UNIVERSITY OF BOLTON School of Business and Creative Technologies

Name: Phung Quoc Hieu

Student ID: 1012421

Intake Number: 5

Module: Financial Control in Management Control SystemsBST3004 (HE6)

Tutor: W O Burke

Assignment Number: One (Semester 2- 2010/11)

Assignment Title/Theme: Ratio Analysis Submission Deadline: 22nd April 2011

Abstract

Nowadays, in anywhere or anytime, the word “globalization” is told a lot. It happens not only in business but also in other industries. In business, when talking about globalization, there is a problem that the managers have to face with is “cross-cultural communication” like the different languages. And the solution for them is financial statement. Even it is a language of business, but in order to understand it and apply it in specific cases that is required the tools, knowledge or experiences. So a tool is used widely by most of international investors or consultants is “ratio analysis “. Ratio analysis is the calculation the numbers from financial statement and the comparison those ratios with other firms or industry ratio. This assignment is divided into two parts. First part is about the calculation ratios and critically evaluates the performance of Grand Hotel. The second is the critically review limitations associated with ratio analysis.

Part one

  Ratio Working 2009 Working 2010

Return on Equity(ROE)

PBIT x100 $398,000 x100

97.07%

$292,000 x100 61.02%Average Owners Equity $410,000 $478,500

Return on Assets(ROA)

PBIT x100 $398,000 x100 46.88% $292,000 x100 32.18%

Average Total Assets -CL $1007500 - $158600

$1070650 - $163100

Net Profit Margin(NP%)

PBIT x100 $398,000 x100 18.26% $292,000 x100 13.08% Sales $2,180,000 $2,232,000

Gross Profit Margin(GP%)

Gross Profit x100 $1,350,000 x100 61.93% $1,282,000 x100 57.44%

Sales $2,180,000 $2,232,000

Asset Turnover

Sales   $2,180,000   $2.57 $2,232,000   $2.46Average Total Assets - CL   $8,489,000   $907,550  

Fixed assets Turnover

Sales   $2,180,000   $2.74 $2,232,000   $2.81

Average Fixed assets   $794,500   $793,650  

Working Capital Turnover

Sales   $2,180,000   $85.83 $2,232,000   $25.83Average Working Capital   $25,400   $86,400  

Current ratio

Current Assets   $191,000   1.26 $308,000   1.77Current Liabilities   $152,200   $174,000  

Acid test ratio

CA – (Inventory + Prepayments)

  $191000 - ($27000+$2000)

  1.06 $308000 - ($25000+$4000)

  1.6

Current Liabilities   $152,200   $174,000  

Inventory Turnover

Average Inventory x 365 x365 $25,500 x365 11.2 days

$26,000 x365 9.98 days

Cost of sales $830,000 $950,000

Average Average Accts. Receivable x365 $85,000 x365 23.7 $105,000 x365 28.62

Collection Period

days days Credit sales $130,800 $1,339,200

Average PaybackPeriod

Average Accts. Payable x365 $46,750 x365 20.48 days

$52,250 x365 20.12 days Purchases $833,000 $948,000

EPS Profit after tax   $228,000   $1.26 $147,000   $0.82

No of Ordinary shares $180,000 $180,000

P/E Share price   $11.43   9.07 7.35   8.96

EPS   $1.26   0.82  

Dividend Cover

Profit after tax   $228,000   1.21 times

$147,000   2.96 timesOrdinary Dividend   $188,000   $49,700  

Dividend per share

Dividend   $188,000   $1.04 $49,700   $0.28Number of shares   $180,000   $180,000  

Dividend Yield

Dividend per share x100 $1.04 x100 9.10% 0.28 x100 4%

Share price $11.43 7.35

Gearing ratio

Prior charge capital x100 $400,000 x100 93.02% $390,000 x100 73.96%

Total Owners Equity $430,000 $527,300

Debt ratio Total Liabilities x100 $585,000 x100 57.64% $599,000 x100 53.18%

Total Assets $1,015,000 $1,126,300

Interest cover

PBIT   $398,000   6.6 times

$292,000   4.86 times Interest   $60,000   $60,000  

When evaluating the performance of a firm, the most of the tools is used is Ratio analysis. However, this essay is focused on evaluate the profitability and liquidity ratios of Grand Hotel based on ideal ratios. In financial ratios have some key sectors which are suitable for each purpose.

