Financial Ratio Analysis and Interpretation

This assignment focuses on analyzing various financial ratios, including liquidity, profitability, solvency, and activity ratios. It requires calculating these ratios using provided financial statements and interpreting their results to assess the financial health and performance of a company. The document also explores the practical applications of ratio analysis in corporate finance decision-making.

FINANCIAL MANAGEMENT AND
CONTROL

TABLE OF CONTENTS
INTRODUCTION...........................................................................................................................3
Part A...............................................................................................................................................3
1 Ratio analysis............................................................................................................................3
2 Limitation of ratio analysis.....................................................................................................13
Part B.............................................................................................................................................14
1 Investment appraisal method and interpretation of results.....................................................14
2 Benefits and limitations of the project evaluation methods....................................................18
3 Sources of finance...................................................................................................................19
CONCLUSION..............................................................................................................................20
REFERENCES..............................................................................................................................21

INTRODUCTION
Finance and the project management are the domain that heavily affects firm performance
and business decisions. In the current report, ratio analysis is done and performance of the firm is
measured as well as comments are given on same. Along with this, project evaluation methods
are applied on the cash flows and results are interpreted. In middle part of the report limitations
and benefits of the project evaluation method are discussed in detail. At end of the report,
sources of finance are discussed in context of project finance.
Part A
1 Ratio analysis
Table 1Ratio analysis
2015 2016
Gross profit 7382 5825
Net sales 18920 16243
Gross profit ratio 39% 36%
Net profit 972.84 570.17
Net sales 18920 16243
Net profit ratio 5% 4%
Operating profit 2582 1783
Net sales 18920 16243
Operating profit ratio 14% 11%
Liquidity ratio
Current assets 7006 6503
Current liability 24927.6 27528
Current ratio 0.28 0.24
Current assets 7006.00 6503.00
Stock 1320.00 1543.00
Prepaid expenses 0.00 0.00
Current liability 24927.60 27528.00
Liquid ratio 0.23 0.18
Gearing ratio

Debt 2130 3578
Equity 19635.16 20108
Debt equity ratio 0.108478872 0.177939129
EBIT 2582 1783
Interest 1130 932
Interest coverage ratio 2.28 1.91
Asset utilization ratio
Net sales 18920 16243
Fixed assets 20331.6 25726
Fixed asset turnover ratio 0.93 0.63
Investor ratio
Net profit 972.84 570.17
Shares outstanding 12410 12410
EPS 0.08 0.05
Net profit 972.84 570.17
Shareholder equity 19635.16 20108
ROE 0.05 0.03
Defining ratios
 Gross profit ratio: Cost is the factor which heavily affects the firm performance to a
large extent in terms of profitability in business. It is important to identify the extent to
which the firm has strong control on its expenses. Further, this is measured by using
gross profit ratio (Brealey and et.al., 2012). If gross profit increases in comparison to the
previous year then it is assumed that good performance is given by the firm in terms of
cost control.
 Net profit ratio: Net profit ratio is used to measure the overall profitability of business
firm. Firm capability to control on indirect expenses is measured by using net profit ratio.
This is the reason due to which net profit ratio is used by most business firms.
 Operating profit ratio: Gross and net profit ratio operating ratio is one of the most
important ratio. This is the ratio which reflects the performance of firm in terms control
that it have on the operating expenses. It can be said that profitability ratio is important to
the managers.

 Current ratio: Liquidity position matter a lot for the organization because it indicates that
whether firm will be able to meet its short term finance needs sufficiently. Proportion of
current assets to current liability is compared in the current ratio to access the firm
performance and availability of cash which will be used to meet the short term
obligations.
 Liquid ratio: There is a high degree of similarity between current and liquid ratio
(Gitman and Zutter, 2012). In the liquid ratio, stock and prepaid expenses are subtracted
from the current assets to identify the more accurate liquidity position of the business
firm.
 Debt equity ratio: Capital structure of Zurich Plc is measured by using the debt equity
ratio (Debt to equity ratio, 2017). In the mentioned ratio, debt is compared with equity to
identify whether the capital structure is balanced or not.
 Interest coverage ratio: Interest coverage ratio reflects the extent to which by using
profit interest can be covered. In other words, it can be said that number of times interest
can be paid by using profit is revealed by the interest coverage ratio.
 Fixed asset turnover ratio: Fixed asset turnover ratio is used to measure the efficiency
with which firm is using its asset to generate sales in its business (Embrechts,
Klüppelberg and Mikosch, 2013). This ratio reflects the extent to which resources are
efficiently used by the firm in its business.
 EPS: Earning per share is one of the most important ratio which reflect the portion of
earning that comes on each share that investor possessed in current time period. If EPS is
increasing then it is assumed that the firm performance has been improved.
 Return on equity: Return on equity refers to the return that is earned on per unit of equity
that same hold for the specific time period. Elevation in value of return on equity reflects
that the firm is giving good amount of return to the investor for the risk they have taken
for investing in the business firm.
To,
Board of Directors,
Zurich Plc.
Date: 20th March 2017
Profitability ratios:

 Gross profit ratio:
2015 2016
34.00%
35.00%
36.00%
37.00%
38.00%
39.00%
40.00%
39.02%
35.86%
Illustration 1: GP ratio
Interpretation
It can be observed from the image given above that, in the FY 2015 gross profit ratio was
39.02% and the same reduced to 35.86% in the FY 2016. This reflects that gross profit ratio
reduced by about 4%. Lack of control on direct expenses is the main reason due to which such a
sharp decline is observed in the relevant ratio. Apart from this, decline in sales is another reason
due to which such a low performance is observed in the ratio. Situation clearly indicates that
mangers need to take action to curb the elevation in expenses so that gross profit percentage can
be enhanced in the business.
 Operating profit ratio:
2015 2016
0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
12.00%
14.00%
16.00%
13.65%
10.98%
Illustration 2: OP ratio
Interpretation

Operating profit ratio has declined slightly by 2% in the current financial year. Operating profit
and sales valued reduced at the sharp rate and fast elevation in operating expenses led to decline
in ratio value by 2%. This reflects that there is a strong need to maintain control on sales and
administrative and other operating expenses in the business. By doing so, the operating profit can
be increased in the business and performance can be improved. Reduction in the operating profit
will lead to improvement in value of net profit in the business. Thus, it can be said that there is a
wide impact of value of the operating profit on the firm performance.
 Net profit ratio:
2015 2016
0.00%
1.00%
2.00%
3.00%
4.00%
5.00%
6.00%
5.14%
3.51%
Illustration 3: NP ratio
Interpretation
Net profit ratio reveals the extent to which indirect expenses are controlled in the business.
Image given above clearly indicates that net profit ratio declined from 5.14% to 3.51%. This
decline in net profit ratio states that the managers inability to maintain cap on the indirect
expenses in the business. It can be said that management of Zurich Plc is highly inefficient and it
failed to control expenses which resulted in the poor business performance in FY 2016. Thus, it
can be assumed that management of the firm is required to focus on cost that is incurred by the
firm in its business.
Liquidity ratio:
 Current ratio

2015 2016
0.21
0.22
0.23
0.24
0.25
0.26
0.27
0.28
0.29
0.28
0.24
Illustration 4: Current ratio
Interpretation
Current ratio is indicating the proportion of current assets in the capital structure relative to the
current liability. In the FY 2015, current ratio stands at 0.28 and it reduced slightly to 0.24. This
decline in the value of current ratio is observed because firm is earning low amount of profit in
its business. It can be observed that the firm’s liquidity position was not good in the previous
financial year. For paying every one unit of current liability there is 0.28 units of current assets in
the business. Situation become worse in the current fiscal year and only 0.24 units are now
available to pay single unit of current liability. So, it can be said that liquidity condition was
already poor and same become worse in the FY 2016.
 Quick ratio

2015 2016
0
0.05
0.1
0.15
0.2
0.25 0.23
0.18
Illustration 5: Quick ratio
Interpretation
Quick ratio reveal the liquidity position of the business firm. There is a high degree of similarity
between current and quick ratio. However, there is a slight difference between both ratios in
terms of stock and prepaid expenses. Stock and prepaid expenses are not included in current ratio
because it is not possible in any condition to sale stock overnight in the market. Due to this
reason stock is not included in the quick ratio formula. It can be seen from the table that value of
quick ratio is 0.23 in the FY 2015 and same in the FY 2016 0.18. It can be seen from the image
given above that liquidity condition of the firm become poor. Earlier also firm was not in good
condition and further it get deteriorate. Thus, it is a matter of concern for the business firm and
there is a need to improve lots of things in the business.
Gearing ratios:
 Debt to equity ratio:

2015 2016
0
0.02
0.04
0.06
0.08
0.1
0.12
0.14
0.16
0.18
0.2
0.11
0.18
Illustration 6: Debt to equity ratios
Interpretation
Debt equity ratio of the firm is 0.11 in the FY 2015 and same increased to 0.18. This reflects that
firm capital structure is in good condition. Debt only cover 18% of equity of the business firm
which is very low. This reflects that there is no huge amount of debt in the firm balance sheet.
Elevation in the debt equity ratio indicate that capital structure of the business firm become more
balanced and further there is a need to increase debt equity ratio value in the business. This will
be beneficial for the business firm.
 Interest coverage ratio:
2015 2016
1.7
1.8
1.9
2
2.1
2.2
2.3
2.4
2.28
1.91
Illustration 7: Interest coverage ratio
Interpretation
Interest coverage ratio was 2.26 in the FY 2015 and same reduced to 1.91 in the current financial
year. This decline in the interest coverage ratio revealed that firm ability to pay interest or

finance cost out of profit get reduced. This is the negative sign for the business firm. Its liquidity
position is also not good and on this basis it can be said that firm needs to improve its
performance. There must be improvement in the interest coverage ratio of the business firm.
Higher will be the profit and if there will be control on the expenses then in that case interest
coverage ratio will be improved.
Asset utilization ratios:
 Fixed assets turnover ratio:
2015 2016
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1 0.93
0.63
Illustration 8: Fixed assets turnover ratio
Interpretation
Fixed asset turnover ratio in the FY 2015 was 0.93 which reduced to 0.63 and this reflects that
firm failed to make effective use of fixed assets in its business. Facts revealed that in the FY
2015 firm rotate its fixed assets 0.93 times in a year. This ratio reduced it 0.63 which reflects that
only 0.63 times asset is rotated to generate sales in the business. Thus, assets are less efficiently
used by the firm in its business to generate sales in the business.
 Total assets turnover ratio:

2015 2016
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.69
0.5
Illustration 9: Total assets turnover ratio
Interpretation
Total asset turnover ratio was 0.69 in the FY 2015 and same reduced to 0.5 in to FY 2016. This
reduction in the value of ratio is reflecting that firm is not using its current and fixed units in
proper manner. This reflect that management of the business firm is not efficient and it must
properly managed its resources so that more and more sales can be generated in the business and
profit can be maximized.
Investor ratios:
 Earnings per share:
2015 2016
0
0.01
0.02
0.03
0.04
0.05
0.06
0.07
0.08
0.09
0.08
0.05
Illustration 10: Earning per share
Interpretation

Earnings per share is the one of the most important investor ratio that is used by the investors to
identify the extent to which business firm is giving return to the investors on the per unit of share
they hold in the specific time period. Earnings per share in respect to business firm reflect the
amount of profit that it is giving on each unit to the shareholders. EPS in case of firm was 0.08 in
the FY 2015 and same in the FY 2016 0.05. It can be said that earning on per share that
individual investor hold get reduced and this negatively affect the business firm. Thus, it can be
said that it is very important for the firm to enhance revenue amount growth rate so that more
and more return can be given to the investors.
 Return on equity:
2015 2016
0
0.01
0.02
0.03
0.04
0.05
0.06
0.05
0.03
Illustration 11: Return on equity
Interpretation
Return on equity declined from 0.05 to 0.03 and this reflects that less return is received by the
investors on shares they currently hold. Hence, it can be said that there is strong need to improve
performance.
2 Limitation of ratio analysis
There are lots of limitation of ratio analysis and same are described below.
One of the major limitation of ratio analysis is that in case of current ratio, quick and debt as well
as equity ratio there are some standards. Managers in order to evaluate business firms use these
ratios standards. Situation does not remain same every time and due to this reason it is not fair to

