Financial Ratio Analysis For E & A Limited - 2016 Vs 2015

a. Calculate the following financial ratios for E & A Limited(including the calculations as an appendix)

b. Comment on E & A Limited’s liquidity, activity, profitability, and solvency for the financial year 2016, in comparison with ratios in 2015, based on the ratios from (a). Explain how the ratio analysis may have influenced the audit.

Liquidity Analysis

1.03     0.69

 0.41                      0.25

1.06times        0.86times

(8.54%)           (12.34%)

(69%)               (50.2%)

4.88                  2.60

0.83                 0.72

(12.27%)    (12.33%)

Use of ratio analysis to Comment on company’s financial position in following areas:

Liquidity of any company can be defined as its ability to repay its financial obligations whenever they are due. The current, quick and debt equity ratios determines the liquidity position of the company. Current ratio indicates the company’s ability to repay its short term debt obligations from its current assets without having any need to dispose of other revenue generating assets. Quick ratio indicates the firm’s ability to repay its current liabilities using quick assets. From the above analysis it can be said that the company is trying to improve liquidity position of its business as both of its ratios have increased in year 2016 in comparison to year 2015.  The ideal current ratio is considered to be 2: 1 (Drake & Fabozzi, 2010). But the company’s current ratio in 2016 is just 1.03:1 which is considerably low. Also, the debt equity ratio in 2016 has been increased by 2.28 times when compared to year 2015. An increase in this ratio indicates that the company is facing higher risk as the potential investors are not ready to invest their funds in the company and therefore the company is raising funds from its creditors which imposes higher liquidity risk on the company. Liquidity position thus cannot be considered as appropriate. Hence, the company is required to maintain more of current assets to meet its short term debt obligations.

Profitability is defined as the company’s position when it is efficient enough to generate returns (profits) on its total assets and investments of investors. It also indicates the amount of income a company generates from every dollar of sales (Fridson & Alvarez, 2011). As the return on assets and return on equity are found to be negative in both the years i.e. 2016 and 2015 (from the above calculations) it can be analysed that company is inefficient in earning adequate returns by utilising its assets and the funds of investors. The current net profit margin is also negative indicating the losses company is facing. Even when the loss has reduced by $ 4558000 the net profit ratio has declined by .06% because income of the company was not enough to cover its expenses. It shows that the profitability position of the company is below average. Therefore it needs to improve it by making proper utilisation of investor’s funds and its assets.

Solvency position of a company determines its ability to repay all its financial obligations whether short term or long term (Babalola & Abiola, 2013). Solvency ratio of debt to asset measures the quantum of total assets financed by the creditor’s loan compared to the quantum of asset financed by investor’s funds. The company with higher ratio is riskier since it is involves higher interest cost. An increase in 2016’s ratio means that the finance expenses have increased. The report also shows increase in finance from $480300 to $7356000 indicating that company relies heavily on creditor’s to expand business.

Activity ratios are used to determine the company’s ability to turn its assets liabilities into cash or in sales. Higher the activity ratios higher is the firm’s efficiency to convert its assets and liabilities into cash (Brigham & Houston, 2012). In the present case it can be said that the receivable turnover ratio of year 2016 has increased by .20 times in comparison with the year 2015. It indicates that the firm is efficient enough to convert its credit sales into cash by collecting cash from the customers on time.

Ratio Analysis helps the auditors to undertake audit process by using functions like analytical procedures. Analytical procedure enables the auditor to compare and contrast various facts which are the results of ratio analysis. In the present case of E&A Limited the ratio analysis has helped the auditors to compare the results of previous year with that of current year. With the help of ratio analysis the auditor could understand the root causes of deviations that resulted in degrading the company’ financial performance. Moreover, this analysis has enabled the auditor to identify the key areas were users attention is required so that it can influence their decision.

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