The Ratio Analysis of Rolls Royce - Case Study Example

Table of Contents Particulars Page No 1.0 Introduction 2 2.0 Ratio Analysis 2 3.0 Conclusion 6 4.0 Appendices of Calculations/Data 7 5.0 References 9 1.0 Introduction The report analyzes the financial statement of Rolls Royse for 2014 and 2015 so that the financial performance can be gauged. The report looks at carrying out financial analysis through different ratios which are liquidity ratio, profitability ratios, efficiency ratios and gearing ratios. The report provides descriptive information regarding the performance and brings forward the core areas which needs to be improved so that overall performance can be further improved. 2.0 Ratio Analysis Analyzing the financial statement through ratios provides useful information regarding the financial performance and key areas which the business needs to focus on. It looks at comparing the past performance of the firm or comparing the financials with other players in the industry so that useful interpretation can be made. The ratio analysis of Rolls Royce based on different ratios for 2014 and 2015 is as under Profitability Ratios Profitability ratios help to gauge the performance of the firm and help to understand the manner in which the different resources of the business were used to generate profits for the shareholders of the company. The profitability ratios for Rolls Royce for 2014 and 2015 is as Description Formula 2015 2014 Net Profit Margin (Net Profit/ sales)*100 0.61 0.42 Total Asset Turnover (Net Sales/Average Total Assets) 0.61 0.62 Gross Profit Margin (Gross Profit/ Sales)*100 23.80 23.32 Operating Income Margin (Operating Income/Net Sales)*100 10.92 10.12 Sales to Fixed Asset Ratio (Net Sales/Average Fixed Assets) 1.35 1.25 Return on Capital Employed (Earnings Before Interest and Tax/ Capital Employed) 0.30 0.22 The net profit margin has increased to 0.61% in 2015 from 0.42% in 2014 showing decrease in expenses and better management of resources. When we look at the same from the point of view of gross profit margin it is seen that the gross profit margin has increased considerably to 23.8% in 2015 from 23.32% in 2014. The same is being reflected in the increase in net profit showing efficiency and improvement in performance (Eljelly, 2004). The operating income shows slight improvement showing that the performance of the business has improved and the resources are better used. This ratio also shows that the daily operations have grown resulting in improvement in business. Asset turnover ratio highlights the efficiency of the business to use its assets to generate sales. It has remained nearly the same both in 2014 and 2015. The business has instead witnessed improvement in profits which has become possible due to control on cost reflecting better effectiveness in carrying out the daily activities. The return on capital employed shows that the return for the shareholder has improved as it has reached to 0.3 in 2015 as compared to 0.22 in 2014. This shows that the shareholders will be compensated properly as it will help the business to ensure proper return for the risk undertaken by investing in the organization. Liquidity Ratios Liquidity ratio helps to analyze the ability of the business to meet its financial needs over a short period of time. It shows the financial stability and the manner in which the short term obligations will be paid. The liquidity ratios for Rolls Royce for 2014 and 2015 is as Description Formula 2015 2014 Current Ratio (Total Current Assets/ Total Current Liabilities) 1.48 1.46 Acid Test Ratio (Cash Marketable Securities+ Net Trade Receivable)/ Total Current Liabilities 1.16 1.10 Working Capital Total current Assets- Total Current Liabilities 3943 3503 The current ratio shows similar figures as it stands at 1.48 in 2015 as compared to 1.46 in 2014. It has improved but very little. The overall ratio shows that the firm has abundant liquidity and will be able to pay off its short term obligations easily in the short run (Filbeck & Krueger, 2005). The working capital has also improved in 2015 as compared to 2014 as it is 3943 in 2015 and 3503 in 2014. This shows that the business has more liquidity which is being reflected in the liquidity ratios. The increase corresponds to the fact that the business will be able to meet the short term obligations in a better way (Deloof, 2003). Acid test ratio shows improvement in 2015 as it is 1.16 in 2015 as compared to 1.1 in 2014. This shows that the business has fewer inventories and will be able to easily convert the short term assets into liquid cash (Saleem & Rehman, 2011). Since, the ratio is above 1 even after removing inventory it will help the business to meet the short term obligations easily. Gearing Ratios Gearing ratios help to measure the leverage of the firm and the impact it has on the capital of the business. This shows the manner in which the business will be able to raise long term finance and improve its overall business performance. The ratios for Rolls Royce for 2015 and 2014 is as Description Formula 2015 2014 Debt Ratio Total Liabilities/ Total Assets 0.78 0.71 Debt/Equity Total Liabilities/ Total Equity 3.45 2.48 Debt to Tangible Net Worth Total Liabilities/ (Total Equity- Intangible Assets) 0.28 0.37 Cash Flow/ Total Debt Cash Flow From Operations/ Total Liabilities 0.06 0.08 Interest Coverage Ratio Earnings Before Interest and Taxes/ Interest Expenses 2.76 1.06 The debt ratio has increased to 0.78 in 2015 from 0.71 in 2014 showing that the firm’s assets which are claimed by creditors have decreased thereby reducing the opportunity to raise fresh finance in the future (Antony, 2004). This is something that the business has to look at so that better effectiveness can be achieved. The debt to equity has increased showing more