Introduction
Pehr Weisengraf could not interpret the financial ratios of his business after he was presented with a document of the calculated ratios by the banker following a failure to secure a loan for his business from the bank. The ratios are calculated to predict and ascertain the performance of the business by credit issuing institutions. The comparison of the ratios from the previous and current year did not match the required industry average that could have consequently determined what amount of loan could be awarded to his business. In this regard, it is essential that Weisengraf learns what the ratios mean and what can be done to favor securing a loan from the bank.
What the Ratios Mean
Current Ratio – This is a financial ratio of liquidity that assesses a business’s ability to its short term debts (Bull, 2008). Professional Confectioners’ current ratio decreased from the previous year to the current and did not meet the industry’s average. This meant that the business was less likely to meet its debt if a loan was awarded.
Quick Ratio – This ratio helps in the determination of the business’s ability to eliminate its current liabilities given the current quick assets of the business. In the case of Pehr’s business, this ratio was not favorable in the issue of loans.
Debt Ratio – It is a ratio that compares the entire debts that the business is engaged in to the total assets owned by the same business. High debt ratio makes the business more leverage and therefore weak in equity (Bull, 2008). Such is the case with Professional Confectioners.
Debt to Net Worth Ratio – This ratio measures how well a business can manage to protect its creditors (Bull, 2008). High ratio means that the business little protects its creditors and therefore, the chances that it is likely to fault its obligations to them. The ratio increased in the two years considered, hitting higher than the required average, thus the banker’s decision.
Inventory Turnover Ratio – The ratio was used to show the number of times Professional Confectioners’ inventory had been sold or replaced in a given time period. This ratio was lower than the required average for this business.
Average Collection Period – This gives the time period within which the business customers pay what they owe the business. These days had exceeded the required average that would favor the business in securing a loan.
Net Sales to Working Capital Ratio – This is a comparison of the sales of the business less cost of goods sold to the capital that keeps the business operational in its daily activities. High ration is favorable to the business, but for Professional Confectioners, this was not the case in the assessment of loan qualification.
Net Profit on Sales Ratio – This ratio measures the business’s earned profit for each unit of sale made. High ratio is better to the performance of the business. However, this was not the case in this business.
Net Profit to Equity Ratio – In this case, returns on investments made are evaluated (Bull, 2008). Pehr’s business is at a better position because its ratio is over and above the industry average.
What Needs to be Done to Improve the Ratios
The business needs to reduce the time it takes to meet its short term obligations. Professional Confectioners little protects its creditors making it unreasonable for the banker to award a loan. If the company reduces risks to creditors, the ratio would increase to favor its benefit from loans. The business further needs to work on its assets so as to reduce the time it would take to alleviate its liabilities in due time. Professional Confectioners also need to be less leverage in order to build a strong equity. As much as the business works on improving its ratios, the average collection period and the net profit to equity ratios can be maintained in a bid to secure a loan.
Fortune 100 – Nike
Nike is a major sports company that has a global established market share. This company has never in its history of growth faulted any liabilities to it (Wellington, 2007). It enjoys less leverage to its assets and its operations with its creditors have achieved a minimum dispute. Its revenues have had a tremendous increase especially from the year 2004 when they hit $13,739 Million US Dollars to date. The company enjoys an average of 7% revenue turnover in its operations and performance (Bull, 2005).
Conclusion
The financial ratios are a major determinant of a business’ well being. This welfare relates to operations and performance in all the fields that determine its functionality. If the Professional Confectioners undertake the required change of activities on its ratios, it is guaranteed that on the favor of the ratios, the business can secure a loan. The interrelationship of variables in the functionality of a business is essential to its success.
References
Bull, R. (2005). Financial Ratios: Building a Model Success for Your Business. California:
Spiro Press.
Charles, H. (2008). Financial Reporting and Analysis. Chicago: Cengage.
Wellington, G. (2007). Financial ratios: how to use financial ratios to maximize value and
success for your business. Chicago: Elsevier Ltd.
