Financial Ratios:

Financial ratio analysis is used to evaluate relationships among items given in the financial
statement in order to determine how well an observed company is performing. These relationships
help investors, creditors, and internal company management understand how well a company is
performing. Ratios are designed to reveal some important aspects of a company’s financial health.
There are many ratios, most of them are standardized and divided into four main categories:
profitability, liquidity, activity (efficiency), and leverage (debt) ratios. They can be used for
comparisons between companies, between a company and its industry average, and to identify
trends over time for a single company.

1. Profitability Ratios:
Profitability refers to the ability to generate income. In analyzing a company's
financial statements, the most common profitability ratios used include: gross profit
margin, net profit margin or return on sales, return on assets, and return on equity.
i. Gross Profit Margin:
Gross profit margin, or gross profit rate, measures the percentage of gross revenues
in relation to net sales. Gross profit is what remains of net sales after deducting the cost
of merchandise sold (cost of sales). The formula for gross profit margin is:
Gross profit margin = Gross profit ÷ Net sales
where, Gross profit = Net sales - Cost of sales

ii. Net Profit Margin:

The net profit margin (also known as return on sales) is the percentage of net
income to net sales. Net income the bottom line amount in the income statement. It
represents the income left after all expenses and losses are deducted. The net profit
margin is computed as follows:
Net profit margin = Net income ÷ Net sales

iii. Return on Assets:

Return on assets represents the measure of return on investment in financial
statement analysis. It determines the rate of return in using company resources to
generate income. The formula in computing for return on assets is:

Return on assets = Net income ÷ Average total assets

iv. Return on Equity
The return on equity measures percentage of net income generated by stockholders'
equity. It determines how profitable a company is in utilizing owner's investment
Return on equity = Net income ÷ Average stockholders' equity
 GP Margin of FFC in 2016 is on increasing side and then it decreases in 2017 i.e. 19.95%
which is because their cost is increased while they managed the cost element in 2018 and
they increased their GP margin by almost 5% which is 24.77%. On the other hand, ICI GP
margin is lower than FFC in all 3 years, ICI GP margin is on a decreasing trend every year
they are not managing cost efficiently and effectively as FFC did.

 NP Margin of FFC in 2016 is 13.63 percent indicates the company earns 13.63 cents in
profit for every PKR it collects, while in 2017 it slightly went down and then in next year
it increased their NP Margin because their revenue increased, COGS decreased and
Operating cost decreased. While on the other side, ICI is on a decreasing trend their NP
Margin is decreasing in every year because of high costs.

 ROA was stable in 2016 and 2017 because there were no new assets brought while in 2018
they brought asset and managed it nicely (primarily driven by stock in trade and short term
investments.) which results in higher ROA while on the other side ICI ROE is on decreasing
trend every year because they are not utilizing their assets nicely.

 FFC, Increase in NP Margin, decrease in Asset turnover and increase in Leverage ratio
causes increase in ROE for 2016 while in 2017 all the ratios are opposite as compare to
2016 which results in decrease in ROE, and in 2018 ROE is increase again because they
managed to increase the NP Margin and Leverage ratio and decreased the Asset turnover
ratio. While on the other hand, ROE of ICI is on a decreasing trend because NP Margin is
and Leverage ratios are decreasing every year and asset turnover is stable and increased in
past three years.
 2. Liquidity Ratios:

Liquidity ratio analysis refers to the use of several ratios to determine the ability of an
organization to pay its bills in a timely manner. This analysis is especially important for lenders
and creditors, who want to gain some idea of the financial situation of a borrower or customer
before granting them credit. There are several ratios available for this analysis, all of which use
the same concept of comparing liquid assets to short-term liabilities. These ratios are:

Cash ratio:

Compares the amount of cash and investments to short-term liabilities. This ratio excludes
any assets that might not be immediately convertible into cash, especially inventory.

Quick ratio:

Same as the cash ratio, but includes accounts receivable as an asset. This ratio explicitly
avoids inventory, which may be difficult to convert into cash.

Current ratio:

Compares all current assets to all current liabilities. This ratio includes inventory, which is
not especially liquid, and which can therefore mis-represent the liquidity of a business.

 FFC current ratio in 2016 and 2017 is same i.e. 0.95 but their quick ratio is increased in
2017 i.e. from 0.79 to 0.88 because their cash increased while in 2018 their current ratio
went down and quick ratio is also going down because of increase in inventory and slightly
decrease in A/R and cash. While on the other hand, current ratio of ICI is more than 1 in
all 3 years which is good sign for a company but when we see their Quick ratio which is
very lower than FFC which means they have more than enough stocks they are not utilizing
the inventory efficiently which might obsolete in future and also they are not able to pay
its short term debt from its current assets.
 Cash ratio of FFC is 0.03 in 2016 and then its increased in 2017 i.e. 0.3 while in 2018 its
went down to -0.15 which is not a good sign for a company which means they are not able
to pay their liabilities from its cash. While on the other hand, ICI cash ratio is stable/same
in all three years i.e. 0.01 but it’s not a good sign for ICI as well because they don’t have
enough money as well to pay their short term liability from available cash.
 3. Activity Ratios:

Activity ratios measures how efficiently the business is running. We often call this as
“Assets Management Ratio” i.e. how efficiently the assets of the company are being used by the
management to generate maximum possible revenue. Usually, this ratio indicates how much sales
have taken place in comparison to various categories of assets.

