A report for the Eagles Ltd board of directors has been prepared by external consultant. In this report ratio analyses have been used to comment on the performance of the business over two year period (2008 and 2009). Profitability, Liquidity, Efficiency and Gearing ratios have been calculated (See Appendix) and used to reveal and explain the situation in the company.
Firstly the importance of each kind of financial ratios is explained. Then each ratio is analysed according to provided information (income statement and balance sheet). Finally recommendation for further actions for Eagles Ltd is given.
• If used incorrectly ratios can be useless and misleading ...view middle of the document...
Gross profit margin
According to Atrill and McLaney (2008) gross profit is used to measure company’s financial health. Khan and Jain (2007) states that this ratio reveals the amount of left over money after company has accounted for the cost of goods sold. Gross margin for Eagles Ltd in 2008 was 46.3% that is considered to be high index. After paying for inventories sold, company was left over with 46.3p from each £ of sales revenue. With this amount company is supposed to cover other operating expenses and also leave an operating profit for the current year. The following year company experienced slight decrease (10.7%) in gross margin.
Analysis of Gross profit margin and ROCE ratio
The reasons of 5% decrease in gross profit margin can be stated:
• ineffective stock control
• selling price not increasing in line with the costs of the goods that company sells.
Eagles Ltd can ensure adequate coverage for operating expenses (See calculation in Appendix) and sufficient return to the owners of the business.
ROCE can be influenced by factors such as:
• economic climate,
• degree of competition,
• industry characteristics, and
• the type of customer (Atrill and McLaney, 2008).
Eagles Ltd was left with 28.7p (2008) and with 19.2p (2009) as an operating profit for every £ of sales revenue.
Efficiency ratios measures how well you business is conducting in the market. This ratio is important as to valuate if company’s credit term are appropriate and whether purchasing has been effective. (Reference for Business, 2010)
Efficiency ratios 2008 2009
Inventory period 68 days 60 days
Trade receivables period 23 days 36 days
Inventories turnover period
Bragg (2007) states that inventories turnover period measures the ability of company to convert its debt and equity into dollars of sales. Eagles Ltd in 2008 could have sold its entire inventory in 68 days whereas in 2009 it took only 60 days. For company it can be crucial to find the right level of inventories turnover period as the longer the period the more costly it can be for company to stock their inventories in warehouses (Atrill and McLaney, 2008).
Trade receivables period
Khan and Jain (2007) suggest that trade receivables period estimates how long does it take for customers to pay their outstanding debts. From this ratio (whether it is high or low) conclusions can be made referring to the quality of the credit and collection procedures that company uses. For Eagles Ltd this ratio was 23 days (2008) and 36 days (2009). That means that in 2009 company had to wait 36 days to receive money from customers who bought their inventories on credit.
Analyses of Inventories turnover ratio and Trade receivables period
In 2008 it took 68 days for Eagles Ltd to sell all of their inventories whereas in 2009 it took 60 days. This improvement could have saved some money, because the cost of holding inventories might have decreased. On the other hand...