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Long Term Debt Paying Ability Ratio

Discuss about the Investment Report of Gulf Cement Company.

Gulf Cement Company is a company which is engaged in the manufacturing business of cement. The company operates in United Arab Emirates and also has major portion of the business there. The company is claimed to be the largest producer of cement in UAE and is estimated to have a production capacity of 2.5 million tons of cement which shows that the business is engaged in large scale production of cement.

As per the requirement of the assignment, an analysis of ratio is to be done for the company on order to judge the financial performance of the company in comparison with the industry average (Delen, Kuzey & Uyar, 2013). The different ratios are analysed on the basis of long-term debt paying ability ratio, profitability ratio, investor analysis.

Long-Term Debt Paying Ability ratio refers to the company’s ability to meet the debts of the company. In other words, such types of ratios are associated with the debt servicing and paying capability of the company. The different ratios which are included in such category along with their respective industry average is given below:

GCEM Average Ratios (4)

> < ?

Industrial Average ((1)+(2)+(3)+(5))/4

Status
(Risky or Health?)

1- Times Interest Earned

13.439

64.294

Risky

2- Fixed Charge Coverage

13.439

64.294

Risky

3- Debit Ratio

0.145

0.382

Health

4- Debt/Equity Ratio

0.172

29.874

Health

5- Debt to Tangible Net Worth Ratio

0.172

29.884

Health

6- Operating Cash Flow/Total Debt

0.320

0.165

Risky

 


Figure 1: (Table Showing Long-term Debt Paying Ability ratio and their Industry Averages)

Source: (Created by the Author)

  • Time Interest Earned: It is a ratio which measures the ability of the company to meet the interest requirements of the debt which is taken by the business (Fracassi, 2016). Another name for Times interest earned is interest coverage ratio. In the case of GCEM, the time interest earned is very low as compared to the company’s average. The situation as shown in the table is risky for the company and hence the company needs to improve the ratio and avoid risks.
  • Fixed Charge Coverage: This ratio is the measure of the ability of the firm to meet the fixed expenses of the business in an effective manner before incurring any interest expense and tax expenses. In general, it is more or less an extension of the Times Interest earned. As shown in the table above fixed charge coverage should be a bit higher and also close to the industry averages. The company however has a low fixed charge coverage which indicates that the company is unable to effectively meet the fixed expenses of the company.
  • Debt Ratio: Debt ratio is the measure of the amount of debt capital which is used by the business in the capital structure of the company. In the case of the company the debt ratio is 0.145 which is much less than industry average. This is a favorable status as most business likes to keep their debt ratio to a minimum so as there is lower amount of risk in the business.
  • Debt to Equity Ratio: The debt equity ratio of any company analyzes the capital structure of the company on the basis of which the company is operating. Debt equity ratio is an important indicator as to how the business is performing (Heikal, Khaddafi & Ummah, 2014). In the case of the company, the debt equity ratio is much lower than the result which is depicted in the industry averages. It is considered from the perspective of the risks which are associated with debts the lower are the ratios the more favorable is the business. As per the table which is shown above the debt equity ratio is much less than the industry average and therefore it is considered to be favorable.
  • Debt to Tangible net worth ratio: It is a measure of the level of creditors protection in case of insolvency of the business. In the above table it is shown that the debt to tangible net worth of the company is 0.172 which is lower than the industry average and it is showing a favorable result as per the concerns of the company.
  • Operating Cash Flow/ total debt: This ratio depicts the relationship between the operating cash flow of the company and total debt of the company which is shown in the balance sheet of the company (Higgins, 2012). In the case of GCEM, the operating cash flow by total debt of the company is showing unfavorable results and the company needs to improve this ratio and make it favorable again.

The profitability ratios of the company are the measure of the profitability of the company which can be related to gross profit, operating profit and net profit. The profitability ratio of the company also includes ratio like return on equity, return on assets and other significant ratios (Komala & Nugroho, 2013). The profitability ratio of any company is considered to be important as they are most looked out for in the financial reports of the company. The table which depicts the profitability ratio along with the industry averages of the same for GCEM is given below:

GCEM Average Ratios (4)

> < ?

Industrial Average ((1)+(2)+(3)+(5))/4

Status
(Risky or Health?)

