Financial Ratios Analysis for SMEs

This assignment examines the financial sustainability of Small and Medium-Sized Enterprises (SMEs) in the cultural and creative sector. Students will utilize various financial ratios to assess the financial health and performance of these businesses, exploring their unique challenges and funding sources. The analysis will draw upon academic literature and real-world examples to provide insights into the financial management practices of SMEs in this dynamic sector.

Portfolio-Case Study

TABLE OF CONTENTS
INTRODUCTION...........................................................................................................................1
Portfolio 1........................................................................................................................................1
A. Computation of 10 financial ratios....................................................................................1
B. Interpretation of above calculated financial ratios.............................................................3
C. Recommendations to increase performance of companies..............................................13
D. Discuss limitations of ratios............................................................................................14
Portfolio 2......................................................................................................................................15
Capital Investment Appraisal ........................................................................................................15
A. NPV, ARR and Payback period calculations..................................................................15
B. Limitations of the investment appraisal...........................................................................18
CONCLUSION..............................................................................................................................19
REFERENCES..............................................................................................................................20

INTRODUCTION
Financial statements are important elements of business. From this, financial ratios are
computed which provides financial position of the company and are useful for comparison as
well with another company. This report deals with comparison of two companies such as Sports
direct plc and JD Sports organisation which are retailers of sport goods. For such comparison,
financial ratios are being calculated so that financial position of both the organisations may be
highlighted with much ease (Rodrigues and Rodrigues, 2018). Various capital investment
appraisal techniques are also highlighted and there limitations as well. Both the firms are
required that they perform well in the market by increasing efficiency so that financial position
may be strengthen up to great extent with much ease. The poor performance of both of them may
be reduced by implementing strategies so that they may gain efficiency in the market with much
ease.
Portfolio 1
A. Computation of 10 financial ratios
Sports Direct International Plc
Ratios Formula 2016 2015
Current ratio
Current Assets/ Current
Liabilities 2.43 :1 2.3 :1
Quick ratio
CA- Stock - Prepaid Expenses /
Current Liabilities 0.62 :1 0.94 :1
Gross Profit margin
Revenue - Cost of goods sold /
Revenue 44.00% 43.00%
Operating Profit margin
Operating income / Net sales *
100 7.68% 10.43%
1

Net Profit margin Net profits / Net sales x 100 9.60% 8.52%
Gearing ratios
Total debt + Bank overdrafts /
Shareholders' equity 0.70% 0.52%
Earnings per share Net income/ Outstanding shares 40.60% 46.80%
Return on capital employed EBIT / Capital employed 0.19% 0.17%
Average inventories turnover
period Sales / Average Inventory 2.65% 2.61%
Dividend payout ratio Dividends / Net income 0 0
JD Sports Fashion Plc
Ratios Formula 2016 2015
Current ratio
Current Assets/ Current
Liabilities 1.46 :1 1.22 :1
Quick ratio
CA- Stock - Prepaid Expenses /
Current Liabilities 0.78 :1 0.53 :1
Gross Profit margin Revenue - Cost of goods sold / 49.00% 48.00%
2

Revenue
Operating Profit margin
Operating income / Net sales *
100 7.30% 6.10%
Net Profit margin Net profits / Net sales x 100 14.00% 11.83%
Gearing ratios
Total debt + Bank overdrafts /
Shareholders' equity 0.97% 1.90%
Earnings per share Net income/ Outstanding shares 50.61% 35.17%
Return on capital employed EBIT / Capital employed 0.29% 0.25%
Average inventories turnover
period Sales / Average Inventory 2.47% 2.38%
Dividend payout ratio Dividends / Net income 16.20% 27.60%
3

B. Interpretation of above calculated financial ratios
1. Current ratio -
The current ratio is an important aspect to firm as it ensures that whether it is capable to
meet obligations or not. The above calculations show that sports direct international plc has 2.30
and 2.43 ratio in 2015 and 2016 years that directly indicates it will be able to pay off liabilities
within stipulated time with much ease (Borin, Donato and Sinapi, 2018). While, JD sports
fashion plc has current ratio in 2015 and 2016 as 1.22 and 1.46 which is not at all good. It has not
welled liquidity position then sports direct international plc. Ideal ratio is 2 : 1.
2. Quick ratio-
4
Sports Direct International Plc JD Sports Fashion Plc
0
0.005
0.01
0.015
0.02
0.025
0.03
2015
2016

