In current time period business conditions become uncertain and it is very important to evaluate business performance time to time so that risk management can be done on time. In this regard ratio analysis is done by the managers and performance of the firm is evaluated. In the report after doing ratio analysis project evaluation methods are applied on the cash flows. It is very important to use project evaluation methods by the firm because by doing so it can be ensured that most viable project is selected for the business firm. Thus, project must be evaluated by the managers by using multiple methods like NPV and IRR etc. It is clear that there is huge importance of the ratio analysis and project evaluation method for the business firms.
Profitability ratio is one of the most important ratio that is used by the managers to evaluate the firm performance. The extent to which within a limit expenditures are made by the business firm is measured by using this ratio. In the profitability ratios there are types that are often used by the managers namely gross and net profit ratio which is used to access the firm performance in terms of controlling direct and indirect expenses of the business. Year on year basis comparison is made between ratios and in this way performance is measured. It is very important for the business firm to evaluate its liquidity position time to time. By doing so cash management strategy can be prepared in proper manner (Kotz, Kozubowski and Podgorski, 2012). There are two sort of ratios that comes in category of liquidity ratio namely current and quick ratio. Current ratio reflects that extent to which any company can pay an entire amount of current liability by using a current assets. In order to get better overview of the liquidity position liquid ratio is used. Under this ratio out of current assets stock and prepaid expenses amount is deducted. This is because stock cannot be sold in the market in short span of time. Thus, it can be said that by using liquid ration instead current ratio in better way performance of the business firm can be measured.
Analysis and interpretation
- Gross profit ratio: Gross profit ratio of Morrison reduced from the 7% to 4% which revealed that in past time period direct expenses were covering low percentage of sales value in comparison to current time period. Morrison needs to improve its performance and in this regard needs to develop excellent cost control strategy in the business.
- Net profit ratio: Net profit ratio is another important ratio which reflect the firm performance in terms of curbing enhancement in the indirect expenses (Covas and Den Haan, 2012). Fact that are in table reflect that net profit ratio of the firm is very low in all years. It was 4% in the FY 2012 and 2013 and become negative in the FY 2014 and 2015. This ratio become slightly positive to 1% in the FY 2016. This reflects that overall performance of the firm does not get improved.
- Current ratio: Liquidity position of Morrison is not good at all as verified from the low values of current ratio which is less than one. Value of ratio reduced from 0.57 to 0.48 and this reveal that firm cannot pay even 50% amount of its current liability from its current assets. On this front Morrison needs to improve its performance.
- Liquid ratio: In case of liquid ratio some improvement is observed in the firm performance (Kwong, Jones-Evans and Thompson, 2012). In first three analyzed year’s ratio value declined to 0.21 to 0.16. However, sign of improvement is observed in the FY 2015 and 2016 and ratio value enhanced to 0.18 and 0.22. Still improvement is required in the firm performance.
Problems and limitations of ratio analysis as a tool of financial analysis
There are some problems associated with ratio analysis. One of the major problem with ratio analysis is that it is very difficult to determine the standard value for comparison in respect to ratios. Thus, one by using its own judgment determine standard for ratios. If one will make wrong judgment in terms of setting standard then in that case wrong interpretation will be made by the managers of the firm (Embrechts, Klüppelberg and Mikosch, 2013). This is the major problem that is associated with ratio analysis. Main limitation of ratio analysis is that for current ratio standard are determined which is 2:1 and same for liquid ratio is 1:1. In case of recession it is not possible to maintain ratio at these standards. In case actual results are less the 2:1 and 1:1 firm performance will be considered poor even from recession point of view it is good. Thus, sometimes use of these standards lead to making wrong interpretation by the managers. This is the major limitation of ratio analysis.
