Posted on 31st Dec 2024 11:26:48 PM Banking, Finance
INTRODUCTION OF RATIO ANALYSIS
Definition of Ratio Analysis
Ratio analysis is items in financial statements like the balance sheet, income statement and cash flow statement; the ratios of one item – or a combination of items - to another item or combination are then calculated. Ratio analysis is used to evaluate various aspects of a company’s operating and financial performance such as its efficiency, liquidity, profitability and solvency. The trend of these ratios over time is studied to check whether they are improving or deteriorating. Ratios are also compared across different companies in the same sector to see how they stack up, and to get an idea of comparative valuations.
Introduction to Financial Ratios
When computing financial ratios and when doing other financial statement analysis always keep in mind that the financial statements reflect the accounting principles. This means assets are generally not reported at their current value. It is also likely that many brand names and unique product lines will not be included among the assets reported on the balance sheet, even though they may be the most valuable of all the items owned by a company.
These examples are signals that financial ratios and financial statement analysis have limitations. It is also important to realize that an impressive financial ratio in one industry might be viewed as less than impressive in a different industry.
Our explanation of financial ratios analysis is organized as follows:
INCOME STATEMENT
Financial analysis is the use of financial statements to analyze a company’s financial position and performance and to assess future financial performance.
Generally, financial ratios are classified on the basis of function or test, on the basis of financial statements, and on the basis of importance. These three classifications are briefly discussed below:
CLASSIFICATION OF FINANCIAL RATIOS
On the basis of function or test, the ratios are classified as liquidity ratios, profitability ratios, activity ratios and solvency ratios.
Liquidity Ratios:
Liquidity ratios measure the adequacy of current and liquid assets and help evaluate the ability of the business to pay its short-term debts. The ability of a business to pay its short-term debts is frequently referred to as short-term solvency position or liquidity position of the business.
Generally a business with sufficient current and liquid assets to pay its current liabilities as and when they become due is considered to have a strong liquidity position and a businesses with insufficient current and liquid assets is considered to have weak liquidity position.
Short-term creditors like suppliers of goods and commercial banks use liquidity ratios to know whether the business has adequate current and liquid assets to meet its current obligations. Financial institutions hesitate to offer short-term loans to businesses with weak short-term solvency position.
Four commonly used liquidity ratios are given below:
Unfortunately, liquidity ratios are not true measure of liquidity because they tell about the quantity but nothing about the quality of the current assets and, therefore, should be used carefully. For a useful analysis of liquidity, these ratios are used in conjunction with activity ratios (also known as current assets movement ratios). Examples of activity ratios are receivables turnover ratio, accounts payable turnover ratio and inventory turnover ratio etc.
Profitability ratios:
Profit is the primary objective of all businesses. All businesses need a consistent improvement in profit to survive and prosper. A business that continually suffers losses cannot survive for a long period.
Profitability ratios measure the efficiency of management in the employment of business resources to earn profits. These ratios indicate the success or failure of a business enterprise for a particular period of time.
Profitability ratios are used by almost all the parties connected with the business.
A strong profitability position ensures common stockholders a higher dividend income and appreciation in the value of the common stock in future.
Creditors, financial institutions and preferred stockholders expect a prompt payment of interest and fixed dividend income if the business has good profitability position.
Management needs higher profits to pay dividends and reinvest a portion in the business to increase the production capacity and strengthen the overall financial position of the company.
Some important profitability ratios are given below:
Activity ratios:
Activity ratios (also known as turnover ratios) measure the efficiency of a firm or company in generating revenues by converting its production into cash or sales. Generally a fast conversion increases revenues and profits.
Activity ratios show how frequently the assets are converted into cash or sales and, therefore, are frequently used in conjunction with liquidity ratios for a deep analysis of liquidity.
Some important activity ratios are:
Solvency ratios:
Solvency ratios (also known as long-term solvency ratios) measure the ability of a business to survive for a long period of time. These ratios are very important for stockholders and creditors.
Solvency ratios are normally used to:
Some frequently used long-term solvency ratios are given below:
Ratio Analysis:
Ratio Analysis is done to measure the financial performance of the company and to understand that in which track the company is going in the future. So, it is basically one technique of assessing the company’s financial performance
In ratio analysis, financial items of a particular year are compared. Here relationships between the financial items are examined. So, by doing ratio analysis we can judge the various financial aspects of a firm. Then when we compare one year’s ratios with another then we come to know that how much progress was made during the compared period. The ratio analysis is very important to investors, creditors and financial analysts as it helps in decision making.
