Accounting ratio also is defined as financial ratio. The term of accounting ratio is to examined the two most important financial statements of profit and loss account and balance sheet. To recapitulate - the trading performance of a company for a period of time is measured in the profit and loss account by deducting running costs from sales income. A balance sheet sets out the financial position of the company at a particular point in time, namely, the end of the accounting period. It lists the assets owned by the company at that date matched by an equal list of the sources of finance. A person experienced in reading company accounts can get some insight into a company's affairs by examining these financial statements. Changes in some of the key items can be identified by comparing the current year's figure with the previous year's figure, but conclusions drawn from this approach can be misleading. Consider the following situation. Example Consider a company whose profit increased by 5 per cent over the previous year. This might appear to be a good performance until one considered that a 4 per cent rate of inflation existed during the year, and that an extra 10 per cent of capital employed was needed to earn that extra profit.
Ratios can be expressed in one of three forms although it is mainly convention which determines which form one particular ratio will take.
The three forms are:
A)a percentage - say when profit is expressed as a percentage of sales turnover;
B)a multiple - for example, sales being three times the size of the capital employed;
C)a true ratio - as when the ratio of current assets to current liabilities was 2:1.
Purpose of accounting ratio
Accounting ratios are purpose to compare the below:
A) A company's results when it reach a period of time
B) The result between a company with another company. It is the best to compare with the best ,such as a world class company, or to compare with the industry standard for that type of business.
C)the company's results with those expected. It is useful to use budgets for this purpose
5aspects and area of business measured
A)Profitability ratios is measure to compare the profitability of one company with another or of one company over time.
B)Liquidity ratios, used to compare the liquidity of one company with another or of one company over time.
C)Investment ratios, used by potential investors when making investment decisions.
D)Efficiency ratios, used to compare company efficiency with others or with itself from one year to another.
Formula of the aspects and area of bussiness uses
Profitability of company
A)Gross profit markup
B)Gross profit margin
C)Profit margin on sales
D)Basic earning power (BEP)
E)Return on total assests (ROA)
F)Return on common equity (ROE)
Liquidity of company
A)Current ratio / working capital ratio
B)Liquid ratio / quick ratio / acid-test ratio
Asset management of company
A)Inventory turnover or stock turnover
B)Fixed assets turnover
C)Total assets turnover
D)Debtor ratio
E)Debtor payment period
F)Days sale outstanding(DSO)
Debts management and capital gearing of company
A)Debts ratio / total debts to total assets ratio
B)Capital gearing ratio
C)Debts equity ratio
D)Times interest earned / interest cover
E)Creditor ratio
F)Creditor payment period
Market value of investment to ordinary shareholders / common stockholders
A)Earnings per share
B)Price / earnings ratio (P/E ratio)
C)Dividend cover
D)Earnings yield
E)Dividend yield
F)Price / cash flow ratio
G)Market price / book value ratio
Comparison inter-temporal and inter-firms
Inter-temporal comparison
There are many problems in trying to identify trends and make comparisons, below are just few:
a) Impacts of changes in technology on the price of assets, the likely return and the future markets.
b) Impacts of a changing environment on the results reflected in the accounting information.
c) Problems associated with establishing a normal base year to compare other years with.
d) Effects of price changes make comparisons difficult unless adjustments are made.
e) Potential effects of changes in accounting policies on the reported results.
Inter-firm comparison
Many problems are in trying to identify trends and make comparisons. Below are just few examples:
a) Impacts of the size of the business and its comparators on risk structure and returns.
b) Impacts of different environments on results, e.g. different countries or home based versus multinational firms.
c) Selection of industry norms and the usefulness of norms based on averages.
d) Different firms using different accounting policies.
e) Different firms having different financial and business risk profiles and the impacts on analysis.
