UNIVERSITY OF BOLTON School of Business and Creative Technologies

Name: Vu Hoang Chuong

Student ID: 1012414

Intake Number: 5

Module: Financial Control in Management Control SystemsBST3004 (HE6)

Tutor: W O Burke

Assignment Number: One (Semester 2- 2010/11)

Assignment Title/Theme: Ratio Analysis Submission Deadline: 22nd April 2011

INTRODUCTIONThe purpose of this essay is to evaluate Grand Hotel’s financial performance using analysis of ratios. The data is provided by Balance Sheet and Income Statement of 2009 and 2010. This essay contains two parts: ratios analysis; and limitations.

RATIO ANALYSISFinancial Ratios are ratios that are calculated basing on data taken from financial statement. Ratios analysis is used to evaluate company’s performance and position. There are 20 typical ratios that divided into 3 main categories are Profitability ratios; Liquidity ratios; and Gearing ratios. Below is the ratio analysis basing on the calculation resulted in appendix 2.

Profitability ratiosRatio analysis for Grand Hotel mainly focuses on profitability ratios. Profitability ratios are used to assess company’s ability to generate revenues based on its total expenses or costs for a period. It can be company profitability ratios, activity ratios as sales in return of assets, or shareholder profitability ratios in view of investors.

Company profitability ratios areconcern with measuringthese kinds of ratios: Return on Equity (ROE), Return on Assets (ROA), Net Profit Margin (NP), and Gross Profit margin (GP).Both return on equity and return on assets reveal efficiency and profitability of investment. They have high rate at 97.1% and 46.9% in 2009, but reduce to 61% and 32.2% in 2010. A decrease of return on equity indicates a decrease in term of profitability of investment.Gross profit margin and net profit margin are defined as gross and net profit divided by sales, which indicate how much of sales given to the owners before costs of sales and operational cost respectively. They both have a slight decline between 2009 and 2010, from 61.9% to 57.4% and from 18.3% to 13.1%. It is expected to have company profitability ratios at high rate as high performance.

Activities ratios such as Asset Turnover, Fixed Assets Turnover, and Working Capital Turnover ratios, which show how efficiency the assets contribute toward sales. Thus, the higher rate of these ratios indicates the more effectiveness of management in utilizing assets. As of Grand Hotel case, asset turnover and fixed assets turnover almost remain from 2.57 to 2.46 and from 2.74 to 2.81 between 2009 and 2010.

Investors ratios are listed in Appendix 2 are Earnings per Share (EPS), Price/Earnings ratio (PE), Dividend Cover,Dividend per Share, and Dividend Yield. Earnings per share aregoodfor profitability. The higher of earnings per share show the more of demand for shares. Price/earnings ratio is also good with high rate. Grand Hotel has earnings per share decreased from 1.3 to 0.8 at a low rate of profit per share. Price/earnings ratio keeps unchanged at rate of 9:1 from 2009 to 2010. Dividend per share indicates how much profit left to shareholders per share. Dividend cover refers to the times dividend is covered by profits. Dividend yield means amount of payment in dividend compared to market price per share. Grand Hotel has dividend cover increased from 1.2 to 3, but dividend per share decreased from 1 to 0.3. Dividend yield also decreases from 9.1% to 3.8%. Low dividend yield indicates the relatively stable finance of company.

Liquidity ratiosLiquidity ratios are measures of ability to meet short-term debts. Current ratio and acid test ratio are the rate of current assets to current liabilities. Analysts use acid test ratio to evaluate more exactly the ability of liquidity. It is expected to have these ratios at least 1. The lower ratios, the greater ability that company must sell inventory to meet obligations. However, it is not necessary to have much higher rate that may not positively increase. In 2009, Grand Hotel meets its liabilities with current ratio is 1.3 and acid test ratio is 1.1. It shows an upward trend relatively to 1.8 and 1.6 in 2010.

Inventory turnover, average collection period, and average payback period all measure number of days that stocks of goods are held before being sold, debtors are collected from credit customers, and payables are paid to creditors. The shorter these ratios are in term of time, and then more cash is raised on sale of inventory and faster to collect debtors and also to pay creditors. However, it is not necessary to be as short as possible because of undesirably negative effects. Grand Hotel has short period ratios with inventory turnover of 11.2 days in 2009, slightly decreases to 10 days in 2010; average collection period is 23.7 days in 2009, increases to 28.6 days in 2010; average payback period is 20.5 days in 2009 and a little bit lowers to 20.1 days in 2010. All the ratios at the end of two years are less than 30 days or within one month, even average collection period increases 5 days on previous year while others nearly unchanged.

Gearing ratiosMost companies have to borrow money to expand business or to invest in new assets. The more they borrow, the more interest they must pay even success or not. So, it can bring them chance to develop or otherwise become risk. Gearing ratio is a tool to figure clearly company’s debt situation. The high gearing ratio, the more risk companies will face to, especially in case of increasing interest rate. Grand Hotel has very high gearing ratio at 74% in 2010; even it had been already decreased from 93% in 2009.