1. Current Ratio:
Current ratio is an efficient tool to measure that the organization is capable in meeting up its short term debts or not. Current ratio basically assesses a firm’s liquidity because, if a firm is enough liquid and it has enough resources then it can pay back the all debts that need to cover during 12 months.
Current Ratio is an indication of a company's ability to meet short-term debt obligations, the higher the ratio, the more liquid the company is. Current ratio is calculated by dividing firm’s current asset by current liability.
Formula: Current Assets ∕ Current Liabilities
Satisfactory current ratio actually varies from industry to industry but in general, if the current ratio lies between 1.5 and 3 then it indicates that the business is healthy. If the current ratio is below 1then it means that the current liabilities are higher than the current asset, so the firm can face many difficulties while paying back short term debts. On the other hand if the current ratio is too high then it indicates that the firm is not efficient to utilize its short term financing facilities. It may also indicate that the firm has problem in working capital management.
Low current ratios normally indicate that the firm is in trouble to meet current obligation but not necessarily always a low current ratio indicates a huge problem. Firms which have not much currents assets but have a strong long term plans and prospects, they definitely can sort out ways to tackle this problem. There are many firms who have a current ratio under 1 but they are surviving quite well. So, low current ratio does not always mean that the firm is at an alarming stage or very near to be bankrupt but of course it is better to maintain a standard current ratio in order to ensure fewer risks.
From the perspective of short term creditors, a high current ratio is appreciable because it means that the company is eager to pay back current debts within 12 months. A high current ratio also indicates that the firm is much efficient to convert its goods into cash quickly.
In short, current ratio should be compared within the same industry as the benchmark ratio varies from industry to industry.
2. Quick Ratio:
This ratio assesses the capacity of an organization to recover its current liabilities by using the organization’s quick assets. The asset which can be turned into cash rapidly at an amount that is very close to its book value is known as quick asset.
Quick ratio is also known as Acid-test ratio and liquid ratio. Any quick ratio less than 1 means that the firm cannot pay back its current debts.
Formula: (Current Asset-inventory) ∕ Current Liabilities
From the formula, we can see that inventory is not included in the quick ratio, where as it is included in the current ratio. Always a high quick ratio is not considered as good, if it happens that the firm has huge account receivables but those will be collected after a long time and the current liabilities are lesser but needs to be paid instantly then the quick ratio will be higher but still the firm is in a great risk as there is liquidity crisis. On the other hand, opposite thing can be happen when the firm has lesser current assets which will be mature soon and more current liabilities which need to be paid in much later. In this case, the quick ratio will be lower but despite of that the firm is risk free as there is no hurry of payments. Standard quick ratio is 1:1 or above. Higher the quick ratio, the company is more liquid but yes the benchmark figure is different in different industries.
3. Net Working Capital:
Net working capital is the capital by which firms can fund its daily operations. It is one of the standard assessments of liquidity of an organization. This ratio finds out that the firms have excess current assets over the current liabilities or not. If the firm has higher current assets then the ratio will be positive which means the organization has the ability to operate daily business and to cover immediate obligations. Diminishing working capital is an alarm that business is going to face troubles and the worst scenario is the bankruptcy.
Net working capital is also known as working capital and working capital ratio. It gives the investors another clear view of the firm which is the operational efficiency. A firm which is quite efficient in running business and collecting money from customers, the net working capital of that firm will be between 1.2 and 2 because much high working capital indicates that huge money is tied up in inventories and to the borrowers. So, consecutive increases in working capital is a signal of slow collection which is not good for business.
Formula: Net Working Capital= Current Assets-Current Liabilities
Here we can see that GSK Bangladesh Ltd has maintained positive net working capital which indicates their operational efficiency. From 2007 to 2010 the working capital ratio was too high and these were above 2 which is a sign that GSK is slow at payment collections and operating cycle is not enough efficient. Satisfactory thing is, in 2011 it was little high than 2 which means it used its current assets properly than the previous years.
