Profitability Ratios

The present report is prepared to analyse the financial performance of Wizard Industries using the key accounting and financial technique called ratio analysis. The financial ratios in relation to profitability and efficiency aspects of financial performance of the company are calculated to assess its financial health from different angles. Use of key profitability ratios is made to identify whether the business of Wizard industries is generating sufficient profits and has it utilised its assets and funds of shareholder’s investment in business in such a way that maximum returns could be offered to the shareholders of the company.

For the purpose of analysis of financial performance of Wizard Industries a comparative study of financial ratios at both inter-firm as well as intra-firm level has been done. Under the intra-firm analysis, the financial performance of company in 2015 is compared with that of 2014 in order to evaluate whether the overall financial performance has improved or declined in 2015. On the other side, the financial performance of company is compared against the average industry results as a part of inter-firm analysis so as to determine the financial standing of the company in the industry within which it operates its business.

Profitability Ratios
		2015	2014 Save Time On Research and Writing Hire a Pro to Write You a 100% Plagiarism-Free Paper. Get My Paper
Net profit Margin	PAT/ Sales	0.07%	5.16%
		1100/1605100	95000/1841300
Return on equity	Net profit after tax/Average shareholder’s equity	0.38%	30.97%
		1100/((252500+321400)*0.5)	95000/((321400+292000)*0.5)
Return on assets	EBIT/Average  Total Assets	7.37%	19.71%
		66550/((881900+925200)*0.5)	172650/((925400+826100)*.50)
Efficiency Ratios
Inventory Turnover Ratio	COGS/ Average Inventory Ratio	4.29	4.51
		1258900/((256600+330000)*.50)	1397400/((330000+289900)*.50)
Receivable Turnover Ratio	Sales/ Average Accounts Receivable	4.16	5.59
		1605100/((410800+361800)*.50)	1841300/((361800+297300)*.50)
Average collection period	365/Receivable Turnover Ratio	87.84	65.33
		365/4.16	365/5.59

Net profit margin is the profitability ratio that measures the quantum of sales revenue remained after paying off all the business expenses of the year. It the profit that is used to offer returns to the investors or can be transferred to reserves for its further utilisation in business only (Weygandt, Kimmel & Kieso, 2015). In the present case, Wizard Industries could not earn sufficient profits out of its business in FY 2015. Also, there has been a significant decline in the net profit margin in 2015 as compared to 2014 because of decline in the sales and increasing the operating as well as interest expenses.

Return on equity ratio measures the rate at which the shareholders of the company will receive the return in lieu of their shareholdings (Nissim & Penman, 2001). In the present case of Wizard Industries, company could barely offer any returns to its shareholders in 2015 because of the fact it could not earn sufficient profits that could be distributed among its shareholders. In 2014, the company had paid considerable returns to its shareholders due to its higher profitability.

Return on assets ratio measures the efficiency with which company manages its assets in its business for the production of profits in the given period of time ((Innocent, Mary & Matthew, 2013). The return on assets in 2015 has been considerably lower than that of 2014. It shows that Wizard Industries could not use its assets efficiently in 2015 to generate desirable sales so that sufficient returns could be offered to the shareholders.

Net profit Margin

Inventory turnover ratio is the efficiency ratio the measures the number of times the average inventory of the business is converted into sales during the given period of time (Higgins, 2012). Higher ITR is better as it reflects more efficiency of the firm. In 2015 the ITR has slightly declined from that of 2014 and this shows that the inventory management practices have slightly become inefficient.

Receivable turnover ratio measures the efficiency with which the accounts receivables of the company are managed by way of their conversion into cash sales in the given period (Foster, 2004). The RTR is also degraded in 2015 as compared to 2014, which shows that company could convert its accounts receivables into sales as quickly as it had practiced in 2014.

The average collection period ratio calculated the average number of days which are taken by the company to convert its accounts receivables into sales. The collection period has enhanced in 2015 which indicates that the cash conversion cycle of the company has slowed down in 2015 as compared to 2014 because of its inefficiency to convert its accounts receivables into cash.

The comparison of Wizard’s performance against the average industry results has shown that there has been a significant difference in the net profit margin rate as well as the rate of return on equity. This clearly shows that the company is not performing in line with the performance of other firms in the industry. The lower profitability in terms of net margins and returns to the equity shareholders indicates that the company might have to face intense competitive pressure from its peer competitors as the existing and potential shareholders would not have found the company as a better investment option because of its lower profitability. However, there is no significant difference between the ROA of the company and its industry averages which shows that company is managing its overall assets in the appropriate manner but still there is a room for the improvement in its asset management practices to achieve the competiveness.

In terms of efficiency in managing the current assets such as accounts receivables and inventories Wizard Industries is not performing as sound as the other firms in the industry which is providing its rival firms a competitive advantage over it. The inventory and receivables management practices of the company are not strong enough to meet at-least the average industry standards. Hence, Wizard is taking more time to convert its inventory and accounts receivables into cash.

Return on equity

Though ratio analysis is the most commonly used technique of financial analysis yet it suffers from various limitations which will be discussed below:

• Use of historical information:

The ratio analysis takes into account the information of the results that have been achieved in past which do not necessarily reflect the performance of the company in future. The balance sheet which is used to extract data for the purpose of performance analysis is generally prepared on historical cost basis and not the fair value basis. The impact of inflationary forces on different components of financial statements is given consideration while analysing the performance of the company.

• Poor comparability:

The first and foremost factor that makes affects the comparability feature of the ratio analysis tool is that the average of performance of all the firms is taken to identify the industry standards and not the performance of the leaders  of the industry which provides better standards against which the company must perform. Further, it is a general fact that not all the companies prepare their financial statements using t different accounting policies.

• No reasons of changes in performance:

Ratio analysis helps a firm to determine the changes in the performance from one period to another but it does not depict the reasons of such changes. There could be various reasons of fluctuation of financial performance of the business over a period of time and it is necessary for the managers to identify the root causes of such changes in order to improve the financial performance in the subsequent period.

• Use of different concepts in calculation:

The multiplicity of the method of calculation of a single ratio on account of application of different concepts also affects the utility of financial ratios. Different concepts produce different results for a particular ratio which makes it different for the users of ratios to interpret those ratios (Lesakova, 2007). 

Conclusion:

Hence, it can be said that the financial performance of Wizard industry in 2015 has miserably declined from the level that was achieved in 2014 and also it does not have sound market position to sustain for the longer period in the market.

References:

Foster, G. (2004). Financial Statement Analysis, 2/e. Pearson Education India.

Higgins, R.C. (2012). Analysis for financial management. McGraw-Hill/Irwin.

Innocent, E.C., Mary, O.I. and Matthew, O.M. (2013). Financial ratio analysis as a determinant of profitability in Nigerian pharmaceutical industry. International journal of business and management, 8(8), p.107.

Lesakova, L., 2007, June. Uses and limitations of profitability ratio analysis in managerial practice. In International Conference on Management, Enterprise and Benchmarking, pp. 1-2.

Nissim, D. and Penman, S.H.(2001). Ratio analysis and equity valuation: From research to practice. Review of accounting studies, 6(1), pp.109-154.

Penman, S.H. and Penman, S.H.(2001). Financial statement analysis and security valuation. New York, NY: McGraw-Hill/Irwin.

Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2015). Financial & managerial accounting. John Wiley & Sons.