Electronic Equipment Venture (EEV)
Electronic Equipment Venture (EEV)
Introduction
In measuring performance of an organization, in terms of stability, efficiency, profitability, and liquidity, ratio analysis is vital (Drake, 2010). Ratio analysis is useful in many ways. Ratios help in the analysis of financial statements whereby it guides the understanding of the financial standing of a company. Investors, bankers, creditors, and management utilize ratios to analyze financial situation and make decisions (Hofmann, 2001). Ratios are essential for determining the company’s efficiency, in terms of management and operations. They help determine the company utilizes its assets and generates profit. The ratios also help in identifying weakness, formulating financial plans, and comparing performance. With ratios, Electronic Equipment Venture can check its short term and long term solvency. However, non-financial measures are useful too because they complement ratios in decision making. Ratios are crucial tools for the investor when assessing the potential and future analysis of a company before making an investment.
Problem Analysis
Financial ratios are vital tools in predicting the performance of Electronic Equipment Venture. They give an idea of profitability, asset utilization, and efficiency. However, predicting the future performance of business is complex and requires other performance measures (Gitman & McDaniel, 2008). These measures analyze other dynamics that influence performance such as customer satisfaction, employee satisfaction, innovation, and internal operations (Gibson, 2007). These are functions of the balanced scorecard. This paper analyses the financial ratios of Electronic Equipment Venture by use of the balance sheet and financial statement provided for 2008, 2009, and 2010. The goal is to demonstrate the usefulness of ratios while describing the role of non-financial measures in the performance appraisal of a company.
Non-financial Measures
The non-financial measures comprise customer satisfaction are vital for financial evaluation (Gitman & McDaniel, 2008). They are the components that make up the balanced score card. They include customer satisfaction, innovation, job satisfaction and internal processes. These measures of financial performance are very useful determinants of future status of the financial position of a company. In the current status of market dynamics, there is a focus on the quality of management and company’s shareholder value. They are particularly relevant if the financial performance measures do not completely reflect the contribution of management to the total value of the company. They are an indicator of the company’s long-term financial performance in that they facilitate a focus on the customer. Non-financial measures integrate the analysis of the customer, employee, and internal business procedures.
Financial Measures
Measures of liquidity: Liquidity ratio provides information on the ability of a company to meet its obligations i.e. generate cash for its short term needs (Gibson, 2007). Measures of liquidity include current ratio, quick ratio, and debt to equity ratio. Current ratio is current assets to current liabilities. It indicates the ability of a firm to satisfy its liabilities with its assets at the current condition. The quick ratio is the ratio of quick assets to liabilities. This is the ability of the company to sustain its current liabilities with its most liquid assets. The net working to sales ratio is the other measure of liquidity. It is the ration of net working capital to sales. It indicates the firm’s liquid assets relative to the need for liquidity expressed by sales. In general terms, a large liquidity ratio demonstrates a better ability of the company to meet its short term obligations. In relation to Electronic Equipment Venture, the current ratio is 3.1 i.e. its amount of current assets is high relative to the company’s liabilities. This gives the company assurance against diminishing factory returns. In cases where current assets are more than the firm needs to provide assurance, the firm is investing heavily on low or non-earning assets.
Utilization of Assets: In order to understand how well the company utilizes assets, activity ratios are very useful (Gitman & McDaniel, 2008). For the most part, turnover ratios evaluate the benefits of individual assets. Turnover ratios include inventory or accounts receivable. Investment in assets is essential for growing sales and managing the company’s operating costs, and, thus, increasing profitability of the business. Asset utilization analysis also facilitates comparison with other companies in the analysis of the opportunity cost. In calculating the inventory turnover, the analysis divides cost of goods sold by the inventory i.e. it is the ratio of cost of goods sold to inventory. It indicates the number of times of the creation and sale of inventory. Accounts receivable turnover is the ratio of accounts receivable to net credit sales.