4. Inventory Turnover Ratio:
In the business, the sufficient volume of inventory is must and we can judge that enough inventory is being produced or not through the inventory turnover ratio. This ratio basically shows that over a period, how many times the inventories are sold and renovated in a business. Generally, a company with high inventory turnover ratio is assumed as strong one. When the inventory level is very high then the ratio will be low which means the inventories are kept idle in the warehouse so definitely it is bad for future growth. Huge amount of inventories also symbolize that the rate of return on the inventory investment is near to zero.
The turnover ratios of the unpreserved goods are normally very high as these are sold out quickly. Although high inventory turnover ratio is always desired but sometimes high ratio may also indicate ineffective buying as lower inventory purchasing will cause the ratio to be high.
Formula: Inventory Turnover Ratio = Sales ∕ Inventory
The ratio is also calculated in this manner,
Inventory Turnover Ratio = Cost of Goods Sold ∕ Average Inventory
5. Inventory Conversion Period:
The inventory conversion period is the period during which the inventories are used to produce new goods and then preparing them for selling to the end users. Lower the conversion period, higher the firm’s ability to convert the raw materials into finished goods.
Formula: Inventory Conversion Period = (Inventory ∕ Cost of Goods Sold) × 365 days
In case of inventory conversion period, lower figure is more acceptable.
6. Total Asset Turnover:
Total Asset Turnover judge that how much sales revenue is gathered in against of each dollar of assets. Through this ratio, the effectiveness of asset management of the firm is measured. Higher the ratio, higher the efficacy of the firm and the vice versa.
Total Asset Turnover = Revenue ∕ Total Assets
From the asset turnover, we can also guess that pricing strategy as the high asset turnover signals towards the low profit margin which means costs have increased and need to cut down.
7. Debt Ratio:
This ratio finds out that how much of the total asset is funded through debt. So, it actually shows the dependency on debt in order to manage assets. If the ratio is higher then it means that the firm has higher debt and it is more dependent to its creditors for necessary financing. If the ratio is higher than 1, it indicates excess debt over total assets and the vice versa. Although higher debt is not a problem if interest payments are made on time, if it is not then definitely a great risk for the firm. Sometimes, higher debt can also give the firm the benefit of financial leverage.
Formula: Total Debt / Total Assets
8. Debt to Equity Ratio:
The debt to equity ratio is the best way to measure the financial leverage of any firm; it is one of the most important ratios of any firm. Higher the ratio, higher the debt amount of the firm, therefore higher financial leverage.
If the ratio is lower, the leverage of the firm is also lower. It presents the parentage of a company’s asset that is financed by debt versus equity. It is a widespread quantity of the long term capability of a firm’s business and along with current ratio, a measure of its liquidity, or its ability to cover its expenses. So, it often takes only long term debts instead of total liabilities.
Sometimes, it happens that higher debt leads the firm to gain higher debt as cost of debt is lower than the cost of equity but it is not good for the firm to always apply this technique because if the firm fails to meet up the obligations of debts ten the firm can reach even in the stage of the bankruptcy. So, the firms should be much analytical and attentive when to take higher debts. Higher debt can lead to both higher gain and risk, so firms should be very careful while taking financial leverage.
Formula: Total Debt / Shareholder’s Equity
9. Time Interest Earned Ratio:
Time Interest Earned ratio is basically a solvency ratio which assesses that firm has the capacity or not to pay back all its loans. This ratio is also known as interest coverage ratio. Through this ratio it can be judged that how many times a firm can face its interest expenses that are due to the taken borrowings. If the ratio is higher, then it means that the firm has the ability to payback its loans but if the amount is too high then it mean that the firm is unnecessarily using the maximum portion of earnings to repay the loans.
In this case the company can afford using low portion of returns in repayment of loans and can reinvest the earnings on more volume in order to ensure high growth. On the other hand, if the ratio is less than 1 then it means that the firm is not achieving much profit to meet up the debt obligations.
Formula: Earnings before Interest and Tax / Interest Expenses
10. Gross Profit Margin:
Profitability depends on a large number of policies and managerial decisions of a firm. All the effects of liquidity, asset and debt management on the income s judged through the profitability ratios. Gross profit Margin, Profit Margin, Return on Assets and Return on Equity are the mostly used profitability ratios.
The relationship of sales and cost of goods sold is assessed through gross profit margin. High ratio indicates a secure position for the company. Low profit margin signals towards less safe position because it means that sales are diminishing, therefore generating low revenues. It is also a great tool of identifying pricing strategy and cost control. It helps to cut cost by presenting that cost is relatively low or high than the revenues. So, from the low profit margin we actually get the idea that I which way we need to control our costs.
