Profitability and Financial Ratios for Company Analysis and Project Financing

This article discusses profitability and financial ratios used to assess a company's financial health and risk level. It also explores various methods of financing a project, including equity, debt, venture capital, bank loans, and government grants.

FINANCE

Answer a).
Profitability ratios interpret and compare income statement to show whether a
company is able to generate the profits from the operations. These ratios focus on return on
investment made by shareholders. Profitability ratios show how efficiently the company
achieves profits from operations. These ratios are used to assess the ability of business to
generate revenue and profits in relation to associated expenses. Higher ratio as compared to
its competitor`s ratio or previous year indicates that organisation is performing well (Mousa,
2015). Under the profitability ratio, a company uses certain ratios, which are discussed
under:-
Gross profit margin- This margin measures where a company mark up COGS above its sales.
This ratio compares gross margin of an organisation to its net sales. Gross profit ratio looks at
COGS as a percentage of net sales. This ratio evaluates at how well companies control the
cost of inventory and manufacturing of product and consequently pass the cost to customers.
Investors use gross profit ratio to calculate the percentage to compare a company in which
they want to invest to the other similar companies (Mousa, 2015). This ratio tells investors
that whether the gross profit margin of target company is sound or not.
Operating margin- This ratio measure and evaluation of overall operational efficiency,
incorporating ordinary expenses and daily business activity. Operating margin refers to the
percentage of sales, which is left after including all the additional operating expense. This
ratio is used to determine the efficiency of the management of the company by analysing

operating expenses to net sales. This ratio uses operating profit or income which is total pre-
tax income generated from operations (Mousa, 2015).
Return on assets- Profitability is analysed in relation to assets to look whether the company is
deploying its assets to generate revenue and profits. Return in this ratio refers to net income
or profits which is generated from sales after the costs, taxes and expenses (Willy, 2016).
From the point of investors, asset turnover ratio reveals to investor the lump sum amount of
sales for $1 of assets. This tells the investor that how much profit an organisation generate for
each $1 in assets. Return on assets is always a good way to measure the intensity of assets of
the business (Uechi, Akutsu, Stanley, Marcus, & Kenett, 2015).
Answer b).
Financial ratios are used to measure the company’s capital structure and its risk level as being
assessed in context to company`s debt level. It is an ability of the company to accomplish
outstanding debt which is absolutely critical to company`s financial soundness and its
operating ability. Certain financial ratios used by the investors to assess the organisation`s
financial risk and overall financial health that comprises of Debt-equity ratio, interest
coverage ratio, and debt-capital ratio (Mitrovic, Knezevic, & Velickovic, 2015). Investors
and the analysts use these ratios to measure the level of financial risk. Solvency ratios are
used to measure ability of the company to meet the long-term obligations. In general, it
measures the size of the company`s operations in relation to their obligations. By analysing
the solvency ratio, an investor can get insight in how a company is likely continue to meet the
debt obligations. Higher is the ratio, stronger is the financial strength. Lower ratio, on the
other hand, indicates that company has financial struggles in future (Willy, 2016).

Debt-equity ratio
This ratio shows the relationship between total liabilities and shareholder`s equity. This ratio
is used to assess the company`s financial leverage. This solvency ratio measures company`s
total debt that are relative to value to net assets, it is used to assess the extent to which a
company can take debt by leveraging its total assets. Company who have high risk, it means
that company will be aggressive while financing its development through debt. If company
employ a lot of debt to accelerate growth, possibly it will be able to more profit then it will
even be able to execute it without financing. If leverage increases the earning by more
amount then shareholders expect more profits. If debt cost will be high and outweighs the
capital structure then share value may decrease (Uechi, Akutsu, Stanley, Marcus, & Kenett,
2015).
Interest coverage ratio
Interest coverage ratio is used to decide how simply an organisation is able to pay its interest
expenses for outstanding debt. It is computed by dividing the (EBIT) net profit before interest
and Tax by interest on long-term debt. A investor never wants ICR should be low as if it is
represents greater risk of company`s debt and probability of bankruptcy. Low ICR indicates
less operating profits available for paying the interest and the company becomes more
vulnerable to fluctuating interest rates. Whereas, high ICR indicates that organisation is
looking for more reliable opportunities to attract earnings through leverage. It is assumed that
if ICR is below I then the company has poor financial health. Investors investigate company`s

stability where declining ICR indicates that company is unable to pay off its debt obligations
(Uechi, Akutsu, Stanley, Marcus, & Kenett, 2015).
Answer c).
The client knows that MDM is considering a project that will cost €200 million. This project
needs fund which can be arranged through different possible methods of financing. Relying
on only source is not at all the proper use of one`s wisdom. The main sources include equity,
debt, venture capital, bank loans, and government grants. Financing the project through
alternative sources can have different implications on the overall cost of the project,
company`s liabilities, project`s income, cash flow and assets (Uechi, Akutsu, Stanley,
Marcus, & Kenett, 2015). While financing through bank, it is important to undertake that
every source reflect risk and cost associated with bank for providing finance. The commercial
loan is not repayable on demand and it is available for a time period of three to ten years
unless any of the party breaches the contract. Loan can be tied for any assets and other
equipment for which company borrow the money for. At the initial stage, once loan is
accessed, a company just need to negotiate a repayment amount means the company needs to
only pay the interest amount, and repayment of total capital is frozen for some time. The
company is not liable to pay any part of profits from the total profits. Whereas, the interest
payment and rate of interest is fixed expenses. The company is liable to pay a fixed expense
as rate of interest rather than contributing anything from profit.
Although, almost every company use a combination of debt and equity. Therefore, potential
advantages of equity financing, investors are very much interested in company`s success as
high returns will realise that the company is performance through investment. The process of