- Total Assets Turnover Ratio:

This ratio measures the efficiency of the firm in utilizing its Assets. A high ratio
represents efficient utilization of total Assets in generating sales.

Formula: (Sales or Cost of Goods Sold)/ Total Assets

- Fixed Assets Turnover Ratio:

This ratio measures the efficiency of the firm in utilizing its Fixed Assets. A high ratio
represents efficient utilization of Fixed Assets in generating sales.

Formula: (Sales or Cost of Goods Sold)/ Fixed Assets

- Inventory Turnover ratio:

This ratio describes the relationship between the cost of goods sold and inventory
held in the business. This ratio indicates how fast inventory/ Stock is consumed/ sold. A high
ratio is good for the company. Low ratio indicated that stock is not consumed/ sold or
remains in a warehouse for a longer period of time.

Formula: Cost of Goods Sold/Average Inventory

Average Inventory = (Opening Stock + Closing Stock)/2

- Debtor Turnover ratio:

This ratio helps the company to know the collection and credit policies of the firm. It
measures how efficiently the management is managing its accounts receivable. A high ratio
represents better credit policy as compared to a low ratio.

Formula: Credit Sales/Average Debtors where, {Average Debtor = (Opening Debtor +

Closing Debtor)/2}

- Creditors Turnover ratio:

This ratio helps the company to know the payment policy that is being offered by the
vendors to the company. It also reflects how management is managing its account payable. A
high ratio represents that in the ability of management to finance its credit purchase and vice
versa.

Formula: Credit Purchase/ Average Creditors

Average Creditor = (Opening Creditor + Closing Creditor)/2

 Total asset Turnover for FFC is 0.72, its increased in 2017 i.e. 0.84 and then it decreased
in 2018 by 0.04 i.e. 0.8 which is not a good sign for a company in every year they are not
utilizing their assets properly to generate sales which results in decrease in asset turnover
ratios. While on the other hand, ICI total asset turnover ratio is utilizing their assets
efficiently which results in increase in TA turnover ratio every year and it’s a good sign for
ICI.
 Fixed asset turnover ratio of FFC is on a decreasing trend despite their sales are on an
increasing side every year but due to purchase of fixed asset as well i.e. due to investment
in natural gas compressors under sustainability plan besides investment in regular capital
expenditure which causes fixed asset ratio declines every year. While on the other hand,
ICI sales are increasing more than they purchase fixed asset which in results increasing the
fixed asset ratio every year.
 For FFC, its cost increased in 2018 and decreased in inventory which causes decrease in
this inventory turnover ratio. While on the other hand, ICI its increased from 4.22 to 4.51
from 2017 to 2018 because its Cost decreased and inventory increased slightly.
 Revival of customary urea demand has resulted in improvement of market dynamics, hence
despite higher record revenue the Company has successfully curtailed credit sales, leading
to increased debtor’s turnover from 23 times in 2017 to 29 times in the 2018. While on the
other hand ICI Debtor turnover ratio has decreased from 19.15 to 15.62 in 2018.
 Payable turnover ratio is increased every year for FFC because their purchases increased
but at the same time their payable is also increased but not at the same rate at which
purchases increased payable rate due to increase in long-term loans obtained for multiple
acquisition / expansion projects in Soda Ash, Chemicals and Agri Sciences and Life
Sciences Businesses but its purchases increased more increasing rate than payables.
 4. Leverage Ratios:

A leverage ratio is any one of several financial measurements that look at how much capital
comes in the form of debt (loans) or assesses the ability of a company to meet its financial
obligations.

- The Debt-to-Equity (D/E) Ratio:

Financial leverage ratio is the debt-to-equity ratio. It is expressed as:

Debt-to-Equity Ratio = Total Liabilities/Total Shareholders' Equity

A high debt/equity ratio generally indicates that a company has been aggressive in financing its
growth with debt. This can result in volatile earnings as a result of the additional interest expense.
If the company's interest expense grows too high, it may increase the company's chances of a
default or bankruptcy.

- The Equity Multiplier:

The equity multiplier is similar, but replaces debt with assets in the numerator:

Equity Multiplier = Total Assets/Total Equity

Although debt is not specifically referenced in the formula, it is an underlying factor given that
total assets includes debt.

- The Interest Coverage Ratio:

This ratio, which equals operating income divided by interest expenses, showcases the
company's ability to make interest payments. You generally want to see a ratio of 3.0 or higher,
although this varies from industry to industry.

 FFC is financing 20% amount of financing by debt via lenders, versus 80% of funding
through equity via shareholders in 2016 while debt ratios are increasing in following years.
While on the other hand, FFC is financing 33% amount of financing by debt via lenders,
versus 67% of funding through equity via shareholders in 2016, this ratio is increased in
2017 while slightly reduced in 2018. Lower this ratio better is for company.
 Financial leverage ratio for FFC in all 3 years are lower which means company is more
funded by stockholders. While on the other hand, ICI financial leverage ratios are high in
all 3 years which means company is mostly funded by debt which is not good for ICI they
have to bear debt servicing costs which means that they will have to generate more cash
flows to sustain optimal operating conditions.
 Interest coverage ratio for FFC is 14.25, 7.44 and 8.23 in 2016,2017 and 2018 it is
decreasing because the debt financing is increasing in following 2 years of 2016. While on
the other hand, ICI can only pay 12, 7 and 3 times interest payments from its EBIT in 2016,
2017 and 2018 the reason for decreasing this ratio because the company is more financed
by debt then stockholders.