The financial statement of a company represents the financial position and financial performance of the company. The financial statement includes income statement, balance sheet, cash flow statement and change in equity. The process of reviewing the financial statement for better decision making is referred to as the financial statement analysis. The analysis of financial statement is not only useful to management but is also helpful for creditors, investors and other regulatory authorities (Uechi et al. 2015). The financial statement is mainly useful for understanding trend and proportion analysis. There are two methods of financial statement analysis. The first one is horizontal and vertical analysis and the second one is ratio analysis. In this report, the financial statement of Pro Diver is analyzed using key financial ratios. The financial ratio is a method of comparing the financial and accounts and categories (Weil et al. 2013). These financial ratios are the most widely used tools for analyzing the financial statement because it is easily calculated and is easily understandable. In this report key ratios are computed in order to analyze the financial statement of Pro Diver.
Financial Ratio Analysis
The current ratio measures the ability of the company to pay off its short term debts with current assets. The current ratio is both the efficiency ratio and a liquidity ratio. It is an important ratio to measure the liquidity of the company (Vogel 2014). Current assets include cash and cash equivalents, marketable securities that can be easily converted to cash and inventories. The current ratio is calculated by dividing current asset with current liability. The formula is given below:
Current Ratio= Current Assets / Current Liability
The current ratio represents the company’s current liability in terms of its current assets. A company with the higher current ratio is in a more favorable position than a company with lower current ratio. If the current ratio of the company is, 1 that represents that current assets is equal to current liability (Ozturk and Acaravci 2013). This means all the current liabilities can be paid of using the current assets. If the current ratio is, less than one this means that company does not have sufficient current assets to pay of its current liabilities. In this situation, the company will have to sell fixed assets in order to pay current liabilities (Healy and Palepu 2012). The current ratio less than one are unfavorable condition for any company. The current ratio more means that there are excess current assets after paying of the current liabilities. This is a favorable condition for any company. The most favorable current ratio is considered as two but it differs according to the various industries.
In the given case, the current ratio of the Pro Divers is 1.29. This means that the company has enough current assets to pay of its current liability. The current ratio of the company is not very high therefore though the current ratio is favorable but the situation is not very encouraging.
Debt Equity Ratio
The debt equity ratio compares the total debt of the company with the total equity. This ratio shows the financing structure of the company. It is also referred to as the gearing ratio. It represents the proportion of financing to equity of the company. The debt equity ratio can be calculated in more than one ways. In one method debt, equity ratio is calculated by dividing total liability with total equity (Delen et al. 2013). In another method debt equity ratio is calculated by dividing long term debt with the total equity. In this report, the first formula is used for calculating the debt equity ratio. The formula is shown below:
Debt equity ratio= total liability / total equity
The debt equity ratio represents the proportion in which the total asset of the company is financed. A low debt equity ratio indicates that the company is not utilizing the cheap source of finance properly. On the other hand, a higher debt equity ratio indicates that the company is facing high financial risk (Brigham and Houston 2012). The companies generally prefer to maintain a balanced debt equity ratio. It is not easy to determine the optimum debt equity ratio it primarily depends on the industry standards. The debt equity ratio of one suggests that the investors and creditors of the company has equal stake in the asset of the business as the shareholders. A debt equity ratio more than one suggests that the company is more risky as the stake on the business assets of the investors and creditors are more than the shareholder (Brigham and Ehrhardt 2013). In this, case the debt equity ratio of the Pro Diver is1.44. This means that creditors and investors than its shareholders finance the assets of the company more. As unlike the shareholders, the investors and creditors are required to repay so for a business with high debt equity ratio is considered risky. Therefore, from the analysis of the debt equity ratio it can be concluded that Pro Diver Company is in financial risk.
