Financial ratio analysis and interpretation

¶ … gross margin ratio is a means by which the firm's ability to convert revenue into profit. The gross margin for Agilecor has fluctuated significantly over the past three years. This is a reflection of the absurd amount of fluctuation in the firm's business over the past three years. This degree of instability across the company's operations will inevitably reflect in a high degree of volatility in revenues, profits and therefore in margins. A firm that is performing well will demonstrate margins that are either consistent or growing. This is because steady or growing margins indicate that the firm has control over both its operating costs and over its pricing. Agilecor's wildly fluctuating business indicates that the firm has essentially no control over demand, pricing or costs. Under such a situation, strong performance is almost incidental to management's actions.

The return on investment measures the return (net profit) relative to the growth in assets, a proxy for the amount of capital investment that the firm conducts. The return on investment in 1999 was 0.7%, in 2000 it was 11.4% and in 2001 it was 0%. This indicates that only in 2000 did the firm have any significant return on its investment. For 1999, the firm's returns were very modest; for 2001 those returns were negligible. Over time, a company that is performing well should expect to have a return on investment that covers the opportunity cost of capital. That is to say, the firm should consistently make more money on the capital it expends than it would if it simply invested that money. Agilecor has not yet achieved that level of consistent success, because its returns on investment are variable, and in two of the three years very low.

Fixed asset turnover is an indicator of how well the company utilizes its fixed asset base to generate revenue. Because the operating nature of each industry is different, the fixed asset turnover will vary significantly from industry to industry. Therefore, the most important uses for this ratio are to compare across firms in a single industry or the same firm over time. Agilecor's fluctuating sales have left it with a volatile fixed asset ratio. In 1999 it was 0.29; in 2000 it was 1.26; and in 2001 it was 0.1. This high degree of volatility indicates that the company's ability to generate revenues is almost entirely disassociated from its fixed asset level. However, this could indicate that the firm is in an industry with low fixed assets but highly volatile earnings streams (for example, real estate sales).

Total liabilities to total assets is an indicator of the firm's degree of leverage. For 2000, this was 0.27; for 2001 this was 0.67. These figures indicate that Agilecor is increasing its leverage. Given, the company's erratic performance, it is not surprising that the degree of leverage is increasing -- debt can help stabilize a company with highly volatile income streams.