Formula: Gross Profit Margin = Gross Profit / Sales
11. Net Profit Margin:
This is the ratio of Net Income to Sales or Revenues. Through the net profit margin, we asses that out of each dollar of sales, how much is kept as earning. This is also known as profit margin. Higher the profit margin, better the condition of the firm. Higher profit margin means that from the sales, higher portion is remaining as profit so it also indicates towards efficient expense controlling ability.
Formula of Net Profit Margin = Net Income/Sales
12. Return On Assets (ROA):
ROA is the measurement tool by which we can know that a firm is how much profitable in comparison with its total assets. So, it measures that the firm how efficiently uses its assets to generate profits. This is also known as Return on Investment (ROI) as it tells that a firm how effectively transforms its investments on profits. It is often expressed in percentage. Higher ROA is always desired as it indicates that higher profit has been made through fewer investments.
Formula: ROA=Net Income/Total Assets
13. Earnings per Share:
Earnings per share or EPS express the earned profit against per share. It is considered as an important tool while measuring a stock’s performance. Investors often judge the firms with the EPS and always prefer a high EPS. However, always high EPS does not mean that the firm is doing well because the Net income can be manipulated and for this reason EPS can be overestimated. Often firms do these in order to attract the public. So, relying only on EPS is never a wise decision. Another important point is same EPS of two firms do not indicate that the firms are equally strong; here we need to judge that which firm has earned same EPS by less investment. The firm which has done so is in better position and more efficient.
Formula: Net Income/ Number of Common Stock Outstanding
14. Payout Ratio:
The dividend payout ratio is actually the percentage of earnings that is given to the investors of the firm. High payout ratio always attracts the investors because it means that the firm is in good position and generating huge profit. That’s why investors always seek for high dividends and often switch to another stock in order to fulfill their desire. It is not always true that firms in good condition can only afford dividend payment, it also happens that a firm with a future growth prospect currently giving low or zero dividends but in long run it will provide the investors high capital gain. So, investors should not only seek high dividends, they should be more aware about high capital gain. Sometimes, excess amount dividend payment is a bad sign, it indicates that organization is wasting money unnecessarily rather than reinvesting from which future of the business could be more secured.
Formula: Dividend Payout Ratio = Total Dividend/ Net Income
15. Price Earnings Ratio or P/E:
This is the ratio of market value to EPS. Through this ratio, the recent trading price of the firm is compared with its EPS.
The P/E ratio actually represents the expectation of investors about the firm. Higher P/E means that investors have high expectations about the firm’s future growth and that’s why they are interested to invest.
The P/E ratio has also another meaning, sometimes it also indicates that how much the investors are willing to pay for per dollar of earnings. So, in this case it is referred as multiple. The average P/E ratio is 20-25 times. Comparing P/E ratio within firms of same industry gives the idea that which firm is performing well.
Formula: P/E ratio= Market Price/EPS
Book-To-Market Ratio
A ratio used to find the value of a company by comparing the book value of a firm to its market value. Book value is calculated by looking at the firm's historical cost, or accounting value. Market value is determined in the stock market through its market capitalization. The market to book financial ratio, also called the price to book ratio, measures the market value of a company relative to its book or accounting value. The market value of the company is its value at any point in time as determined by the financial marketplace. The book value, or historical value, is almost always lower than the market value since some assets may be off-balance sheet items
Formula: Market to book = Share price of the stock/Book value per share
Return on Equity
The amount of net income returned as a percentage of shareholders equity. Return on equity measures a corporation's profitability by revealing how much profit a company generates with the money shareholders have invested.
ROE is expressed as a percentage and calculated as:
Return on Equity = Net Income/Shareholder's Equity
RATIO ANALYSIS OF COCA-COLA
Company View
The Coca-Cola Company is an American multinational beverage corporation and manufacturer, retailer, and marketer of nonalcoholic beverage concentrates and syrups, which is headquartered in Atlanta, Georgia. The company is best known for its flagship product Coca-Cola, invented in 1886 by pharmacist John Stith Pemberton in Columbus, Georgia. The Coca-Cola formula and brand was bought in 1889 by Asa Griggs Candler (December 30, 1851 – March 12, 1929), who incorporated The Coca-Cola Company in 1892. The company operates a franchised distribution system dating from 1889 where The Coca-Cola Company only produces syrup concentrate which is then sold to various bottlers throughout the world who hold an exclusive territory. The Coca-Cola Company owns its anchor bottler in North America, Coca-Cola
For generations, the simple pleasure of drinking Coca-Cola has been associated with special times, special places and timeless moments but also with the satisfying experience of everyday life. That is the magic of Coke.
