Financial Ratios for Pace Ltd with Calculations Finance Essay

Introduction:

Jill Dempsey and Mike Greaves started Pace Leisurewear Ltd five year ago. Pace Leisurewear are a manufacture and designer of leisure and casual clothes which aimed younger and higher-income group people. After lots of planning, they integrated product design and development with the sales and marketing. Clothes range are designed by young and team led by Jane Barker which attracted many buyers and then orders converted by marketing team led by Jill Dempsey. Company's sales started increasing after economy coming out of recession with new exports markets in France and Switzerland. Mike and Jill invested in Pace Leisurewear from their life time savings and major contribution or largest shareholder is Keeble Estates Ltd, owned by Keeble brother, David and John Keeble. The board of directors of Pace Leisurewear Ltd are Jill Dempsey, Mike Geaves, Jane Berker, David Keeble and John Keeble.

Problems with Pace Leisurewear Ltd:

According to draft accounts from auditors, company profit has doubled; however, the company's cash situation is poor because they have invested a lot on additional plant and after selling old machines they didn't get anything plus expenses includes £ 2.8 million for depreciation itself. The main problem which is Pace Leisurewear going to face is reduction of bank overdraft by half in next 6 months. Cash situation of company is very poor and they need large injection of funds in order to fulfil Arena orders and sort out company's liquidity problem. Keeble brother already rejected the offer to introduce another major share holder in company because this may dilute Keeble brother's influence.

Financial ratios:

In order to monitor business performance, accounting ratios plays important role in interpreting financial information about company. The more you know about how business is performing, more it will be easier to make informed decisions about how to manage growth in business. These ratios include following details, like, sales, purchases and payment made to employees etc. Used to see how business is doing. We need to analyse these details in order to forecast and compare with competitors. Below are the ratios for Pace Leisurewear ltd with calculation:

Liquidity Ratio:

A business is considered to be solvent when it can pay its debts whenever they become due. This means it can pay its suppliers properly by having enough working capital.

There are two key ratios that help us determining business solvency:

Current Ratio

Quick Ratio

Current Assets include Stock, Trade debtors, other debtors and cash according to balance sheet as on 2008.

Current liabilities include trade creditors, other creditors, taxation, dividends and bank over drafts according to balance sheet as on 2008.

Current assets includes short term assets or receivable and current liabilities implies short term liabilities which is payable in one year.

Current assets for year before last totalled as 4356 (000) and last year as 9974 (000) and current liabilities totalled for year before last as 2482 (000) and for last year as 8844 (000), Ideally, current ratio should be 2: 1 which shows business has enough current assets to pay current liabilities. Current ratio for year before last is 1.8:1 which shows company has enough liquidity to pay his debts, however, current year ratio stating 1:1 which increases concern about the Pace Leisurewear ltd ability to pay its short term debts.

Quick ratio or acid-test ratio measures liquidity more accurate than current ratio because it does not includes value of stock in current assets. Stock takes time to get converted into cash with payment terms typically standing more than 30 days.

In order to calculate quick ratio, we need to remove stock from current assets. Ideal quick ratio should be 1:1, Company year before last quick ratio was 0.8:1 which is somehow acceptable, however, current year quick ratio comes to 0.5:1 which shows company is going to face serious problem with liquidity. Stock totalled for year before last was 2418(000) and for last year was 5820 (000), stock figure shows, company's frequently doubled its stock.

Profitability ratios:

We can measure business is profitable with the help of Profit and loss statement, but in order to put profit into prospective, whether, profit is growing in proportion to the size of business or business is profitable in his sector etc. Below are the profitability ratios of Pace Leisurewear Ltd.

Return on Capital employed: ROCE shows company's profitability percentage on profit before interest and tax over capital employed. Higher the ROCE higher the company's profitability. Year before last ROCE was approx. 20% which increased to 29% in last year because Profit before tax and interest was doubled as compare to year before last, however, at the same time company also increased their fixed assets and current assets to 14470 (000) and 9974 (000). That's why there's in only 9% increase in ROCE otherwise ROCE figure would be 40%.

