'Financial management is a process of planning decisions in order to maximize the owners' wealth. Financial managers have a major role in cash management, in the acquisition of funds, and in all aspects of raising and allocating financial capital, taking into account the trade-off between risk and return. Financial managers need accounting and financial information to carry out their responsibilities'.
Dyson James Limited
'We want creative, courageous and unconditioned fresh-thinkers. We don't stick people behind a desk. We like to give people a chance to make a difference'. James Dyson.
Dyson's UK head office is on the border of Malmesbury in Wiltshire - and it's won numerous architectural awards. Dyson is into invention of new products which makes life easier to the consumers. Dyson is the one who likes to make thing enhanced. What began through a solitary inspiration in UK has seen us open offices across the globe. Relatively a few of them are situated at UK, USA, Canada, Singapore, Malaysia, Germany, France, Holland and Japan.
RATIO ANALYSIS:
Hussain, A. (1985, p.81), describes ratio analysis as,
Ratio analysis is a power full tool of financial analysis.
A ratio is defined as 'the indicated quotient of two mathematical expressions' and as 'the relationship between two or more things'. In financial analysis a ratio is used as an index or yardstick for evaluating the financial position and performance of a firm.
PERL ANALYSIS:
To know the financial strength of a company PERL analysis tool is used to establish the performance and growth of the company, it also evaluates the risk and the liquidity factors in a company.
The following tools are used to evaluate the PERL analysis:
Performance
Efficiency
Risk
Liquidity
PERL YEAR
ANALYSIS 2008 2007
PERFORMANCE
GROSS PROFIT 57.24% 60.98%
NET PROFIT 9.88% 10.50%
OPERATING PROFIT 14.32% 14.53%
ROCE 44.96% 70.30%
ROE 195.20% 70.36%
RFCE 78.68% 84.00%
ROTA 21.37% 25.29%
EFFICIENCY
FAT 5.49 : 1 5.78 : 1
LAT 5.86 : 1 5.44 : 1
LPR 255.31 £ 277.46 £
DEBTOR AGE 80.15 days 69.45 days
CREDITOR AGE 77.20 days 93.44 days
STOCK TURN OVER 112.32 days 91.52 days
RISK
GEARING 334.16 % 0.080 %
INTEREST COVER 7.62 times 29.05 times
INTEREST GEARING 13.12 % 3.44 %
LIQUIDITY
CURRENT RATIO 1.62 : 1 1.17 : 1
ACID TEST RATIO 1.18 : 1 0.89 : 1
CASH EXHAUSTION RATIO 33.02 days 25.08 days
OPERATING CASH FLOW TO 47.66 % 39.71 %
MATURING OBLIGATIONS
PERFORMANCE:
GROSS PROFIT: Gross profit ratio helps to measure the firm's profitability. Gross profit is the result generated between volume of sales, cost of production and prices.
Gross Profit = Gross Profit*100
Sales
Year
2008
2007
Calculations
359697* 100
628306
372776* 100
611260
Outcome
57.24%
60.98%
Interpretation: The Company's profitability is measured in terms of Gross profit ratio, where it has a dip of 3% in 2008. The reason for this dip in profitability could be due to increase in cost of production as a result of managerial efficiency.
NET PROFIT: Net profit ratio is calculated as the net profit to sales and profit after tax and expressed in percentage. It is a measure of the company's managerial ability to offer reasonable reward to the owners for providing their capital at risk, reducing selling price and increase cost of production.
Net Profit = Net Profit*100
Sales
Year
2008
2007
Calculations
62129* 100
628306
64214* 100
611260
Outcome
9.88%
10.50%
Interpretation: Net profit has decreased from 2007 to 2008 that 0.60%. This may be because of all the expenses incurred during the year and also the interest payable and similar charges which were increased in 2008. This implies that the company's profitability has decreased in 2008 and it is not in a better position to reward its owners.
OPERATING PROFIT: Operating profit includes all the production over head, administration expenses, distribution overhead, selling expense and research and development. Operational profit is calculated by the operational profit by the total sales, where operational profit includes all the expenses and overheads of the company.
