problem
You need to choose a public listed company of PN17 status (Bursa Malaysia) and evaluate its recent two years operation.
Your answers must include the following:
• Description of the company’s history, the nature of products/services in operation and the objectives.
• A fully worked out appendix on financial analysis of the financial statements which highlights the profitability, liquidity, management, efficiency, capital structure and investment ratios.
Profitability ratios measure a company’s ability to generate earnings relative to sales, assets and equity. Ratios assess the ability of the company to generate earnings, profits and cash flows relative to relative to some metric, often the amount of money invested. They highlight how effectively the profitability of a company is being managed.
General exs of profitability ratios comprise return on sales, return on investment, return on equity, return on capital employed (ROCE), cash return on capital invested (CROCI), gross profit margin and net profit margin. All of these ratios point out how well a company is performing at generating profits or revenues relative to a certain metric.
Different profitability ratios offer different useful insights into the financial health and performance of a company. For ex, gross profit and net profit ratios tell how well the company is managing its expenses. Return on capital employed (ROCE) tells how well the company is using capital employed to generate returns. Return on investment tells whether the company is generating enough profits for its shareholders.
For most of these ratios, a higher value is desirable. Higher value means that the company is doing well and it is good at generating profits, revenues and cash flows. Profitability ratios are of little value in isolation. They give meaningful information only when they are analyzed in comparison to competitors or compared to the ratios in previous periods. Hence, trend analysis and industry analysis is required to draw meaningful conclusions about the profitability of a company.
Background knowledge of the nature of business of a company is essential when analyzing profitability ratios. Like sales of some businesses are seasonal and they experience seasonality in their operations. The retail industry is case of such businesses. Revenues of retail industry are generally very high in the fourth quarter due to Christmas. Hence, it would not be useful to compare the profitability ratios of this quarter with the profitability ratios of earlier quarters. For meaningful conclusions, profitability ratios of this quarter must be compared to the profitability ratios of similar quarters in the previous years.
Liquidity ratios are the ratios which find out the ability of the company to meet its short term debt obligations. These ratios find out the capability of a company to pay off its short-term liabilities when they fall due.
Liquidity ratios are the result of dividing cash and other liquid assets by the short term borrowings and present liabilities. They show the number of times the short term debt obligations are covered by the cash and liquid assets. If the value is greater than 1, it means the short term obligations are fully covered.
Usually, the higher the liquidity ratios are, the higher the margin of safety that the company posses to meet its present liabilities. Liquidity ratios greater than 1 specify that the company is in good financial health and it is less likely fall into financial difficulties.
Most general exs of liquidity ratios comprise current ratio, acid test ratio (also known as quick ratio), cash ratio and working capital ratio. Different assets are considered to be relevant by different analysts. Some analysts consider only the cash and cash equivalents as relevant assets because they are most likely to be used to meet short term liabilities in an emergency. Some analysts consider the debtors and trade receivables as relevant assets in addition to cash and cash equivalents. The value of inventory is also considered relevant asset for calculations of liquidity ratios by some analysts.
Concept of cash cycle is also significant for better understanding of liquidity ratios. The cash continuously cycles through the operations of a company. A company’s cash is generally tied up in the finished goods, the raw materials, and trade debtors. It is not until the inventory is sold, sales invoices raised, and the debtors’ make payments that the company receives cash. The cash tied up in the cash cycle is known as working capital, and liquidity ratios try to measure the balance between current assets and current liabilities.
A company should posses the ability to release cash from cash cycle to meet its financial obligations when the creditors seek payment. In other words, a company must posses the ability to translate its short term assets into cash. The liquidity ratios attempt to measure this ability of a company.
Asset management (turnover) ratios compare the assets of a company to its sales revenue. Asset management ratios indicate how successfully a company is utilizing its assets to generate revenues. Analysis of asset management ratios tells how efficiently and effectively a company is using its assets in the generation of revenues. They indicate the ability of a company to translate its assets into the sales. Asset management ratios are also known as asset turnover ratios and asset efficiency ratios.
Asset management ratios are computed for different assets. Common exs of asset turnover ratios include fixed asset turnover, inventory turnover, accounts payable turnover ratio, accounts receivable turnover ratio, and cash conversion cycle. These ratios provide important insights into different financial areas of the company and its highlights its strengths and weaknesses.
High asset turnover ratios are desirable because they mean that the company is utilizing its assets efficiently to produce sales. The higher the asset turnover ratios, the more sales the company is generating from its assets.
Even though higher asset turnover ratios are preferable, but what is considered to be high for one industry, may be low for another. Therefore it is not useful to compare asset turnover ratios of different industries. Different industries have different requirements with regard to assets. It will be unwise to compare an ecommerce store which requires little assets to a manufacturing organization which requires large manufacturing facilities, plant and equipment.
Low asset turnover ratios mean ineffective utilization of assets. Low asset turnover ratios mean that the company is not managing its assets wisely. They might also indicate that the assets are obsolete. Companies with low asset turnover ratios are likely to be operating below their full capacity.
Financial analyses have highlighted relationship between profit margins and asset turnover ratios. It has often been observed that companies with high profit margins have lower asset turnover ratios, whereas, companies with lower profit margins tend to have higher asset turnover ratios.
Asset turnover ratios are not always very useful. Asset turnover ratios would not give useful insights into the asset management of companies which sell highly profitable products but not often.
• Comment on financial position of the business concern.
• What financial decision you recommend to alleviate the above chosen company from a PN17 status.