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Liquidity Ratios

Discuss about the Capital Structure and Corporate Performance.

The assignment deals with the financial analysis of ratios of Maldives Transport and Contracting Company (MTCC). Maldives Transport and Contracting company is engaged in marine and land transport business and also has a separate division which deals with marine and land constructions. The company was one of the first public sector company which was established. The financial performance of the company is to be analyzed with the help of significant ratios.

The major ratios which are to be analyzed for the company are liquidity, profitability and efficiency ratios. The analysis will be containing an insight of the capital structure of the company and stock performance of MTCC. Liquidity ratios are used to measure the liquidity of the company which means whether the business has enough liquid cash to meet the short-term liabilities of the company or not (Higgins 2012). In the liquidity ratio sub-head, the most significant ratios are current ratio, liquid ratio and cash ratio. As per the calculation shown, the current ratio of the company has first declined from 1.34 in 2014 to 1.28 in 2015 and then again increased to 1.34 in 2016. This shows that the company is more than capable of handling the short-term business requirements. If the current ratio of the company is above 1 then it signifies that the company is able to meet with the current short-term expenses of the business which MTCC has as stated above (Ahrendsen and Katchova 2012). An ideal current ratio is however 2:1, which means that the current assets must be twice of current liabilities. The quick ratio of the company shows that the ratio is on an increasing trend from 2014. The ratio increased from 0.96 in 2014 to 1.08 in 2016 as per calculations. This is a favorable result as the higher the quick ratio the more liquidity the business has and ideally quick ratio should be greater than 1. However, the ideal results of a quick ratio vary from industry to industry. The cash ratio of the company has decreased and the ratio suggest the real cash of the company is falling. The ratio however does not take into consideration account receivable and inventory and only considers cash and asset which are close to cash.

The profitability ratios of the company measure the overall profitability of the company considering the significant areas such as gross profit, net profit, operating profit and similar other areas (Al Karim and Alam 2013). These ratios depict whether the company is performing well in terms of profitability or not. The gross profit ratio shows that the gross profit of the company first increases from 18.73% in 2014 to 23.84% in 2015 and then again decreases to 22% in 2016. The gross profit for the year 2016 has decreased which the company needs to improve and also analyze why the gross profit of the company fall during 2016. The net profit ratio of the company also shows a fluctuating and a similar result when compared to gross profit ratio. The net profit ratio of the company for the year 2016 show a ratio of 8.80% which is even lesser than the ratio result which was calculated for 2014 which is 10.57%. This is not a favorable sign for the business and therefore the business needs to improve the same. Net profit ratio is a financial indicator and the company needs to improve the overall net profit of the company (Tugas 2012). The operating profit ratio also depicts a fluctuating result and has a similar result and analysis as gross profit ratio and net profit ratio of the company.  The return on assets and return on equity also show unfavorable results for the company in the year 2016. The return on asset has decreased from 0.9 in 2015 to 0.8 which is shown in 2016. The return on equity also shows a decreasing trend which was 30.22% in 2015 which has reduced to 18.70% in 2016 which is even lesser than the estimate of 2014.

Profitability Ratios

The next group of significant ratios which are to be considered are the efficiency ratio of the company. Such type of ratios generally covers all types of asset turnover ratio of the company. The receivable turnover ratio of the company shows how efficiently the company is able to collect the credit allowed on sales by the company. an high account receivable ratio signifies that the company has a strong credit policy and all credit operations are running smoothly. The receivable turnover ratio of the company shows that the ratio has increased in 2016 which is 1.59 and the same was 1.44 in 2015. Therefore, it suggests that there has been improvement in the receivable turnover ratio or collection policy of the company as the case may be. The inventory turnover ratio shows that the ratio has significantly increased in 2016 in comparison with 2015 results. The inventory ratio of the company for the year 2016 is 4.28 which is much more than previous two years results. The higher the inventory turnover ratio the more favorable for the business as it will then portray a strong sales structure and lesser inventory in stocks (Ehiedu 2014). While lower inventory turnover ratio shows poor sales structure and more inventory capacity at hand of the company which is being unused by the company. The asset turnover ratio of the company also shows that the ratio has increased from the previous years results (Tehrani, Mehragan and Golkani 2012). The asset turnover ratio for the year 2016 is shown at 0.89. Asset turnover ratio measures the capability of the company to generate revenue or sales in comparison to the assets of the company.

