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Financial Ratio Analysis Practical Examp
Financial Ratio Analysis Practical Examp
Saadatullah Ahmadzai
UNIVERSITYOF HUDDERSFIELD QueensgateHuddersfieldHD1 3DH
Contents
1. Introduction ........................................................................................................................................... 2
2. Ratio Analysis ....................................................................................................................................... 2
Current Ratio............................................................................................................................................. 2
Efficiency Ratio: Sales revenue to capital employed ratio: ...................................................................... 3
Gearing Ratio: ........................................................................................................................................... 6
Debt as a % of income .............................................................................................................................. 7
3. Horizontal Analysis .............................................................................................................................. 8
4. Conclusion and Recommendation ...................................................................................................... 11
5. References ........................................................................................................................................... 13
6. Appendices.......................................................................................................................................... 15
Table of Figures
This report has been developed to recommend The University of Heraldfield (TUH) how to finance
its capital expenditures. The report has developed based on The University of Manchester (UoM)
and University of Leeds (UoL) recent financial statements analysis as they are TUH two prime
competitors in West-Yorkshire. The statements will be analyzed through key ratios calculation and
horizontal analysis.
2. RATIO ANALYSIS
To analyze and evaluate the financial performance and condition of an organization, financial
ratios can play a key role (Chen and Shimerda, 1981). It is an effective method to manipulate
numbers into expressive information (Bamber and Parry, 2014). Ratios highlight the financial
changes, so it is important to investigate the reasons behind these changes (Atrill & McLaney,
2015). Ratios are important indicator to measure organizations liquidity, profitability, efficiency
and etc. (Altman, 1968).
Current Ratio: This ratio provides the details of short term position of an organization. Current
ratio is a good indicator of the financial health of an organization and can tell the short-term debt
obligations payment capability of an entity (Pizzica, et al, 2014;2015).
For both selected universities this ratio has been calculated and shown in below figure:
As above figures-1,2 show the current ratio is changing throughout the examination period.
UoM lowest in 2012 was 1.142:1 which means the university current assets can cover 1.142
times its current liabilities, while in 2013 the highest 1.997:1 shows that the current assets are
near double the current liabilities. Similarly the current ratio of UoL is also changing from 1.31
to 1.73. Based on mentioned literatures the excessive higher current ratio indicates organization’s
inefficiency and too low indicates that the entity is not able to perform its day’s today operations
(Refer to Appendix-1). The report will further clarify the effects of this ratio under the
evaluation of efficiency ratio.
This ratio provides analysis about short term resources utilization. It indicates that how well the
assets have been used to create sales (income) and working capital have managed (defensively or
aggressively) (Bamber and Parry, 2014).
Figure 3: The UoM Efficiency ratio
Both universities efficiency ratios are almost inversely proportional with the Current ratios which
are clearly indicated in figure-4 and 6 for UoM and UoL respectively. The higher the Current ratio
the lower the efficiency ratio, for instance as shown in figure-2 in 2011 the UoL lowest current
ratio was 1.31:1 whereas as the figure-4 indicates for same year it has the highest number of times
efficiency of 0.992 for the same year. This indicates that in order to improve efficiency the proper
utilization of current-assets and current-liabilities are required.
Gearing Ratio:
Appendix-2 explains this ratio. Below tables indicate both universities gearing ratios:
As shown in figure 7 the UoM gearing ratio has increased significantly from 18.155% in 2011 to
32.239% in 2013 and then reduced slightly to 28.719% in 2015. Though, UoL gearing ratio has
gradually decreased from 9.661% in 2011 to 4.620% in 2015. UoL shows much lower reliance on
debt than the UoM does specially in last three years. It also indicates that the UoM risk level is
higher than the UoL. It is worth to mention that high proportion of debt is risky as it possesses
repayment obligation and interest charges. Nevertheless, it is recommended to keep the proportion
of equity higher than the proportion of debt (ACCA, 2016).
Debt as a % of income: Below figures provide both universities debt level in term of annual
income.
It can be seen from figure-9 the UoM debt percentage is the highest in 2013 which had highest
gearing ratio at the same year too. While the UoL both gearing ratio and debt percentage has
decreased after each year.
