1.
QUESTION
2. BASED ON THE ABOVE QUESTION, THE ANSWER AS FOLLOW.
3. RATIO ANALYSIS – HOW SHOULD YOU WRITE YOUR COMMENT.
Comment for each Ratio category should be done by looking at the result of working /
calculation of recent year analysis. Student Must understand each ratio function, and apply the
concept to your comment.
1. Liquidity Ratio
RATIO WORKING / RESULT INDUSTRY REMARK
CALCULATION AVERAGE
C R = C A / CL 117,000 / 44,000 2.66 times 2.50 times GOOD
QR = [ CA –
IN’TORY – PRE [ 117,000 – 50,000 –
EXP ] / CL 12,000 ] / 44,000 1.25 times 1.20 times GOOD
Net Working Capital
[NWC] 117,000 – 44,000
COMMENT:
1. Both ratios show good performance since both result are above the industry average
performance.
2. Therefore, it shows that the company able to fulfill their current obligations with their
available current assets.
3. CR provides an indication of the extent to the firm’s liquidity: that is how far the claims of
short-term creditors are covered by current assets, that is ability to pay is RM2.66 for RM1 of
its short-term liability.
4. Positive NWC
Note
o Liquidity ratio (LR) measure overall firm’s ability to meet its maturing or short – term
obligation.
o LR focuses on the availability of short-term assets such as cash and liquid asset to pay short-
term obligations such as accounts payable, notes payable and other current maturities.
o Normally, higher liquidity is preferred as it indicates higher ability to meet short-term
obligations as they come due.
2. Asset Management Ratios
o This set of ratios measures the effectiveness and efficiency of the firm in managing its
assets. It relates the payoff from investment in certain assets.
o Four category of ratios involves:
o Inventory Turnover (ITO)
o Average Collection Period (ACP)
o Total Assets Turnover (TATO)
o Fixed Asset Turnover (FATO)
RATIO WORKING / RESULT INDUSTR REMARK
CALCULATION Y
AVERAG
E
ITO = COGS / 301,500 / 50,000 6.03 times 8. times POOR
IN’TORY
ACP = [ ACC [ 30,000 X 360 ] / 13.49 days 20 days GOOD
REC X 360 ] / 800,800
SALES
COMMENT:
1. ITO ratios show poor performance compared to the industry average performance. ITO
shows the firm is holding excess stocks, means low chance of stock out to meet sales.
Firm’s effectiveness in its inventory management is relatively poor.
2. Firm’s ACP perform better than industry, since firm manage to collect their Account
Receivable in shorter period, that is 13.49 days. Their credit policy are good as more cash
is available in the firm.
Note
o ITO also known as inventory utilization ratio. It measures how effectively the firm is using
its inventory to generate sales. Higher ratio is better.
o Represents the number of times inventory is sold and replaced in a year. A high ratio
indicates that the company is efficient in managing its inventories.
o ACP used to appraise the firm’s account receivable and its credit policy. It represents that
average length of time that the firm must wait after making credit sales before receiving
the cash.
o ACP measures the average number of days it takes a company to collect a receivable. The
shorter the ACP, the better.
RATIO WORKING / RESULT INDUST REMAR
CALCULATIO RY K
N AVERAG
E
FATO = NET SALES* / 800,800 / 250,000 3.20 times 3.30 times POOR
NET FIXED ASSETS
TATO = NET SALES* / 800,800 / 367,000 2.18 times 2.51 times POOR
TOTAL ASSETS
COMMENT:
1. FATO ratios show the firm manages to generate RM1.21 for every RM1 investment in its
fixed assets. The ratio is relatively low that indicates under utilisation of its fixed assets.
2. Firm’s TATO perform lower than industry, the firm only manage to generate RM2.18 for
RM1 investment in its overall assets. Lower ratio indicates the firm’s investment in total
assets is less productive.
Note
o *NET SALES OR SALES [Please refer to question, which data available.]
o FATO represents the firm’s utilisation of its plant & equipment to generate revenue from
their investment in fixed assets.
o TATO Measures overall efficiency of a company in generating sales using its assets. Similar
to FATO, higher ratio is preferable.
[ Assets Turnover – measure of how well a firm is putting its assets to work. Lower
AT, it may mean that the level of sales has not yet reached the amount appropriate for
the invested assets.]
[FATO – if a firm has a decreasing FATO ratio it indicates that production is running at
less than capacity.]
3. Leverage Ratios
Leverage ratios are used to determine the relative level of debt load that a business has
incurred. These ratios compare the total debt obligation to either the assets or equity of a
business
RATIO WORKING / RESULT INDUSTR REMARK
CALCULATION Y
AVERAG
E
DR = T [44,000 + 120,000] 44.69 % 55.50% GOOD
LIABILITIES / T / 367,000
ASSETS
TIE = EBIT / 409,300 / 9,600 42.64 times 35 times GOOD
INTEREST
COMMENT:
1. The firm’s ratio shows good performance as compared to the industry average. Firm’s
dependency on debt are much lesser than the industry average.
