Financial statement analysis
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Financial statements analysis is the process of identifying the strengths, weaknesses, opportunities, and threats of a business entity. The relationship between the various items in the financial statements is established through ratio analysis (Chew and Parkinson 2013). Ratios are into valuation ratios, liquidity ratios, gearing ratios, profitability ratios, and efficiency ratios.
The following financial ratios were derived from Dynasty Ltd to help come up with a decision on whether to invest in the company or not.
2014 2015
- Current ratio = current assets/current liabilities = 4618/1974 2911/2076
=2.33 =1.4
- Debt-equity ratio = long term debt/equity * 100 = 11000/14344 4000/ 13035
=76% =30%
- Net profit margin = net profit/sales * 100 = 1309/24600 1963/19800
=5% 9%
- Return on assets = net profit/total assets * 100 = 1309/27318 1963/19111
5% 10%
- Return on equity = net profit/equity * 100 = 1309/14344 1963/13035
9% 15%
- Quick ratio = current asset – stock/current liabilities = 4618-2059/1974 2911-1525/2076
=0.12 0.66
- Total asset turnover = sales / total assets = 24600/27318 19800/19111
=0.9 1.03
- Debt ratio = total liabilities/total asset *100 12974/27318 6076/19111
=47% 31%
Before investing in a company, an investor’s main interest is whether the investment will give good returns. The ratios can help identify if a decision to invest is wise (O’bryan 2010). A risky investment is volatile and has no guarantee of profits. An investment worth of investing has good returns and is consistent in profit making over the years. Looking at the 2014-2015 ratios for the company, the net profit margin, return on assets and return on equity have improved. These ratios are profitability ratios that indicate the ability of a company to make profits. The current ratio has declined while quick test ratio has improved. Capital structure ratios; debt ratio and debt to equity ratios have improved regarding fewer liabilities compared to assets.
The improvement in the liquidity ratios shows that the company is making improvements profit-wise, and it is not risky to invest in its stock. The gearing ratios have improved since total debt has reduced in the one year period hence it is wise to invest in the company.
Other than the ratios, the level of involvement of shareholders by the company in making decisions should also be considered. Shareholders to be represented on the company board of directors. The period of payment and how dividends are paid out is crucial in making the decision on whether to invest or not. The company that is worth investing in should value its shareholders and promptly pay out dividends as and when they fall due.
Alexis should invest in the company because profit has increased over the one year period. Long-term debt structure has reduced meaning that the company can finance its operations from the available assets and has improved in the management of the accounts (Ray, 2012). Although the current ratio has reduced, most of the financial ratios have improved which is good sign that investing in the company is not risky since the possibility of high returns is high.
Financial ratios are a representation of a company’s financial strength. The ratios can be benchmarked against the industrial averages and the historical ratios. If the ratios are improving over the years, then the decision to invest is advisable. If the ratios show a decline, an investor should not invest in the firm as the stock is risky. A company’s ratios should be at par with the industrial averages or above the industrial average.
References
Chew Lynsie, Parkinson Alan, 2013. Making Sense of Accounting for Business. Published by Harlow: Pearson.
Ray Proctor, 2012, Managerial Accounting: Decision making and performance improvement
David W, O’bryan, 2010, Financial Accounting: A course for all majors.
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