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Report Report Document Transcript

  • INSTITUTE OF COST AND MANAGEMENT ACCOUNTANTS OF PAKISTAN REPORT ON RATIO ANALYSIS OF M/S RANI LIMITED PREPARED FOR: Board of Directors PREPARED BY: Management Accountant
  • TABLE OF CONTENTSParticulars Page No. Executive Summary 3-4 Introduction 5 Financial Position and Ratio Analysis 6 - 10 Suggestions & Conclusion 11 - 12 Appendices  Horizontal & Vertical Analysis of Income Statement 13  Comparative Ratios & averages 14  Trend of Ratios & Percentages 15  Graphical Representation 16 Page 2 of 16
  • EXECUTIVE SUMMARYThis report provides an analysis and evaluation of the current and prospectiveprofitability, liquidity and financial stability of Rani Ltd. Methods of Analysisinclude trend horizontal and vertical analyses as well as ratios such as Current andQuick Ratios. Other calculations include return on Shareholders Equity and TotalAssets and earnings per share to name a few. All calculation can be found in theappendices. Results of data analyzed show that the company’s total revenue hasincreased but Net profit Margin have declined due to increase in cost of sales.Over all liquidity position of Rani Ltd. is satisfactory although quick ratio is atalarming level. Corrective measures are required to avoid any liquidity problemsin future.The Operating cycle is rising due to huge level of inventories, and receivablescollection period. Fall in liquidity ratios, rapid increase in revenues, increase ininventory in relation to revenue, uneven increase in receivables and increase inaccounts payable period and decrease in profit margin are the symptoms of“Overtrading”.In line with the decrease in net profit, earning per share has also drasticallyreduced to Rs.3.22 (2010) from Rs.2.665 (2012) over preceding years. Page 3 of 16
  • This report finds the prospects of the company in its current position are notpositive. The major areas of weakness require further investigation and remedialinvestigation. Recommendations discussed include:  Improving the average collection period for trade debtors  Improving the Inventory turnover  Avoiding unnecessary overtradingThis report also indicates the fact that the analyses conducted has limitations.Some of the limitations include  Nature and Type of the company is not known  Current Economic condition is also unknown  Data limitations as not enough information is provided or enough detail Page 4 of 16
  • INTRODUCTIONThis report provides information obtained through ratio analysis, regarding theprofitability, liquidity and financial stability of Rani Ltd for the years 2010-2012.This report will pay particular attention to the earning power, liquidity and creditmanagement, inventory management, and will highlight major strengths andweaknesses while offering some explanation for observed changes.The report will comment on the prospects of the company and makerecommendations that would improve Rani Ltd’s current performance. Theseobservations do have limitations which will be noted. This report will explain howa cash flow statement and a prospectus could enhance analysis. Page 5 of 16
  • Financial Position and Ratio AnalysisRani Ltd had a very good performance in the past but now some performanceindicators show that the present results are deteriorating and not in line with theprevious financial indicators of the company.We understand that the term of reference of the assignment is to analyze theperformance and financial position of the company.We have analyzed the financial position of the company on the basis ofinformation and ratios provided to us on the following grounds: • Profitability of the Company • Liquidity Position • Efficiency Indicators • Investment Perspective Page 6 of 16
  • PROFITABILITY OF THE COMPANYAll three profitability ratios given in the table below (see appendices) havepositive values during the year, as the company gained gross profit andcomprehensive income from operational and financial activity for this period butoverall profitability of the Rani ltd has considerably declined due to the variousreasons out of which very obvious indicators are Cost of goods sold to net salesratio which show that the in spite of increase in sales over last three years Cost ofgood sold has increased as % of total sales. This is mainly due to the amount ofinventory that Rani Ltd is maintaining in 2012.As a result of above, very logically net profit to net sales ratio has significantlyreduced from 13.90% in 2010 to only 10.43% in 2012. This is certainly veryalarming position for the management of the company as well as shareholders ofthe company. If the trend goes on further in next coming year it is very obviousthat the company will start incurring losses in the near future.On the same lines Return on net worth has been falling to 7.54% in 2012 from10.60 % in 2010 which indicates that the returns are not up to the mark and maybe below the required rate of return of the company and will certainly be notacceptable to the investors of the company. Page 7 of 16