1-Net Profit Margin

0.050

4.236

Risky

2-Total Asset Turnover

0.435

0.326

Health

3-Return on Assets

0.021

0.069

Risky

4-Operating Income Margin

0.017

4.582

Risky

5-Operating Asset Turnover

0.966

1.495

Risky

6-Return on Operating Assets

0.004

2.248

Risky

7-DuPont Return on Operating Assets

0.004

2.248

Risky

8-Sales to Fixed Assets

0.800

0.661

Health

9-Return on Investment

0.038

0.114

Risky

10-Return on Total Equity

0.026

5.528

Risky

11-Return on Common Equity

0.038

0.436

Risky

12-Gross Profit Margin

0.077

0.296

Risky

Figure 2: (Table showing Profitability ratio and their industry averages)

Source: (Created by the Author)

  • Net profit Margin: The net profit margin of the company measures the net profit which is earned by the company in relation to sales of the company (Agha, 2014). The net profit margin of the company as shown in the table above is very low as compared to the industry average of the company. This is not a good indicator for the company as the company needs to have a better net profit margin as it is one of the crucial financial and performance indicator of the company. Thus, as shown by the table above the results of the company is risky.
  • Total Asset turnover ratio: The ratio measures the ability of the business to generate sales with the use of assets which the company has. The ratio basically establishes a relation between the sales and the total assets of the company (Delen, Kuzey & Uyar, 2013). The asset turnover ratio of the company as shown in the table is more than the industry average and thus the results are favorable in nature.
  • Return on assets: This refers to the profits which can be earned by the business by utilizing the assets of the company. The figure which is shown as the return of asset for the company is 0.21 which is much less than the industry results. The company needs to improve this ratio as it is one of the financial indicators which show whether the company is performing or not. Moreover, as shown in the table above it is unfavorable for the business to have such low return on assets.
  • Operating Income Margin: The operating income margin of the company shows the relationship between the operating profits of the business and overall sales of the business. The operating profit is an extension of the net profit margin of the business. Similar to the results of net profit margin the operating profit margin is also lower than the industry average and is highly unfavorable for the business as indicated in the table above.
  • Operating Asset turnover: The operating asset turnover ratio is an extension of total asset turnover ratio and as per the table the ratio is 0.966 which is much lower than the industry average and hence it is unfavorable.
  • Return on operating assets: This ratio is also an extension of return on assets and measures the profit which can be earned by operating assets of the business. As per the table, the return on operating asset is very low as compared to industry average.
  • Du-Pont Return on Operating assets: The ratio is similar to normal return from operating activities but the formula of Du-Pont is applied on the same. The table show that the result is lower than the industry average of the company and the results are same as the results of return on operating assets of the company.
  • Sales to Fixed Assets: This ratio measures the relation between the sales of a company to the fixed assets of the company. The table shows that the result which is 0.800 which is more than industry average which shows a result of 0.661. Thus, the result of this ratio is favorable.
  • Return on Investment: This is one of the most important indicators for performance measurement of the company. Return on investment measure the amount of profit which is generated from investment (Rehman & Takumi, 2012). The return of investment of the company is low in comparison to industry average. The return on investment results of the company is showing unfavorable results (Area, 2014).
  • Return on total equity: it represents the return on the total equity of the business which includes equity as well as preference form of capital (Kabajeh, Al Nu’aimat & Dahmash, 2012). The result which is depicted in the table show that the results are unfavorable in comparison to industry averages.
  • Return on Common equity: In this case the return from equity shares are only considered and the results show that the company is having unfavorable return on common equity.
  • Gross Margin: The gross margin of the company also depicts similar results as the net profit margin of the company which is unfavorable (Verma et al., 2016).

This measures the ratios which are useful for investors of the company and they are portrayed in a table below:

GCEM Average Ratios (4)

> < ?

Industrial Average ((1)+(2)+(3)+(5))/4

Status
(Risky or Health?)

1-Degree of Financial Leverage

0.948

0.966

Health

2- All-Inclusive Degree of
Financial Leverage

0.460

0.723

Health

3- Earnings per Share

0.038

0.379

Risky

4- Price/Earnings Ratio

0.000

0.000

5- Percentage of Earnings Retained

1.314

0.469

Risky

6- Dividend Payout

-0.314

0.531

Health

7- Dividend Yield

0.000

0.000

8- Book Value per Share

1.000

0.827

Risky

9- Materiality of Options

0.000

0.000

Figure 3: (Table Showing Investor analysis ratio and their industry average)

Source: (Created by the Author)