The quick ratios calculated for both the companies may be interpreted that quick ratio of
sports direct international plc is 0.94 and 0.62 in the year 2015 and 2016 which means that it has
poor liquidity position and will be unable to meet its extreme short-term obligations. On the
other hand, JD sports fashion plc has 0.53 and 0.78 in 2015 and 2017 which is also poor. Quick
ratios of both companies are not good to meet obligations on time.
3. Gross profit margin-
5
Sports Direct International Plc JD Sports Fashion Plc
0
0.001
0.002
0.003
0.004
0.005
0.006
0.007
0.008
0.009
0.01
2015
2016

From above chart, it may be interpreted that gross profit ratio of sports direct organisation
is 43.81 % and 44.23 % in the year 2015 and 2016 respectively. It will generate more profit as it
is increased from the past year (Du and Rada, 2018). While, JD sports organisation has 48 % and
49 % in the year 2015 and 2016 which is also good and will be able to produce more revenue.
4. Operating profit margin-
6
Sports Direct International Plc JD Sports Fashion Plc
0.41
0.42
0.43
0.44
0.45
0.46
0.47
0.48
0.49
0.5
2015
2016

From the chart, it may be conveyed that operating profit margin ratio of sports direct
company is 10.43 % and 7.68 % which is not good. This profit is analysed by creditors and
investors so that they may conclude about giving loan to company or investing in the same. But
operating profit has been declined (Dimitropoulos, Vrondou and Avgerinou, 2018). However, JD
sports company has 6.1 % and 7.3 % which is much poor than other company as stakeholders'
will not be attracted to the company for investment.
5. Net profit margin-
7
Sports Direct International Plc JD Sports Fashion Plc
0
0.02
0.04
0.06
0.08
0.1
0.12
2015
2016

The chart shows net profit margin ratios of two organisations. It reveals that sports direct
firm has net profit in 2015 and 2016 as 8.52 % and 9.60 % that it is not good as cost exceeds
profits. This has been guided by market analysts that more the net profit margin, better for the
company as it will be generate more profits in the near future with much ease. While, JD sports
has 11.83 % and 14 % which is also not good as cost exceeds revenue but is good in comparison
to sports direct organisation.
6. Gearing ratio-
8
Sports Direct International Plc JD Sports Fashion Plc
0
0.02
0.04
0.06
0.08
0.1
0.12
0.14
0.16
2015
2016

From the above computation, it may be interpreted that gearing ratio of Sports direct firm
has 0.52 % and 0.70 % in the year 2015 and 2016 which is good as lower the gearing ratio, better
for the company (Hofmann, Strewe and Bosia, 2018). The lower is better as debt payable to
creditors is lower. It is better for the financial position of it in the market. In addition to this, JD
sports company has 1.9 % and 0.90 % in both years which is also good for the company as it has
lower debt.
7. Earnings per share-
9
Sports Direct International Plc JD Sports Fashion Plc
0
0.2
0.4
0.6
0.8
1
1.2
1.4
1.6
1.8
2
2015
2016

From the above calculation, it may be interpreted that earnings per share of sports direct
has good earnings as it has 46.8 % and 40.6 % in 2015 and 2016 years which is good as investors
will be attracted towards it. Moreover, the market price of shares will increased. Further, it
shows viability of business. On the other hand, JD sports has 35.71 % and 50.61 % in both
financial years as market price of shares is increased up to great extent.
8. Return on capital employed-
10
Sports Direct International Plc JD Sports Fashion Plc
0
0.001
0.002
0.003
0.004
0.005
0.006
2015
2016

From the calculations, it may be interpreted that return on capital employed of sports
direct is 0.73 % and 0.19 % in both years which shows that it is earning good return on capital
employed in the organisation. JD sports company has 0.25 % and 0.29 % in 2015 and 2016
which is also good rate as it is effectively making revenue on capital employed in the business
with much ease.
9. Average stock turnover ratio-
11
Sports Direct International Plc JD Sports Fashion Plc
0
0.05
0.1
0.15
0.2
0.25
0.3
0.35
2015
2016

The above calculations show that sports direct has good inventory turnover ratio as it has
inventory management and is quickly selling stock as inventory turnover ratio is 2.61 % and 2.65
% in both financial years (Altman and et.al, 2017). While, other company has 2.28 % and 2.47 %
in 2015 and 2016 years respectively which is also good as it is better managing inventories in the
most productive way.
10. Dividend payout ratio-
12
Sports Direct International Plc JD Sports Fashion Plc
0.022
0.0225
0.023
0.0235
0.024
0.0245
0.025
0.0255
0.026
0.0265
0.027
2015
2016