3. HORIZONTAL ANALYSIS
Horizontal analysis is used to make line-by-line comparison and analytical review. This method is
used to measure relative level financial performance of organizations over a certain period
(Bamber and Parry, 2014). Both universities horizontal analyses are as follow:
Figure 13: Top UoM and bottom UoL income and expenditure accounts
Figure 14: Top UoM and bottom UoL income horizontal analysis
Figure 15: Both universities income horizontal analysis comparison
Both universities income had sluggish period during 2012 and 2013 and then improved
significantly in both 2014 and 2015.
Figure 16: Top UoM and bottom UoL Surplus and expenditure horizontal analysis
Both universities had a good 2011 year with highest percentage improvement of surplus and had
the lowest surplus improvement in 2013 where the surplus was below the previous year because
on same year both universities expenditures increased specially UoL’s which shows the highest.
It also can be noticed that UoL surplus improvement is much higher than UoM in recent two
years. The expenditure move is changing by smaller margin in single digit range except 2015
where UoM expenditure increased 13.547% than last year.
Both univesities interest chareges horizontal analysis are reducing each year except UoM 2014
where they paid a long term bond of £12822000 which casued the move (The University of
Manchester, 2014, p-32/33). This indicates reduction in overall debt and its obligations.
Based on above analysis the following are recommendations for TUH to finance its capital
expenditures:
Both universities gearing ratios suggest that they have reliance on debt. UoM had
maximum 32.2% and UoL 9.6%. Though it contains interest payables and repayment but
it provides faster financial source which can be utilized to attract more student sooner rather
than waiting for surplus add up. As shown in Figure-14 horizontal analysis this strategy
clearly improved the income level. So it is also recommended for TUH to utilize the debt
opportunities. Nevertheless, it is recommended to keep the proportion of equity higher than
the proportion of debt.
“The University has secured the funding from investors to enable work to begin on our
vision to create a single campus with the construction of new research building” (UoM
2013, p-1). This suggests that they have utilized external borrowing. Both universities debt
level in relation to income ratio has shown above in Figure-9 and 10. UoM had debt up-to
52.15% of their income though high debt is risky but UoM had huge success in term of
13.9% revenue improvement in 2015. Based on this as a long term finance source for
capital expenditure TUH can also utilize external funding in same range with consideration
of their annual income.
As it was noticed in current ratio analysis that it was inversely related to the efficiency
ratio. So in order to remain efficient it is recommended to utilize the working capital
which includes cash as well appropriately. It is recommended to invest the surplus cash
on capital expenditure.
Financing from reserves (retained surplus) is another effective way for TUH capital
investment as this doesn’t include interests’ charges and repayment obligation. Below
figure shows UoM retain surplus in relation to income which provide a view which
amount of surplus to retain.
Bond debt is also recommended which will provide the university a longer maturity
period up to 30 years with reasonable coupon payments. UoM utilize bond debt to
finance their expenditures to good effect (The University of Manchester, 2014, p-32/33).
It is also recommended not to exceed the external funding amount limit, as shown in
Figure-12 the highest interest payable in percentage of income among both university is
2.199% of income.
5. REFERENCES
Afrifa, G., A., and Padachi, K. (2016). Working capital level influence on SME profitability.
Journal of Small Business and Enterprise Development. 1(23), 44-63. DOI:
10.1108/JSBED-01-2014-0014.
Altman, E. I. (1968). Financial ratios, discriminant analysis and the prediction of corporate
bankruptcy. The Journal of Finance, 23(4), 589-609. DOI: 10.1111/j.1540-
6261.1968.tb00843.x.
Atrill, P., & McLaney, E. J. (2015). Accounting and finance for non-specialists (Ninth ed.).
Harlow: Pearson Education.
Bamber, M., & Parry, S. (2014). Accounting and finance for managers: A decision-making
approach (1st ed.). GB: Kogan Page Ltd.
Chen, K. H., & Shimerda, T. A. (1981). An Empirical Analysis of Useful Financial Ratios.
