Accounting and Control in Business

Executive Summury

After carrying out a ratio analysis of Domino Pizza , a number of inferences can be drawn. The firm is operating profitably as the profitability ratios surpass the industrial average. The restaurant however is not financially stable owing to its low current, quick and debt ratios. But on the other hand it is effectively utilizing its assets to generate sales revenue. It has high inventory and accounts receivable turnovers compared to those of the industrial average.

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The management ought to improve the restaurant’s profitability through a cost reduction mechanism. They also need to invest in projects that generate positive net present values for the benefit of the shareholders.

Introduction

This report on financial ratio analysis is aimed at measuring the general performance of the restaurant. The ratios would help users to get an in- depth understanding of the restaurant’s profitability, financial stability and efficiency with which it is utilizing its assets to generate sales revenue. For the management, their objective would be on how to improve on poor areas and maintain good performance. Its intended users are: the management of the restaurant, customers, employees and the government, who would use it for taxation purposes. The sources of the data used have been the published financial statements i.e. the Profit and loss accounts and the balance sheets of the past four years. The restaurant specializes in the sale of foods and drinks to a wide range of customers. the following ratios will be calculated in order to access the performance of the company:- Profitability ratio, liquidity ratio, investment ratio, gearing ratio and employee ratio.

Profitability ratio

2007 2006
a) Gross profit
= Gross profit
Sales
44,155,000×100
114,891,000
= 38.4%
37,154,000x 100%
94,965,000
= 39.1%
b) Net Profit
= Net Profit before interest and tax
Sales
18,576,000×100
114,891,000
= 16.2%
14,299,000x 100%
94,965,000
= 15.1%
c) return on equity
Net Profit after interest and tax
equity
13,239,000×100
9,858,000
= 138.29%
9,996,000×100
8,938,000
= 111.8%
d)return on assets
Net Profit before interest and tax
Total assets
18,667,000×100
48293,000
=38.65%
14,299,000×100
42,098,000
= 34%

All the profitability ratios show good results overtime. In fact most of net profits show an improvement rate for 2007 of 16.2% from 15.1% in the year 2006. While the gross profit margin has decreased from 39.1% in year 2006 to 38.4% in year 2007. However this is because of change in cost of sales or change in selling price. It can be noted that the profitability of the Domino Pizza is improving from the perspective of net profit over time. This Profit Margin on Sales figures show that the company has shown improved in the profit position and is rather making more profits from 2006 to 2007. However gross profit margin it shows that the company has sacrificed more than its sales revenue in 2007 to cost of sales or reduction in prices.

Return on Assets is also used for the same purpose of measuring the overall performance. However to be meaningful to calculate the ROA it should be adjusted for implicit interest which is difficult to estimate and hence makes the process unnecessarily complicated. The figures show that performance is increasing and it is easy to say that the performance of the company itself has improved. It has changed from 34% to 38.65% which is improved probably associated with the improved profit margin that may be due management of the company expenses.

However one needs to compare its position with the market and also its rival companies to have a clearer picture. The rate of return on Equity can be taken as a good measure to estimate the firm’s performance, from the shareholders’ point of view. However it fails to measure an overall performance of the firm. The higher this ratio is the better. If ROE is less than the ‘cost of equity’ the firm can be said to be destroying value. In the above statistics it seems that the shareholders’ viewed the firm’s performance to improve from 2006 to 2007. It improved from 111.8% to 138.29%.

Liquidity ratio

Feb 2008 Feb 2007
a) Current Working capital ratio
Current Assets
Current liabilities
28,117,000
27,575,000
= 1.02:1
22,823,000
22,638,000
= 1.01:1
b) Quick Asset/Acid Test
= Current Assets – Stock
Current Liabilities
28,117,000-2340000
27,575,000
= 0.9:1
22,823,000-1818000
22,638,000
= 0.92:1
c) cash ratio
Cash + marketable securities
Current liabilities
14,629,000+857000
27,575,000

=0.56:1

10,262,000+864000
22,638,000
=0.49:1
d)cash flow from operation ratio
cash flow from operation
current liabilities
20,088,000
27,575,000
= 0.72:1
15,013,000
22,638,000
= 0.66:1
e)defensive interval
Cash + marketable securities + debtors
Projected expenditure
‘000’
14,629,+857+10,071
27632

=0.92:1

‘000’
10,262+864+9632
25992
=0.80:1

On liquidity, the current ratio indicates that the firm was not financially stable. This ratio was 1.02:1 and 1.01:1 for years 2007 and 2006 respectively. This means that for every £1. of current liabilities there are only £1.02 of current assets for 2007 while in 2006 it is £ 1 of current assets for £ 1.01. The recommended ratio is 2:1 i.e. current assets should be twice as much as current liabilities. But in this case, they are less than the recommended. Compared to the industrial average ratio of 2:1, the Domino Pizza is not better of. Through the years 2006 and 2007, its financial stability improved by a small margin as shown by the ratios 1.01:1 and 1.02:1 respectively.

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The quick Asset Acid test ratio also declines from 0.92:1 in 2006 to 0.9:1 in 2007. The ratio indicates how able the firm is in meeting its financial obligations from the most liquid assets. It shows that the firm is weak in it liquidity. Should be there Technical default then the company be in the woods that it will go under.

