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future level of risk and return, which directly affect the share price. The
firm’s creditors are interested in the short term liquidity of the
company and its ability to make interest and principal payments. A
secondary concern of creditors is the firm’s profitability: they want
assurance that the business is healthy. Management like stake holders
is concerned with all aspects of the firm’s financial situation, and its
attempts to produce financial ratios that will be considered favorable
by both owners and creditors. In addition management uses ratios to
monitor the firm’s performance from period to period.
Advantages of Ratio Analysis:
Ratio analysis is analysis important and age old technique of financial
analysis. The followings are some of the advantages of ratio analysis.
• Simplifies Financial Statements:
It simplifies the comprehension of financial statements. Ratio
tells the whole story of changes in the financial condition of the
business.
• Facilitates Inter Firm Comparison:
It provides data for inter firm comparison. Ratio highlights the
factors associated with the successful and unsuccessful firm.
They also reveal strong firms and weak firms, overvalued and
under valued firms.
• Helps in Planning:
it helps in planning and forecasting. Ratios can assist
management in its basic function of forecasting, learning,
coordination, control and communication.
• Helps in Investment Decisions.
It helps in investment decisions in the case of investors and the
landing decisions in the case bankers and other financial
institution.
Types of ratio Comparison:
3. Activity Ratios
• Stock Turn over Ratio.
• Debtors Turn Over Ratio.
• Creditors Turn Over Ratio
Business:
The Company's core business is to manufacture and supply industrial
gases to the various industries in the country. The Company also
markets medical gases, welding equipment and consumables and
anesthetic and related medical equipment. From the very inception the
company has been a pioneer and pacesetter in the industrial
development of the country
products. Every year about 1000 new products and processes to meet
the evolving needs of worldwide customers are added in the product
range. BOC Gases constantly review their systems and use their world
wide experiences to identify and shares the best operating practices
from each market in order to apply them to customer needs in other.
BOC Pakistan, being a member of the BOC Group can offer customers
in Pakistan both the experience to solve local problems and the highest
international standards demanded by the industrial leaders of today.
short term obligations of a firm can be met only when there are
sufficient liquid assets. Therefore, a firm must insure that it does not
suffer from lake of liquidity on the capacity to pay its current
obligations. If a firm fails to meet such current obligations due to lack
of good liquidity position its good will in the market is likely to be
affected beyond the repair. It will result in a loss of creditors’
confidence in the firm. Even a very high liquidity is not good for a firm
because such a situation represents unnecessarily excessive funds of
the firm being tied up in current assets.
Liquidity Ratios:
These are the most important ratios from the lenders’ point of view.
These are the ratios which measure the short term solvency or
financial position of firm. These ratios are calculated to comment upon
the short-term paying capacity of a concern or a firm’s ability to meet
its current obligations.
The various liquidity ratios are current ratio, liquid ratio (Acid
Test Ratio) and absolute liquid ratio.
Current Ratio:
Current ratio measures general liquidity and is widely used to make
the analysis for a short term financial position or liquidity of a firm.
Current ratio is basically a relationship between current assets and
current liabilities. This ratio is also known as working capital ratio.
Significance:
Current ratio is a general and quick measure of liquidity of a firm. It
represents the margin of safety to creditors. It is an index of the firm’s
financial stability. It is also an index of technical solvency and an index
of the strength of working capital.
A relatively high current ratio is an indication that the firm is liquid and
has the ability to pay its current obligations in time as and when they
= 1.21:1 = 1.73:1
Interpretation:
The current ratio of BOC Pakistan Ltd. up to 30th September 2005
shows that it has the ability to meet all its obligations in respect of
financial debts. But the ratio up to December 31st is the indication that
the enterprise has been in good liquid position since last fifteen
months. It is an attractive sign for the stakeholders to keep full
confidence in the operations and policies of the enterprise. The
company can avail easily short term borrowing facility from banks and
financial institutions with more reliably than the previous year as its
current position is better than the previous year.
Liquid Assets
Current Liabilitie s
= 1.08:1 = 1.41:1
Interpretation:
The liquid ratio of BOC Pakistan Ltd. is showing its better liquidity
position and its liquid ratio is better than the requirement that is
usually observed by the banks and other financial institutions. The
stake holders especially creditors can rely on the company because
BOC Pakistan Ltd. has liquid assets to pay the short term liabilities in
time or when they will become due. The liquidity of the enterprise has
been increased from the last year which is an indication of the better
business operations and policies.
Significance:
Gross profit ratio may indicate to what extend the selling prices of
goods per unit may be reduced with incurring losses on operation. It
reflects the efficiency with which a firm produces its products. As the
gross profit is form by deducting cost of goods sold from net sales,
higher the gross profit ratio better it is. There is no standard GP ratio
for evaluation. It may vary from business to business. However the
gross profit earned should be sufficient to recover all operating
expenses and to build up reserves after paying all fixed interest
charges and dividends.
