Monitoring Financial Performance: Paper Example

Introduction

This report aims to analyze the financial performance of My Food Company Limited over a period of three years 2014, 2015 and 2016. The assessment will be through an evaluation of the firm's profitability, financial stability, and utilization of assets from the financial data in the company's financial reports. Thus, it will give a better understanding of the entity's financial health and performance. From the analysis, the financial ratios reveal that the profitability of the business has been declining. My Food Company Limited has increased its debt levels over the three years while its interest coverage has declined. Consequently, the stability of the firm has deteriorated. The asset utilization ratios suggest that the efficiency of business has worsened as indicated by weak results from inventory turnover and the debtor's collection period. The firm needs to improve on these two ratios to achieve optimum efficiency. The report will as well give recommendations on how the business can improve its performance.

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Profitability Analysis

Profitability refers to the extent to which an entity yields monetary gain from its operations hence it is a primary goal that determines the firm's long-run survival. Consequently, it is vital to evaluate the past and current profitability and also project the future profits of an entity. The gross profit margin gauges the capacity of a firm to control production costs since it indicates the leftover revenues after factoring the cost of production. The gross profit margin increased gradually over the three years from 36.48% in 2014 to 37% in 2015 and ultimately 59% in 2016 (see appendix). The increasing trend demonstrates that My Food Company Limited was able to efficiently manage its cost of sales hence improving profitability. Also, the firm had high sales over the years with a notable growth of 57% between 2014 and 2015. Despite the increasing trend, the ratio of 59% in 2016 was below the industry standard of 64%, therefore, the firm was not able to achieve a gross profit level equivalent to that of its peers.

The net profit margin is a profitability yardstick that relates the net profit to sales thus indicates the efficiency of a firm in controlling overheads. My Food Company Limited has experienced a deterioration in its profitability from 2014 to 2016. The net income has reduced significantly over the three years from a profit of $71,625 in 2014 to a loss of $136,622 in 2016. Subsequently, the net margin has declined from 5.71% in 2014 to (0.72) % in 2015 and ultimately (10.89) % in 2016 (see appendix). The firm has not been prudent in controlling its costs as indicated by the increasing total expenditure from $259,257 to $897,499 which was an increase of 246% over the three years. Therefore, the business has not been able to achieve favorable net incomes over the three years, the firm's net margin of (10.89) % was below the industry standard of 19.23%. The return on assets (ROA) indicates the portion of earnings that a firm earns relative to its overall resources. ROA was 19.9% in 2014 however it decreased significantly to (1.83) % in 2015 and slightly increased to (1.11) % in 2016. The decrease was mainly due to the significant investment in non-current assets while the net income was decreasing. Overall, the entity's total assets grew from $359,973 to $1,232,696 a growth of 242%.

The firm can adopt several measures which will oversee an improvement to the deteriorating profitability. The firm's management may undertake a closer look at its key cost areas thereby identifying potential areas with wastage which can be reduced. Additionally, the firm may undertake pricing considerations depending on any changes in the marketplace. The entity may also make effective purchases by regularly reviewing its suppliers to see if the same materials can be bought more cheaply and efficiently and that the business gets the best deals from suppliers. Assuming there are no other barriers to expansion safe for finances, the business may consider market expansion to other regions considering that it has lost a significant market share in Australia and New Zealand. Hindrances such as cultural barriers, regulations, technology, and taxes may hamper foreign market entry. New markets can transform the business and ultimately income from increased sales however it requires adequate research before implementation.

Financial Stability Analysis

Financial stability of a firm relates to whether a business is performing hence it refers to the capacity of an entity to cater for overhead expenses, reduce debt levels and return capital to investors. Conversely, a financially unstable business is one that does not generate sufficient revenues to cater for the costs of operation and maintain the going concern status. Both the short-term and long-term financial positions are essential for a firm's survival. Liquidity analysis evaluates the ability of a business to cater for near-term obligations with short-term assets. The current and quick ratios evaluate the liquidity of a firm. While the current ratios examine the capacity to pay off near-term obligations using current assets, the quick ratios gauge the capacity to meet current obligations using liquid assets. Over the three years, the business was able to maintain the current ratios at a reasonable standard of one and above. Despite this, the ratio presents a declining trend from 2.13 to 1.23 and ultimately 1 over the period (see appendix). The fall in the ratio was due to the increase in current liabilities at a rate that was faster than current assets. The decline suggests that the firm's ability to cater for current obligations was deteriorating. In 2016, the company was not able to match the industry standard of 2.25:1, which further indicate that it was not sufficiently liquid.

