EXECUTIVE SUMMARY

The case illustrates the importance of the financial ratio analysis in terms of decision

making, where it necessary to confronting with external demand; in this instance from

the financial intermediary called ABC Bank Ltd. By analyzing the various Ratios and

subsequent factors which influenced company’s financial performance and position in

the local hotel called RDB PLC and Local hospitality context, the report will highlights

the importance of understanding relevant ratios to compute credit worthiness of the

company to find out whether the banking facility could be granted or not.

.
Introduction

RDB PLC is in a hospitality trade, sited in Galle and newly setup venture in
Trincomalee. As per the current economic volatility and with the expectations of tourism
boom which happened as a result of the post war social and financial stability in the
country, The company is expected to widen its horizons by further financing its
activities via gaining an additional long term loan from the ABC Bank Ltd.

With reference to the request made by RDB Ltd , This report is all about analyzing the
relevant financial element by using its ratios in order to justify the decision taken in. The
report further suggests the fact that assessment of credit worthiness in not merely
depends on the ratio analysis but also ascertain with other factors.

SELECTION CRITERIA OF RATIOS

Financial Ratios

Ratio analysis is a relationship between two or more financial indicators which can be
used as yard stick for evaluating financial position and the performances, credit
worthiness of an organization. This can be used to benchmark the organization and
enable to do financial forecasts and trends in decision making. Further Business can be
reviewed with sound understanding of the company’s historical information, as well as
future financial stability.

Profitability ROCE, Gross Profit, Net Profit

Financial Gearing Gearing Ratio, Interest Cover

Liquidity Current Ratio, Quick Ratio

Efficiency Debt Collection Period
1. Return on capital employed (ROCE)

This shows how much profit earns from the investment the shareholders have made in
their company and this indicates the profitability in order to review the overall
performance of the business. This is needed to see, whether the company is able to
generate returns (profit) to its investors. Basically this measures primary success of the
company.

2. Gross Profit

This means, the profit the business makes on its cost of sales. The gross profit margin
is used to analyze how efficiently a company is using its resources to generate profits. A
reasonable growing in the gross profit margin is a good indication that the business is in
a growing market.

3. Net Profit

By subtracting selling, general and administrative expenses from a company's gross

profit number, we get operating income. Management has control over operating
expenses and it measures the relative impact. A growth in this ratio means that the
business has managed its expenses in relation to sales.

4. Gearing Ratio

This gives the information on the company’s capital structure. It gives the composition
between the debt and equity capital. This tells weather the shareholders funds can
cover the existing long term debts taken by the Company.

5. Interest cover

Interest cover is the safety margin that the business has in terms of being able to meet
its interest obligations. This is needed to ascertain whether the company is making
sufficient profits to cover its interest payments and measure of risk associated with
borrowing.
6. Current ratio

This measures the ability of a company of paying the short term obligations. It assures
that sufficient current assets to settle its current liabilities and to maintain proper working
capital management. Should be 2:1. Less than 1 is considered as unfavorable.

7. Quick asset ratio (Acid Test)

This measures the ability that it has sufficient liquid assets to settle its current liabilities.
and maintains proper working capital and It should not be less than 1.

8. Debt collection period

This indicates the creditability of the company in settling its trade creditors. This gives
the information on the company’s internal debt collecting efficiency and indicates the
extent of liquidity. Too longer the period could indicate that the debtors are in financial
trouble.
ANALYSING THE FINANCIAL PERFORMANCE AND THE FINANCIAL POSITION

PROFITABILITY RATIOS

According to the case, it can be noted that ROCE ratio has declined compared to the
previous year.

ROCE

2009 2010

27% 23%

This could be due to, drop in sales or maybe a net loss from the newly started
venture in Trincomalee has affected the returns adversely. According to the financial
performance there is a significant drop in the profitability of RDB PLC.

Gross Profit

2009 2010

52% 57%

Gross Profit ratio has increased by 5% and at the same time Net Profit ratio has
declined by 6%.

Net Profit Ratio

 2009 2010

28% 22%

Although the GP ratio has increased, there is a drop in the NP ratio. This could indicate
an increase in the Overhead related expenses of the company i.e. Business has not
managed its expenses in relation to sales.

FINANCIAL GEARING RATIOS

Gearing Ratio

2009 2010

54% 48%

Gearing Ratio has declined by 6% compared to last year and lowering the gearing will
minimize the risk exposure to recover the long term debts by shareholders funds. The
ratio provides that the company has managed to settle its loans and thereby increase its
equity base i.e. Share Capital, Retained Profits

Interest Cover
 2009 2010

6 times 4 times

The company has sufficient profits to cover its interest component, but there is a drop
compared to last year, may be due to profit decline, which could be due to the new hotel

Compared to last year, although the both Gearing and Interest cover ratios are declined,
company’s debt settlement capacity is favorable.

LIQUIDITY RATIOS

Current Ratio

2009 2010

2 1.2

Although the company has sufficient current assets to cover its current liabilities,
compared to last year it has declined. RDB Plc’s Current ratio is below the stranded
level

Quick Ratio
 2009 2010

0.8 0.6

.Quick ratio also has declined and it maintains a level below 1. Main reason for this is
company is maintaining a larger buffer stocks.

EFFICIENCY RATIOS

2009 2010

90 days 60 days

Compared to last financial year, company’s debt collection ratio has declined, i.e.
company has been efficient in collecting its dues from its debtor.

RECOMMENDATION
According to the results of the ratio analysis we can identify that profitability ratios were
reduced compared to last year. We can assume that reduction in profitability ratio
mainly due to the investment in new business ventures in Trincomalee.

Gearing ratios are the main concern of a banker in order to grant a loan facility. Both
gearing and interest cover ratio are favorable and it represents that the company has
the ability to repay its loans by profits.

Analysis represents that both liquidity ratios are unfavorable and decline compared to
last year. As per case they are in short of working capital requirement.

However the company has failed to improve the current and quick ratio, further analysis
is needed on the company’s working capital management. We would suggest to
consider following relevant information for the further analysis pertaining to the case
given.

This can be categorized in three dimensions

Financial Info

• Audited & projected P&L/Income Statement/ Balance Sheet

• Cash flow statement

Non Financial Info

• Identify weather the Company is a long standing customer of the bank

• Directors Characters. (Past track records)

• Market Analysis (SWOT, PESTEL, Michel Porters Five Forces etc)

• Competitor Analysis

• Risk exposure (Market risk, Environmental risk, Operation risk, Legal risk….)

Bank Records

• Business turnover
 • Average bank balance

• Range of the Account

• Standing orders and direct debits and any unpaid cheques

• CRIB Records

On the other hand company is very efficient in collecting it debts which provides that
company can manage its current assets efficiently after financing the working capital.

At the same time the company wants to obtain a long term loan to meet its working
capital requirement and settle some of the loans which are taken with higher interest
rates.

Normally banks are issuing long term loans for purchase of fixed assets and refinancing
of the company where they issue temporary overdrafts (TOD) to cover working capital
requirements.

As bankers, we can state that if the RDB PLC needs to fulfill is both requirement it
should go for a TOD and on the other hand to re-finance it s loans with higher interest
rates RDB PLC can apply for a long term loan. Although the company is running
efficiently and in a favorable position to cover its debts we need to further analyze the
factors mentioned below to grant the loan facility.

CONCLUSION

To re-captivate the whole scenario of the given case, we can conclude, the decision has
to be drawn in favorable to the company, subject to fulfillment of other financial,
nonfinancial and bank records with a satisfactory collateral facility.