Accounting Ratio Analysis for Finances
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Published: Wed, 03 Jan 2018
Ratio analysis is a useful tool for analyzing financial statements. Calculating ratios will aid in understanding the company’s strategy and in understanding its strengths and weaknesses relative to other companies and over time. They can sometimes be useful in identifying earnings management and in understanding the effect of accounting choices on the firm’s reported profitability and growth. Finally, the ratios help in obtaining a better understanding of a firm’s current profitability, growth, and risk which can improve forecasts of future profitability and growth and estimates of the cost of capital.
In reviewing the basic financial ratios, we will examine the ratios of Best Buy for the fiscal years ended March 2, 2002 and March 3, 2001. Excerpts from Best Buy’s financial statements are included at the end of this document. Best Buy is a growing company. The following table reflects the growth in sales and income during the year ended March 2, 2002:
A number of accounting ratios are used to measure different aspects of performance. Many of these are derived from a single ratio known as the return on capitol employed. Any business would want high return on their capitol as this is the return on of investments made. But also they want the return to be as high as possible against their competitors. If we look at the results of Marks and Spencer over the five years the ROCE fell from 24.88% to just 14.44% that’s a fall of 10.44% however. Compare that to the ROCE of next which was 65.54 in 2005 and it stayed around until 2008 when it went upto 84.73 however in 2009 that figure come down to just 40.10 in 2009 despite the big fall Next look like they are outperforming marks and spencer on the return of the capital invested
All businesses want to get as high profit as possible marks and spencers gross profit margin over the period of five years it has been stable if will look at between 2006 and 2008 the gross profit margin stayed around 38% that figure saw a fall of just under 1% in 2009 however marks and spencer is doing better than Next as the gross profit margin of next is lower that m&s and comparing over the five years they continue to experience a fall in gross profit margin but between 2007 (27.77) and 2008 (28.51) they experienced an increase of just under 1% in 2009 that did not improve because it started to fall again lower than 2008
The net profit margin of m&s was looking was looking good up until 2009 as in 2008 it was 12.51 up from 9.38 in 2005 so it was good period however in 2009 that figure was 7.79 lower than the net profit margin of 2005. more worryingly for m&s next is outperforming them over the five years not only are they getting high net profit margin but also it is stable at around 14% between 2005 and 2008
Sales per employee
The asset turnover is how well the firm is putting its assets to work. The ratio indicates that the asset turnover of Next is better that M&S if we compared between 2005 and 2008 however m&s look like they gained ground in 2009 when their asset turnover was 3.41 up from 1.74 in 2008 compared this to next in 2008 Next’s asset turnover was 5.66 this was higher than m&s 2008 asset turnover but in 2009 next that figure fell down to just 3.06 and this lower than m&s if we compared the same year.
The stock turnover of m&s has been experiencing downward trend in the past five years the 2005 stock turnover was 23.38 but continouos fall in the next four years meant m&s stock was turning over 16.91 however the decrease in stock turnover m&s will be encouraged that their competitor next is doing worst than them as their stock turnover was just 10.27
Debtors turnover and debtors collection period
This ratio indicates the speed with which debtors/accounts recievable are being collected, thus it is indicative of efficiency of trade management. The higher the ratio and shorter collection period the better the trade credit management and the better is the liquidity of the debtors and visa versa.
we can see that the control of credit operating by M&S is far better than Next. The debtors’ turnover being 108.53 and the debtor collection period being approximately 3 days compare to 5.77 for the debtors turnover and 63 days for the debtor collection period for Next. Businesses usually operate on a 30, 60 or 90 days policy in terms of debt of payment.
Creditor collection period
This ratio reflects the time it takes the company to pay its suppliers. Thus, the longer you can hold off payment the longer you have cash on disposal. We can see that the creditors collection period is low (roughly 14 days) compare to next (approximately 22 days) to pay their debts. So marks and spencer might want to look in to ways of improving relationship with suppliers so that they have enough time to pay them.
The current ratio is the ratio of total current assets to total current liabilities. The current assets of a firm represents those which can be in the ordinary business, converted in to cash within short period of time. Marks and spencer current ratio decreased in the past five years from 0.65 in 2005 to 0.60 in 2009 and the company is below the national average which is 1.8:1, next is doing better than m&s even though they are also still below national average with a current ratio of 1.54:1 in 2009 but that is far from national average like m&s.
this ratio specifies whether your current assets that could be quickly converted into cash are sufficient to cover current liabilities. Until recently, a Current Ratio of 2:1 was considered standard. A firm that had additional sufficient quick assets available to creditors was believed to be in sound financial condition.
Again just like the current ratio both companies are operating below the national average. M&S acid test did not show much improvement over the past five years if we compare it to next in the same period 2005 of the both companies was 0.39:1 for M&S and 0.82:1 for next however if we look the difference between the two companies m&s is 0.37:1 lower than 2005 but next is improving slightly with acid test of 1.09:1 in 2009.
The gearing ratio reflects the amount of finance raised from the banks in relation to the total capital employed. If the gearing ratio is around 40% it is unlikely that a bank would make any further loans. We can see that both companies are far above the 40% and therefore even though they have good reputations it may cause some problems when obtaining loan. This really needs to be looked at and M&S must be concerned about this. However, very large company generally operate above this rate.
UK is passing through a strong economic downturn and overall spending by the consumers is consistently decreasing. The economic growth of UK over the last three years is slowly and consistently decliningwith forecasts for negative growth in 2009 and some recovery in 2010. These trends also indicate that almost every sector of the economy will be affected with the slow down in the consumer spending due to credit crunch.
It is critical to note that there is a marked difference between the corporate social responsibility of the firm as well as improving the overall corporate image of the firm. Linking corporate social responsibility with the improvement of corporate image therefore is something which most of the companies attempt to achieve. (Moir, 2001). At the moment it looks like m&s has escaped from criticism like child labour
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