Financial Analysis

An in-depth look at the financial structure of most of the businesses is very essential to underpin the credit portfolio of the business.

Balance sheet provides a view of the health and stability of the business. It lay down an image of what the business owns (its assets) and what it owes (its liabilities). For lending loan to businesses, it is very important to make financial ratios as a part of loan agreement. It is required to keep certain percentage of equity above the debt of the business or current assets should be above a particular percentage of the current liabilities of the business (Casu et al., 2005).

The given balance sheet of the business lay down that the current asset of the business is 1598 (in thousands) in FY 2015 which is more than the current liabilities which is 1547 (in thousands). The net worth of the business is calculated by subtracting total liabilities from total assets which is 509 (in thousands). This is a fundamental metric to gauge the financial health of a business.

The given income statement of the business shows that the net profit after tax is equivalent to 105 (in thousands). This shows that the business performed well through its core operations. This is a measure to portray the operating efficiency of a company.

One of the fundamental ways to identify the financial health or credit worthiness of the firm is to look closely at the financial ratios of the firm. These financial ratios provide basic information about the amount of debt, quantity of inventory, or the duration of collecting receivables. With the help of financial ratios it is easy to compare between different aspects of the performance of a business (Chen, 1981).

There are different ratios and all of them fall under four basic categories:

Liquidity Ratios: These provide an overview of the financial health of a business. This measure the liquidity of a company, that is, whether the company have enough liquid assets (easily converted to cash) to cover its debts. Current ratio measures the liquidity of a firm. It tells the capability of a firm to generate cash to meet its short term financial needs. It is also known as working capital ratio. It is calculated by dividing current assets by current liabilities (Barnes, 1987).

In the balance sheet, the current assets of FY 2015 is equivalent to 1598 (in thousands), and the current liabilities is equal to 1547 (in thousands). Thus, the current ratio would be 1.033. The current ratio is close to 1, which means the company could easily function. However, the business deals with heavy assets and work in progress inventory, therefore, a higher current ratio is preferred to cover the short term liabilities.

Efficiency Ratios: These ratios measure the efficiency of the business like cash flows and operational results. Inventory turnover ratio tells us the time taken to sell inventory and replace it during the year. It is said that it is costly if the inventory sits for long in the business. In the given case, 60 days is the time duration it takes to sell the inventory.

Profitability Ratios: These ratios also help to evaluate the financial viability of the company. The net profit margin is equivalent to 2.58. This indicates the earning of the business relative to its sales. A higher ratio indicates that the business is efficient and is able to expand. Return on tangible assets is equivalent to 7.94. This tells how well the company is using its assets.

Leverage Ratios: These ratios measure the solvency of a business. It shows the extent to which the business is using its long term debt to keep up its business. This is a very important measure to look after before lending money to the business. The debt to equity ratio of the business is equivalent to 105.70 per cent which is high. The debt to total assets ratio is equivalent to 24.26 per cent. These two ratios help to analyse whether the assets are financed by company’s own investment or its creditors. It is preferred that loans should be given to the firms with lower leverage ratios (Beaver, 1966).

References for Empirical Analysis of Useful Financial Ratios

Barnes, P. (1987). The analysis and use of financial ratios: A review article. Journal of Business Finance & Accounting, 14(4), 449-461.

Beaver, W. H. (1966). Financial ratios as predictors of failure. Journal of accounting research, 71-111.

Chen, K. H., & Shimerda, T. A. (1981). An empirical analysis of useful financial ratios. Financial management, 51-60.

Casu, B., & Girardone, C. (2005). An analysis of the relevance of off-balance sheet items in explaining productivity change in European banking. Applied Financial Economics, 15(15), 1053-1061.

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