GEMINI ELECTRONIC CASE STUDY: FINANCIAL RATIO ANALYSIS The financial ratio was divided into four parts:i. Liquidity – particularly interesting to short-term creditors it is focus on current assets and current liability General rule for the current ratio should be at least 2:1 For the Gemini Electronic the current ratio is consistent and it is increase in year 2006. But we note that Gemini Electronics is slightly less liquid than the average firm in the industry because the current ratio is lower than the industry average. ii. Assets management Both fixed assets turnover and total asset turnover are less than industry average, indicating that Gemini Electronics is using its asset inefficiently than the industry average in generating sales. In term of collecting receivables (your sales money), Gemini Electronics was becoming slow during year 2009. One of the causes is many retailers (clients) demanded more generous credit terms than net 30 days, which standard in the industry. Besides that, interest was also not charged on overdue account. iii. Long-term debt paying ability Gemini Electronics’ debt ratio and debt equity ratio indicate that Gemini Electronics is more leveraged than the average firm in industry. [Leverage means the amount of debt used to finance a firm's assets. A firm with significantly more debt than equity is considered to be highly leveraged.] The higher leverage explains Gemini Electronics poor financial performance relative to the electronics industry because the leverage commits Gemini Electronics to interest payments that must be paid regardless of economic and market conditions. iv. Profitability The ratios indicated that Gemini Electronic has a higher cost of sales than the average firm in the electronics industry, resulting in a lower gross profit margin, and higher indirect costs, resulting in lower net profit margin performance relative to the electronics industry. Revenue (-) Cost of sales = Gross Profit (-) Operating cost:Direct cost Indirect cost = Net profit When referring to the Gemini Electronics cases the leverage was high because of all the assets were financed with term loans. This is the factors of the leverage becoming high. if a company has $10M in debt and $20M in equity. equity. Total Assets/ Avg. Total Equity . It is expressed as: Total debt / Total Equity For example. it has a debt-to-equity ratio of 0. BREAKING DOWN 'Leverage Ratio' Too much debt can be dangerous for a company and its investors. Leverage Ratios for Evaluating Solvency and Capital Structure The most well known financial leverage ratio is the debt-to-equity ratio. A leverage ratio is any one of several financial measurements that look at how much capital comes in the form of debt (loans).50 = ($10M/$20M). The financial leverage ratio is similar. assets and interest expenses. On the other hand. If a company's operations can generate a higher rate of return than the interest rate on its loans. and if it is very high. A high debt/equity ratio generally indicates that a company has been aggressive in financing its growth with debt. This can result in volatile earnings as a result of the additional interest expense. There are several different specific ratios that may be categorized as a leverage ratio. A reluctance or inability to borrow may be a sign that operating margins are simply too tight. or assesses the ability of a company to meet financial obligations.DEFINITION of 'Leverage Ratio' Companies rely on a mixture of owners' equity and debt to finance their operations. it may increase the chances of a default or bankruptcy. then the debt is helping to fuel growth in profits. too few debts can also raise questions. but replaces debt with assets in the numerator: Avg. Uncontrolled debt levels can lead to credit downgrades or worse. but the main factors considered are include debt. harmful? Well. a company will have less cash to fund marketing. traders have developed a number of ratios that help separate healthy borrowers from those swimming in debt. Large debt loads can make businesses particularly vulnerable during an economic downturn. . becomes excessive. investors are likely to lose confidence and bid down the share price. seasoned investors take a good look at liabilities before purchasing corporate stock or bonds. the challenge is determining whether the organization’s debt level is sustainable. yes and no. research and development and other important investments. For the investor. also known as leveraging. With interest payments taking a large chunk out of top-line sales. For these reasons. If the corporation struggles to make regular interest payments. most companies have had to borrow at one point or another to buy equipment. The problem is when the use of debt. bankruptcy becomes a very real possibility. It may have to take out a loan or sell bonds to pay for the construction and equipment costs. As a way to quickly size up businesses in this regard. in and of itself. In some cases. Is having debt. Consider a company that wants to build a new plant because of increased demand for its products. but it’s expecting future sales to more than make up for any associated borrowing costs.Leverage While some businesses pride themselves on being debt-free. borrowing may actually be a positive sign. In more extreme cases. build new offices or cut payroll checks. Generally.LIQUIDITY A class of financial metrics that is used to determine a company's ability to pay off its short-terms debts obligations. Formula: As of March 31. A company's ability to turn short-term assets into cash to cover debts is of the utmost importance when creditors are seeking payment. Current ratio . 3 Example Ratios: i.measures whether or not a firm has enough resources to pay its debts over the next 12 months. 