Essay on “Accounting Analysis”
The liquidity of any firm is its capability to meet all of its short term obligations as and when they become due. In general, it is the firms overall solvency and the financial standing that allows it to pay the bills as they are due. Since, the most common reason for financial distress of any firm stems from a poor liquidity position, firms must pay utmost attention to their own liquidity. This is also because; these ratios provide a quick overview regarding the overall position of their cash-flows and even the impending failure of their business.
Working Capital Management
As an investor, one should pay careful attention to the liquidity position of the business. The working capital ratio has been relatively poor at a negative figure of 0.08 for the years 2007, 2008 and 2009. This indicates that the firm has an increasing number of creditors than stocks and debtors, which mean they also, face an increased risk of facing bad debts resulting from these creditors. The position has improved slightly in the years 2010 and 2011 at -0.07. Although the figure is still negative, but they seem to have recovered some of the owed amount from the creditors.
Under working capital we also have the debtor days, which is the number of days within which the Wm Morrison Supermarket repays their debts which stood at only 4.41 days in 2007. This had increase to 5.6 and 6.16 days in 2008 and 2009 respectively, but had fallen to 4.76 in 2010. Again in 2011 the ratio had increased to 5.94. The most disturbing part is that the creditor’s days are at an alarmingly higher rate since the last 5 years; throughout 2007 to 2011.
The creditor’s day’s ratio is a useful tool that is used to evaluate the account receivable collection policy of any business organization. In this case, Wm Morrison Supermarket seems to lack a proper policy since, the creditor’s day stood at 43.97 days in 2007 compared to debtor’s day of a mere 4.41 days in 2007. In 2011, the creditor’s days stood at 42.39 days in contrast to debtor’s days of 5.94 days. The situation did not improve much and the decrease in the debtors days in almost negligible. The high level of collection days may indicate extremely poor performance of the collection department of the supermarket. However, in some cases businesses may intentionally increase the credit collection time to fend off competition in the marketplace.
The stock inventory days measures the amount of time it takes to convert existing stocks into sales which stood at 11.24 days. The stock inventory days differ from one industry to another, and generally a higher inventory day for a supermarket is not uncommon. So investors should not be concerned much about this. The primary concern for the potential investors in the high level of creditors and also the creditor’s days; which may indicate that the supermarket is failing to collect its due amount diligently.
Liquidity and efficiency ratios
Maintaining a healthy level of liquidity is extremely crucial for any business. The first ratio used for measuring the liquidity of Wm Morrison Supermarket is the current ratio. The current ratio measure the firm’s relatively amount of current assets and current liabilities. As a general rule the current ratio of 2 is deemed to be more acceptable, however, Wm Morrison supermarket had a current ratio of just 0.41 in 2007.
The current ratio had increased slightly in the years 2008 and 2009 at 0.49 and 0.53 percent respectively. However, it fell to 0.51 in 2010 and then increased by a small amount in 2011 at 0.55. Although, in 2011 it has the highest current ration over the past 5 years, it is still underperforming compared to industry standards. The current liability, especially creditors has stayed at an increasingly high rate for the last five years. This high level of creditors is possibly restricting the increase of the current ratio.
The quick or acid test ratio shows the liquidity of the firm excluding the stocks. In this case, the standard quick ratio is around 1, but again the quick ratio of the Wm Morrison supermarket is quite low. In the year 2007, the quick ratio of the company stood at around 0.21 only and in 2008 and 2009 it had increased to 0.25 and 0.29 respectively. But in the years 2010 and 2011 is had stayed constant at 0.24.
This means that the company is not making significant investments in stocks at well but the number of creditors is increasing constantly over the past 5 years. Investors must be cautious while analyzing the liquidity position. A company that fails to recover its debts in 5 years is exposed to an increased risk of making bad debts which may propel the company into a major liquidity crisis. The company should take immediate steps to recover their debts if they want to avoid a liquidity disaster, which will also fend off good investors.
Both the working capital and liquidity and efficiency ratios are vital to scrutinize before making an investment. In the case of Wm Morrison supermarket, the working capital and the liquidity positions are both quite volatile. Both the quick ratio and the current ratios are significantly lower than the acceptable standards. Therefore, investing in Wm Morrison supermarket will be extremely risky for any investor.
However, the asset turnover ratio of the company stood at around 1.89 in the year 2007. The asset turnover ratio shows the amount of sales generated by 1 dollar of asset. This ratio has increased steadily over the last five years which is a positive sign. Every dollar worth of asset has generated 2.06 of sales. Apart from this the gross profit and the net profit margin of the company is also increasing. Therefore, the investors may face a tough choice in deciding whether to invest or not.
Overall the ratios provided, show poor performance of the Wm Morrison supermarket and investing in their company seems quite risky, but the profit ratios seem to be increasing over the last couple of years.