finance assignment ratio analysis

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What Is Ratio Analysis?

• What Does It Tell You?
• Application

The Bottom Line

• Corporate Finance
• Financial Ratios

Financial Ratio Analysis: Definition, Types, Examples, and How to Use

Ratio analysis is a quantitative method of gaining insight into a company's liquidity, operational efficiency, and profitability by studying its financial statements such as the balance sheet and income statement. Ratio analysis is a cornerstone of fundamental equity analysis .

Key Takeaways

• Ratio analysis compares line-item data from a company's financial statements to reveal insights regarding profitability, liquidity, operational efficiency, and solvency.
• Ratio analysis can mark how a company is performing over time, while comparing a company to another within the same industry or sector.
• Ratio analysis may also be required by external parties that set benchmarks often tied to risk.
• While ratios offer useful insight into a company, they should be paired with other metrics, to obtain a broader picture of a company's financial health.
• Examples of ratio analysis include current ratio, gross profit margin ratio, inventory turnover ratio.

Investopedia / Theresa Chiechi

What Does Ratio Analysis Tell You?

Investors and analysts employ ratio analysis to evaluate the financial health of companies by scrutinizing past and current financial statements. Comparative data can demonstrate how a company is performing over time and can be used to estimate likely future performance. This data can also compare a company's financial standing with industry averages while measuring how a company stacks up against others within the same sector.

Investors can use ratio analysis easily, and every figure needed to calculate the ratios is found on a company's financial statements.

Ratios are comparison points for companies. They evaluate stocks within an industry. Likewise, they measure a company today against its historical numbers. In most cases, it is also important to understand the variables driving ratios as management has the flexibility to, at times, alter its strategy to make it's stock and company ratios more attractive. Generally, ratios are typically not used in isolation but rather in combination with other ratios. Having a good idea of the ratios in each of the four previously mentioned categories will give you a comprehensive view of the company from different angles and help you spot potential red flags.

A ratio is the relation between two amounts showing the number of times one value contains or is contained within the other.

Types of Ratio Analysis

The various kinds of financial ratios available may be broadly grouped into the following six silos, based on the sets of data they provide:

1. Liquidity Ratios

Liquidity ratios measure a company's ability to pay off its short-term debts as they become due, using the company's current or quick assets. Liquidity ratios include the current ratio, quick ratio, and working capital ratio.

2. Solvency Ratios

Also called financial leverage ratios, solvency ratios compare a company's debt levels with its assets, equity, and earnings, to evaluate the likelihood of a company staying afloat over the long haul, by paying off its long-term debt as well as the interest on its debt. Examples of solvency ratios include: debt-equity ratios, debt-assets ratios, and interest coverage ratios.

3. Profitability Ratios

These ratios convey how well a company can generate profits from its operations. Profit margin, return on assets, return on equity, return on capital employed, and gross margin ratios are all examples of profitability ratios .

4. Efficiency Ratios

Also called activity ratios, efficiency ratios evaluate how efficiently a company uses its assets and liabilities to generate sales and maximize profits. Key efficiency ratios include: turnover ratio, inventory turnover, and days' sales in inventory.

5. Coverage Ratios

Coverage ratios measure a company's ability to make the interest payments and other obligations associated with its debts. Examples include the times interest earned ratio and the debt-service coverage ratio .

6. Market Prospect Ratios

These are the most commonly used ratios in fundamental analysis. They include dividend yield , P/E ratio , earnings per share (EPS), and dividend payout ratio . Investors use these metrics to predict earnings and future performance.

For example, if the average P/E ratio of all companies in the S&P 500 index is 20, and the majority of companies have P/Es between 15 and 25, a stock with a P/E ratio of seven would be considered undervalued. In contrast, one with a P/E ratio of 50 would be considered overvalued. The former may trend upwards in the future, while the latter may trend downwards until each aligns with its intrinsic value.

Most ratio analysis is only used for internal decision making. Though some benchmarks are set externally (discussed below), ratio analysis is often not a required aspect of budgeting or planning.

Application of Ratio Analysis

The fundamental basis of ratio analysis is to compare multiple figures and derive a calculated value. By itself, that value may hold little to no value. Instead, ratio analysis must often be applied to a comparable to determine whether or a company's financial health is strong, weak, improving, or deteriorating.

Ratio Analysis Over Time

A company can perform ratio analysis over time to get a better understanding of the trajectory of its company. Instead of being focused on where it is today, the company is more interested n how the company has performed over time, what changes have worked, and what risks still exist looking to the future. Performing ratio analysis is a central part in forming long-term decisions and strategic planning .

To perform ratio analysis over time, a company selects a single financial ratio, then calculates that ratio on a fixed cadence (i.e. calculating its quick ratio every month). Be mindful of seasonality and how temporarily fluctuations in account balances may impact month-over-month ratio calculations. Then, a company analyzes how the ratio has changed over time (whether it is improving, the rate at which it is changing, and whether the company wanted the ratio to change over time).

Ratio Analysis Across Companies

Imagine a company with a 10% gross profit margin. A company may be thrilled with this financial ratio until it learns that every competitor is achieving a gross profit margin of 25%. Ratio analysis is incredibly useful for a company to better stand how its performance compares to similar companies.

To correctly implement ratio analysis to compare different companies, consider only analyzing similar companies within the same industry . In addition, be mindful how different capital structures and company sizes may impact a company's ability to be efficient. In addition, consider how companies with varying product lines (i.e. some technology companies may offer products as well as services, two different product lines with varying impacts to ratio analysis).

Different industries simply have different ratio expectations. A debt-equity ratio that might be normal for a utility company that can obtain low-cost debt might be deemed unsustainably high for a technology company that relies more heavily on private investor funding.

Ratio Analysis Against Benchmarks

Companies may set internal targets for their financial ratios. These calculations may hold current levels steady or strive for operational growth. For example, a company's existing current ratio may be 1.1; if the company wants to become more liquid, it may set the internal target of having a current ratio of 1.2 by the end of the fiscal year.

Benchmarks are also frequently implemented by external parties such lenders. Lending institutions often set requirements for financial health as part of covenants in loan documents. Covenants form part of the loan's terms and conditions and companies must maintain certain metrics or the loan may be recalled.

