Working Capital Ratios

The stock to cost of goods sold ratio showed a 16% decrease to 47 days in 2002 and then a 69% increase in 2003 to 79 days. It is desirable that the stock turnover days are low since less money gets tied up in stock that way. If the company were able to convert this stock into cash quicker it would help its cash flow position. The nature of the business, the company being an Engineering company might have influenced the stock turnover since goods make take extended time to be manufactured or long lead time for procurement hence there is a need to keep high inventory so as not to lose sales.

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Debtors Days or Days sales Outstanding indicated the number of days sales that were tied up in receivables and represented an average length of time that Highlow Engineering must wait after making a sale to receive payment. A traditional year of 365 days was used in these calculations. The debtors days trend shown an increase, for 2001 was 121 as opposed to 146 days to 2002 and 154 for 2003.

This was not a desirable result because it meant that debtors were taking progressively longer to pay their debts and the company will eventually run into cash flow problems and potentially even bankruptcy it this continues. Like most company Highlow Engineering might have had a sales term, a common one being payment due within 30 or 40 days. Since the debtors days was significantly greater than 40 days then customers an average were not paying their bills on time. If prolonged this will deprive the company of funds, which it could use to invest in useful assets. If the trend continues to rise steps should be taken to enforce collection of outstanding debts.

For Creditors Days ratio I choose not to include the advance payment by customers in the creditors numbers since it is not really trade credit given by the suppliers. This ratio indicated the average number of days that Highlow Engineering took to pay its suppliers for goods purchased on credit. The trend showed a increase in the ratio from 84 days in 2001 to 87 days 2002 and then an decrease to 72 days in 2003. Examining this and the debtors ratio showed that an average the firm was paying its creditors within 3 months of crediting the supplies but was paid by its debtors up to 5 months after selling the goods. This will lead to cash flow problems in the short-term and could have more serious impact in the long run.

The net working assets to sale ratio reflects what is seen in the working capital ratios. It showed a constant increase of 8 percentage points between each year from 2001 to 2003. Stock and debtors were increasing while creditors were decreasing. Effects of this explained earlier.

The Liquidity Ratios examined were the current ratio and the quick or acid test ratio. The current ratio, which indicates the firm’s ability to meet short-term debts, was found to be decreasing from a ratio of 2.75:1 in 2001 to a ratio of 1.6:1 in 2003. As explained earlier, this indicated a downward trend in the extent to which the current liabilities were covered by those assets expected to be converted to cash in the near future. Further examination of the financial statements gave an insight to possible reasons for the trend observed. It appears that there was a significant increase in the firm’s current liabilities moving from �8000 in the year ending 2001 to over �17,000 in the year ending 2003. Such a decline in the ratio could be as a result of the company paying its bills more slowly or is borrowing more in the form of overdrafts to pays its bills. A significant portion of the increase in current liability was as a result of a 150% increase in the bank overdraft between year-end 2002 and 2003.

During the same period there were only small increases in the current assets of the company. With a current ratio of 2.75:1 in year 2001 Highlow Engineering could liquidate current assets at 1/ 2.75 = 36.4% of book value and would still be able to pay off creditors in full. With the 2002 ratio of 2.04:1, they could liquidate current assets at 49% and still pay creditors in full. At 1.6:1 in 2003 they would have to liquidate at 62.5% of book value to pay off all the creditors in full.

The Quick or Acid Test Ratio showed the ability of Highlow Engineering to pay off its short-term obligations without relying on the sale of its inventory, since in practice inventory is the least liquid of the company’s current assets. Like the current ratio this ratio is also showing a trend of decline from 2.25:1 in 2001 to 1.28:1 in 2003. This ratio of 1.28 in 2003 is very low and is a cause for concern, unless the company can collect from the debtors since the outstanding debt is significant and would be able to pay off their liability.

Risk Ratios:

Interest cover ratio is an indication of the firm’s ability to meet its annual interest payment. There was a constant increase in the interest cover ratios calculated for Highlow Engineering Company from 3.67 times in 2001 to 3.98 to 4.39 times in 2003. This meant that the operating income would be able to cover the interest charges better in 2003 than in the previous years. In 2002 the operating income would have to decline 3.98 times before Highlow becomes unable to meet its annual interest payment. When profits are low, maybe because of increased expenses such as wages and overheads then the firm might not be able to cover its interest charges or might cover by a low margin and would have difficulty borrowing further funds.

Gearing ratio showed a decline by 3.5 percentage points in 2002 and a further deduction 2 percentage point in 2003. It also indicated that for these 3 years approximately 40% of the firm is funded by long-term debts.

The Debt to Equity and the Debt ratios both varied together from approximately 40% in 2001 to 53% in 2002 and increasing further to 70% in 2003. This is showing what was explained earlier that the company is taking on a significant increase in debts Shareholders Ratios: Investors and potential investors would be pleased with the trend seen for the earnings per share, which showed a growth from 16 pence in 2001 to 18 in 2002 to a high of 27 pence per share in 2003.

The dividend yield of the company was 5.6 %. If the investors can get a higher return elsewhere on their investment they may choose not to reinvest in Highlow Engineering Company. The dividend cover ratio indicates how much of the available profit is distributed to shareholders and how much is retained to be used within the firm. There was a small increase in Highlow dividend cover from 2.08 in 2001 to a high of 2.55 in 2003. For every �2.08 made in 2001 �1 was distributed to the shareholder.