  • Degree of Financial leverage: The financial leverage is the measure of the firm’s debt in the capital structure (Ozdagli, 2012). As shown in the table above the financial the results of the ratio is lower than the industry average which is favorable in nature.
  • All inclusive degree of Financial leverage: This ratio is also an extension of the financial leverage of the business and the results which are depicted in the table after comparison is made with the industry average is favorable.
  • EPS: The earning per share of the business is lower than the industry average as shown in the table which is a matter of concern for the company as it is one of the most important indicators of the performance of the company.
  • Percentage of earning retained: This ratio depicts the percentage of retained earnings which the company has been able to save. The table depicts that the retained earnings of the company is more than the industry averages.
  • Dividend Payout ratio: The dividend payout ratio of the company as shown in the table is unfavorable in comparison to the industry averages (Ouma, 2012).
  • Book value per Share: The book value of shares as shown in the table above is more than the industry average and as depicted it is risky for the business.

Altman’s Z Score which is used in business can be used by companies in order to predict bankruptcy in the next tow years or not.  The formula which is used for the purpose of calculations can be derived from the income statement and balance sheet of the company (Altman et al., 2014). The results of the Z score is obtained with the help of five major ratio of the business which are liquidity, solvency, profitability, leverage and also the probability that he company might be headed towards insolvency (Altman et al., 2017).

Profitability Ratio

In the case of GCEM, the Z score of the company is 4.11 which shows that the company is not headed towards insolvency. A score which is below 1.8 suggest that the company is definitely headed towards bankruptcy and a score of above 3 is favorable which the company has obtained.

D: Bankruptcy Prediction (Z-score)

X1= Working Capital/Total Assets

0.298877776

X2= Retained Earnings/Total Assets

0.389692176

X3= EBIT/Total Assets

0.042016549

X4 = Market Value of Equity/Total Liabilities

4.437301145

X5 = Sales / Total Assets

0.40639165

Z=1.2X1 + 1.4X2 + 3.3X3 + 0.6X4 + 1.0X5

4.111649327


References

Agha, H. (2014). Impact of working capital management on profitability. European Scientific Journal, ESJ, 10(1).

Altman, E. I., Iwanicz?Drozdowska, M., Laitinen, E. K., & Suvas, A. (2017). Financial Distress Prediction in an International Context: A Review and Empirical Analysis of Altman's Z?Score Model. Journal of International Financial Management & Accounting, 28(2), 131-171.

Altman, E., Iwanicz-Drozdowska, M., Laitinen, E., & Suvas, A. (2014). Distressed Firm and Bankruptcy Prediction in an International Context: A Review and Empirical Analysis of Altman's Z-Score Model.

Area, M. C. (2014). Return on Investment.

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

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

Fracassi, C. (2016). Corporate finance policies and social networks. Management Science, 63(8), 2420-2438.

Heikal, M., Khaddafi, M., & Ummah, A. (2014). Influence analysis of return on assets (ROA), return on equity (ROE), net profit margin (NPM), debt to equity ratio (DER), and current ratio (CR), against corporate profit growth in automotive in Indonesia Stock Exchange. International Journal of Academic Research in Business and Social Sciences, 4(12), 101.

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

Kabajeh, M. A. M., Al Nu’aimat, S. M. A., & Dahmash, F. N. (2012). The relationship between the ROA, ROE and ROI ratios with Jordanian insurance public companies market share prices. International Journal of Humanities and Social Science, 2(11), 115-120.

Komala, L. A. P., & Nugroho, P. I. (2013). The Effects of Profitability Ratio, Liquidity, and Debt towards Investment Return. Journal of Business and Economics, 4(11), 1176-1186.

Ouma, O. P. (2012). The relationship between dividend payout and firm performance: a study of listed companies in Kenya. European Scientific Journal, ESJ, 8(9).

Ozdagli, A. K. (2012). Financial leverage, corporate investment, and stock returns. The Review of Financial Studies, 25(4), 1033-1069.

Rehman, A., & Takumi, H. (2012). Determinants of dividend payout ratio: Evidence from Karachi Stock Exchange (KSE). Journal of Contemporary Issues in Business Research, 1(1), 20-27.

Verma, S., Kim, B., Jhong, H. R., Ma, S., & Kenis, P. J. (2016). A Gross?Margin Model for Defining Technoeconomic Benchmarks in the Electroreduction of CO2. ChemSusChem, 9(15), 1972-1979.

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[Accessed 01 March 2024].

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