Organization Performance Using Financial Ratios
Organization Performance Using Financial Ratios
Ratio analysis refers to the process of determining, analysing and interpreting relationships by using financial statements. It is majorly used to evaluate various aspects of a firm’s financial and operating performance, such as profitability, liquidity, efficiency and solvency. The trend is then studied to determine whether they are deteriorating or improving (Nezlobin, Rajan, & Reichelstein, 2014).
Financial ratio is an indicator used to analyse firm’s financial performance. The ratios are used by the creditors, accountants, analysts, shareholders and bankers to examine and evaluate data presented on a company’s financial statements (Nezlobin, Rajan, & Reichelstein, 2014).
Depending on the outcome of their evaluation, creditors and bankers may choose to retract or extend financial and shareholders may adjust their commitment level in the entity. Therefore, financial ratios are essential tools that judge the efficiency, profitability, solvency and liquidity of the company.
Most financial analysts would use efficiency ratio to evaluate the financial condition of the company. The ratio is often measured over a 3-to-5-year period and it provides additional insights into areas of your firm such as cash flow, collections, and operational results. It measures how well the organization utilizes its assets to generate income. Efficiency ratio often looks at the period it takes the entity to collect cash (Lewellen, 2004).
Efficiency ratios include sales to receivables turnover, inventory turnover and return on assets turnover. Sales to receivables compare trade receivables of a firm to revenues. Inventory turnover measures the number of times inventory is repurchased (Lewellen, 2004).
In both scenarios, a higher number shows a higher level of efficiency when collecting receivables or selling inventory. Return on assets is used to compare net income to total assets and assists in showing the level of efficiency of the management in utilizing its assets to generate revenue.
Bristol-Myers Squibb ability to pay its financial obligations is evaluated by the liquidity ratios. Liquidity ratios measures the ability of a firm to pay off its short-term obligations when due. Current ratio reveals the firm’s ability to pay its current obligations.
Bristol-Myers Squibb current ratio for three years is 1.52, 1.73 and 1.30. The current ratio is more than one for the three years and therefore, the company can pay its financial obligations easily.
2013 = 18916/12440 = 1.52
2014 = 14608/8461 = 1.73
2015 = 10415/8017 = 1.30
Quick ratio measures the ability of an entity to access cash easily to meet its financial demands. Bristol-Myers Squibb quick ratio for the three years 2013, 2014 and 2015 are 1.40, 1.54 and 1.15 respectively. For the past three years, quick ratio is greater than 1 and the company can easily pay its short term obligations.
Quick ratio = (Total current assets – Inventory)/ Total current liabilities
2013 = (18916-1498) / 12440 = 1.40
2014 = (14608-1560)/ 8461 = 1.54
2015 = (10415-1221) / 8017 = 1.15
Profitability trends of Bristol-Myers Squibb are evaluated by analysis of profitability ratios. Profitability ratios help users of the company’s financial statements to determine the general effectiveness of management in generating sales from investments.
Commonly used ratios are operating profit margin, net profit margin and gross profit margin. Gross profit margin is the percentage of gross profit out of revenue or sales.
Gross profit margin = Gross profit/ Revenue
2013 = 11766/16385 × 100 = 71.81%
2014 = 11947/15879 × 100 = 75.24%
2015 = 12651/16560 × 100 = 76.39%
Bristol-Myers Squibb firm’s gross profit margin for the fiscal years ended Dec. 2013, 2014 and 2015 are 71.81, 75.24 and 76.39 respectively. The company has a positive gross profit margin and this is good since it makes net profit as well as covers the labour, rental, marketing and advertising expenses. Thus, the company’s gross margin increases over the years and its profitability trends are favourable.
Operating margin = Operating Income/Revenue
2013 = 3090/16390 × 100 = 18.9%
2014 = 2584/15880 × 100 = 16.3%
2015 = 2261/16560 × 100 = 13.7%
Operating margin of Bristol-Myers Squibb Company for the past three years is 18.7, 16.32, and 13.7 respectively. Unlike its gross margin, the firm’s operating margin reduces over the years. The company is less efficient in its operations in the current year as compared to the preceding years and therefore, its profitability trends are unfavourable. This is due to the competitions faced by the company and it will not be stable during times of recessions or slowdown (Bristol-Myers Squibb Company (BMY) Financial Information)
Net Margin = Net Income/ Revenue
2013 = 2560/16390 = 15.64%
2014 = 2000/15880 = 12.62%
2015 = 1565/16560 × 100 = 9.45%
Bristol-Myers Squibb firm’s net margin for the past three fiscal years is 15.64, 12.62 and 9.45 correspondingly. The long term trend of net margin is a good indicator of the health and competitiveness of the business.
The net margin is not reliable in determining the profitability of the firm since they can be manipulated by adjusting depreciation, amortization and depletion of non-current assets. Therefore, net margin of Bristol-Myers Squibb is unfavourable since it decreases over the past three years.
Over the next five years, Bristol-Myers Squibb earnings are expected to grow at an expected average annual rate of 21.45%. This year forecasted earnings are expected to increase by 29.35% and next year’s earnings will be expected to increase by 29%.
The quick ratio of the company is expected to increase for the next five years since the ratio is greater than one and it fluctuates from one year to the other. Therefore, Bristol-Myers Squibb Company will be able to pay its obligations in the future with ease. Also, a current ratio of the firm will be greater than one in the next five years as it has remained favorable for a long period of time. The company will be able to pay its obligations when due in the future and this guarantees its viability in the future.
The gross profit margin of the company has increased steadily over the years and this is an indicator of it viability in the future. The gross profit margin will increase in the future and thus, increasing the profitability of the company and as a result being viable.
The operating margin of the company reduced drastically over the past three years and this is a concern for the future viability of the organization’s operations. However, this ratio does not always portray the real position of the firm due to the adjustments in depreciation, amortization and depletion.
References
Bristol-Myers Squibb Company (BMY) Financial Information. Retrieved from https://finance.yahoo.com/q?s=BMY
Lewellen, J. (2004). Predicting returns with financial ratios. Journal of Financial Economics, 74(2), 209-235.
Nezlobin, A., Rajan, M. V., & Reichelstein, S. (2014). Capital Investments and Financial Ratios (No. 3052).
