Financial Performance Analysis using Ratio Analysis

Purpose

The purpose of this report is to allow the users of the reports to have a clear picture of financial performance of the company so that they can take sound economic decisions related to the company.

Scope

As a part of this report, the financial performance of Capral Limited in 2017 and 2016 is analysed through the use of key technique of financial management i.e. Ratio Analysis. To understand the overall financial performance of the company it is necessary to assess its financial performance from various aspects such as profitability, liquidity, efficiency and solvency. In the present report, certain ratios have been calculated to comment on the profitability and liquidity position of the company.

Limitations:

Though ratio analysis is the key technique of financial management but even it suffers from certain limitations that do not allow it to complete achieve its core purpose of accurate financial decision making. In the present report, the company’s performance has been compared with the performance of a large corporation which is not even in the direct competition with Capral Limited because of non-availability of financial information of the company’s direct competitor. The grounds of comparison are not appropriately comparable.

Carpal limited is an Australian company which is engaged in the business of rolling, drawing as well as extruding the aluminium. It is the leading supplier of fabricated as well non-fabricated aluminium products in Australia. The company is trading as a public company and is ranked at 849^th position among the top 2000 corporations in Australia. Carpal operates its business through various divisions such as manufacturing division, business systems, aluminium centres and industrial solutions. The manufacturing unit of the company is operated through various manufacturing sites that are located in multiple places of Australia. These sites undertake the extrusion and distribution of aluminium products in the Australian market. The building system of the company provides a wide range of products like windows, doors, showers, wardrobes etc. Through its trade centres, it provides a wide range of services such as transportation, geometric extrusions and so on. The industrial solution unit offers solutions to the company’s customers in the areas of cost and risk analysis.

All the ratios that have been discussed and calculated above are analysed and interpreted in the further section of the report to understand the true state of company’s financial position.

Current ratio:

Current ratio of a firm measures its ability to meet out its short term liabilities that are due in the one year through the use of its current assets. It shows how efficiently the firm is managing its current assets to deal with its current liabilities. Higher the current ratio, higher is the firm’s ability to pay off its current liabilities without even disposing the fixed assets of the business. The ideal current ratio is 2:1 and this implies that the firm must at least have twice the current assets of its current liabilities (Accounting explained. 2018).

Current Ratio Analysis

The current ratio of the company in both the reported years i.e. 2017 and 2016, is slightly above the benchmark of 2:1 and this shows that company is managing its current assets efficiently and is able to meet its current liabilities that are going to be due in one year. Moreover, the current ratio has slightly improved in 2017 as compared to 2016 and this shows that the company is striving to improve further its liquidity position (Yahoo Finance 2018).

Quick ratio:

This ratio is also called as acid test ratio or liquid ratio. This ratio is used to gauge the ability of firm to square off its short term financial obligations with the use of its quick assets only. Quick assets of the firm are those assets that can easily be convertible into cash within the period of 90 days or any short term period. Besides cash and cash equivalents, the other quick assets of the company could range from its short term investment to marketable securities to accounts receivables. Current assets like inventories and prepaid expenses are not considered as the quick assets of business as these assets are generally not capable of getting converted into cash quickly and easily as and when required. Ideally, the company must maintain a liquid ratio of at least 1:1 (Papadopoulos, 2011).

The quick ratio of Capral Ltd. is also slightly above the ideal ratio and this shows that the company has adequate quantum of its liquid assets and hence its liquidity position could be said to be satisfactory.

Gross profit margin:

This ratio is an important financial metric of measuring the financial performance of the company in terms of profitability. It is expressed as the percentage terms. Gross profit is the proportion of company’s earnings that remains after meeting the cost of goods sold in a particular year (Fridson & Alvarez, 2011). This ratio takes into account the expenses that are incurred in the business only to undertake the core business activities i.e. the purchase and sale of raw material and finished goods. It does not take into account the operating expenses of the business such as depreciation, finance cost, occupancy cost etc.  Though, there is no standard gross profit ratio but the company must at least have 25% of its GP ratio. 

The profitability position of the company has been identified using the gross profits, return on equity and return on assets. All the three ratios have depicted that the profitability position of the company has declined in 2017 when compared to that of 2016. However, the Gross profit ratio of the company in 2017 is satisfactory enough in both the years. The current GP ratio of 40.19% shows that the earnings that remains with the company after meeting its cost of basic operations is 40.19% of the total revenue of the company.