The next group of ratios is the capital structure ratio which measures the components of the capital structure of the company. The debt ratio of the company shows that the company’s debt ratio has decreased from the result of 2015. The debt ratio for 2015 was 0.61 which has reduced to 0.58 in 2016. From the perspective of risks debt ratios of any company are preferred to be lower as the risk is also low. In this case it can be said that it is favorable for the business of MTCC. The equity ratio shows how much equity capital has the business incorporated in the capital structure of the company. The equity ratio of the company has increased from 2015 which was 0.39 to 0.42 which is shown in 2016. This signifies that the company is now using more of equity in comparison to last year. The gearing ratio of the company shows the total debt which is used by the business in comparison to the equity capital of the business. It is similar to Debt equity ratio however it contains more variations which can provide different results. The gearing ratio of the company 7.07% in 2016 which is lower than previous year figure as the company has reduced the debts of the company. This shows that the company is payoff the debt capital and incorporating more of equity capital in the capital structure mix of the company (Babalola and Abiola 2013). The debt equity ratio of the company shows that the ratio has reduced from 1.59 in 2015 to 1.40 in 2016 which also shows that the company is reducing the debt capital of the company. With the analysis of the debt equity ratio it is evident that the company is trying to restructure the capital structure of the company and add more of equity capital in the mix. However, the full benefit of the capital structure can be extracted when a certain balance is attained between debt and equity capital funds.

Efficiency Ratios

The stock performance ratios are related and measures the performance of the company on the basis of valuation of stock or earning per shares or market value of shares (Delen, Kuzey and Uyar 2013). Earning per share is the measure of the company’s profit per share which is earned by the shareholders of the company (Brigham and Houston 2012). The earning per share of the company has fallen sharply from 312.76 in 2015 to 23.076 in 2016 which is a drastic fall. This is a serious concern for the business as if it is not improved than the company’s stock prices and market valuation will repeatedly fall. The dividend payout ratio show that the ratio is much more than previous year’s measure which shows that the company has declared dividend in spite of low Earning per share. Price earning ratio is the measure of the price which the investor pays for $ 1 profit in the company. The price earning ratio of the company has increased from the previous year results.

The following recommendations can be offered to the company for improvement in the key financial ratios:

  1. The company needs to improve the profitability ratios which are gross profit, net profit and operating profit ratios which are financial indicators and must be improved at all cost for which the company needs to increase the sales revenue which will then increase the gross profit of the company.
  2. The company needs to improve its Eps as it is the first thing which an potential investor looks for in the financial statement as It is the measure of earning capacity of the company.
  3. The company needs to attain a balance in capital structure mix in order to fully take benefit of the same (Zeitun and Tian 2014).

Any business which is planning to start or establish itself in the market needs to plan out the financial requirement which the business needs. In other words, there are certain expenses which initially which the business must incur in order to establish the business in the market (Lee, Sameen and Cowling 2015). The two most popular form of business which can be open are partnership form of business and private limited companies.

A partnership form of business is a business where two or more parties cooperate together in order to run a business. In case of partnership the liability of the partners may be unlimited or limited as per the agreement in the Partnership deed (Allen and Kraakman 2016). Whereas in a Private Limited Company the shareholders are the owners of the company, however the company is operated by board of directors who are representatives of the shareholders of the company. The liability in a company is limited to the number of shares which is held by the shareholders of the company. Moreover, a company is regarded as a legal person whereas a partnership form of business does not enjoy such a right 9Burns 2016). Both the above forms of businesses require initial capital to start up the business and also long-term finances for smooth operation of the business. In case of partnership form of business, the various options of financing which are available are:

Capital Structure Ratios

Personal Savings: In a partnership form of business personal savings is an important source of finance. The partners of the firm contribute to the total capital of the firm and operates in a similar fashion whenever there is additional requirement of funds (Gbandi and Amissah 2014). In case of a startup partnership business, generally individuals resort to capital contributions which will be made by the partners of the firm to meet the start up cost of the business instead of taking a loan from banks. The amount which is contributed by the partners are the basis on which the profit which is earned by the firm is distributed among the partners unless otherwise agreed upon.

