Company`s financial analysis

REPORT

To : Institutional Investor

From : Financial Analyst

Subject : Examination of profitability and cash position

Date : 21st February 2007

The ratios depicted at the end of this report provide an overview of the profitability and liquidity of the group . The profitability of the firm is seriously deteriorating . Indeed the return on capital employed which is a ratio that shows the profit earned per ?100 long term capital employed has decreased drastically . The return on capital employed has also fallen to a low percentage , revealing that the profit of the company

can be quickly eroded and turned into a loss (Randall H (1999 br

463 . It is therefore imperative that debt borrowings are controlled by management in to diminish the negative effect their interest poses on profitability . Indeed in 2005 the profit after taxation amounted only to ?15 million , encountering a decrease of 97 .5 , which was actually sustained by a reduction in debts during the year

The gross profit margin also decreased by nearly 50 from 2004 to 2005 This ratio represents the gross profit gained by the company for every ?100 of sales income . The higher this ratio , the better the profitability of the firm (Wood F . et al (2002 ,

375 and 376 . From a financial statement analysis one can notice that the decrease in the gross profit margin was primarily due to a substantial decrease in turnover of 9 .1 . This further deteriorated the profitability of the organisation

On the contrary , the liquidity of the organisation improved considerably . The current ratio , which signifies how many times the current assets of the firm cover the short term liabilities improved showing a higher ratio of current assets in relation to current liabilities . The acid test ratio is a solvency ratio that analyses the coverage of the assets that can be quickly converted into cash with the current liabilities , which also improved for this firm . In this respect , the stock value is deducted from the current assets , because it is the least liquid asset (Randall H (1999 ,

468 . It is also important stating that the cash and cash equivalents enhanced by ?640 million as revealed in the cash flow statement of the corporation

One would ponder why are profitability and solvency moving on the opposite direction , how is that possible ? The reason behind it rests on the principles upon which financial statements lie , which is the accrual basis of accounting . This concept states that transactions are recorded when they occur and not when cash or cash equivalents are received (International Accounting Standards (2000 ,

88 . Therefore certain events would be recorded in the profit and loss account and would not be entered in the cash flow statement of the group and vice versa . For example , in the cash flow statement one can notice that the cash flow increase was mainly due to high proceeds derived from sale of operations of ?1 ,144 million . This had a positive effect on the cash and cash equivalents , but adversely affected the profitability...