University of Essex

Watley’s Financial Report

28 June 2024
Contents
Introduction....................................................................................................3
Ratio analysis..............................................................................................4
Liquidity Ratio..........................................................................................4
Gearing Ratio...........................................................................................5
Activity Ratio............................................................................................5
Profitability Ratio......................................................................................5
Critical analysis...........................................................................................6
Liquidity Ratio..........................................................................................6
Gearing Ratio...........................................................................................6
Activity Ratio............................................................................................7
Profitability Ratio......................................................................................7
References...................................................................................................9
Introduction
Ratio analysis is an essential tool for understanding the trends,
structure, composition, and operational patterns of a business. This
analysis helps to assess concepts such as solvency, liquidity, profitability,
coverage of fixed financial expenses, business performance, and return on
capital employed. It also simplifies the task of efficient financial
management. Additionally, stakeholders and administrators in the
financial sector can easily obtain valuable information from reliable ratio
analysis. It plays a crucial role in understanding the financial performance
of the company, as poor performance suggests underlying issues.
Essentially, ratio analysis serves as a tool for guiding business
development. When a business does well over time, it sets a strong
economic base. This means more jobs and money for workers.
Shareholders and investors also get a good return on their investment.
Ratio analysis
This analysis is the primary method for evaluating a company's
financial situation. The goal of this analysis is to identify both the
strengths and weaknesses of the company by comparing various financial
variables in its statements. This process allows stakeholders, such as
shareholders, investors, creditors, debtors, and employees, to gain a
comprehensive understanding of the financial interactions and
management performance. Financial analysis involves finding out the
financial strengths and weaknesses of a company by looking at the
balance sheet and profit and loss account. The way the figures are
presented in the financial statements makes it easy to compare them with
other figures and draw some meaningful conclusions. Ratio analysis is
based on the numbers in the profit and loss account and the balance
sheet of any business.

If a small business fails to meet or surpass these benchmarks, it is

necessary to pinpoint the issue, develop viable and sustainable solutions,
and monitor financial performance to assess the effectiveness of the
actions taken to address the problem. Thorough financial evaluation,
including ratio analysis, can help mitigate financial issues and create
business continuity plans. The main goal of ratio analysis is to gain a
deeper understanding of financial performance and suggest ways to
improve it. This involves examining each ratio to pinpoint areas where the
company is doing well financially and areas where there is room for
improvement. When it comes to strength, the aim is to continue building
on these strong areas as the company grows. For weaknesses, the
objective is to make strides in improving how the company operates. An
effective ratio analysis can help improve decision-making by accurately
evaluating strengths, weaknesses, and trends in financial performance.

Liquidity Ratio
Based on Watley’s financial reports we can calculate its liquidity for
year 2014 by considering their Current Assets and divide them with their
Current Liabilities.

Currents assets Current liabilities

300 270

300/270 equals to 1.11

For the year 2015 its liquidity ratio would look like this.
 Currents assets Current liabilities

480 210

300/270 equals to 2.28

Gearing Ratio
Gearing ratios for year 2014 would look like this:
non-current liabilities capital employed

470 1550
200/1550 is equal to 30%

While for year 2015 it would look like this:

non-current capital employed

liabilities

410 1630

200/1550 is equal 25%

Cost of goods Average inventory

1290 90

1290/90 is equal to 14.33

Activity Ratio
Activity ratios, also known as turnover ratios or efficiency ratios,
measure how efficiently a business is using its assets. For the year 2014
calculation is below.
For the year 2015 the calculation would look like this:

Profitability Ratio
Profit is a key indicator of a company's success, representing the
balance between operational achievements and needs.

For the year 2014 it would be calculated like this:

Profit Capital employed

400 1550

400/1550 is equal to 25.8%

While for the year 2015 it looks like this:

Profit Capital employed

300 1630

300/1630 is equal to 18.4%

Critical analysis
Liquidity Ratio
Liquidity ratios assess a company's ability to fulfil its short-term
financial responsibilities, such as repaying short-term debt and taking
advantage of borrowing costs by timing accounts payable. These ratios
Cost of goods Average inventory

1500 140

1500/140 is equal to 10.71

include the current and quick liquid cash ratios. The current ratio
compares short-term obligations and borrowings using current assets or
liabilities, revealing the company's ability to meet these obligations with
liquid assets. The quick ratio provides a more detailed analysis of the
availability of cash and assets that can be quickly converted into cash.
When liquidity is taken into consideration for Watley’s, it can be seen that
in the situation where Watley’s must repay its liabilities, they can
successfully do it.

