201

0
ICBT BATCH 30

VIRAJ
MALLAWARACHC
HI

[MANAGING
FINANCIAL
RESOURCES AND
DECISIONS]
[PRESENTED TO MR.CHAMILA AMARATHUNGA]
 ACKNOWLEDGEMENT

I would like thankful to lecture Mr. Chamila Amaratunga

for his tremendous efforts in teaching us the subject

Managing Financial Resources and Decisions and also

for the extra knowledge provided to keep us motivated

in finance and in Life.

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Statement of Originality of Submitted Work

I; VIRAJ MALLAWARACHCHI

Student Id NO: ICBT BATCH 30 NUMBER 12

Module Name: MANAGING FINANCIAL RESOURCES

AND DECISIONS

I hereby confirm that the work presented here

in this report and in all other associated material;
is wholly my own work.
And I agree to assessment for plagiarism

Signature: VIRAJ MALLAWARACHCHI

Date: 28-06-2010

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EXECUTIVE SUMMARY

This assignment consists of detailing of Budgeting and forecasting in a business to

understand the organizational future requirements and to work towards a goal.
The various types of budgets which are used in organizations are listed with examples
where the cost and calculation methods and what type of details are taken into
consideration in an organization for planning the future.
An organization will want to get their costing and prices accurate as the business world is
so competitive and to be ahead of others. It is explained in detail how the cost factors
being considered when pricing for products and services.
In the final question of the assignment have explained about the ratios which are used by
on various conditions and given a vast explanation on the same.

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Task 01 (P3)

Make financial decisions based on financial information such as budgets and make
appropriate decisions, unit costs and make pricing decisions using relevant
information.

The Budget

A budget could be simply defined as a financial document used to project future income
and expenses. The budgeting carried out by the organizations to estimate whether the
company can continue to operate with its projected income and expenses.

The process of calculating cost in an organization begins with necessary purchases

including tangible assets (for example; building, equipment) and services (for example;
insurance, lease). The budget should contain detail explanation on expected financial
results of business activities. The assets are valued at each and every cost. All other
expenses such as labor, factory overhead, machinery are also included into business
budget.

The need of a budget to an organization

• To stay in control of the organization’s finance in advance

• To set standards for expenses and revenue
• To use as a tool to compare financial figures on actual and predicted
• To measure how to run the business at a profit
• To plan future growth of the business
• The statement of all financial/non financial transactions value
• The actual profit indicator

The main elements of preparing a budget sheet

1. Track income and expenses

2. Group income and expenses into categories

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 3. Realistic data including with backup records as documentary proof

A sample budget sheet

The budget of a company is often made annually, but may not be. A finished budget,
usually require considerable effort, is a plan for the short-term future, typically one year.
While traditionally the Finance department compiles the company's budget, modern
software allows hundreds or even thousands of people in various departments to list their
expected revenues and expenses in the final budget. (operations, human resources, IT etc)
If the actual figures delivered through the budgeted activities during the predicted period
of time, it suggests the management of the organization understand the business and will
drive successfully driving towards the intended direction.

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Types of Budgets

In the scope of finance it is necessary to be familiar with the various types of budgets.
The types of budgets include master, operating (for income statement items comprised of
revenue and expenses), financial (for balance sheet items), cash, static (fixed), flexible,
capital expenditure (facilities), and program (appropriations for specific activities such as
research and development, and advertising). These budgets are briefly explained below.

Operating and Financial Budgets

The operating budget deals with the costs for merchandise or services produced. The
financial budget examines the expected assets, liabilities, and stockholders' equity of the
business. It is being mainly used to analyze company's financial wealth. The operating
budget reflects daily expenses and usually being made annually.

Cash Budget

The cash budget is made for cash planning and control. It presents expected cash inflow
and outflow for a certain period of time. The cash budget helps management keep cash
balances in reasonable relationship to its needs and aids in avoiding idle cash and
possible cash shortages. The cash budget typically consists of four major sections;

1. Receipts section - is the beginning of cash balance, cash collections from customers,
and other sources as leasing, hire purchase and interest on fixed deposits.
2. Disbursement/payment section - comprised of all cash payments made by purpose
3. Cash surplus or deficit section – indicates the difference between cash receipts and
cash payments.
4. Financing section - Provides a detailed account of borrowings and repayments
expected during a certain period of time.

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Static or Fixed Budget

Static or fixed budget is budgeted figures at the expected capacity level. Allowances are
set forth for specific purposes with monetary limitations. It is used when a company is
relatively stable. Stability usually refers to sales. This form is budgeting does not cope
with a static budget is that it lacks the flexibility to adjust to unpredictable changes.