Companies also use debt ratio and interest cover as gearing ratio to evaluate the company’s debt status. Debt ratio indicates the rate between total debts to total assets. Otherwise, interest cover indicates how profits companies use borrowed funds. Grand Hotel has average debt ratio with 53% in 2010 after falling from 58% in 2009. This is acceptable ratio. Vice versa, interest cover is at high rate, 6.6 times in 2009. It shows an effectiveness to give high cover for interest costs. However, it is essential to consider because this ratio has decreased to 4.9 times in 2010.

LIMITATIONS OF RATIOSIn spite of advantage, ratio analysis still has certain limitations in case of using it not in proper way.

Data, calculations and ratios ProblemsData is the source of calculations to have appropriate ratios for evaluation. Therefore, it must be correct data and proper formulas. Any wrong data or formula at the beginning will give out incorrect result.

Financial ratios are calculated from historical data in financial statement. They just reflect on historical status and create basis for future evaluation and making decision. Moreover, they may sometimes out-of-date that lead to wrong interpretation of company’s current finance situation.

Data is recorded on financial statement as summary at the end of fiscal year. It seems to be general with only main data. In that case, there may be some important information omitted. Analysts only have an overview in total but not in details to figure out a real picture of finance.

“Window dressing” is one of methodologies that accountants use to justify data before provide formal financial statement. This is useful technique in owners’ view to show how strong their performance is, but can cause misleadings in others’ view to figure a full picture for analysis. Analyzing will get in trouble with these kinds of questionable data.

Analysis is only based on data in financial statement or qualities information. However, it is essential to make combination with other outside information such as quantities information before final decision making. For example, investors consider profitability and efficiency ratios before making investment. They also need to get outside information that somehow affects to change their decision.

There is no one agreed definition of financial ratios or ratios are not absolutely measures. Analysts use ratios to understand company’s performance or financial situation. However, it is really difficult to interpret whether it is high or low, good or bad. For example, low average payback period shows how effectively company manages its receivables, but may have impact on customers’ relationships.

Limited comparabilityThe most commonly techniques used in ratios analysis is to evaluate company’s finance over period. For example, ratios analysis for Grand Hotel in this case is to make comparison of ratios between two years 2009 and 2010. However, this needs to be treated with care of changes over time that will be presented more detail in next part.

One of good ways to evaluate company’s financial position is making comparison to other companies. However different accounting systems among companies make comparisons become more difficult. One ratio may be interpreted different from various companies’ views. Further, it is principle to make comparison to competitors in same industries.

Even making comparison between two companies in the same industries, they may not comparable. These two companies can focused on different aspect of business. For example, both two companies operate in fashion industry, but one company can be manufacturer, other can be wholesalers.Making comparison to average industry also makes analysts get in trouble. Large companies usually working in various types of industries. It is challenge for company to choose standard industry average for treatment.

Impact of changes overtimeCompanies cannot be evaluated in a stable environment. Any change from inner factors to outside conditions can result into changes of ratio calculation, then interpretation. Changes in accounting policies or standards are used to update over time. Standard accounts or policies change may leads to recalculation of ratios at the beginning and for a period.

Some other factors of change are inflation/deflation, price level changes, technology changes, government’s influence and seasonal factors, etc. When comparing one period to other period on financial statement, analysts need to pay attention to inflation factor because it can also be different period in the inflation. Besides, it is necessary to identify whether the increasing of earning is due to inflation or performance movement. Price level changes may have effect on kinds of return ratios such as return on fixed assets, return on capital employed, etc. It is impossible to adjust values to reflect correctly changing in prices. With technology changes, it should be considered to make comparison in the same level of technologies to decide which one is more efficiency.

Businesses should take care of trend in the industry that they work in. This is directly impact on development of company and also orientation to other possible changes. For instance, technology industry always has new trends of development.

Generally, ratio analysis are very useful methodology to assess a company’s financial situation. It can be made by making comparison inner company from past to present, then to predict future potential; by making comparison with other competitors in the same industry; and with industry averages. It will be more effective if limitations are taken into careful consideration.

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APPENDIX 2: RATIOS CALCULATION

Ratios Working 2009 Working 2010

1 Return on Equity (ROE) 97.1% 61%

2 Return on Assets (ROA) 46.9% 32.2%

3 Net Profit Margin (NP%) 18.3% 13.1%

4 Gross Profit Margin (GP%) 61.9% 57.4%

5 Asset Turnover 2.57 2.46

6 Fixed Assets Turnover 2.74 2.81

7 Working Capital Turnover 85.8 25.8

8 Current Ratio 1.3 1.8

9 Acid Test Ratio 1.1 1.6

10 Inventory Turnover 11.2 10

11 Average Collection Period 23.7 28.6

12 Average Payback Period 20.5 20.1

13 EPS 1.3 0.8

14 P/E 9:1 9:1

15 Dividend Cover 1.2 3

16 Dividend per Share 1 0.3

17 Dividend Yield 9.1% 3.8%

18 Gearing Ratio 93% 74%

19 Debt Ratio 57.6% 53.2%

20 Interest Cover 6.6 4.9