The financial statements do not provide a comprehensive overview of the financial performance of the company. Therefore, it is important to use several techniques to evaluate the financial performance of the company. An example of such a technique is ratio analysis. Ratio analysis enables the stakeholders to evaluate the profitability, liquidity, and solvency of the company.
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Besides, ratios provide a common base for comparing the performance of the company with other companies in the same industry. This guides the stakeholders in making decisions that relate to their association with the company. The treatise provides an analysis of the information presented in the balance sheet. It also carried out ratio analysis.
The current assets in the balance sheet should be arranged in the order of liquidity. This implies that the most liquid asset should be recorded first. In most cases, cash will be the first item because it is the most liquid. The balance sheet of Jack in the Box Inc. follows this order.
The most liquid item that is, cash and cash equivalent is first in the list while the last item is other current assets. The balance sheet can also be prepared in order of permanence. In this case, the non-current assets will be first in the list followed by current assets arranged in order of permanence. The value of current assets declined from $231,181 in 2012 to $175,429 in 2013. The decrease amounted to $55,752.
The company classifies the assets into current assets and records the non-current assets in separate lines for each of the items. Therefore, the current assets are listed and a total of the current assets is provided. The other assets that are listed on separate lines are property and equipment (at cost, accumulated depreciation and net book value), goodwill, and other assets. The total assets amounted to $1,463,725 for the year 2012 and $1,360,418 for the year 2013. Therefore, there was a decline in the value of total assets by $103,307.
Cash equivalents are investment securities that have low risk and low return. These securities are extremely liquid, they are short-term and have a great credit quality. The examples of these securities are corporate commercial paper, Treasury bills, and certificates of deposits.
The reported amount of current liabilities at the end of the year 2013 was made up of current maturities of long-term debt ($20,931), accounts payable ($26,594), and accrued liabilities ($169,792). The total current liabilities at the end of that period amounted to $217,317. Further, the items that made up current liabilities for the year 2012 were current maturities of long-term debt ($15,952), accounts payable ($94,713), and accrued liabilities ($164,637). Thus, the total current liabilities at the end of the year 2012 amounted to $275,302. Therefore, it can be noted that there was a decline in the amount of current liabilities by $57,985.
Usefulness of the balances reported
Analysis of current assets, total assets and current liabilities of the company is an important aspect to a potential investors, creditors and employees. The current assets and current liabilities give information on the working capital financing policy used by the company. It also provides information on the liquidity of the company.
For example, the value of current liabilities exceeded the value of current assets. This shows that the company is experiencing problems in paying current liabilities. It may also imply that the company is using an aggressive working capital financing policy.
This may not be a good indication to investors, creditors and employees. The value of total assets gives information on the asset base of the company. Growth in the value of total assets shows that the company is experiencing growth in performance. However, a decline in the amount of total assets does not provide a favorable sign to the potential investors, creditors and employees.
Calculation of ratios
The table presented below shows the calculation of ratios. The end year values will be used in the calculation.
|Current ratio |
Current assets / current liabilities
|175,429 / 217,317 |
|231,181 / 275,302 |
|Quick ratio |
(Current assets – inventory) / current liabilities
|(175,429 – 8,203) / |
|(231,181 – 7,752) / |
|Receivables turnover |
Credit sales / accounts receivables
|1,151,886 / 41,972 |
|1,160,397 / 78,798 |
|Inventory turnover |
Cost of sales / inventory
|1,151,886 / 8,203 |
|1,160,397 / 7,752 |
|Asset turnover |
Sales / total assets
|1,151,886 / 1,489,407 |
|1,160,397 / 1,529,650 |
|Profit margin |
Net profit / revenue
|28,324 / 1,151,886 |
|45,174 / 1,160,397 |
|Return on assets |
Net profit / total assets
|28,324 / 1,489,407 |
|45,174 / 1,529,650 |
|Return on common stockholder’s equity |
Net profit / shareholder’s equity
|28,324 / 417,231 |
|45,174 / 411,945 |
|Debt to total assets |
Total debt / total assets
|(359,514 + 20,931) / 1,489,407 |
|(405,276 + 15,952) / 1,529,650 |
|Times interest earned |
Earnings before interest and taxes (EBIT) / interest expense
|101,506 / 12,061 |
|89,704 / 14,962 |
Interpretation of ratios
The current ratio declined from 0.8397 in 2012 to 0.8072 in 2013 while the quick ratio declined from 0.8116 in 2012 to 0.7695 in 2013. The decline is not a good indication and it may discourage the debt providers, creditors and investors. It shows that the company is facing problems in paying debts. Besides, it shows that the current assets cannot adequately cover current liabilities. Receivables turnover increased from 14.73 in 2012 to 27.44.
The ratio shows an improvement in efficiency because the company can collect debt within a shorter period of time. The inventory turnover ratio declined from 149.69 in 2012 to 140.42 in 2013. The decline is not a good sign because it shows a reduction in the movement of stock. A supplier, debtor, debt provider, and an investor will be interested in these ratios because they measure the efficiency and management of liquidity.
The asset turnover ratio declined from 0.7586 in 2012 to 0.7734 in 2013. The increase was attributed to a decline in the value of total asset. It shows that the amount of sales generated per unit of total assets increased. The profit margin declined from 3.89% in 2012 to 2.46% in 2013. The decline implies that the profitability reduced. It shows that the company is not efficient in managing pricing and the cost of running the business.
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Further, return on assets declined from 2.95% in 2012 to 1.90% in 2013. This shows a decline in the ability of the company to generate sales from the assets available. Finally, the return on shareholder’s equity declined from 10.97% in 2012 to 6.79% in 2013. This shows a decline in efficiency of the company in using the capital provided by shareholders to generate profit. Profitability ratios are important to all the users these are, debtors, supplier, investors, employees, government, investors, community, and debtor providers.
The debt to asset ratio provides information on the leverage level of the company. The ratio declined from 0.2754 in 2012 to 0.2554 in 2013. This shows a decline in leverage. A potential investor and a debt provider will be interested in this ratio because it gives information on the leverage risk of the company.
A low ratio implies that the company has a low level of leverage risk and this will attract investors. The times interest earned ratio measures the number of times the interest expense can be paid from EBIT. The ratio increased from 5.9955 times in 2012 to 8.4161 times in 2013. The increase can be attributed to an increase in profitability and a decline in interest expense. A potential investor and a debt provider will be interested in this ratio because it measures the solvency of the company.
The discussion above shows that the company experienced a decline in performance in the year 2013. First, the company reported a decline in total assets and current liabilities. It implies that the overall financial position of the company declined. Secondly, the liquidity ratios reveal that the company is experiencing problems in paying current obligations.
Thirdly, the profitability ratios show that there was a decline in profitability in 2013. Finally, the leverage level and solvency of the company improved because the amount of debt reduced. Therefore, it can be concluded that the overall financial position of the company declined in 2013.