Financial Ratio Analysis: Legal And Assessment Answer

Answer:

The 2 companies chosen for comparison are Easy jet and the first group plc. These companies have been undertaken due to their good services for the travellers.

The Easy jet company is one of the leading airline companies of Europe that operates across 6,000 routes across more than 30 countries with the fleet of over 200 airbus aircraft. The company employs about 8,000 people and comprises of 2,000 pilots and 4,500 cabin crews. The company flew 60 million passenger during the last year. The company has the strong position in the following key markets:

No. 1 at London Gatwick, London Luton, London Southend, Bristol, Edinburgh, Milan Malpensa, Naples, Venice, Nice, Basel and Geneva; No. 2 at London Stansted, Paris Orly, Paris Charles De Gaulle, Lisbon, Lyon, and Rome Fiumicinowith over 300 million people within a one hour drive of an EasyJet airport.

(Corporate.easyjet.com, 2015)

The second company under review is known by the name of First group plc which is the leading transport operator in the United Kingdom and North America. The company has the revenues that exceeded to more than £6.7 billion during the year 2013-14. The services of the company helps it creating a strong and a vibrant opportunity of providing the choices to the customers and the communities. During the previous financial year, about 2.5 billion people were transported by the company to get to work, education, visit fmailities and friends and much more. The company employs about 117,000 employees to render the services. The company has about 5 operating division and leading positions in the markets.

(Firstgroupplc.com, 2015)

This report aims at discussing the ratios and the significant items in the income statement, cash flows statement and the balance sheet. Further, this report aims at throw some light on the other aspects that have been stated in the annual report of the company.

Ratio analysis:

Easy Jet:

The following is the required ratio analysis:


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Particulars

2014

2013

2012

2011

2010

Remarks

 Solvency ratios:

 

 

 

 

 

 

 Total liabilities to net worth ratio:

             1.04

             1.19

             1.21

           1.30

        1.36

Decreased

 Total liabilities

      2,250.00

      2,395.00

      2,169.00

    2,225.00

 2,040.70

 

 Net worth

      2,172.00

      2,017.00

      1,794.00

    1,705.00

 1,500.70

 

 Fixed assets to net worth ratio:

             1.17

             1.13

             1.34

           1.26

        1.28

Decreased

 Fixed assets

      2,542.00

      2,280.00

      2,395.00

    2,149.00

 1,928.10


 

 Net worth

      2,172.00

      2,017.00

      1,794.00

    1,705.00

 1,500.70

 

 Leverage ratios:

 

 

 

 

 

 

 Debt equity ratio:

             0.79

             0.91

             1.10

           1.30

        1.36

Decreased

 Debt

      1,726.00

      1,830.00

      1,978.00

    2,216.00

 2,040.70

 

 Equity

      2,172.00

      2,017.00

      1,794.00

    1,705.00

 1,500.70

 

 Interest coverage ratio:

           52.82

           20.71

           41.52

           8.97

        6.50

Increased

 Operating income

         581.00

         497.00

         331.00

       269.00

    173.60

 

 Interest expense

           11.00

           24.00

           25.00

         30.00

      26.70

 

 Profitability ratio:

 

 

 

 

 

 

 Gross profit ratio:

             0.31

             0.29

             0.27

           0.27

        0.40

Decreased

 Gross profit

      1,383.00

      1,250.00

      1,038.00

       920.00

 1,179.50

 

 Revenue

      4,527.00

      4,258.00

      3,854.00

    3,452.00

 2,973.10

 

 Net profit ratio:

             0.10

             0.09

             0.07

           0.07

        0.04

Increased

 Net profit

         450.00

         398.00

         255.00

       225.00

    121.30

 

 Revenue

      4,527.00

      4,258.00

      3,854.00

    3,452.00

 2,973.10

 

 Operational efficiency ratios:

 

 

 

 

 

 

 Total asset turnover ratio:

             1.02

             0.98

             0.88

           0.81

        0.77

Increased

 Net sales

      4,527.00

      4,258.00

      3,854.00

    3,452.00

 2,973.10

 

 Average total assets

      4,447.00

      4,353.50

      4,382.00

    4,235.75

 3,837.75

 

 Equity turnover ratio:

             2.16

             2.23

             2.20

           2.15

        2.12

Increased

 Net sales

      4,527.00

      4,258.00

      3,854.00

    3,452.00

 2,973.10

 

 Average total equity

      2,094.50

      1,905.50

      1,749.50

    1,602.85

 1,404.00

 


The total liabilities to net worth is the ratio that is expressed between the total liabilities and the net worth. The ratio shows that it has only increased over the years which is s positive sign.

