The aim of every organization is usually about maximizing profits while minimizing costs. Financial management is concerned with the management of the financial records of an organization to ensure that every activity is performed as planned by the organization. Financial records such as the balance sheet, the cash flow statements indicate the performance of the organization at a given period of a financial period. Financial ratios are generated from financial statements like the balance sheet and they are usually utilized by the internal operators as well as the external users such as creditors and investors. This paper analyses the financial ratios of CUERO ltd. The ratios examined in this paper are the profitability, liquidity/Gearing, asset Utilization, and efficiency ratios.
Profitability ratios indicate the performance of an organization in terms of revenue and profit realized. Both the management of the organization, the owners, and the investors desires high-profit margins. Some of the profitability ratios include the gross profit margin, return on assets and return on investment (Brigham, Gapenski & Ehrhardt, 1999).
Profit margin: This ratio is calculated by the division of net income by the revenue realized from sales in an organization. Given the financial statements of Cuero Ltd, the profit margin of the company is:
- 2010 Profit margin = 18,289 / 40,879 = 44.73%
- 2009 profit margin = 20,500 / 41,500 = 49.39%
The above profit margins reveal that the company realized reduced profit in the financial year 2010 as compared to the financial year 2009.
Return on assets: this ratio indicates the earnings of an organization from the investments made in the assets. The management of the organization as well as the current and potential investors utilizes the ratio. The ratio excludes any future commitments. It is calculated by dividing the cash flows of the organization realized from the operations by all assets.
These ratios show the ability of the organization to meet the short-term financial obligations of the organization. The liquidity ratios indicate the liquidity nature of a firm at any given period. One of the most commonly used liquidity ratios is the current ratio.
Current ratio: this ratio is calculated by dividing the current assets by current liabilities. This is worked out as below.
- 2010 Current ratio = 12151/19100 =0.63
- 2009 current ratio = 19250 / 16500 = 1.17
The calculated current ratio indicates that the company had a higher current ratio is 2009 as compared to 2010. Therefore, the liquidity of the company was higher in 2009 than in 2010 meaning that the company was able to repay its short-term obligations more in 2009 than in 2010. The low ratio in 2010 indicates that the company is unable to meet its obligations as they fall due, though it does not mean that the firm may become insolvent (Moyer, McGuigan & Kretlow, 2001).
Quick ratio: this ratio also measures the liquidity of a company. It is calculated by subtracting the stock of an organization from the current assets and then dividing the outcome by the current liabilities. The quick ratio of CUERO Ltd is worked out as below:
- 2010 Quick ratio = 22151-10790/19100 = 0.59
- 2009 quick ratio = 19250-8000/16500 = 0.68
The quick ratio in the year 2010 is lower than that of 2009.
The investments that an organization makes are usually funded by internal and external funds. Internal funds for an organization include the equity of the owner while external funding is usually obtained from the people outside the organization such as the investors, shareholders, and financial institutions. The gearing ratio is used by an organization to indicate the level of owner’s funding as compared to debt funding in the company’s investments (Copeland & Weston, 1992). A high gearing ratio indicates that an organization’s investment funding depends on debt-financed by investors as compared to the equity of the owner.
Debt ratio: this ratio is found by the division of all debts of the organization by all the assets. A higher ratio indicates that the company has more debt when compared to its assets. For CUERO Ltd, this ratio is calculated below.
- 2010 Debt ratio: 19100 / 65131 = 0.29
- 2009 debt ratio: 16500 / 59250 = 0.27
This indicates that the company has more assets than debt. Therefore, the company is funded internally more than external funding from the investors.
According to Brigham & Houston (1998), these ratios indicate the internal use of assets and liabilities by an organization. The ratios can be calculated using receivable s turnover, repayment of liabilities, and the use of inventory generally.
Sales to inventory ratio: this ratio provides a comparison of the stock to sales ratios of an organization with the competitors in the industry. The ratio indicates loss of sales when it is high because the firm may have less stock or it has lost customer loyalty and the customers’ purchase products elsewhere. When the ratio is very low, it indicates that the inventory of the company is stagnant or obsolete (Lasher, 2000). The ratio is calculated by the division of the annual net sales by the stock of the organization as illustrated below.
- 2010 sales to inventory ratio = 40879 / 10790 = 3.788
- 2009 sales to inventory ratio = 41500 / 8000 = 5.187
The calculation of the ratio shows that the 2010 ratio is lower than 2009. Therefore, the company is doing well with the ratio being moderate.
Benefits of using financial ratio analysis
Financial ratios are important in reviewing the financial performance of an organization. They help an organization to determine its path of profitability as it compares its performance with the industry and the competitors in the industry. It helps an organization to deeply analyze its returns on investments in assets the net present value and the flow of cash in the company. Using financial ratios, a firm can calculate its expenses and find areas of its weaknesses that will enable it to strategize in order to minimize the costs as it optimizes the profit.
Limitations of using financial ratio analysis
According to Brealey & Meyers (2000), the use of financial ratio analysis is only based on financial data and not economic data. The company needs to utilize the economic data for it to be able to understand the business environment. Additionally, the financial record does not capture some items that do not appear on the balance sheet. The basic ratios can be manipulated easily.
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