Coca-Cola, the brand…is the heart of our company. It has always been and always will be. Coca-Cola, Fanta and Sprite create the magic to provide consumers with special moments. Consumers of all ages want great tasting beverages that also provide nutrients for healthy growth and to make them feel their best. Coca-Cola compliments and shares the best moments of all consumers!
AM Beverage Limited is the authorized bottler of Coca-Cola, Fanta and Sprite. The bottling operation started after acquiring the plant of K. Rahman & Company in 1982. In 1987 the company made an aggressive move to expand the market by establishing a new bottling plant of 450 bottles per minute (BPM) capacity in Cumilla. With this move the company immediately gained the market leadership position from the competitors. Strategic planning in further capacity building, investment in logistics and support services as well as aggressive marketing approach rewarded the enterprise with dividends in better market share and product availability across the territory.
In 1990 the company was awarded the President’s Turtle Award by the President of The Coca-Cola Company in recognition of its contribution to positioning the brand. This is the most prestigious reward for bottlers by Coca-Cola.
In 1997 the company established another bottling plant at Chittagong. This state of the art bottling plant of 650 BPM capacities is the most modern plant in the country, equipped with straight-line technology from Germany. This plant was established to expand the market further and to deliver products at every consumer’s doorstep, even to the most remote areas of Bangladesh.
BALANCE SHEET OF COCA COLA
Ratio analysis is based on line items in financial statements like the balance sheet, income statement and cash flow statement; the ratios of one item – or a combination of items - to another item or combination are then calculated
Liquidity Ratios:
Liquidity ratios measure the adequacy of current and liquid assets and help evaluate the ability of the business to pay its short-term debts. The ability of a business to pay its short-term debts is frequently referred to as short-term solvency position or liquidity position of the business.
Activity ratios:
Activity ratios (also known as turnover ratios) measure the efficiency of a firm or company in generating revenues by converting its production into cash or sales. Generally a fast conversion increases revenues and profits.
Solvency ratios:
Solvency ratios (also known as long-term solvency ratios) measure the ability of a business to survive for a long period of time. These ratios are very important for stockholders and creditors.
Profitability ratios:
Profit is the primary objective of all businesses. All businesses need a consistent improvement in profit to survive and prosper. A business that continually suffers losses cannot survive for a long period.
Profitability ratios measure the efficiency of management in the employment of business resources to earn profits. These ratios indicate the success or failure of a business enterprise for a particular period of time.
Profitability ratios are used by almost all the parties connected with the business.
A strong profitability position ensures common stockholders a higher dividend income and appreciation in the value of the common stock in future.
Operating Profit Margin:
Profitability depends on a large number of policies and managerial decisions of a firm. All the effects of liquidity, asset and debt management on the income s judged through the profitability ratios.
Return on Assets (ROA):
ROA is the measurement tool by which we can know that a firm is how much profitable in comparison with its total assets. So, it measures that the firm how efficiently uses its assets to generate profits.
Market Ratio:
A ratio used to find the value of a company by comparing the book value of a firm to its market value. Book value is calculated by looking at the firm's historical cost, or accounting value. Market value is determined in the stock market through its market capitalization.
CONCLUSION
After applying all the ratios we got an idea that Coca Cola Company is a profitable firm. Because throughout the analysis of two years, the company is getting profitable return on short term and long term investment, their profit margin has been increased as well and they are in the position to pay their debts with their resources.
Financial ratios analysis is a part of financial statement analysis and through this we can have knowledge about the company’s present and past performance. Most importantly it gives us an idea that what can be the company’s performance in the future. Ratio analysis involves the calculation of statistical relationship between data and it is a very popular technique of financial statement analysis. Throughout my analysis, we came to know about the financial strength, operational efficacy and management efficacy of coca cola. We have realized that coca cola is performing f well, though they have some financial threats which are increasing recently.
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