The total fixed assets to net worth is the ratio between the total fixed assets and the net worth. The ratio shows that it has only increased over the years which is good.

The following table shows the details of the ratios calculated:
 

  •  
  •  
  •  
  •  

Debt equity

Ascertain the extent to which the equity as well as the liabilities of the company is used to finance its assets.

dividing the total liabilities by shareholder’s equity

  •  

Interest coverage

ratio used to determine the ease with which the company is able to pay off the interest on outstanding borrowings

dividing the earnings before interest and taxes by the interest expense

  •  

 

Net profit margin

ratio that is expressed between the net income that is earned by a company and the sales that are affected during that period

dividing the net income by sales

  •  

Gross profit margin

ratio that is expressed between the gross income that is earned by a company and the sales that are affected during that period

dividing the net income by sales

  •  

Asset turnover

measure that helps in ascertaining the extent to which the management is efficient in deploying the assets of the company in order to generate revenues

dividing the sales by the average of opening and closing assets

  •  

Return on equity

Earnings that the company earns by investing the funds of the shareholder’s in the business. The more the return on equity, the better is the profitability of the business.

 

dividing the net income by the average of opening as well as the closing balance of the shareholder’s equity

  •  


The company increased its equity but also decreased its debt.

The company must focus on the ways through which it can increase its profitability

First group PLC:

The following table shows the ratio analysis of the company concerned:
 

Particulars

  1.  
  1.  
  1.  
  1.  
  1.  
  •  

Solvency ratios:

 

 

 

 

 

 

Total liabilities to net worth ratio:

3.09

5.79

5.09

4.54

5.14

  •  

Total liabilities

3,784.80

4,716.80

4,439.90

4,315.20

4,681.90

 

Net worth

1,223.00

814.50

872.60

950.90

910.50

 

Fixed assets to net worth ratio:

1.52

2.43

2.30

2.19

2.51

  •  

Fixed assets

1,864.90

1,977.60

2,006.30

2,082.90

2,284.10

 

Net worth

1,223.00

814.50

872.60

950.90

910.50

 

Leverage ratios:

 

 

 

 

 

 

Debt equity ratio:

2.86

5.29

4.62

4.08

4.52

  •  

Debt

3,496.30

4,307.30

4,034.60

3,882.90

4,111.30

 

Equity

1,223.00

814.50

872.60

950.90

910.50

 

Interest coverage ratio:

1.41

0.82

0.54

1.68

1.91

  •  

Operating income

232.20

139.80

91.70

309.30

364.20

 

Interest expense

165.00

170.50

170.10

184.00

190.70

 

Profitability ratio:

 

 

 

 

 

 

Gross profit ratio:

0.03

0.02

0.07

0.05

0.06

  •  

Gross profit

232.20

139.80

447.00

313.70

365.30

 

Revenue

6,717.40

6,900.90

6,678.70

6,429.20

6,261.90

 

Net profit ratio:

0.01

-0.00

0.03

0.02

0.02

  •  

Net profit

64.20

-5.00

220.30

117.10

147.10

 

Revenue

6,717.40

6,900.90

6,678.70

6,429.20

6,261.90

 

Operational efficiency ratios:

 

 

 

 

 

 

Total asset turnover ratio:

1.27

1.27

0.63

1.18

1.09

  •  

Net sales

6,717.40

6,900.90

6,678.70

6,429.20

6,261.90

 

Average total assets

5,269.55

5,421.90

10,580.60

5,429.25

5,754.45

 

Equity turnover ratio:

6.59

8.18

7.29

6.91

7.30

  •  

Net sales

6,717.40

6,900.90

6,678.70

6,429.20

6,261.90

 

Average total equity

1,018.75

843.55

915.95

930.70

857.40

 


The following table shows the details of the ratios calculated:
 

  •  
  •  
  •  
  •  

Debt equity

Ascertain the extent to which the equity as well as the liabilities of the company is used to finance its assets.

dividing the total liabilities by shareholder’s equity

  •  

Interest coverage

ratio used to determine the ease with which the company is able to pay off the interest on outstanding borrowings

dividing the earnings before interest and taxes by the interest expense

  •  

 

Net profit margin

ratio that is expressed between the net income that is earned by a company and the sales that are affected during that period

dividing the net income by sales

  •  

Gross profit margin

ratio that is expressed between the gross income that is earned by a company and the sales that are affected during that period

dividing the net income by sales

  •  

Asset turnover

measure that helps in ascertaining the extent to which the management is efficient in deploying the assets of the company in order to generate revenues

dividing the sales by the average of opening and closing assets

  •  

Return on equity

Earnings that the company earns by investing the funds of the shareholder’s in the business. The more the return on equity, the better is the profitability of the business.

