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Analysis of Financial Ratios

1619 words | 6 page(s)

2012 vs. 2013 Performance
As far as Price Smart, Inc. (Price Smart) current ratio is concerned, it slightly improved from 2.3 times in 2012 to 2.4 times in 2013 which is a positive trend. Current ratio measures the short liquidity of a company and generally, a ratio of above 1 is preferable as it indicates that the company is able to cover its short term liabilities through short term assets. An even better measure of short term liquidity is quick ratio which excludes inventory from current assets to give even more reliable picture of company’s short term liquidity. Price Smart’s quick ratio improved from 1.7 times in 2012 to 1.8 times in 2013 which is again a positive development. It shows that the company has adequate liquid resources to meet its short term liabilities.

Inventory turnover ratio tells us how quickly the company is able to sell its inventory and once again the higher numbers are preferred. In Price Smart’s case, inventory turnover ratio increased from 8.6 times in 2012 to 8.9 times in 2013 which means the company sold its inventory faster in 2013 as compared to the previous year. Not only higher inventory turnover ratio helps improve liquidity position but may also improve profitability in addition to revenues due to lower storage and wear-and-tear costs. It is clear that Price Smart’s inventory management system has become more efficient during the period.

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Average collection period tells us how quickly a company collects from its customers to whom it sold products/service on credit. In this case, lower numbers are preferable because it means the company is collecting from customers more quickly. As far as Price Smart is concerned, its average collection period improved from 1.1 days in 2012 to only 0.5 days in 2013 which is a vast improvement and may have made significant contributions towards company’s liquidity position and probably even profitability due to lower risk of bad debt. Total asset turnover tells us about the asset utilization rate of the company as to how efficiently the assets are being used to generate sales, thus, higher numbers are preferable. In Price Smart’s case, the total asset turnover rate remained unchanged at 2.8 times between 2012 and 2013.

Debt to total assets ratio tells us how much of the capital has been provided by lenders. The optimal number varies from industry to industry but generally lower number is preferable since it indicates lower financial leverage. In Price Smart’s case, debt to total assets ratio declined from 43.1 percent in 2012 to 41.8 percent in 2013 which is a positive development. Times interest earned ratio tells us about the company’s ability to meet its interest obligations, thus, a higher number is preferable. Price Smart’s times interest earned ratio improved from 17.4 percent in 2012 to a staggering 44.1 percent in 2013 which is a step in the right direction. This vast improvement could also be attributed to management’s efforts to lower debt level which may, in turn, have reduced interest payments.

Gross profit margin tells us the remaining portion of revenue after direct production costs have been deducted. In other words, it is an indicator of a company’s pricing power. Price Smart’s gross profit margin increased from 3.3 percent in 2012 to 3.7 percent in 2013 which is a step in the right direction. One reason may be higher prices but the other possibility may be lower production costs through greater manufacturing efficiency or volume discounts on bulk purchases.

Return on assets (ROA) tells us about the income generated by each dollar of asset. Price Smart’s ROA increased from 9.2 percent in 2012 to 10.2 percent which is positive news. This shows that the company has been using its average assets to generate higher return. Similarly, return on equity (ROE) refers to the income earned proportional to investment by shareholders and higher the number, the better. Price Smart’s ROE increased from 16.1 percent in 2012 to 17.5 percent in 2013 which is a positive trend and makes investment in this company more attractive. It shows that the company earned higher average net income per each dollar of shareholders’ equity.

2013 Performance vs. Industry Average
It is not only important to compare an organization’s performance over time but also with the competition. As far as Price Smart is concerned, the company did better than the average industry player in most areas. The company’s current ratio of 2.4 times was higher than the industry average of 1.7 times in 2013 which means Price Smart’s short term liquidity was in better state. The company’s quick ratio at 1.8 times was twice the industry average of 0.9 times, not only proving that Price Smart does a better job of maintaining short term liquidity but it also hints at the possibility of Price Smart having more efficient inventory management system. As predicted, Price Smart’s inventory turnover ratio indeed proves that Price Smart has more efficient inventory management system than the average industry player as its inventory turnover ratio of 8.9 times was significantly higher than the industry average of 6.8 times.