If these benchmarks are not met, an entire loan may be callable or a company may be faced with an adjusted higher rate of interest to compensation for this risk. An example of a benchmark set by a lender is often the debt service coverage ratio which measures a company's cash flow against it's debt balances.

Examples of Ratio Analysis in Use

Ratio analysis can predict a company's future performance — for better or worse. Successful companies generally boast solid ratios in all areas, where any sudden hint of weakness in one area may spark a significant stock sell-off. Let's look at a few simple examples

Net profit margin , often referred to simply as profit margin or the bottom line, is a ratio that investors use to compare the profitability of companies within the same sector. It's calculated by dividing a company's net income by its revenues. Instead of dissecting financial statements to compare how profitable companies are, an investor can use this ratio instead. For example, suppose company ABC and company DEF are in the same sector with profit margins of 50% and 10%, respectively. An investor can easily compare the two companies and conclude that ABC converted 50% of its revenues into profits, while DEF only converted 10%.

Using the companies from the above example, suppose ABC has a P/E ratio of 100, while DEF has a P/E ratio of 10. An average investor concludes that investors are willing to pay $100 per $1 of earnings ABC generates and only $10 per $1 of earnings DEF generates.

What Are the Types of Ratio Analysis?

Financial ratio analysis is often broken into six different types: profitability, solvency, liquidity, turnover, coverage, and market prospects ratios. Other non-financial metrics may be scattered across various departments and industries. For example, a marketing department may use a conversion click ratio to analyze customer capture.

What Are the Uses of Ratio Analysis?

Ratio analysis serves three main uses. First, ratio analysis can be performed to track changes to a company over time to better understand the trajectory of operations. Second, ratio analysis can be performed to compare results with other similar companies to see how the company is doing compared to competitors. Third, ratio analysis can be performed to strive for specific internally-set or externally-set benchmarks.

Why Is Ratio Analysis Important?

Ratio analysis is important because it may portray a more accurate representation of the state of operations for a company. Consider a company that made $1 billion of revenue last quarter. Though this seems ideal, the company might have had a negative gross profit margin, a decrease in liquidity ratio metrics, and lower earnings compared to equity than in prior periods. Static numbers on their own may not fully explain how a company is performing.

What Is an Example of Ratio Analysis?

Consider the inventory turnover ratio that measures how quickly a company converts inventory to a sale. A company can track its inventory turnover over a full calendar year to see how quickly it converted goods to cash each month. Then, a company can explore the reasons certain months lagged or why certain months exceeded expectations.

There is often an overwhelming amount of data and information useful for a company to make decisions. To make better use of their information, a company may compare several numbers together. This process called ratio analysis allows a company to gain better insights to how it is performing over time, against competition, and against internal goals. Ratio analysis is usually rooted heavily with financial metrics, though ratio analysis can be performed with non-financial data.

• Valuing a Company: Business Valuation Defined With 6 Methods 1 of 37
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• Financial Statements: List of Types and How to Read Them 4 of 37
• Balance Sheet: Explanation, Components, and Examples 5 of 37
• Cash Flow Statement: How to Read and Understand It 6 of 37
• 6 Basic Financial Ratios and What They Reveal 7 of 37
• 5 Must-Have Metrics for Value Investors 8 of 37
• Earnings Per Share (EPS): What It Means and How to Calculate It 9 of 37
• P/E Ratio Definition: Price-to-Earnings Ratio Formula and Examples 10 of 37
• Price-to-Book (PB) Ratio: Meaning, Formula, and Example 11 of 37
• Price/Earnings-to-Growth (PEG) Ratio: What It Is and the Formula 12 of 37
• Fundamental Analysis: Principles, Types, and How to Use It 13 of 37
• Absolute Value: Definition, Calculation Methods, Example 14 of 37
• Relative Valuation Model: Definition, Steps, and Types of Models 15 of 37
• Intrinsic Value of a Stock: What It Is and Formulas to Calculate It 16 of 37
• Intrinsic Value vs. Current Market Value: What's the Difference? 17 of 37
• The Comparables Approach to Equity Valuation 18 of 37
• The 4 Basic Elements of Stock Value 19 of 37
• How to Become Your Own Stock Analyst 20 of 37
• Due Diligence in 10 Easy Steps 21 of 37
• Determining the Value of a Preferred Stock 22 of 37
• Qualitative Analysis 23 of 37
• How to Choose the Best Stock Valuation Method 24 of 37
• Bottom-Up Investing: Definition, Example, Vs. Top-Down 25 of 37
• Financial Ratio Analysis: Definition, Types, Examples, and How to Use 26 of 37
• What Book Value Means to Investors 27 of 37
• Liquidation Value: Definition, What's Excluded, and Example 28 of 37
• Market Capitalization: How Is It Calculated and What Does It Tell Investors? 29 of 37
• Discounted Cash Flow (DCF) Explained With Formula and Examples 30 of 37
• Enterprise Value (EV) Formula and What It Means 31 of 37
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• How to Analyze Corporate Profit Margins 33 of 37
• Return on Equity (ROE) Calculation and What It Means 34 of 37
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Key Financial Ratio Analysis Assignment Sample

• Subject Name : Accounting and Finance

Table of Contents

Rationale behind Ratio Analysis.

Liquidity Ratios.

Conclusion.

References.

Rationale Behind Ratio Analysis

Financial analysis is considered as the process of estimating the projects, businesses, finance-related transactions and events in order to examine the overall performance and sustainability of the organization (Aydiner et al., 2019). It is basically used to analyze the solvency, liquidity and profitability level of the company to order effectively decision making process. If it is done for internal purposes, then a financial analysis can help the management in making future decisions in an effective and efficient manner and if it is done externally, then it helps the investors to select the best investment opportunities from where they can grab higher returns on their investment. It is considered as an overall aspect of the finance function of the organization that includes examination of historical information and data to obtain information about the current and future financial position and health of the company. The goals and objectives of the business organization are set in financial terms and their results are also measured in financial terms. There are three major sources of data used for financial analysis, namely, statement of profit and loss, balance sheet and the statement of cash flows.

