Profitability ratio helps to measures how a firm is performing in term of its ability to generate profit. When these ratios are higher than a competitors ratio or than the company ratio from the previous period this is the sign that company is doing well.
Following ratios are included in profitability ratio.
Net profit margin:-
This ratio known as operating profit margin ratio which is Indicate the ability of the company to control the cost and maximize the sales.
Formula:-
NPR (2008) =100x (552/21,015) =2.63%
NPR (2007) =100x (836/27,450) =3.05%
NPR (2006) = 100x (944/21,900) =4.54%
Analysis of net profit margin of Spectrum manufacturing company :-
Performance of Spectrum Company goes down because NPR in 2006 is 4.54% and in 2007 it is 3.05% and in 2008 is 2.63% this figure clearly shows the performance of company gradually fall down. It will affect the reputation of the company. This figure's will not attract to the investor and lenders.
Gross profit margin:-
The gross profit margin ratio show that how much company have control on their cost of production and it includes the % of the net sales after les the cost of good sales.
Formula:-
GPR (2008) =100x (5895/21,015) =28.05%
GPR (2007) =100x (6225/27,450) =22.68%
GPR (2006) =100x (5325/21,900) =24.32%
Analysis of gross profit margin of Spectrum manufacturing company :-
Gross profit margin ratio of the spectrum company in 2006 is 24.32% but it goes down little bit came on 22.68% in 2007 further company did not allow GPR to go down a part of that company management bring their GPR to 28.05% in 2008 which higher than the 2006 and 2007 GPR it mean company very well control on its production cost.
Net Asset turnover:-
Net asset turnover is measurement of a company that how well a company use its asset to produce sales revenue.
Formula:-
Capital employed = Total asset - Current liabilities
NAT (2008) = (21,015/8626) =2.44times
NAT (2007) = (27,450/7810) =3.52times
NAT (2006) = (21,900/5878) =3.73times
Analysis of net Asset turnover of Spectrum manufacturing company :-
Net asset turnover ratio of the spectrum company going down year by year because of its bad management u can see in 2006 total sales ratio of this company was good with the figure of 3.73 but in 2007 its gone down with the little figure 0.21 but in 2008 its shows very low figure as compare to the previous years. This ratio showing the efficiency to make the profit is very low. And the management of the spectrum company have no control on his expense. And this is very bad sign for any company.
Return on Capital Employed (ROCE):-
It is commonly used as a measure for comparing the performance between businesses and for assessing whether a business generates enough returns to pay for its cost of capital.
Formula:-
ROCE (2008) = 100 x (1832/8626) = 21.24 %
ROCE (2007) = 100 x (2222/7810) = 28.45%
ROCE (2006) = 100 x (2377/5878) = 40.44%
Analysis of return on capital employed of Spectrum manufacturing company:-
High percentage of the ROCE show the big part of earning can be reinvested in the company for the good of the shareholder's high ROCE is a sign of successful growth of company.
As we can see in spectrum manufacturing company that ROCE is declining in each year in 2006 it was 40.44% which is very good but in next year it decline to 28.45%and even worse in 2008 where it comes to 21.24%.this shows the company is not able to reinvest the profit back in to the business and even if they are applying it back in the business they are not doing it efficiently. This is also suggesting the company is losing its market share.
Leverage Ratio:-
Leverage ratio tell us the firm capacity to repay its loan. Leverage ratio can be calculated with the following ratios as under:-
Debt to Equity Ratio:-
This ratio tells us that how much firm funds came from debt against equity.
Formula:-
DER (2008) = 100 x (3686/4940) = 74.62 %
DER (2007) = 100 x (3302/4508) = 73.24 %
DER (2006) = 100 x (1779/4099) = 43.40 %
Analysis of debt to equity ratio of Spectrum manufacturing company:-
For spectrum manufacturing we can see that debt to equity ratio is increasing every year. This show that company is more relaying on debt financing instead of equity financing.
Debt ratio:-
This ratio is financial ratio that indicates the percentage of the company asset providing through debt.
