Purpose: To enable students in utilising financial ratios for the purpose of evaluating a firms financial performance and financial position as well as in recognising firms facing financial distress and using ratios to make decisions for improvement.

Requirement: Financial Statement Analysis

A Co. and B Co. are competitors in a particular manufacturing sector. An extract of financial statements for each company is as follows: Use them in a ratio analysis that compares the companys financial leverage and profitability.

Item A Co. B Co.

Total assets RM10,000,000 RM10,000,000

Total equity (all common) 9,000,000 5,000,000

Total debt 1,000,000 5,000,000

Annual interest 100,000 500,000

Total sales 25,000,000 25,000,000

EBIT 6,250,000 6,250,000

Earnings available for

common stockholders 3,690,000 3,450,000

Required:

Calculate the following debt and coverage ratios for the two companies. Discuss briefly their financial risk and ability to cover the costs in relation to each other.

Debt ratio. (2 marks)

Times interest earned ratio. (2 marks)

(b) Calculate the following profitability ratios for the two companies. Discuss briefly their profitability relative to each other.

Operating profit margin. (1.5 marks)

Net profit margin. (1.5 marks)

Return on total assets. (1.5 marks)

Return on common equity. (1.5 marks)

(c) In what way has the larger debt of B Co. made it more profitable than A Co.? What are the risks that B Co.s investors undertake when they choose to purchase its stock instead of A Co.s?

(2 marks)

(d) While ratio analysis can provide some useful information concerning a companys operations and financial condition, it does have limitations. Discuss briefly. (3 marks)

(Total:15 marks)