Computation of Ratios

The objective of this report is to assess the financial performance of Smart Computers. The report would take into the account the profitability, financial stability and asset utilization ratio in order to suggest the business for further scope of improvement (Warren & Jones, 2018). The ratio reflects how well the company is making use of its funds to use its equity investment.

The main purpose of financial analysis is to examine the previous performance of the company and present financial statements. The objective of financial performance is to discover the probable areas of weakness and areas of problems that may be discussed with the company owner (Macve, 2015). The main purpose of financial analysis is to examine the unusual movement in the items for each year and for the patters of revenue and profits.

The structure of this report would include the computation of ratios and a comparative ratio analysis will be performed for the business profitability, financial stability and asset utilization against the industry standards. A conclusive summary will be provided covering the vital points of the ratio analysis with limitations associated to financial analysis.

Financial analysis can be defined as the procedure for assessing the business, projects, budgets and financial related entities in order to ascertain their performance and suitability (Kimmel et al., 2016). In other words, financial analysis is useful in analysing whether the entity is stable, solvent liquid or profitable enough to permit the financial investment.

Computation of Ratios:

Particulars	2017	2018	2019
Gross Profit	600250	926000	1626000
Sales	1000000	1500000	2400000
Gross Profit Ratio	60%	62%	68%
Particulars	2017	2018	2019
Net Profit	-30000	160000	613000
Sales	1000000	1500000	2400000
Net Profit Ratio	-3%	11%	26%
Particulars	2017	2018	2019
Net Income	-30000	160000	613000
Shareholder’s Equity	1560000	1404000	1252000
Return on Equity	-2%	11%	49%

Particulars	2017	2018	2019
Current Assets	225000	351000	738000
Current Liabilities	80000	232000	591000
Current Ratio	2.81	1.51	1.25
Particulars	2017	2018	2019
Current Assets	225000	351000	738000
Less: Inventory	60000	101000	188000
Liquid Assets	165000	250000	550000
Current Liabilities	80000	232000	591000
Quick Ratio	2.06	1.08	0.93
Particulars	2017	2018	2019
Total Equity	1560000	1404000	1252000
Total Assets	1965000	2061000	2418000
Equity Ratio	79%	68%	52%

Particulars	2017	2018	2019
Cost of Goods Sold	399750	574000	774000
Average Inventory	47500	80500	144500
Inventory Turnover Ratio	8.42	7.13	5.36
Particulars	2017	2018	2019
Ending Inventory	60000	101000	188000
Cost of Goods Sold	399750	574000	774000
Inventory Turnover in Days	54.78	64.22	88.66
Particulars	2017	2018	2019
Net Credit Sales	1000000	1500000	2400000
Average Accounts Receivables	175000	195000	400000
Accounts Receivables Turnover	5.71	7.69	6.00
Accounts Receivables	140000	250000	550000
Total Credit Sales	1000000	1500000	2400000
Accounts Receivables Turnover  (Days)	51.1	60.83	83.65

The profitability ratio analysis can be defined as the way of assessing the performance of the company (Maynard, 2017). 

Gross profit ratio is defined as the ratio which computes the total percentage of sales which exceeds the total cost of goods sold (Barth, 2015). As evident from the above stated table Smart Computers reported a steadily rising gross profit over the three-year span. During 2019 the gross profit ratio for the company stood 68% while the industry standard is 64.00%. This implies that the company has reported an improved performance from the present industry standard. The ratio evidently shows that the Smart Computers has been successfully managing its inventory by using its labour force and materials to manufacture and sell products at profit.

On the other hand, Net profit ratio is the profitability metric which measures the percentage of every dollar derived by the business is treated as profit at the end of the year (Hoyle et al., 2015). The net profit margin for the company over the last three years constitute a steady rise following a negative decline in 2017. The net profit for 2019 stood 26% while the industry standard stood 21.68%. Smart Computers has produced a higher margin and has been successful in translating more amount of sales into profits. The investors and analyst can typically use the industry standard to compare the company’s performance in order to understand how efficiently Smart Computers is managed and can also forecast the future profitability depending upon the management’s sales projections. 

Gross Profit Ratio

The stability is regarded as the long term counterpart of the liquidity. The financial stability assesses the amount of debt that can be supported by the company and whether the debt and equity is balanced (Williams & Dobelman, 2017). 