From the above table, it may be interpreted that dividend payout ratio of sports direct
organisation is 0 in both financial years which implies that it is not earning profits and is in debt.
It also shows that it is retaining dividend amount which is payable to shareholders'. While, JD
Sports has 27.6 % and 16.2 % in 2015 and 2016 years which is good as it is imparting dividends
and is earning good quantum of profits.
13
Sports Direct International Plc JD Sports Fashion Plc
0
0.05
0.1
0.15
0.2
0.25
0.3
2015
2016

C. Recommendations to increase performance of companies
Firstly coming to current ratios, Sport direct has ideal ratio as it will be able to pay off
current liabilities with much ease. But it is not good for JD Sports company. It is hereby
recommended that it should sell off unproductive assets as it increases costs and gains nothing to
the organisation (Dyreng, Mayew and Schipper, 2017). Moreover, it increases interest on it. In
addition, quick ratio of Sports direct company is better than JD sports company. It is
recommended that liabilities must be paid off on time.
Gross profit margin is not good for both the organisations. It is recommended that cash
discounts should be taken from the suppliers of raw materials. Taking discounts will initiate
more profit and as a result, company may be able to strengthen financial position. Further,
moving to operating profit margin, both the companies have poor operating profit margin. It may
be increased by minimising cost of goods sold. This may be done by reviewing expenses and
cutting down cost of sales. This will provide better operating profit to both firms.
Earnings per share can be increased by taking buy backs of shares. It is vital part of
organisation as shareholders' are attracted to invest in profitable company and make sure that
good returns are being generated. As such, Sports direct plc should buy backs shares. Stock
turnover ratio or inventory turnover ratio may be improved by buying less inventory from
suppliers as additional inventories increases costs for procurement. It leads to spoilage and
increases cost incurred in maintaining in warehouse. As such, it is recommended that companies
should buy only required inventories for production purpose as more inventories maximises
handling costs and gradually increases expenditures of the organisation.
Gearing ratios should also be lower down so that no burden of paying debt may arise.
However, debt should be taken but in less amount. Instead of this, organisation should make a
perfect blend or mixture of both debt and equity so that advantages of both of them may be used
by organisation (Atoom, Malkawi and Al Share, 2017). It is recommended that adequate mix of
debt and equity is better for both companies. Moreover, dividend payout ratio may be improved
by Sports direct as in both years, it has retained it and not distributed to shareholders' which is
not good as they may lose interest in the organisation. Company should increase performance so
that dividends may be provided to shareholders'.
14

D. Discuss limitations of ratios
Ratios impart effective results but has certain limitations as well. It is based on previous
accounting figures and facts which are deficient and may be manipulated. This impacts adversely
and as such, it does not provide concrete conclusions. Moreover, comparison is not possible as
one organisation charges different methods and other one uses different method for valuation
purpose and as such, it does not generate accurate results (Delen, Kuzey and Uyar, 2013). This
may be explained with an example, Sports direct company is using FIFO method for valuing
stock and JD sports uses LIFO method which shows variations and leads to inaccurate results.
Apart from this, different methods are charge for depreciation, preliminary expenses
which is difficult for comparison purpose as well. Accounting policies are also followed
differently by various companies. As such, JD Sports uses diminishing method for calculating
depreciation and at the same time, Sports direct plc uses straight line method and as a result,
conclusions drawn are different which is not provided by financial ratios and as such, they are
difficult to compare (Limitations of financial ratios).
Inflation may lead to difference in balance sheets as historical cost based balance sheets
and accounting figures are not adjusted as firms purchase assets on different dates and often lead
to misconception and does not provide appropriate results to organisation. As a result, without
adjustment false information is provided to business which is not meaningful. Apart from this,
financial ratios are not useful as it does not initiate operational changes which is required by the
company. This leads to misconception as ratios calculated years ago and then compared with
same ratios today produces inaccurate conclusions. As a result, misleading conclusions are laid
by financial ratios which provides improper conclusions.
Moreover, company follows different strategies for attracting customers'. As such, if JD
Sports plc follows low cost strategy and as such, low profit margin may be forecasted by it.
While, if Sports direct plc charges high prices of its products and following more profit margin,
then if two companies are compare on the basis of financial ratios, results will be misleading and
of no use to both companies (Buchman, Harris and Liu, 2016). As such, financial ratios are
unable to compare two companies which follows different methods and accounting polices. It is
not much reliable to calculate financial ratios as concrete results are not delivered by it.
15