 

dividing the net income by the average of opening as well as the closing balance of the shareholder’s equity

  •  


The company needs to focus on its revenues since that is the major concern. Further, the company must take measures for the reduction of the expenses since only that would only help in the increasing of the profit amount.

The company though was able to reduce its debt but it also increased its equity. It should have financed the same from the regular profits that were being earned.

Limitations of ratio analysis:

The analysis of the ratios is used to compare the information of the company that has bene taken from the financial statements so as to gain an understanding of the results, financial position and the cash flow of the business concerned. This serves as the tool for the outsiders such as the credit analyst, lender to the analyst of the stocks. The people are required to create a picture of the financial statements and the position of the business and assess its profitability merely by using the financial statements.

But then the ratio analysies does suffer from many of the limitations as well:. The following are the limitations:

Historical: all of the information that is used in analysing the ratios is actually the results of the historical data. This does not mean that the same results will be there for the future to. But then these ratios could be used for the pro forma information and for comparison with the results in order to ensure consistency.

Historical versus current cost: the information that is contained by the income statements consist of the current costs but then the balance sheet contains the amounts that is historical which is capable of being substantially varied. Due to this disparity, unusual ratios would be derived.

Inflation: in case, there is inflation during the years, then that would mean that those numbers are not comparable across the various periods. If the inflation rate is 100%, then that would entail the figure of sales being doubled when the sales have not increased at all.

Aggregation: the information that has been contained in the financial statements would lead to the using of the ratios that may have been aggregated during the past period so that when the ratio analysis is run on the trend line that would not compare the information through the entire period.

Operational changes: any company may undergo a number of changes during the year and this could be to such an extent that the ratios that have been calculated several years ago could be compared with the same ratio even today. This could lead to the misleading conclusion. In order to illustrate, when there is an implementation of a constraint analysis system, then that might lead to a reduced investment in the fixed asset whereas the analysis may show that the fixed assets base of the company is getting too old.

Accounting policies: the different companies have different accounting policies. For example, one company may use the written down value of depreciation whereas the other may use the straight line depreciation method. The amount of the depreciation and therefore, the amount of the net profit would vary in both the cases. Therefore, in such cases, the comparison of the 2 cannot be done.

Business conditions: the analysis of the ratios has to be done keeping in mind the environment in which the business is operating. In order to illustrate this, the credit period of 45 days may be considered bad during the peak season but then the same could be considered to be good during the times the economy is contracting and the customers are no more bale to pay off their bills.

Interpretation: it would be difficult task to assess the reason for a specific ratio. In order to illustrate, the current ratio of 2:1 may be considered to be excellent till the time the company realises that it has a huge amount of stock that could affect its cash position. When a detailed analysis has been undertaken, that might reveal that the current ratio may be at that level for some reason but then that will not be the same in the near future too.

Strategy of the company: it could be dangerous for the company to conduct an analysis of the ratios by comparing the 2 firms that are having and that are following a different set of the strategies. In order to illustrate, one company that could be following a low cost strategy and would be willing to accept a lower amount of gross margin in return of an increased amount of market share. But then there could be another company that may be focussing on the high customer service strategy wherein the prices charged may be higher and the gross margins may also be higher but that will never help in the attainment of the required levels of the revenue for the first company

Point in time: there are some of the ratios that extract some information from the balance sheet and then there are some of the ratios that extract the information from the income statement. The major problem in this is that the balance sheet is for the last day of the year but the income statement is prepared evenly throughout the year. In case, there is an unusual spike or a decline in the balance of an account as on the last day of the reporting period, then that would impact the outcome of the ratio analysis.

In the nutshell, the analysis of the ratios has a number of inherent limitations attached with its name but then it also has some of its uses. As long as anyone is well aware about the problems and use some other methods as well for the collecting of and for the interpretation of the information, the ratio analysis would still be useful.

(Accountingtools.com, 2015)

The following are some of the advantages of the ratio analysis:

It simplifies the financial statements

It helps in benchmarking and in comparing the companies that are of different sizes

It helps in the analyses of the trends that involves the comparing of the single period over a period

It highlights the major information in the simplest way. Any person who is using that information is able to judge the profitability of the company merely by looking at the numbers instead of reading the entire financial statements.

The following are more of the limitations of the ratio analysis:

The different companies have different economic conditions that are exposed to them and therefore, these are the factors that impact the two companies from the different industries, so, comparison these two companies would give out the misleading results.

The financial accounting information is affected by a number of estimates and a set of assumptions. The accounting standards allow the use of the different accounting policies that impairs the comparability and the analysis of the ratios that are not very useful in such situations.

The analysis of the ratios explains the relationship between the information of the past but the users are concerned about the information about the future and the current information.