Profitability ratios: Profit margin ratios compare components of revenue with sales to give an idea of what comprises a company’s income expressed as a portion of each dollar of sales (Gibson, 2007). The gross profit margin represents the ratio of profit to sales. Operating profit margin indicates how much of a dollar remains after operating expenses. Net profit margin is the other measure of profitability which divides net income by sales to represent how much of each dollar remains after all expenses. Profitability is the ultimate objective of business and is, therefore, the most vital indicator of performance. Therefore, the determination of profitability should combine financial measures as given with non-financial measures that provide a better picture of the situation of financial performance of a company.
Summary of Findings
| Ratio |
2008 |
2009 |
2010 |
|
| Liquidity | Current Ratio |
3.1 |
3.7 |
2.9 |
| Quick Ratio |
0.4 |
0.4 |
0.2 |
|
| Debt to Equity Ratio |
1.4 |
1.3 |
1.5 |
|
| Efficiency | Inventory Turn Over |
7.1 |
6.2 |
5 |
| Accounts Payable Sales |
3 |
2.9 |
4.2 |
|
| Profitability Ratio | Profit Margin |
5.7 |
1.9 |
1.2 |
| Return on Assets |
40.6 |
11.5 |
5.9 |
|
| Return on Net Worth |
56.7 |
15.3 |
8.7 |
In relation to the profitability margin, the gross profit margin of EEV is declining from 5.7% in 2008 to 1.9 percent and 1.2 percent for 2009 and 2010 respectively. The Return on assets ratio is also declining from 40.6 percent, to 11.5 percent, and finally to 5.9 percent. In terms of return on net worth, the same trend of decline is evident. The ratio goes down from 56.7 percent, to 25.3 percent, and, then, to 8.7 percent. In terms of liquidity, there is also an overall decline from 2008 to 2010, though by a slight margin. The current ratio, it dropped from 3.1 to 2.9 through the same period. Quick ratio drops from a value of 0.4 in 2008 to 0.2 in 2010. Debt to equity ratio drops from 1.4 in 2008 to 1.3 but improved to 1.5 in 2010. In terms of efficiency, the inventory turnover dropped from 7.1 percent in 2008 to 5 percent in 2010.
In view of the ratios and the trend, Electronic Equipment Venture may have to consider combining with another unit because the ratios are in favor of expansion so as to improve sales and profitability. It is evident that utilization of the company assets does not occur in a way that maximizes income from individual assets. The profit margin is diminishing, as well as the return on assets. In terms of efficiency, the company’s inventory is reducing over time. This implies that the company is inefficient in managing inventory. It could be due to rising costs of keeping inventory or other costs coming from the business.
Analytical Limitation
Performance analysis using financial indicators only compromise long-term considerations. Financial ratios are only relevant to the short-term financial planning. Using both financial and non-financial measures provides an integrated tool that defines the future for business. Non-financial measures such as customer support and others that draw from the principle of the balanced scorecard provide a complete tool whose analytic capacity are representative of the future.
Recommendation
The performance measures point to a decline in efficiency, profitability, and utilization of assets. In this regard, Electronic Equipment Venture needs to device ways to manage assets, improve efficiency and grow profits. Alternatively, the company can combine with another business unit so as to expand its assets and share management best practices.
References
Drake, P. (2010). “Financial Ratio Analysis”. Retrieved from http://educ.jmu.edu/~drakepp/principles/module2/fin_rat.pdf
Gibson, C. (2007). “Financial Reporting and Analysis: Using Financial Accounting Information”. Mason, OH: Cengage.
Gitman, L & McDaniel, C. (2008). “The Future of Business: Essentials”. Mason, OH: Cengage.
Hofmann, C. (2001). “Balancing Financial and Nonfinancial Performance Measures”. Hanover: University of Hanover.
Markowitz, H. (2009). “The Theory and Practice of Investment Management”. Hoboken, NJ: John Wiley & Sons.
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