Liquidity Ratios

Liquidity ratios help in measuring and analyzing the ability of the company to pay off its current liabilities. It relates to the cash availability and other short term assets to cover up short term debts, accounts payable and other current liabilities. The ideal current ratio stands at 2:1 and the company’s ratio is lower than this ideal ratio (Rashid, 2018). However, the current ratio of Easy Jet is rising continuously which indicates good liquidity position of the company. Company’s current assets are increasing at a higher speed as compared to its current liabilities. The quick ratio of the company is also rising. In 2019, the quick ratio has been increased to 0.83 from 0.58 in 2018 which indicates that the firm has sufficient amount of funds and assets to pay off the amount of current liabilities. Therefore, the overall liquidity position of the company is quite good.

Profitability ratios help in measuring and analyzing the financial performance of the company in an effective and efficient manner by taking into consideration the total amount of revenue received by the company in a specific year, operating expenses incurred by the company along with shareholders' equity (Sroufe & Sroufe, 2018). It refers to the performance of the company’s management in utilizing the resources of the business. There is a fall in the net profit margin of Easy Jet from 28% in 2018 to 21% in 2019 which indicates that the cost of goods sold is rising that might be resulting due to fall in sales revenue, unfavorable purchase pattern, inefficient promotional policies adopted by the company and so on. The return on assets ratio has also been declined from 16.76% in 2018 to 12.71% in 2019 which is showing that Easy Jet is not effectively using its assets. Fall in the ratio of return of equity from 30.70% in 2018 to 21.17% in 2019 indicates that the company is decreasing the amount that it is paying as dividends to its shareholders on the amount invested by them. Fall in return on equity also shows that the company is retaining a higher amount of profits to meet its future growth prospects.

Efficiency ratios help in accomplishing a better understanding of the usage of assets by the company in a specific period of time (Arkan, 2016). The asset turnover ratio of the company is quite similar for the years 2018 and 2019. This indicates that the company is using its assets in a consistent manner over the past three years. However, there has a significant decline in accounts receivable turnover ratio from 2018 to 2019. In 2019, accounts receivable ratio is 49.96% which was at 88.78%.

Financial gearing ratio is considered as an appropriate tool to measure the leverage of the company. It is generally considered safer for the company to have lower debt to equity ratio as on debt, regular payment of interest is to be made irrespective of the amount of profits earned by the company (Ehrhardt & Brigham, 2016). This ratio has been declining over the past three years which shows that the amount of total equity is increasing as compared to the debt amount. Lowering down the interest expenses will help the company in raising the profit level which can then be used to pay off higher dividend to the equity shareholders.

Conclusion on Key Financial Ratio Analysis

It can be concluded that financial analysis is essential for all types of business owners and managers in order to determine and analyze the progress of the organization towards achieving the goals and objectives of the company along with competing with other rival firms in the industry. It must be performed regularly by the management to identify and adopt the trends that are influencing the operations of Easy Jet Company. It is considered beneficial for the company owners to conduct financial analysis as it provides important measures of the success or progress of the company from the perspective of investors, creditors and other outside analysts.

References for Key Financial Ratio Analysis

Arkan, T. (2016). The importance of financial ratios in predicting stock price trends: A case study in emerging markets. Finanse, Rynki Finansowe, Ubezpieczenia, 79(1), 13-26.

Aydiner, A. S., Tatoglu, E., Bayraktar, E., Zaim, S., & Delen, D. (2019). Business analytics and firm performance: The mediating role of business process performance. Journal of Business Research, 96, 228-237.

Ehrhardt, M. C., & Brigham, E. F. (2016). Corporate finance: A focused approach. Cengage learning.

Rashid, C. A. (2018). Efficiency of Financial Ratios Analysis for Evaluating Companies’ Liquidity. International Journal of Social Sciences & Educational Studies, 4(4), 110.

Sroufe, R. P., & Sroufe, R. P. (2018). Value Creation for Stakeholders and Shareholders', Integrated Management.

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A Complete Tutorial On Ratio Analysis In Accounting

Table of Contents

Introduction

In accounting, ratio analysis refers to a method that helps companies to gain insight into their liquidity, profitability, and operational efficiency by comparing financial data and information included in their financial statements. Ratio analysis stands as a cornerstone of a company’s fundamental analysis. Also, Companies use this analysis for evaluating relationships among the items of their financial statements (Delen, Kuzey & Uyar, 2013). However, these ratios are also used for identifying a company’s trends in relation to profitability, liquidity, and solvency over time or for comparing two/more companies at the same point in time. The current essay is constructed to provide a complete tutorial on ratio analysis. You can consider it as a financial accounting assignment help guide as well.

Main Body/Discussion

Ratio analysis is conducted by considering a company’s financial statement and it uses to focus on three major aspects such as profitability, liquidity, and solvency. In fact, these ratios help potential shareholders or investors to gauge a company’s financial performance over a certain period of time by comparing its financial performance with another company before finalizing investment decisions (Babalola & Abiola, 2013). Now, outside business analysts use different types of financial ratios for assessing companies, whereas insiders of a corporate rely less on these ratios because they have access to more detailed operational and financial data about their company.

However, this analysis involves evaluating a company’s financial performance and health by using its financial data as available in its historical and current financial statements. Sometimes, this analysis is used in order to establish a trend-line on the basis of a company’s financial results over a number of financial years i.e. reporting periods.

The major categories of financial ratios are discussed below including formulas.

Profitability Ratios

Profitability ratios refer to the financial metrics that are used by investors and analysts to evaluate and measure a company’s ability to generate profit (income) relative to its revenue, operating costs, shareholders’ equity, and balance sheet assets during a certain period of time. Also, these ratios show how well an organization uses its assets for producing profit as well as value to its shareholders. Profitability ratios are categorized into margin ratios and return ratios.