In industry, fixed budgets are appropriate for those departments whose workload does not
have a direct current relationship to sales, production, or some other volume determinant
related to the department's operations. The work of the departments is determined by
management decision rather than by sales volume. Mostly administrative, marketing, and
manufacturing management departments belong to this category.

The business transactions in an organization which demonstrate fixed budget are

appropriations for capital expenditures, major repair projects, advertising or promotional
programs.

Advantages of different budgeting systems:

• Budgeting systems integrates the activities of entire organization

• Budgeting helps to examine level of performance to benchmark expectations and
achieved
• Budget is a way of management plan execution
• Provides the organization a better understanding about resource allocation
• Budgeting strengthens planning and controlling area of the organization vital for
growth of the business in the long run
• Budgeting fluctuation monitoring to better the decisions

In some organizations different budgeting systems are created to perform different

activities but it all interconnected towards the balance sheet.

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Abstracted above are sample budgeting sheets of an organization for the financial year
2007 and 2008. The main elements of a budget sheet are:
• Total sales value
• Total income
• Total operating costs
• Total expenses
• Net income
• Opening Income

Total operating income

Operating income is a calculation the difference between the operating revenue and
operating expenses of a certain organization. The estimated income of the financial year
2007 is 188500 and 100400 in year 2008 indicates a 46.7% decrease while the actual
figure decrease by 53%.

Operating expenses

Operating expenses are the expenses incurred in the daily operations of the company, but
exclude extraordinary expenses. Generally operating revenue as the revenue from sources
that recur from year to year, and operating expenses as the expenses within a class that
recurs from year to year. The estimated expense of year 2007 indicates a figure of 90275
and 90640 in year 2008. It is a 0.40% increase while the actual figure decreased by
0.14%.

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Unit cost

The cost of a given unit of a product or service could be simply identified as unit cost.

Unit cost calculation

The unit cost prices one generally means the costs per piece of a property (also average
costs, there total costs/quantity) contrary to the total costs. The process of the unit cost
price depends on the manufacturing technology used by the organization.

Unit cost formula

Variable cost + Fixed cost

Number of Unit sold = Unit cost

Assumption

Fixed cost = $150000

Variable cost = $10
Units sold = 25000

$10 + $150000 = $16

25000

Price per unit = $16

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Pricing

Almost every organization in the world set prices on its goods and services. Price can be
identified in different forms under the same concept.

• RENT for a building or an apartment

• TUTION FEE on education
• FARE on travel expenses
• INTERESTS for borrowed money

The pricing factor determines by buyers and sellers. Setting price for goods and services
arose with the development of large scale retailers at the end of nineteenth century. In the
current business context the technology has merged labor, machinery, investors,
entrepreneurs, buyers and sellers in way which had never happened before. Web sites
allow buyers to compare price and other benefits offered by sellers rather than just
picking a product on for sale. Thus new technology also helps sellers to collect detail
information about buyers, buying habits, buyer preferences and affordable price to tailor
them in a proper manner.

In the entire marketing mix price is the main element that generates income to a
company. When setting the price, an organization should consider facts such as;

• Not to limit only for cost

• Price should revise as per market change
• Range of products offered by the organization
• Market position and market segment of organization
• Purchasing occasions

Price is the key element used to support product’s quality and positioning because when a
firm develop its strategies, must decide where to position its product on price and quality.

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The need of a pricing objective to an organization

• Survival/soul existence – this is a short term objective appropriate only for

organizations facing problems with overcapacity, intense competition and
changing consumer wants. The company could survive as long as price covers
variable and fixed costs.

• Maximize profit – organizations estimate the demand and cost associated with
alternative pricing to decide the price which could maximize profit, cast flow and
return on investments.

• Maximize market share – When an organization produce high sales volume it

could lower the unit cost and higher long run profit. This is also known as price
penetration, the firms set the lowest price, assuming the market is highly price
sensitive.

• Maximize market skimming – An organization set higher price to “skim” the

market. A skimming price will be set under the conditions as, when a sufficient
number of buyers have a high market demand, the high unit cost incurred when
producing a small volume, to keep away the competitors by setting a higher initial
price and the manufacturing products known to be superior

When selecting an appropriate pricing method organizations tend to consider six major
steps to obtain its goals,

1. selecting the pricing objective

2. determining demand
3. estimating costs
4. analyzing competitor’s pricing strategy
5. selecting a pricing method

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 6. selecting the final price
Finance and price selection

When setting the price an organization mainly consider about three criteria:

• Customer demand
• Cost
• Competitor price

First, cost set a floor to the price. Second competitor prices and the price of substitutes
provide an orienting price and thirdly an assessment of unique product features
establishes the ceiling price. Therefore when selecting a price, an organization should
include one or more of these considerations. The main price setting methods can be
identified under six categories.