Project evaluation method
Net present value
NPV is another which is used for the project evaluation by the managers. Under this method net value of the project is computed after subtracting proposed invested corpus amount from the current value of cash flows. Higher is the value of project low will be value of NPV or vice versa (Chimucheka and Rungani, 2013). At 10% discount rate NPV of project is 718 which is low and positive. On other hand, NPV at 20% discount rate is -1029 and this indicate that alternative is not profitable for the firm. Thus, project will be viable for the business firm if debt will be taken at 10% discount rate instead of 20%. So, project will be profitable at 10% interest rate for the business firm. This reflects that firms must always try to borrow debt at low interest rate so that profitability of the project can be maximized to possible extent.
IRR indicate real return that can be earned on the project. IRR on the project is 14% which is sufficient and it can be said that project is viable for the firm.
The Directors of SIG plc Date: 6th March 2017
Subject: Discussion on project evaluation method
Results clearly indicate that project is viable for the firm because its IRR is 14% and NPV is positive. Thus, investment must be made in the project.
Building company must be acquired because by doing so business firm can expand its business at rapid pace in its industry. The availability of infrastructure in the business will increased at rapid rate. Thus, it can be said that investment must be made in the Bristol project.
Evaluating investment appraisal method
There are different type of investment appraisal methods like NPV and IRR. There are merits and demerits of both methods. In case of NPV strong point is that present values are used in the calculation. The only demerit is that process of calculation is too complex. In case of IRR main merit is that it reflect real return that can be earned on the project. Like NPV calculation process is tough and everyone cannot do calculation in proper manner. This is the major drawback of the IRR method.
Appraising financing of investment
Investment can be finance through equity and debt both. There are positive and negative points of both sources of finance (He and Tang, 2012). In case of debt interest rate charged is moderate and finance cost remain low. The only demerit is that it is necessary to pay interest on time. The only demerit is that it is inevitable to pay interest on time. In case of equity finance cost payment can be delayed but ownership get diluted. Thus, it will be better to finance project through debt.
Challenges in acquisition process
It is very difficult to determine uncertainty level in terms of cash flows that are associated with specific project (Information Technology Investment and Firm Performance: A Meta-Analysis, 2004). Hence, even project evaluation method is depicting positive results but if economic environment become uncertain it become difficult to earn estimated amount. Thus, it is big challenge to earn estimated amount of revenue on project.
Application of investment on firm performance
Investment greatly affect the firm performance because with increase in same new sources of cash inflow comes in existence which lead to growth of the business firm. Thus, with passage of time business firm must try to make fresh investment in its business.
On the basis of above discussion it is concluded that it is necessary for the company to use ratio analysis method in day to day practice. This is because by doing so firm performance can be tracked and steps that must be taken to improve performance can be identified. It is also concluded that project evaluation method help business firm in selecting most appropriate project. Thus, it can be said that there is great use of project evaluation methods for the managers of the firms.
Books and journals
- Chimucheka, T. and Rungani, E.C., 2013. Obstacles to accessing finance by small business operators in the Buffalo City Metropolitan Municipality. East Asian Journal of Business Management. 3(2). pp.23-29.
- Covas, F. and Den Haan, W.J., 2012. The role of debt and equity finance over the business cycle. The Economic Journal. 122(565). pp.1262-1286.
- Embrechts, P., Klüppelberg, C. and Mikosch, T., 2013. Modelling extremal events: for insurance and finance. Springer Science & Business Media.
- He, X. and Tang, L., 2012. Exploration on building of visualization platform to innovate business operation pattern of supply chain finance. Physics procedia. 33. pp.1886-1893.
- Kotz, S., Kozubowski, T. and Podgorski, K., 2012. The Laplace distribution and generalizations: a revisit with applications to communications, economics, engineering, and finance. Springer Science & Business Media.
- Kwong, C., Jones-Evans, D. and Thompson, P., 2012. Differences in perceptions of access to finance between potential male and female entrepreneurs: Evidence from the UK. International Journal of Entrepreneurial Behavior & Research. 18(1). pp.75-97.