The Accountant of Cosmo Ltd. has prepared the following summaries from the Balance Sheet of the company as at 31st December, 2006 :
| Liabilities | 31st Dec.’ 06 (RS.) | 31st Dec.’ 05 (RS.) | Assets | 31st Dec.’ 06 (RS.) | 31st Dec.’ 05 (RS.) |
| Ordinary Shares of Rs.100 each | 4,00,000 | 3,50,000 | Fixed Assets(at cost) | 4,70,000 | 3,71,100 |
| Premium on Shares | 20,000 | 20,000 | Less: Depreciation | 81,900 | 70,500 |
| General Reserve | 70,000 | 50,000 | | 3,88,100 | 3,00,600 |
| Profit and Loss A/c | 12,500 | 7,500 | Stock in trade | 1,70,500 | 81,400 |
| Creditors | 1,97,700 | 45,400 | Sundry Debtors | 1,42,700 | 85,600 |
| Proposed Dividend | 20,000 | 12,000 | Cash and Bank Balances | 45,900 | 27,300 |
| Provision for Taxation | 27,000 | 10,000 | | | |
| TOTAL (Rs.) | 7,47,200 | 4,94,900 | TOTAL (Rs.) | 7,47,200 | 4,94,900 |
The following additional information is available from the books of the company
(i) The profit for the period 2005 was Rs.46,000.
(ii) Income-tax Rs.9,000 was paid during the year in respect of the previous year and the balance was transferred to General Reserve Account. The proposed dividend for the year 2005 was duly paid.
You are required to calculate the important ratios and comment on the financial position of the company.
Solution.
Profitability Ratios
Return on equity = (Net profit before Interest, Tax and Dividend / Capital Employed) x 100
Year 2005 = [Rs 46000 / (Rs.3,50,000+20,000+50,000+7,500)] x 100
= (46000 / 427500) x 100
= 10.76%
Year 2006 = [Rs 71000 / (Rs.4,00,000+20,000+70,000+12,500)] x 100
= 14.13%
Proprietary Ratio = (Proprietors Funds / Total Assets) x 100
Year 2005 = (4,27,500 / 4,94,900) x 100
= 86.38%
Year 2006 = (5,02,500 / 7,47,200) x 100
= 67.25%
Fixed Assets ratio = (net fixed assets / capital employed) x 100
Year 2005 = (3,00,600 / 4,27,500) x 100
= 70.31%
Year 2006 = (3,88,100 / 5,02,500) x 100
= 77.23%
Liquidity ratios
Current ratio = current assets / current liabilities
Year 2005 = 1,94,300 / 67,400
= 2.88 : 1
Year 2006 = 3,59,100 / 2,44,700
= 1.467 : 1
Liquid ratio = liquid assets / current liabilities
Year 2005 = 1,12,900 / 67,400
= 1.675 : 1
Year 2006 = 1,88,600 / 2,44,700
= 0.77 : 1
Liquidity ratios are mainly used to give an idea of the company's ability to pay back its short-term liabilities (debt and payables) with its short-term assets (cash, inventory, receivables). The higher the ratio, the more capable the company is of paying its obligations. A ratio under 1 suggests that the company would be unable to pay off its obligations if they came due at that point. While this shows the company is not in good financial health, it does not necessarily mean that it will go bankrupt - as there are many ways to access financing - but it is definitely not a good sign.
The short term financial position of company in 2006 is weak in comparison to 2005.
The Proprietary Ratio represents the proportion of Proprietors’ Equity to Total Assets. The long term financial position has also become weak.
The higher this Proprietary ratio denotes that the shareholders have provided the funds to purchase the assets of the concern instead of relying on other sources of funds like bank borrowings, trade creditors and others
This ratio is a test of credit strength as too low a proprietary ratio would mean that the enterprise is relying a lot more on its creditors to supply its working capital.
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