  • LIQUIDITY POSITIONCurrent ratio of Rani Ltd has increased from 1.26 times in the year 2010 to 1.43times in the year 2012, as we know that the normal level of current ratio is 2 : 1that shows sound liquidity position. There is increase in current ratio fromprevious year’s ration, this increase in current ratio is indicating pilling up ofinventories as compared to acid test ratio which is increasing as well.Higher current ratio is also indicating under utilization of working capital as excesscurrent asset can be invested into more efficient utilization. For absolute reasonof this increase shows that the company has been involved in over trading due towhich account receivable & inventories turnover have declined and operatingcycle days have increased.The Quick/acid test ratio is very useful in measuring the liquidity position of afirm. It measures the firm’s capacity to pay off current obligations immediatelyand is more rigorous test of liquidity than the current ratio. Usually a high liquidratio is an indicates that the firm is liquid and has the ability to meets its currentor liquid liabilities in time and on the other hand a low liquidity ratio representsthat the firm’s liquidity position is not good. The Quick Ratio which is 0.64 time in2012 is at alarming situation, because, generally, a quick ratio of 1:1 is consideredto be satisfactory. It means that Rani Ltd does not have enough assets which canbe transferred to monetary funds in a very short time to meet current liabilities.Working capital is required to maintain to meet the operational needs of thecompany such as purchase of raw material and payment of salaries and wages tolabor but in Rani Ltd working capital has been rising above the needs which is dueto the increase in receivables and inventories that causing extra financing cost tothe company. But if we compare working capital with inventories, it turns out thatinventories are not covered with working capital in full at the end of the periodanalyzed . The value of working capital is deemed to be normal when itcorresponds to the amount of inventories, which are the least liquid part ofcurrent assets. Page 8 of 16
  • EFFICIENCY INDICATORSDebtors turnover has gone down abnormally during the current period overpreceding years i.e. from 24.99 times in 2010 to 7.31 times in 2012 as a resultcollection period has increased to 49 days from 14 days which certainly needextra financing. As we know that higher the collection period, the greater is thechance of bad debts.Inventories need detailed analysis from all aspects. Inventories could be of rawmaterial, work in progress and finished goods, all these when accumulate, blockhuge amount of funds. This increase could be due to the obsolete or out datedstock or due to excessive orders which were not matched with the productionschedules which result increase in storage cost.In terms of days, presently it is taking 100 days to move to the customers whichhas been increased from 84 days in 2010. It means that the company needs extrafinancing for these extra days of pilling up of inventories.The detailed analysis of receivables and inventories concludes that the Operatingcycle has severely moved up by 48 days from the level of 90 days in 2010 to 138days in 2012. Page 9 of 16
  • INVESTMENT PERSPECTIVEEarning per share has been continuously falling and presently it has reached to2.66 in 2012 from 3.22per share in 2010. EPS has decreased by 17% from 2010to 2012Reasons for this declining trend are the same as discussed earlier in profitabilityratio, but point of concern is that despite declined in profitability and earning pershare, company has maintained dividend per share of Rs 2 which is perhaps torestrain share price from drastic reduction, this strategy might not work inefficient market as investors are more informed and take rational decisions, onthe other hand, company will not be able to maintain this level of dividend pershare in near future as the company might be in a financial difficulty and may notbe able to distribute dividends at this level of profitsDividend Per share of Rani ltd has increased from previous year which is goodindicator for investors as he/she receives dividend despite the fact that thecompany is not having good profitability performance as compared to previousyears.Book Value per share of Rani Ltd has also increased from 19.59 in 2010 to 21.32 in2012.Gearing Ratio measures the percentage of capital employed that is financed bydebt and long term financing. The higher the gearing ratio, the higher is thedependence on borrowing and long term financing. Gearing Ratio between 25%to 50% is considered normal for a business which is happy to finance its activitiesusing debts. Rani Ltd has maintained its gearing ratio at approximately 27% sincelast 2010 which means that Rani ltd is neither issuing equity nor raising long termliabilities. Page 10 of 16