Operating Profit = Operating Profit*100
Sales
Year
2008
Calculations
90029* 100
628306
Outcome
14.32%
Interpretation: Operating profit in 2008 is low by 0.20% as compared to 2007 and has not made a big difference to speak about. But in fact the investment made in administration expense was low in 2008 where the company has cut down cost in that sector and this has reduced the figure to match up with previous years.
ROCE: Return on capital employed ratio is a elementary measure of company's performance. The ratio is expressed as the relation between the operating profit generated in that period and the long-term capital invested in the business. It is then expressed in percentage.
(ROCE) Return on Capital Employed = PBIT*100
Capital Employed
Where, Capital Employed = Share Holders Funds + Long Term Liability
Therefore, Capital Employed For 2008 = 46121+154119 = 200240
For 2007 = 126249+102 = 126246
Year
2008
2007
Calculations
90029* 100
200240
88832* 100
126351
Outcome
44.96%
70.30%
Interpretation: In 2008 ROCE has decreased by over a margin of 26 %. The reason for this is a massive increase in long term liabilities.
But in 2007 they had a good ROCA % of about 26 % which would have given better potential rewards for the share holders.
ROE: Return on equity ratio shows the company's profit earned in comparison to the book value of the owners equity. This ratio is used for those businesses which are privately owned because they have no word to determine the market value of owner's equity. ROE plays a secondary factor and not the primary factor for driving market prices.
(ROE) Return on Equity = PBIT*100
Equity Capital Employed
Where, Equity Capital Employed = Share Holders Fund - Minority Interest
Therefore, Equity Capital Employed For 2008 = 46121 - 0
For 2007 = 126249 - 3
Year
2008
2007
Calculations
90029* 100
46121
88832* 100
126246
Outcome
195.20%
70.36%
Interpretation: When we assume that ROE has increased by a big figure in 2008 compared to 2007 by 125 % the reason behind this may be the fact of the share holders investing in the company. In 2007 they had more share holders enjoying the benefit of the profits, and in 2008 the benefit is enjoyed by the owners of the company.
But, when we look into the director's report there are no signs of share holders in the company in 2007 compare to many in 2008. The process of share holders is misleading the ratios.
RFCE: Return of fixed capital employed provides an idea of how well the company is gaining its profits on the fixed capital. It is calculated as operating profit by total fixed capital employed and expressed in percentage.
(RFCE) Return of Fixed Capital Employed = PBIT*100
Total Fixed Capital Employed
Where, Total Fixed Capital is all of the Fixed Assets of the Organisation including Intangibles.
Year
2008
2007
Calculations
90029* 100
114413
88832* 100
105751
Outcome
78.68%
84.00%
Interpretation: In the year 2007 RFCE has increased and the reason for this may be the increase in intangibles such as good will, patents, trademarks, etc. But in 2008 thought the sales were increased there was a reduction in operating profits and also intangibles so this might be the reason for RFCE to decrease in 2008.
ROTA: Return on fixed assets shows the profit gained from the total assets of the company. Assets include both fixed and current assets.
(ROTA) Return on Total Assets = PBIT*100
Fixed Assets + Current Assets
Fixed Assets + Current Assets = 2008 = 114413+306745 = 421158
2007= 105751+245490 = 351241
Year
2008
2007
Calculations
90029* 100
421158
88832* 100
351241
Outcome
21.37%
25.29%
Interpretation: In 2007 the return on fixed assets has shown a good result over 2008. The reason for this is in 2008 the company might have invested in subsidiaries and research and development (R&D). There is also an increase in current assets and fixed assets in 2008 which might have not matched the target efficiency of the profits.
Efficiency:
FIXED ASSET TURNOVER: Fixed asset turnover is also known as investment turnover ratio. It measures the company's managerial effectiveness in terms of plant and equipment operations. The calculation is expressed as dividing sales by fixed assets.