So this is an illusionary impact again but the liquidity position shows remarkable improvement especially in terms of cash ratio, cash from operations ratio and defensive interval. When compared two years, I find that 2007 much better off compared to 2006 where there is a different inferences about liquidity. The cash ratio improved from 0.49:1 to 0.56:1 for years 2006 and 2007 respectively. While the cash from operations ratio changed from 0.66:1 to 0.72:1, this is an improvement.

Gearing ratio

a) Debt to total capital Ratio
= Total Liabilities
Total capital
38,396,000
48293000
= 0.8:1
33,112,000
42098000
=0.79:1
b) Debt to equity capital Ratio
= total debt
Equity capital
38,396,000
9,858,000
= 3.9:1
17,352,000
8,938,000
= 1.9:1

There is improvement of the debt ratio it increases from 0.79:1 to 0.8:1 from 2006 to 2007 respectively. The debt ratio is an indicator of the percentage/ratio of total assets that have been financed through borrowed capital. It means that in 2007 80% of the total assets were financed through debt and 2006 they were 79% respectively. It means the firm is financing its assets using external sources more which are less costly. The ratio shows creditworthiness of the firm, this figure means that it is falling as it is increasing is, lucrative from creditors’ point view from 2006 to 2007 and is fall in credibility from the managers’ perspective. The debt to equity ratio is 3.9:1 and 1.9:1 for years 2007 and 2006 it is also a fall in the credit worthiness of the firm. it means that chances of bankruptcy are increasing as time goes on. The management should strive to reduce the debt of the company to keep it going.

Investment ratio

a) Accounts Receivable Turnover
= Sales
Average Debtors
114891000
(10071+9632]000/2
= 11.7 times
94965000
9632000
= 9.9 times
b) average collection period
= 365
Receivable turnover
365
11.7
= 32 days
365
9.9
= 37 days
c)fixed asset turnover
Sales
Average fixed assets
114891000
(18404+18103]000/2
= 6.3 times
94965000
18103000
= 5.2 times
d)Total assets turnover
Sales
Average fixed assets
114891000
(48293+42098]000/2
= 2.5 times
94965000
42098000
= 2.3 times
e)inventory turnover
Credit Sales
Average inventory
114891000
(2340+1818]000/2
= 55.3 times
94965000
1818000
= 52.2 times
b) average collection period
= 365
Inventory turnover
365
55.3
= 7 days
365
52.2
= 7 days

The rate at which Domino Pizza converts debtors into cash is increasing over the two years. It is times 11.7 in 2007 and time 9.9 for year 2006 i.e. the debtors payments frequency. As shown by the account receivable turnover, the number of days was turned to cash is 37 days for 2006 and 32 days for 2007. This was the same for 2007. It means that the efficiency with which the firm is utilizing its debtors to generate cash is high and it is improving. Although accounts receivable shows a constant performance with no change, the profits are have decreased that is gross profit margin.

The higher value of the inventory turnover ratio is not always a good indicator for the firm. The inventory turnover rate measures the number of times the firm has turned its inventory during the past 12 months. The values here show a steady improvement in the firm’s condition of inventory since it has improved from times 52.2 to times 55.3 for year 2006 and 2007 respectively.

The fixed asset turnover and total asset turnover also showed a positive growth that for fixed assets it improved from times 5.2 to times 6.3 for year 2006 to year 2007. The total asset turnover has changed from 2.3 to times 2.5 for years 2006 to year 2007. This shows how the investment in various assets was used.

Conclusion

Therefore the operating efficiency is high and improving and this is influencing the value of ROE. More or less we find that the operating efficiency is responsible for the improvement of returns that is which shows steady progress. In order to achieve better future results, better or close to industrial average, the firm needs to cut down its operating expenses. This would considerably improve the profitability ratios. They also have to review their policy on capital management and keep optimal levels of various items of current assets. This would improve the firm’s liquidity position. In order to improve the return on owner’s equity ratio, the management should invest in viable projects that would yield positive NPV’s.This has the effect of maximizing their wealth.

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References

Joel G. Siegel, Jae K. Shim, “Accounting Handbook”, SC Barron’s Educational Series, 2006, pp 45-88.

Financial Accounting Standards Board, American Institute of Certified Public Accountants Task Force on Service Transactions, Financial accounting Standards Board, 1999, pp 58-69.

Lindsay R. (1967) Financial Management, An Analytical Approach; R.D Irwin.

Luecke R (2002) Finance for Managers; Harvard Business School.

Loren A. Nikolai, John D. Bazley, “Intermediate Accounting”, South-Western College Pub., 1999, pp 4-54.

Index to Accounting and Auditing Technical Pronouncements: (IAATP) Technical Pronouncements. American Institute of Certified Public Accountants, 1999. University of Michigan 2006, pp 21-32.

Scalar, Elliott D. (2000). You Do not Always Get What You Pay For: The Economics of Privatization. Ithaca: Cornell University Press.

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Tippett, M. (1990) “An Induced Theory of Financial Ratios”, Accounting and Business Research, Vol.21, No.81, pp.77-85

White G.I., Sondhi A.C. and Fried D., (1997): l Analysis and Use of Finanacial Statements, Wiley, U.S.A.

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