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Ratio Analysis Report

Essay by   •  January 26, 2011  •  1,684 Words (7 Pages)  •  1,448 Views

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EXECUTIVE SUMMARY

The purpose of the following report is to aid Over the Hill Pty Ltd in planning the direction that the company may want to go over the next few years. The report entails a financial analysis and summaries, which will give the executive board an understanding of how well the current managing director is performing, and whether his contract should be renewed.

Figures were obtained from comparative balance sheets and profit and loss statements from the relevant years as well as additional information that was forwarded by the board. This information enabled the development of percentage and ratio analysis (see appendices), which was then used to create the report.

The investigation revealed that the company had improved its position compared to previous years. The profitability of the company was significantly better whilst the liquidity had remained reasonably steady. The solvency of the company had declined however, which affected the long-term obligations of the business.

Overall, the company is in a much sounder position than it had been a few years earlier. The management style of Mr Vinloony has improved the direction of the business and the forthcoming results have come reasonably promptly. It is therefore recommended that Mr Vinloony’s contract is extended for a further period as designated by the board to enable the company to continue its growth.

PROFITABILTY

Over the Hill Pty Ltd on initial viewing seems to have had a fairly successful year in 2002 in comparison to its previous years. An analysis of the Vertical, Horizontal and trend analysis shows significant growth in 2002 (up 230%) in net profit compared to negative results in previous years. This is due to a combination of growth in net sales (up 18.18%) and a decrease in the operating expenses of the business (-1.16%) compared to 2001. The cost of goods sold did increase between 2002 and 2001 but was still under the percentage growth of the net sales.

The return of assets has increased steadily over the three years rising up to 13.61% from a low of 5.70% in 2000. This brings the return of assets well above the industry average of 9% and indicates that the company has managed its resources well in developing a fair return on its assets.

The return on shareholders equity has also boomed over the last year by an impressive 20.26% from 5.17% in 2000.This is a combination of increased profits and a decrease in the average shareholder equity, which is due to lower retained profits by the shareholders.

An increase in operating profit in 2002 also led to a substantial increase in the earnings per share that the company could obtain. The ratio for 2002 was at $0.69 compared to an estimated $0.27 in 2000.

The company had an extremely high dividend payout in 2001 (900%) followed by a more stable payout to its investors in 2002 (152%). This high percentage was due to the poor return of assets that the company had in 2000, in which the high dividend allowed the shareholders to use this money in areas that would be more beneficial to the company.

Strong sales and increasing profit margins have helped raise the company into a profitable situation that has not been seen too much in previous years. This has been helped by managing to decrease the number of expenses that the business had.

LIQUIDITY

Over the Hill Pty Ltd ability to satisfy its short term obligations are still in a stable position at the current state but has decreased over the last couple of years. The current ratio has decreased from 2.6:1 in 2000, down to 2.38:1 in 2002. This is due to the company keeping fewer inventories as assets and more cash in the bank without decreasing liabilities at the same time. This has put the company below the industry average of 2.6:1 and raises questions on the short-term future of the company with its creditors and owners if this trend continues.

By checking the quick ratio (acid test) we can quickly see if the company would be able to pay off its liabilities without having to sell any of its inventory. Over the three-year period analysed, the results seem to indicate that the company is fairly liquid (over 1:1 ratio) but may have found it a bit tougher if 2001 if it had to be liquidated (0.95:1).

The receivables turnover has significantly decreased over the three-year period and has indicated an improvement in the crediting procedures that have been developed within the company. The average collection period has decreased significantly to an average of 42 days, which enables the company to use this money within the business at an earlier stage.

Poor sales and lower inventory balances in 2001 contributed to the inventory turnover dropping to almost 3 times a year. This improved slightly in 2002 as sales picked up within the business. This does affect the liquidity but does not have a real damaging effect to the products sold due to the nature of the business (antiques).

The liquidity ratios do indicate that Over the Hill Pty Ltd is in a stable position and is a reasonably liquid business. This would need to be carefully observed over time tough to guarantee the short-term obligations of the business.

SOLVENCY

The debt and Equity ratios are valuable tools used to indicate asset protection and therefore the long-term stability of the company. Over the Hill Pty Ltd had a strong long-term position in 2000 due to the smaller amount of liabilities it had. As these liabilities have grown, the assets have fluctuated slightly but have not increased much in the three-year period. This has caused the debt ratio to grow to 65.38% and the Equity ratio to drop to 34.62% raising doubts about the long-term future of the business.

The capitalisation ratio suggests the way that the business structures its debt and equity. In 2002, Over the Hill Pty Ltd had a ratio of 2.89 times, which suggests that it’s business operations were mainly funded by debt whilst a small proportion of the total assets were funded by shareholders equity.

Over the Hill Pty Ltd is operating at a reasonably acceptable level of 4.3 times which indicates that the company’s financial commitments are covered by the company’s

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