Ratio Analysis: Purpose, Calculation, and Movement of Ratios

This document provides an in-depth analysis of ratio analysis, including the purpose of calculating ratios, how to calculate different ratios, and the movement of ratios over two years. It covers liquidity, profitability, and solvency ratios and their significance in evaluating a company's financial performance.

RATIO ANALYSIS

Contents
Introduction...........................................................................................................................................2
Part 1.....................................................................................................................................................2
Part 2.....................................................................................................................................................4
Purpose of calculating ratios..............................................................................................................5
Movement of ratios in two years.......................................................................................................7
Some of the main concerns for the company are-............................................................................14
Evaluation and interpretation of ratios.............................................................................................14
Conclusion...........................................................................................................................................16
References...........................................................................................................................................17
Appendix.............................................................................................................................................18

Introduction
The report is divided into two sub parts; the first part describes and identifies stakeholders of
Tesco and how well it serves its stakeholders by undertaking either CSR activities or
customer relationship management. On the other hand, the second session brings out a ratio
analysis on Benedict Company. This analysis helps the company to evaluate its business
operations and find the areas to improve (Wood, 2016).
Part 1
Answer-1
A stakeholder is a person, organisation, agency, authority, social group, and society who have
stake in business. A stakeholder can be either internal or external who are interested in
business and its activities. Stake includes vital interest in business activities that have
ownership, legal interest, moral rights, and property rights (Tesco PLC, 2019). A legal
interest is to pay the wages or honour contracts. Moral right includes the right of consumers,
which do not harm business activities intentionally. Stakeholders has the right to affect the
business either can be affected by business, or affected by both business and affect the
business. Examples of Tesco`s stakeholders are employees, suppliers, and local community.
Tesco is a member of various multi stakeholder collaborations, which support the broad
responsibility that source strategy especially on high-risk supply chains (Tesco PLC, 2019).
Employee is a stakeholder who works in the business operations. The employees of Tesco
Company are able to avail a secure employment, opportunity promoted with a good means of
rewards. Employees are people to whom Tesco pays to provide services to them (Tesco PLC,
2019). Tesco needs to provide the employees with better working conditions with the
reasonable hours if they treat them fairly. Existing employees are retained in the company
due to high credibility. Directors pay strives its attention to prepare the strategic decisions for

the organisation. Government may influence the law rights to change the behaviour of health,
safety, and environment (Tesco PLC, 2019).
Local community- It is a group of people that interact with the surroundings. This local
community comprises of public staff, residents, and business operators. Most importantly, it
includes interaction of sharing the information and resources as the establishment of
commercial relationships of business and customers. The initiatives that are taken by Tesco
revolve around local community and environment includes giving computers to local schools
and providing certain jobs to people. For example- the aim of BCI (better cotton initiative) is
to produce a cotton production for the people who actually who produces it by developing
better cotton as a sustainable mainstream commodity. Another example of CBI
(Confederation of British Industry) is UK`s premier enterprise that provides a level for
regional, national and international to enable policymakers. Cool farm Alliance, which is an
non-profit organisation that enable the farmers to reduce the environmental impact. Members
such as food companies such as PepsiCo, Tesco suppliers and NGOs are the major brands.
Tesco is one of its founding member in 2012 (Tesco PLC, 2019).
Suppliers- Supplier is the one who supply particular products to service and product.
Suppliers supply products to Tesco that want stable orders and fast payment. Suppliers
interested in Tesco represented a company with high credible. Recently in 2015, Tesco has
tried to rebuild its relationships with the suppliers by launching new online network so that
business will be efficient enough to interact with the Britain`s biggest retailer. The
supermarket has created a network of Tesco suppliers that claims with the help approximately
5000 members. These communicate to the retailer and other suppliers, which includes a range
of issues that potentially provide the platform to the suppliers to complain when they are, not
treated well (Tesco PLC, 2019).

