# Ratio Analysis for Alpha Company

2021-05-11
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This paper discusses the various ratios for Alpha Company. The paper evaluates the ratios under liquidity ratios, leverage ratios, profitability and asset management ratios.

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Liquidity

Liquidity ratios tell whether an organization can meet its short-term obligations that fall due. Current ratio and acid test ratio tells whether a company is liquid or not (Shim & Siegel, 2000).

Current ratio

The current ratio for Alpha is 1.7, which is greater than the recommended value, 1. This means that the company current assets are greater than the current liabilities. There are no chances that the company will face difficulties paying its shorter debts that fall due. It also means that the company has cash to buy items that are needed in the daily operations of the company.

It is recommendable that the company pays off some of its current liabilities so as to reduce misuse of cash in the company. The presence of cash and equivalents in the workplace encourage misuse by employees which can have adverse effects on the company. There is a need to allow the customers some days before they pay debts, because this can increase sales for the company. Increased debts increase the current assets hence the current ratio.

Acid test ratio

This ratio considers that some items categorized as current assets are not liquid and cannot be easily converted into cash to make payments that are needed (Periasamy, 2009). For Alpha Company, the acid test ratio is 1.04, which is not very close to the value of the current ratio. However, the company is doing well since it is evident that the company can make payment for the current liabilities without selling inventory.

The company has to manage the current assets well, by ensuring that the current liabilities are paid for. The alpha company can also invest some of its cash in short-term investments such that the gains from such investments can be used to pay off current liabilities.

Leverage ratios

Leverage ratios show whether a company is at the risk of becoming bankrupt because of its inability to pay long-term liabilities. This part evaluates two leverage ratios which are debt utilization ratio and interest coverage ratio.

Debt utilization ratio

The ratio evaluates the company debts compared to the total assets the company owns. For Alpha company, the debt utilization ratio is 0.5, meaning that the company debts are half the value of the company assets. The company can sell its assets and repay its debts, leaving half of its assets in place to continue with operations. The company is in a position to borrow more cash and engage in investments that bring in more revenues for the company.

It is recommendable that the company manage its various sources of capital in such a way that ensures that the company is not at a risk of becoming bankrupt. As for now, the company should take an additional loan in case it has viable projects that can generate more cash. It can use its assets as a security in this case. This is as long as the company continues to generate more revenues hence paying off its debts from the revenues generated.

Interest coverage ratio

This ratio tells whether a company is able to repay its interest with ease and the principle amount also. The higher the value of the ratio, the better it is for the company. Looking at the case of Alpha, the value for interest coverage ratio is 8.8times, meaning that the annual interest for the company is well covered by the profits that are generated by the company. With such a ratio, there are no chances that the company will default in payment of its interest. There is no credit risk associated with the company, and creditors have greater confidence with the company.

It is recommendable that the company continuously pay its debts to reduce its burden. While the ratio does not show the principle amount that is to be paid, it is important for Alpha Company to repay its principle loan to ensure that the loans do not become a great cost for the company.

Profitability ratios

These ratios are very important because they show whether the company is achieving its main objective of creating value for the shareholders invested funds (Brigham, 2013). Return on assets ratio, gross profits ratio and return on equity ratios are evaluated in the case of Alpha Company. The higher the ratios are, the better is the company in terms of performance.

Return on assets

The return on assets ratio measures the extent to which a company is utilizing its assets to create value for the company (Brigham, 2008). For Alpha Company, the ratio is 5%, which shows that the company is creating a positive value for the company shareholders using its assets. This is considering that the ratio is positive. However, the value is very low, and there is a great room for improvement.

It is recommendable that the company uses its assets in a better way to generate more profits. If the company is making a significant amount of revenues, there is a need to evaluate the costs and expenses that have to be managed to ensure that the net profit for the company is higher and that the return on assets ratio is higher than it is now.

Return on equity

The ratio compares net profits to the equity for the company (Glynn, 2008). According to the analysis, the value is 11%, which is positive and shows that the company is creating a positive value for the company shareholders. The company is utilizing its equity well to generate value for the company. However, a positive trend showing an increase in the value is important.

The recommendation is that there is a great room for improvement, and the company should evaluate its revenues and develop strategies to increase the same, as well as reduce the expenses where possible to ensure that the company has greater net profits value.

Gross profit margin

The ratio shows the profits generated before including expenses in the financial statements (Gibson, 2009). It shows the potential the company has in generating net profits. For Alpha Company, the gross profits margin ratio was 29%. This is a reasonable value for the company since the company is creating positive value.