use these standard values to interpret firm performance. Standard value of current ratio is 2:1 and
this reflect that there must be double current assets relative to current liability. In case there is
recession in the market cash inflow in the business is heavily affected (Finance and Network,
2013). In such a scenario it is not possible to earn sufficient amount of profit in the business.
Hence, it is a very hard task to maintain standard ratio of 2:1 in the situation when economy is in
crisis. If in that situation managers will use same standard to measure firm performance then in
that case false interpretation of performance will be made by the managers. Thus, it is the big
limitation of the ratio analysis method. Instead of setting parameters managers must just compare
ratio values and must measure firm performance. There are some other limitation of ratio
analysis method. It can be observed that standard ratio of debt equity ratio is 0.5:1. When
economic crisis comes in existence then in that case it is very difficult to raise cash inflow in the
business. Due to this less amount of fund remain with firm and it is very difficult to fund project
from internal source of finance (Kotz, Kozubowski and Podgorski, 2012). If there is already high
debt equity ratio like 0.4:1 and it increased to 0.5 or 0.6 then it will be interpreted firm condition
is not good. In case economy is in recession then poor business conditions and sluggish demand
can be assumed major factors for sharp elevation in debt equity ratio. Thus, in that situation there
is high probability that debt equity ratio will be higher than 0.
Part B
1 Investment appraisal method and interpretation of results
A. Payback period:
Table 2: Computation of payback period
Year Cash flow of machine (in £) Cumulative cash flow (in £)
Initial investment -£2000000
1 870000 870000
2 870000 1740000
3 870000 2610000

4 870000 3480000
5 870000 4350000
6 870000 5220000
PP 2.30 years
Interpretation
Payback period is the one of the important method that is used to evaluate the project. It
is very important for the business firm to identify the time up to which it have to wait to cover
investment amount from the cash flows. Results indicate that project can cover investment
amount in 2 year and three month. Overall project life is 6 years and investment on same is
covered in 2 years and three months. Thus, it can be said that project is viable for the business
firm.
B. Discounted payback period:
Table 3: Computation of discounted payback period
Year
Cash flow of
machine (in £)
Discounting
factor @ 10%
Discounted
cash flow
Cumulative
discounted cash flow
Initial investment -£2000000
1 870000 0.9091 790909 790909
2 870000 0.8264 719008 1509917
3 870000 0.7513 653644 2163561
4 870000 0.6830 594222 2757783
5 870000 0.6209 540202 3297984
6 870000 0.5645 491092 3789077
DPP 2.75 years
Interpretation

Discounted pay back is the method under which cash flows are discounted at the specific
interest rate. By doing so their current value is computed (Minsky, 2015). It can be seen from the
table that project investment amount can be covered in two year and seven months. It can be seen
that project is taking more time to cover investment amount on the project then earlier method. It
can also be seen that there is no significant difference between times that is taken by the project
to cover investment amount in case of both projects.
C. Accounting rate of return:
Table 4: Computation of ARR
Year Cash flow of machine (in £)
Initial investment -£2000000
1 870000
2 870000
3 870000
4 870000
5 870000
6 870000
Total 5220000
Average 870000
Initial investment 2000000
ARR 43.50%
Interpretation
ARR reflects the average return that can be earned on the project. ARR of the project is
43.50% and it can be said that good amount of return can be earned on the project on average
basis. ARR is simply computed by following a specific approach under which first of all values

of cash flows is added and same is divided by the number of years (Tirole, 2010). In this way
average of the cash flows for the project is computed. Due to high percentage of ARR project is
assumed viable for the business firm.
D. Net present value:
Table 5: Computation of NPV
Year
Cash flow of machine
(in £)
Discounting factor
@ 10%
Present value of
machine
Initial investment -£2000000
1 870000 0.9091 790909
2 870000 0.8264 719008
3 870000 0.7513 653644
4 870000 0.6830 594222
5 870000 0.6209 540202
6 870000 0.5645 491092
Total 3789077
Less: initial investment 2000000
NPV £1789077
Interpretation
Net present value refers to the net present value of the project that is computed by
following a specific approach. Under NPV first of all present value of the cash flows is
computed and them same is added (Bakand, Hayes and Dechsakulthorn, 2012). From the
relevant value initial investment amount is deducted and in this way present value of the project
is calculated. It can be observed from the table that net present value of the project is £1789077.
This means that project is viable for the firm because value of its NPV is positive and is very
high. Due to this reason it is assumed profitable for the business firm.

E. Internal rate of return:
Table 6: Computation of IRR
Year Cash flow of machine (in £)
Initial investment -£2000000
1 870000
2 870000
3 870000
4 870000
5 870000
6 870000
IRR 36.89%
Interpretation
IRR refers to the internal rate of return that can be earned on the project. IRR of the
current project is 36.89% and this reflects that sufficient amount of return can be gained on the
project. Due to this reason project is assumed viable for the firm.
2 Benefits and limitations of the project evaluation methods
There are varied project evaluation methods and each of them have some merits and
demerits. The merits and demerits of the project evaluation methods is explained below.
Payback period
Merits
This is the one of the most important method that is used by the business firm to evaluate the
project (Buchanan, 2014). One of the main merit of this method is that an individual easily
obtain an information about the time period after which project will start giving return to the
investors.