In the first place, liquidity ratios included: current ratio, quick ratio, inventory turnover, average collection period. Current ratio is the first key ratio is paid attention. It tests how the hotel can manage the current assets to pay-off the current liabilities. A current ratio is regarded 2:1 (Weetman, 2006, p. 341). The current ratio of Grand Hotel increases by 0.51 from 1.26 in 2009 to 1.77 in 2010 and it is larger than 1. It might be a good position because the hotel has more cash from customers’ booking room. However, the increasing in the number of empty rooms can also affect the increasing of current ratio. In such cases, the current ratio can not reflect the real story in the behind. So the better way is considering other ratio before getting any conclusions. Another useful liquidity ratio is quick ratio or acid test ratio. This ratio is used to indicate the firm’s ability to meet its current liabilities without inventories and prepaid expenses. If paying debt with only inventories such as foods, wines... it takes a lot of time to convert them into cash. Or with prepaid expenses such as employees insurance cannot be converted back into cash. The quick ratio in 2009 is 1.06 and increases to 1.6 in 2010. It might be a good sign for the hotel because without inventories and prepaid expenses, they can pay for current liabilities. But from the point of view of an investor, they expect this

ratio is lower than 1, they do not want their money is “free” and it seems the hotel has too much cash in hand.There seems to be a problem because the ideal ratio for hotel industry is 0.50 for current ratio and quick ratio is 0.39 (Reuters, 2011). This hotel not only has high value number in those ratios but also they have problem with collecting money from account receivable. It increases 5days while the average payback period is nearly constant is 20 days.However, Grand Hotel can manage their liquidity. They use cash to invest on some short-term investments. It ensures that they have enough money in case they have to pay debt on the due date while the collecting from debtors has problems. The CEO could make there might be no problem with liquidity and could make the investors happy with that. But it is just for the short term, they invest money into the hotel, expect the business can be expanded and get the return from that successful business not from other investment sources.

In second place, profitability ratios focus on return on equity (ROE), return on assets (ROA) and net profit margin. They show how well the management use the investment on asset to create sales and control costs to maximize the profit. (Weetman, 2006, p. 339)By examining the ratios, Grand Hotel is less profitable in 2010 than it was in 2009. Net profit margin downs from 18.26% to 13.08%. Besides that, the ROE ratio which is used to determine how much the investor can get back from their capital investment (Bragg, 2002, p. 126). But after 2009, the ROE decreased from 97.07% to 61.02%. It might make the investors confuse. In addition to that problems, this hotel use the assets to generate the profit ineffectively because the ROA ratio also decreases by 14.7%. With those ratios, this hotel has the difficulties in using financial resources to maximize the profit. The reason might be the increasing of the inflation or interest which might leads to the increasing in the costs and makes the profit decreases.The ratios are decrease in 2010 but it might be understood by the reasons of global crisis. The return on investment could be lower than previous year but the hotel has the ability to pay off the debt by the assets, especially current assets. The hotel has longer days in collecting debtors might be the debtors also have problems from financial crisis. But the investors might be satisfied because the dividend cover is still high 2.96 in 2010, interest cover is 4.86.There is no conclusion about Grand Hotel‘s performance is good or bad. This essay is as the suggestion about how this hotel manages their business.

Part two

Even ratio analysis is a concept that is used widely, but it has some limitations which have to be considered before making any conclusion.

The first limitation of ratios is the accounting information. Each firm chooses the accounting method to prepare the report. Such as straight-line or decreasing balance method which is used for depreciation assets. Depreciation is non-cash account but it affects the result of income statement. So it affects the ratios such as net profit margin. Besides that, for inventory, one firm can use LIFO method while another uses FIFO method. That makes the financial statement is different and leads to different ratios.

The second is the financial statement. It could come from the accounting concept. The numbers are recorded should be historical data. However, the market price changes, affect the value of assets. And the ratios are also affected such as the ROA. Besides that, Stephen A. Ross et al (2010) mentions that “the different firms end their fiscal years at different times”. For the firms depend on the season like hotel, there are the fluctuations in accounts and that leads to the difficulties in comparing the balance sheet.

Another limitation is some ratios have positive effect but some are not. The difference in value of numbers makes the situation is so complicated. It might be because there does not have any standard or formulate calculating system for the ratios analysis. So different investors or in different countries, they have their own way in calculating the ratios. And it makes the decisions are made difficultly.

The last limitation in this essay is the ratios are suitable for each industry or the size of the firms. For example, according Reuters, UK (2011) the P/E ratio in hotel industry is 31.08, but in beverages industry is 36.65 or 14.68 in personal services industry. Besides that, for huge firms in different industry, the mistake of the ratios or comparison is more complicated. It could be mistake in consolidation or different industries. So the ratios analysis could be a useful method when applying in small or medium size firms.The ratio analysis is not the final decision; it is just the tool which supports for decision making or recommendations. Certainly, it can be changed by times or the skill of an analyst. So besides the ratio analysis, the investigation for more information is necessary.

Ratio analysis is still the useful method for the investors in decision making process. It can show what happens with the inventory, sales, cash or how well a firm satisfies their shareholders. The more ratios are linked, the clearer whole finance picture of a firm is. Once again, this method has to be combined with other information to get the final conclusion about the good or bad of a firm’s performance.

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