Price Smart’s average collection period was merely 0.5 days in 2013 which was way below the industry average of 33 days. It proves Price Smart is one of the industry leaders and its competition has to resort to generous credit policies to boost their sales. Thus, Price Smart has proven itself to have far more efficient liquidity management system than the average competition. The company’s total asset turnover ratio at 2.8 times was lower than the industry average of 4.6 times and this is the first ratio so far in which the company is behind an average industry player. It may be that the company’s asset base is too huge. Another possibility is a significant proportion of unproductive assets.

As far as debt to total assets ratio is concerned, Price Smart’s ratio at 41.8 percent was slightly higher than the industry average of 40 percent in 2013. These numbers do prove that companies in the same industry tend to have quite similar capital structures. Price Smart may benefit by further reducing financial leverage but one can take comfort from the fact that company’s financial leverage did decline from 2012 to 2013. Price Smart’s times interest earned ratio at 44.1 times was significantly higher than the industry average of 28.6 times, again confirming the company’s superior liquidity status as compared to the average competition. One possibility for this may be that the company gets better terms from lenders due to its better financial position as compared to the average competitor.

Price Smart’s gross profit margin of 3.7 percent was way below the industry average of 38.7 percent in 2013 which does come as a surprise. This is also a cause of concern because the deduction of operating expenses may result in net loss as 3.7 percent is quite low gross profit margin. One possibility may be that the company competes on the basis of low prices, hence, low profit margins as compared to the competition. Not surprisingly, the company’s ROA at 10.2 percent was also less than the industry average of 18.3 percent in 2013. As noted above, the company’s asset base may be too large and it’s prices too low, both of which negatively affect ROA. The company’s ROE at 17.5 percent was also less than the industry average of 28.7 percent in 2013 which means Price Smart’s shareholders are not faring as well as shareholders of an average competitor. It is clear that the company needs to improve its profitability even if it means adopting another pricing strategy.

Recommendations
One of the areas Price Smart’s management should look into is its asset base. The company’s asset base seems huge and there must be room to sell some of the least productive assets. Doing so will not only help the company improve its asset utilization rate but will also improve its liquidity position as well as profitability because assets involve depreciation. It should also improve return on total assets. Another area the company’s management should look into is its current pricing strategy. Volume is important but so is profitability and the company’s current gross profit margin is so low that it leaves little room for net profit after all operating expenses have been deducted. The gross profit margin is drastically lower than the average competition. The company should reevaluate its pricing and competitive strategy because doing so may allow it to get rid of some of the least profitable customers. Another suggestion to the company is to further reduce debt. The company has already seen dramatic improvement in areas such as times interest earned ratio by slightly reduce debt from 2012 to 2013. Even if the company brings the debt to total assets ratio to 40 percent which is the industry average, the results will be remarkable in liquidity area and it should also improve profitability. Given the fact that gross profit margin is already quite low, this will be huge boost to company’s profitability status.

Summary of Performance
Overall, Price Smart performed well than the average industry competitor. Two major areas where the company did worse than the average industry player are asset utilization and gross profit margin. The company’s short term liquidity indicators such as current ratio and quick ratio were significantly better than the industry average. Similarly, Price Smart is also significantly better in inventory management debt collection from customers. But the return on assets and equity lag behind the industry average which is to be expected due to low profitability.

Summary of Recommendation
Price Smart’s management may benefit from selling unproductive assets to reduce asset base as well as improve asset utilization rate, liquidity, and even profitability. The company’s management should also reevaluate its pricing and competitive strategy because the current gross profit margin rate is too low. Similarly, the company may also significantly benefit from further reducing financial leverage, especially in liquidity area.

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