1.1Two Companies Are Selected
The two companies that selected were Gamuda Berhad and WCT Berhad for business performance. Gamuda Berhad is an engineering, property and infrastructure company in Malaysia.The company was incorporated on October 6, 1976 and was listed on the main board of Bursa Malaysia on 10 August 1992. The group's main projects range from the construction of highways, airport runways, railways, tunnels, water treatment plants and dams, to infrastructure privatization and the development of new townships.
One of their first major project is the Shah Alam Expressway, a 34.5 km six lanes expressway stretches from the Sri Petaling interchange in Kuala Lumpur to the Pandamaran interchange in Klang. Gamuda is a leader in turnkey and Build-Operate-Transfer (B.O.T.) civil engineering infrastructure and township development, with projects and investments in South East and Far East Asia, Indochina, South Asia and the Middle East.Gamuda also is the lead shareholder in the 450MW Nam Theun 1 hydropower project located in central Laos, which would supply 2,000 GWh of hydroelectric power to the Electricity Generating Authority of Thailand.
Established on 14 January 1981 as WCT Earthworks & Building Contractors Sdn Bhd, the Company became a public company on 1 April 1994. WCT made its debut on the Malaysia Stock Exchange on 16 February 1995. The Company assumed its present name WCT Berhad since 5 June 2008 to reflect the diverse businesses within the WCT Group of Companies.
Over the years, with continuous hard work, perseverance, and beliefs in management productivity and efficiency, WCT has elevated its standing and solid reputation in the construction industry both local and abroad. As a team, we strived through the period of slow economic growth in the mid-1980s, as well as the financial crisis in the late 90s. These periods have not only strengthened our position in the construction and property industry but also propelled us into expanding our products and services to include project management, construction design, value engineering and assets management.
1.2 Financial Statement Analysis
Below is an accounting ratio for two companies.
1.2.1 Profitability
Ratio
Ratio with Formula
Calculation for Gamuda Berhad
Calculation for
WCT Berhad
Gross Profit Markup
Gross Profit Margin
Operating Profit Margin on Sales
Profit Margin on Sales
Basic Earning Power
Return on Total Assets
Return on Common Equity
1.2.2 Liquidity
Ratio
Ratio with Formula
Calculation for Gamuda Berhad
Calculation for
WCT Berhad
Current Ratio
Acid-test Ratio
1.2.3 Asset Management
Ratio
Ratio with Formula
Calculation for Gamuda Berhad
Calculation for
WCT berhad
Inventory Turnover
Total Assets Turnover
Debtor Ratio
Day Sales Outstanding
1.2.4 Debts Management
Ratio
Ratio with Formula
Calculation for Gamuda Berhad
Calculation for
WCT Berhad
Debts Ratio
Debts Equity Ratio
Times Interest Earned or Interest Cover
1.2.5 Market Value of Investment to Stockholders
Ratio
Ratio with Formula
Calculation for Gamuda Berhad
Calculation for
WCT Berhad
Earnings Per Share
Price Earnings Ratio
Earnings Yield
Market Price Per Book Value Ratio
1.3 Accounting ratio between WCT Berhad and Gramuda Berhad
1.3.1 Profitibility
The Gamuda Berhad profitability ratio counted in the aspect between two companies that is higher than WCT Berhad. Gross profit margin , operating profit margin , basic earning power, return on total assets and return on common equity are all lower than industry average. This indicates that company was ineffective in controlling its expenditures and inefficiently using its assets and capital in running business activities at higher operating costs to reduce its profit earning.
1.3.2 Liquidity
In the liquidity, Gamuda Berhad current ratio and acid-test ratio was higher than WCT Berhad. Current ratio and acid-test ratio both are lower than industry average , indicating that company might have lesser amount of current assets and liquid assets in relation to its current liabilities so that company has low liquidity to finance its short-term debts and might be facing some short-term financial problem.
1.3.3 Assets management
In the assets management, the inventory turnover of Gamuda Berhad was lower than WCT Berhad . Asset Management Ratios attempt to measure the firm's success in managing its assets to generate sales. For example, these ratios can provide insight into the success of the firm's credit policy and inventory management. These ratios are also known as Activity or Turnover Ratios. In general, the higher the Receivables Turnover Ratio the better since this implies that the firm is collecting on its accounts receivables sooner.
