Evaluation and comparison of ratios calculated in Part C
For comparing the financial information, ratios are a great tool. They provide the bird’s eye view of the major aspects of the business and hence makes the information comparable and helps in analyzing and taking decisions as per the requirement of stakeholders.
The main categories of financial ratios are:
These categories of ratios are used to evaluate and compare the profit earning capability of the company. It not only compares the income but also the expenses and costs. The two types of ratios of this category are ("Profitability Ratios - Calculate Margin, Profits, Return on Equity (ROE)", 2018):
- Return on assets ratio– This ratio shows the return earned on the assets invested. ROA is calculated by dividing profit with total assets. This ratio helps in determining the profit generated by the assets employed. For Sunbay Sales, the return on asset is 12.20% which means that by investing $100 into assets the company is able to generate the profit of $12.20.
- Profit margin ratio– This is a profitability ratio shown in a percentage form. This is the most important ratio and is calculated by dividing the profit earned by the business with sales. For Sunbay Sales, this ratio is 30.80%. it means company is earning a profit of 30.80% on its sales.
For measuring and comparing the efficiency of the company’s assets and operations the efficiency ratios are used. It helps in determining the effective utilization of business assets and liabilities. The two types of ratios of this category are ("Efficiency Ratios | Example | My Accounting Course", 2018):
- Assets turnover ratio– This ratio shows the efficiency and utilization of company’s assets against its sales. It is calculated by dividing the sales with total assets employed. This ratio is expressed in times. For Sunbay Sales, this ratio is 0.40 times which means that sales are 0.4 times of assets employed.
- Times debtors turnover – This ratio shows the debtors as a percentage to sales. It shows how efficient a company is in extending credit to its debtors. For Sunbay Sales, this ratio is 4.92 times. It means sales is 4.92 times of its debtors.
Another set of ratios used to measure the liquidity of the company is termed as liquidity ratios. The two types of ratios of this category are ("Financial Analysis and Accounting Book of Reference: Statement of Financial Position | IFRS Statements | IFRS Reports | ReadyRatios.com", 2018):
- Current ratio– Current ratio shows the company’s ability to pay off its current liabilities from its current assets and is calculated by dividing current assets with its current liabilities. For Sunbay Sales, the current ratio is 6.13 times meaning thereby the current assets are 6.13 times of its current liabilities.
- Quick ratio– This ratio shows the relationship between quick assets and its current liabilities and measures the effectiveness of company to pay off its current liabilities from its quick assets. Quick assets are current assets less prepayments and inventories. For Sunbay Sales, this ratio is 4.84 times.
Capital Structure Ratios
Every organization has a capital structure either in the form of debt, equity or both. The optimum combination to be used and its results are measured through these ratios. The two types of ratios of this category are
- Debt to equity ratio– This is the most famous and used ratio and shows the component of debt and equity and is calculated by dividing debt with equity ("Debt-to-equity ratio", 2018). For Sunbay Sales, this ratio is 0.22 times meaning thereby the debt is 21.57% and remaining is equity in the capital structure of the company.
- Debt ratio– This ratio compares the debt of the company with the total assets employed and shows the equity as a percentage to its assets. For Sunbay Sales, this ratio is 0.16 times.
Limitation of Ratio Analysis
Although, the ratio analysis is very useful, however it has some cons as well. These cons or disadvantages include that it ignore the market price and is generally calculated on the book value of assets, liabilities, assets and equities. Further, the interpretation of ratios differ from person to person and so its uses and comparability (Bragg, 2018).
Moreover, there is no common standard or policies governing the ratio analysis, so its computation also differs from company to company and person to person.
By analyzing the above information and details, we can conclude that the Sunbay Sales has a good financial health. However, there are certain areas which need improvement.
Our recommendation is to improve the current ratio by optimizing the utilizing its economic resources. For this, the company can increase its current liabilities by taking short term debts, this will improve the current ratio strengthening the liquidity of the company.
Bragg, S. (2018). The limitations of ratio analysis. AccountingTools. Retrieved from https://www.accountingtools.com/articles/what-are-the-limitations-of-ratio-analysis.html
Efficiency Ratios | Example | My Accounting Course. (2018). My Accounting Course. Retrieved from https://www.myaccountingcourse.com/financial-ratios/efficiency-ratios
Profitability Ratios - Calculate Margin, Profits, Return on Equity (ROE). (2018). Corporate Finance Institute. Retrieved from https://corporatefinanceinstitute.com/resources/knowledge/finance/profitability-ratios/
Debt-to-equity ratio. (2018). En.wikipedia.org. Retrieved from https://en.wikipedia.org/wiki/Debt-to-equity_ratio
Financial Analysis and Accounting Book of Reference: Statement of Financial Position | IFRS Statements | IFRS Reports | ReadyRatios.com. (2018). Readyratios.com. Retrieved from https://www.readyratios.com/reference/liquidity/