Industry Average Of 3 9 Times example essay topic

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 the year before compared to industry averages which remained the same. For the following year, pricing practices, selling techniques and expense control will have to be monitored closely. Other ways to improve this ratio is to increase revenue through prices or advertising, or decrease costs in any way possible, perhaps even to the extent of reducing staff. The rate of return on Owner's Equity for Robert Lee Enterprises was well above the industry averages for both 2003 and 2004.

The rate of return on owner's equity measures the return on investment provided by the owners. In 2003, the rate of return on owner's equity was 17.69%, with an increase of 2.16% to 19.85% for the year 2004. This is an exceptional figure considering it is over 4% above the industry average and improved by 2% for the following year, whilst industry averages dropped by 1% to 12% for the year 2004. As a result, this is proving to be a very good investment for the owner with return higher than bank interest rates and the share market. MANAGEMENT EFFECTIVENESS The turnover of accounts receivable ratio indicates how quickly customers are paying the business. The greater the number of times the accounts receivable turn over throughout the year, the shorter the time between sales and cash collection.

For 2003, the inventory turned over 4.52 times, compared with the industry average of 6 times, 1.42 times below. For 2004 however, the turnover increased to 6.1 times, 0.2 above the industry average of 5.9 times. The business's turnover of accounts receivable therefore resulted in an increase of 1.48% compared with a drop of 0.1% times in the industry. There has been an improvement from 4.3 to 5.8 times per year, i.e. an improvement from 84 days to 62 days turnover. As this is still slightly over a normal 60-day credit period, it is obvious that the implementation of credit or collection policies is not quite efficient enough and needs further action. Management has done well to reduce the turnover of Accounts Receivable, but must still monitor and continue to improve this area.

The turnover of inventories ratio indicates how often a business' inventory turns over during the course of the year. In 2003, the turnover of inventories was 2.07 times, below the industry average of 3.5 times. In 2004, this figure increased to 3.5 times, although still below the industry average of 3.9 times. Between 2003 and 2004 there was a slight increase of 0.32, however compared to the industries average increased of 0.40 times, this is not significant enough. The change in ratio shows an improvement from 2.07 to 3.5 times per year, i.e. an improvement from 176 days to 104 days.

This indicates that the overall level of the business activity has improved. Inventory is being used or sold more efficiently. A slow rate of turnover can lead to losses due to deterioration of inventory or the need to sell at a lower margin in order to move inventory. RECOMMENDATIONS After analysing the 2003 and 2004 Profit and Loss Statements and Balance Sheets for the two-year period, it appears that the business is moving in the right direction, but not without problems and dangers. Attention must be given to halting the trend in the indicators of the businesses short-term financial stability. Further increase in sales activity is necessary, in particular cash sales so that the business is able to generate better cash flow and turnover of inventories.

The most important aspect that Mr Lee should investigate is increasing the current ratio, otherwise the business will have to obtain finance from outside sources or liquidate some non-current assets. The credit policy of Robert Lee Enterprises should also be investigated in order to strengthen the procedures currently in place. The turnover of accounts receivable and cash flow and to minimise bad debts should also be a priority. To enhance future performance, Robert Lee Enterprises should consider expanding their distributive area, either expanding to cover a larger area in Queensland or look at inter-state selling. The sales team should consider a mail-out of the brochures to cover more area in a smaller amount of time. This would reduce the deterioration on the vehicles and allow more time to be spent on taking orders.

Follow-up calls and weekly / fortnightly mail outs would have to make, but this will save time that would otherwise be spent on travelling, depreciation on vehicles and general expenses such as fuel. A web-site may be another way of reaching a larger market. It is evident that Mr Lee is a very intelligent businessman. The sales figure for 2003 was $52000, and this increased in 1-year to $720000. This $200,000 increase however, was not followed through to the net profit. Mr Lee has purchased motor vehicles (the account increased by $20000), as well as Buildings and Land (totalling $210,000).

In the beginning of 2004, there was an extraordinary expense, fire damage, but this $18000 can be expected to appear the following year, as an insurance claim should have been claimed, and the insurance company should cover the fire damage. The management of Robert Lee Enterprises has done well with improvements in most areas although it still has some challenging tasks ahead of it.