The other main positive point associated with relevant project evaluation method is that it is very
easy to use mentioned method. Thus, any person that have little knowledge of the project
management can also use this method.
Demerits
One of the main demerit of the project evaluation method is that usually present value concept is
not used in the calculation. Due to this reason it does not measure viability of the project from
current time period.
Average rate of return
Merit
 Main merit of the average rate of return is that it measure performance of the project on
average basis. Means that it reflect the average amount of return that can be gained on the
project. Thus, overview of the project is obtained through this method in terms of
viability.
Demerit
 Main limitation of the average rate of return method is that present value concept is not
taken in to account and due to this reason like payback period mentioned method does
not evaluate viability of the project.
Net present value
Merit
 The main merit of the net present value method is that present value formula is used to
calculate current value of the project. It can be said that viability of the project is
measured accurately by the business firm.
 Other main merit of this method is that initial investment amount is at valued at present
value and cash flow current value is also calculated (Wilmott, 2013). Thus, fair
comparison is made between the initial investment and cash flows and due to this reason
it is assumed that net present value method fairly evaluate the projects.
Demerit
Main demerit of the net present value method is that complicated process is followed to
calculate the current value of the project. Due to this reason those individuals that does not have
background in finance and project management can not apply mentioned method accurately on
the cash flow.

Internal rate of return
Merit
 Main merit of the internal rate of return method is that it reveal the real return that can be
earned on the project.
Demerit
 Calculation process is hard in case of internal rate of return method and due to this reason
like NPV every one cannot do accurate calculation of internal rate of return.
3 Sources of finance
Some of the sources of finance for the current project is given below. Private equity: Private equity is the source of finance through which relevant project can
be financed. Under this source of finance private equity firm in installments make an
investment in the business firm (Pigou, 2013). Thus, project can be finance through
private equity firm. It must be noted that private equity firm obtain a shareholding in the
firm in lieu of the investment that it is going to make in any specific firm. Thus, it can be
said that firm have to pay higher cost of reduction in ownership if project is finance
through private equity. Bank loan: Bank loan is another option that is available to the business firm. By
presenting the statistics of cash flows and project evaluation method firm can prove that
its project is viable. By doing so easily project can be financed from the business firm.
Thus, it can be said that through bank loan easily project can be financed by the business
firm. Retained earnings: Retained earnings is the part of the sales revenue that remain as
residual amount with the business firm. Company that have good financial position can
easily finance its project through retained earnings. This is because such kind of firm
have huge amount of retained earnings in their business and due to this reason they can
internally finance entire project on their own level (Billio. and et.al., 2012). Thus, such
kind of firms do not need to take bank loan to finance machine purchase. There are many
advantages of using retained earnings in the business because there is no cost of
mentioned source of finance. This is the reason due to which most of the business firm’s
use retained earnings to finance the project.

As per finance concepts there are three sort of decisions that can be taken by the managers.
These three decisions that comes under finance concept are financing, investment as well as
dividend decisions. Financing decisions: In order to manage business operations and to run business
smoothly lots of amount of fund is required by the business firm. Finance cost is the one
of the factor that affects the net cash flow that is received from the specific project. Firm
must maintain optimum capital structure in its business so that cost can be minimized
and burden of finance cost of specific source of finance can be reduced in the business. Investment decisions: Investment decisions heavily affect any business. Firm decisions
to invest in specific project heavily affect its profitability in the future time period.
While selecting any project it must be ensured that project evaluation methods are used
to evaluate the project. By doing so it can be ensured that viable project is selected in the
business. Dividend decisions: Dividend decisions taken by the business firm is dependent on the
number of factors like profit that firm earned in its business and its past years dividend
policy. Before making any decisions mangers can use ratio analysis method to evaluate
its condition and can accordingly make final decisions. If ratios reflect that condition is
not good then in that case managers can put forth proposal for nonpayment of dividend
before shareholders.
CONCLUSION
On the basis of above discussion it is concluded that ratio analysis have a great significance
for the firms because by using same time to time performance of same can be evaluated and
right decisions can be taken in respect to improving performance. It is also concluded that there
are different project evaluation methods and each of them have some merits and demerits. This
does not undermine importance of the project evaluation methods because each of them measure
viability of project in different manner. There are many sources that can be taken in to account in
order to finance the project. Sources of finance must be cautiously selected by the business firms
for project finance.