1. Markup pricing

The most common pricing method is to add a standard markup to the product’s cost.
Furthermore this can be identified as an adding a markup to the unit cost in order to
achieve estimated sales revenue.

Assumption - The manufacturer A’s unit cost

Fixed cost = $150000

Variable cost = $10
Units sold = 25000

$10 + $150000 = $16

25000

Price per unit = $16

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If the manufacturer wants to earn 20% markup on sales, the markup price is;

Markup price = unit cost

(1-desired return on sales)
= $16
(1-0.2)
= $20

The manufacturer sells the product at $20 and makes a profit of $4 per unit. If the
manufacturer wants to earn 50% on their selling price, they will markup the unit at $50.
This theory is applicable up to cost markup of 100%.

The disadvantages of Markup pricing

• it does not consider market demand

• ignores perceived value
• does not consider competitor price

Markup pricing works only if the marked-up price actually brings in the estimated level
of sales. The companies introduce a new product often mark its price high to recover their
costs as early as possible but it could be a failure if competitor prices are low.
Example: Philips tried to make substantial profit out of each videodisc players but
Japanese competitors priced low and succeeded capturing market share rapidly.

The advantages of Markup pricing

• It helps sellers to observe costs much more easily

• If all firms in a certain industry use this method price tend to be similar
• Cost plus pricing known to be fairer to both buyers and sellers and is a fair return
on investment

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 2. Target return pricing

The target return pricing applies when an organization determines the price that would
yield its target rate of return on investments.

Example; suppose a manufacturer A in the previous example invested 1 million and

wants to earn 20% return on invested capital the target return price is indicated as
explained below;

Target return price = unit cost + desired return x invested capital

Unit sales
= $16 + 0.20 X 1000000
25000
= $20

3. Perceived value pricing

Some organizations believe the buyer’s or the customer perception of value is the crucial
factor to determine price. The perceived value pricing is to determine market perception
of the offer’s value accurately.
Example; Manufacturer A setting a price of $16 per unit at the initial stage of product in
market, could give him a proper feedback on customer willingness to purchase. It helps to
decide to go ahead with the new product at that price or it could be reduce or increase.

4. Value pricing

It is a method in which the organization charges a fairly low price for a high quality
offering. This is a major trend in the computer industry, which has shifted from charging

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top dollar for cutting-edge computers to offering basic computers at lower prices. Also
retail giant Wal-Mart and Amazon.com use the same pricing strategy.
5. Going rate pricing

The firm bases its price largely on competitor’s price. In oligopolistic industries that sell
a commodity, mainly aiming at welfare of the community such as steel, paper or fertilizer
firms usually charge the same price.
When costs are difficult to measure or competitive response is uncertain, firms feel that
the going price represents a good solution, since it seems to reflect the industry’s
collective wisdom as to the price that will yield a fair return and not jeopardize industrial
harmony.

6. Sealed – bid pricing

Sealed bid pricing is a strategy which set price on expectations of how competitors will
price rather than on a rigid relationship to the firm’s own cost or demand. Sealed bid
pricing consists of two opposite pulls.
• Submitting the lowest price
• Upper than the manufacturing cost for a unit

By implementing this strategy company estimates profit and probability of winning with
each price bid. Through expanding the profit margin by probability of winning the bid on
the basis of that price, the company can calculate the expected profit for each bid. An
organization makes number of bids, is a way of achieving the maximum profit in the long
run.

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EXECUTIVE SUMMARY

Financial decisions of an organization depend on financial documents such as budgeting

sheets, profit and loss account and balance sheet. All these documents read the most
important factor as Price. It is the only marketing mix element that generates income to
the organization. After developing pricing strategies, firms often face situations in which
they need to change prices by initiating price cuts or price increments. In these situations
organization need to consider how stakeholders will react to price changes in order to
implement appropriate pricing strategy.

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TASK 02

Analyze and evaluate the financial performance of a business and explain the
purpose of the main financial statement.

FINANCIAL STATEMENT

A financial statement is referred to as a report which quantitatively describes the financial

strength of the business organization.