1.3.4 Debts management
Debt is called Financial Leverage because the use of debt can improve returns to stockholders in good years and increase their losses in bad years. Debt generally represents a fixed cost of financing to a firm. Thus, if the firm can earn more on assets which are financed with debt than the cost of servicing the debt then these additional earnings will flow through to the stockholders. Moreover, our tax law favors debt as a source of financing since interest expense is tax deductible.
1.3.5 Market Value to common stockholders
While in market value to common stockholders , the earning per share and earning yield of WCT Berhad was higher than Gamuda Berhad. Due to lower earning per share , stockholders have to use more times of profit earning , more times of net cash inflow and longer period to recover back their share investment . This is evidenced by the Price / earning ratio and Price / cash flow ratio being higher than industry average
1.4 Conclusion
Ratios on their own do not provide information to enable managers to gauge performance or make control decisions. It is necessary to provide budgeted or target ratios, ratios of previous accounting periods, or ratios of other companies or divisions, as a yardstick for comparison. Not just that, ratios compared over a period of time at historical cost will not be properly comparable where inflation in prices has occurred during the period unless an adjustment is made to the ratios to make allowance for price level differences. Example, using current values of assets. And also, there must be careful definition of ratios used. For example, should return equal profit before interest and taxation, profit after taxation, profit before interest, taxation and investment income? Similarly, should capital employed include or exclude intangible assets and should assets be valued at net book value, gross book value or net placement cost?
The ratios of different companies cannot be properly compared where each company uses a different method to:
1) Value fixed assets
2) Value closing stock
3) Apportion overheads, in absorption costing
4) Account for development costs
5)account for good will
Ratio analysis is not foolproof. There are many problems in trying to identify trends and make comparisons. Below are some inter-firms comparison problems:
a) Impacts of the size of the business and its comparators on risk structure and returns.
b) Impacts of different environments on results, e.g. different countries or home based versus multinational firms.
c) Selection of industry norms and the usefulness of norms based on averages.
d) Different firms using different accounting policies.
e) Different firms having different financial and business risk profiles and the impacts on analysis
Question 2
2.0 Definition of Financial Market
Organizations and people who are lack of fund and waiting to borrow money are bought together with those having surplus fund for lending out in the financial market so that those lack of fund can borrow money from those having surplus fund in the market. There are many different financial markets. Different financial markets serve different type of customers and operate in different parts of the country. Financial markets differ from physical asset markets because physical asset markets are also called tangible asset markets or real asset market to deal with the tangible, real and physical products such as computer, machinery, real estate and other physical assets whereas the financial markets are to deal with different types of financial instruments such as stocks or shares, bonds, notes, mortgages and other claims on real assets as well as with the derivative securities or commodities whose values are derived from changes in the prices of other assets. Financial market and physical asset market both also can operate as the spot market or future market. Spot market refers to the deals being bought or sold for on the spot delivery within a few days whereas future market refers to the deals being bought or sold for on the future delivery at some future date such as six months or a year into the future. There are some major financial markets as follows:
Money markets:
This is the financial market dealing with short-term, highly liquid debt securities in which funds are borrowed or loaned for short periods of less than one year.
Capital markets:
This is the financial market dealing with stocks or shares, intermediate or long-term debts in which funds are borrowed or loaned for long periods of one year or more than one year.
Mortgage markets:
This is the financial market dealing with loans on residential, commercial, industrial real estate and farmland.
Consumer credit markets:
This is the financial market dealing with loans on autos and appliances, as well as loans for education, vacations and so on.
Primary markets:
This is the financial market in which corporations raise capital by issuing new securities or new shares.
Secondary markets:
This is the financial market in which the existing and already outstanding securities or other financial assets are traded among investors after they have been issued by the corporations.
