ANALYSIS AND INTERPRETATION OF FINANCIAL REPORTS
I have examined the Profit and Loss Statements and Balance Sheets for the two-year period of 2003 to 2004. The following report will evaluate the firm’s profitability, financial stability and aspects of management efficiency as measured by various financial ratios. Comparisons will be made where possible, both within the organisation and with the current industry averages. Recommendations will also be suggested for the areas in need of concern.
FINANCIAL STABILITY
The current ratio measures the business’s financial health, indicating if the business would be able to meet its current obligations by measuring if there are enough assets to cover the liabilities. For 2003 and 2004, the business’s current ratio was 1.21:1, 0.99:1 respectively, both times above the industry average. However, although the current ratios for the two years were above the industry average, the common rule of thumb is 2:1. For 2004, the ratio was below 1:1, and can therefore the current assets of the business would not be sufficient enough to pay current liabilities. This situation seems to have been brought about by the use of short-term funds to purchase a long-term asset – the land and buildings. Such a practise is not desirable and could result in long-term problems for Mr Lee.
The equity ratio measures the percentage of funds provided by owner. For 2003, the funds provided from internal sources (the owner, i.e., Mr Robert Lee) were 43.44%. This figure indicates that Mr Lee was 4.62% above the industry average. The other funds must be debt funds that come from outside sources (liabilities). During 2004, the equity ratio dropped to 40%, 1% below the industry average. It is a good time to borrow due to low interest rates and tax-deductible interest.
EARNING CAPACITY
The gross profit ratio measures the profit per dollar of sales. In the year 2003, Robert Lee Enterprises produced 40.38% cents in every dollar of sales as gross profit. During the year 2004, this figure dropped by .10% to 40.28% although the industry average dropped by 2%. Mr Lee will have to ensure that this figure does not decline in the following year, as this will signify a loss and will not even produce a return for the owner. This figure can be increased by improved sales and reducing the cost of goods sold.
If the gross profit ratio continues to decline over a considerable period, Mr Lee should be highly concerned. To ensure that this is not the case, a price increase should be considered, or an advertising campaign to increase the sales.
The net profit ratio measures the net profit per dollar of sales. For the year 2003, the net profit was 8.85%, which was below the industry average of 9% by 0.15%. For the year 2004, the net profit was 10.83%, 1.83% above the industry average for that year. It was also an increase of 1.98% on [next page]