MAIN FINANCIAL STATEMENTS

Business organizations report information in the form of financial statements which are
issued on a periodic basis. The four main financial statements include:

• Balance Sheet - Statement of financial position at a given point in time

• Income Statement or Profit & Loss – Revenues minus expenses for a given time
period ending at a specified date

• Statement of Owner’s equity – Statement of retained earnings or equity statement

• Statement of Cash Flows – Summarizes sources and uses of cash; indicates

weather enough money is available to carry out day to day business activities

BALANCE SHEET

A balance sheet can be described as a snapshot of a firm’s financial condition at a

specific moment in time which is generally at the closing of an accounting period. A
balance sheet is made up of assets, Liabilities and owners’ or shareholders equity.
A balance sheet helps the business proprietor to gather information on the financial
strengths and the potential capabilities of the business quickly. The balance sheet can also
be used to identify and analyze trends, mainly in the areas of receivables and payables.

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Balance sheet one of the most vital and basic elements in providing financial reporting to
potential leaders such as banks and other financial institutions, investors and vendors who
are considering how much credit to grant the business.

INCOME STATEMENT/PROFIT AND LOSS ACCOUNT

An income statement is also commonly known as P&L statement. This is a summary of a

firm’s profit and loss during any one given period of time. For instance, a month, 3
months, 6 months, 1 year etc… The income statement helps to record all revenues
generated and the operating expenses for a business during a given period of time.
An income statement enables a firm to keep track of revenues and expenses so that they
can determine the operating performance of the business over a specific period of time. It
further enables a firm to find out what areas in the business are over budget and under
budgeted. In addition items that are causing unexpected expenditures can be highlighted
such as phone, fax, e-mail or supply expenses. Income statements can also help firm track
dramatic increases in product returns or cost of goods sold as a percentage of sales. They
can also be used to determine income tax liability.
It is crucial to format an income statement so that it is appropriate to the business being
conducted. Balance sheet and the income statement is the most vital document demanded
by finance sources in order for them to decide weather to grant the firm loans and provide
them with purchases on credit basis.

STATEMENT OF OWNERS’ EQUITY

This is also referred to as the “statement of retained earnings”. This document is one of
the four main financial statements that quantify the financial position of organizations
operations at a specific period in time. The statement of owner’s equity details the
changes made to the owners equity account during the accounting period as the
organization issues dividend payments and retains money for the use within the
organization for investment. To completely define the statement of owners’ equity the
firm has to settle the previous equity balance with withdrawals or dividend payments,
investments and income of the present financial year.

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OWNER’S EQUITY FORMULA:

Assets – Liabilities = Owners equity

The owner’s equity column is also the variance on the balance sheet between asset and
liability accounts. The statement of retained earnings therefore uses information from the
income statement and provides information to the Balance sheet. This is because retained
earnings appear on the balance sheet and most commonly are influenced by income and
dividends.

CASH FLOW STATEMENT

This is an accounting document which indicates the amount of money generated and
utilized by the business organization over a certain period of time. Cash flow can be used
to asses the firms financial health. Cash flows are of two types:

• Cash inflows – money coming into the business from various sources. EG:
Financing, operations or investment. Personal finance can also be considered such
as donations and gifts.

• Cash outflows – money going out of the business to outside parties in the form of
expenses or investments.

The cash flow statement is vital for a business and is used by shareholders and investors.
This is because the income statement is prepared under the accrual basis of accounting.
Therefore revenues reported may not have been gathered as well as expenses reported
may not have been paid. Although the balance sheet changes could be used to determine
the facts but the cash flow statement records already has included all that information.

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ACCOUNTING RATIOS

Financial ratios are helpful indicators to analyze a business organizations financial

position. Rations can be calculated from financial information gathered from financial
statements. EG: Balance Sheet, Income statement, Cash flow statement and statement of
changes in equity.
Rations are helpful to analyze market trends and to further compare the firm’s financial
health with their main rivals. In some instances, ratios can even help a business to
forecast future liquidation. Thus in other words, accounting ratios highlights the
relationship between accounting data.
Financial ratios can be categorized into several categories:
• Liquidity ratios

• Asset turn over ratios

• Financial leverage ratios

• Profitability ratios

• Dividend policy ratios

ADVANTAGES OF ACCOUNTING RATIOS

• Simplifies financial statements – It helps to analyze financial statements with an

ease and better understanding of the financial condition of the business
organization

• Facilitates inter-firm comparison - It provides facts for inter firm comparison.

Ratios indicate factors involved with successful and unsuccessful firms.

• Helps in planning – It helps a firm’s management to plan and forecast. In

addition provides a support to the management with planning, coordinating,
controlling and communication.

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 • Helps in investment decisions - It helps in investment decisions in the case of
investors and loan decisions in the position of bankers etc.