Day’s Sales Outstanding Ratio
This ratio measures the number of days the company takes to collect cash from its credit sales. It highlights the efficiency and effectiveness of the collection department. This ratio is also known as average collection period or days sales on receivable (Kou et al. 2014). This ratio shows how sooner the cash is collected it is useful because cash collected can be invested in a more useful manner. It is calculated by dividing the account receivable with the net credit sales and multiplying the same with the 365 days. The formula is given below:
Days Sales Outstanding= (Account Receivable/ Net Credit Sales) X 365
The number of days it takes to convert credit sales into cash is measured by this ratio. The lower the ratio more favorable it is because it represents the companies to collect cash from its debtors early and in a timely manner. This also minimizes the risk of bad debt therefore putting the company in a more favorable position. The higher ratio represents that the collection department of the company is not operating effectively and hence the useful funds of the company is blocked in credit sales (Hunjra and Bashir 2014). On analyzing the financial statement of the Pro Diver, the day’s sales outstanding ratio is calculated to be 17.43 days. This represents that in this case the company collects cash on credit sales in 17.43 days. Therefore based on the analysis it can be concluded that the collection department of the company is operating effectively.
Receivable Turnover Ratio
The receivable turnover ratio calculates the number of days the company requires to convert its account receivable into cash. This ratio is an efficiency ratio or activity ratio that measures the efficiency of the collection department (Sharma and Mehra 2016). The receivable turnover ratio is calculated by dividing credit sales with the average account receivable. The formula for calculation is given below:
Receivable turnover ratio= Net credit Sales/ Average Accounts receivable
This ratio measures the efficiency of the collection department. Therefore higher the ratio more favorable it is because higher ratio represents that the company are collecting receivables more frequently. In the case of Pro Diver, the receivable turn over ratio is 20.93. This means that the Pro Diver Company has collected the accounts receivables more than 20 times in this financial year (Yu et al. 2014). Therefore, from the above analysis it can be concluded that the company in favorable position as the ratio is high.
Fixed Asset Turnover Ratio
The fixed assets turnover ratio calculates the efficiency with which the companies for producing revenue utilize the fixed assets. The investors and creditors for determining the operational efficiency of the company closely monitor the fixed asset turn over ratio. The fixed assets turnover ratio is calculated by dividing Net sales with net assets (Al Mamun 2013). The company calculates the net assets by subtracting accumulated depreciation from the total assets. The formula is given below:
Fixed Asset turnover ratio= Net Sales/ Net fixed assets
A higher ratio indicates that the companies are utilizing the assets effectively. On the other hand, a lower ratio indicates that the company is unable to utilize the assets at its full potential. Therefore, the companies with higher fixed asset turnover ratio are in conditions that are more favorable. In the given case of Pro Diver, the fixed asset turnover ratio is 0.40. this means only 40% of the assets are utilized in generating revenue. As the ratio is low, so the company is in unfavorable position.
Net Margin Ratio
This ratio represents the net profit earned by the company for per one-dollar sales. This is a profitability ratio and represents the profit generating capacity of the company. It is a key ratio and it is important for all the stakeholders of the company (Konchitchki and Patatoukas 2013). This is calculated by dividing Net profit by sales of the company. The formula is given below:
Net margin %= Net profit/ Net sales X100
This ratio is the measure of the company’s ability to generate higher revenue and reducing expenses and making higher profits. The company with the higher profits is in position that is more favorable. In this case, the company is earning profit of 30% that is reasonably higher therefore, it can be concluded that the company is favorable position.
Return on Equity
The return on equity measures the ability of the company to generate revenue from the shares fund. It is a profitability ratio and represents the profit that is earned by investing one dollar by its shareholders (Brown 2012). It is calculated by dividing net income by shareholders equity. The formula is given below:
Return on Equity= Net income / Share holders equity
This ratio indicates the effectiveness with which the company for generating income utilizes the funds of the shareholders. The higher the ratio the better it is for the company. In the case of Pro Diver the return on equity is 30%. As the company has high return on equity so the company is in better position.
Return on Assets
This ratio represents the net income that is produced by the utilizing the assets of the company (Goldmann 2016). This is calculated by dividing net income with the total assets. The formula is given below:
Return on Assets= Net Income/ total Assets
This represents the efficiency with which the company for generating profits utilizes the assets. The higher the ratio the better it is for the company. In the case of Pro Diver, the ratio is 12% that is low compared to ROE. The company is not in favorable position as far as ROA.
The analysis of the key financial ratio shows that the collection department of the company is operating effectively. The analysis also shows that overall liquidity position of the company is not favorable and the company is not effectively utilizing the fixed assets to generate sales. The company has high profitability as reflected by the key ratios but the company is unable to generate enough revenue from utilizing the assets. Based on overall analysis it can be concluded that the company Pro Diver is in favorable position but it needs to increase its efficiency in certain departments.
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