(FAT) Fixed Asset Turnover Ratio = Sales
Fixed Asset Turnover
Year
2008
2007
Calculations
628306
114413
611260
105751
Outcome
1
5.78 : 1
Interpretation: In 2007 they had a high fixed asset turn over which would mean higher managerial effectiveness. In 2008 they had a lower ratio compared to 2007. This would mean underutilization of the assets and subsistence of ideal capacity leading to inadequacy of the management in utilizing the available assets.
LAT: Labour asset turnover ratio describes the sales to the labour cost in the business. It refers to the labour cost required to produce a product and sell and the revenue generated out of it. The labours are treated as an asset.
(LAT) Labour Asset Turnover Ratio = Sales Revenue
Labour Cost
Year
2008
2007
Calculations
628306
107068
611260
112258
Outcome
5.86 : 1
5.44 : 1
Interpretation: In 2008 the increase in LAT was due to the increase in sales and decrease in labour cost. But in 2007 the labour cost was increased and this may be due to the increase in labours and the sales were not up to the mark to the output produced by the labours.
LPR: Labour performance ratio helps to understand the labour's contribution towards the sales. It also refers to each labour contributing to the overall sales.LPR is calculated as sales by full time employees.
(LPR) Labour Productivity Ratio = Sales Revenue
(FTE) Full Time Equivalent Employees
Year
2008
2007
Calculations
628306
2461
611260
2203
Outcome
255.31 GBP
277.46 GBP
Interpretation: In the year 2007 the labour performance was 277.46 GBP where each labour contributed a good amount to the company's sales compared to 2008 were each labour contributed only 255.31 GBP.
The reason for this may be in 2008 the company would have recruited more employees where the employee's contribution wouldn't have reflected yet.
DEBTOR AGE: Debtor age refers to the credit management efficiency of the company. It is calculated by dividing credit sales by debtors multiplied by 365 and expressed in days.
Debtor Age = Debtors* 365
(Credit) Sales
Year
2008
2007
Calculations
137984* 365
628306
116307* 365
611260
Outcome
80.15 days
69.45 days
Interpretation: In the year 2007 they had a shorter collection period which meant quick conversion of debtors and receivables into cash.
But in 2008 they provided debtors to pay them back in 80 days compared to 2007 payment in 69 days. This extension would increase the sales as the debtors would take more stock from the next year as they will have extra time to pay back to the company.
CREDITORS AGE: Creditors age is considered as the swiftness to which the company makes payments to its creditors. It is expressed as creditors by purchases multiplied by the total numbers of days in a year (365 days).
Creditor Age = Creditors* 365
Purchases
Year
2008
2007
Calculations
56813* 365
268609
61053* 365
238484
Outcome
77.20 days
93.44 days
Interpretation: In 2008 they had a low creditor age which would mean rapid payments to the creditors which would be welcomed by them and in turn would also increase the company's goodwill. But in 2007 they had high creditor age which may be deferred discharge of the creditor's claim which would not be at the company's notice at least in the long run.
But if we assume the other way round in 2007 compared to 2008 the company is still holding the cash which would help in short term investments.
STOCK TURNOVER: Stock turnover often called as Inventory turnover ratio. The calculation is done as dividing the cost of sales by stock for sales multiplied by 365 days. The ratio is expressed in days which indicate how quickly the stock is converted into sales during the year.
Stock turnover = Stock for sale* 365
Cost of sales
Year
2008
2007
Calculations
82665* 365
268609
59800* 365
238484
Outcome
112.32 days
91.52 days
Interpretation: In 2008 the stock turnover is more than in 2007. This indicates that in 2008 they had greater transport cost and high menace of stocks becoming obsolete.
But the other reason for this was in 2008 there was a rescission process taking place. So maybe this is one of the reasons for slow movement of stock.
In 2007 they had a good movement of stock as this company does not deal with consumable products which are consumed every day, but these are products which are purchased once in a life time.
Risk:
GEARING: Gearing ratio is a measure to financial leverage. Gearing ratio describes the long term borrowings to the share holder's funds and expressed in percentage. More leverage the firm has, that riskier the firm may be.