2. Firm’s TIE also indicates strong ability to fulfill their interest obligation for the year, since
the amount is relatively high.
Note
o Total Debt = Total Liabilities – consists of Current Liabilities and Long-Term Liabilities
(include bonds, mortgage, LT Loan, etc). Lower ratio is better.
o DR measures the percentage of total funds provided by creditors as compared to funds
provides from owner capital.
o TIE – measures the firm’s ability to meet interest payments and the extent to which
earning can decline without resulting in financial problem due to its inability to meet
annual interest costs. Higher ratio indicates lower risks of default.
RATIO WORKING / RESULT INDUSTRY REMARK
CALCULATION AVERAGE
DER = T [44,000 + 120,000] / 0.81 1.0 POOR
LIABILITIES / [30,300 + 172,700]
EQUITY
EQ RATIO (ER) = [30,300 + 172,700] / 55.31 % 60.10 % POOR
T EQ / T ASSETS 367,000
COMMENT:
1. Ratio indicates that creditors provided RM0.81 for every RM1 provided by owners. The
creditor’s position is less risky compared to the owners. The firm’s DER ratio is less than 1
implies that it is a conservative firm.
2. ER indicates poor result compared to industry average. A low equity ratio is not necessarily
bad. It means that, if the business is profitable, the return on investment is quite high,
since investors did not have to invest large amount of funds.
Note
o DER measures the percentage of total funds provided by creditors as compared to funds
provides from owner capital.
o The DER also measure the relationship between the capital contributed by creditors and
the capital contributed by shareholders. It shows the extent to which shareholders'
equity can fulfill a company's obligations to creditors in the event of a liquidation.
o Equity Ratio (ER) determines the portion of total assets provided by equity (i.e. owners'
contributions and the company's accumulated profits). Potential investors and creditors
prefer to see a high equity ratio, since it implies that a company is conservatively managed
and always pays its bills on time.
4. Profitability Ratios
The profitability ratios measure the combine effects of liquidity, asset management, and debt
management on overall operating results of the firm. Comprises of:
o GPM, OPM, NPM;
o ROA, ROE
RATIO WORKING / RESULT INDUSTR REMARK
CALCULATION Y
AVERAG
E
OPM = EBIT / T [499,300 – 90,000] 51.11 % 45.10 % GOOD
SALES / 800,800
NPM = EAT / T 239,820 / 800,800 29.95 % 21.0 % GOOD
SALES
ROA = EAT / T 239,820 / 367,000 65.35 % 50.0 % GOOD
ASSETS
COMMENT:
1. The firm’s ratio shows good performance as compared to the industry average. All 3 ratios
(OPM, NPM & ROA are better than industry. It shows that the firm able to generate higher
return which brings better growth prospect for the firm.
2. All ratios indicate firm’s ability to satisfy the firm’s goal to maximize the owner’s wealth &
to attract new capital is higher.
3. For ROA, every dollar that firm’s invested in assets during the year produced RM0.65 of
net income, this can be a healthy return rate no matter what the investment is.
Note
o The OPM measures how much profit a company makes on a dollar of sales, after paying
for variable costs of production, such as wages and raw materials, but before paying
interest and tax (EBIT).
o Generally, a higher operating profit margin is desirable as it suggests greater potential to
derive profits and more cushion against any increase in competition or costs.
o NPM is the most commonly used profitability ratio since it compares the ‘bottom line’ to
the amount of sales.
o ROA - measures how effectively a company can earn a return on its investment in assets.
In other words, ROA shows how efficiently a company can convert the money used to
purchase assets into net income or profits.
RATIO WORKING / RESULT INDUSTRY REMARK
CALCULATION AVERAGE
GPM = G PROFIT / 499,300 / 800,800 62.35 % 58.10 % GOOD
T SALES
ROE = EAT / T 239,820 / 203,000 1,181.3 % 23.40 % GOOD
EQUITY
COMMENT:
1. Both firm’s ratio shows better and higher results as compared to the industry average
ratio.
2. GPM shows firm’s able to control cost of goods sold relative to its sales, therefore GPM
produce relatively higher ratio.
3. While ROE is higher due to firm’s better return being received from investment of the
equity.
Note
o The difference between gross margin ratio and operating margin ratio is the inclusion of
non-production overheads (i.e. selling, distribution, general and administration expenses)
in the calculation of operating margin.
o ROE – higher return is better as it indicates higher return for the owners of the firm.