2014. the higher the value of the ratio. Microsoft’s balance sheet listed the following: Current Assets: Current Liabilities: . for example. Bankruptcy analysts and mortgage originators frequently use the liquidity ratios to determine whether a company will be able to continue as a going concern. the larger the margin of safety that the company possesses to cover short-term debts. Quick ratio.006.740.000 Total current assets Accounts payable $109. Quick assets are current assets that can be converted to cash within 90 days or in the short-term. it does indicate the company is not in good financial health.000 the more able a company is to pay off its obligations. short-term investments or marketable securities.22.903. Investors and analysts would consider Microsoft. While acceptable ratios vary depending on the specific industry. and current accounts receivable.000 Short-term investments $76.000 Inventory $1.000 Net receivables $14.22 $9. A ratio that is too high may indicate that the company is not efficiently using its current assets or short-term financing. a ratio between 1.000 Microsoft’s current 3. . ii.measures the ability of a company to pay its current liabilities when they come due with only quick assets.903.000 Short-term debt $2.000 Other current liabilities $21.958.Cash and cash equivalents $11. financially healthy and capable of paying off its obligations.006.945. Total current liabilities $33.853. with a current ratio of 3.000 ratio = $109. Eg: Cash.000 = The higher the ratio.000 / $33. cash equivalents.5 and 3 is generally considered healthy.000.921. A ratio under 1= a company unable to pay off its obligations if they become due at that point in time.000 Other current assets $3.920.572. A ratio under 1 does not necessarily mean that a company will go bankrupt however. iii. Operating cash flow ratio. Formula: .A measure of how well current liabilities are covered by the cash flow generated from a company's operations.. In other words. Sally only generates 33 cents.000 The total asset turnover ratio is calculated like this: As you can see. The total asset turnover ratio is a general efficiency ratio that measures how efficiently a company uses all of its assets.ASSET MANAGEMENT. Sally's start up in not very efficient with its use of assets. This gives investors and creditors an idea of how a company is managed and uses its assets to produce products and sales.000 Ending Assets: $100. Here is what the financial statements reported: Beginning Assets: $50. . This means that for every dollar in assets. Lower ratios mean that the company have management or production problems. For instance. so he asks for her financial statements.33. mean the company is using its assets more efficiently. Formula Example Sally's Tech Company is a tech start up company that manufactures a new tablet computer. a ratio of 1 means that the net sales of a company = the average total assets for the year. In other words. Sally's ratio is only . so a higher ratio is always more favorable.000 Net Sales: $25. the company is generating 1 dollar of sales for every dollar invested in assets.measures how efficiently a firm uses its assets to generate sales. The investor wants to know how well Sally uses her assets to produce sales. Example Dave's Guitar Shop is thinking about applying for a new loan.000.5 is often considered to be less risky. This ratio measures the financial leverage of a company. In other words. In other words. The debt ratio shows the overall debt burden of the company—not just the current debt. this is a highly leverage firm. A debt ratio of .5 is reasonable ratio. uncertain economic times. but .the debt ratio shows a company's ability to pay off its liabilities with its assets. Companies with higher levels of liabilities compared with assets are considered highly leveraged and more risky for lenders. the business no longer can operate. Once its assets are sold off. This helps investors and creditors analysis the overall debt burden on the company as well as the firm's ability to pay off the debt in future. Formula Make sure you use the total liabilities and the total assets in your calculation. this shows how many assets the company must sell in order to pay off all of its liabilities. The banker discovers that Dave has total assets of $100. Dave's debt ratio would be calculated like this: .000 and total liabilities of $25. Each industry has its own benchmarks for debt. the company would have to sell off all of its assets in order to pay off its liabilities. A lower debt ratio: a more stable business with the potential of longevity because has lower overall debt. The bank asks for Dave's balance to examine his overall debt levels.Debt Ratio . A ratio of 1: total liabilities = total assets. Analysis A lower ratios is more favorable than a higher ratio. Obviously. In other words.25. Dave only has a debt ratio of . PROFITABILITYMeasures the amount of net income earned with each dollar of sales generated by comparing the net income and net sales of a company. . it measures how much profits are produced at a certain level of sales. This is a relatively low ratio and implies that Dave will be able to pay back his loan. This ratio also indirectly measures how well a company manages its expenses relative to its net sales. Analysis The profit margin ratio directly measures what percentage of sales is made up of net income. The Since most of the time generating additional revenues is much more difficult than cutting expenses. managers generally tend to reduce spending budgets to improve their profit ratio. In other words. In other words. Dave shouldn't have a problem getting approved for his loan. the profit margin ratio shows what percentage of sales are left over after all expenses are paid by the business. Dave has 4 times as many assets as he has liabilities. That is why companies strive to achieve higher ratios.As you can see.