Question One

Introduction

Analyzing financial statements through the use of financial ratios is a popular technique

that assists both business owner and manager to make decision for corrective action to

improve performance of the business. It is a ratio of selected numerical values taken from

enterprise's financial statements. There are many standard ratios try to evaluate the

overall financial condition of a corporation or other organization.

[http://en.wikipedia.org/wiki/Financial_ratio] Since Jordan limited is considering the

possibility of diversifying its operations, the profitability; liquidity; efficiency; and

shareholder ratios of Plum Ltd, Mapple Ltd and Zodiac Ltd has been analyzed to gauge

the takeover decision. In order to identify the potential takeover target, detail analysis and

faithful recommendations are illustrated in this assignment.

Significance of each ratio

Financial ratios are often used to indicate trends in profitability, in operating efficiency

and asset utilization, in liquidity, in leverage and in short-term and long-term financial

statement analysis. [Han Kang Hong, Sng Gek Neo, and Pang Yang Hoong, 1990,

Company Accounting & Finance, 2nd end FT Law & Tax Asia Pacific, Singaore]

Profitability ratio

Profitability ratios use to measure trading performance of a business by comparing profit

to sales or capital. The six profitability ratios includes ROCE before tax, Net profit, Asset

turnover ratio, gross profit, Sales/fixed assets, and Sales/current assets are important for
manager to measures the firm’s use of its assets and control of its expenses to generate an

acceptable rate of return. Besides, bankers and lenders, employees, shareholders and

potential shareholders would interest in these ratio because they should protect their own

benefit. Consequently the higher the profitability ratios are, the more benefit it is the

business can offer its stakeholders.

Liquidity ratio

Current ratio and acid test ratio are liquidity ratios that use to measure the firms’ ability to

meet short-term financial obligation. These ratios are necessary for every business to

continue business and grow. Both liquidity ratios should ideally be between 2:1 and 1:1,

if the ratio fall bellows 1:1, then the business is said to be potentially ‘insolvent.’ These

ratios are important to bankers and creditors because they need to evaluate the

creditworthiness of the company and the likelihood of insolvency in order to decide

whether to extant credit or not. Additionally, shareholders and management also use these

ratios to determine whether to invest to a company or divest existing shareholding.

Efficiency ratio

Debtors average collection days and Average stock holding period are efficiency ratios

that use to measure the speed and efficiency made of assets and other resource. A faster

turnover of assets and debt means that less money is tied up in the assets. Thus, higher

efficiency indicates the better financial performance. Shareholders and banker need these

in formations to help them to predict future events.

Shareholder ratio

Shareholder ratios concerned with value of ordinary shares. Ordinary dividend% and

dividend cover are considered as shareholders ratios. Shareholders are interested in these

ratios because they need to measure how much benefit can gains from a company. Hence,

the higher this ratios is, the more profit have been retained. This ratio is important to

identify how strong a firm is to gain profit.

Analysis of profitability & comments

The first profitability ratio ROCE before tax in the statement indicates the net profit can

be earned from each Ringgit of fixed assets and working capital. Zodiac Ltd has highest

volume in this ratio which is 25%. Mapple Ltd has 23.7% and Plum Ltd has only 22.1 %.

This means that Zodiac Ltd made far better use of its capital, earned greater profit as

achieving a return of RM 25 net profit for every RM 100 invested.

The second ratio net profit % or net profit as percentage of sales gives the profit margin

of sales. It tells about the net profit of each Ringgit of sales make. Among the three firms,

Mapple Ltd makes more profitability sales because the company can gain RM 12.5 net

profit from every RM 100 of sales. However, sales of Plum Ltd can gain 12% of net sales

which is only 0.5% different from Mapple Ltd. Disappointingly; Zodiac Ltd earned only

RM 3.75 net profit of every RM100 sales.

Asset turnover ratio is the third profitability ratio in the statement that efficiency of assets

in generating sales. In this ratio, Zodiac Ltd has extremely good performance which is
3.75. However, Mapple Ltd is moderate one among three firms but its asset turnover ratio

is only 1.16.Plum Ltd has the lowest volume about 1.45. These reflect favorably on

Zodiac Ltd’s ability to efficiency employ assets.

The next profitability ratio is Gross profit % or gross profit as percentage of sales that

reveals the profit before deducting expenses that makes from sales. The sales of Mapple

Ltd make more gross profit among those firms, achieving RM 25 from every RM100 of

sales. Plum Ltd has 25% gross profit on sales whereas Zodiac Ltd has only 10% gross

profit on sales.

The following ratio in the statements is Sales/fixed assets. This tells the utilization or

turnover of fixed assets. According to the statement, every RM 100 of Zodiac Ltd can

bring in the highest sales revenue which is RM 11.6. Fixed assets of Plum Ltd gain

medium sales revenue about RM 4.8 of every RM 100 fixed assets compared among the

three firms. Fixed asset of Mapple Ltd bring the lowest sales revenue which is RM2.2

from every RM 100 of fixed assets.

