Financial and Managerial Accounting: Analysis of Liquidity, Profitability, Financial Leverage, and Activity Measures

This article provides an analysis of the liquidity, profitability, financial leverage, and activity measures of a2 Milk Company. It includes calculations of working capital, current ratio, acid test ratio, ROI, ROE, PE ratio, debt ratio, debt/equity ratio, account receivable turnover, and inventory turnover. The overall assessment concludes that the company is a good investment opportunity.

Running head: FINANCIAL AND MANAGERIAL ACCOUNTING
Financial and managerial accounting
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1FINANCIAL AND MANAGERIAL ACCOUNTING
Table of Contents
Liquidity.....................................................................................................................................2
Profitability................................................................................................................................2
Financial leverage......................................................................................................................3
Activity measures.......................................................................................................................4
Overall assessment.....................................................................................................................5
Reference....................................................................................................................................6

2FINANCIAL AND MANAGERIAL ACCOUNTING
Liquidity
1. Calculation of working capital, current ratio and acid test ratio
Ratio Formula 2017 2016 2015
Liquidity
Working capital
Current assets - current
liabilities 155,940 105,615 31,581
Current ratio
current assets/current
liabilities 2.52 2.38 2.09
Acid test ratio
(Current assets-prepayments-
inventories)/current liabilities 1.89 1.49 1.59
2. Liquidity position
It can be seen from the above calculation that the working capital ratio of the
company is in increasing trend and it significantly increased $ 31,581,000 to $ 105,615,000
from 2015 to 2016. However, it further increased to $ 155,940,000 in 2017. The current ratio
of the company is in increasing trend and it went up to 2.52 from 2.09 over the years from
2015 to 2017. Therefore, for all the years the current ratio of the company was better than the
industry average of 2. On the other hand the acid test ratio of the company for 2017 was 1.89
that is better than the industry average of 1.6. However, for other years it is slightly lower
than the industry average. Therefore, the overall liquidity position of the company is strong
and the company is efficient in paying off its short-term liabilities (Sarlin 2015).
3. Relation of working capital with current ratio
Working capital is the difference amount of current assets remained after deducting
the amount of current liabilities whereas the current ratio is computed through dividing the
current assets by current liabilities.
If the firm has higher working capita it is expected to have higher current ratio. The
reason is that higher working capital represent higher amount of current assets as compared to
current liabilities and the same results into higher current ratio.
Profitability
4, 5, 6. ROI, ROE and PE ratio for 2015, 2016 and 2017

3FINANCIAL AND MANAGERIAL ACCOUNTING
Ratio Formula 2017 2016 2015
Profitability
Net profit margin Net profit/sales *100 0.19 0.08 -0.01
Total asset turnover Sales / total asset *100 1.60 1.68 1.74
Return on investment
Net profit margin * total asset
turnover 29.69 12.89 -1.28
Return on equity Net profit / shareholder's equity 0.42 0.20 -0.04
P/E ratio Price per share / EPS 29.70 39.50 -193.94
Dividend payout ratio NA NA NA
Dividend yield ratio NA NA NA
7. Dividend payout ratio and dividend yield
As the company did not pay dividend for the year 2015, 2016 and 2017, the dividend payout
ratio and dividend yield is nil.
8. Analysis of profitability
From the above calculation it can be seen that return on investment of the company
for the year 2017 is 29.69% that is better than the industry average of 15%. However, for
2016 the ratio is 12.89 that is lower than the industry average. Industry average for net profit
margin is 10%. However, except for 2017 other year’s profit margin is lower than the
industry average. Total assets turnover of the company for all the 3 years are better than the
industry average of 1.5. ROE and P/E ratio of the company for the year 2016 and 2017 is
better than the industry average of 20% and 14.0 respectively. However, as the company was
not able to earn positive income for the year 2015 the entire profitability ratio for 2015 is in
negative. Therefore, the overall profitability position of the company for 2017 is better than
the industry average (Delen, Kuzey and Uyar 2013).
9. Dividend
For the last 3 years the company did not pay any dividend and therefore the dividend
yield is nil. Dividend yield is calculated through dividing the dividend per share by share
price per share. On the other hand ROI is calculated through dividing the net profit by total
asset. Therefore, if ROI increase by 5% there must have been increase in the net profit of the
company. Hence, the dividend yield expectations of the investors will increase with the
increase in net profit (The a2 Milk Company 2018).