Margin ratios

This category of profitability ratios includes i) Gross profit margin that compares a company’s gross profit from the business to its sales revenue. It shows a business’s earning by taking the required costs of production into account. ii) Operating profit margin that looks at a company’s earnings (operating profit) as a % of sales before deducting income taxes and interest expenses. iii)However, Net profit margin, the most vital profitability ratio that looks at the net income (after deducting taxes and interest from operating profit) of a company and compares it to total revenue, and provides a final picture of a company’s profitability.

iv) EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) margin that represents a company’s profitability before taking non-operating elements like interest, taxes, and non-cash items such as amortization and depreciation into account. v) Cash flow margin that uses to express the relationship between a company’s sales and cash flows it generates from its operating activities. Also, this ratio measures a company’s ability to convert its sales into liquid cash. However, the higher this ratio, the more cash available to a company from sales which it can use to pay dividends, suppliers’ dues, utilities, service debt, and for purchasing capital assets (corporatefinanceinstitute.com, 2020). 

Read Also- What is the major objective of managerial accounting?

Return ratios

In order to solve the finance assignment dealing with financial ratios in accounting, you must be well versed with the basics which go like this. i) ROA (return on assets) that represents the % of a company’s net income relative to its total assets and reveals how much profit (after-tax profit) a company uses to generate for every single dollar of assets it holds. Also, it measures a company’s asset intensity. ii) ROE (return on equity) which uses to express the % of a company’s net profit relative to its stockholders’ equity or the percentage of return equity investors can get on on the money they have invested into a company.

The investors and stock analysts use to focus on this ratio. iii) ROIC (return on invested capital) that measures the return generated by a company compared to the capital, raised from shareholders and bondholders, it has invested in its business ( corporatefinanceinstitute.com , 2020).

Liquidity Ratios

These ratios measure a company’s ability to pay off its short‐term financial obligations or debts and to meet its unexpected cash requirements. Accordingly, the analysis of liquidity ratios is very important for creditors and lenders who want to get some ideas regarding a company’s financial condition before granting credit to it. In fact, the most commonly used liquidity ratios are the current ratio, quick ratio, and working capital ratio. Also, the current ratio represents the ability of a company to meet its short-term debt or financial obligations and measures whether the company holds enough resources that it can use to repay its debts in the next twelve months.

The quick ratio measures the ability of a company to meet all its short-term financial obligations by using liquid assets (cash or quickly convertible assets) it holds. Consequently, it tells about the short-term debts of a company that it can repay by selling its liquid assets at short notice to the creditors. However, the working capital ratio is used for measuring a company’s capability to meet its current financial obligations and how many liquid assets are available in a company’s hands (Brigham & Ehrhardt, 2013).

Solvency Ratio

The solvency ratio measures a company’s ability to meet its long-term debts. Moreover, it quantifies a company’s size after its tax income without counting its non-cash expenses for depreciation. It indicates a company’s solvency by judging its financial health. There are some common solvency ratios that are used for checking a company’s solvency such as debt-to-equity ratio, debt-to-asset ratio, and debt-to-capital ratio.

The debt-to-equity ratio indicates the relative proportion of debts and shareholders’ equity a company uses to finance its assets. The debt-to-assets ratio indicates the financial leverage of a company. It indicates how much of the total assets of a company were purchased or financed by its creditors. the debt-to-capital ratio measures the financial leverage of a company and is calculated by dividing interest-bearing debt (both short-term and long-term liabilities) and by the company’s total capital (all interest-bearing debt + shareholders’ equity) (Khidmat & Rehman, 2014).

Efficiency Ratios

These ratios measure the capability of a company to utilize its assets as well as to manage its corporate liabilities effectively in a short-term period or for the current financial period. Some of the most common efficiency ratios are inventory turnover ratio that indicates the movement or utilization of inventory, accounts turnover ratio which indicates how fast a company collects its dues from its customers, and assets turnover ratio that uses to measure the value of an organization’s revenue or sales relative to the value of assets it holds.

This ratio acts as an indicator of a company’s efficiency in using assets for revenue generation purposes. A higher asset turnover ratio indicates the greater efficiency of a company. Another efficiency ratio is accounted payables turnover ratio that uses to measure the faster a company repays its trade suppliers. It indicates a company’s financial condition by indicating the speed of the company’s activity to repay dues (Babalola & Abiola, 2013).

This essay is fully equipped with the key financial ratios used by business analysts, investors, and other stakeholders to gauge a company’s financial performance for the current year or for a certain period of time. Financial ratio analysis guides investors to select the most profitable company to invest in and helps creditors and other loan-providing organizations to decide where it is profitable for them to grant loans to a company or not. Overall, analysis of financial ratios is very helpful to understand a company’s financial statements, identify trends over the years and measure its actual financial state.

Read Also- Revenue Expenditure: Full Explanation

Examples of Ratio used in Financial Analysis

There are different types of possible ratios that can be used for analysis purposes. But there is only a small core group that is typically used to gain an understanding of an entity. Such ratios include the following-

• Current Ratio : These types of ratios are used to compare the current assests to current liabilities. This happens to see that whether a business has enough cash to pay its immediate liabilities.
• Days Sales Outsatnding: These types of ratios are used to determine the ability of a business to effectively issue credit to the customers and also to be paid back on the given peiod of time.
• Debt to Equity Ratio: This usually compares the proportion of debt to equity, to see if a business has taken on too much debt.
• Dividend Payout Ratio: This is usually the percentage of earning that are paid to investors in the form of dividends. If the percentage is low, then it will be an indicator that there is no room left for the dividend payments that could increase the sustainability.
• Gross Profit Ratio: This ratio is probably used for calculating the proportion of earnings generated by the sale of goods or services., before the administrative expenses are included.
• Inventory Turnover: This is used to calculate the the time it takes to sell of the inventory. A low turn over may figure out that a business has an excessive investment in inventory, and therefore is at risk of having obsolete inventory.
• Net-Profit Ratio: This is used to calculate the proportion of net profit to sales. A low proportion can indicate the bloated cost structure or pricing pressure.
• Price Earning Ratio: This is used to compare the price paid for a company’s shares to the earnings reported by the business. An excessively high ratio signals that there is no basis for a high stock price, which could presage a stock price decline.
• Return on assests: This is used to calculate the ability of management to efficiently use assests that could generate the profits. In case there is low return then it indicated that there is a bloated investment in assets.

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INTRODUCTION OF FINANCIAL MANAGEMENT AND ANALYSIS ASSIGNMENT SAMPLE

Rationale behind choosing tesco, performance analysis, profitability ratios, liquidity ratios, working capital ratio, capital structure, stock market performance, limitation of ratio analysis, conclusion and recommendation.

