Financial Ratio Analysis Essay Sample

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Although sales have increased by 12% from 2009 to 2011
( £60m /£500m) , gross margins have decreased from 59% to 53.6% over the 3 years . Reasons for the decrease in gross margin are not clear but could include : change in sales mix to higher percent of lower margin products increase in raw material costs within cost of sales that ABC is unable or unwilling to pass on to customer because of competition = squeeze in margins because of competition ABC wants to gain market share and is reducing its margins to enable it to gain share • Net margin (Return On Sales ) has decreased from 21% to 14.6% over the 3 years as :

overall profit before tax has decreased by 18% ( £115m/£140m) over the period primarily because “other costs including depreciation” have increased by 36% over the 3 years ( £75m/£55m) and net interest has doubled from an expense of £5m in 2009 to an expense of £10m in 2011 gross margins have decreased as discussed above

• ROCE has declined dramatically from 68% in 2009 to just under 30% in 2011 primarily because : profit before tax has reduced by 18% over the 3 years as  discussed above

capital employed has increased by 88% over the 3 years
( £385m/£205m) as retained profits have more than doubled total equity from £125m to £285m over the period. This increase has been used to fund a big increase in fixed assets which have doubled from £120m to £240m over the 3 years • Return on shareholder funds (ROSF) has declined dramatically from 84% in 2009 to just under 29% for the same reasons as the reduction in ROCE described above

• Earnings per share have reduced by 35% from £10.50 in 2009 to £6.83 in 2011 as :
after tax profit has declined by 22% over the period
the number of issued shares has increased by 20% ( from 10 to 12 m)
• Dividends per share have reduced from £3 a share to £1 a share over the period as dividends have reduced from £30m in 2009 to £12m in 2011. This reduction in total dividends partly
reflects: – the reduction in after tax profits over the period

– the decision by ABC to retain a large percentage of its profits for funding increases in fixed assets as discussed above ( 71% in 2009 and 85% in 2011)
• The current and quick ratios have both improved over period and are at healthy levels in 2011 ( > 2 for Current ratio and >1 for Quick ratio) • Stock turnover time is about the same in 2011 (176 days) as in 2009 (178 days)

Debtor payment time has increased from 36.5 days in 2009 to 45.6 days in 2011 but is still substantially less that the time that ABC takes to pay its creditors – 154 days in 2011 ( was 169 days in 2009). Gearing has reduced from 39% in 2009 to 25.9% in 2011 as long term debt increased by £20m in 2011 and total equity has increased from £125m in 2009 to £285m in 2011.

Overall conclusions :

Although total sales have increased in the 3 years from 2009 to 2011 , profit margins and the returns to shareholders have decreased – dramatically in the latter case. This reduction of returns to shareholders is also directly linked to the decision to retain a substantial and increasing share of after tax profits to fund big additions to ABC’s fixed assets – possibly to modernise its facilities or to expand its markets or product range in the near future . Liquidity is sound and ABC appears to be fairly efficient at collecting its debts in less time than it takes to pay its creditors. Stock turnover is slow but stable over the 3 years

Gearing is healthy and decreased over the 3 years.

3) Additional Financial information required to fully evaluate ABC plc’s financial performance

Additional data required is primarily :

yearly cash flow statements including details of capital expenditure and timing of dividend payments and tax payments details of increase in long term debt from 2009 to 2011 including duration of loans and interest % details of Cost of Sales and of Distribution and Admin costs to help explain why gross and net margins have changed eg subdivision of Cost of sales into raw material, labour and overhead costs details of “Other costs” including identification of depreciation content share price changes : to enable calculation of Price/earnings ratio and Dividend yield financial performance of key competitors during this period

earlier years (2008 and 2007) to establish trends .
subdivision of year into first and second halves – and also possibly quarter years – to assess up to date profit and profitability performance for the second half and 4th quarter of 2011

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