The last profitability ratio in this statement is sales/current assets. This ratio represents

the turnover of current assets. In this case, current assets of Zodiac Ltd is the most

valuable one because current assets of Zodiac Ltd can gain as more as 5.5% sales

revenue. Performance of Plum Ltd also good because its’ current assets gain 5.2% sales

revenue which is only 0.2% low than Zodiac. Plum Ltd defeat because its’ current assets

can earn only 2.1% sales revenue.

Analysis of liquidity & comments

The two following ratios include current ratios and acid test ratios are liquidity ratios.

Current ratio indicates the extent to which the claims of short-term creditors are covered

by assets that can be translated into cash in the short-term. Firm that has the most stable

performance in current ratio is Plum Ltd. Plum Ltd has RM3.75 of assets to meet a

Ringgit of debt. Zodiac is average performance on current ratio as it has RM 1.5 to meet

each Ringgit of debt whereas Mapple Ltd that has only RM 1.4 to meet each Ringgit of

debt. Compare to another two firms, Mapple Ltd’s, the position has slightly deteriorated.

If the liability of Zodiac Ltd and Mapple Ltd are increasing until their assets divide by

liquidity become less than one, the business is potentially bankrupt.

Acid test ratio is useful to measure a firm’s ability to pay off short-term obligations

without relying on the sale of inventory. [Carlos Correia, David Flynn, Enrico Uliana,

Michael Wormald, 2006, Financial Management, Juta and Company Limited] The

performance of Plum Ltd, Mapple Ltd and Zodiac Ltd is 2.25, 0.4, and 0.9 respectively

on Acid test ratio. This reveals that Plum Ltd is the most stable performance. Mapple Ltd

is in the most deteriorate situation. However Zodiac not the most lousiness firms but it is

in urgent situation because the acid test ratio is falls below 1:1. Nevertheless, Acid test

ratio doesn’t crucial because it is related to Stock Turnover. The faster stock is sold, the

less important is Acid test ratio.

Analysis of efficiency & comments

The followed ratios are about the efficiency of debtor collection and stock holding. For

the debtors average collection days ratio, Zodiac Ltd has outstanding performance

because the debtor collection date is only 37 days. Plum Ltd used of moderate period to

collect its debt which is 40 days. Nevertheless, Mapple Ltd has longest debtor collection

period which is 42 days. This indicates that Mapple Ltd has no proper credit control

system, whereas Zodiac has an extremely efficient credit control system.

The stock turnover ratios reveal that the average period for Zodiac Ltd‘s stock was only

in 28 days which is far faster one compared to the other two firms. The average stock

holding period of Plum Ltd is in 84 days whereby Mapple Ltd is in the lengthiness 134

days. This reveals that Mapple Ltd is in a dangerous situation as the customers’ orders

could not be fulfilled in time and sales may be lost to competitors.

Analysis of shareholder ratio & comment

The second last ratio mentioned in the statement is ordinary dividend ratio that indicates

value of a share worth. Zodiac Ltd has a greater performance in its’ ordinary dividend

ratio as 30%. Mapple Ltd is the moderate one which is 15% whereby Plum Ltd is the

lousiest one which is only 10%.

The last ratio in the statement is dividend cover ratio that measures the number of times

profit can pay ordinary shares dividend. Dividend cover measures the number of times

profit can pay ordinary shares dividend. Mapple Ltd is better in this ratio because its
profit can pay as more as five time to the ordinary shares dividend. Plum Ltd has 4.3

times which is only 0.7 times slightly lower than Mapple Ltd. Nevertheless, profit of

Zodiac Ltd has only one time to pay for its ordinary shares dividend. Hence, Mapple Ltd

is more capable in paying dividends to shareholders.

Recommendation

Financial ratios is useful for decision making because it provide a profile of the past

performance and financial strength of a company. Zodiac Ltd has better overall

performance in profitability ratios but the gross profit ratio and net profit ratio of Zodiac

Ltd is the lowest one among three firms. Whereby, Mapple Ltd is better in the net profit%

ratio and gross profit% ratio. This represents the profit margin on sales of Zodiac very

low. At least Zodiac Ltd has make profit on sales, the volume of profits makes would not

very important to influence the takeover decision.

Liquidity ratios show that Plum Ltd has better capable ability to meet its current liability

out of its current assets. However, Zodiac Ltd not the best in this ratios but its still is in

safety situation because it has fastest stock holding period and debtors average collection

days. As a result of the efficiency, Zodiac Ltd no needs to face financial insufficient

problem.

Shareholder ratios shows that shares of Zodiac Ltd is worthiness, whereby the dividend

cover times of Zodiac Ltd is fewest but Mapple Ltd has more dividend cover times. This

means Zodiac Ltd has high capital gains but lower dividend pay out rates.
Conclusion

Conclusively, Zodiac Ltd is the suggested firm to be takeover by Jordan Ltd because it

can gain more profit on assets. Besides, however its profit on sales is fewest among three

firms but it is more efficiency in collecting debt and holding stock. As a result, Zodiac

Ltd has the most stable performance. As Jordan takeover Zodiac Ltd, Jordan Ltd no needs

to take a lot of risk to facing financial insufficient problems. In addition, shareholder

would be more interested in Zodiac Ltd’s because the business provides highest return on

investment.