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Ratio Analysis Involves Examining Various Financi...

Ratio analysis

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Šar Mađ
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6 views

Ratio Analysis Involves Examining Various Financi...

Ratio analysis

Uploaded by

Šar Mađ
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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Here's a breakdown of the ratio analysis, interpretations, and recommendations.

Part 1: Ratio Calculations

Company A

● a) Gross Profit Margin Ratio


○ Formula: (Gross Profit / Net Sales) * 100
○ Calculation: (2,000,000 / 5,000,000) * 100 = 40%
● b) Net Profit Margin Ratio
○ Formula: (Net Income / Net Sales) * 100
○ Calculation: (1,000,000 / 5,000,000) * 100 = 20%
● c) Return on Equity (ROE) Ratio
○ Formula: (Net Income / Shareholders' Equity) * 100
○ Calculation: (1,000,000 / 4,000,000) * 100 = 25%
● d) Earnings per Share (EPS)
○ Formula: Net Income / Number of Outstanding Shares
○ Calculation: 1,000,000 / 500,000 = Rs. 2

Company B

● a) Gross Profit Margin Ratio


○ Formula: (Gross Profit / Net Sales) * 100
○ Calculation: (2,700,000 / 6,000,000) *100 = 45%
● b) Net Profit Margin Ratio
○ Formula: (Net Income / Net Sales) * 100
○ Calculation: (1,500,000 / 6,000,000) *100 = 25%
● c) Return on Equity (ROE) Ratio
○ Formula: (Net Income / Shareholders' Equity) * 100
○ Calculation: (1,500,000 / 5,000,000) * 100 = 30%
● d) Earnings per Share (EPS)
○ Formula: Net Income / Number of Outstanding Shares
○ Calculation: 1,500,000 / 700,000 = Rs. 2.14 (approximately)

Part 2: Analysis, Comparison, and Recommendations

Analysis

● Gross Profit Margin: Company B has a higher gross profit margin (45%) compared to
Company A (40%). This indicates that Company B is more efficient at managing its cost of
goods sold and generating a higher profit per rupee of sales.
● Net Profit Margin: Both companies have the same net profit margin of 25%. This means
they convert sales into net income at the same rate.
● Return on Equity: Company B exhibits a higher ROE (30%) than Company A (25%). This
suggests that Company B is more effective at utilizing its shareholder's equity to generate
profits.
● Earnings per Share: Company B has slightly higher EPS (Rs. 2.14) compared to Company
A (Rs. 2), implying it generates slightly more earnings per share of stock.

Comparison
Overall, Company B demonstrates a slightly stronger profitability profile compared to Company
A. This is evident in its higher gross profit margin, return on equity, and earnings per share.

Recommendations

Based on the profitability analysis, I would recommend the following to your client:

● Favorable Investment: Company B appears to be a slightly more attractive investment


option from a profitability standpoint. However, it's important to remember that this analysis is
based solely on profitability ratios. A comprehensive investment decision should consider
other factors as well.
● Diversification: I would also suggest considering diversification by allocating funds to both
Company A and Company B. This helps mitigate risk and potentially benefit from the
strengths of both companies.
● Further Research: Conduct a more in-depth analysis that includes other financial ratios
(e.g., liquidity, solvency, asset turnover), qualitative factors, and industry comparisons before
making a final investment decision.

Important Note: Ratios are just one tool in investment analysis. Market conditions, growth
potential, company management, and other factors should always be considered before
investing.

Let me know if you'd like any other aspects of the companies analyzed or any additional
recommendations made!

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