Answer-2
Environmental Social Review and the Corporate Governance Report help the Tesco to serve
its stakeholders very well. According to environment and social review, Tesco serves very
well to supplier and local community as a stakeholders identified above. Overall approach for
the suppliers is to make use of edible crops as much as possible (Tesco PLC, 2019). The
company also believe that most of the edible crops so that it can believe in the specification
to accommodate more crops. The company has also introduced new range of crops, which
fall outside the specifications. Range began with parsnips, potatoes and other number of
vegetables and fruits. The company is planning to develop different new changes through
forecasting the order that can help the supplier to reduce the waste. For instance- company is
trailing flexible ordering of how they will work with their suppliers to grow and offer their
farmers a certain volume to supply rather than limiting it to certain specific number.
In order to serve to the local community, company undertake to cure customers, local
community, and their health issues. Another way of achieving it can be by creating
partnership and health experts for Diabetes and heart foundation that supports the prevention
of the biggest health issues. The company is combining the charity`s expert of health with
Tesco to approach local communities of UK (Tesco PLC, 2019). This gave Tesco, a unique
opportunity to promote healthier choices in the nation and improve the way the live their life.
This will be a prevention project to promote essential health research. In order to serve the
group of local communities, the company is able to range above 1.3 million children as a part
of Tesco happy eating habits that include cooking courses and farm to the fork trails (Tesco
PLC, 2019). Moreover, the company has reduced its greenhouse gas emission (net carbon
intensity for retail floor spaces) from 2015/2016 to 2017 (Tesco PLC, 2019).
Part 2
Answer-1

Purpose of calculating ratios
The main purpose of conducting ratio analysis is to analyse different aspects of company`s
financial and operating performance. It is a tool, which improves the understanding of
financial statements. To analyse the performance, the company judges on the basis of five
types of ratios named as liquidity, solvency, profitability, and activity turnover (Thornblad,
Zeitzmann, and Carlson, 2018).
Liquidity ratio-
Liquidity ratios are calculated to determine whether the company will be able to pay off the
short-term loan obligations. These ratios determine the ability of debtors to pay current debt
obligations.
Current Ratio
Current ratio is calculated to know how efficient company`s current assets are to pay off
short-term current liabilities such as wages outstanding (Kowalik, 2018).
Quick ratio
Quick ratio is more relevant to investors and creditors, which ensures that they are at less
level of risk to overcome their debt in short term. As inventory is considered less liquid than
other current assets so as when Quick ratio is greater than one, it depicts company is able to
meet short-term obligations (Thornblad, Zeitzmann, and Carlson, 2018).
Profitability ratios-
Profitability ratios are used to measure the profitability that is a way to evaluate the
company`s performance. The purpose of Profitability ratios is to analyse the company`s
ability to generate profits when as compared to the expenses and cost associated with this
generation (Vats, and Patel, 2017).

Gross profit ratio- this is a financial metric which is calculated to analyse the how capable is
the company to generate its gross profit margin by increasing its sales and reducing the cost
of goods sold. It also means that if a company is earning high gross margin then it is in a
better position to have strong other profitability ratios (Kowalik, 2018).
Operating profit margin- this ratio indicates that how efficient is the company in
controlling cost and expenses especially when associated with its normal business operations
(Laitinen, and Laitinen, 2018).
Return on Capital Employed- it is calculated to measure how efficient is the company in
generating profits from the capital employed. Higher Return on Capital Employed indicates
that a company can invest back a large sum of profits in the company to benefit the
shareholders (Thornblad, Zeitzmann, and Carlson, 2018).
Return on Equity- this ratio measures the efficiency of a organisation to generate the profits
from the shareholder`s investment (Kowalik, 2018).
Return on Total assets- it measures the efficiency of company while using the assets to
generate certain earning before the payment of any contractual obligation. This ratio
establishes a relationship between company`s resources and the income.
Solvency ratio- solvency ratio measures that how efficiently a company can meet the debt
and other several obligations. This measures whether the company`s cash flow will be
sufficient enough to meet its short and long-term liabilities (Tonchia, 2018).
Debt- equity ratio- This ratio analysis the company`s financial leverage which relates
amount of debt-financing to the total of equity financing. This ratio helps the lenders,
creditors, and company`s management to understand the riskiness of company`s financial or
capital structure (Kowalik, 2018).

