Liquidity Ratios: Review

Liquidity ratios assess the company’s likelihood of meeting temporary obligation when they fall due, a firm is at risk if the liquidity risk is low and to reduce this risk a firm must strive to attain a ratio that is more than one for both current and quick ratio since one represent margin of safety (Microstrategy.com, 2011). CFS current ratio in the year ended 30th June 2011 was 1.54:1; which was an increase of 5% when compared to the year ended June 2010. The quick ratio was at 0.77:1 which is an increase of 31% compared to 2010. Therefore, the current liabilities can cover current liabilities 1.54 times using current ratio or 0.77 times using quick ratio. Quick ratio is the most preferred liquidity ratio when compared to current ratio (Microstrategy.com, 2011) because it does not include illiquid assets such as inventory, thus based on this financial analysis CFS is facing liquidity risk.

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Profitability ratios

These ratios indicate the managers’ effectiveness in cost control; a profitable company will be able to meet short term debts and shareholders will also receive reasonable returns on their investment in form of dividends (Universalteacher4u.com, 2011). The Gross profit margin, Return on investment, and Return on Capital employed shows a very high figure and this implies that managers effectively utilized long term loans to generate returns to the shareholders and that they were able to control cost of sales. The net profit margin was low because operating expenses were very high at 48.27% in relation to sales, while the operating profit margin (16.09%) was low as a result of high operating expenses.

Gearing ratios

The firm’s leverage is measured by gearing/leverage ratios, a firms faces financial risks if the ratio is very high; therefore, the firm should use the appropriate mix of debt and owner’s funds (NetMBA.com, 2011). The firm’s financial cost (interest) can be covered by earnings 43 times which is safe for the company as it is able to pay financing charges to the debt owners or the bank. In 2011, the debt-Equity ratio reduced by 24% to 31.94% from 42.21% in 2010. This means that CFS is not highly geared as the ratio is less than 100%. The debt ratio dropped by 18% from 29.68% to 24.21%; this means that the firm is not highly geared because the ratio is less than 50%.

In conclusion, CFS is facing liquidity risk due to less liquid current assets maintained by the firm, CFS is more profitable and the company is not facing finance risk as it is not highly geared. I would therefore recommend Yehuda Bigalli to continue with the business as it is not exposed to the above mentioned risks and it is more profitable. However, he should try to control the operating expenses in order to improve the business net profit.

Ratio analysis is a good measure in condensing accounting information presented by the firms in their annual reports (NetMBA.com, 2011). Nevertheless, it has limitations which the user of ratios should put in mind; the limitation includes; use of irrelevant information in undertaking of future decision (historical information), management quality, experience and morale of employees (NetMBA.com, 2011). Different users of accounting information will also use different terms to depict financial information for example including preference shares in equity or referring to return on capital employed as gross capital employed (Universalteacher4u.com, 2011).

References

Microstrategy.com.2011. Financial Analysis, Web.

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NetMBA.com.2011. Financial ratios, Web.

Universalteacher4u.com. 2011. Ratio Analysis, Web.

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