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Financial management is the arrangement of funds with an aim to achieve desired objective of the organisation in an effective and efficient manner. This is the differentiated function that is associated with the top management (Ahrendsen and Katchova, 2012). The main purpose of preparing this report is to determine the financial position of the company by calculating various ratios. In addition to this, impact of legal, political, economic and tax changes on the financial statements of the company is also evaluated. Along with this, the other purpose of preparing this report is to find out the stock market performance of the company. In regard to all this, weakness of ratio analysis will be assessed to improve the same. In order to study the financial statements of the company, ratio analysis has been done by using various secondary data sources like internet, books and journals.

The main purpose of choosing Tesco is to determine the financial performance of the company for the last five years. Tesco is a multinational company of UK which deals in all types of consumer goods.

In the following report, Tesco has been taken into consideration. It is a multinational retail and grocery company which deals in all types of consumer products. It is the third largest retail company headquartered in Welwyn Garden City, Hertfordshire. This company is a public limited company listed on London Stock exchange. This company was founded in 1919 by Jack Cohen. In the year 1990, Tesco has repositioned its structure and move on from state down-market and low-cost retailer ( Tesco PLC ADR , 2015). This in turn proves to be very successful for the company. Tesco had a market capitalization of around £18.1 billion up to 22 April 2015.

Tesco is one of the fastest growing companies in retail industry. It is continuously providing new and innovative consumer goods which in turn attract the large number of customer. As it is a growing company so analysing the financial statements of this company will prove to be very beneficial for us. Another reason of using this company is to analyse its financial position and to decide whether investing in this company prove to be beneficial or not. It is one of the growing industries which in turn will provide lot of reliable data in order to analyse the financial performance of various industry. In addition to this, retail industry is one of the fastest growing company which in turn will help to find out the latest trend that are taking place in the corporate world.

Profitability ratio indicates the part of the sales revenue that is covered by the gross profit. This ratio also indicates the firm’s ability control its direct expenses (Estrada, 2005). In order to measure firm’s performance on cost control, it is necessary to compare current year ratio value with the previous year. If sales is growing rapidly but direct expenses grow at slow pace, then it means that firm is keeping good control on direct expenses.

Interpretation

Gross profit ratio of the Tesco is declining continuously and in last year, it was negative. This reflects that every year firm is earning less gross profit on sales. There is an increase in previous year’s sales but gross profit increases at slow rate. Hence, it can be said that less control on direct expenses is one the main reasons which are responsible for the decline of the firm’s gross profit. On the other hand, there is a net profit ratio which indicates the proportion of the net profit on sales. This also reflects firm’s capability to control indirect expenses. Net profit ratio of the firm is declining sharply and it was negative in the last fiscal year. This shows that condition of the firm is very critical. This decline is observed in the sales because there was loose control on the indirect expenses of the firm. There may be many other reasons that are responsible for the low net profit. Due to recession, demand for products fall from people side and due to this reason, Tesco earns low amount of profit on sales. In the retail industry, there is a stiff competition and due to this reason, firms operating in this industry are continuously reducing their product’s prices. This leads to low earning of margin on sales. Tesco is also compelled to reduce its product price and due to this reason; it is earning low profit on per unit of sales. This is the basic reason behind decline in profit.

Current ratio- This ratio indicates the firm’s liquidity position. If current ratio is increased, then it means that firm has large amount of current assets to meet its current liability on time (Kastantin, 2005). Current ratio of the Tesco is fluctuating steadily. It shows good increase in current ratio at good growth rate but also declines at fast rate as well. However, in past years, its performance was not good this is because; it failed to beat benchmark of 2:1 which is a set standard. It is even when its current ratio value failed to become 1. Current figure of current ratio indicates that for every one pound of current liability, firm has 0.67 pound of current assets. Hence, firm is not in the position to pay its current liabilities on time. It can be said that firm needs to make lots of efforts in order to improve its liquidity position in the business.

Quick ratio- This ratio gives a clear picture of firm’s liquidity position than current ratio. In this ratio, same formula is applied but prepaid expenses and stock are not included in the company’s current assets. Hence, quick ratio shows company’s liquidity position in a proper manner. Quick ratio of Tesco is also declining steadily and the one main thing on which attention is needed is that there is a huge gap in the current and quick ratio. This reflects that stock and prepaid expenses cover a large portion of the Tesco’s current assets. On this basis, it is stated that firm must try to make its liquidity position as strong as possible.

Working capital is calculated by the company in order to find out the efficiency and short term financial health of the company (Leong, Pagani and Zaima, 2009).

As per the above calculation, it can be interpreted that working capital of the company is constantly fluctuating. Company's current assets are less as compared to current liabilities. The reason behind this situation can be that company is not able to make payment to its creditors on time. Therefore, in order to overcome this problem, company should start preparing various strategies and financial activities in advance.

Capital structure shows how a company is able to finance its overall activities and operations by using various sources of finance. Debt of the company includes all types of bonds that are issued by the company (Nissim and Penman, 2001). On the other hand, shareholders equity includes retained earnings, preference shares, equity shares and many more things.. Below is the calculation of debt-equity ratio of Tesco. 

As per the above calculation, it can be interpreted that company's debt is more as compared to that of equity which is not a good sign. In order to be successful, equity of the company should always be more as compared to that of its debt. In short, it can be said that debt is the expense of the company and equity is the income.

In the above calculation, it can be seen that debt equity ratio of Tesco is constantly increases. From year 2011 to 2014, debt equity ratio was growing at a slow rate, but in year 2015, its capital structure ratio increases at a high speed. This is turn shows that firm is not able to properly manage all its operations. Liabilities of the Tesco are constantly increasing. In addition to this, it also indicates that Tesco is not able to pay to its creditors on time due to which its liabilities are constantly increasing. The reason behind this condition can be that Company is not able to reduce the cost of its production. Change in economic condition of the organization can also be one of the reasons for the reduction in the level of equity. It also shows that they are not able to maintain the balance between its inflow and outflow of cash. In addition to this, they are also not able to hold a balance between assets and liabilities of the enterprise.

