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Financial Ratio Analysis of the Restaurant

Introduction

This report on financial ratio analysis is aimed at measuring the general performance of the restaurant. The ratios would help users to get an in- depth understanding of the restaurant’s profitability, financial stability and efficiency with which it is utilizing its assets to generate sales revenue. For the management, their objective would be on how to improve on poor areas and maintain good performance. Its intended users are: the management of the restaurant, customers, employees and the government, who would use it for taxation purposes. The sources of the data used should be published financial statements i.e. the Profit and loss accounts and the balance sheets of the past four years.

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Ratio analysis

Financial ratios are those ratios, which measures the financial performance of the company. This ratios range from the ability of the firm to generate income, ability of the management to use company assets to generate income and the ability of the firm to pay for capital invested. Ratio analysis provides indicators that are used to assess and compare the financial performance of companies both over time and between companies in the same industry. In order to make the ratio analysis useful the information used should be uniform and systematic. Financial ratio have various limitations depending on their interpretations they are various ratios that are used in assessing the financial performance of the company this ratios include liquidity ratios, solvency ratios, profitability ratios, efficiency ratios and valuation ratios.

Liquidity ratios are ratios such as current ratio, quick ratio and cash ratio which are used to measure the ability of the firm to meet short-term current obligations this ratio is centered in the working capital of the firm. The ability of the firm to meet short-term obligations depends on cash resources in the balance sheet.

Profitability ratios are used to measure the ability of form to generate profit, sustain and increase profit and be able to pay dividends and interest. They are number of ratios in this category they include return on assets, return on equity, profit margin and return on investment to mention on a few.

The other ratio is the solvency ratio it measures the ability of the firm to pay long-term obligations by meeting current liabilities as they follow due for payment as well as long-term liabilities. It is measured using total debt to equity, long-term to equity shareholders’ equity ratio and many others. The long-term financial stability of the firm depends on this ratio because it is used in evaluating the long-term risk and returns. It determines the capital structure of the company.

The other ratio that is used is the efficiency ratio this ratios measure how efficient is the management is running the company. This ratios include inventory asset turnover, receive turnover. The last category of ratios is valuation ratios these ratios are used in valuing the company they include price earning ratio, earning yield ratio, dividend coverage ratio and many others.

The management uses various categories of ratios in measuring various financial performances of the company. If they want to improve the management efficiency they will use activity and efficiency ratio. If they want to measure they performance with the industry they will use profitability, liquidity and this other ratios

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References

Cohen, Jerome B.,Edward D. Zinbarg, and Arthur Zeikel, Investment Analysis and Portfolio management, 5th ed. Homewood, IL; Richard D.Irwin, 1987.

Largay, James A III and Clyde P. Stickney, cash flows, ratio analysis and the W.T Grant Bankruptcy, financial analysis journal (1980).

Saunders, Anthony, financial institution management: a modern prospective 2nd ed. (Chicago, IL: Richard D Irwin) 1997.

Appendix

The sample of financial analysis of a company is as follows:

1999 2000 2001 2002
Profitability
a) Gross profit
= Gross profit
Sales
1,163,422
1,125,576
= 1:1.48
= 67.4%
1,176,903
1,750,597
= 1:1.49
= 67.2%
973,070
1,482,057
= 1:1.52
= 65.66%
1,268,495
2,154,659
= 1:1.70
= 58.87%
b) Net Profit
= Net Profit
Sales
107,719
1,725,576
= 1:16
= 6.24%
97,226
1,750,597
= 1:18
= 5.55%
40,326
1,482,057
= 1:36.75
= 2.72%
(11,526)
2,154,659
= – 1:190
= – 0.53%
c) Return on Owner’s Equity
(ROI)
= Net Profit
after tax
Equity
107,719
264,998
= 1:2.46
= 40.65%
97,226
312,224
= 1:3.21
= 31.14%
40,326
327550
1:8.12
= 12.31%
(11,526)
314,024
= – 1:27.24
= 3.67%
d) Return on Total Assets
= Net Profit
after Tax
Total Assets
107,719
513,548
= 1:4.77
= 20.96%
97,226
586,654
= 1:6.03
= 16.57%
40,326
536,708
= 1:13.31
= 7.51%
(11,526)
483,494
= – 1:41.95
= – 2.38%
e)Financial Stability
Current Working capital
Current Assets
Current liabilities
64,498
12,350
= 0.19:1
77,425
54,930
= 0.71:1
45,926
38,158
= 0.83:1
20,125
21,470
= 1.07:1
f) Quick Asset/Acid Test
= Current Assets – Stock
Current Liabilities
64,498 – 15,300
12,350
= 0.25:1
77,425 – 125,000
54,930
= 0.85:1
45,926 – 11,200
38,158
= 1.10:1
20,125 – 9,300
21,470
= 1.98:1
g) Debt Ratio
= Total Liabilities
Total Assets
248,550
513,548
= 0.48
= 48%
274,430
586,654
= 46.78%
209,158
536,708
38.97%
169,470
483,494
= 35.05%
h) Business Activity
Turnover of Inventory
= Cost of Sales
Average Stock
562,154
[36,852+15,300]/2
= 22 times
573,694
[15,300+12,500]/2
= 41 times
508,987
[12,500+11,200] /2
= 43 times
886,164
[11,200+9,300]/2
= 86 times
i) Accounts Receivable Turnover
= Credit Sales
Average Debtors
1,725,576
[10,053+12,748]/2
= 151 times
1,750,597
[1,748+43,600]/2
= 63 times
1,482,057
[43,600+18076] /2
= 48 times
2,154,659
[18076+8,500] /2
= 162 times