G.P Ratio
Gross Pr ofit
= ×100
Net Sales
= 41.96% = 39.83%
Interpretation:
The gross profit percentage of BOC Pakistan Ltd. has been reduced
from 41.96% to 39.83%. Although there is increase in Gross Profit
(28%) and sales (36%) but this increment is not relatively equal to the
increase in cost of sales which is 41%. Management should assess that
why their cost has been increased. However this GP Margin is still up to
the mark GP margin can be made by increasing sales, by decreasing
cost and adopting better purchase policies.
This is the ratio of net profit (before tax) to net sales expresses as
percentage:
Significance:
This used to measure the overall profitability and hence it is very
useful to proprietors. The ratio is very useful as if the net profit is not
sufficient the firm should not be able to achieve a satisfactory return
on its investment. This ratio also indicates the firm’s capacity to face
adverse economic conditions such as price competition low demand
etc. obviously, higher the ratio the better is the profitability.
Net Profit Ratio
Net Pr ofit aftere Taxation
= ×100
Net Sales
= 21.10% = 18.90%
Interpretation:
Net profit ratio of the company is decreased from 21.10% to 18.90%.
One reason of this decrease is the remarkable increment in some
expenses like deprecation, repairs and maintenance and traveling
expenses due to revision of estimated useful life of assets and rising in
fuel prices. There is a pressure on the profit margin of the company.
Significance:
This ratio shows the operational efficiency of the business. Some of the
revenues and expenses of a business is result from activities other
then the company’s basic business operations. This ratio shows a
relationship between revenue earned from customers and expenses
incurred in producing this revenue. In effect operating profit ratio
measures the profitability of a company’s basic or core business
operations and leaves out other types of revenues and expenses are
excluded.
Operating Profit Ratio
EBIT
= ×100
Net Sales
= 29.58% = 24.5%
Interpretation:
It has been observed and mentioned earlier that profit margins of BOC
Pakistan Ltd. are decreasing as we compare them with the previous
years. An operating profit ratio equal to 25% to 30% is considered
normally good and company is needed to raise its profitability to
maintain the confidence of the stake holders through better business
operations.
the enterprise’s production and direct cost and vice versa. It can be
helpful for the management to make better purchasing, production and
other direct cost decisions as it related directly sales to the cost of
sales.
= 58.03% = 60.17%
Interpretation:
The cost of sales of BOC Pakistan Ltd. in 2006 has been increased which
reduced the GP margin of the company. The company should be cost efficient to
attract the investors. Although there is not a substantial increase but
management is needed to reduce the cost to make better profitability. And if the
company is running already at low cost then there is need to increase the sales
of its products.
maximize its earning. This ratio indicated the extent to which this
primary objective of business is being achieved. It is calculated for net
profit after interest and tax because share holders are interested in the
profit which is available for them in respect of dividends. This is better
measure then the return on equity capital because it includes not only
capital but also the reserves which are maintained for several financial
purposes. Inter firm caparison of this ratio determines whether the
investment in the firm is attractive or not as investors would like to
invest only where the return is higher.
Returns on share holder fund
Net Pr ofit After Tax
= Share Holder Fund ×100
= 34.79% = 37.09%
Share Holder Fund = Capital +Reserves
Interpretation:
There is increase in the return from the last year and it is an indication
that the operations of business are good and management efficiently
employs the share holders’ fund in generating the revenues. It is also a
better sign for the stock holders that there investments are being
utilized to give them better returns.
Return on Capital Employed:
It is relation ship between operating profit and capital employed of the
company. There are various methods to calculate the capital
employed. We use the share capital, long term liabilities and reserves
to calculate the capital employed. Capital employed can also be
calculated with the debit side of the balance sheet.
Significance:
= 41.66% = 47.36%
Capital Employed = long term liabilities + share Holder’s Fund
Interpretation:
As there is remarkable increase in the ratio which is an indication that
the management is using efficiently funds provided by the creditors
and shareholders and the reserves of previous profits kept for the
financial purposes. There is a suitable return to the capital employed
that is 47.36 % which means funds of Rs. 100 are generating profit of
Rs. 47.36. This is good sign for the stake holders especially for the
investors which are interested in the return of the capital employed.
Earning per Share:
Earning per share is a small variation of return on equity capital and it
is calculated by net profit after tax and preference dividend dived by
the total number of equity shares. It determines the per share earning
in Rupees.
Significance:
In the BOC Pak (Ltd) there is no prefers share holder so the formula will be.
Earning After Tax
= No .Of Ordinary Shares
stock exchange at market price don’t look for dividend rather they care
about capital gain.
Price Earning Ratio
Dividend Per Share
×100
= Market Value Per Share
This ratio is relationship between dividend per share paid and the market value
per share expressed in terms of percentage.
Significance:
This ratio is much better tool then the earning yield ratio because it relates
dividends paid with the market value of share. It helps investor assess that how
much return he is going to get on the proposed investment.
BOC Pakistan Ltd. is paying much dividends and its retained earning per share is
lower. The company is paying more dividends and retaining lesser portion of the
profit for its reserves. This policy might be the result that already company’s
reserves are three times greater than the share capital. Investors are going to
have adequate return on their investments because 83 % of the profit is being
paid to them.
