Calculation and Interpretation of Financial Ratios
The income statement and balance sheet are the traditional basic financial statements of a business enterprise. They do not give all the information related to the financial operations of a firm. Still, they provide some extremely useful information to the extent that balance sheet mirrors the financial position on a particular date in terms of structures of assets, liabilities and owners’ equity and others and profit and loss account shows the results operations during a certain period of time in terms of revenues obtained and the cost incurred during the year.
In depth analysis of financial statements is supported with ratio-analysis. It is the most widely used technique of financial statement analysis. Ratio analysis is a systematic use of ratio to interpret the financial statements so that the strengths and weaknesses of a firm as well as its historical performance and current financial condition can be determined. Ratios are relative figures reflecting the relationship between variables. A single figure by itself has no meaning but when expressed in terms of related figure, it yields significant inferences. Ratios can be divided into profitability ratio, liquidity ratio and activity ratio.
To analyse the financial statement and condition of the Pace Leisurewear Ltd, the method of ‘ratio analysis’ is used as a major tool. Here, return on capital employed, return on equity (shareholders’ fund), gross profit margin, net profit margin, inventory holding period, average collection period for trade receivables, sales to capital employed ratio, current ratio, quick assets (liquid or acid test) ratio and gearing ratio are used as major tools for the interpretation of business condition and financial statements, though there are other tools for the interpretation. Calculation and interpretation of these ratios provide us with the information about liquidity, profitability and efficiency of the company. The calculation and interpretation of the ratios can be shown as below:
Return on Capital Employed (ROCE)
ROCE ratio tells us how much profit we earn from the investment the shareholders have made in their company. If the company has low ROCE ratio, it is using its resources inefficiently, even if its profit margin is high. The higher the ratio the more efficient is the use of capital employed.
In context of the Pace Leisurewear Ltd, ROCE ratio was increased in the last year than the year before last. From the calculation, we got, it was 30% in the last year whereas it was 20% in the year before last. So, we can say that the company had better performance in the last year than the year before last.
Return on Equity
This ratio indicates the profitability to the shareholders of the firm with deduction of all expenses and taxes.
In context of this company, the return on equity ratio was increased which is good for the company. It was 32.5% in the last year and 18% in the year before last.
Gross Profit Margin
It indicates the efficiency of operations and firm’s pricing policies. The larger the gross profit margin, the better for the company. It looks at how well a company controls the cost of its inventory and manufacturing of its products and subsequently pass on the cost to its customers.
From the calculation we found that the gross profit margin ratio was increased. It was 46.16% in the year before last and 48.16% in the last year which is good for the company.
Net Profit Margin
This ratio measures the relationship between net profit and sales of a firm. A high net profit margin in ratio is an indicative of adequate return to the owners as well as enables a firm to wit
