About the report:
In this report, we will analyze the financial performance of Double Ace Industries using the tools of ratio analysis where along with calculating six ratios under varied sections, we will also compare the results with the industrial average. Each ratio calculation will also be followed by an in-depth analysis about ongoing financial situation and with appropriate recommendations, if required. We are sure that by the end of this report we will be having a sound knowledge about the financial position of the company over the year and how its performance is comparable to the industrial average.
i) Quick Ratio
Formula: (Cash+ Accounts Receivables+ Marketable Investments)/ Current liabilities
Also known as ‘Acid Ratio’, this liquidity ratio is a stringent barometer to measure the liquidity position of the company as it calculates the ability of the company to honor its current obligations only through most liquid assets such as Cash, Receivables and Marketable Investments. Below calculated is the quick ratio for the company for the year 2012 and 2013:
2012: (42000+78000)/264000= 0.45
2013: (46500+131750)/292950= 0.60
Referring to the above calculation we notice that over the year, the liquidity position of the company has improved with quick ratio multiple increasing from 0.45 to 0.60 courtesy higher proportion increase in Cash+ Accounts Receivable in comparison to the current liabilities.
However, the results are still not satisfactory when compared to the industrial average. Important to note that the average quick ratio of the industry is 1.4 times that is more than double than the existing quick ratio of the company. Hence the company needs to continue further improvement in its liquidity roots through higher proportion increase in more liquid current assets as against current liabilities.
Formula: (Earnings after tax/ Net Revenue)*100
The main crux ratio indicating the bottom line profit margins of the company earned from its business activities. This ratio carries great significance for the shareholders as it has the capacity to affect their investment decision in the company. Below calculated is the net profit margin of the company for the yea r2012 and 2013:
2013: 72380/520000= 13.92%
Noted from the above calculation we notice that during the year the profit margins of the company have declined significantly from 19.60% to 13.92%. Important to note that during the year 2013, the company did earn higher gross margin but the profit margins were eroded by higher operating expenses and interest expense that resulted in an undesirable slump in the net profit margins.
The decline in ratio multiple is also alarming for the company as when compared to the industrial average of 18%, the profit margin of 13.92% is undoubtedly indicating poor profitability. Hence, the management should consider this situation with high preference and should try to control its operating expenses in addition to increasing revenue figures so as to bring the profit margins at least in line with the industrial average.
iii)Return on Equity
Formula: Net Income/ Total Equity
Also referred as Return on Total Equity, this ratio indicates the profit margins available to equityholders of the company. Analyst and equityholders become too concerned if the ratio is on consistent declining trend and may re-consider their ratings and investment decision, respectively. Below calculated is the Return on Equity ratio for the company followed by the analysis:
2012: 88200/270000= 32.66%
2013: 72380/ 286750= 25.24%
The trend of poor performance during 2013 is easily visible on our calculation for ROE multiple of the company. The shareholders of the company will not be ecstatic to witness the decline in the ROE multiple from 32.66% to 25.24% . In addition, the multiple is also significantly lower than the industrial average of 36%. This indicates that the company has not been successful in generating appreciable returns for its equityholders and this might significantly affect their confidence of their investment in the company.
iv)Inventory Turnover Ratio
Formula: Cost of Goods Sold/ Average Inventory
An important asset utilization ratio indicating the firm’s efficiency with respect to its processing and inventory management. Every company would like to have inventory turnover ratio close o the industry norms. Below calculated is the inventory turnover ratio for 2012 and 2013 for Double Ace Industries:
2012: 270000/60000= 4.50
The above calculation indicates that over the year the ITR multiple of the company has declined from 4.50 to 3.63. This again is an indication of inefficiency of the management relating to their inventory as the declined inventory turnover ratio multiple indicates that it now takes more time for the company to process and turnover their inventory, hence leaving capital tied up for a longer period of time. This may also mean that the company is losing its sales and inventory is turning obsolete.
Furthermore, the results were also not in-line with the industrial averages of 4.6 times. Hence, the management should actively focus on improving its inventory turnover.
v) Total Asset Turnover
Formula: Revenue/ Total Assets
Another asset utilization ratio used to ascertain the effectiveness of the firm’s use of its total assets to create revenue. Important to note, different type of industries have different turnover ratios. For Instance, a company involved into manufacturing business is likely t have asset turnover close to one(1). On the other hand, a retail business might have turnover ratio near ten(10). Hence it is always advisable to compare this ratio using the industrial average. Below calculated is the total asset turnover ratio of Double Ace Industries for the year 2012 and 2013:
2012:450000/600000= 0.75 times
2013:520000/ 775000= 0.67 times
While we are reaching to the conclusion of the report, we find another ratio multiple that is indicating the poor performance of the company during 2013. Noted from the above calculation, the total asset turnover ratio of the company declined from 0.75 to 0.67 times indicating the inefficiency of the management to generate revenue using the asset base. In addition, a low turnover ratio also indicates that the company has too much capital tied up in its asset base.
Furthermore, the results are also not favorable when compared to the industrial average of 1.2 times. This means that the management in addition to all other areas, needs to focus on it asset turnover too and using the asset base to generate revenue.
vi) Total Debt Ratio
Formula: Total Debt/ Total Asset
A solvency ratio that that indicates the debt utilization pattern of the company in relative to their total assets. Higher is the ratio, higher is the leverage sued by the company to finance their asset base, vice-versa. Important to note, for the purpose of calculating Debt Ratio of Double Ace Industries, we will include both short-term as well as long-term debt for the numerator. Below calculated is the debt ratio of the company for the year 2012 and 2013:
2012: (115500+66000)/600000= 0.30
2013: (195300+195300)/7750000= 0.50
The above calculation indicates that the even the solvency roots of the company has not remained strong. During 2013, the debt ratio of the company increased from 0.30 to 0.50 indicating that around half of the total asset base of the company has been financed through debt sources. This indicates that the company is getting itself more close to the financial risk with high financial leverage.
The results were also not in-line with the industrial average of 40%. Hence, the company should review its capital structure composition and it may go for increased equity financing as higher leverage will only increase its financial risk and if the interest costs become greater than the benefits of the borrowed funds, it may also witness bankruptcy. Apart from equity, the owner may also introduce own capital to fund the asset base. In this way, it will not have to face the financial risk associated with the debt financing and will also be able to avoid the dilution risk of equity financing.
Financial Ratios Summary
Double Ace Industries VS industry averages
At the end of this report, we conclude that the year 2013 was indeed a poor financial year for Double Ace Industries. Our analysis began well as we witnessed improvement in the quick ratio of the company indicating strength in the liquidity roots. However, as we moved further, we found that the company is fighting hard with its financial performance.
Most importantly for the shareholders, the profit margins of the company declined significantly and with ROE multiple falling from 32.66% to 25.24%, we can expect that shareholders might sell out their position if the trend continues to persist over the coming quarters. As for the asset utilization ratios, decreased inventory turnover ratio and asset turnover ratio indicated the ineffectiveness of the management of the company to use their asset base efficiently. Finally, the our analysis was concluded with the calculation of Total Debt ratio that indicated that over the year, the company went for high leverage as more asset base was found to be financed using the debt financing. Hence, it was not only the profitability and asset utilization but also the solvency roots of the company that were found to be losing their strength.
Hence, the management of the company needs to review their performance and should ensure that the follow up measures not only improve their financial performance but must also get in line with the industrial average ratios.
Robinson, T. (2011). Financial Accounting Standards. In C. Institute, Financial Reporting and Analysis (pp. 32-41). Boston: Custom.