This report involves the completed corporate performance analysis of Blacksea Plc during the financial period of the financial years 2009 and 2010. This will include analyzing the financial statements, specifically the income statement and the balance sheet. This report analysis consists of the financial ratio analysis of Blacksea Plc. It will focus on the profitability (return on capital employed, return on assets, net profit margin, gross profit margin and asset turnover), efficiency (Receivables/Debtors period, Payables/Creditors period and inventories) and liquidity (current and quick acid test) ratios.
A ratio is an expression of a relationship between two or more quantitative variables. On the other hand, financial ratios show the interrelationships between different elements in the financial statements. A clear understanding of these relationships provides the user with a deeper insight, concerning the financial status of a business, which is very appropriate, when making financial decisions. The analysis of financial ratios involves determining a standardized connection between figures, showing up in the financial statements as well as using those relationships, known as ratios, to evaluate the business' financial performance and position. A number of techniques have to be used in ensuring that financial statements of different businesses have been simplified and made compatible. Such method may incorporate the use of great tools, for example, common sized financial statements and ratios analysis. However, although ratios are easy to understand and calculate they have a number of disadvantages that will be argued in this paper.
Financial Ratio Analysis - Profitability
Return on capital employed assesses the profitability and efficiency of the company and considered by many investors who would like to invest. It indicates whether the company has enough revenue and profits, so as to use its capital assets to the fullest. The return on capital employed has decreased from 24.42% in the year 2009 to 6.44% in the year 2010. This decrease shows that the company is not profitable. It also shows that the company is not using its capital in an efficient way and that shareholders aren’t investing as much in the company. Return on capital employed and net profit margin are two ratios that are interrelated. The decrease is probably due to increased competition in the industry (Perks & Leiwy 2010).
Gross profit margin assesses the company’s health financially. This is done by looking at the cash balance from revenue after accounting for cost of goods sold. Gross profit margin is used, when making comparison of a company with its competitors. The gross profit margin has also decreased from 12.3% in the year 2009 to 4.72% in the year 2010. This is an indicator that the company is not efficient in its production process. The decrease is probably due to increased competition in the industry, leading to lower selling prices and, thus, a lower gross profit (Atrill 2009).
The net profit margin is worsening. It has decreased from 4.17% in the year 2009 to 1.52% in the year 2010. A decrease is an indicator that the company cannot control its costs, since it is experiencing a lower margin of safety. The company needs to employ good pricing strategies for it to be profitable. The decrease is due to a lack of internal control over the company’s expenses (Perks & Leiwy 2010).
The Return on assets is a ratio, used to assess how profitable a company’s assets are when they generate revenue. It informs an investor on how much profit a company creates for each dollar in assets. The return on assets has decreased from 12.20% in the year 2009 to 2.59% in the year 2010. Asset turnover shows the relationship between revenues and assets. It tells an investor the total sales for each dollar of assets. The asset turnover for 2009 is 2.92 times, while for 2010 is 1.69 times. The decrease shows that the company’s management is not doing its job efficiently (Gibson 2008).
Financial Ratio Analysis - Efficiency
The trade receivables/debtors collection period is 11.7 days in the year 2009 and 12.8 days in the year 2010. Both periods are low. However, though the trade receivables are more than the trade payables and they are the indicators that there is a negative cash flow. This ratio shows the velocity of debt collection in the company. The trade payables/creditors collection period is 0.9 days in the year 2009 and 1.2 days in the year 2010. This shows that the debts are not being repaid on time (Watson & Head 2010).
Financial Ratio Analysis - Liquidity
The current ratio for the year 2009 is 1.1:1, while for the year 2010 is 0.8:1. The company has the capability to still pay its debts annually and its short term obligations. The quick/acid test ratio is an indicator of the company’s liquidity position. The quick/acid test ratio for the year 2009 is 1.1:1, while for the year 2010 is 0.8:1. This ratio is the same as the current ratio. This is so since there was no inventory turnover. The decrease in the current and quick ratio is due to the probability that the company does not have liquid assets and if they are there they do not have higher returns. The company is having cash shortage and, thus, has been forced to sell its inventory so as to ensure sales (Gibson 2008).
Following the financial analysis of Blacksea Plc, investors should not invest in it. This is so since the asset turnover of the company has worsened, showing that the total sales for each dollar of assets are 1.69 times in 2010, compared to 2.92 times for the previous year. This is also evident from the return on assets, which shows that the company is not generating much profit for each dollar in assets, showing a decrease of 9.61% from 2009 to 2010.
Return on capital employed also shows that investors who would like to invest cannot invest in the company. This is so since the company is no longer profitable and is not using its capital in an efficient way. The return on capital employed has decreased from 24.42% in the year 2009 to 6.44% in the year 2010 (Westerfield & Ross 1988).
The use of financial ratios is not very helpful, especially when used on a standalone basis. Analysts evaluate all financial ratios against the most prevalent type of comparison. Financial analysts will naturally identify those companies in the same industry and, thereby, consider the average of the industry, which is compared to the company being evaluated. Lev and Sunder further argue that the relationship between the variables, used in the computation of financial ratios, is based on assumptions, which have not been verified (Westerfield & Ross 1988). These authors state that the primary reason ratios are appropriate because “they control size and other factors”, to mean that ratios hold the size of the firm and other factors constant. The questions, raised by these authors, are: “are there theories to test the control for size hypothesis, what is the structural relationship between examined variables and size; and what is the best way to control for industry-wide factors”.
Most financial ratios mostly rely on the information, which has been documented in the financial statements. Most financial statements are associated with several limitations, therefore, leading to limitations in the ratios, derived from them. The existence of various accounting concepts and conventions has also been a major contributor of disadvantages, associated with financial ratios. Personal opinion has always played a great part in determining the accuracy and relevancy of figures, obtained in financial statements. The subsequent ratios, obtained from such statements, are only useful if they are evaluated against past business results.
It can be argued that practitioners and researchers use financial ratios as a financial analysis tool, never bothering to evaluate their underlying theories and methodologies. The use of financial ratios is based on years of acceptance, assumptions and generalizations, which may not be necessarily valid. From this paper’s review, it is clear that there are few theories that support the use of financial ratios for financial analysis. This problem necessitated studies to enable the deduction of theories from statistical data, and there has been one such development, facilitated by GT approach, a research method, commonly used in accounting research. Grounded theory (GT) approach is a research design that uses available data to formulate a theory. Marcus (2001) defines GT “as an inductive, iterative, comparative and systematic method for data collection and analysis. It starts with empirical data and inductively develops theory to explain the data collected, using a set of coding procedures” (Marcus 2001). GT approach is handy in the identification and explanation of new and old ideas. GT approach may be what researchers need for theory formulation to justify the use of financial ratios in financial analysis.
Conclusion & Recommendation
By assessing the efficiency ratios, the company knows how well it will use its assets and liabilities internally. The profitability ratios, on the other hand, give the financial performance and position of the company, while liquidity ratios assess the working capital of the company financially. Blacksea Plc needs to change its pricing strategies. The organization should employ good pricing strategies for it to be profitable (Atrill 2009).
Blacksea Plc can increase its return on capital employed by cutting down on unnecessary costs. This, in turn, will help in increasing the profit margin, since the lower the net profit, the lower the return on capital employed. Investors, the owners, creditors and shareholders among others need to invest more in the company. At the same time, the company needs to control its costs so as to prevent experiencing a lower margin of safety. It should also be efficient in its production process and the company’s assets should be utilized efficiently. The company needs to focus on its strengths and look out for new opportunities, so as to have a competitive advantage over its competitors as well as attract more clients (Atrill 2009).