To determine the liquidity of the Smart Computers liquidity ratio has been assessed. The current ratio is regarded as the liquid ratio that evaluates the ability of the organization in paying their short term liabilities with the help of its current assets. The current ratio of Smart Computer over the three-year trend has reported a declining trend as the ratio in 2017 stood 2.81 while in 2019 the ratio has declined to 1.25. The industry standard for current ratio is 1.90 and the ratio posted by Smart Computer is lower than the industry standard. This is primary due to the rising current liabilities. This implies that the company has limited amount of time in raising funds to pay their short term liabilities. The ratio sheds light on the overall burden of debt for Smart Computers and may face problems in paying off its short term creditors. 

The equity ratio is regarded as the investment ratio which determines the sum of assets which is financed by the owner’s investment by comparing the company’s total asset with the total equity. To measure the financial stability of Smart Computers the equity ratio has been computed to determine the equity and debt burden. In the last three years the equity ratio for the company has stood high. The equity ratio for the year 2019 stood 52% while the industry standard for this ratio is 56.3%. Despite the equity ratio of Smart Computer is lower than the industry standard but it can be interpreted that the higher equity represents higher amount of debt financing. The higher equity ratio however for Smart Computers can be termed favourable because this shows the potential for the shareholders that the company is worth making investment.

The asset utilization ratios are considered as very helpful for assessing how well the company is performing in comparison to its peers. 

The inventory turnover ratio refers the efficiency ratio which represents how well the company is managing its inventory in comparison to the cost of goods sold with the average period of inventory (Robinson et al., 2015). The inventory turnover ratio for Smart Computer has represented an improvement in the last three years as the ratio has improved to 5.36 times in 2019 whereas the industry standard for the same ratio stood 8 times. The improving ratio is evidence that Smart Computer is not overspending in its inventory and has been successful in its waste resource by reducing its storage of non-saleable inventory. The company is using its asset effectively to turn its inventory in cash.

Net Profit Ratio

The accounts receivable turnover ratio is referred as the activity ratio which assesses the number of times a business is successful in turning its accounts receivable in cash during the period (Maynard, 2017). The accounts receivable turnover ratio for Smart Computer has stood relatively lower in the last three financial years. The ratio during 2019 stood 6.00 whereas the industry standard for the same period was 9 times. This signifies that the company has managed to collect revenue from its credit sales only 6 times in an accounting year which reflects a moderately average quality of credit collection period.

Conclusion: 

To summarize the key points obtained the company is highly profitable because the gross profit and net profit of the company has been high. The company has efficiently used its resources to produce profits. The investors can gain confidence from its profitability to gauge into the quality of performance for the company. Another vital point from the analysis is that the company has reported higher amount of liabilities. The burden of debt has been rising and this may impact the liquidity position as it may face difficulty in meeting its short term debt obligation.

Commenting upon the limitation of financial analysis, it highly dependent on the historical cost and the transactions are recorded initially at cost. This may act as the concern while reviewing the balance sheet where the assets and liabilities values might change over the time. 

On evaluating the variance report the two variance that would be investigated initially are the

1. Sales
2. Net Profit

The main reason for investigating the sales is that the company has significantly invested on the advertisement however the sales has not made any significant progress. On the other hand, the net profit has declined significantly from the actual figures because there has been a significant rise in the wages and advertisement expenses. 

References:

Barth, M. E. (2015). Financial accounting research, practice, and financial accountability. Abacus, 51(4), 499-510.

Hoyle, J. B., Schaefer, T., & Doupnik, T. (2015). Advanced accounting. McGraw Hill.

Kimmel, P. D., Weygandt, J. J., Kieso, D. E., & Trenholm, B. (2016). Financial Accounting. Wiley Custom Learning Solutions.

Macve, R. (2015). A Conceptual Framework for Financial Accounting and Reporting: Vision, Tool, Or Threat?. Routledge.

Maynard, J. (2017). Financial accounting, reporting, and analysis. Oxford University Press.

Robinson, T. R., Henry, E., Pirie, W. L., & Broihahn, M. A. (2015). International financial statement analysis. John Wiley & Sons.

Warren, C., & Jones, J. (2018). Corporate financial accounting. Cengage Learning.

Williams, E. E., & Dobelman, J. A. (2017). Financial statement analysis. World Scientific Book Chapters, 109-169.