The company can make improvements further to achieve a greater ratio, which would be beneficial for the company. At the same time, the company should take care of the expenses incurred by the company, such that the generated gross profits are not all utilized in paying expenses in the company such that the net profits are very low. By managing expenses, it is possible to create a positive value for the company considering the value of the gross profits.

Turnover ratios

These ratios tell whether the company is managing the various company assets well to generate revenues and liquidity of the company.

Accounts receivable turnover

The ratio measures the efficiency in collecting receivables, and the higher the ratio, the better it is for the company. For Alpha Company, the accounts receivable turnover ratio is 5.79times. The ratio shows that the company collects its receivables 5.79times in a year.

The ratio is low, and there is a need to increase it as long as this does not affect the sales revenue. The discount period can be reduced to ensure that the company remains more liquid by continuous receipt of revenues from the creditors.

Average age of accounts receivable

This is a conversion of the accounts receivable turnover in days (Sharan, 2009). The ratio of Alpha indicates 63 days, meaning that receivables are collected after every 63 days. This is more than two months, and the company may suffer because of a shortage of cash for the company.

There is a need for the company to reduce the credit period, and be more vigilant in the collection of receivables. This may increase the costs of collecting receivables, but the benefits of being liquid are far much greater for the company.

Inventory turnover

The ratio measures the extent to which the inventory in the company is moving. A greater ratio is recommended. For Alpha Company, inventory turnover is 4times, which is a low ratio and should be improved. It shows that the company stock is not moving fast enough.

The company should engage in marketing activities to encourage more sales which will mean that the company is moving fast.

Average age of the inventory

This ratio tells the number of days the inventory is in the company stores before it is sold to the customers. The ratio is 87days for Alpha Company, meaning that the company takes a lot of time before selling its inventory. There is a need to manage inventory in a better way to avoid storage costs at the company.

The company can adapt Just-in-time strategy to ensure that the inventory does not stay for a long period in the company stores. The company can also market its products to ensure that it moves fast. This can help reduce the number of days it takes before the stock is sold (Chandra, 2008).

Asset turnover ratio

The ratio tells the rate at which the company is generating revenues using its assets (Chandra, 2005). A greater ratio is recommended. For Alpha company, the ratio is 0.86, meaning that the company is not efficiently generating revenues using its assets. There is room for improvement, and the company can use its assets to generate more revenues.

It is recommended that the company makes efforts to utilize its assets more. The assets have to be put in a better use to ensure that the revenues generated are reasonable, based on the assets the company has. The company has to find better ways of using its assets to generate revenues (Wahlen, & Baginski, 2011).

Conclusion

The company is doing well in various sectors according to the ratios. The company has a good liquidity and leverage, meaning that the company cannot face any financial problems any time soon. The company is also in a better position to borrow more funds and invest in projects that have good returns. The company needs to improve on asset utilization, by ensuring that all the assets are put into good use to generate revenues and profits. The company also need to improve its profitability since there is a great room for improvements.

References

Brigham, E. F., & Ehrhardt, M. C. (2008). Financial management: Theory and practice. Mason, OH: Thomson South-Western.

Brigham, E. F., & Houston, J. F. (2013). Fundamentals of financial management. Mason, Ohio: South-Western.

Chandra, P. (2005). Fundamentals of financial management. New Delhi: Tata McGraw-Hill Pub.

Chandra, P. (2008). Financial management: Theory and practice. New Delhi: Tata McGraw-Hill Pub.

Gibson, C. H. (2009). Financial reporting & analysis: Using financial accounting information. Mason, OH: South-Western Cengage Learning.

Glynn, J. J. (2008). Accounting for managers. London: Cengage Learning.

Periasamy, P. (2009). Financial management. New Delhi: Tata McGraw-Hill.

Peterson, D. P., & Fabozzi, F. J. (2012). Analysis of financial statements. Hoboken, NJ: Wiley.

Riahi-Belkaoui, A. (1998). Financial analysis and the predictability of important economic events. Westport, Ct: Quorum.

Rajasekaran, V., & Lalitha, R. (2011). Financial accounting. New Delhi: Dorling Kindersley.

Sharan, V. (2009). Fundamentals of financial management. Delhi: Pearson Education / Dorling Kindersley (India.

Shim, J. K., & Siegel, J. G. (2000). Financial management. Hauppauge, N.Y: Barron's.

Wahlen, J. M. & Baginski, S. P., Bradshaw, M. T., & Stickney, C. P. (2011). Financial reporting, financial statement analysis, and valuation: A strategic perspective. Mason, OH: South-Western Cengage Learning.

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