E a rn in ag fte rT a x
= D iv id enDd e cla red
396,694 449,761
= 300464 = 375,581
= 25 days = 36 days
Interpretation:
The results of the stock turn over ratio show that there is a little bit
mismanagement of the inventory because rotation period has been
increased from 25 to 36 days and stock turn over ratio of BOC Pakistan
Ltd. has been shifted from 14 to 10 times which means last year stock
of the company converted 14 times into sale in period of 25 days and
in year 2006 it could be converted only 10 times into sales and the
whole process was completed in 36 days. BOC Pakistan Ltd. is needed
to be efficient in inventory. One reason of this substantial increase may
be the increased cost of goods sold during this year (increased up to
41%).
Debtors or Receivables Turnover Ratio:
= 22 days = 22 days
Interpretation:
BOC Pakistan Ltd. is working on relatively better debtor turnover ratio
and average debtors collection period showing that debtors are more
liquid and company is much efficient in the management of its debtors.
Creditors/Payables Turnover ratio:
This ratio is similar to Debtors/Receivable turnover ratio. It
compares the creditors with total credit purchases. It signifies the
credit period enjoyed by the firm in paying creditors. Accounts payable
include both sundry creditors and bills payable. Same as debtor’s
turnover ratio, creditor’s turnover ratio can be calculated in two forms.
Significance:
The average payment period ratio represents the number of
days taken by the firm to pay its creditors. A higher creditors turn over
ratio or a lower credit period ratio signifies that the creditors being
paid promptly, thus enhancing the creditworthiness of the company.
However, a very favorable ratio to this effect also shows that the
business is not taking full advantage of credit facilities allowed by the
creditors.
Creditors Turn over Ratio
Credit Purchase
= Avg .Trade Creditors
Significance:
The average payment period ratio represents the number of days
taken by the firm to pay its creditors. A higher creditor’s turn over ratio
or low credit period ratio signifies that the creditors being pair
promptly, thus enhancing the credit worthiness of the company
however, a very favorable ratio to this effect also shows that the
business is not taking full advantage of credit facilities allowed by the
creditors.
No. of Days (Average Payment Period)
Avg .Trade Creditors
= ×365
Credit Purchase
= 50 days = 41 days
Interpretation:
As the credit purchases were not available in the financials of BOC Pakistan Ltd.
so we have calculated the creditors turn over ratio by assuming all the purchases
as credit. BOC Pakistan Ltd. has improved its creditors turn over ratio from the
previous years as in previous years creditors were paid in the span of 50 days
which has been reduced in the current year to 41 days. It is clear indication that
company has enhanced its credit worthiness. Although the volume of purchases
and creditors is increased during the year 2006 but as the company’s liquidity is
very good and company has made its creditors turn over ratio better.
= 1:2.9 = 1:4
Interpretation:
Debt equity ratio of the company is being increased from the previous
year from 1:2.9 to 1:4 which is indication that the company now has
more funds to pay out the long term funds. One reason of the
company’s improved debt equity ratio is the payment of the long term
funds. On one side the long term debts are being decreased and on
other side there is a substantial increase in the share holders’ fund
which made the credibility better. Debt equity ratio = 1:1 (for Rs.1 of
long term debts share holders have Rs.1) is considered satisfactory but
the debt equity ratio of the BOC Pakistan Ltd. is above standard which
is sign for the financial institutions that the company is in position to
pay back the loans acquired with in time or when they will become
due.
Debt Service or Interest Coverage Ratio:
This ratio relates the fixed interest charges to the income earned by
the business. It is also known as interest Coverage Ratio. It indicates
whether the business has earned sufficient profits to pay periodically
the interest charges.
Significance:
The interest Coverage Ratio is very important from the lender’s
point of view. It indicates the number of times interest is covered by
the profits available to pay interest charges. It is an index of the
financial strength of an enterprise. A high ratio assures the lender a
regular and periodical interest income. But the weakness of the ratio
may create some problems to the financial manager in raising funds
from debts sources.
Interest Coverage Ratio
Net Pr ofit Before Interest & Tax
= Fixed Interest Ch arg e
Interpretation:
The results of the interest coverage ratio of BOC Pakistan Ltd. for both
periods are clear indication of the company’s ability to pay the periodic
interest on long term borrowings and especially in year 2006 the
company’s profit before tax is 42 times greater than its financial costs.
Through the analysis of this solvency ratio the confidence of the
bankers and other financial institutions with respect to the credibility
will definitely increase and they will feel the repayment of their loaned
principal together with interest very safe.
One reason of this improved ratio is that company has repaid a
substantial portion of its long term liabilities which has reduced the
payment of interest.
Capital Gearing Ratio:
Closely related to solvency ratios is the Capital Gearing Ratio
which is mainly used to analyze the capital structure of a company.
the company. After analyzing the over all long term solvency ratio the
creditors will finance the company because they will fill their financing
very safe.