Initial public offering (IPO) market:
This is the financial market in which firms or corporations "go public" by offering securities or shares to the public for the first time.
Private market:
This is the financial market in which financial transactions are worked out privately and directly between two parties without going to public where the transactions may be structured in any manner that appeals to the two parties, Examples of private market transactions are bank loans and placement of debts with insurance companies.
2.1 Transfer of capital or fund between savers
There are three different ways in which capital or fund can be transferred between savers and borrowers. These are explained as follows:
2.1.1 Direct transfer from savers to borrowers:
It takes place when a corporation issues and sells its stocks or bonds directly to savers without passing through any financial institution so that the corporation as borrower directly delivers its securities to savers who in turn give money to the corporation. By this, the capital or fund is directly transferred from savers to corporation. This is shown in following diagram:
2.1.2 Indirect transfer from savers to borrowers through investment banking house:
It takes place when an investment bank underwrites the issuance of a corporation's securities where the investment bank serves as a middleman to facilitate the issuance of corporation's securities by purchasing the securities of corporation and then resell the same securities if the corporation to savers so that the money paid by the savers for purchase of corporation which acts as borrower. Therefore, the corporation's securities and the savers money merely pass through the investment banking house. By this, the capital or fund is indirectly transferred through investment banking house from savers to corporation (borrower).This is shown in following diagram:
2.1.3 Indirect transfer from savers to borrowers through a financial intermediary:
In takes place when a financial intermediary such as a bank or a mutual fund obtains fund from savers by issuing its own securities or certificate of deposit savers. Then, the financial intermediary uses the fund collected from savers to purchase and to hold the securities of other corporations as investments. In this case, the capital or fund is transferred from savers to financial intermediary when savers pay money to financial intermediary in exchange for receiving certificate of deposit or securities issued by the financial intermediary. Then, in turn the financial intermediary will further transfer this fund to other corporation. Most of the savers prefer to hold certificate of deposit and the securities of financial intermediary because they are safer and more liquid than mortgages and loans. Therefore, financial intermediaries greatly increase the efficiency of money and capital markets. This shown in following diagram:
2.2 Investment banking house
For the investment banking house is an organisation that underwrites and distributes the new issue of business corporations securities to assist corporation obtain fund for financing. An investment bank may also assist companies involved in mergers and acquisitions, and provides ancillary services such as market making, trading of derivatives, fixed income instruments, exchange, commodities, and equity securities. For examples of for the investment banking house are Merrill Lynch and Morgan Stanley Dean Witter.
Financial intermediaries
For the financial intermediaries are specialized financial firms that facilitate the transfer of funds from savers to demanders of capital or borrower. After that, the financial intermediaries are generally large; they gain economics of scale in analyzing the creditworthiness of potential borrowers, in processing and collecting loans, and in pooling risks and helping individual savers to diversify their fund investments. Followings are some of major financial intermediaries. Most people do not enter financial markets directly but use intermediaries or middlemen. Commercial banks are the financial intermediary we meet most often in macroeconomics, but mutual funds, pension funds, credit unions, savings and loan associations, and to some extent insurance companies are also important financial intermediaries. Let's say the commercial banks; commercial banks are the traditional like the departmental stores of finance. For the historically, commercial banks were the major institutions that handled checking accounts and through which Federal Reserve System expanded or contracted the money supply. Savings and loan associations is the individual savers and residential and commercial mortgage borrowers where they collect funds from many small savers and then lend out this money to house buyers and other types of borrowers. Mutual savings fund also is the similar to savings and loan associations which accepts savings from individuals and then lend out money mainly on a long-term basis to house buyers and consumers. Credit unions are often the cheapest source of funds available to individual borrowers. Pension funds invest primarily in bonds, stocks, mortgages and real estate. Insurance companies have also offered a variety of tax-deferred savings plans designed to provide benefits to the participants when they retire and the last one mutual fund is collect funds from savers and then use these funds to buy stocks, long-term bonds and short-term debt instruments issued by businesses or government units.