DISADVANTAGES OF RATIO ANALYSIS

• Limitations of financial statements: Ratios are calculated mainly using the

information available in the financial statements. Financial statements themselves
are recorded with adherence to certain restrictions. In turn making ratios also
adhere to those barriers. For instance, Non-financial information changes are not
relevant by the financial statement although it is crucial for the business.

• Comparative study required – Ratios are helpful in judging the efficiency of the
firm only when they are compared with the previous year’s records. However, this
information therefore can only provide accountants with a small peek of the past
performance and projections for future may not prove correct since several factors
such as market conditions, management policies could affect the future
operations.

• Ratios only are insufficient – Ratios are only indicators. They cannot be taken as
the final regarding favorable or adverse financial position of the firm. Other
factors also must be considered.

• Issues of price level changes – Price fluctuations can cause an affect on the
validity of ratios calculated for various time periods. In this case, ratio analysis
may not highlight the trend in solvency and profitability of the company. The

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 financial statements, therefore, be adjusted keeping in view the price level
changes in a meaningful comparison is to be made through accounting ratios.

• Lack of adequate standard – No fixed standard can be laid down for principle
ratios. Hence, there are no well conventional standards or rules of thumb for all
ratios which can be accepted as norm. It makes interpretation of the ratios tough.

• Limited use of single ratios – A single ratio does not convey a lot. To make a
better interpretation, several types of ratios must be calculated which is likely to
confuse the analyst rather than helping him/her to make any favorable effective
decisions.

• Personal bias- Ratio is the only means of financial analysis and not an end in
itself. Ratios have to be interpreted and therefore different people may analyze
and interpret the same ratio in numerous ways.

• Incomparable – Not only industries differ in their nature, but also the business
organizations in the similar industry widely differ in their size and accounting
procedures. It makes ratios difficult to compare and misleading.

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JOHN KEELLS HOTELS PLC

In the terms of market capitalization, John Keells Holdings PLC is the largest listed
conglomerate existing in the Colombo Stock Exchange. John Keells Hotels PLC is the
largest hotelier in the island and amongst the world in Maldives. John Keells Hotels PLC
owns several popular Hotels in Sri Lanka such as: Cinnamon Grand Colombo, Cinnamon
Lakeside Colombo, Cinnamon Lodge Habarana, Chaaya Citadel Kandy, Chaaya Village
Habarana, Chaaya Blue Trincomalee, Bentota Beach Hotel, Bentota, Coral Garden,
Hikkaduwa, Yala Village.

VISION STATEMENT
“To be the hospitality market leader”

MISSION STATEMENT
“To strive for perfection when providing guest experiences that exceed expectations and
be recognized as en emerging regional leader in hospitality, through the discovery of
quality service propositions, supported by superior performance from our people and

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technology, whilst nurturing values on responsible tourism and providing a sustainable
future for all stakeholders”.

VALUES
• Changing constantly, re-inventing and re-involving

• Striving to get things right the first time

• Doing the right thing always

• Fostering a great place to work

• Building strong relationships based on openness and trust

TYPES OF RATIOS USE IN THE ORGANIZATION

LIQUIDITY RATIO

This type of ratios supports the firm with information regarding the businesses ability to
meet its short term goals and financial obligations. They are of particular significance to
those extending short term credit to the business.
Liquidity ratio provides the basis for answering two main questions:
• Does the business organization have enough cash and near-cash assets to pay its
expenses on time?

• How fast can the firm transform its liquid cash assets (accounts receivables and
inventory) into cash?

 Current ratio is computed as follows:

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 CURRENT RATIO = CURRENT ASSETS
CURRENT LIABILITIES

2010 2009
Current Ratio = 4,818,208 1,510,487
3,605,060 4,148,104

Current Ratio = 1.34 times 0.36 times

The above current ratio is a test used to identify the financial strength of a business. With
the analysis of the current ratio for M/s. John Keells Hotels Group provides us with an
understanding on how many assets are likely to be converted to money within a year in
order to clear the debts taken. John Keells Hotels Group primary sources are the firms’
current assets which are used to repay current and maturing financial debts. When
analyzing the above current ratio calculation, it is understood that both 2010 & 2009
reflects a negative picture of the firm because the norm for this ratio is 2:1. This means
that John Keells Hotel Group PLC have insufficient assets in the business. This can be
due to the firm accruing assets on credit basis. However, the firm has proven a slight
increase of 0.98 in the year 2010 in contrast to the previous mentioned year.