Portfolio 2
Capital Investment Appraisal
A. NPV, ARR and Payback period calculations
Calculation of Payback period :
Project 1
Year net cash flow Cumulative cash inflow
2017 90 90
2018 90 180
2019 90 270
2020 80 350
2021 80 430
2022 70 500
Payback period: 1 + 80 /90
= 1.8 years
Average rate of return
Year Profit
2017 65
2018 65
2019 65
2020 55
2021 55
2022 45
16

Average profit 58.33
Average initial investment (170+20)/2 90
ARR (average profit / average investment) 64.81%
17

Calculation of NPV :
Year Profit Depreciation
net cash
flow
PV factor @
20%
Discounted cash
inflow
2017 65 25 90 0.833 75
2018 65 25 90 0.694 62.5
2019 65 25 90 0.579 52.08
2020 55 25 80 0.482 38.58
2021 55 25 80 0.402 32.15
2022 45 25 70 0.335 23.44
150000 350
Total
discounted
cash inflow 283.76
25
58.33333333
33 II 170
-
56.24335562
41 58.33 NPV 113.76
Project 2
Year Net cash flow Cumulative Cash flow
2017 53.33 53.33
2018 63.33 116.66
2019 73.33 189.99

2020 103.33 293.32
2021 113.33 406.65
2022 93.33 499.98
Payback period: = 170 + 116.66/ 73.33
= 2.73 years
Average rate of return
Year Profit
2017 25
2018 35
2019 45
2020 75
2021 85
2022 65
Average profit 55
Average initial investment (170)/2 85
ARR (average profit / average investment) 87.48%
Calculation of NPV :
Year Profit
Depreciatio
n
Net cash
flow
PV factor @
20%
Discounted cash
inflow
2017 25 28.33 53.33 0.833 44.4

2018 35 28.33 63.33 0.694 44.0
2019 45 28.33 73.33 0.579 42.4
2020 75 28.33 103.33 0.482 49.8
2021 85 28.33 113.33 0.402 45.5
2022 65 28.33 93.33 0.335 31.3
170000 330
Total
discounted
cash inflow 257.49
28.33 32.35% II 170
329.97 32.35% NPV 329.98
B. Limitations of the investment appraisal
ARR (Average Rate of Return) :
ARR is known as average return made by the business over the period. The investment
appraisal technique is good but ignores time value of money. In simple words, business will not
be able to analysis over the period, when it will garner returns on investments. Thus, time of
value is required which is ignored in this concept. Moreover, return of capital also need to be
analysed which is ignored by this concept (Schönbohm, 2013). It uses information that is
reflected in income statements and does nor prefer for using cash flow data which leads to
misconception.
Fair rate of return is not assessed by ARR and thus it is not useful for the management to
rely for results on the basis of this technique. External factors affects organisation but this
methods does not take into account, these factors. This technique is not suitable when investment
is made by company in various instalments.
NPV (Net Present Value) :
It is the investment appraisal technique which utilises time value of money while
computing present value of cash flows by using discounting rate. But practically, this method is

difficult to use and does not provide accurate results to organisation for selecting the project.
Moreover, if amount of mutually exclusive projects are not similar, then inaccurate conclusions
are ascertained which are not useful for the company. Furthermore, this method uses discounting
rate for calculation. This is difficult to compute perfect discounting rate in practical life.
NPV is not good to use for comparing two projects which are unequal. It is difficult to
give correct decision when projects are of different size and are unequal largely. It provides
results which are not accurate and as a result, investors does not rely completely on NPV
(Gunawardena and et.al, 2015). Moreover, it provides estimations related to calculation and as a
result, no concrete conclusions are provided that can be used by management of the company
regarding new investment.
Payback Period :
This method is used as it provides time when will returns be achieved by the business and
as a result, it provides better results to organisation. However, it has certain demerits as well. The
profitability factor is not given by this technique. It only provides when firm will gain results
within time, but how much profits will be garnered is not provided by this concept. As a result,
concrete conclusions are not provided by payback period and as such, management cannot make
better and effective decisions.
This method gives priority to liquidity but does not consider profitability and ignores it
(Meriç, Kamışlı and Temizel, 2017). Thus, profitability aspect is important but is ignored by this
concept. Another limitation of payback period is that it considers only cash flow which is
occurred before calculating payback period and ignores calculation of cash flow which is
occurred after payback period and as a result, improper conclusions are drawn which are not
helpful to company. These capital investment techniques are widely used by the companies but
has certain limitations as well.
CONCLUSION
Hereby it can be concluded that financial ratios are widely used by companies as it gives
them concrete results regarding profitability and efficiency of it with other companies as well. It
is primary and useful tool for making comparison with one another. Both companies such as
Sports direct plc and JD Sports plc are performing poorly in the market. It can be concluded that