Retained profits: The profits which are earned by the firm are reinvested in the business in many cases which is then used as reserves or retained earnings. However. such type of financing cannot be done in the initial years of the business but for long term financing purpose of the business (Fairfield and Jorratt De Luis 2016). This is the most productive type of financing as it does not create a burden on the business as in the case of debts and also the partners are not bringing in any capital into the business.

Short term /Long term Bank loans: This is another mostly used source for financing of capital for the business. The partnership can take a loan as per the requirement of the business that is it can be short term as well as long term in nature. This source of financing can be used by the business at initial stages of the business and also in the pursuance of the long-term business objectives of the firm (Shin 2012). The financing which is done through bank loans can meet both the objectives which can be start up financing as well as long-term financing of the business.


Additional Partner’s Capital: In many situation, there has been cases where the firm is requiring additional capital and the firm does not want to take a loan from banks then they use this technique. Whenever there is an admission of a new partner in the partnership firm, the individual brings in his share of capital for the purpose of investing in the firm and also determining the profit ratio which he is going to get. The additional capital which is brought by the new partners is used for financing purpose of projects and operation of the business. This type of financing is rarely used by firms as admission of a new partner means that the profit sharing ratio diminishes. However, it is commonly seen that a partnership business applies such techniques when a partner retires from a business so as to meet the capital requirements of the business.

Stock Performance Ratios

In case of a company form of business the most common sources of financing for a business are discussed below:

Issue of Shares: The most important sources of financing for a business is through issue of shares which can be equity shares or preference share as per the requirement of the business. The company has the ability to issue shares in order to collect small amount of capital per share from potential investors (Engel and Stiebale 2014). The share capital as collected by the business is used in financing the projects of the company. Such sources of financing are useful in start up business as well as financing for the long-term business objectives. In addition to this, financing with share capital is a reliable source of financing for the business (Bobinaite and Tarvydas 2014).

Bank Loan: This is another option which is available to the company which can be used for financing of the business. The company can take long- term as well as short term loans from banks for day to day operation of the business. However, lumpsum amount for loans as required by the company is not always available and the bank requires certain securities on the basis of which the bank will be allowing the loan to the company (Robb and Robinson 2014). In the startup phases of the business, company generally do not get any loan from the banks unless they provide ample amount of securities against the loan amount.

Debentures: Another source of financing of the business is by issuing debentures for collecting capital. The capital which is collected with the issuance of debentures forms a part of the debt capital of the business. The capital which is collect by the use of debentures can also be used to finance projects and it can issued for collecting funds for start-up cost and also for long-term financial requirements of the business (Buigut et al. 2013).


Retained Earnings. The company form of business also employs the concept of retained earnings. The company retains a part of the profit which is earned by the company during previous year and the business reinvest the profits in the business again (Serrasqueiro and Nunes 2012). The retain earnings method which is used by the business is known as plough back of profits in the business. Moreover, such method is advantageous to the company as it increases the internal strength of the company and makes the company financially strong. The retained earnings of the business depend on the amount of profit which was earned by the business in previous year. Moreover, the business cannot use such type of capital in start up financing of the business and has to resort to other means of sourcing of finance.

Basis

Equity Source of Financing

Debt Source of Financing

Preference Share Source of Financing

Meaning

This refers to the funds which are raised by the business by issuing shares which are also known as equity (Elsas,  Flannery and Garfinkel 2014).

Tis refers to the capital which is taken from a bank or financial institution

This type of capital is similarly raised as equity sources of capital but such shares have rights of their own and are different from equity sources of capital (Gitman, Juchau and Flanagan 2015).

Type of capital

This is regarded as own capital of the business

This is regarded as borrowed capital of the business or also known as loan capital of the business.

This also forms a part of the own capital of the business (Abdulsaleh and Worthington 2013).

Risks

The risks which are associated with equity shares is high as equity shares are generally risky in nature (Bekaert and Harvey 2017).

The risks which is associated with debts are low and debt capital are considered less risker than equity sources of capital.

This type of shares are not as risky as equity shares but has certain risk factor.

Return

The return which is generated by equity share capital is in the form of dividends and such dividends depends on the profit which is earned by the company and also on the decision of the management. If the company is not earning profits than the company will not be paying any dividend.

The return which is related to debt capital is interest which is fixed and regular in nature and generally depends on the agreement of debts of the business

The return which is generated by such sources are fixed unlike equity sources of capital and they are need to be paid even if the company is earning losses.