Interest coverage ratio- higher ICR indicates more interest burden and it tells the possibility
of bankruptcy. ICR is an ability of the company to pay and meet the interest obligation. It
also measures how easily the company pays its outstanding debt (Thornblad, Zeitzmann, and
Carlson, 2018).
Efficiency ratios
This ratio is used to evaluate and reflect company`s ability to employ long-term resources
into use in an most effective way. This ratio is useful for retail businesses.
Receivable turnover ratio- this ratio reveals that the ability of the company to effectively
issue credit to the customers and collect the payment on timely basis (Laitinen, and Laitinen,
2018).
Creditor turnover ratio- ratio reflects the speed or the pace of the company to pay its
suppliers. If the speed of paying the suppliers is slow then it can be an indicator of worsening
financial condition (Tonchia, 2018).
Inventory turnover ratio- this ratio reflects the number of times when a business sell and
replace its inventory during a fix period of time (Thornblad, Zeitzmann, and Carlson, 2018).
Assets turnover ratio- Asset turnover indicates how efficiently organisations use its assets to
generate sales. Higher ratio turns to be good or better (Liang, Lu, Tsai, and Shih, 2016).
Movement of ratios in two years
While comparing the current ratios of both the years, it can be seen that the company have
sufficient current assets to settle its current liabilities. The ratios for both the years are 1.185
for 20X1 and 1.255 for 20X0.

20X0 20X1
1.140
1.160
1.180
1.200
1.220
1.240
1.260
1.280
Current ratio
When looking at the changes in quick ratio, it is seen that in both the years, the ratio is less
than one, which means in both the years, the company is not efficient enough to pay off the
short-term obligation.
20X0 20X1
0.680
0.690
0.700
0.710
0.720
0.730
0.740
0.750
Quick ratio
While analysing profitability ratios, it is seen that the operating profit ratio has decreased to
27 percent in 20X1 whereas it was 35 percent in 20X1.

20X0
20X1
0.00
0.05
0.10
0.15
0.20
0.25
0.30
0.35
Operating Profit Margin
It is seen that net profit ratio in 20X1 has decreased to 21 percent whereas it was 28 percent
in 20X0.
20X0 20X1
0.00
0.05
0.10
0.15
0.20
0.25
0.30
Net Profit Margin
From the table of calculation, it is seen that return on capital employed has decreased in 20X1
from 20X1. In 20X0, it was 34 percent and it decreased to 30 percent in 20X1. It means the
decrease was around 4 percent.

20X0 20X1
0.27
0.28
0.29
0.30
0.31
0.32
0.33
0.34
Return on Capital Employed
It is clearly visible that return on equity decreased in 20X1 from 20X0. The change or
decrease in percent is around 2 percent. The ratio was 37 percent in 20X1 and 39 percent in
20X0.
20X0 20X1
0.34
0.36
0.38
0.40
Return on Equity
It is clearly seen that return on total assets have decreased from 18 percent in 20X0 to 13
percent in 20X1. The change or decrease in ratio is around 5 percent.

20X0 20X1
0.00
0.02
0.04
0.06
0.08
0.10
0.12
0.14
0.16
0.18
0.20
Return on Total assets
While analysing the debt-equity ratio, it is seen that the amount of long-term debt has been
increased in 20X1 as compared to 20X0. It can be interpreted that the ratio has been
increased in 20X1 from 20X0.
20X0 20X1
4.85
4.9
4.95
5
5.05
5.1
Debt- equity
When seeing at interest coverage ratio, it can be interpreted that this ratio has been decreased
in 20X1 as compared to 20X0 because the amount of interest is very less in 20X0 whereas
the amount of interest is was high in 20X1.

20X0 20X1
0
2
4
6
8
10
12
14
16
18
Intrest coverage ratio
While seeing the change in turnover ratios, it can be seen that Receivable turnover ratio has
increased to 5.4 in 20X1 to 4.3 in 20X0. This ratio indicates that the company has increased
the number of times to collect payment. Whereas, in opposition to this, it can be seen that
creditor turnover ratio has increased in 20X1 from 20X0. Although, the change in the number
of times has not shown a major change.
20X0 20X1
0.0
1.0
2.0
3.0
4.0
5.0
6.0
Receivable tunover ratio

20X0 20X1
2.4
2.6
2.8
3.0
Creditor turnover ratio
It is seen that inventory turnover ratio has increased in 20X1 as compared to 20X0. It means
the company has increased the number of times of replacing the inventory has increased in
20X1 as compared to 20X0.
20X0 20X1
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
Inventory turnover ratio
It can be seen that the change in assets turnover ratio in both the years, is just a fraction,
which cannot be even considered. In both the years, it is less than one.