raising the capital with the help of sales of shares can be most appropriate rather than hiring
bank loans. The company will not have to maintain any cost of servicing bank loans and it
allow the company to use the capital for business operations. Different investors can bring
new ideas, valuable skills, experience, deliver value to organisation, and explore other growth
opportunities ideas that can help the company to make and create strategy to appropriate
decisions. Investors invest their left sum of savings and offer the company with new ideas. It
is not necessary to pay whole profits as dividend and investors also understand that retain
earning will lead to more capital investment in near future.
Venture capital is one of the source and method, which is used to and act a finance of the
company. The crucial features of venture capital are high risk, lacks liquidity, long-term
horizons, these investment suggest that they are incurred by innovative projects. Venture
capital participate in the operations of the business. Company can be benefited in so many
ways if it start investing through investment. Apart from financial backing, starting it with
venture capital can provide capital financing to start a business or young business through an
valuable source of guiding and consulting (The Hartford, 2018). Venture capital can help the
organisation to help with variety of business decisions, which are based on financial
management and HR. Making appropriate decisions in key areas of business operations can
become vital as business grows. In some of the critical areas such as personal matters, legal
and tax rules and venture capital can provide support at key stages for the growth of the
company (Mousa, 2015).
Funding through Government grants can benefit and move beyond more projects.
Organisations who use government grants to expand the budgets and strengthen the
outcomes, which is driven by strategic actions. Government grants support a wide range of
projects and priorities of business growth can lead to well-aligned to small organisation
funding programs. Government funding support certain general projects such as business

expansion, hiring and training, research and development, and capital and technology
adoption. Government funding facilitate expansion of improve production and develop new
market with strategic marketing to accomplish sales mission. Moreover, it enables to new
purchase, innovative equipment to deliver capabilities, increase output, and reduce scrap.
Benefits through government funding can go beyond through other funding methods. Loans
and grants improve the project outcomes. It can improve the scale of plan of original projects.
It is not necessary that government funding always need a new project but it can also be used
to expand the extent to which a company can deploy its resources (Bond Street, 2018). For
example- rather than replacing two machines among the five CNC machines that will lead to
improve the productivity. To pace the project timeliness, business funding improves the
amount. Quickness in responding to several market opportunities and drive it to long-term
business growth. Government grants constantly demonstrate technological developments
where it is necessary to decide the time to market, which is a key factor for other business
expansion plans (The Hartford, 2018).
While funding through long-term debt, the company will be able to retain its whole control
on the management decisions, which depends on how much power of ownership, a company
delegates to third party in comparison to equity financing. More inclusion equity financing
will demand approval from mutually agreed actions that rely from hiring new manpower to
selecting the vendors. A lender has no interest to how business run unless its financial
statement is unable to perform and get anything from purchases and suppliers to pay off their
interest instalments (Bond Street, 2018). As long as, the company is able to meet scheduled
payment plan then it debt financers have no interest. There are several advantages to debt
financers that enable and give them a opportunity to convert them from debt to equity.
Interest repayment are tax deductable. It is an compulsory payment that can be even charged

from term loan, working capital account, and line of credit or any other interest payment that
is borrowed for business activities are tax deductable (The Hartford, 2018).

References
Bond Street, (2018). Advantages of Debt Financing. Retrieved from:
https://bondstreet.com/advantages-of-debt-financing/
Mitrovic, A., Knezevic, S., & Velickovic, M. (2015). RATIO ANALYSIS SPECIFICS OF
THE FAMILY DAIRIES'FINANCIAL STATEMENTS. Ekonomika poljoprivrede,
62(4), 1061.
Mousa, G. A. (2015). Financial Ratios versus Data Envelopment Analysis: The Efficiency
Assessment of Banking Sector in Bahrain Bourse. International Journal of Business
and Statistical Analysis, 2(2), 75-84.
The Hartford, (2018) How to Finance Your Business Growth. Retrieved from:
https://www.thehartford.com/business-playbook/in-depth/debt-financing
Uechi, L., Akutsu, T., Stanley, H. E., Marcus, A. J., & Kenett, D. Y. (2015). Sector
dominance ratio analysis of financial markets. Physica A: Statistical Mechanics and
its Applications, 421, 488-509.
Willy, S. (2016). Analysis of Financial Ratios to Measure the Company’s Performance in the
Sectors of Consumer Goods at Pt. Nippon Indosari Corpindo, Tbk and Pt. Mayora
Indah, Tbk.