Critical Analysis of Position and Performance Using Ratios

The investors rely on the information of the performance of the company’s financial position as well as the performance to making informed decisions on their investment. The company’s statements are very important in providing the information to the investors on the position as well as performance. The balance sheet (statement of the financial position) shows the position of the company as at the date when it is prepared while the income statement also known as the profit and loss account shows the performance of the company as it the date when it has been prepared. In this report, I will examine the same statements as stated above assuming that the two companies (Wallace and Gromit) are in the same sector or industry.

Critical Analysis of the Position and Performance using Ratios

The ratios for finance are basically used to provide in-depth information to the shareholders as well as stakeholders before they make an investment. This report will evaluate and analyze the ratios of profitability, efficiency as well as liquidity. Liquidity ratio indicates the firm’s ability to meet its short term or current obligations. One of the liquidity ratios include current ratio. This ratio measures whether the company’s current assets are able to meet the current liabilities when they fall due or when required. In cases of a low ratio, then this indicates that the company cannot meet its current liabilities in the period of short-run while a high liquidity ratio above 1 indicates high level of liquidity and therefore the company can meet its current liabilities as to when they fall due. However, when the ratio is too high, it indicates a high amount of stock which may not be beneficial to the company in the long run (Faruk, 2010). The Current ratio of Wallace Company is 4.3 while that of Gromit is 1.8. The two companies can meet their short term obligations as and when they fall due since their ratios are above 1. However, the high ratio of Wallace doesn’t necessarily imply that it is performing better than Gromit as it may have idle assets and that may imply that the resources are not well utilized.

Quick ratio, on the other hand, provides a comparison between cash and the current or short term liabilities. In this ratio, all the items which are not easily convertible to cash such stock and prepayments while including the short term investments, securities and debtors (Clausen, 2009). The quick ratio for the Wallace Company is 2.36 while that of Gromit is 0.71. The ratio for Wallace shows that the a good position in that every one dollar of the Companies current liabilities is covered by 2.36 dollars of the company’s current assets in case an emergency occurs. This can be made possible by a quick conversion of the debtors in to cash while maintaining a good level of stock. On the other hand, Gromit’s quick ratio shows unhealthy position for the company as its cash is not able to meet the current liabilities.  This may be as a result of high costs of operation or low rate of conversion of receivables.

Receivable collection period shows the number of days the sales remain outstanding. In other words, this means the number of days that the customers take to meet their dues for the goods supplied to them by the company. Few days means that the customers take a short period to for their goods and thus cash is available to the company to further its business operations while a longer period shows that the customers take a longer period to pay their debts thus a poor management of the receivables. The company sets out the credit period and therefore a collection period is considered healthy in a situation whereby the debtors are collected in a lesser period than the set credit period. The period for collection of receivable of Wallace Company is 42.3 days while that of Gromit is 52.8days.

Return on capital employed shows the efficiency and a measure of profitability of the company as well. This is useful to investors as it shows how much is generated for every dollar which is invested in to the company. The ROCE of Wallace Company is 20.9% while that of Gromit is 4.9%. Wallace Company provides a better return to the investor’s dollar when compared to Gromit and therefore it presents a better investment option compared to the Gromit Company.

Gross profit percentage shows the amount of cash which is available after deducting the cost of sales. This indicates the performance and the situation of the company as it shows the amount available to offset the expenses of the company as well as advance business through planning for the business future. Sufficient and stable margin of gross profit is crucial for the company as it will be able to meet its expenses and plan for its development as well. The GP margin for the Wallace Company is 33.9% while that of Gromit is 22.4%. This ratio shows how the Company is efficient in utilizing its assets and labour to produce profits for the company. In this case therefore, Wallace Company has a higher GP margin than Gromit and therefore I can deduce that it has a healthy GP margin.

Net Profit Margin shows the amount of net earnings generated from the net sales. In this ratio, the total expenses are taken away from the income to determine the net income or profit (Tracy, 2004). The NP margin of Wallace is 16.6% while that of Gromit is 3.5%. This implies that in Wallace Company, for every dollar of sales, the company earns 0.16 net profit while in Gromit the company for every dollar of a sale, the Company earns 0.03 as net profit or income. In comparison, Wallace has a better NP margin.

In conclusion, financial statements are the key to viable decision making for investors as they reveal the financial position and performance of the companies in question. In this case, it would be advisable to consider financial statements of the previous financial periods as according to the information and analysis done above, Wallace shows a better performance compared to Gromit.

Addition Information Considered to be Important for Any Potential Investor

First, potential investors should consider the statements of cash flow and their respective trends over the years. This shows the amount of inflows and their respective outflows for the company in particular period while not including the receivables. In simple words, these statements only shows revenues when the company has earned them or is certain to to earn them and expenses when they have been incurred only. This will provide the investor with a better information on the company’s investment as well as operating policies (Weygandt et al., 2001).

Second, the share of the market of Wallace and Gromit are also helpful to the investors since they are a reflection of the profitability of the companies. This shows the size of the company within the market and the share it commands. High share of the market may be as a result of intensive promotions, advertising and leading in terms of pricing strategies. Any increase or decrease of the share of the market affects the stock of the company in the respective industry.