Return on Equity: ROE measures the return on the funds of the owners and equity shows the total investment of the owners of the firm. ROE for year before last was 18% and last year is 33%, which is almost doubles from year before last. Higher the ROE higher the return for share holders. Net profit after tax and preference dividend increased more than double which shows company earning good return from shareholders equity.

Gross profit margin: Gross profit margin or operating profit margin shows the percentage of amount remaining after paying cost of sales. Company's gross profit increased by approx. 65% from 6510(000) to 10792(000) over sales which increased by approx. 60% from 14006(000) to 22410(000). Gross profit margin for year before last was 46% which increased to 48% in last year. The major factor which affected gross profit margin was cost of sales because cost of sales increased by 55% from year before last to last year.

Net profit margin: This shows relationship between net profit and sales and its widely used ratio in business. Ideally, it should be higher or keep on increasing over year. It shows business net profitability. Net profit margin for year before last was 15% which increased to 21% in last year. Profit after tax increased by 134% over previous which is a very good sign for business future prospective.

Asset management/ Efficiency Ratio:

Efficiency ratios helps to figure out how efficiently business using its assets. There are many different types of ratios which help us to measure efficiency of business.

Stock turnover ratio: This ratio shows the number of days that on average money is tied up in stocks. Year before last stock turnover was 118 days which increased to 183 days in last year. Large turnover days, worst for the business because the money is not available to use anywhere else and money got freeze with stock. Stock is the part of working capital and it's important to quickly convert stock into cash to avoid liquidity problem.

Debtors' turnover ratio in days: This ratio shows, how quickly and efficiently business is collecting its debts. Shorter the period better and longer period more chance for bad debts. Year before last debtor turnover was 42 days (approx) which increase to 61 days (approx) in last year, this shows more time money will be held with debtors.

Creditor's turnover ratio in days: The creditor's turnover shows, in how many days business is paying its debts. Creditor turnover days should be always greater than debtor's turnover days. Longer creditors turnover days good for the business because business holding creditors money for a long time. If we compare creditor and debtor's turnover days for year before last, this shows company is collecting debts from debtors in 42 days and paying to creditors in 59 days and in last year, debtor turnover is 61 days and creditor turnover is 82 days (approx) which is quite good for the business.

Borrowing ratio:

Gearing ratio: Gearing ratio measures of financial leverage which demonstrate the degree to which business activities are funded by owner fund versus creditor funds. Year before last gearing ratio was 34% which shows company is less geared as they have loans of 3600 (000) over equity, however, in last year, gearing ratio increases to 42% which shows company is highly geared as compare to previous year. Company increased the loan amount by 83% (approx) which is 6600 (000). Higher the loans, the more interest company will have to pay and this may affect company capacity to pay dividends.

Cash operating cycle: Cash operating cycle helps business in finding average time between purchases of inventory and receiving cash from sales. Cash operating cycle helps in analysing company's liquidity problem. According to the year before last cash operating cycle, its shows business takes 101 days to convert purchases into sales and in cash. Last year cycle increases to 162 days, this state's in order to generate cash, company need to wait for long 162 days.

Plan of action:

After analysing ratio for last two year, I found that company is soon going to face difficulties with liquidity. Bank already going to reduce over draft by half in next six months and this will make situation worst. Company need to consider in areas which require attention.

Company is highly profitable, still company not able to finding investors. Company may look for investors who can invest in the company in exchange of high returns. Company can encourage customers and suppliers to make investment in the company; however, this may create interference in business by customer and suppliers in future policies.

Company need to bring someone with financial background or expertise to take control over firm financing and investing activities. Company has invested a lot in fixed assets during last year, this shows company is growing rapidly without considering liquidity problem. Company need to control its growth and should more concern on orders to be fulfilled.

Converting stock in cash is best possible short term solution, according to efficiency ratios, large number of stock turnover days affecting company cash conversion cycle which increased by 60% (approx) last year. Conversion of stock will reduce cash conversion cycle and thus increase cash inflow in company. Due to large amount of stock, quick ratio also affected badly. Try to get payment from debtors more rapidly and took a hold over creditors payment.

Examine assets which are not required and thus sell them off in order to generate cash in business.

Company can go forward to cancel proposed dividend for a particular year in order to maintain liquidity.

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