Financial Management, 10(1), 51–60. Retrieved from http://www.jstor.org/stable/3665113.
Filbeck, G., & Krueger, T. M. (2005). An analysis of working capital management results
across industries. Mid-American Journal of Business, 20(2), 11. Retrieved from:
http://search.ebscohost.com.libaccess.hud.ac.uk/login.aspx?direct=true&db=bth&AN=1883
7283&site=ehost-live.
Kaur and Singh, (2013). Managing Working Capital Efficiency in Capital Goods Sector in
India. Global Business Review, 2(14), 343 – 355. DOI: 10.1177/0972150913477526.
Pizzica, A. J., Rist, M., & LLC, P. (2014;2015). Financial ratios for executives: How to
assess company strength, fix problems, and make better decisions (1st ed.). Berkeley, CA:
Apress. DOI: 10.1007/978-1-4842-0731-4.
The University of Manchester. (2011). Financial statements for the year ended 31 July
2011. Retrieved from: http://documents.manchester.ac.uk/display.aspx?DocID=27048.
The University of Manchester. (2012). Financial statements for the year ended 31 July
2012. Retrieved from: http://documents.manchester.ac.uk/display.aspx?DocID=27047.
The University of Manchester. (2013). Financial statements for the year ended 31 July
2013. Retrieved from: http://documents.manchester.ac.uk/display.aspx?DocID=27046.
The University of Manchester. (2014). Financial statements for the year ended 31 July
2014. Retrieved from: http://documents.manchester.ac.uk/display.aspx?DocID=27045.
The University of Manchester. (2015). Financial statements for the year ended 31 July
2015. Retrieved from: http://documents.manchester.ac.uk/display.aspx?DocID=27044.
University of Leeds (2011). Annual Report and Accounts 2010/11. Retrieved from:
https://www.leeds.ac.uk/download/74/annual_report_and_accounts_2010-11.
University of Leeds (2012). Annual Report and Accounts 2011/12. Retrieved from:
https://www.leeds.ac.uk/finance/finance_accounts/Ellie%202/AR%20complete%20draft%2
07.pdf.pdf.
University of Leeds (2013). Annual Report and Accounts 2012/13. Retrieved from:
https://www.leeds.ac.uk/download/72/annual_report_and_accounts_2012-13
University of Leeds (2014). Annual Report and Accounts 2013/14. Retrieved from:
https://www.leeds.ac.uk/download/73/annual_report_and_accounts_2013-14.
University of Leeds (2015). Annual Report and Accounts 2014/15. Retrieved from:
https://www.leeds.ac.uk/download/311/annual_report_and_accounts_2014-15.
6. APPENDICES
Appendix-1
Current Ratio: It is challenging to specify an ideal current ratio for Universities. Optimal ratio
is relevant to the success of the university and optimal level of working capital can be achieved
when the risk and efficiency is balanced (Filbeck and Krueger, 2005; Appuhami, 2008) and
profitability (surplus) of the organization is maximized (Banos-Caballer et al, 2014). The
effectiveness improves as working capital level increases but then starts to drop if it rises beyond
a certain level (Afrifa and Padachi, 2016). Furthermore, inadequate current ratio impairs
organization’s liquidity and excessively higher ratio results in deduction of profitability (Kaur
and Singh, 2013).
Appendix-2
Gearing ratio is related to an organization capability to encounter its long term debts. It also
indicates that which proportion of borrowed capital has used to finance the operations (ACCA,
2016). A balance between equity and debt needs to be attained. A higher gearing ratio advocates
risk and insolvency. However, the challenge is to determine which limit is high as low gearing
ratio also suggests that the comparative cost advantages of debts have not been utilized
appropriately (Bamber and Parry, 2014).
(£000)
Year Non-Current Liabilities Total Assets Current Liabilities Total Assets - Gearing Ratio %
Current liabilities
Current Ratio
(£000)
Efficiency Ratio
The University of Manchester
Efficiency Ratio (income to capital employed ratio)= Total income/ Total assets less Current liabilities
(£000)
Year Total income Total Assets less Current Total income to Capital
liabilities employed ratio