20X0 20X1
0.0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
Assets turnover ratio
Some of the main concerns for the company are-
Under the liquidity ratio, it is seen that quick ratio is less than 1 which means that amount of
quick assets is insufficient to pay off current liabilities. The company has to improve quick
assets and liquidity position.
Capital-structure or solvency ratio are the another cause of concern of the company. As the
ideal ratio for debt-equity ratio is 2:1 but the company is relying more on debt to finance its
business. This indicates that company has high risk of bankruptcy that will hamper the
investor’s decision. Whereas, ICR was also 17 percent because of high financing cost but it
decreased to 6.38 percent. The company has to improve its solvency ratios.
These ratios will affect the financial performance of company and its management need to
opt certain measures to improve the position of the company.
Evaluation and interpretation of ratios
If Quick ratio is greater than one then the company will be able to meet the short-term loans
and obligations. So in order to improve its quick ratio, the company has to increase the sales,
which will increase the inventory turnover. Therefore, improved turnover will lead to
increased cash in hand that will help the company to pay off its liabilities as soon as possible.

When interpreting and evaluating all the Profitability ratios, it is seen that operating margin
ratio, net margin ratio, return on capital employed, return on assets, and return on total assets
are decreasing in 20X1 as compared to 20X0. Although, there can be many minor reasons but
some of major reasons can be decreasing sales and increasing interest expenses. Therefore, in
order to improve the profitability ratios, the company should remove unprofitable products or
services from the portfolio of offerings. As products and services with high gross profit are
important to the company. Company should start finding new customers, reduce the
unnecessary overhead cost, expand the business, and boost the productivity that can help the
business to grow (Kowalik, 2018).
While evaluating the efficiency ratios, it is important to understand that increasing efficiency
ratios indicates increased cost and decreasing revenues. It is related to the profitability
position of the company as high profitability reflect low turnover ratios. While interpreting
the assets turnover ratio, it is seen that low profit margin has high asset turnover ratio
whereas high profit margin has low asset turnover. A receivable turnover ratio of the
company when as compared to its industry, the time for 20X0 is 42.55 days, which exactly
doubled in 20X1. Inflated ratio is not a good sign, which will affect the cash conversion
cycle. Higher inventory ratio indicates better liquidity but on the other hand, it also indicates
insufficient inventory levels. An inventory ratio 4 to 6 times is considered as good. It is seen
that company is maintaining an inventory cycle of around seven to eight times (Jacobson, and
von Schedvin, 2015). From the creditor`s turnover ratio of the company, it is seen that. A
high ratio indicates that there is a short time between the purchase of goods and its payment
for the same. Whereas, a lower creditor`s turnover ratio reveals that company is very slow
when paying the suppliers. The industry is operating a margin of 90 days and on the other
hand. Company is paying its creditors in 79 days, which reflects that number of days
increased from the previous year (Jacobson, and Schedvin, 2015).

As a recommendation, Benedict Company has to improve its cause of concerns on the
priority basis. To improve the liquidity, the company can dispose off the assets, which are
useful for the company. Organisation should opt long-term liabilities to finance its activities
but at a low rate that would result into improved current and quick ratio. The inventory
turnover should reduce its number of cycles especially in 20X1. This will result into reduced
cash conversion cycle, which will become strong pillars. The cost of long-term debt has
increased as the finance cost increased in 20X1. Therefore, in order to improve the debt
component, the company should choose low cost debt.
Conclusion
From the above discussion, it can be concluded that Tesco is treating its stakeholders very
well by providing health and educational services. Moreover, to achieve a good market
position, Benedict company has to consider its cause of concerns and improve them as per the
recommendations.