On profitability, it can be noted that the profitability of the Regency Blue Ribbon is declining over time. This is shown by the Gross profit margin ratio and the net profit margin ratio. In 2000, the ratio declined to 67.2% from 67.4% in 1999 before declining further to 65.66% and 58.87% in 2001 and 2002 respectively. The net profit margin ratio also declined to 5.55% in 2000 from 6.24% in 1999. In 2001 it further declined to 2.72% and then –0.53% in 2002. Even though profitability of the company has been declining, it is slightly above the industrial average that stands at 62% for gross profit and 9.1% for net profit.

The return on owner’s equity also shows a down word trend through the periods 1999 to 2002. (See appendix). From the period 1999 to 2001, it was above the industrial average. However in 2002, the ratio was below the industry average of 12.1% i.e. 3.67%. The return on Assets has also shown a declining trend from 20.96% to 16.57%, then to 7.51% and –2.38% in the years 1999, 2000, 2001 and 2002 respectively. However, there exists no record of the industrial average to compare with.

On financial stability, the current ratio indicates that the firm was financially stable only in 1999. This ratio was 0.19:1. This means that for every $1 of current assets there are only $0.19 of current liabilities. The recommended ratio is 0.5:1 i.e. current assets should be twice as much as current liabilities. But in this case, they are more than twice the current liabilities. Compared to the industrial average ratio of 0.95:1, the Regency Blue Ribbon is better of. Through the years 2000, 2001, and 2002, its financial stability declines as shown by the ratios 0.71:1, 0.83:1 and 1.07:1respectively.

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The quick Asset Acid test ratio also declines from 0.25:1 in 1999 to 0.85:1 in 2000. The ratio indicates how able the firm is in meeting its financial obligations from the most liquid assets. It further declines to 1.10:1 to 1.98:1 in 2001 and 2002 respectively.

However there is an improvement of the debt ratio from 48% to 46.78% from 1999 to 2000 respectively The debt ratio is an indicator of the percentage of current assets that have been financed through borrowed capital. It means that in 1999 48% of the total assets were financed through debt. In 2000, 2001 and 2002 they were 46.78%, 38.97% and 35.05% respectively. It means the firm might be financing its assets using internal means like retained earnings that are less costly to the organization.

The rate at which the Regency Blue Riboon converts inventory into finished goods is increasing over the years. As shown by the inventory turnover ratio, the number of times that stock was turned to sales i.e. the ‘buy and sell’ frequency was 22 times in 1999. This improved to 41 times in 2000, then 43 times in 2001. 2002 recorded the highest performance of 86 times. It means that the efficiency with which the firm is utilizing its stock to generate sales revenue is high and improving overtime. It is high above the industrial average of 7 days.

However, activity with regard to debtors (accounts receivable) shows a haphazard performance with improvements being interchanged with poor performance. It was only in 1999 and 2002 when the company recorded a high accounts receivable turnover of 151 times and 142 times respectively. Even though the turnover rates in 2000 and 2001 were lower at 63 times and 48 times respectively, these were above the industrial average of 26.75 days.

If additional borrowings would however adversely affect the restaurant’s balance sheet position, they should withdraw the expansion plan. Additional borrowings can increase the restaurant’s gearing hence subjecting it to financial risk.

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