Stock market is the place where large number of brokers comes together with an aim to buy and sell the stock and various other securities of the different companies. This is the market where electronic trading process takes place (Werner and Brand, 2001).

Henceforth, stock market performance is the presentation of the company over a certain specified time period. This helps the company to enhance financial performance of the particular company. By analysing this performance, one can conclude whether company is growing or moving towards downward.

Therefore, the stock market performance of Tesco Company is listed below: 

On the basis of the above chart, it can be concluded that financial position of Tesco is not good. Its market share is continuously fluctuating. After analysing the last past five years performance of the company, it is seen that from continuous five years, market share of Tesco is declining. In year 2013, it was able to grow its market share as compared to 2012. But still it was not able to grow at high rate. Its market share still shows the negative balance.

Again in the year 2014, its market share again declines at a high rate as compared to 2013. Market share of Tesco’s shows a falling trend from -5.42% to -43.12%. Likewise, in the year 2015, Tesco has made great efforts to grow. It was able to increase its market share from -43.12% to -4.10%. But it cannot be ignored that its market share still shows a negative balance.

Thus, after analysing the overall performance of Tesco, it can be concluded that financial position of the company is not good. Therefore, it is recommended that Tesco should start focusing more on the formation of its strategies with an aim to reduce its cost of production. In addition to this, they should bring innovation in its products.

Ratio analysis can be used to compare the financial statements of various companies and to gain general understanding about the results. But at the same time, it cannot be ignored that there are various limitations of conducting ratio analysis. Some of the weaknesses are as follows:-

• Historical: - All the data that are collected for the purpose of calculating ratios are actually derived from the historical data. The data is not the current data. And it may not be necessary that the same condition or results of the company will be carried forward in future (Ye, Wang and Zheng, 2015). It may change after sometime. Thus, in order to achieve the consistency ratio performance, analysis can be done on Performa information and afterwards comparing the same with historical results may prove to be beneficial.
• Inflation: - Rate of inflation can change at any time period. For instance; the rate of inflation in year 2012 was 100%, in that case sales of products will appear to be double but actual sales of the product do not change.
• Accounting policies: - Different types of policies are adopted by different companies for recording similar financial transaction. This means that two different products are compared together. For instance, suppose one company record the sales of the firm at gross while the other organization to do the same on net basis.
• Company strategies: - Comparing the ratio of two organizations is made by considering different strategies that can prove to be very problematic. For example; suppose one company is considering the low-cost strategy and accept to earn lower gross margin in exchange to the high market shares. On the other hand, another company is considering the high customer services strategy and are accepting to earn higher gross margin and price.
• Past information: - Ratio analysis is done by considering the past data. But the users are much concern about the current and future data ( Contents, 2015 ).
• Data collected from balance sheet: - While calculating the ratio analysis, the data is collected from the balance sheet. But the information recorded in the balance sheet is the one that is generally recorded at the end of the reporting period. If the balance reduces on the reporting date, then it can create an adverse impact on the outcome of the ratio analysis.
• Business environment: - Irregular business environment of the various organisations can also affects the ratio analyses. For example: - 40 days outstanding sales may considered to be poor at the time of rapid growing sales. But the same may prove to be good at the time of economic contraction.
• Selection of different sources of finance: - Ratio of the companies cannot be compared for those who use different sources of finance. For example, one company may purchase the property while other is leasing the same or some other firm finances its business unit by using long term borrowing whereas the other may collect funds from shareholders or from reserves.
• Accounting practices : - Different accounting practices can affect analyses of the ratio even when the comparison is done for the similar company. For example- LIFO v/s FIFO or leasing v/s buying equipments.

On the basis of above report, it can be concluded that financial position of Tesco from the last five year is not good. Its liabilities and debts are constantly increasing and assets and equity are reducing. This indicates that the company is not properly able to manage its all operations. In addition to this, it can interpret that Tesco’s gross profit and net profit ratio are reducing constantly. While in the year 2015, it has been seen that company's gross profit and net profit margin reduces at a high speed. Company has suffered a huge loss in year 2015. The current assets of the company are less as compared to its current liabilities for the last five years. Recommendation

After analysing the financial position of the company by calculating various ratios, it can be interpreted that company is not doing well. Therefore, recommendations that can be followed by the Tesco in order to improve its financial position have been discussed below:

• Tesco should make efforts to reduce the cost of sales and manufacturing. This in turn will help the company to generate more and more revenue. In addition to this, company will also be able to grow up from negative trends and start generating profit.
• Tesco should try to introduce new and innovative products in the market. But before doing so, company should start doing research and take feedback from the customers. This in turn will help the company to analyse the latest trend, taste and preference of the customers. After which company will be able to manufacture accordingly ( Financial ratios , 2015).
• Tesco should make an attempt to change the perception of customers. Positive perception will help Tesco to grow.
• This retail firm should also try to reduce their expenses and generate more income.
• Company should make an attempt to choose the best source of finance for raising its capital. They should analyse whether the selected source will generate more income or will increase the debt of the company.
• Company should prepare various strategies in advance in order to overcome any uncertainty that can occur due to change in internal and external environment ( Tesco PLC ADR, 2015). Formation of these strategies will also help the company to analyse the price of its competitor’s products.
• Tesco should also start planning all its financial activities in advance in order to overcome various uncertainties, maintain the flow of cash, proper utilization of available resources and to effectively distribute the resource and capital in each and every department. This in turn will help the company to avoid the condition of deficit and surplus outcomes.

Books and Journals

Ahrendsen, L. B. and Katchova, L. A., 2012. Financial ratio analysis using ARMS data. Agricultural Finance Review. 72(2). pp. 262 – 272.

Estrada, J., 2005. Adjusting P/E ratios by growth and risk: the PERG ratio. International Journal of Managerial Finance. 1(3). pp. 187 – 203.

Kastantin, T. J., 2005. Beyond earnings management: Using ratios to predict Enron's collapse. Managerial Finance. 31(9). pp.35 – 51.

Leong, K., Pagani, M. and Zaima, K. J., 2009. Portfolio strategies using EVA, earnings ratio or book‐to‐market: Is one best?. Review of Accounting and Finance. 8(1). pp. 76 – 86.

