accountant to deal with their transactions immediately. Then, the next problem is bank loan. They spent a lot on that addition plant and they did not get anything from the old machines they got rid of, but most of that was covered by the bank loan, They pay all the expenses include depreciation without check. I suggest they have to focus on their balance sheet, income statement and cash flow statement. They need to reduce the bank loan. For all the purchases, PL should be retained their cash as long as possible by ensuring that full advantage is taken of credit facilities offered by supplies. They have to utilize the creditors payment period. The next one is also about bank problem, it is overdraft. The bank wants PL to reduce the overdraft by half over the next six months. However, they just got a big order from Arena. They need to produce the goods as soon. The good suggestion for this is that the directors of PL need to make a plan of how do they reduce their overdraft from bank. After that, they have to arrange the meeting to negotiate with bank again.
Moreover, the board of directors was not able to agree on a way of dealing with financial problem by the company. In the meeting, they do not consider that finance problem is from overdraft. This is not fist time that company breached its overdraft limit. This time, bank informed them to pay off such a large part of the overdraft in such a short period of time. The meeting should make deal with all the shareholders to concern about the problem, not ignored it. Furthermore, the stocks and debtors collection are also the problems. As stock turnover period shows last year's stock is higher than the year before last. PL has to reduce the stocks in order to reduce the cost or expenses at the same time they can promote their goods to reduce the stock. In addition, they can give some discount to customer so as to receive the money quickly.
Finally, the directors seem to seek the solution to solve the finance problem. On is to look someone who was prepared to make a significant investment in the business. They felt that only a large injection of new funds could keep the business on track. but the Keeble brothers rejected. In this point, if PL does not solve their finance problem to focus on their financial ratios and overdraft, maybe they can
collect capital to solve the problem on this time. But it kinds of worry about next time, the problem is getting worse. PL can establish a new group to discuss how to manage the problems. Another one result form meeting is to seek to help. This can find out the real problem and to seek the method to solve the problem.
In conclusion, not many company focus on their finance problem. Even they calculate the accounting ratios, they are spending less time to analyze it. According to each figure, it will show the sign of financial in danger. There are several types of financial ratio such as profitability ratios, efficiency ratios, liquidity ratios, capital ratios and investment ratios. Company can follow these to check it in the period. These methods can help company to be health within their finance position. What is more, profit is important to company, but profit is not the only number to show its positive to company. There are many factors that company have to concern it.
All the information from:
Dr. Mohamed Saeudy Lectures Notes (Ratio Analysis)
Atrill P. and Mclaney E. 2008, Accounting and Finance for non-specialists 6th
