The investor came to me and gave me the profit and loss account and balance sheet of two well-known companies; Burton plc and Next plc. He wants to invest in one of those companies. My task is to use different ratio analysis and work out which is the best company for the investor to invest in. I will be using two types of ratios; profitability ratios and solvency ratios. Ratios show how well a business is doing and does it need to change its strategy to improve. Profitability ratios measure whether a business is making a good amount of profit. It is important to consider the size of the business.
There are four ways in which you may measure the size of the business. This is a way to find out whether it has enough working capital for it to work out the current ratio. The higher the ratio of current asset to current liabilities, the higher the amount of working capital in he business. The higher the ratio, the ratio, therefore, the safer is the business. Acid test ratio The acid test ratio is stricter measurement of solvency then the current ratio. Stock is part of the working capital of the business. However, it might be difficult to sell off stock quickly if the business faced a cash crisis.
Burton plc- from 1991 to 1993, the net profit margin of Burton plc has increased from -0. 81% to -0. 98%. An increase of 1. 79%. This shows that its making a high net profit per i?? of product sold. The higher the profit per i?? , the higher the ratio, therefore the more profitable Burton plc is likely to be. It shows an increasing net profit. Next plc- on the other hand, the net profit margin of Next plc had a tremendous increase. In 1991, the net profit margin of Next plc was -4. 64%, which was lower than Burton plc. But then, in 1993, the net profit margin had reached to 8.
03% – an increase of 12. 67%, a higher net profit margin then Burton plc- in 1993 and even in 1992. Burton plc- In 1991 and 1992, Burton had negative percentages of ROCE (1991: -5. 82% 1992: -0. 11%). This means that it had owed more than the asset of the business; the business could have been insolvent anytime. However, in 1993, the ROCE percentage has increased to 2. 17%. Not a very high increase but has little more asset in business. In current ration, the current assets include stocks. Bu then, there can be hard time to sell the stock in a year, so the acid test ratio subtracts the stock.
The acid test ratio will eventually be lower than the current ratio because then the business will not be dependant on its stock. Burton plc- Burton plc’s acid test ratio was very low; from the period of 1991 until 1993. The acid test ratio of Burton plc in 1993 is quite the same as the acid test ratio of Next plc in 1991- a massive difference. It is a very worrying thing for the business because it is depending on its stock- the business will only get its assets when the stock are sold. This means that most of the assets of the business comes from the stocks they have produced or bought.
Next plc- Next plc’s acid test ration was above expected average and is in a great position. In fact, it is progressing and improving very rapidly year by year. Next plc has no danger of being insolvent because they do not really rely on their stock but other assets such as their debtors, their assets held in their bank and their cash at bank and in hand. So far, I have done used all 5 ratios in my findings and at the previous page, I have drawn up a table showing all the results or findings I have found because it is easier to interpret.
I have done two types of interpretation of the findings; the trading account and the table produced on the previous page. As you can see from the table above, Next plc is making a good progress and is solvent, whereas Burton plc, they are in negatives in many profitability ratios and has very low solvency ratio than Next plc. Recommendation After analysing and going thoroughly through the accounts of both companies; Burton plc and Next plc, I come to this final conclusion that I will advise the investor to invest in Next plc.
This is because using the five ratios above, I have found that Next plc had the biggest value compare to Burton plc. Also using the solvency ratios, Next plc was in a safer position and was very less unlikely to become insolvent. In the other hand, Burton plc is in great danger of becoming insolvent because its solvency ratio were very low, although they were increasing very slowly year by year. Most of Next plc’s values of profitability ratios were very high (above the expected typical business ratios) and Burton plc’s profitability ratios very low and some of them were negative- a great danger for a business.
Next plc’s ratios are increasing at a very fast pace and that it is using a good strategy to keep its business running successfully. In 1991, Next plc was not in a great position and could have been insolvent because it had some negative ratios such as the Return on capital employment (ROCE). But then it 1992 and onwards, it was making a very good progress and had improved a lot. Next plc had a very high increase of net profit margin and gross profit margin from 1991 until 1993. This means it will increase very rapidly and will have a positive value of gross profit margin and net profit margin in 1994.