Nissim, D. and Penman, S. H., 2001. Ratio analysis and equity valuation: From research to practice. Review of accounting studies. 6(1). pp. 109-154.

Werner, R. A and Brand, W. A., 2001. Referencing strategies and techniques in stable isotope ratio analysis. Rapid Communications in Mass Spectrometry. 15(7). pp. 501-519.

Ye, X., Wang, D. and Zheng, X., 2015. Effects of density ratio and diameter ratio on penetration of rotation projectile obliquely impacting a granular medium. Engineering Computations. 32(40). pp. 1025 – 1040.

Contents. 2015. [PDF]. Available through: < https://investor.ryanair.com/wp-content/uploads/2015/07/Annual-Report-2015.pdf> . [Accessed on 10 th  February, 2016].

Financial ratios. 2015. [Online]. Available through: < http://www.cpaclass.com/fsa/ratio-01a.htm>.[Accessed on 10 th  February, 2016 ].

Summary of the balanced scorecard concepts . 2015. [Online]. Available through: < http://maaw.info/BalScoreSum.htm> . [Accessed on 10 th February, 2016].

Tesco PLC ADR. 2015. [Online]. Available through: < http://financials.morningstar.com/balance-sheet/bs.html?t=TSCDY&region=usa&culture=en-US>. [Accessed on 10 th February, 2016 ].

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• Posted on September 17, 2020
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Financial Analysis

Introduction

In this competitive environment, it is essential for the companies to increase the knowledge about the financial terms with respect to evaluate the different financial activities of the business.

This knowledge helps the organization to analyze the market trend related to finance within the competitive market (Walker, 2009). In this way, the main focus of this report is to make a comparison report that can help to show the comparison between two organizations that are working in the same industry.

For accomplishing the purpose of this report, Apple Inc. as a primary company is selected that is listed in the S & P 500. In addition, for comparing performance, Intel is selected as the secondary company that helps to present the comparison with Apple Inc by using trend analysis and ratio analysis techniques.

This report starts with the introduction of both selected companies. This report also highlights the financial performance of both companies that define the company’s financial position with a historical trend within the market.

Moreover, the ratio analysis is also used in this report in context to analyze the financial performance of the companies of last five years. For conducting the comparison between both the companies, different ratios such as liquidity ratio, efficiency ratio, profitability ratio and capital structure ratio and investment ratios are used.

Company Background

Apple Inc. is an American multinational technology company that is founded by Steve Jobs in 1976. Apple has it’s headquartered in Cupertino, California US that serves its users by its IT products and services.

The company works in the information technology industry and provides high quality and performance products as well as services related to IT to its users. At the same time, Apple provides its different products like computer software, computer hardware, digital distribution, consumer electronics etc in different segments.

In the concern of its financial position, the total revenue of Apple Inc. was recorded as $229.234 billion in the financial year 2017. It provides the employment of more than 123,000 employees in its different segments.

In order to compare the performance of Apple, Intel is a well-known company in the information technology industry.  It is headquartered in the same area as Apple. Further, the main source of revenue of Intel is its processors that are used in the computers.

In context to evaluate and analyze the financial performance of Apple last five years, the technique of ratio analysis is really helpful. This ratio is also helpful to make the comparison of the financial performance between Apple Inc and its market competitor Intel.

a) Historical trends in accounting statement entries

In order to determine trends in the accounting statement entries, it is required to conduct trend analysis. For Apple, the following table presents trend analysis by considering income statement, balance sheet, and cash flow statements:

Table 1: Historical Trends of Apple

(Source: Annual Report, 2017a, Annual Report, 2017b, Yahoo Finance, 2018a & Yahoo Finance, 2018b)

Based on the above table, it can be stated that overall, there is an increasing trend in the accounting statement entries from 2014 to 2017 with respect to the base year 2013.

In addition, there is an increasing trend from 2013 to 2015 for all considered accounting statement entries like turnover, profit, long-term debt, cash and cash equivalents, equity, cash flow from operations and dividends.

But at the same time, there is a decline in revenue, gross profit, operating profit, net profit, cash and cash equivalents, and cash flow from operations in 2016 as compared to 2015 due to decline in unit sales and net sales of iPhone units and effect of weakness in foreign currencies relative to the U.S. dollar.

However, values of all these entries increased in 2017 showing an increasing trend as compared to 2016.

Table 2: Historical Trends of Intel

On the other hand, it can be analyzed that there is an increase in total revenue, gross profit, operating income and net profit in 2014 as compared to the base year 2013, however, these values decreased in 2015.

But at the same time, there is a decline in long-term debt, cash and cash equivalents and stakeholder equity, cash flow from operating activities and dividends in the year 2014 in comparison of the base year 2013 followed by an increase in 2015.

However, after this, there is an increasing trend in revenue, gross profit, operating profit, equity, cash flow from operations and dividends from 2015 to 2017 consistently, but a decline in net profit, cash, and cash equivalents is noticed in the year 2017 due to high investment in R&D and strategic alliances with other firms.

b) Historical trends and inter-company comparisons of relevant accounting ratios

This section presents the historical trends and inter-company comparisons of different accounting ratios of Apple and Intel.

Liquidity ratios:

Liquidity ratio provides the information related to the potential of the firm to meet the short-term obligations (Keating, 2014). The below table shows the calculated liquidity ratio of both firms:

Table 3: Liquidity Ratios

From the above table, it can be stated that there is a decline in the current ratio of Apple (from 1.68 to 1.28) as well as Intel (from 2.36 to 1.69) from the year 2013 to 2017 with some fluctuations. But at the same time, the current ratio of both firms is above 1 showing the ability of both firms to meet their current obligations effectively, but it is not equal to ideal ratio of 2:1.

Meanwhile, Intel current ratio is higher than Apple showing better ability of Intel as compared to Apple to meet its short-term obligations. The lower current ratio of Apple as compared to Intel might be due to sharp increase in the short term debts without significant increase in the short-term assets.

In addition, the quick ratio of both firms is more than 1 but with declining trend during this period (for Apple, from 1.64 to 1.23; for Intel, from 2.06 to 1.29).