Ratios deal in numbers: the ratios are only and only expressed in numbers, they do not talk about the product quality or the services that are rendered to the customers, the morale of the employees and these factors do play a major role in assessing the financial performance of the company

The ratios are all about the past and not about the future. The analysts of the investments will make an assumption about the future performance using such ratios

The ratios are very useful when they are used to compare the performance of a company over a longer period of time or as against the comparable businesses and an industry. But this information may not always be available.

The financial information is capable of being massaged so that the figures could be used in the utmost efficient manner. In order to illustrate. May of the businesses accept the payments from the creditors at the end of the financial year so that the cash balance is higher than the normal and the creditor has a lower amount of balance too?

(Accountingexplained.com, 2015)

(tutor2u, 2015)

Impact of legal and tax environment:

Any company is regulated by the environment in which it operates. The same goes with these companies. The taxation and legal issues leads the companies in increasing the contractual obligations that it has to abide by. This only leads to the reduction of the efficiency on the part of the company since it is under immense pressure to comply with the legal obligations and fulfil all the requirements of the government. But then on the other side, the same is very important since they ensures responsibility on the part of the companies.

From the analysis of the above stated figures, it would be right to say that the company is not stable enough for any investor to invest. And an investor would always like to invest in a company that is able to give him a regular rate of return on his investment and also give him some again when he sells his investment. But none of the companies seem worth it.

Therefore, no company is a viable source of an investment.

References:

Accountingexplained.com, (2015). Advantages and Limitations of Financial Ratio Analysis. [Online] Available at: https://accountingexplained.com/financial/ratios/advantages-limitations [Accessed 2 Jun. 2015].

Accountingtools.com, (2015). What are the limitations of ratio analysis? - Questions & Answers - Accounting Tools. [Online] Available at: https://www.accountingtools.com/questions-and-answers/what-are-the-limitations-of-ratio-analysis.html [Accessed 2 Jun. 2015].

corporate.easyjet.com, (2015). Annual report 2011. [Online] Available at: https://corporate.easyjet.com/~/media/Files/E/Easyjet-Plc-V2/pdf/investors/result-center-investor/easyJet_AR10_18_1_2011.pdf [Accessed 2 Jun. 2015].

corporate.easyjet.com, (2015). Annual report 2011. [Online] Available at: https://corporate.easyjet.com/~/media/Files/E/Easyjet-Plc-V2/pdf/investors/result-center-investor/easyJet_AR10_18_1_2011.pdf [Accessed 2 Jun. 2015].

corporate.easyjet.com, (2015). Annual report 2012. [Online] Available at: https://corporate.easyjet.com/~/media/Files/E/Easyjet-Plc-V2/pdf/investors/result-center-investor/annual-report-2012.pdf [Accessed 2 Jun. 2015].

corporate.easyjet.com, (2015). Annual report 2014. [Online] Available at: https://corporate.easyjet.com/~/media/Files/E/Easyjet-Plc-V2/pdf/investors/result-center-investor/annual-report-2014.pdf [Accessed 2 Jun. 2015].

Corporate.easyjet.com, (2015). About us - EasyJet plc. [Online] Available at: https://corporate.easyjet.com/about-easyjet.aspx?sc_lang=en [Accessed 2 Jun. 2015].

Firstgroupplc.com, (2015). About FirstGroup. [Online] Available at: https://www.firstgroupplc.com/about-firstgroup [Accessed 2 Jun. 2015].

Firstgroupplc.com, (2015). Annual Report 2014. [Online] Available at: https://www.firstgroupplc.com/investors/annual-report-2014.aspx [Accessed 2 Jun. 2015].

tutor2u, (2015). Value and Limitations of Ratio Analysis. [Online] Available at: https://beta.tutor2u.net/business/reference/value-and-limitations-of-ratio-analysis [Accessed 2 Jun. 2015].

www.firstgroupplc.com, (2015). Annual report 2011. [Online] Available at: https://www.firstgroupplc.com/~/media/Files/F/Firstgroup-Plc/reports-and-presentations/reports/new/2011_annual_report.pdf [Accessed 2 Jun. 2015].

www.firstgroupplc.com, (2015). Annual report 2012. [Online] Available at: https://www.firstgroupplc.com/~/media/Files/F/Firstgroup-Plc/reports-and-presentations/reports/new/firstgroup-half-yearly-financial-report-2012.pdf [Accessed 2 Jun. 2015].

www.firstgroupplc.com, (2015). Annual report 2013. [Online] Available at: https://www.firstgroupplc.com/~/media/Files/F/Firstgroup-Plc/reports-and-presentations/pdfs/ar/first-group-annual-report-2013.pdf [Accessed 2 Jun. 2015].

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