Gearing Ratio
Typically, when a company has higher gearing ratios, the return on
the shareholder's investment is likely to be more unstable, especially
during times of low earnings. During a period of poor trading and
decreased profits, the company can save money on taxes and interest
payments for borrowed funds. However, the amount of money that needs
to be repaid does not decrease when profits are low. If the company's cash
flow is not enough to cover dividends, interest on loans, and taxes, it may
face financial difficulties.

Gearing ratios indicate the level of external investment in the form

of loans and other sources. They help assess the business's ability to fulfil
its financial obligations. Higher amounts of debt can make it challenging
to meet repayment schedules, particularly for principal repayments.
However, higher earnings from borrowed funds, while also covering
interest costs, will contribute to the business's success.

With the gearing ratio looking into year 2014 and 2015, when
compared it is noticed how in 2014 with 30% Watley’s have a healthy
gearing ration however in 2015 that ration falls down to 25%. Ideal is
between 25% to 50%, with 30% showing healthy ration while 25% shows
low ratio indicating business must take a look at their finances and make
sure ratio doesn’t fall lower, putting business at risk.

Activity Ratio
The profitability of business retailers is largely influenced by the
market they serve, whether they are operating from a physical store or
online. Understanding the optimal inventory turnover, safety stock, and
buffer stock levels is crucial for meeting customer demand and managing
working capital effectively. Identifying the right timing for promotional
sales to clear out excess inventory is also essential to prevent stock from
expiring. Retaining inventory long-term is not a goal of a business, so the
more costs associated with holding stock, the less profitable the business
will be. Acquiring, storing, and managing inventory for sale is crucial for
businesses.

In 2014 Watley’s inventory turnover was 14.33 with a fall down to

10.71 in 2015 meaning Watley’s inventory turnover had dropped and was
not as effective at selling their stock.
 Minimizing costs associated with holding stock is essential for
maximizing profitability. The longer inventory is kept, the greater the risk
of it becoming outdated and difficult to sell. This can lead to a decline in
sales quality, but corrective action can be taken before it's too late.

Profitability Ratio
It is influenced by various factors, which can be managed to
maximize earning potential. One important factor is the retention and use
of capital, with expected returns needing to maintain the purchasing
power of the capital stock. Failure to generate adequate returns can erode
the purchasing power of the capital stock. These particular ratios are
highly important and are widely used by lenders, managers, and investors
as an initial assessment of a firm's financial health.

Profitability ratios assess the firm's ability to operate without

significant income loss, which can indicate poor management or excessive
credit use. These ratios play a vital role in determining a firm's success,
long-term stability, and overall well-being. Management focuses on profit,
creditors use these ratios to assess the firm's ability to repay debts and
adhere to credit agreements, and stockholders anticipate a return on their
investments. It is significant to consider that all costs play a role in
determining selling prices, especially costs that are specific to a particular
market segment. Distinguishing between fixed and variable costs forms
the basis for making pricing decisions and creating product packages.

The ratio is also one of many output measures used to determine

the return on investment for product lines. The gross profit ratio, also
known as the gross margin, is the percentage of gross profit to net sales.
Over time, this ratio demonstrates the amount of profit available to cover
operating expenses and generate a profit for the business. It assesses the
effectiveness of a company's production or purchasing department in
managing costs and is helpful for comparing different product lines based
on markup rather than sales price differentials. A higher ratio indicates a
better margin for covering operating expenses. The ratio is influenced by
sales prices, cost of sales, and the markup or spread between cost of sales
and selling price. When measuring the net profit margin, it is important to
compare industry standards in order to better understand what the
company's stability should look like over time.

When profitability was calculated for Watley’s considering year

2014, their profitability was at 25.8%. When the same was done for year
2015 and compared, it was noticed Watley’s profitability dropped down to
18.4%. That can mean the company had more expenses that year than
previous one with less revenue following after it. Watley’s should definitely
take a look at their targeted market and minimise their cost of sales as it
was higher in 2015 with almost no difference in the profit when compared
to the year before. They have lower costs in 2015 for advertising counting
40 while in 2014 it was at 110 which could mean low advertising
influenced their low profitability and not generating targeted profit.

Generally, the net profit margin should remain stable over time. If
this margin declines or increases at a decreasing rate, it is cause for
concern. Reasons for an unstable net profit margin may include poor
revenue management or dependence on a single customer. The net
operating income is a measure of the company's ability to generate profit
from its revenue. A higher net operating income indicates that the
company is more effective at converting its revenue into profit, resulting
in stronger financial performance. A company with a higher net operating
income is able to achieve better profit margins from its revenue.

Overall, Watley’s has to take into consideration previous years sales,

tax paid and costs of sales and make a solid business plan for the year
ahead. While the numbers dropped, business has plenty of opportunities
to rise back up on the numbers.
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