Financial ratios are used in financial analysis to provide an overall picture of the financial performance of a company. Various categories of ratios show different aspects of the financial performance of a company. These categories are the liquidity ratios, asset turnover ratios, financial leverage ratios, profitability ratios and dividend yield ratios. The financial performance of MEDCO can also be analyzed in the above categories.
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The current ratio and the quick ratio are the liquidity ratios that managements of firms use to measure the ability of the firm to meet their obligations in the course of their operations. As a rule of thumb, the current ratio and quick ratio should be 2:1 and 1.2:1 respectively. The current ratio and quick ratios for the four years are more than the given threshold hence the company is able to meet its short-term obligations. There are asset management ratios such as net working capital and net operating working capital. Both are high for MEDCO hence the company is highly liquid.
Profitability ratios show the success of a company in terms of profits. They include gross profit margin, return on assets and return on equity. MEDCO is highly profitable since the gross margin range for the five years is 65% to 68% and it has been increasing. The return on assets and returns on equity are also high and have been increasing hence the company is highly profitable. The company has low leverage since its used debt is in 2010 and it is very low. The overall financial performance of the company is great and can be utilized for growth and expansion.
From the analysis above, the company has three main strengths. The first strength is profitability because the company is highly profitable and is able to use its assets to generate cash flow as shown in the return on assets ratio. Secondly, the asset management of the company is good. As shown by the current ratio and quick ratio, the company is able to meet its short-term liabilities as they fall due. The company is therefore liquid. The last aspect of strength is that the company has low leverage since it has low debt compared to total equity.
Despite the strengths, the company also has three main weaknesses in its financial performance. The first weakness is that the current and quick ratios are too high. This shows that the company holds many assets in terms of current working capital. These should be used to generate more profits. Another weakness is that the company has ignored the use of debt. Some level of leverage is necessary to enhance the profits of a company since debt is a cheaper source of capital. The company should thus consider adopting some optimum level of leverage in order to enhance profitability. The last weakness is that the company has poor cash management because the level of cash is low compared to current assets.
In order to conduct a detailed analysis of the performance of MEDCO, I would need all the financial statements of the company. I would therefore need the statement of cash flows, statement of changes in equity and notes to the financial statements. I would also require the financial results of the other companies in the industry. This is because a complete analysis of the financial performance of a company includes a comparison against the industry average. I would therefore need a summary of the industrial performance. I would also require an analysis of the business environment under which MEDCO operates. This would be in terms of the technological, sociological, economic, legal and political environment. A good understanding of the competition in the industry would also help provide a complete analysis of the performance of the company.
Working capital management means the use of current assets to attain profits in an organization. Generally, less working capital leads to high sales and vice versa. Working capital is the level of liquidity that a company can make use of to develop and grow its business. MEDCO has high net working capital since it has high current assets than current liabilities. This implies that the company does not attain optimum profitability. The ratios of the company show that the company needs to review its asset management strategies since more assets are not used to generate profits (Brigham & Daves, 2009).
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Networking capital is calculated by deducting the current liabilities from the current assets. On the other hand, net operating working capital is calculated by deducting non-interest-bearing current liabilities from the current assets. The main difference between the net working capital and net operating working capital is that networking capital considers all the current assets and current liabilities while the net operating working capital considers only operating current liabilities which are accounts receivable and inventory and operating current liabilities which are accounts payable.
MEDCO is too liquid. This is because the company has more current assets than it needs in the short term. The company is therefore too liquid and this is disadvantageous. One advantage is that the management could misuse the current assets. The other disadvantage is that high liquidity signifies tied-up capital that could have been used in a more profitable way such as diversification through foreign ventures.
The estimates of the cash flow can be done by extrapolating the trends in the five years performance. This will give the estimated performance of the company in 2011. The estimation has been done in the excel attachment accompanying this paper. From the estimation, the company expects to raise $ 2,058 in operating profits and a net income of $ 2,033 after payment of the taxes. Accelerated growth generally reduces the free cash flow of a company. However, MEDCO has high cash flow hence accelerated growth would not have a great effect on the cash flow of the company. This would only occur if the growth goes beyond a certain limit. MEDCO has much idle cash and accelerated growth would amount to the utilization of this free cash flow.
Brigham, E.F. & Daves, P.R. (2009). Intermediate Financial Management. Ohio: Cengage Learning.