4FINANCIAL AND MANAGERIAL ACCOUNTING
Financial leverage
10. Debt ratio and debt/equity ratio
Ratio Formula 2017 2016 2015
Financial leverage
Debt ratio Total liabilities / total assets 0.30 0.37 0.34
Debt equity ratio Total liabilities / shareholders equity 0.42 0.58 0.52
11. Analysis of leverage position
Looking into the above table regarding the debt ratio and debt equity ratio it can be
found that both the ratios of the company have been increased in the year 2016 as compared
to the year 2015. However, it was able to reduce the ratio during the year 2017. High leverage
ratio represents that the company use high percentage of borrowed funds to finance its assets
and to continue its daily operation. Higher leveraged firm is considered to be exposed to
higher financial risks. Generally, the debt ratio of 40% or lower and debt equity ratio of 1 is
considered as the industry average. It can be identified that both the ratios of the company for
all the 3 years are lower than the industrial average and therefore will be the company will be
considered as lower leveraged (The a2 Milk Company 2018).
12. Relationship of ROI and ROE
ROE as well ROI both are used to measure the profitability of the company. Financial
leverage is the debt amount utilised by any firm for purchasing its assets. Very high level of
financial leverage enhances the un-sustainability risk as the company will be burdened with
higher amount of interest obligation.
If the firm has higher degree for financial leverage the percentage difference among
ROI and ROE will be increased as the debt portion will increase and equity portion will be
reduced which in turn will increase the ROE (Waworuntu, Wantah and Rusmanto 2014).
Activity measures
13. Account receivables
Ratio Formula 2017 2016 2015
Activity measures
Account receivable turnover Sales / average receivables 9.29 8.26 4.60
No. of days sales in 365 / account receivable turnover 39.30 44.19 79.34

5FINANCIAL AND MANAGERIAL ACCOUNTING
receivables
14. Analysis
The company is doing efficient job as the account receivable turnover is in increasing
trend and the company has improved its collection period from 79.34 days to 39.30 days.
The industry average for collection period 45 to 60 days and the company has improved its
receivable days as per the industry average in 2017 (Lunardi et al. 2014).
15. Inventory collection
Ratio Formula 2017 2016 2015
Activity measures
Inventory turnover
Cost of goods sold / average
inventories 7.06 7.02 13.58
No. of days sales in
inventories 365 / inventory turnover 51.73 51.99 26.89
16. Analysis
Though the company’s inventory turnover is in decreasing trend and the company has
increased the days from 26.89 days to 51.73 days to replace its inventory it will still be
considered efficient as the industry average is 35 to 55 days (Post and Byron 2015).
Overall assessment
The criteria that will be taken into consideration to investment are profitability
position, liquidity position, activity measures, financial leverage and return provided to the
shareholders. These all measures will assist to predict the return on the investment of the
investors. However, taking these measures for a2 Milk Company in consideration it can be
concluded that the company is a good investment opportunity.

6FINANCIAL AND MANAGERIAL ACCOUNTING
Reference
Delen, D., Kuzey, C. and Uyar, A., 2013. Measuring firm performance using financial ratios:
A decision tree approach. Expert Systems with Applications, 40(10), pp.3970-3983.
Lunardi, G.L., Becker, J.L., Maçada, A.C.G. and Dolci, P.C., 2014. The impact of adopting
IT governance on financial performance: An empirical analysis among Brazilian
firms. International Journal of Accounting Information Systems, 15(1), pp.66-81.
Post, C. and Byron, K., 2015. Women on boards and firm financial performance: A meta-
analysis. Academy of Management Journal, 58(5), pp.1546-1571.
Sarlin, P., 2015. Data and dimension reduction for visual financial performance
analysis. Information Visualization, 14(2), pp.148-167.
The a2 Milk Company. 2018. The a2 Milk Company. [online] Available at:
https://thea2milkcompany.com/ [Accessed 29 May 2018].
Waworuntu, S.R., Wantah, M.D. and Rusmanto, T., 2014. CSR and financial performance
analysis: evidence from top ASEAN listed companies. Procedia-Social and Behavioral
Sciences, 164, pp.493-500.