Gross Profit Ratio
Operating Profit Ratio
Net Asset Turnover
1.5 : 1
1.7 : 1
0.6 : 1
1.0 : 1
Sample Plc’s Gross Profit Ratio has reduced to 40% in 2012 (down by 13%). The possible reasons can be increased production costs that can be because of improved quality, or lowered selling prices that could have been used to generate higher sales level in 2012 as evidenced by the much improved net asset turnover ratio.
However, the operating profit did not reduce in line with the reduced gross profit as it was 19% in 2012 (only reduced by 10%). This shows that Sample Plc did control its administration and distribution costs very well despite the increase in sales.
ROCE increased by 3% in 2012 which shows that the company’s decision to increase sales by reducing margins or increasing product quality proved to be a good one as the overall effect was positive. However, the ROE reduced by 2% in 2012. This shows that we are paying a lot more interest & taxes in 2012. I presume that taxes are charged at standard rates so it must be the interest element that was substantially higher in 2012. Looking at the increased gearing, we know that extra fundings were raised through loans. We need to check whether we are paying an interest rate too high which is causing the profit after tax figure to be lower because of the increased interest payments.
As we partially discussed before, the net asset turnover ratio has also improved substantially which means that we are now generating higher sales than last 2011. This is a positive sign especially given the fact that administration and distribution costs did not increase and were instead saved in 2012. It is reasonable to assume that the increase in sales was achieved through either price promotions or improved quality as the gross profit has reduced in 2012.
It is considered ideal for companies to maintain a current ratio of 2:1 and quick ratio of 1:1. However, Sample Plc’s current ratio in 2011 was 1.7:1 which went further down to 1.5:1. In the absence of industry averages, it is hard to comment whether this is an acceptable level. However, we can notice for sure that the current ratio has reduced in 2012 and this should be investigated. We do not want a situation whereby we are unable to pay our expenses and short term debts because of lack of funds. Same is the case with the quick ratio which reduced by 40% in 2012 to 0.6:1. This shows increased investment in stock which could be a sign of overtrading but we need to assess other factors as well before tagging the situation as that of overtrading.
Our credit customers were granted an extra 5 days in 2012 to pay back the debt. I think it is very reasonable to grant this much extension if you wish the substantially increase your sales, so I will not call it a worrying point. Stock took 71 days in 2012 to be converted into sales (28 days more as compared to 2011). This also caused the current & quick ratios to decline as discussed above meaning that our liquidity position has been affected by this decision. Was it really necessary to pile up this much stock and block our investment in stock to increase sales? It would have made a little bit of sense to pile up stock if we were getting substantial discounts to buy bulk quantities or if we were getting substantially higher credit period from the suppliers. As it appears in this case, we did not save on production costs and we got less credit…