Recommendations


Thus, from the comparison of the above three sources of capital it can be said that the equity source of capital is very useful even though it is a risky source of capital. The consultancy business will be able to collect bulk amount of capital from equity sources and also there is no pressure of dividends in initial years even if the business earns losses.

Reference

Abdulsaleh, A.M. and Worthington, A.C., 2013. Small and medium-sized enterprises financing: A review of literature. International Journal of Business and Management, 8(14), p.36.

Ahrendsen, B.L. and Katchova, A.L., 2012. Financial ratio analysis using ARMS data. Agricultural Finance Review, 72(2), pp.262-272.

Al Karim, R. and Alam, T., 2013. An evaluation of financial performance of private commercial banks in Bangladesh: Ratio analysis. Journal of Business Studies Quarterly, 5(2), p.65.

Allen, W.T. and Kraakman, R., 2016. Commentaries and cases on the law of business organization. Wolters Kluwer law & business.

Babalola, Y.A. and Abiola, F.R., 2013. Financial ratio analysis of firms: A tool for decision making. International journal of management sciences, 1(4), pp.132-137.

Bekaert, G. and Harvey, C., 2017. Emerging equity markets in a globalizing world.

Bobinaite, V. and Tarvydas, D., 2014. Financing instruments and channels for the increasing production and consumption of renewable energy: Lithuanian case. Renewable and Sustainable Energy Reviews, 38, pp.259-276.

Brigham, E.F. and Houston, J.F., 2012. Fundamentals of financial management. Cengage Learning.

Buigut, K., Soi, N., Koskei, I. and Kibet, J., 2013. The effect of capital structure on share price on listed firms in Kenya. A case of energy listed firms. European Journal of Business and Management , 5(9), pp.29-35.

Burns, P., 2016. Entrepreneurship and small business. Palgrave Macmillan Limited.

Delen, D., Kuzey, C. and Uyar, A., 2013. Measuring firm performance using financial ratios: A decision tree approach. Expert Systems with Applications, 40(10), pp.3970-3983.

Ehiedu, V.C., 2014. The impact of liquidity on profitability of some selected companies: The financial statement analysis (FSA) approach. Research Journal of Finance and Accounting, 5(5), pp.81-90.

Elsas, R., Flannery, M.J. and Garfinkel, J.A., 2014. Financing major investments: information about capital structure decisions. Review of Finance, 18(4), pp.1341-1386.

Engel, D. and Stiebale, J., 2014. Private equity, investment and financial constraints: firm-level evidence for France and the United Kingdom. Small Business Economics, 43(1), pp.197-212.

Fairfield, T. and Jorratt De Luis, M., 2016. Top income shares, business profits, and effective tax rates in contemporary Chile. Review of Income and Wealth, 62(S1).

Gbandi, E.C. and Amissah, G., 2014. Financing options for small and medium enterprises (SMEs) in Nigeria. European Scientific Journal, ESJ, 10(1).

Gitman, L.J., Juchau, R. and Flanagan, J., 2015. Principles of managerial finance. Pearson Higher Education AU.

Higgins, R.C., 2012. Analysis for financial management. McGraw-Hill/Irwin.

Lee, N., Sameen, H. and Cowling, M., 2015. Access to finance for innovative SMEs since the financial crisis. Research policy, 44(2), pp.370-380.

Robb, A.M. and Robinson, D.T., 2014. The capital structure decisions of new firms. The Review of Financial Studies, 27(1), pp.153-179.

Serrasqueiro, Z. and Nunes, P.M., 2012. Is age a determinant of SMEs' financing decisions? Empirical evidence using panel data models. Entrepreneurship Theory and Practice, 36(4), pp.627-654.

Shin, H.S., 2012. Global banking glut and loan risk premium. IMF Economic Review, 60(2), pp.155-192.

 Tehrani, R., Mehragan, M.R. and Golkani, M.R., 2012. A Model for Evaluating Financial Performance of Companies by Data Envelopment Analysis-A Case Study of 36 Corporations Affiliated with a Private Organization. International Business Research, 5(8), p.8.

Tugas, F.C., 2012. A Comparative Analysis of the Financial Ratios of Listed Firms Belonging to the Education Subsector in the Philippines for the Years 2009-2011. International Journal of Business and Social Science, 3(21).

Zeitun, R. and Tian, G., 2014. Capital structure and corporate performance: evidence from Jordan.

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