Subject: Interpret financial statements
From carrying out a detailed analyse of the financial statements and ratios of Mr Purdy, a report has been prepared to discuss the profitability, liquidity, and working capital management.
Profitability is a type of measurement that helps to determine the ability of a company to generate earnings in comparison to its costs and expenses over a certain time period. The company with a higher profitability ratio than their competitors is considered to be doing well.
Gross Profit Percentage
Gross profit percentage is a key measurement that a company would use when it is evaluating its financial performance. Gross profit is the difference between sales and cost of sales. On the attached sheets you are able to see that in 2011, Mr Purdy’s business had a gross profit percentage of 30.3%. This means that Mr Purdy’s business received £30.30 for every £100 that was made in the sales within the business. Although when you look at the percentage in 2012 it had fallen to 17.2%.
This is the percentage of net income to revenues. The revenue expenditure is anything that relates to the day to day running of a business, such as, wages, salaries, heating and electricity. By looking at Mr Purdy’s ratios you can see that the net profit figures have decreased quite a lot over the past year. To help this figure Mr Purdy would need to lower his expenses within the business. If you took a look at your employee profile you could consider some redundancies for some of your higher rate staff and take in part time staff. By advertising part-time jobs, they are usually given to students as they are paid at a lower rate.
Return on Capital Employed
Return on capital employed is a ratio that indicates the efficiency and profitability of a company's capital investments. ROCE should always be higher than the rate at which the company borrows; otherwise any increase in borrowing will reduce shareholders' earnings. A variation of this ratio is return on average capital employed, which takes the average of opening and closing capital employed for the time period. As you can see from the attached sheets, in 2011 Mr Purdy had a 17.5% on return on capital employed and in 2012 they had 4.99% on return on capital employed.
Efficiency is the measurement of how well a company can manage income and expenses. The accounts monitored are accounts receivable and payable.
Debtor Collection Period
By looking at Mr Purdy’s ratios you can see that over the past year the credit period for the customers is too long. To find a solution for this problem, Mr Purdy needs to find ways for reducing these credit terms, such as chasing slow payers. If you chase them enough then they will pay quicker.
Creditor Payment Period
By looking at the creditor payment period for Mr Purdy’s business you can see that it is not so good although it has been increasing over the past year. In 2011 it was 79 days and in 2012 it was 140 days. Mr Purdy needs to be careful that he does not let this trend continue as it could affect the business in a negative way such as losing suppliers.
In 2011 you can see that it took 132 days for Mr Purdy to sell his stock, although in 2012 it took Mr Purdy 123 days to sell his stock. As you are able to tell from the ratios it is taking Mr Purdy not as long to sell stock in 2012 as it was for him in 2011.
Liquidity is the availability of liquid assets to a market or company. Most people would say the term that liquidity is the life blood of a business. Mr Purdy needs to have a good cash flow within his business or else it would not be able to survive to stay open. Although you may be generating good profits you must be able to manage your cash flows to avoid the risk of going out of business.