Report for the board of directors of Pace Leisurewear Ltd (from now on called PL Ltd for short) investigating the financial position and performance of PL Ltd. PL Ltd was founded by Jill Dempsey and Mike Greaves five years ago and do business to the designing and manufacturing industry for casual and leisure clothe for aiming to younger and more high-income market. The company its consisted by Jill Dempsey who is the managing director and marketing director owning 350.000 shares, Mike Greaves production director owning 350.000 shares, Jane Barker design director owning 20.000 shares and David (Chairman) and John Keeble(Non-executive director) who jointly own 1.000.000 shares.
Despite their recent successful year the company at the moment is facing a serious economic problem and dilemma. The bank that they are working with requested from them a significant reduction in overdraft and they need to have an plan of action as soon as possible. After holding a meeting with all the board memenbers they did not come to a clear solution for the future of the company, as a conclusion they decided to hire Drake Management Consultants in order to produce a plan of action for the board's consideration.
Financial Analysis of Pace Leisurewear Ltd
In order to do the financial analysis of PL Ltd we need to calculate and find the financial ratios of the company. The financial ratios will help us highlight and measure the financial strengths and weaknesses of PL Ltd and tell us if the company is profitable, do they have enough money to pay their bills, can the company pay its employees higher wages, is the company paying its share of tax, is the company using its assets efficiently enough and does the company have a gearing problem.
Ratio Formulas
Year 1
Year 2
= 20%
= 29%
=18%
=33%
=46%
=48%
=15%
=21%
=116 days
=182 days
=42 days
=61 days
=59 days
=81 days
= 1.8:1
=1.1:1
=0.8:1
=0.5:1
=34%
=42%
Financial ratios of PL Ltd.
The ratios are grouped into categories, each of which related to a particular aspect of financial performance or position. Following are the categories:
Profitability ratios
ROCE : We start with Return of capital employed (ROCE) ratio, the first year we had 20% ROCE and the next year we had a 29% ROCE, meaning we had an increase of 9% better capital utilizing from last year.
Gross Profit Margin : In the first year we had a 46% of Gross profit margin where in the next year we had a 48% of Gross profit margin meaning that for every 1£ of sales (after taking out Cost of Sales) we take out 48p.
Net Profit Margin : In the first year we had a 15% of Net profit Margin and at the second year we had 21%.
ROE : Return of equity (ROE) measures the return on the funds of the owners and equity shows the total investment of the owners of the firm. ROE for last year was 18% and current year is 33%, which is almost doubles from last year.
Efficiency ratios
Stock turnover in days : For year 1 we had 116 days as stock turnover and in the second year we had 182 days, meaning that we had a raise of 66 days which is not a good thing because we want to goods to be sold as fast as possible and the main reason for that is that the higher the days the worse for us because the money is not available to be used elsewhere.
Debtor turnover in days : For year 1 we had a 42 days and for year 2 we had 61 days, despite that the increase does not affect us, because is still lower from our creditor turnover in days, this is not a good sign because it means we do not have a strict debt collection policy.
Creditors turnover in days : For the first year we had 59 days and for the second year we had 81 days indicating that we might have a problem of liquidity due to the higher stock turnover and also the increase of debtor turnover.
Liquidity ratios
Current ratio : For the first year we had a 1,8:1 ratio and for the second year a 1,1 :1 ratio, the fact that the current ratio is lower than last year is not definitely a bad thing, because we need to know also the acid test ratio, although is shows that the liquidity of the business is low.(Most of the companies tent to have 2:1 as an ideal ratio)
Acid test ratio : In the first year we had a 0,8 :1 ratio and in the second year 0,5 :1. This factor is indicating that we are having a liquidity problem because our current assets do not quite cover our current liabilities.
Capital ratios
Gearing ratio: In the first year we had 34% of gearing and in the second year we had 42% of gearing showing a substantial increase in the level of gearing which is a good thing if it is followed by an increase of profits at this year.
Comments
Despite that the ratio analysis offer as a quick and useful method of analyzing the position and performance of a business, they are not without their problems and limitations. So although PL Ltd seems to have a very good profitability level and giving a much greater return on the funds invested in it (i.e. its ROCE is considerably higher, profitability ratios), the company does not seem to meet the expectations of their credit holders. However, there are indications that PL Ltd has a significant liquidity problem as shown by both the current and quick ratios , this can be seen at first from the creditor turnover days which they have been increased, showing a potential liquidity problem, and finally from their liquidity ratios showing a decrease of the current ratio and most important a significant decrease of acid test ratio indicating that the company is going to face real financial problems.
Expectation and Proposal for solution
Since the main problem is liquidity the first thing PL Ltd needs to do is to try and liquefied all of the remaining stock. The main problem is not the debt rather a liquidity problem, in order to overcome their current position the following actions should be followed :
Decrease stock turnover in days, because we see a significant increase from the first year 116days to 182 days, it is crucial the stock to be sold in less days in order to produce money faster.
It is eminent to have a strict debtor policy in order to collect our debt faster, because as we can see we had an increase of the debtor turnover in days from the first year 42 to 61 the second year
Increase the current ratio from 1,1 :1 at least to 2:1 the next year, because PL Ltd is not a company that uses fast transactions like i.e. supermarkets, it is needed to have a current ratio at 2:1.
PL Ltd should try to cut down their expenses.
In general PL Ltd needs to reconsider their working capital cycle since this is vital to a business. They have to have funds available to pay their day to day bills, wages and so on. The working capital is made up of the current assets net of the current liabilities. It is very important to a company to manage its working capital carefully. This is particularly true where there is a substantial time lag between making the product and receiving the money for it. In this situation the company has paid out all the costs associated with making the product but not yet got any money for it. They must therefore ensure they have enough cash to do this.
At the end I would like to propose that is necessary for the PL Ltd to have a prosperous future to find new investors for the company despite the initial denial of David and John Keeble. It is an distinguished need to find new funds to be "injected" to the company since the bank has decided to cut down their overdraft.
