Example of a Financial Ratio Analysis for a Trading Company

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Trading Company AFS

FINANCIAL ANALYSIS OF THE TRADING COMPANY (PTY) LTD
Holistic over view of operating performance
(Using a traffic light system to quickly highlight performance) 1. RONA - Return on Net Operating Assets 2010 18.4% 2009 21.2%

Net Operating profit (Income Statement) Net Operating Assets (Balance Sheet)

135 735

84 396

Note: Net Operating Assets - take total net Assets, and add back cash, overdraft balances, tax and dividends. These are financing factors, and are not part of operations' responsibility 1 a. Profitability Net Operating profit (Income Statement) Sales 9.0% 135 1500 7.0% 84 1200

1 b. Asset efficiency (sweat) Sales Net operating Assets

2.04 1500 735

3.03 1200 396

Conclusion: Management has delivered a weaker RONA over the past year, despite improved profitability from operations. the marginal drop in RONA is a result of the following factors: While profitability has improved, Asset sweat has declined significantly ( by 32%), and has more than off-set the good work in managing top - line improvement. Further analysis now needs to be done, with an eye on those indicators which are driven by the use of assets

Now dive deeper into the company's performance, keeping the big picture in mind. This allows you to focus on items that drive the above three ratios 2010 2. Profitability Trading Margin (Gross Profit) 2 a. Gross Margin Net Operating profit (Income Statement) Sales 28.5% 427 1500 25.0% 300 1200 2009

2.b Net income after tax (NIAT) NIAT Sales

2.5% 38 1500

3.0% 36 1200

2 c. Return on Owners Equity NIAT Owners Equity

11.2% 38 340

11.3% 36 320

Conclusion: Management has improved the trading margin of the company, either by improving price, and or improving the direct input costs, such as transport costs of the delivery fleet - this could be via improved usage of the assets, better configuration of the vehicle fleet and better routing of deliveries However, the NIAT figure has declined - so between margin and after tax income, inefficiencies have crept in , and negated the good work done by sales and distribution departments ROE reflects this, as there has been no growth in the return on investment to Shareholders - we need to understand why - remember the low / declining Asset Sweat in RONA, so we already have an idea - lets check this out now.

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Trading Company AFS

2010 3. Operational Efficiency 3 a. Inventory Turnover / turn Sales Inventory 5.1 1500 295

2009

10.0 1200 120

3 b. Receivables Collection (days) Accounts Receivables (Sales + VAT) divided by 365 days

80 375 4.68

53 200 3.75

3 c. Fixed Asset Turnover / usage Sales Fixed Assets

9.7 1500 155

10.3 1200 116

Conclusions: Operational efficiency has deteriorated over the prior year - significantly! Inventory turnover has declined by 50% - a huge decline - what has happened: obsolete stock building up? Unaccounted for write offs for dead stock? purchasing department buying too much product, despite increased sales? product mix changed and procurement not advised? Receivables is a disaster - in both years! Normal terms in SA is 30 days. The current year has seen credit management deteriorate significantly - the longer or older the debt owing to the company, the greater the likelihood of bad debt write offs Are there large amounts of disputed invoices - credit notes outstanding - this will effect profitability If so, has the company really done so well on its profit generation as indicated? Fixed asset usage, despite increased turnover (proceeds), has declined by 6% - are the years asset purchased justified? Is there idle plant - can we improve the usage by increasing the number of shifts. Too many delivery vehicles - check optimisation of fleet.

2010 4. Liquidity 4 a. Current ratio Current Assets Current liabilities 6.7 700 105

2009

5.7 344 60

4b. Quick ratio current assets - inventory current liabilities

3.9 405 105...
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