Exceptional Service Grading Company Financial Ratio Analysis
In accordance with Way (2019), financial statements are crucial in providing executives the information necessary to confer with external parties’ key things akin to the fiscal conditions, informing the operative results, the current cash flow situation, and stockholder equity. While Financial Ratio analysis entails determining financial performance using five main types of proportions derived from an organization’s budget reports: profitability, liquidity, activity, debt, and market. Financial ratios are employed by firm management, shareholders, and financial institutions (Lumen Learning, n.d.).
Gross Profit Margin
The Gross Profit Margin (GPM) or gross margin ratio displays how much profit is made for every dollar of revenue. It is a statistic used by financial analysts to analyze the financial health of a firm by estimating the amount of money left over from product sales or service supplied after deducting the cost of items sold or service rendered (Bloomenthal, 2021).
The formula to calculate the Gross Profit Margin is:
Gross Profit Margin (%) = (Gross Profit / Revenue)*100%
Therefore,
Gross Profit Margin (2017) = (1,637,600 / 6,595,400)*100% = 24.83%
Gross Profit Margin (2018) = (2,696,900 / 9,200,000)*100% = 29.31%
From the previous data, we know that in 2017 and 2018, Exceptional Grading Company earned 24.83 and 29.31 cents per dollar, respectively. The 4.48% rise from 2017 to 2018 was attributable to an increase in contracts in 2018.
Current Ratio
According to Fernando (2022), the current ratio is a liquidity ratio that assesses a company’s capacity to pay short-term or one-year commitments. It explains to investors and analysts how a firm might optimize its current assets on its balance sheet in order to pay down its current debt and other payables. A current ratio less than 1.00 indicates an inability to meet short-term obligations, whereas a percentage greater than 1.00 indicates a stronger financial ability to remain solvent (Fernando, 2022).
The formula to calculate the Current Ratio is:
Current Ratio = Current Assets / Current Liabilities
Therefore,
Current Ratio (2017) = 4,576,900 / 3,292,850 = 1.39
Current Ratio (2018) = (5,652,200 / 3,325,950 = 1.70
By looking at the company’s current ratio in 2017 and 2018, we know that the company has enough current assets to cover liabilities in 2017 and 2018. As we can see on the above calculation, the current ratio increased from 1.39 in 2017 to 1.70 in 2018.
Debt Ratio
A debt ratio is a financial statistic that reflects the degree of indebtedness in a firm. The debt ratio is defined as the decimal or percentage ratio of total debt to total assets. It is defined as the percentage of a company’s assets that are funded by debt. A ratio larger than one indicates that a significant portion of a firm’s assets are supported by debt, implying that the organization has more liabilities than assets. A high ratio suggests that a corporation is at danger of loan default if interest rates unexpectedly rise. A ratio less than one indicates that a bigger share of a company’s assets are supported by equity (Hayes, 2022).
The formula to calculate the Debt Ratio is:
Debt Ratio = Total Debt / Total Assets
Therefore,
Debt Ratio (2017) = 5,875,400 / 4,067,900 = 0.692 or 69.2%
Debt Ratio (2018) = 7,007,800 / 4,170,300 = 0.595 or 59.5%
According to Hayes (2022), debt ratios of 0.4 or lower are deemed preferable (from a pure risk aspect), but debt ratios of 0.6 or higher make borrowing money more difficult. While a low debt ratio indicates better trustworthiness, there is also a danger connected with a corporation having too little debt. As we can see here, the debt ratio in 2018 is decreasing to 0.595 might be attributed to two factors: an increase in contracts obtained in 2018 or the fact that Exceptional Grading Company had just joined the market in 2017 and required capital investment.
Return on Assets Ratio (RAR)
The Return on Assets Ratio (RAR) measures how much net revenue was earned for every dollar of average assets invested. Return on assets is calculated by dividing net income by the average total assets (Heisinger & Hoyle, 2012).
The formula to calculate the Debt Ratio is:
Return on Assets Ratio (ROA) = Net Income / Total Assets
Therefore,
ROA (2017) = 454,500 / 5,875,400 = 0.077 or 7.7%
ROA (2018) = 1,330,000 / 7,007,800 = 0.190 or 19%
This calculation means Exceptional Grading Company earned 7.7 cents per asset in 2017. In 2018, this was raised to 19 cents. The cause for this improvement is as previously mentioned in the previous calculation of debt ratio.
Quick Ratio
The Fast Ratio (QR) or acid-test ratio determines if a business has enough quick (or highly liquid) assets to meet current obligations. The quick ratio is calculated by dividing quick assets by current liabilities (Heisinger & Hoyle, n.d.)
The formula to calculate the Debt Ratio is:
Quick Ratio = (Current Assets — Inventor) / Current Liabilities
Therefore,
Quick Ratio (2017) = (4,576,900–100,200) / 3,292,850 = 1.36
Quick Ratio (2018) = (5,652,200–89,800) / 3,325,950 = 1.67
The Quick Ratios for 2017 and 2018 are both more than 1.0, showing that the firm has enough quick assets to cover obligations throughout the 2017–2018 period. Again, there is a rise of liquid assets over liabilities in 2018, which is due to the same causes indicated before.
Analysis
From 2017 to 2018, the rise in service contracts resulted in a 39.5% increase in income. Profits increased by 104.3% from 2017 to 2018 due to an increase in service contract income. From 2017 to 2018, net income climbed by 192.6% due to a rise in revenues and earnings. The investing of earnings earned in 2018 boosted cash by 105.3%. (Dividends are not paid) Due to the acquisition of extra debt in 2018, note receivable grew by 35%.
Conclusion
The company’s financial status in terms of cash flow is positive, based on the numerous financial ratio assessments and the observed trend, indicating that the company has adequate liquidity or capital to start on new initiatives. However, we should be aware that The financial ratio analysis may disregard price changes induced by inflation owing to temporal delays in the publishing of financial statements. A change in accounting policies can have an impact on financial reporting, affecting the recorded results. Furthermore, changes in operations and seasons may be neglected when calculating ratios. During a ratio study, financial figures may be manipulated in favor of the corporation. A follow-up question that I would like to ask Management regarding the new project is “What are the projected costs, expected income, related risk, and the detail business plan?”
References
Bloomenthal, A. (2021, March 19). Gross profit margin (GP): Formula for how to calculate and what GP tells you. Investopedia. Retrieved November 16, 2022, from https://www.investopedia.com/terms/g/gross_profit_margin.asp
Fernando, J. (2022, July 11). Current ratio explained with formula and examples. Investopedia. Retrieved November 16, 2022, from https://www.investopedia.com/terms/c/currentratio.asp
Hayes, A. (2022, March 28). Current ratio explained with formula and examples. Investopedia. Retrieved November 16, 2022, from https://www.investopedia.com/terms/c/currentratio.asp
Heisinger, K., & Hoyle, J. B. (n.d.). Accounting for Managers. https://2012books.lardbucket.org/books/accounting-for-managers/index.html
Lumen Learning. (n.d.). Financial ratio analysis | Introduction to business. Lumen Learning — Simple Book Production. Retrieved November 16, 2022, from https://courses.lumenlearning.com/wm-introductiontobusiness/chapter/financial-ratio-analysis/
Way, J. (2019, February 4). What Is the Importance of a Company’s Financial Statements? CHRON. Retrieved November 16, 2022, from https://smallbusiness.chron.com/importance-companys-financial-statements-21332.html
Note:
This article is written based on University of The People Financial Management (BUS 5111) written assignment by Fristy Tania in November 2022
