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Financial Ratios

The budgets represent the overall policies of the company expressed in monetary terms and they also define the responsibilities of the executives in relation to the requirements of the overall policies of the company. Hence the company will closely monitor the performance of the individual managers by comparing the actual results with the budgeted figures. This will facilitate the executives to take the necessary corrective action wherever required or to change the policies of the company if it is essential.

Budgetary control thus assists the management in their functions of planning, coordinating, and controlling the activities of the individuals and the overall performance of the firm. Accounting and Investigation of variances: A variance represents the difference between the budgeted and actual figures. Variances are calculated at the end of the budget period once the actual figures are known. The variances may be either faourable or adverse. Favourable variances occur when the actual figures are better than the budget figures. On the contrary adverse variances occur when the actual figures are worse than the budgeted figures.

It is the responsibility of the managers to examine the variances and identify the reasons why the variances have occurred. By analyzing the variances the managers may

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be able to improve upon the performance of the firm. Normally in any business the financial ratios help to identify areas in which the company needs to carry out further investigation and also point out the areas in which the company needs to improve the performance in comparison with the competitors to gain a competitive advantage. There are numerous financial ratios that can be calculated from the data contained in the financial statements of the companies.

The ratios that are commonly used are: Profitability Ratios: These ratios indicate the profitability of the company by identifying whether the return on the investment is at satisfactory level. These ratios also tell on the operating margin and gross margin efficiency of the firm and these ratios are often used to make comparisons of performances of firms within an industry. Liquidity Ratios: Indicate how liquid the company has kept its various current assets and how able the company is to meet its current liabilities. Turnover Ratios: These ratios indicate how well the company is able to use its assets in improving the sales of the company.

Capital Ratios: The capital ratios exhibit the composition and relationship that exists between owned and borrowed funds employed in the firm. Apart from the above ratios there are Dividend ratios which shed light on the financial performance of the company’s shares. From the above table the financial position of the company XYZ Co Plc can be assessed. The table shows the various ratios for the two periods 20X6 and 20X7 and also the comparative ratios for the industry. Based on the financial ratios the financial standing of the company can be detailed as below:

As compared to the industry average the company is performing better in terms of the return on capital employed. While the industry average is 15 percent the company has achieved a return of 16. 08 percent. The company has also improved its performance over the last year. This is shown by the increase in the percentage from 14. 26 in the last year. Though the gross profit is slightly less than the average for the industry, the company has done well in terms of the operating profit and is also showing an increasing trend.

The operating profit for the company is higher at 10.63 percent than the industry average of 10 percent. The profitability of has improved from 9. 76 percent for the last year to 10. 63 percent for the current year. This percentage reflects the improvement in the profitability of the company. Similarly the company has employed its assets judiciously, which is evident from the assets turnover ratio of 1. 89 times for the current year as compared to 1. 5 times of the average for the industry. The liquidity of the company with respect to its ability to meet the current liabilities is also well maintained at 2. 35 times which in fact is a good ratio as compared to the 2.2 time to current liabilities maintained in the industry.

Though slightly less than the average for the industry the quick (acid-test) ratio also indicates a good liquidity position of the company in terms of the financial ability to meet the current liabilities. As far as the stock and debtors are concerned the company is well maintaining its position much better than the industry as shown by the number of day’s stock holding and the debtors collection periods. The current assets are maintained at comfortable levels implying that the company is able to manage its current assets in a well planned manner.

While the industry average for the debtors collection period is 206 days the company maintains a 43 days collection period which is a good sign that the company is able to have a better control over its debtors. The inventory position of the company is also held comfortably without locking too much funds in the stock. The company’s interest coverage is very impressive that it can meet the interest obligations 8. 33 times as against the industry average of 3 times. This implies that the company is working more on its owned funds than borrowed funds. This is also evidenced by a gearing ratio of 50:50

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