 Acid-test or quick ratio can be computed as follows:

CURRENT RATIO = CURRENT ASSETS –INVENTORIES

CURRENT LIABILITIES

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 2,010 2,009
Current Ratio = 4,818,208 - 129,239 1,510,487 - 127,992
3,605, 060 4,148,104
Current Ratio = 1.30 times 0.33 times

Acid test ratio is a stringent test that shows weather the firm has sufficient short term
assets to cover its immediate liabilities without having to sell inventory. The acid test
ratio is far accurate and reliable than working capital ratio because the working capital
ratio allows for the inclusion of inventory assets.
When analyzing the acid test ratio of John Keells Hotels PLC, it is evident that in the
present year the firm does not show any visible liquidity problem because the benchmark
for the acid test ratio is 1:1. Between the years 2009 and 2010 the firm acid test ratio
highlights an increase of 0.97. However in comparison to the previous year 2009, John
Keells suffered from a liquidity problem because they were very much lower than the
acid test ratio norm. An improvement above expected could be mainly due to the firm
managing their assets properly in order to avoid future liquidity issues. This is because if
current liabilities are not paid in time it could be very damaging to the firms image as
well which could result in a long term loss for the hotels. This approach can also be
referred to as “efficiency” ratio because they provide a basis for assessing how
effectively John Keells Hotels PLC is utilizing its resources in generating sales.

 Average collection period

AVERAGE COLLECTION PERIOD = ACCOUNTS RECEIVABLE

ANNUAL CREDIT SALES/365 DAYS

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 2,010 2,009
Average Collection Period = 1,008,973 819,031
6,038,073 5,114,000

Average Collection Period = 1,008,973 819,031

16,542.67 14,010.96

Average Collection Period = 60.99 days 58.46 days

The average collection period ratio is also known as Debtors collection period ratio. This
represents the average number of days the business has to wait before its debtors are
converted into cash. The industry norm for A.C.P is 63 days. When analyzing the average
collection period of John Keells Hotels PLC we can identify that both 2009 and 2010
years are not facing any problems with collection from debtors. The year 2009 has shown
a favorable collection period than in 2010. This is because there is a 2.53 difference
between both the years which gives a perception that the present year is facing a slightly
lengthier collection period. On average, John Keells Hotels PLC collects its credit sales
every 61 days where as last year collections were made in 58 days. The reason for the
extended days for collection may be due to the company providing a longer credit period
in order to retain its customers. The firm however is not showing any collection problems
mainly because they provide discounts for early payments from their customers.

Accounts receivable turnover ratio

ACCOUNTS RECEIVABLE TURNOVER RATIO =CREDIT SALES

ACCOUNT RECEIVABLE

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 2010 2009
Accounts Receivable Turnover Ratio = 6,038,073 5,114,000
1,008,973 819,031

Accounts Receivable Turnover Ratio = 5.98 times 6.24 times

Accounts receivable ratio is commonly used in place of the average collection period
ratio because it contains the same information. The industry average in this case is 5:8
times. When analyzing the above accounts receivable ratio it is evident that 5.98 times
easily translates into an average collection period of 61 days.

Working:

365/5.98 = 61 days.

Similarly the previous year amount will also be equal to the number of days calculated by
the “average collection period ratio”.

Working:

365/6.24 = 58 days.

Inventory turnover ratio

INVENTORY TURNOVER = COST OF GOODS SOLD

INVENTORIES

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INVENTORY TURNOVER = COST OF GOODS SOLD
INVENTORIES

2010 2009
Inventory Turnover = 1,832,385 1,653,083
129,239 127,992

Inventory Turnover = 14.18 times 12.92 times

Inventory turn over shows the effectiveness and efficiency with which a business
organization is managing its investments in stocks is reflected in the number of times its
stocks are replaced during a year. John Keells Hotels PLC inventory turnover ratio in the
year 2009 is 12.92 which is higher than the favorably higher when comparing the
industry norm of 3.6 times. Since then to the present year the inventory turnover has
shown a reasonable increase by 1.26 times. This is because since the war era had ended in
the year 2009 in the island, more tourists are encouraged to visit Sri Lanka. Last year
when things were tougher than ever, they seized every opportunity to grow their business
in anticipation of the good times ahead. The country is expecting approximately 2 million
travelers to choose our island as the holiday of choice and the increase shown is mainly
due to the emerging tourism growth taking place as time goes on.

PROFITABILITY RATIOS

Profitability ratios tend to provide a business organization several different means of

measuring the success of the firm at generating profits. A business makes profits from its
operating decisions and also financing decisions. This section considers operating
profitability before the costs of company’s financing have been subtracted.