Third, the PESTLE analysis is also an important tool for consideration before making the investment. PESTLE means Political, Economic, Social- Cultural, Technological, Legal and Eco factors. This in simple terms shows the external broader environment in which the company operates. This environment provides the investors with tax policies and changes thereof, the rates of inflation, interest rates charged or received, stability of the government and respective regulations for the industry by the government and these are very useful to investors (Tracy, 2004).

Fourth, the dividends to be received for every share the investor buys from the company is also important. This can be obtained from the previous or past years analysis of the financial statements. This includes the percentage of shares attributable to the shareholders, the amount received by each shareholder and the trend of the price per share to determine whether it is increasing or decreasing. This is a very important analysis which should be done for Wallace and Gromit before investing (Thachappilly, 2009).

Fifth, the investors should also seek to know the competitors of Wallace and Gromit. This will provide a knowledge on the potential future competitors as well as the current. This will provide the investors with information about the strength of the competitors and whether Wallace or Gromit will be able to withstand such a competition in the future or it will liquidate as a result of the stiffness of the competition.

In conclusion, other than the above discussed factors, the investors should also consider the capital budgeting plans for the company, the quality of the management of the companies and their respective boards of directors, how stable the pound is in the financial markets, rating in terms of credit, satisfaction of their customers through feedback information as well as the leverages of the company.

Critical Exploration of the Financing Option and Respective Effect on Financial Ratios

Business growth requires proper policies to be laid in place to carry out expansion of the company to avoid problems that might result from the expansion and subsequently affect the business. This might be so as the problems don’t reveal immediately after expansion but might take time.

The Gromit Company can carry out expansion in developing its facilities for infrastructure such as machines, increasing the labour force and improving its quality as well, developing roads around the premises of the company, while not leaving out new projects. There are many options for funding the proposed or planned pounds 2.5 million expansion available to Gromit and they include debt, approaching joint ventures as well as equity. However, the above options pose some possible risks according to the report provided above on its performance.

In case Gromit decides to get a loan or a debt to finance this planned expansion, the company is required to pay interests as and when they fall due according to the agreement with the creditors. However, considering that the company has a net profit margin of 3.5%, the dues for the respective interest could also prove to be an obstacle in its operations. It would therefore be advisable to evaluate the terms of the debt before entering or securing the loan to determine whether the company will be in a position to service its interest and the repayments as and when they fall due without affecting the operations of the firm negatively. It would be also advisable to calculate the total debt ratio for the company as this does not seem to be a better option for the company. The alternative to this problem would be seeking some low charging interest cycle to get the loan.

If the company does not see the debt or bank loan as the best option, it can opt for a joint venture. Just like any form of financing, JT has its own advantages and disadvantages. A good JT can be useful to the company in helping it access new markets, expand channels of distribution, increase the capacity for production as well as increasing the effectiveness of the methods of production. It can also help in improving the quality of staff and minimizing the costs of operation. The problem with JTs may arise where the goals and objectives are not well spelt out and communicated with clarity to every stakeholder (Jenkins, 2009).

Lastly, the other option available to Gromit is private equity. This funding source is similar to companies which venture in providing capital to parties who have viable ideas or who have started their businesses and have run short of capital. Once they make the investment, they will actively be engaged in the management roles for the company. The investors not only bring in to the company funds but also expertise and a wealth of experience to the organization. They aim to get the maximum return (profit0 for their funds in the company and therefore can do anything to gain profit including restrictions on the management (Fichter, 2010).

Recommendations

The growth of a business through expansion necessitate proper laying of policies and planning. It also requires analyzing the challenges that might arise and how to handle them. The following recommendations may be necessary when carrying out the process of expansion:

The company can get advisory services from a board of advisors before carrying out expansion.

The company can carry out the expansion using a pilot run in order to reduce risks if this might be useful and applicable to the project.

Conclusion

According to the report and analysis conducted above, expanding of the operations of Gromit might impact the company positively or negatively although the aim of the expansion is increase the company’s productivity. This therefore calls for careful scrutiny of all matters which are important before carry out the expansion including outsourcing project evaluators and consultants.

References

Clausen, J. (2009). Accounting 101–Financial Statement Analysis in Accounting: Liquidity Ratio Analysis Balance Sheet Assets and Liabilities. Journal of Financial Statement.

Faruk, H., & Habib, A. (2010). Performance evaluation and ratio analysis of Pharmaceutical Company in Bangladesh.

Fichter, J. R. (2010). So Great a profit. Cambridge: Harvard University Press.

Jenkins, L. (2009). Contribution margin and breakeven analysis: Determining when a Company will realize a profit. Journal of Contribution Margin and Breakeven Analysis, 8, 65-83.

Thachappilly, G. (2009). Financial ratio analysis for performance check: Financial statement analysis with ratios can reveal problem areas. Journal of Financial Ratio Analysis for Performance Evaluation.

Weygandt, J. J. (2001). Wcs Principles of Accounting. New Jersey: John Wiley & Sons.