References
Jacobson, T. and von Schedvin, E., 2015. Trade credit and the propagation of corporate
failure: an empirical analysis. Econometrica, 83(4), pp.1315-1371.
Kowalik, M., 2018. Profitability and Financial Liquidity of the Chemical Industry
Companies. Finanse, Rynki Finansowe, Ubezpieczenia, (1 (91) Zarządzanie finansami),
pp.47-58.
Laitinen, E.K. and Laitinen, T., 2018. Financial reporting: profitability ratios in the different
stages of life cycle. Archives of Business Research, 6(11).
Liang, D., Lu, C.C., Tsai, C.F. and Shih, G.A., 2016. Financial ratios and corporate
governance indicators in bankruptcy prediction: A comprehensive study. European Journal
of Operational Research, 252(2), pp.561-572.
Ponikvar, N., Kejžar, K.Z. and Peljhan, D., 2018. The role of financial constraints for
alternative firm exit modes. Small Business Economics, 51(1), pp.85-103.
Rosita, T., Nurwahyuni, A. and Sari, K., 2018. The Implications of National Health Insurance
on District Public Hospitals Performance: Financial Analysis. KnE Life Sciences, 4(4),
pp.205-215.
Tesco PLC, (2019) Tesco and multi-stakeholder initiatives for responsible sourcing.
Available on: https://www.tescoplc.com/reports-and-policies/multi-stakeholder-initiatives/
[Accessed on 13/01/19]
Thornblad, D.B., Zeitzmann, H.K. and Carlson, K.D., 2018. Negative Denominators in Index
Variables: The Vulnerability of Return on Equity, Debt to Equity, and Other
Ratios. Electronic Journal of Business Research Methods, 16(1), pp.1-10.

Tonchia, S., 2018. Project Cost Management and Finance. In Industrial Project
Management (pp. 153-170). Springer, Berlin, Heidelberg.
Vats, S. and Patel, K., 2017. Ratio Analysis of a Private Limited Company with Relevance to
Change in Type of Enterprise-A Case Study of Write Fine Products Pvt. Ltd. Umbragam,
Gujarat. Journal of Applied Management-Jidnyasa, 9(2), pp.37-43.
Wood, D.A., 2016. Comparing the publication process in accounting, economics, finance,
management, marketing, psychology, and the natural sciences. Accounting Horizons, 30(3),
pp.341-361.
Appendix
Financial Data of Benedict Co.
Particulars 20X1 20X0
$ '000 $ '000
Total Revenue 30,800 24,900
COGS 16000 14500
Gross profit 14800.0 10400.0
EBIT 8300.0 8700.0
interest 1300.0 500.0
Net profit 6600 7000
Current Assets 12800 6400
Quick Asests 7600 3800
Inventory 5200 2600
Average inventory 3900.0 3900.0
Trade receivables/Debtors 7600.0 3800.0
Average Debtors 5700.0 5700.0
Total Assets 50800 39000
Average assets 44900 44900
Current Liabilities 10800.0 5100.0
Trade Payables/Creditors 6800 4300
Average creditors 5550 5550
Total Liabilities 50800 39000
Capital Employed 28000.0 25900.0
Long term loans 12,000 8,000
Shareholders' Equity 10000 7900
Average shareholder`s equity 17900 17900
Dividend per Share (DPS) 0.25 0.2
Earnings per Share (EPS) 0.37 0.39

Price per Share 1 1
Dividend per Share (DPS) 0.25 0.2
Earnings per Share (EPS) 0.37 0.39
Price per Share 1 1
Computation of ratio analysis
Liquidity ratio Formula 20X0
20X
1
Current ratio Current Assets ÷ Current Liabilities 1.255
1.18
5
Quick ratio Quick Assets ÷ Current Liabilities 0.745
0.70
4
Profitability Ratios 20X0
20X
1
Operating Profit
Margin Operating profit/Net sales 0.35 0.27
Net Profit Margin Net Profit/Net Sales 0.28 0.21
Return on Capital
Employed
Net Profit after Taxes/ Gross Capital
Employed 0.34 0.30
Return on Equity
Net Income ÷ Average Stockholders'
Equity 0.39 0.37
Return on Total assets Net Income ÷ Average Total Assets 0.18 0.13
Liquidity Ratios
Capital structure
ratio 20X0
20X
1
Debt- equity
Debt-Equity Ratio = Total Liabilities ÷
Total Equity
4.9367088
61 5.08
Intrest coverage ratio EBIT ÷ Interest Expense 17.4 6.38
Turnover ratio
Efficiency ratio 20X0
20X
1
Receivable tunover
ratio
Net Credit Sales ÷ Average Accounts
Receivable 4.4 5.4
Creditor turnover ratio Net Credit Purchases ÷ Ave. Accounts Payable 2.6 2.9
Inventory turnover ratio Cost of Sales ÷ Average Inventory 6.6 7.9
Assets turnover ratio Net Sales ÷ Average Total Assets 0.6 0.7