The significant issues that this company faces are connected to the ROI, ROCE, and operating margin ratios, which decreased significantly in 2012 and 2013. Although ROI and ROCE improved in 2014, data from previous years may indicate issues with how executives manage the company’s resources. For instance, Mcclure (2018) states that General Machinery’s problems with ROCE may suggest that the company does not have a competitive advantage over other organizations in the industry.
Moreover, the gross margin of the General Machinery decreased from 2010 until 2014 by 5%; therefore, the company generates less profit per each dollar it spends. It can be concluded that the problems discussed above indicate that the company is not using its resources efficiently enough, which is a risk for an investor.
To improve performance, the company has to pay additional attention to its gross margin and overhead costs, which may be causing the issues described above. One has to analyze the gross profit to identify the possible problems. Thus, an increase in gross profit margin with an increase in total gross profit may be connected to the lesser selling price (“Gross profit margin ratio,” n.d.).
Alternatively, if total gross profit increased over the years of analysis, the competition in the industry may have improved, or the market has less demand for General Machinery’s products. Therefore, the recommendation is to examine the existing pricing strategy and market conditions to identify the causes of issues.
The Cash Flow statement helps interpret the ratios and financial performance of the company by providing information regarding the actual profitability of a business. Schmidt (2018) states that this data helps examine “company’s sources of cash and uses of cash, over a specified period” (para. 2). Ratio analysis provides information about the financial resources that General Machinery has and its application for generating profit, which meets the requirement of case questions because it helps identify issues that this company faces and their sources. The most important ratios are gross profit margin and overhead sales over the past two years.
It is because by using this information an investor can determine whether General Machinery is capable of maximizing gross margin and controlling overhead costs. Additionally, investors may be interested in the dividends per share ratio because it indicates how much profit investors can receive from General Machinery. The ratios of lesser value are asset turnover and inventory turnover because they show the percentage of stock that General Machinery has and usage of assets, which are not crucial for this analysis.
One needs to compare current year ratios with previous year ratios to understand the dynamic of the company’s operations. According to Collier (2016), they allow examining “trends in performance year on year,” (p. 168). Ratios of competitors in the same industry or a benchmark are crucial for analyses of ROE and similar statements. It is because different business sectors may have different approaches to using resources, setting margins, and retaining profit, depending on the objectives and specifics of a business.
Therefore, the general analysis of these ratios may be ineffective because the calculations would not provide a clear understanding of the actual operations. Additionally, it is crucial to analyze companies for investment opportunities not only by examining ratio computations but also by reviewing the specific circumstances and industry changes that may affect a particular business.
References
Collier, P. M. (2016). Accounting for managers: Interpreting accounting information for decision making (5th ed.). Hoboken, NJ: Wiley.
Gross profit margin ratio. (n.d.). Web.
Mcclure, B. (2018). Spotting profitability with return on capital employed. Web.
Schmidt, M. (2018). Cash flow statements: Reviewing cash flow from operations. Web.