Solvency analysis examines the capacity of an entity to cater for its long-term financial commitments hence it determines the ability of a firm to continue operating into the foreseeable future. The equity ratio compares the total equity of a business to the total assets thus it indicates the proportion of an entity's total assets that the investor's own and how leveraged a firm is in debt. The company's equity ratio significantly declined from 29.3% to 3.8 % over the three years due to a decrease in the firm's total equity from $105,450 to ($52,903). The decline implies that the company was financing its assets using more debt rather than investors' funds. Consequently, the company has additional exposure to financial risk since it was not generating sufficient cash flows to service the debt and interest expense as indicated by the falling operating surplus. The industry standard was 68%, thus the firm was below the standard with an equity ratio of 3.8% in 2016. The gearing ratio evaluates the level of financial risk by comparing the entity's borrowed funds to the capital employed. My Food Company Limited did not have any long-term debts in 2014, however, in 2015 the business borrowed $132,340 and $604,452 in 2016 consequently, gearing ratio increased from 59% to 93% (see appendix). Firms in the industry had an average ratio of 32% in 2016 thus the company's ratio of 93% was much higher which suggest the business was highly indebted than its peers. The interest coverage ratio relates the operating profit to interest expense thus it evaluates the ability of a business to make contractual interest payments on outstanding debts. Over the years, the capacity of the company to service its interest payments has deteriorated considerably as shown by the decreasing times' interest earned ratio from 202 times in 2014 to 92 times in 2015 and ultimately 18 times in 2016 (see appendix). Compared to an industry average of 32 times interest coverage, the firm's coverage of 18 times was low. The decrease was due to the rise in interest expense from $2,255 to $45,598 an increase of 1,922% over the three years since the firm increased its debt levels. Overall, the firm's capital structure has changed over the three years since it has increased financial leverage to finance its activities.

The company can adopt several measures to improve its financial stability. Firstly, the business should undertake an effective control of its inventory since high levels take up a sizeable amount of working capital which impacts on liquidity. A reduction in the working capital will avail funds which will enhance the liquidity position thus sufficient funds will be available to meet debt covenants or pay down the debt. Also, the firm's management may consider implementing cost-cutting measures which will improve the bottom line leaving extra cash which can be used to reduce debt levels. Despite the firm reporting high gross incomes over the three years, expenditures increased and as a result, the business recorded low surplus with 2016 reporting a deficit. Hence, effective management of the costs will be crucial to improving the bottom line. Assuming My Food Company Limited is a publicly listed company, the board may sanction the sale of shares to the public and utilize the proceeds to pay the debt. Additionally, the company may negotiate with the financiers and convert the outstanding debt to shares. The firm may also consider consolidating and restructuring its debts which will oversee a reduction in monthly payments. Assuming the firm has different loans with various lenders, the business may consolidate its debts with one financier and negotiate for an extended payment period which will oversee a reduction in the monthly payments and the pressure of handling several financiers. Consolidation of debt is only applicable where the company has facilities from different financiers.

Asset Utilization Analysis

Asset utilization ratios evaluate how well the management of a firm is utilizing the available resources to produce sales. The inventory turnover ratio indicates the efficiency of a company in generating sales by showing the number of times it converts its inventory. In 2014 and 2015, this ratio is coming out to be almost the same, that is, 8.06 and 8.59 times respectively (see appendix). However, in 2016 the ratio significantly declined to 1.99 times which impacts on the day's inventory on hand. A low turnover implies that the business holds inventory for a long time thus affecting the liquidity resulting in inefficiencies. When compared to the industry average of 43 times, the firm's ratio of 1.99 times indicates inefficient operations for My Food Company Limited. Debtor's collection period evaluates a firm's credit management by showing the number of days a firm takes to collect accounts receivables. A high ratio means it takes the firm longer to collect outstanding debts which affect liquidity. The ratio improved from approximately 44 days in 2014 to 32 days in 2015 but deteriorated in 2016 since the number increased to 42 days (see appendix). The company has a higher collection period of 42 days relative to the industry standard of 30 days which means it took more time to make collections compared to its peers. The trade payables payment period is a measure of the number of days it takes a business to settle amounts owing to creditors. A longer period is preferred as it enables a firm to maintain sufficient liquidity levels. The ratio presents an increasing trend of approximately 47, 77 and 183 days respectively over the three years. The increase was due to the rise in accounts payables from $102,350 to $261,151 over the period while the cost of sales declined. When compared to the industry average of 45 days, the extremely long period of 183 days indicates the business was not prompt in making payments which may adversely affect relations with suppliers who may limit access to credit facilities.

The firm may undertake an appropriate...