Ratio Analysis: Comparing Financial Ratios of Two Firms and the Industry

 

Ratio Analysis: Comparing Financial Ratios of Two Firms and the Industry

Financial ratios are essential tools for evaluating a firm’s performance and comparing it to industry benchmarks. In this analysis, we will examine liquidity, leverage, profitability, asset management, and price ratios for two firms and compare them to industry standards. By drawing conclusions from the findings, we can assess the financial health and performance of each firm.

Firm A: ABC Corporation

Liquidity Ratios:

Current Ratio: 1.5
Quick Ratio: 0.8

Leverage Ratios:

Debt-to-Equity Ratio: 0.6
Interest Coverage Ratio: 5

Profitability Ratios:

Gross Profit Margin: 25%
Net Profit Margin: 10%
Return on Assets (ROA): 15%
Return on Equity (ROE): 20%

Asset Management Ratios:

Inventory Turnover: 6 times
Accounts Receivable Turnover: 8 times
Total Asset Turnover: 0.9 times

Price Ratios:

Price-to-Earnings Ratio (P/E): 12
Price-to-Sales Ratio (P/S): 1.5
Dividend Yield: 3%

Firm B: XYZ Corporation

Liquidity Ratios:

Current Ratio: 2
Quick Ratio: 1.2

Leverage Ratios:

Debt-to-Equity Ratio: 0.8
Interest Coverage Ratio: 4

Profitability Ratios:

Gross Profit Margin: 30%
Net Profit Margin: 12%
Return on Assets (ROA): 18%
Return on Equity (ROE): 25%

Asset Management Ratios:

Inventory Turnover: 8 times
Accounts Receivable Turnover: 10 times
Total Asset Turnover: 1.2 times

Price Ratios:

Price-to-Earnings Ratio (P/E): 15
Price-to-Sales Ratio (P/S): 2
Dividend Yield: 2.5%

Industry Standards:

Liquidity Ratios:

Current Ratio: 1.8
Quick Ratio: 1

Leverage Ratios:

Debt-to-Equity Ratio: 0.7
Interest Coverage Ratio: 6

Profitability Ratios:

Gross Profit Margin: 28%
Net Profit Margin: 14%
Return on Assets (ROA): 17%
Return on Equity (ROE): 22%

Asset Management Ratios:

Inventory Turnover: 7 times
Accounts Receivable Turnover: 9 times
Total Asset Turnover: 1 times

Price Ratios:

Price-to-Earnings Ratio (P/E): 14
Price-to-Sales Ratio (P/S): 1.8
Dividend Yield: 2.8%

Findings and Conclusions:

Liquidity: Firm A has a lower current ratio and quick ratio compared to both Firm B and the industry benchmarks. This indicates that Firm A may have lower short-term liquidity and may face challenges in meeting immediate obligations.

Leverage: Both firms have lower debt-to-equity ratios compared to the industry average, suggesting that they have lower financial risk and rely less on debt financing. However, Firm B has a higher interest coverage ratio, indicating better ability to cover interest expenses.

Profitability: Firm B outperforms both Firm A and industry averages in terms of gross profit margin, net profit margin, ROA, and ROE. This suggests that Firm B is more efficient in generating profits and utilizing assets to generate returns.

Asset Management: Firm B demonstrates higher efficiency in managing inventories and accounts receivable, as indicated by higher turnover ratios compared to both Firm A and industry standards. However, both firms have lower total asset turnover ratios than the industry average, indicating room for improvement in utilizing assets to generate sales.

Price Ratios: Firm B has higher price-to-earnings and price-to-sales ratios compared to both Firm A and industry benchmarks, suggesting that investors have higher expectations for future growth and profitability from Firm B.

Based on the findings, it can be concluded that Firm B performs better than Firm A in terms of profitability, asset management, and market expectations. However, both firms have areas for improvement in liquidity and asset utilization to align with industry standards. It is crucial for each firm to assess its weaknesses and strengths identified through the ratio analysis to make informed decisions and implement strategies for financial improvement and growth.