Gearing = Long term borrowing* 100
Share holders' funds
Year
2008
2007
Calculations
154119 * 100
46121
102* 100
126249
Outcome
334.16 %
0.080 %
Interpretation: If we observe the above figures gearing ratio has boomed rapidly from nearly 0% to 335%.
In 2008 the figures of 334.16 % is due to the long term borrowings in the bank the pay back the share holders. This high gearing in the company may serve its debts regardless of how bad sales are.
INTEREST COVER: The Company has the skill to handle the financial burden in one measure that is interest cover ratio. The ratio speaks about how far the company's can cover or meet the interest payments associated with debt.
Interest Cover = PBIT
Interest Payable
Year
2008
2007
Calculations
90029
11802
88832
3057
Outcome
7.62 times
29.05 times
Interpretation: From the above table we can interpret that in 2008 they had to pay their interest every 7.62 times from their profit which means their profit will get exhausted soon. But in 2007 they had 29.05 times to pay out which means they had more time to pay their profit and hold back their profits.
This is because in 2008 the company had more borrowings compared to 2007.
INTEREST GEARING: Interest gearing also refers to interest cover but expressed in percentage.
Interest Gearing = 1* 100
Interest cover
Year
2008
2007
Calculations
1* 100
7.62
1* 100
29.05
Outcome
13.12 %
3.44 %
Interpretation: From this table in 2008 the company had to pay their debts 13.12% out of their profit. But in 2007 they had to pay only 3.44% which was good.
Liquidity:
CURRENT RATIO: Current ratio will test the short term solvency in a business. Current ratio is used to compare the company's current asset to its current liabilities. Formula used to calculate is:
Current Ratio = Current Assets
Current Liabilities
Year
2008
2007
Calculations
306745
188830
245490
208522
Outcome
1.62 : 1
1.17 : 1
Interpretation: In this ratio we can interpret that in 2008 the ratio of current asset to current liability is more and in a good position. This is because they had more stock, debtors and cash in hand compared to 2007.
For every GBP of a liability, they have enough assets to overcome it in the near future. It has increased by over 0.40 times from 2007 to 2008.
ACID TEST RATIO: Acid test ratio also know as quick ratio is calculated to know the worst case scenario where when a pack of wolves (creditors) could fall on the business and demand to pay back their business liabilities. Acid test ratio is calculated by excluding stock and prepaid expenses to know how fast the business can quickly convert the cash.
Acid Test Ratio = Current Assets - Stock
Current Liabilities
Current Assets - Stock = 2008 = 306745 - 82665 = 224080
2007 = 245490 - 59800 = 185690
Year
2008
2007
Calculations
224080
188830
185690
208522
Outcome
1.18 : 1
0.89 : 1
Interpretation: In 2008 the company is still in a comfortable position to pay back its liabilities without any problem. But in 2007 they were just struggling to pay back their liabilities. The company has worked hard to overcome this issue and in a good position in 2008.
The actual figure for a company to be in a good position to pay back the liabilities is 1.00 and above.
CASH EXHAUSTION RATIO: Cash exhaustion ratio explains the company's liquid cash in hand or bank which is spent in the business and the rapid speed in which it is exhausting. The main function of the company is to have a control on cash exhaustion ratio because it will reduce the cash for other payments such as liabilities. It is calculated as:
Cash Exhaustion Ratio = Total Operating Cost = Average daily Cash spent
365
= Cash in hand
Average daily Cash spent
Year
2008
2007
Calculations
505819 = 1385.80
365
45767
1385.80
500675 = 1371.71
365
34405
1371.71
Outcome
33.02 days
25.08 days
Interpretation: From the above table we can interpret that in the year 2008 the liquid cash was more compared to 2007. Due to this the company has an advantage to hold back the cash for about a few days where they can invest in other areas of the business.
OPERATING CASH FLOW TO MATURING OBLIGATIONS: Operating cash flow to maturing obligations refers to the ability to meet debts from cash flow statement.
