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Accounting and Finance Report

Ratio analysis is deemed to be important when assessing the performance of a firm and can be used as a tool to predict company failure or success. However ratio analysis shouldn’t be the only provider of information it should be supplemented by other information. E.g. external factors and non-financial information should be considered also past records need to be considered to look at the longer-term picture of the company. But past records are merely a guide and don’t always illustrate future performance. Furthermore the trends of the market need to be analysed.

However this information is not all available, this report will consider four main areas of ratio analysis which are: profitability, efficiency, liquidity and investment to come a concise conclusion on whether or not an investment in Longway P.L.C would prove beneficial.

Liquidity ratios
“Liquidity is concerned with the short term solvency of the company” Solvency is extremely important for survival because the firm needs to pay its debts to stay in business. In order the assess the liquidity of Longway I made use of the “acid test” shows that the liquidity in 2001 was 1.0:1 times then it increased to 1.19:1 times in 2002. This shows that the longway can repay its short-term obligations. It shows also shows that liquidity is increasing. A company could actually survive on 1.0. The current ratio also shows that the company is in a safe position with regards to liquidity.

Profitability ratios
The profitability of longway has shown significant decreases between 2001-2002. For instance Return on investment has dropped from 32.8% in 2001 to 11.5% in 2002. Also Net profit has dropped from 23% in 2001 to 8.3% in 2002, similarly has gross profit. Return on equity has more than halved in the same period this doesn’t show maximisation of profit or maximisation of sales therefore stability looks poor.

Efficiency ratios
The creditor days have fallen from 243 days in 2001 to 209 days in 2002, which shows greater efficiency in paying for supplies bought on credit. However debtor days have risen which shows delayed payments from credit customers, which could create cash flow problems.

Investment ratios
Earnings per share have dramatically dropped in just two years, from 20pence per share to only 6 pence per share. This shows that shareholders are not maximising there wealth and could be willing to sell, obviously would have poor consequences for longways. Furthermore the price/earnings ratio shows significant decreases and underpins that the investments in longways have minimal returns.

Consideration/ Discussion of directors views and recommendation

I must disagree with the financial director who believes the liquidity of longways is poor, this is clearly not the case as shown in the liquidity ratio’s .

The profitability has undisputedly fallen and I must agree with him on that score.
However the comment made by the operations director suggesting that over the last five years longway has shown a financial decline cannot be commented on because we only have information from 2001-2002, which does actually show a decline in the one year period. However without seeing previous years records only a limited judgment can be made simply because 2002 could simply have been a one off poor year.

I believe by investing in longway, it would make good marketing sense because a greater proportion of the market would be acquired but I don’t believe there is any significant financial logic behind the investment based on the profitability ratios. However its unfair to make assumptions about profitability because the remainder of the market needs to be considered, furthermore do past records of performance. I don’t believe that records of just two years can justify a clear decision about investment. Liquidity does show that the company could in fact survive but I don’t feel as though the profitability margins are great enough to make such an investment as they show huge decreases between 2001-2002. The reasons why the profitability has dropped need to be considered and the external factors need to be explored before fully justifying this decison

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