Formula:-
DER (2008) = (3686/4940) = 0.63 Times
DER (2007) = (3302/4508) = 0.63 Times
DER (2006) = (1779/4099) = 0.47 Times
Analysis of debt ratio of Spectrum manufacturing company:-
If we analysis the spectrum manufacturing company ratio, there is slightly increase in the ratio with in 3 year it has increase from 0.47to 0.63 in years 2006 to 2008 respectively. Although the ratio result is not bad but it slightly increasing which shows the trend that company liabilities increasing year by year.
Current asset ratio:-
Current asset ratio shows the relation between current asset and current liabilities. This ratio also called as working capital ratio.
Formula:-
CAR (2008) = (8756/4770) = 1.84 Times
CAR (2007) = (9138/4307) = 2.12 Times
CAR (2006) = (5519/1916) = 2.88 Times
Analysis of current asset ratio of Spectrum manufacturing company:-
It is said that normal current ratio should be around or over 2. The current ratio of the company was 2.88 times in 2006 but it decreases to 2.12 and 1.83 in year 2007 and 2008 respectively which shows the current asset decreases as compare to the current liabilities.
FINANCIAL AND NON FINACIAL TECHNIQUES:-
FINANCIAL TECHNIQUES:-
Market Ratios:-
Market ratios measures the investor response to owning a company stock and the cost of issuing stock.
Dividend cover:
This ratio measure the amount of earning that is paid in form of dividend, for example no of times the dividend paid to the share holder are from earning's lower cover would indicate that small percentage of earning are being retained and reinvested in the business while a higher dividend cover shows vice versa.
Formula:-
Dividend Cover (times) =
Liquidity ratio:-
In liquidity ratios there are lots of ratios but one of the receivable turnover ratio.
Receivable turnover ratio:-
This ratio measure the no of days to collect the money from receivables.
Formula:-
This ratio will tell u how good your debtors are .The leaser the time of collection the better your debtors are and vice versa. If you cannot collect the amount from debtors this will tell to the investor that your collection procedure is not good.
Non financial techniques:-
Although the overriding objectives of the most business organizations are to maximum profit the exceptions are those corporations, wholly owned government statutory institutions and their agencies. Therefore, the use of only financial ratios and the other financial techniques based on financial statements can not necessarily reflect true and accurate measure of all their performance.non financial techniques are easy to calculate and are less likely to manipulated.
Techniques that can be used to measure the performance of these institutions are
Marketing effectiveness:-
Trend in market share.
Number of customers.
Client contact hours per sales person.
Service quality:-
Personal of repeat business.
Customer waiting time.
Proportion of deliveries on time.
Client turnover.
Production performance:-
As production is very big and complex process and contain various management issue so this area of business activity is consider very rich for non financial indicators. The following performance should be seen to measure efficiency of the company.
Number of suppliers.
Manufacturing lead time.
Output per person.
Adherence to delivery dates met.
Personnel:-
This tell us that how good staff company has with it. The company which have more skilled staff is consider more efficient than the company have less skill staff.
Staff turnover.
Training time per employee.
Days lost through absenteeism.
Number of complaints received.
Advantages and disadvantages of ratio analysis:-
Advantages of ratio analysis:-
Ratio analysis is a very good tool to find out the efficiency of the company. Following are the advantages of ratio analysis
profitability analysis:-
When any investor wanted to invest in any company he can find out the profitability and efficiency of a company by using ratio analysis and compare it with different company.
Forecasting benefits:-
Ratio analysis helps in forecasting budget and future trend of a company. By comparing its ratio result with previous years better forecasting of trends can be done.
Simplify accounting information:-
Ratio analysis is very useful as they simplify the detailed and complicated figures.
Comparative analysis:-
By doing ratio analysis a company can compare its result with different company in the same industry or even by its previous year and can find out where it is standing in the market and can remove its weakness.
Disadvantages of ratio analysis:-
Although ratio analysis has so many advantages but there are certain disadvantages as well which should be kept in mind while using ratios.
Results can be Misleading:- Ratio analysis result can be misleading some time because there is no absolute data available. For example if two firms have same gross profit ratio of 30% but the profit earned is £10000 of one firm and £1000000 of the other. Although the profitability ratio is same but magnitude of profit is very different.