 Operating profitability in relation to sales

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 GROSS PROFIT MARGIN = GROSS PROFIT X 100
NET SALES

2010 2009
Gross profit margin = 4,205,688 3,460,917
6,038,073 5,114,000

Gross profit margin = 0.6965 or 69.65% 0.6768 or 67.68%

The Gross profit margin indicates the businesses mark up upon costs of goods sold as
well as their ability of management to reduce their costs of goods sold in relation to sales
plus the method for deciding the costs. Gross profit margin of John Keells Hotels PLC
constitutes 69.65% of sales in the year 2010. This indicates a 1.97% increase in profit
from sales in contrast to the previous year. The industry average for Gross profit margin
is 26.7%.

John Keells have performed exceptionally well in relation to the industry average. This
could be because the supplier power is less as there are several suppliers to choose from.
Since prices of supplies is less the firm can set a reasonable price which is accommodated
with a favorable profit mark up. Another factor could be because the suppliers are
providing economies of scale which in turn reduces the cost of sales. In my opinion, John
Keells can further improve their gross profit margin by backward integrating because
acquiring ownership of ones supply chain. This in turn can further reduce input costs.

 Operating profit margin

OPERATING PROFIT MARGIN = NET OPERATING INCOME

SALES
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 2010 2009
Operating profit margin = 208,147 (221,479)
6,038,073 5,114,000

Operating profit margin = 0.0345 or 3.45% 0.0433 or 4.33%

Operating profit margin indicates how effective a firm is at controlling the costs
and expenses which are linked with their normal business operations. The
operating profit margin therefore serves as an overall measuring of operating
effectiveness. The operating profit margin industry average is 8.9%.

When analyzing John Keells Hotels PLC it is evident that both the years are very
low in comparison to the industry norm. In the year 2009 the operating profit
margin obtained was 4.33% but it has highlighted a reduction by 0.88%. This
means that in both the years the firm operating efficiency is very minimum
because the expenses per pound of sales are very high than the industry norm.
This could be because even though the war has ended the country is still
recovering. Therefore since there is heavy tax incurred on various
products/services the expenses tend to increase. Which intern leads to heavy costs
been incurred.

 Operating income return on investment

RETURN ON INVESTMENT = NET OPERATING INCOME

TOTAL ASSETS
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 2010 2009
Return on investment=
Gross profit 4,205,688 3,460,917
Administration costs 2,614,181 2,406,136
Distribution costs 173,171 158,062
Other operating costs 875,018 862,702
Total 3,662,370 3,426,900
Operating profit 543,318 34,017

Return on investment= 173,171 158,062

17,928,388 14,748,293

Return on investment=

Operating income return on investments reflects the rate of return on the business total
investment before interest and taxes. When analyzing the operating income return on
investment it shows a reduction of 0.34% from 2009 to 2010. The ratio norm is 12.5%
thus it clearly shows that John Keells Hotels PLC is not up to par with their operating
income return on investment. In the year 2009 the business has obtained a 1.5% return on
its total assets before interest and taxes have been paid. The following year has shown a
slight decline from previous year.

Total asset turnover

TOTAL ASSET TURNOVER = SALES

TOTAL ASSET
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 2010 2009
Total asset turnover = 6,038,073 5,114,000
17,928,388 14,748,293

Total asset turnover = 0.337 times 0.347 times

Turn over ratio is used to analyze weather the assets are being utilized to the optimum
level. According to the above figures calculated both the years indicate that the firm has
not utilized their assets well. The industry average for this ratio is 1.4 times. This means
the firm has to streamline their assets with the sales of the company. A slight reduction
of 0.01 times can be identified in the year 2010 when comparing to the previous year.

 Non-current asset turnover

NON CURRENT ASSET TURNOVER = SALES

NON CURRENT ASSETS

2010 2009
Non current asset turnover = 6,038,073 5,114,000
13,110,180 13,237,806

Non current asset turnover = 0.461 times 0.386 times

Non - current asset turnover ratio has an industry norm of 9.8 times.

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 LEVERAGE RATIOS

This helps the business to know to which extent it is utilizing borrowed money.
Business organizations that have a very high leverage may be at a risk because
they might fall into bankruptcy if they are unable to make payments for the
borrowing taken. This can also result in banks, other financial institutions from
refusing to provide the business organization with loans in the future.