Quick Ratio Analysis

Return on Equity:

It is the profitability ratio that measures the quantum of net profits earned during the course of the business using the funds invested by the shareholders of the company.  Higher the return on equity ratio, stronger is the profitability position of the company. Return on equity shows the efficiency of the company in utilising the funds of its shareholders for the purpose of generating returns (Wang & Zhou, 2016). The declining return on equity ratio shows that the company in 2017 is not able to generate as much returns as it earned in 2016 because of its inefficiency to use the funds invested by its shareholders (Capral Aluminium, 2017).

Return on Assets: 

It is the income generated by the business from the appropriate deployment of its total assets. Higher return on assets ratio shows the company’s efficiency in utilising its total assets of the business for the purpose of producing profits (Tracy, 2012).

Even the return on asset ratio has been declined in 2017 as compared to 2016 and this shows that the company must not have utilised its total assets in such a way that would have allowed it to earn higher returns as the income of business (IBIS World, 2017). Though, there is no standard rate prescribed for the ideal return on assets and return on equity ratio but as the general investor tendency, higher ROE and ROA percentages are preferred by them because it shows the return potential of the company.

In order to evaluate the company’s performance in terms of asset efficiency, the days inventory ratio of Capral Ltd. is calculated and this ratio is compared with that of Rio Tinto Inc. which is also an Australian company and is a leading corporation that is engaged in the business of mining and extracting aluminium products (Yahoo Finance, 2018). The company is the global leader in the aluminium product refining. The inventory turnover ratio of the company has been calculated for the purpose of calculating the inventory day’s ratio (Accounting explained, 2013). The days inventory ratio of the company shows the number of days that the firm will take to sell of all its inventory that is held for the purpose of sale only during the course of business. The days inventory ratio of Carpal is 107 days however that of Rio Tinto is just 47 days. This shows that Rio Tinto is managing its inventory more efficiently than Carpal Ltd as the former company is able to sell its inventories in the time that is quite lower than that of Rio Tinto. Inventory is an important element of the business that requires proper management in order to carry out business in the most smooth and effective way so that proper flow of cash by way of timely conversion of inventory into sales. The management of Carpal Ltd. must make efforts to minimise its days inventory ratio so as to control its cost of carrying inventories.

Conclusion:

From the above ratio analysis, it can be concluded that the company’s financial performance in terms of profitability has degraded in 2017 as compared to 2016 but its liquidity position is satisfactory. Further, the inventory management practices of the company are not as adequate as its competitors and hence the company must strive to improve these practices. 

References:

Accounting explained. 2013. Financial Ratio Analysis. Available at: https://accountingexplained.com/financial/ratios/ accessed on 05.08.2018.

Accounting tools. 2018. Ratio Analysis. Available at:  https://www.accountingtools.com/articles/ratio-analysis.html accessed on 05.08.2018

Bloomberg (2018) Company Overview of Capral Limited [online]. Available from https://www.bloomberg.com/research/stocks/private/snapshot.asp?privcapId=874819 accessed on 05.08.2018.

Capral Aluminium (2017) Annual Report . Available from https://member.afraccess.com/media?id=CMN://2A1069260&filename=20180306/CAA_01958748.pdf accessed on 05.08.2018.

Fridson, M.S., and Alvarez, F. (2011) Financial Statement Analysis: A Practitioner’s Guide 4^th ed. U.S: John Wiley & Sons.

IBIS World (2017) Capral Limited – Premium Company Report Australia [online]. Available from https://www.ibisworld.com.au/australian-company-research-reports/manufacturing/capral-limited-company.html  accessed on 05.08.2018.

Papadopoulos, P. 2011. Investment Report – Fundamental Analysis/ Ratio Analysis. GRIN Verlag.

Rio Tinto (2017) Annual Report . Available from https://www.riotinto.com/documents/RT_2017_Annual_Report.pdf accessed on 05.08.2018.

Tracy, A. (2012) Ratio Analysis Fundamentals: How 17 Financial Ratios Can Allow You to Analyse Any Business on the Planet 1^st ed. RatioAnalysis.net

Tracy, A. 2012. Ratio Analysis Fundamentals: How 17 Financial Ratios Can Allow You to Analyse Any Business on the Planet. RatioAnalysis.net.

Wang, D., and Zhou, F. (2016) The Application of Financial Analysis in Business Management. Journal of Business and Management, 4(2016), 471-475.

Yahoo Finance (2018) Rio Tinto plc (RIO) . Available from https://finance.yahoo.com/quote/RIO/ accessed on 05.08.2018.