Financial Analysis - Problem Solving Example

1 Rate of return on total assets (Net Profit / Average Assets) * 100 4362/((29935+28045)/2) 15.05%

2 Rate of return on ordinary equity (Net Profit-Pref. Dividend) / Average Shareholder Funds) * 100 (4362-50) /((14215+12605)/2) 32.16%

3 Profit margin (Net Profit /Sales) * 100 4362/55000 7.93%

4 Earnings per share (Net Profit / # of Equity Shares) 4362/7200 0.61

5 Price-earnings ratio (Market Price / EPS) 12/D7 19.81

6 Dividend yield (Dividend / Market Price) * 100 2702/(7200*12) 3.13%

7 Dividend payout(Dividend / Net Profit) * 100 2702/4362 61.94%

8 Current ratio (Current Assets / Current liabilities) 12745/5780 2.21

9 Quick ratio (acid ratio) (Quick Assets / Current liabilities) (12745-7000)/5780 0.99

10 Receivables turnover (Sales / Average Receivables) 55000/((4100+3675)/2) 14.15

11 Inventory turnover (COGS / Average Inventory) 35100/((7000+6930)/2) 5.04

12 Debt ratio (Debt / Total Assets) * 100 9940/29935 33.21%

Part B

Analysis of Profitability

The net profit margin of the company is higher than industry average which shows that the company is able to generate higher rate of profit from sale of goods and services. However, rate of return on total assets of the company is lower than industry average. This shows that the company has not been able to use its assets effectively. This is further evidenced by lower than industry average inventory turnover ratio. The return on equity shareholder fuds of the company is higher than industry average. EPS of the company is higher than industry average. This has been possible because of higher net profit margin earned by the company and use of preference share capital. The P / E Ratio of the company is higher than industry average. This suggest that the shares of the company are favourable with the investors. The investors are giving higher amount for shares of the company as compared to other companies. The dividend yield of the company is lower than industry average because of higher market price and lower dividend payout ratio. The company is paying just 61.94% of the amount as dividend against industry average of 70%.

Analysis of Liquidity

The current assets and quick assets ratios are lower than the industry average. This shows that proportion of current liabilities against current assets and quick assets is higher. A lower current and quick ratio generally indicates poor liquidity position. However, the liquidity ratios of the company are still good despite lower than industry numbers. Therefore, we can conclude that liquidity position of the company is adequate to pay its current liabilities.

Analysis of Gearing

The gearing ratio shows how much of the assets are financed through debt. The companies use gearing to finance assets as cost of debt is lower than equity and this helps in increasing return on equity capital. The debt ratio of the company is slightly lower than the industry average. This shows that the company is using less proportion of debt as compared to its peers. This shows low finance risk of the company.

The receivable turnover ratio of the company is just above the industry average which suggest that the company has good collection system and it is recovering its dues on time. The inventory turnover ratio of the company is lower than industry average which shows that the company is not able to sell its inventories quickly.

Question 2

Part a

An asset is a resource controlled by enterprise as a result of past events from which future benefits are expected. Therefore, two criteria must be met for an item to be classified as an asset; control and expected future benefits. The Chef is a nature person and the restaurant cannot control him. He may leave the restaurant if he wants. Moreover, future expected benefits from the services of Chef cannot be accurately estimated as we cannot estimate life of a nature person. Therefore, Chef cannot be recorded as an asset in the balance sheet of the restaurant.

Part b

Sr. No. Transaction Affected Financial Statement Remarks

1 Purchase equipment for cash Balance Sheet Increase fixed assets and decrease cash no effect on total assets

2 Provide services to a client, with payment to be received within 40 days. Income Statement and Balance Sheet Increase Equity and Accounts Receivables, Decrease Inventory.

3 Pay a liability. Balance Sheet Decrease Liability and Cash

4 Invest additional cash into the business by the owner. Balance Sheet Increase Equity and Cash

5 Collect an account receivable in cash.

Balance Sheet Increase Cash and decrease accounts receivables

6 Pay wages to employees.

Income Statement and Balance Sheet Decrease Equity and Cash

7 Receive the electricity bill in the mail, to be paid within 30 days. Income Statement and Balance Sheet Decrease Equity and Increase Liability

8 Sell a piece of equipment for cash. Income Statement and Balance Sheet Increase Equity and Cash

9 Withdraw cash by the owner for private use. Balance Sheet Decrease Equity and Cash

10 Borrow money on a long-term basis from a bank. Balance Sheet Increase Cash and Liability