 Debt Ratio

DEBT RATIO = TOTAL LIABILITIES

TOTAL ASSETS

2010 2009
Debt Ratio = 3,605,060 4,148,104
3,123,560 3,376,454

6,728,620 7,524,558

Debt Ratio = 6,728,620 7,524,558

17,928,388.00 14,748,293.00

Debt Ratio = 0.3753 or 37.53% 0.5102 or 51.02%

The gearing ratio has an industry average of 54.9%. When analyzing the above ratio, it is
evident that John Keels Hotels PLC has financed More than half of the assets were been
financed in the year 2009 with borrowed funds. However, due to the increase in revenue
by Rs.924073 Million in the year 2010 the management has been able to reduce their debt
by a vast amount which is approximately 13.49%.

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  Long term debt to total capitalization

LONG TERM DEBT TO TOTAL CAPITALIZATION = TOTAL OF NON CURRENT LIABILITY

TOTAL EQUITY

2010 2009
Long term debt to total 3,123,560 3,376,454
capitalization=
11,199,768 7,223,735

Long term debt to total 0.2789 or 0.4674 or

capitalization= 27.89% 46.74%

The long term debt to total capitalization ratio indicates the degree to which the business
organization has used long term debt in its permanent financing. Total capitalization
represents the sum of all the permanent sources of financing used by the firm including
long term debt, Preference shares and Ordinary equity. The industry norm is 22.8% for
this ratio. When we analyze it shows that in the year 2009 John Keels Hotels PLC has
used almost half of its permanent financing from debt sources. However, we have seem
an improvement in the present year because the management has cleared most of its long
term debt and have brought it down to about 18.85% which is almost in par with the
industry average.

 Net profit margin

NET PROFIT MARGIN = NET INCOME AFTER TAX

SALES

2010 2009
Net profit margin= 205,158 (220,976)
6,038,073 5,114,000

Net profit margin= 0.0339 or 3.39% 0.0432 or 4.32%

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The industry average for net profit margin is 4.14%. The net profit margin involves the
net after tax profits of the firm as a percentage of sales. When comparing the years 2009
and 2010 it is shown that it has been a reduction on the net profit margin by 0.93%. 2009
net profit margin highlights a very favorable year because John Keels have obtained even
higher net profit when comparing to the industry average. As the present year net profit is
low investors would not be very pleased in the performance of the business. Potential
investors would also withhold from investing in John Keels Hotels PLC.

 Return on total assets

RETURN ON TOTAL ASSET = PROFIT BEFORE INTEREST & TAX

AVERAGE TOTAL ASSETS

2010 2009
Return on total assets = 208,147 (221,479)
17,928,388/ 2 14,748,293/ 2

Return on total assets = 0.0116 or 1.16% 0.0150 or 1.50%

 Return on equity

RETURN ON EQUITY = NET PROFIT AFTER TAX X 100

EQUITY

2010 2009
Return on equity= 205,158 (220,976)
11,199,768 7,223,735

Return on equity= 0.0183 or 1.83% 0.0306 or 3.06%

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Financial statements of different organizations

Organizations could be divided to four main categories

• Sole proprietorship
• Partnerships
• Corporate
• Non profit organizations

The main financial documents are identified as balance sheet, Profit & loss, cash flow
statement, changes in equity statement. A sample Profit & Loss sheet is given below:

Profit & Loss Statement for Company ABC

Fiscal Year 2004 and 2005
Figures (USD) 2004 2005
Sales 370,000 400,000
Cost of Goods Sold (COGS) (70,000) (75,000)
Gross Profit 300,000 325,000
General Operating Expenses (R&D) (35,000) (40,000)
Depreciation (12,000) (12,000)
Operating Income 183,000 273,000
Other Income (Interest Income) 8,000 12,000
Extraordinary Income — (3,000)
Earnings Before Interest & Tax (EBIT) 191,000 282,000
Interest Expense (10,000) (10,000)
Net Profit Before Taxes (NPBT) 181,000 272,000
Taxes (10%) (18,100) (27,200)
Net Profit After Taxes (NPAT) 162,900 244,800
Dividends Paid to Shareholders — (20,000)
Retained Earnings 162,900 224,800

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A sample balance sheet is stated below:

41
 CONCLUSION

John Keells Hotels PLC and Aitken Spence Hotels PLC are two market leaders existing
in the hospitality industry. Both these blue chip organizations are in very high
competition with each other. However based on the information accrued from the ratios
which have been extracted from the financial statements of 2009/10 it is evident that
Aitken Spence is performing some what better than its rival John Keells Hotels Group.
However there is no 100% best performance seen from either company which indicates
that there is still room for improvement. John Keells must improve by utilizing the
resources more efficiently and Aitken Spence should maintain consistency and improve
further.

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