However, it is higher for Intel in comparison of Apple showing better ability of the firm to meet its short-term obligations in contingency (Edmonds et al., 2015). It is because there might be possibility of increasing short-term debts for Apple.

It also indicates that both companies can settle their short-term debts for more than 1 time without considering the inventories.  However, there is better consistency in the liquidity of Apple due to fewer fluctuations as compared to Intel.

Profitability ratios:

These ratios provide the information related to the profitable situation of the company to generate sufficient returns for the investors (Petty et al., 2015). The below table shows the calculated profitability ratio of both firms:

Table 4: Profitability ratios

Regarding these ratios, it can be interpreted that there is a decline in return on capital employed (from 29.58% to 22.35%) and net profit margin (from 21.68% to 21.09%) from 2013 to 2017 for Apple, but there is an increase in return on equity (from 40.60% to 47.81%) during this period. The increase in return on equity may be associated with finance access by Apple in procurement of assets as costs incurred on borrowing.

However, there is a significant increase in return on capital employed (from 1.59% to 16.95%) and return on equity (from 21.64% to 29.49%), but a decline in net profit margin (from 18.25% to 15.30%) is also noticed from 2013 to 2017 for Intel.

The decline in net profit for both companies was because of rising cost of operations including R&D and depreciation of assets that largely affected the net profits of the firms. So, it is crucial for the management of both firms to take measures for reducing operating expenses.

But at the same time, the values of all profitability ratios are higher for Apple as compared to Intel during this period. It suggests that Apple is capable of generating higher profits as compared to Intel for its investors (Warren et al., 2013).

Efficiency Ratios:

These ratios provide the information related to the efficiency of the management to use the available resources including inventory and assets to increase sales (McKinney, 2015). In concern of these ratios, the following table presents the efficiency of the management of both firms:

Table 5: Efficiency ratios

In relation to inventory ratio, it can be depicted that the inventory turnover ratio for Apple (from 60.76% to 29.05%) as well as Intel (from 5.14% to 3.39%) declined from the year 2013 to the year 2017.

It might be due to significant increase in sales as compared to inventories of both firms with some fluctuations. However, it is higher for Apple showing the efficiency of the management to convert inventory into sales faster in comparison to Intel due to high innovation and quality focus on production.

It also shows that Apple is a labour intensive company or it adds value to brought-in products and converts its inventory into sales in shorter period as compared to Intel.

At the same time, the asset turnover ratio for both firms how high fluctuations but overall, there is a decline in asset turnover for Apple (from 105% to 84%) and Intel (from 67% to 59%) during this period indicating declining ability of the management to utilize and convert the assets into sales (Graham and Smart, 2011).

However, the value of asset turnover is higher for Apple in comparison to Intel showing the higher efficiency of Apple’s management to convert assets into sales. It means Apple uses assets efficiently to convert them into sales in less time period as compared to Intel.

Capital Structure ratios:

Capital structure ratio is related to the ratio reflecting the fund arrangement of the firm. It shows the ability of the firm to manage the capital structure effectively (Keating, 2014). The below table shows the comparison between capital structure ratio of Apple and Intel:

Table 6: Capital Structure ratios

From the above table, it can be stated that there is an increase in debt to asset ratio of Apple (0.4 to 0.64) and Intel (from 0.37 to 0.44) from the year 2013 to the year 2017 showing the increasing contribution of debt in capital structure as both firms have increased the investment in R&D and advanced technologies more.

However, the value of debt to asset ratio for Apple is higher than Intel reflecting higher debt portion in capital structure as compared to Intel. The same results are obtained in relation to debt to equity ratio as this ratio for Apple (from 0.68 to 1.8) and Intel (from 0.59 to 0.79) increased during this period indicating the increasing contribution of debt in the capital structure.

However, it also shows that debt to equity ratio is higher for Apple or more than 1 means company uses more debt as compared to equity in its capital structure to keep the financing cost low, protect the shareholders and make large investments in R&D and innovative projects (Droms and Wright, 2010).

But the debt to equity ratio is less than 1 for Intel as the company uses more equity in its financing to increase its creditworthiness for future contingency. The regular increase in debt ratio during this period for both companies shows that both companies appear to be improving its debt position.

Interest cover ratio of Apple declined over the years from 355 to 26.41 significantly at the same time, there is slight decrease in this ratio from 29 to 28 for Intel. However, it is higher for both firms imply ability of both firms to pay their interests easily. But, in 2017, interest coverage ratio is slightly higher for Intel as compared to Apple as Intel finds it easier to meet its interest payments as compared to Apple.

Stock Market Ratio:

Investment ratios are significant to provide the information related to returns on investment by the company to the investors that help them to make investment decisions. In relation to Apple and Intel, the below table presents the calculated investment ratios:

Table 7: Stock market ratios

Based on the above table, it can be analyzed that EPS for Apple has been increasing from $5.66 in 2013 to $ 9.21 in 2017 with fluctuation in the year 2016 due to impact on revenues by the competitors showing an increasing trend and ability of the firm to provide higher stock returns.

But at the same time, the company’s dividend per share declined from $11.80 in 2013 to $ 2.03 in 2015 but after this, it increased up to $2.46 till 2017. It shows that from 2013 to 2015, company reinvested its profits in R&D and new product development more affecting the dividend per share but after this, it started to increase this return to the shareholders to remain its stock attractive for the investors.

On the other hand, EPS and DPS of Intel are less as compared to Apple showing the lower ability of the firm to generate adequate stock returns comparatively. However, EPS (from $1.88 to $1.99) and DPS (from $ 0.90 to $1.12) both increased from the year 2013 to the year 2017 indicating the increasing ability of the firm to generate stock returns on its shares for the investors (Brigham & Ehrhardt, 2013).

Based on the above analysis and discussion, it can be summarized that Apple is performing better than Intel but at the same time, the financial performance of Apple is declining due to increasing competition and changing customers’ preferences.

In addition, it is also concluded that historical trends showed that both companies have fluctuations in trends of accounting statement entries. At the same time, ratio analysis reflects that Apple has higher liquidity, profitability and efficiency and investment ratios as compared to Intel and uses more debt in its capital structure as compared to Intel.

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