Financial statements are written records that convey the business activities and the financial performance of a company (Richardson, 2019). One of the duties of publicly listed companies is to publish their audited financial statements after each financial year. The profit and loss (P&L) statement outlines the costs, expenses and revenue. Cash flow summarizes the movement of cash into or out. The balance sheet provides a snapshot as to how effectively a company’s management uses its resources. Umbrella’s financial statements (Balance Sheet, Profit and Loss Account and Cash-Flow Statements) for the year 2019 can be found in the appendix section at the end of this file.
However, financial statements do not disclose all relevant and required information and suffer from certain inherent limitations. In order to obtain relevant information and understand strengths and weaknesses of an organization, analysis and interpretation of financial statements is necessary. Analysis and interpretation of financial statements refers to a systematic and constant effort to determine significance and meaning of the financial statements to enable forecasting profitability, solvency and prospects of future earnings (Thukaram, 2007). For this purpose, financial ratios work better because they provide a quick and relatively simple means of assessing the financial health of a business.
Profitability ratios are designed for the evaluation of the company’s operational performance (Srivastava, 1986). Here below profitability ratios based on Umbrella’s P&L statements (Appendix A). They indicate the profit earnings capacity of the business throughout 2019 and immediately compare it to 2018.
Table 2: profitability ratios
Operating profit margin ratio shows the efficiency of a company controlling the costs and expenses associated with business operations. It is the most appropriate measure of operational performance. Umbrella operating profit margin is 7.8% for 2019. This means that for every £1 of gross winnings revenue an average of 7.8% was left as operating profit after paying all expenses of operating the business.
Compared to 2018, however, the performance has decreased by almost 10%. This is the first signal how bad was 2019 for Umbrella and why 2020 started with a strong focus on cost control.
The gross profit margin shows how much from each pound of a company’s revenue is left after taking away the cost of goods sold, and therefore how much money is available to cover overhead, other expenses and of course retained earnings and dividends (Marr, 2012). Gross profit margin ratio for the Umbrella Inc in 2019 was 55.7%, which means that for each £1 of winning revenue, £0.55 was left to cover other operating costs. This indicates that the company is likely to make a reasonable profit as long as it keeps the remaining costs under control. Again, compared to the previous year this ratio decreased significantly.
The net profit margin gives an understanding on how much profit a company makes for each dollar in revenue (Marr, 2012). It is a key indicator of how well a company runs. Umbrella Inc had a net profit margin ratio of 6.2% in 2019, showing a considerable decrease compared to 2018, where it was 14.5%. This still means that the business is suffering.
Liquidity ratios measure a firm’s ability to satisfy its short-term obligations as they come due. They are good leading indicators of cash flow problems (Megginson, et al., 2008).
Table 3: Liquidity Ratios
The current ratio is a test of a business’s short-term solvency. It indicates a business’s capability to pay its liabilities that come due in the near future. The ratio is a tough indicator of whether cash on hand plus the cash to be collected from accounts receivable and from selling inventory will be enough to pay off the liabilities that will come due in the next period (Tracy, 2011). The higher current ratio, the more liquid business is considered to be. The minimum level for this ratio is often started as 1.0 (Atrill & McLaney, 2017). In 2018, Umbrella Inc had a current ratio of 0.8 times or 0.8: 1 and comparing it to the previous year it has not changed. This means that the liquid current assets do not quite cover the current liabilities, so the business may be experiencing some liquidity problems. Thus, the current ratio for Umbrella Inc is worrying as it suggests that the business may struggle to meet its short-term obligations.