Operating cash flow to = Cash inflow from operating activities* 100
maturing obligations Current Liabilities
Year
2008
2007
Calculations
90006* 100
188830
82816* 100
208522
Outcome
47.66 %
39.71 %
Interpretation: In 2008 the operating cash flow to maturing obligations is higher to 2007 which means the company has greater liquidity in 2008.
ADVANTAGES AND LIMITATIONS OF RATIO ANANLSIS
ADVANTAGES:
Ratios analysis helps to determine the future course of action. This will help the company to make changes. Ratio analysis helps the firm to keep the right path of progress. If the firm is moving in an incorrect way ratio analysis determines the correct way and keeps it back to track. Ratio analysis provides a clear image with the help of data. It provides a bird's eye view of the financial image of the business. Ratio analysis helps to compare with inter and intra firm activities. It helps in comparing the risk and return relationship of different firms. It also helps to compare its competitors, business standings etc in the same period. Ratio analysis helps in trend analysis where the trend in ratio and variability over a period may become more effective than the ratio at the given point of time. Ratio analysis helps in observing the operational efficiency with the help of capital structure, profitability, liquidity etc. Ratio analysis helps to point out the strength and weakness of the company. Ratio analysis helps in setting ideas. Ratio analysis is a power full tool in detecting window dressing where by using previous figures the manipulations can be detected. But in a shot term it is difficult to find out but not in the long term. Ratio analysis helps to know the performance, efficiency, risk and liquidity of a company. Ratio analysis helps to find out the liquid position of the company where the company is good or bad in paying its liabilities and shows the creditors and debtor days. Ratios are easily understood which helps to make changes quickly. Ratio analysis helps in a process of planning, control, communications and fore casting. With the help of ratio analysis the owners of the company will have sufficient information in investment. Ratio analysis gives information for the share holders to invest in the company if the company is doing well. Ratio analysis gives information on return on investments made by the owners. Ratio analysis also provides information on stock turnover because stock turnover is one of the major aspects of any firm. If there is no movement of stocks this will badly affect the firm by making the stock as a dead investment and there will be no return on investment made to produce that stock.
LIMITATIONS:
Many massive organisations function in different divisions in different industries. So, industrial averages are difficult to develop. But, ratio analysis is useful only in small and narrowly focused firms than for large multi divisional ones. Inflation can also turn the ratios up and down. Where, inflation may have badly misshapen the company's balance sheet. Further inflation will also affect the inventory cost, depreciation charges and profits are also affected. Therefore, ratio analysis will not help the company by providing actual figures. Ratios are sign insensitive because they are unable to detect the impact of negative number. Mechanical calculations may give a wrong signal. Therefore the ratios should be explained with caution. Accounting statements are not drawn on comparable source when the company is using different book-keeping methods. Hence the impact of difference accounting methods cannot be reflected through ratios. In today's accounting books of a company, they will not record certain obligations arising from contracts. Therefore, ratios which are derived from these books will not show the actual solvency position of the firm. Ratios can easily be manipulated and window dressed. This explains that financial statements are not coinciding with typical position of a company's working cycle. Time and circumstances may lead to manipulation. By doing this they can show that the company is in good health. Ratio analysis is difficult to generalize whether a particular ratio is good or bad. This will impact on companies overall performance. Seasonal factors can have an impact on ratio analysis. Ratio analysis does not include non-financial factors. Ratio analysis is difficult to compare between companies or competitors because of insufficient data or information. While preparing ratio analysis there will be missing data. So therefore some analysis will not be met or done. Balance sheet is only a snap on the given day or time of accounting. By this ratios cannot be analysed. Ratio analysis ignores areas such as health and safety and the environment. When ratios are compared between companies, each company would have used different formants of accounting procedures resulting in different ratio figures. The depreciation changes should not have an impact on accounting policies. This may result in change of fixed assets. Ratio analysis does not spotlight the qualitative issues like potential of new products, product life cycle, quality of infrastructure and profile of debtors and suppliers and also the ethical issues of the staff.
