Financial Ratio Analysis: Profitability, Liquidity, Gearing and Investment

3. FINANCIAL RATIO ANALYSIS

3.1. PROFITABILITY

(Ho, 2013) mentioned that the gross profit ratio assesses the gross profit generated per dollar sales. A drop in this ratio can signify more competition in the market, lowering selling prices or a higher cost of purchases. A rise in this ratio can signify that the firm has a competitive edge in the market and so it is able to charge higher prices for its products, or the firm is able to obtain its supplies at a lower cost. If this ratio remains stable while the net profit ratio is falling, which is the case for EYSI; this can signify that the control over expenses is weak.

(CIMA, 2012) mentioned that the net profit ratio signifies the profit from trading operations before the interest costs are

A firm like EYSI itself that has a quick ratio of less than 1 cannot presently fully pay back its current liabilities.

3.3. GEARING

(AIA, 2012) stated that the gearing ratio assesses the amount of borrowing compared to shareholder’s investment and indicates the decisions made by management on how funds are raised, either borrowing or raising new equity.

(WJEC, 2012) explained that a gearing ratio that is above 80% is considered very high, 60 to 80% is considered high, and below 40% is considered low. When there is high gearing, the profits available to shareholders are reduced due to interest paid on loans. The costs of the business can increase as well if the interest rates rise. However, high gearing is not necessarily bad. It can signify that the firm is seeking expansion plans, and have taken the chance to capitalise by borrowing at low rates. As for low gearing, more profits are distributed to shareholders due to lower interest bills. However, low gearing can signify that the firm is not effective enough to compete or may have limited opportunities for

A lower debt ratio signifies that the firm depends less on borrowing as compared to equity for financing its assets. Usually, the lower the debt ratio, the lesser is the risk. However, the acceptable levels are different across industries.

(AAII, 2010) mentioned that the interest coverage ratio assesses the firm’s ability to pay interest on its outstanding debt. A high number signifies a healthy firm; whereas a ratio below 1 means that the firm is unable to pay its interest obligations due to insufficient earnings. Creditors look at this ratio to evaluate the probability of payment if the firm got into financial distress. Bond investors also look at this ratio to judge the security of the bill. This ratio is also important to shareholders as it can affect a firm’s share price.

3.4.