8) (8 pts,) You just received the most recent financial analysis from your Chief

Question

8) (8 pts,) You just received the most recent financial analysis from your Chief Financial Officer for your firm. Use the table of financial ratios for the last three years in your analysis, given the questions being asked by your board (below). Ratio Earnings on Sales Return on Assets Current Ratio Quick Ratio Debt to Equity Ratio Debt to Asset Ratic Asset Turnover Ratio 2003 6.15 0.81 0.38 2.21 0.69 045 30 1.51 7.16 1.09 0.52 1.80 0.64 3.40 2.79 2.90 8.01 1.38 0.69 1.33 0.57 (2pts). The board wants to know what the trend in profitability has been the last three years (name the ratio(s) you are using in your explanation). Use all ratios that apply to this area in your analysis. a)

Explanation / Answer

a) The trend in profitability can be analysed by observing the ratios of Net profit Margin which is called Earning on Sales, Return on Assets and Return on Assets. So, From the table, we can observe that the ratio of Earning on Sales has increased from 0.45 to 1.51 in the years from 2003 and 2005. Also Return on assets is increasing constantly as well. It has increased from 6.15 in 2003 to 8.01 in 2005. Thus, trend in profitability has increased in the last three years.

b) To Know about the trend in liquidity, which provide information about a firm's ability to meet its short-term financial obligations. The ratios that can be used to analyse trend in liquidity are the current ratio and the quick ratio. In the last three years, current and quick ratio both have increased. Current ratio which measures company’s ability to pay its debt over the next 12 months has increased from 0.81 to 1.38 whereas, quick ratio which is an indicator of company's short-term liquidity has increased from 0.38 to 0.69.

c) The trend in solvency i.e., trend in ABILITY OF FIRM TO MEET FINANCIAL OBLIGATION can be analysed by the trend of leverage ratio. Here Debt Equity ratio can be considered as it is used to measure a company's financial leverage and also indicates how much debt a company is using to finance its assets relative to the amount of value represented in shareholders’ equity. In the last three year, Debt equity ratio has decreased from 2.21 to 1.33. It indicates relatively low debt, and thus poses much less risk to the lender so this is a positive sign, as it appears to have a increasing ability to repay the loan. Debt to Asset ratio has decreased as well in the last three years.

d) Now, the board thinks to expand the existing production capacity. Their Estimation tells that there will be 30% increase in sales. Activity Ratio like Asset Turnover ratio which measures a company's ability to generate sales from its assets by comparing net sales with average total assets shows how efficiently a company can use its assets to generate sales. The ratio here is decreasin in the last three years which indicate a problem with one or more of the asset categories composing total assets — inventory, receivables or fixed assets. Increase in loan by the way won't affect. Because debt equity ratio was decreasing indicating increased capability of repaying loan. So, They should take loan.

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