ABC Supermarket PLC Case Analysis Ratio Analysis Case Study

Excerpt from Case Study :

ABC Supermarket PLC

Case Analysis

Ratio Analysis

The results of ABC Supermarket's financial performance are very different from the comments shared by the Chairman in the 2009 Annual report. Based on the evaluation below, the company's cash, profitability, and liquidity positions all weakened between 2006 and 2009. They also had an issue with managing inventory. However, the stock price increased successively over this period of time. This may have been a factor of raising more debt.

Return on Capital Employed (ROCE)

The Return on Capital Employed ratio (ROCE) tells us how much profit we earn from the investments the shareholders have made in their company. It is also the rate of return a business is making on the total capital employed in the business. Capital will include all sources of funding (shareholders funds + debt).

The single most important indicator of the inherent excellence of a business is the return on capital employed. There is a popular statement that applies to this ratio: "it takes money to make money." Those that understand compounding know that the goal is to make as much money with as little invested as possible while avoiding the dangers of leverage.

ABC Supermarket's ROCE ratio decreased successfully over the past four years. In fact, the ratio dropped 10 points between 2006 and 2009. This is in indication that the company did not leverage investor funds appropriately.

Return on Equity (ROE)

One of the most important profitability metrics is return on equity. Return on equity reveals how much profit a company earned in comparison to the total amount of shareholder equity found on the balance sheet. It's what the shareholders "own." Shareholder equity is a creation of accounting that represents the assets created by the retained earnings of the business and the paid-in capital of the owner

The Return on Equity profile for ABC Supermarket is weakening. Similar to its performance with the Return on Capital Employed ratio, this suggests that management is not leveraging equity appropriately.

Stock Turnover (Days)

Stock turn over ratio and inventory turn over ratio are the same. This ratio is a relationship between the cost of goods sold during a particular period of time and the cost of average inventory during a particular period. It is expressed in number of times. Stock turn over ratio indicates the number of times the stock has been turned over during the period and evaluates the efficiency with which a firm is able to manage its inventory.

This ratio indicates whether investment in stock is within proper limit or not. Given that the number of stock turnover days increased 23% (45 days in 2006 vs. 59 days in 2009), this is indicates that there are some issues managing inventory.

Debtor Collection Period

The term Debtor Collection Period indicates the average time taken to collect trade debts. In other words, a reducing period of time is an indicator of increasing efficiency. It enables the enterprise to compare the real collection period with the granted/theoretical credit period. It is evident based on the reduction over the four-year period that the company operated efficiently in this area.

Current Ratio

The current ratio is a test of a company's financial strength. It calculates how many dollars in assets are likely to be converted to cash within one year in order to pay debts that come due during the same year. An acceptable current ratio varies by industry. Generally speaking, the more liquid the current assets, the smaller the current ratio can be without cause for concern. For most industrial companies, 1.5 is an acceptable current ratio. As the number approaches or falls below 1 (which means the company has a negative working capital), management will need to take a close look at the business and make sure there are no liquidity issues. Companies that have ratios around or below 1 should only be those which have inventories that can immediately be converted into cash.

Normally, one would correlate the

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