Acid-Test Ratio - Case Study Example

Analyses of the ratios: Acid-Test Ratio In cases if the PQ company has the acid test ratio of less than it would be impossible for it to pay their liabilities and would be attracting a great deal of danger. However, if the company has a ratio that is far lower than the working capital ratio, whatever the recent assets the company would have, they would be highly dependent on inventory. The working capital ratio (Current Asses/ Current liabilities) are indicative of the fact that whether a company possesses the short term assets required to cover up its short term debts. If PQ would have a working capital ratio of less than 1 they would have a negative W/C. However, a ratio above 2 would mean that PQ is not investing excess assets. For best and optimal performance, a W/C ratio between 1.2 and 2.0 is sufficient. A debt ratio that is greater than 1 would indicate that Mr. Banks company owns more debts in comparison to assets. Similarly, if his company is capable of having a ratio that is less than 1, this indicates that PQ has more assets compared to debt. When the debt ratio is used in conjunction with other measures of financial health, Mr. Banks would find it easier to determine the risk level his company is to face in the near future. Gross profit margin: If PQ earned $20 million in revenue solely from producing widgets and was successful in incurring $10 million in COGS- related expense, the gross profit margin of Mr. Banks Company would be 50%. This shows that for every dollar that the PQ Company would earn on widgets, the company gets only $0.50 at the final stage. Profit Margin While considering the earning s of PQ, the entire picture of the company’s position is not clearly understood. If the company would amplify its earnings, it is not only that the company would benefit from it, but also the margin of the company would also be improved. For example, if Mr. Banks Company has costs that have risen at a rate greater than the sales, the result would be that the company would face lower profit margins. This would indicate to the company that costs are in dire need to be control in a better manner. Additional factors to be considered: Before converting his investments, Mr. Banks must consider several factors which effect PQ directly and indirectly. For the purpose of equity finance, PQ could become a corporate entity. This is mainly because this brings forward the easiest method for raising capital form several investors. These particularly include those investors which who are not interested in participating in the business actively. An example includes that it becomes far easier and risk free to convince 20 individuals to make an investment of $ 5,000 than to convince an individual to make a contribution of $100,000 and a corporation allows this type of widespread ownership. Furthermore, when Mr. Banks converts his finances into equity shares, he becomes a shareholder of a corporation that does not participate in corporate activities and whose decision is virtually free from liability for activity or debt. Adding further, another important factor that proves to be an advantage to PQ is that the flexibility in structuring the ownership and control over business as well as transfer of shares becomes easier. By converting his investment into equity shares, Mr. Banks would indirectly cause the company to promote itself in a better manner. Publically traded businesses are better recognized as compared to non - publically traded business. Along with the ability to better promote the company and with prestige, going public would allow PQ to attract better personnel involving officers and high- level executives. Companies having equity shares are able to offer better stock options which have the potential to substantially increase in value. The time from which PQ registered securities for the purpose of selling and offering them, the status of PQ changes from private to public. By doing so, Mr. Banks and PQ would face an increase in the capital. A public offering places a value on PQs stock and also the insiders in the company who are responsible for retaining the stock. Such insiders will be able to sell their shares or use them as collateral. Adding further, by making PQ public, Mr. Banks would result in creating a type of currency in the form of the stock that the business could benefit from and can use to make acquisitions. Also, PQ would be able to have an access to the capital markets for the financing needs in the future. In normal cases, PQs debt to equity ratio progresses after an initial public offering. This means that PQ would be able to obtain more favorable loan terms from lenders. By offering securities publicly, PQ as well as its management may be able to retain a certain degree of control. In any case when a private company decided to sell its common stock to venture capitalists in order to raise money in place of doing an initial public offering, the purchasers of the stocks would require authority regarding the decision making power. Accompanying the advantages that Mr. Banks could face regarding the future performance of PQ, there are several disadvantages. There are reasons present due to which PQ should not be made public especially for the purpose of raising money. One of the vital disadvantage is that going public is an expensive method. The cost ranges from $250,000 to $1 million. In cases when PQ would not be able to get the offerings through, the company will lose the money. The typical expenses faced by the company would involve accounting and legal fees, travel costs, underwriter’s expense allowance as well as printing costs and filling fees. Furthermore, by going public, the company would operate under close scrutiny. There is also an increased risk of exposure of PQ to civil liability. This could be for false or misleading statements in the registration statement or for public companies. Also, the officer might also have to face liability for misrepresentations in the reports that are filled with SEC. other factors that are worth considering include double taxation of capital gains upon dissolution as well as double taxation of profits while operating. Thus, Mr. Banks must look deep into the above mentioned factors before making the investment. An attorney possessing the experience in securities law could also prove to be a good aid in analyzing the considerations and making the decisions that would prove to be best for PQ. Ratios: 1. Gross profit ratio: 2012: 600/2300*100= 26.08% 2013: 800/2600*100 = 30.76% The gross profit is always preferable being more than the previous times. It is presented as a percentage of the sales revenue of the company. 2. Net profit ratio: 2012: 165/2300*100 = 7.17% 2013: 250/2600*100 = 9.61% The more net profit of a company, the better it is. The net profit margin in 2012 was 7.17% which is less than the ratio in 2013 being 9.61%. This shows that the company is better in 2013 as compared to 2012. This is suitable for the company. 3. Return on Capital employed 2012: 233/2486+336 * 100 = 8.25% 2013: 352/2460+360 *100 = 12.4% The return on capital employed is always better when it is higher. It can be concluded that the ROCE of the firm is better in 2013. In 2012 it was 8.25% and in 2013 it was 12.4% this confirms that the capital employed by the company in 2013 was more when compared to 2012. 4. Current ratio: 2012: 2486/850 = 2.92:1 2013: 2460/550 = 4.47:1 The current ratio is always favorable when it I above 1. It is the comparison between what the company owns and what it owes. The current assets are what the company has in possession and the current liabilities are what the company owes. 5. Return on total assets: 2012: 233/2486*100 = 9.37% 2013: 352/2460*100 = 14.3% Return on total assets is the return that the company gets over the assets that it has invested within the company. Return on total assets is therefore better when it is higher. In 2012, however the ROTA is less than what it is in 2013 being 14.3% 6. Operating expense ratio 2012: 367/2300*100 = 15.95% 2013: 448/2600*100 = 17.2% The operating expenses are presented as a percentage of the total sales of the company. If the expenses are more it is never better for the company and vice versa. Higher ratio is hence preferable. 7. Non-current asset turnover 2012: 2300/70*100 = 3.28% 2013: 2600/85*100 = 3.05% Fixed assets are also known as non-current assets. The turnover is decreasing in 2013. It is presented as a percentage of the sales. 8. Acid test ratio 2012: 850/860 = 1.01 times 2013: 795/550 = 1.44 times It is a liquidity ratio. It helps in measuring the performance of the company. 9. Receivable turnover ratio: 2012: 800/2300*365 = 127 days 2013: 750/2600*365 = 105 days. Debtors turnover period is the time a debtor has to pay back the loans. Lesser days is always better. Therefore, the company’s liquidity is strong and is working towards the right direction. The position of the business is stable and hence, profitable. Read More