Shiny Ltd. Financial Ratios (Essay Sample)

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Shiny Ltd Financial Ratios
Ratios are important in the determination of the performance of a business and the area s of the business that need improvement, information which is required by investors, potential investors, creditors, and the company management. In addition, ratios can be used to compare the performance of a business to that of others within the same industry, or the company’s current performance in relation to previous performances. Various ratios of Shiny Ltd, a company that manufactures nuts and bolts for sale to industrial users, are computed in the following part for the financial years 2011 and 2012. It is worth noting that all the formulas used in this paper have been derived from Atrill et al., 2008, the class text
* Ratios
* Return on total assets (ROA) - this ratio is computed to compare the net profit generated by companies with the total company assets, and is expressed as a percentage (Atrill et al., 2008). As such, it is computed as under the following formula
ROA= (Net profit before interest and tax/ average total assets) *100
For 2011,
ROA = ($234,000/$984,000)*100=23.78%
For 2012,
ROA= ($167,000/$1083, 000)*100=15.42%
* Net profit margin- this ratio is calculated to measure the relationship between the net profits and the sales of a business, and is expressed as a percentage (Atrill et al., 2008). The formula used to compute it is as follows:
Net profit margin = (net profit before interest and taxation/sales)*100
For year 2011,
Net profit margin= ($234,000/$1,180,000)*100=19.83%
For year 2012,
Net profit margin= ($167,000/$1,200,000)*100=13.92%
* Gross profit margin- this ratio is computed to express the relationship between the gross profit of the business and the sales generated by the business in the same period. It indicates the difference between sales and the cost of sales, and is expressed as a percentage (Atrill et al., 2008). The formula used to compute it is as follows:
Gross profit margin= (gross profit/sales)*100
For year 2011,
Gross profit margin= ($500,000/$1,180,000)*100=42.37%
For year 2012,
Gross profit margin= ($450,000/$1,200,000)*100=37.5%
* Current ratio- this ratio is used to determine how well the company is able to meet its short-term obligations, and as such compares the liquid assets of a business with its short-term liabilities. The ratio is expressed in terms of number of times the current assets will cover the current liabilities (Atrill et al., 2008). It is calculated as follows:
Current ratio= current assets/current liabilities.
For year 2011,
Current ratio= $282,000/$228,000=1.24 times
For year 2012,
Current ratio= $396,000/$238,000=1.66 times
* Liquid or acid test ratio- this is a more stringent liquidity ratio than the current ratio and it shows how well the current assets less inventory of a business can cover for its current obligations (Atrill et al., 2008). Just like the current ratio, it is expressed in terms of the number of times the current assets less inventories will cover the current liabilities. It is calculated as follows:
Acid test ratio= current assets (excluding inventory and prepayments)/current liabilities.For year 2011,
Acid test ratio= ($282,000-$148,000)/$ 228,000=0.59 times
For year 2012,
Acid test ratio= ($396,000-$236,000)/ $238,000=0.67 times
* Average settlement period for debtors- this ratio shows the average period it takes debtors of a business to clear their accounts (Atrill et al., 2008). It is expressed in terms of days, and is calculated as follows,
Average settlement period= (average trade debtors/credit sales) * 365
For 2011,
Average settlement period= ($102,000/$1,180,000)*365=31.55 days
For 2012,
Average settlement period= ((($102,000+$156,000)/2)/ $1,200,000)*365=39.24 days
* Average settlement period for creditors- this ratio shows the average period a business takes to clear its accounts with its creditors and is expressed in terms of days (Atrill et al., 2008). It is calculated as,
Average settlement period= (average trade creditors/credit purchases)*365
For 2011,
Average settlement period= ($60,000/$680,000)*365=32.21 days
For 2012,
Average settlement period= ((($76,000+$60,000)/2)/$750,000)*365=33.1 days
* Average inventory turnover period- this ratio, expressed in terms of days, is calculated to determine the average period that a business holds its inventories, and is computed by comparing the average of opening and closing inventories with the cost of sales (Atrill et al., 2008).
Inventory turnover period= (average inventory held/cost of sales)*365
For 2011,
Inventory turnover period= ($148,000/$680,000)*365=79.44 days
For 2012,
Inventory turnover period= ((($148,000+$236,000)/2)/$750,000)*365=93.44 days
* Financial ratios provide vital information to stakeholders of a business. As for the case of Shiny Ltd, potential creditors would use its ratios as follows.
A higher return on assets is desirable. The return on assets of Shiny Ltd decreases from 23.78% in 2011 to 15.42% in 2012, and potential creditors might interpret this to mean the company might not be able to make profits in the long run and thus avoid extending credit to the company.
The net profit margin of the company falls from 19.83% in 2011 to 13.92% in 2012. As with the case of return on total assets, potential creditors might take this as a show of the company’s decreasing ability to generate profits and therefore avoid extending credit to them.
Likewise, the gross profit margin falls from 42.37% in 2011 to 37.5% in 2012, and potential creditors could take this to mean that the ability of the company to make profits is decreasing and therefore avoid extending credit to them.
Current ratio rises from 1.24 times in 2011 to 1.66 times in 2012. This indicates the company’s increased abili...