Financial Ratio Analysis Harry’s Hamster Limited

2471 words - 10 pages

Example Finance EssayFinancial Ratio Analysis - Harry's Hamster LimitedFinancial statements are useful as they can be used to predict future indicators for a firm using the financial ratio analysis. From an investor's perspective financial statement analysis aims at predicting the future profitability and viability of a company, while from the management's point of view the ratio analysis is important as it helps anticipate the future conditions in which the firm should expect to operate and facilitates strategic decision making (Brigham and Houston 2007, p. 77).Profitability analysisHarry's Hamsters Limited (HHL) experienced growth in its profitability from 2007 to 2008; however, the net income reduced significantly during 2009. The return on equity (ROE) was 4.24 percent in 2007, increased to 14.68 percent in 2008 and decreased back to 5.10 percent in 2010. Similarly, the return on assets (ROA) also initially increased and later declined in 2009; the decline was sharper compared to the decline in ROE as the ROA in 2009 of 1.73 percent is lower than 2.08 percent in 2007. The ROE comprises of two main components: the return on net operating assets (RNOA) and the return on debt (ROD). RNOA for HHL has also deteriorated during 2008 decreasing from 16.61 percent in 2008 to 5.08 percent in 2009. The RNOA is used to weigh the overall performance of the HHL management. The ROD component of the ROE has also deteriorated from 13.68 percent in 2008 to negative 3.32 percent in 2009 (Kemsley 2009, pp. 12-16). The ROCE was the highest in 2008 estimated 11.39 percent. It implies that the capital employed by HHL yielded high returns before the expansion period and that the company was significantly profitable. A considerable decline in 2009 to 4.82 percent can be unfavourable for the investors; however, as the company has not sold its shares to the public a reduction in this ratio for a temporary period is not a major concern for the current owners. The operating profit margins for HHL initially increased from 10 percent in 2007 to 17.45 percent in 2008; however, the company reported lowered margins of 8.53 percent in 2009. The decline in the operating profit margins of HHL is largely attributed to the increase in costs associated with the expansion of the business. The operating margins are expected to recover over the next year assuming that the new operations will become profitable as sales increase. The cost of goods sold have increased in absolute terms but the overall gross profit margins for the company have improved from 35 percent in 2007 to 42.01 percent in 2009. This implies that the company is effectively managing its relations with suppliers and has kept a control over the costs attached to buying the hamsters for breeding; but the operating costs have increased due to the low sales activity in the new operations.Liquidity analysisThe current ratio of HHL remains above the minimum threshold of one and is currently 1.22; historically, the ratio has...

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