Quality ignore:- Ratio analysis only deals with the financial value of the things and ignore quality for example asset ratio ignores the qualities of asset and only see their face value.
Manipulated figures:- Financial ratios are based on accounting records and if they are wrong then ratios results will be false. For instance if value of stock is taken on high price the profit will be high and thus gives a wrong result
Q .1(b) Agency theory:-
This theory actually deals with the problems arising among principle and agents.
Factors of Agency Theory:-
Principle and agent; these two factors make an agency in which one is acting on behalf of other or representing the other.
In context of company principle agent relationship exists between Shareholders (Principle) and Board of Directors (Agent). The use of agency theory comes in place when the interest of shareholder and management conflict with each other or when shareholders cannot monitor the action and information of the management with perfection. These problems are known as agency problem.
The cost of this agency theory is called as Agency Cost.
Implications of Agency Theory:
According to me agency theory can be implicated in Spectrum Manufacturing Company on following two issues.
Investment.
Risk Taking.
Investment:-
This can be one of the main reason for which a conflict can arise among shareholders and board of directors. Shareholder of the company will always think of long term investment where on the other hand manager goes for the short term investment to show the efficiency every year. For spectrum manufacturing company the conflict can arise on the issue of investment. As company is not very financially sound at this point so share holder would not want any investment.
Risk taking:-
For spectrum manufacturing company is not a suitable option at this point to take any risk. As we can see from the result of ratio analysis the company has not progress well in these three years so if management wants to take any risky project on this can cause an agency problem.
Sources of financing a public company:-
There are two sources of financing public company.
Internal source:-
External source:-
Internal source:-
Internal source mean that money that u can earn within your business or your company is called internal source. These can be following types of the internal sources.
Sales of asset:-
Personal savings:-
Retained profit:-
Sales of asset:-
Sales of asset mean those assets which are profit in the business and these assets are not directly involved in predication of goods and services.
Personal saving:-
Personal savings mean that money that the partner or shareholders of the company earn it from his business or a company in shape of profit and they can dispose it as they want.
Retained profit:-
Retained profit is that profit which is left of the business after paying all expenses.
External sources:-
External sources of finance means that money which is come outside the business like banks and some financial insinuations are called external source of finance. There are the following types of external source of finance
Ownership capital:-
Non-ownership capital:-
Ownership capital:-
Capital raised by issuing new shares in market to the new investor or to the already existing owners is called ownership capital. There are the following types of shares
Preference share:-
Ordinary shares:-
Non- ownership capital:-
It is the type of loan which is received against the interest charge is called non-ownership capital. The ownership of the company is not transfer to the person or firm giving you money. Following are the type of non-financial capital is
Over draft facility:-
Debentures:-
Long term loans:-
Other loans:-
Dividend policy:-
What Does Dividend Policy Mean?
The policy a company uses to decide how much it will pay out to shareholders in dividends.
Dividend policy refers to the policy chalked out by companies regarding the amount it would pay to their shareholders as dividend. With profit making comes the question of utilizing the profit gainfully. The companies have two options with them:
The dividend policy to be adopted by the company is based on these two options. Once this is sorted out, a permanent dividend policy can be put into place. These policies shape the attitude of the investors and the financial market in general towards the concerned company. The policies are decided according to the current and future financial positions of the company. The preference and orientation of the investors are also taken into account.
The dividend policy acts as a signal for investors for gauging the future earning possibilities as expected by the management of the company. The dividend policies are directed towards attracting investors to their company. This is termed as the clientele effect. The firms that hold back free cash flows are lesser in value than those firms, which allow free cash flows and pay dividends from them.
The dividend policy of a company has a relation with its common stock value. The Dividend Irrelevance Theory propounds that the dividend policy of a firm has no direct bearing on the cost of its capital or its value. The Dividend Relevance Theory, on the other hand, expostulates that the value of the firm is affected by its dividend policy. The Optimal Dividend Policy helps in increasing the value of the firm to the maximum.