  • SUGGESTIONS & CONCLUSIONThe comparative ratio analysis of Rani Ltd has created several mysteries whichneed to be resolved prior to reach any hasty conclusion. From the interpretationof financial ratios of Rani Ltd, it can be concluded that it is not in a very securefinancial position. Improvement in every area of the company is needed if thecompany is, in the first instance, to survive and then grow.The key areas of reform are the liquidity of the company and the quantity andquality of working capital, profitability and financial stability. Management of RajaLtd must address these areas simultaneously if the company is going to take overRani ltd.It must be remembered that this analysis is limited- a greater of understandingand evaluation can only occur with utilization of other resources such ascomparisons with the companies operating in the same industry as of Rani ltd orcomparisons with budget forecasts and the statement of changes in financialposition. Only after this process can a full appreciation of the company’s currentsituation and possible future occur.At this point the company does not have strong future prospects in the areas ofprofitability, liquidity or stability if it continues on its current path. Raja Ltd shouldbe concerned with current rates of return of Rani Ltd. Before making Investmentin Rani ltd our company should see other factors as wellWe should see if we can get synergies by acquiring the Rani ltd, because fromgiven information and data company is performing not very well so it would be arisky investment if made in hurry.  Company is having acute Working Capital Management Problems.  Rani Ltd has neither Aggressive Working capital policy nor conservative one. Page 11 of 16
  • AVOID OVERTRADINGSolution of all the problems lies in the overtrading. Rani ltd must avoidovertrading activities and take reasonable orders which it can meet easily andhonor them timely, it will reduce extra finance cost, inventory storage costs andother costs related to it. If Raja ltd takes over Rani ltd then we should considerfollowing options:  We must see the future Plans of the company before finalizing any deal.  Raja limited should change its working capital policies (if acquired).  We should see the post acquisition benefits and post acquisition operating policies before taking any decision.  Rani ltd is suffering finance cost as a result of high receivable and inventory level which needs to be lower.  Rani ltd is not issuing the equity nor raising long term loan, so this option must be considered to increase the capital base.  We must take into account Market Price of the Rani ltd.  Board of Directors should investigate for any Intellectual Capital/Assets of the company which may increase the value of the Rani ltd.  We must take into account market value of the shares of the company. Page 12 of 16
  • APPENDICES HORIZONTAL & VERTICAL ANALYSIS OF INCOME STATEMENT Vertical Analysis 2012 2011 2010 % of total Rs % of total Rs % total RsSales 100.0% 100% 100% 20,440.0 19,467.0 18,540.0CGS 59.9% 55% 58% 12,247.0 10,650.0 10,753.0Operating Expenses 15.1% 17% 17% 3,086.0 3,268.0 3,063.0Financial Charges 5.3% 4% 4% 1,082.0 839.0 725.0Net Profit 10.4% 14% 14% 2,132.0 2,650.0 2,578.0 Horizontal AnalysisParticular % 2012 % 2011 % 2010 Increase/(Dec Increase/(Dec Increase/(Dec from previous from previous from previous year year yearSales 5.0% 5.0% 20,440.0 19,467.0 18,540.0CGD 15.0% -1.0% 12,247.0 10,650.0 10,753.0Operating Expenses -5.6% 6.7% Don’t know 3,086.0 3,268.0 3,063.0Financial Charges 29.0% 15.7% 1,082.0 839.0 725.0Net Profit -19.5% 2.8% 2,132.0 2,650.0 2,578.0 Page 13 of 16
  • COMPARATIVE RATIOS, PERCANTAGES & AVERAGES S. No. Description 2012 2011 2010 1 Current Ratio 1.43 1.21 1.26 2 Quick Ratio 0.64 0.56 0.57 3 Working Capital 2239 894 698 4 Net Profit Margin 10.43% 13.61% 13.90% 5 Gross Profit Ratio 40.08% 45.30% 42.00% 6 Return On Assets 7.54% 9.85% 10.60% 7 Interest Cover (Times) 4.72 6.61 6.52 8 Receivable Turnover (Times) 7.31 10.21 24.99 9 Receivable Turnover (Days) 49 35 14 10 Payable Turnover (Times) 31.70 28.84 47.50 11 Payable Turnover (Days) 11 12 8 12 Inventory Turnover (Times) 3.57 4.66 4.42 13 Inventory Turnover (Days) 100 77 84 14 Operating Cycle (Days) 138 100 90 15 Earning Per share 2.66 3.31 3.22 16 Dividend Per Share 2.18 2.06 - 17 Dividend Payout Ratio 0.82 0.62 - 18 Book Value Per Share 21.32 20.84 19.59 19 Return On Capital Employed 22.15 24.48 21.80 20 Return On Shareholder Equity 12.5 15.90 16.44 21 Gearing Ratio 26.02% 26.47% 27.70%Note: Assumed 360 days in a yearAll ratios & percentages are rounded off to the nearest two decimal places Page 14 of 16
  • TRENDS OF RATIOS & PERCENTAGESCurrent RatioQuick RatioWorking CapitalReceivable Turnover (Days)Inventory Turnover (Days)Operating CyclesSalesCost of SalesDividend per Share____________________________________________________Net Profit MarginGross ProfitReturn on AssetsReturn on Capital EmployedReturn on Shareholder EquityEarning Per Share Page 15 of 16
  • GRAPHICAL REPRESENTATION 25000 Profitability Analysis 20000 15000 10000 5000 0 2012 2011 2010 Sales 20440 19467 18540 Cost Of Sales 12247 10650 10753 Net Profit 2132 2650 2578 1.6 1.4 1.2Liquidity 1Position 0.8 0.6 0.4 0.2 0 2012 2011 2010 Current Ratio 1.43 1.21 1.26 Quick Ratio 0.64 0.56 0.57 160 140 120 100 Efficiency 80 Indicators 60 40 20 0 2012 2011 2010 Operating Cycle 138 100 90 Inventory Turnover 100 77 84 ReceivableTurnover 49 35 14 Page 16 of 16