debt for the business thereby reducing the overall risk and reducing the chance to raise further finance in the future. The debt to tangible worth has decreased to 0.28 in 2015 from 0.37 in 2014 showing that the business has more intangible assets and could be due to improved performance (Padachi, 2006). The ratio also shows that the business is better placed and has an opportunity to improve its performance further in the future. The interest coverage ratio further shows that improvement showing the ability of the business to pay the interest easily. It signifies that the business is better placed and has the ability to pay the interest without any problem highlighting better management of the resources. Efficiency Ratios This ratio helps to understand the manner in which the different assets are used and helps to understand the manner in which overall performance is shaped. The ratios for Rolls Royse for 2014 and 2015 is as Description Formula 2015 2014 Sales to Working Capital Net Sales/ Average Working Capital 3.48 3.92 Accounts Receivable Turnover Net sales/Average(Gross) Receivables 2.20 2.49 Accounts Receivable Turnover in Days 365/ Accounts Receivable Turnover 165.91 146.59 Inventory Turnover Cost of Goods Sold/Average Inventory 3.97 3.81 Inventory Turnover In Days 365/Inventory Turnover 91.94 95.80 Net Working Capital to Total Assets (Net Working Capital/ Total Assets)*100 17.66 15.76 Fixed Asset Turnover Ratio Cost of goods sold/ Net Fixed Assets 1.02 0.95 Current Asset Turnover Ratio Cost of Goods Sold/ Current Assets 0.86 0.94 The inventory turnover ratio has improved slightly in 2015 as it has moved to 3.97 from 3.81 in 2014. This shows that the business has been able to revolve its inventory nearly 4 times in a year. This reduces the chances of inventory becoming obsolete and improves the overall chances to manage inventory in a better way. The same gets reflected through the inventory turnover in days which shows that inventory gets rolled in 91.94 days in 2015 as compared to 95.8 days in 2014 highlighting improvement in performance. The accounts receivable ratio has decreased in 2015 as it has moved to 2.2 from 2.4 in 2014. This shows that the business is not able to collect money quickly from its debtors thereby increasing the risk as the chances of bad debts increases (Lyroudi & Lazaridis, 2000). The same gets reflected through the receivable turnover in days which shows that money gets collected from the market in 165.91 days highlighting the increased risk that the business faces. 3.0 Conclusion The paper thereby presents the manner in which Rolls Royce has performed in 2015 as compared to 2014 and brings the areas which they need to work on. The analysis helps to understand the strength area and areas which have to be improved for better performance in the future. 4.0 Appendices of Calculations Profitability Ratios   Year Year Description Formula 2015 2014 Net Profit Margin (Net Profit/ sales)*100 0.61 0.42 Total Asset Turnover (Net Sales/Average Total Assets) 0.61 0.62 Gross Profit Margin (Gross Profit/ Sales)*100 23.80 23.32 Operating Income Margin (Operating Income/Net Sales)*100 10.92 10.12 Sales to Fixed Asset Ratio (Net Sales/Average Fixed Assets) 1.35 1.25 Return on Capital Employed (Earnings Before Interest and Tax/ Capital Employed) 0.30 0.22 Liquidity Ratios       Description Formula 2015 2014 Current Ratio (Total Current Assets/ Total Current Liabilities) 1.48 1.46 Acid Test Ratio (Cash + Marketable Securities+ Net Trade Receivable)/ Total Current Liabilities 1.16 1.10 Efficiency Ratios       Description Formula 2015 2014 Working Capital Total current Assets- Total Current Liabilities 3943 3503 Sales to Working Capital Net Sales/ Average Working Capital 3.48 3.92 Accounts Receivable Turnover Net sales/Average(Gross) Receivables 2.20 2.49 Accounts Receivable Turnover in Days 365/ Accounts Receivable Turnover 165.91 146.59 Inventory Turnover Cost of Goods Sold/Average Inventory 3.97 3.81 Inventory Turnover In Days 365/Inventory Turnover 91.94 95.80 Net Working Capital to Total Assets (Net Working Capital/ Total Assets)*100 17.66 15.76 Fixed Asset Turnover Ratio Cost of goods sold/ Net Fixed Assets 1.02 0.95 Current Asset Turnover Ratio Cost of Goods Sold/ Current Assets 0.86 0.94 Solvency Ratios & Gearing Ratios       Description Formula 2015 2014 Debt Ratio Total Liabilities/ Total Assets 0.78 0.71 Debt/Equity Total Liabilities/ Total Equity 3.45 2.48 Debt to Tangible Net Worth Total Liabilities/ (Total Equity- Intangible Assets) 0.28 0.37 Cash Flow/ Total Debt Cash Flow From Operations/ Total Liabilities 0.06 0.08 Interest Coverage Ratio Earnings Before Interest and Taxes/ Interest Expenses 2.76 1.06 5.0 References Antony, T. (2004). Thin Capitalization: Issues on the Gearing Ratio. Journal on Australian Taxation, 7 (1), 39-57 Deloof, M. (2003). Does Working Capital Management Affect Profitability of Belgian Firms? Journal of Business Finance & Accounting, 30(3&4), 573-587. Eljelly, A. (2004). “Liquidity-Profitability Tradeoff: An empirical Investigation in an Emerging Market”, International Journal of Commerce & Management, 14(2), 48 - 61 Filbeck, G., & Krueger, T. M. (2005). An analysis of working capital management results across industries. Mid-American Journal of Business, 20(2), 10-17. Lyroudi, K., & Lazaridis, Y. (2000). The Cash Conversion Cycle and Liquidity Analysis of the Food Industry in Greece [Electronic Version]. EFMA 2000 Athens Padachi, K. (2006). Trends in working capital management and its impact on firms’ performance: an analysis of Mauritian small manufacturing firms. International Review of Business Research Papers, 2(2), 45-58. Saleem, Q. & Rehman, R. (2011). Impacts of Liquidity Ratios on Profitability. Interdisciplinary Journal of Research in Business, 1 (7), 95-98 Read More