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Financial Ratio of Jewelry Showrooms

Essay by   •  April 21, 2016  •  Case Study  •  1,144 Words (5 Pages)  •  479 Views

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Legend Jewellery Ltd

Glory Jewellery Ltd

2,014

2,015

2,014

2,015

Formula (Calculation)

a. Working Capital (“WC”)

440,000

335,000

896,000

876,000

= Current Asset - Current Liability

Current Asset

671,000

862,000

1,003,000

1,097,000

Current Liability

231,000

527,000

107,000

221,000

b. Current Ratio (“CR”)

2.90

1.64

9.37

4.96

= Current Asset/ Current Liability

c. Quick Ratio (“QR”)

0.90

0.53

4.39

3.22

= liquid current assets / current liability

Liquid current Assets

209,000

278,000

470,000

711,000

= cash + marketable securities + account receivable

d. Inventory Turnover (“IT”)

N/A

5.38

N/A

3.86

= cost of goods sold/ average inventory

Average Inventory

N/A

523,000

N/A

459,500

= (beginning + ending inventories) /2

e. Net Profit Margin (“NPM”)

0.05

0.01

0.29

0.29

= Net income / Net sales = Net Profit / Turnover

f. Return on Asset (“ROA”)

N/A

0.03

N/A

0.69

= Net income / Average Total Asset

Average Total Asset

N/A

1,167,500

N/A

1,260,000

g. Return on Equity (“ROE”)

N/A

0.20

N/A

0.91

= Net income / Average Stockholders' equity

Average Stockholders Equity

N/A

198,500

N/A

960,500

= (beginning + ending total shareholders' funds) /2

  1. WC is a measure of a company's efficiency and its short-term financial health.  It is a safety cushion to the creditors.  The higher figure is the better sign to the creditors.  Both Legend Jewellery Ltd (“Legend”) and Glory Jewellery Ltd (“Glory”) has a decreasing WC from $440,000 to $335,000 and from $896,000 to $876,000 respectively.  However, no matter in 2014 or 2015, Glory has more than double WC than Jewellery.  Thus, Glory has a better WC than Legend.  

  1. CR is a liquidity and efficiency ratio that measures a company's ability to pay off its short-term liabilities with its current assets.  The CR is an important measure of liquidity because short-term liabilities are due within the next year.  A higher CR is more favourable because it shows the company can more easily make current debt payments.  Both Legend and Glory has a decreasing CR from 2.9 to 1.67 and from 9.37 to 4.96 respectively.  For Legend, it dropped more than 57% from 2014 to 2015.  For Glory, it dropped 53% from 2014 to 2015.  Thus, Glory has a better CR than Legend.
  1. QR is a liquidity ratio that measures the ability of a company to pay its current liabilities when they come due with only quick assets.  Quick assets include cash, marketable securities and current accounts receivable.  Higher QR is more favourable because it shows that the company has more quick assets than current liability.  The QR of 1 means that quick assets equal current assets.  Both Legend and Glory has a decreasing QR from 0.9 to 0.53 and from 4.39 to 3.22 respectively.  However, the QR of Legend for 2014 and 2015 were both below than 1, thus Legend could not pay off its current liability without selling any long-term assets.  For Glory, the QR was above 1, thus Glory could pay off its current liability without selling any long-term assets.  Thus, Glory has a better QR than Legend.
  1. IT is a measure of how many times a company sold its total average inventory dollar amount during the year.  It is an efficiency ratio that shows how effectively inventory is managed by comparing cost of goods sold with average inventory for a period and how efficiently a company can control its merchandise.  This shows the company does not overspend by buying too much inventory and wastes resources by storing non-salable inventory.  Legend (5.38) has a higher IT ratio than Glory (3.86).  This means Legend and Glory respectively sold 5.38 times and 3.86 of its inventory during the year.  Thus, Legend has a better IT than Glory.  
  1. NPM is a profitability ratio that measures the amount of net income earned with each dollar of sales generated by comparing the net income and net sales of a company.  It shows what percentage of sales is left over after all expenses are paid by the business.  It measures how much profits are produced at a certain level of sales.  The NPM of Legend decreased from 0.05 to 0.01 from 2014 to 2015 while Glory remains unchanged (0.29) in 2014 and 2015.  Legend could only converted 1% of her sales into profits in 2015 while Glory could converted 29%, thus Glory has a better net profit margin than Legend.
  1. ROA is a profitability ratio that measures how efficiently a company can manage its assets to produce profits during a period, i.e. how profitable a company’s assets are.  It helps both management and investors see how well the company can convert its investments in assets into profits.  A higher ratio is more favorable because it shows that the company is more effectively managing its assets to produce greater amounts of net income.  A positive ROA usually indicates an upward profit trend.  Glory (0.69) has a higher ROA than Legend (0.03), which means Glory is more efficiency than Legend to manage its assets to produce profits.  Thus, Glory has a better ROA than Legend.
  1. ROE is a profitability ratio that measures the ability of a company to generate profits from its shareholders investments in the company.  It shows how much profit each dollar of common stockholders' equity generates.  A higher ratio is more than favourable.  Glory (0.91) has a higher ROE than Legend (0.20), which means Glory is more efficiency than Legend to generate profits from its shareholders investments.  Thus, Glory has a better ROE than Legend.  

ii)

Based on the above ratios, Mr. Au is advised to join Glory, the reasons are as following:-

  1. Glory had a higher WC, CR and QR than Legend in both 2014 and 2015.  These ratios were the short term solvency ratios, the higher ratios means the company had a higher ability to convert non cash assets into cash.  Considering that both Glory and Legend had a decrease on WC, CR and QR from 2014 and 2015, Glory with a higher ratio than Legend means it is still safer than Legend.

  1. Legend had a high increase on Current Asset in 2015 comparing with 2014 while Glory had a more steadily difference.  The increase on Current Asset of Legend was mainly due to the increase on Inventory, it may be due to Legend had a bad business in 2015 thus causing the large amount on Inventory.  However, Glory had a higher cash amount and lower Inventory amount from 2014 to 2015, it is likely that Glory had a better business than Legend.
  1. For NPM, the earning power of Glory is 29 times of Legend.  Glory obviously had a higher amount than Legend which is steadily while Legend had a low and decreased NPM from 2014 to 2015.  
  1. Glory had a higher ROA and ROE than Legend, it appears that Glory is more effectively managing its assets to produce greater amounts of net income than Legend.  Glory is more efficiently using the shareholders’ money to generate net income.  

Hence, Glory had a better financial condition with better business continuity and a lower bankruptcy chance.

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