# The Analysis of Financial Ratio

## Introduction

It is worth noting that the company’s financial statements released at the end of each financial year are very important to build strong and sound relationships with the various stakeholders who are involved in the organization’s businesses. Financial ratios are tools used by different stakeholders within the company to assess the financial health of the corporation. The creditors want to confirm that the company’s debt status is managed well, and the company is reluctant to settle its principal and interest payments. The creditors are in turn highly interested in the solvency ratios.

The shareholders of the firm are eager to get abreast of the business activities taking place in the organization and, as a result, the profitability of the firm. They want to know if the value of their stock is increasing. They are interested in being informed about the earnings per share, which rate determines the dividends that they will be given as the profits. The management of the company in their turn try to do their best to improve the liquidity and activity of the ratios. Thus, the managers make strategic decisions based on the findings to ensure that the company is efficient and has sound cash management practices.

## Liquidity

### Current ratio

This is a ratio used to analyse the ability of the company to settle short-term obligations. It is calculated as follows:

Barcello Current ratio = current assets / current liabilities = 575,448,385 / 445,692,832 = 1.29

Sol Melia’s Current ratio = current assets / current liabilities = 823,000,000/824,100,000 = 0.99

The liquidity ratios of both companies are low. It is recommended that the appropriate liquidity ratio would be 2:1. The Sol Melia liquidity ratio is lower than the Barcelo ratio, showing that it has lower liquidity, and as a result, it has higher risks when it comes to settling short-term obligations.

### Acid Test Ratio

This ratio measures the ability of the firm to settle its short-term liabilities without selling its stocks or inventories. It is a stricter ratio than the current ratio.

Barcello Acid Test ratio = current assets – inventory / current liabilities

= 575,448,385 – 12,455,139 / 445,692,832 = 1.26

Sol Melia Acid Test ratio = current assets – inventory / current liabilities

= 823,000,000 – 90,100,000/ 824,100,000 = 0.89

The Sol Melia liquidity ratio is lower than the Barcello ratio showing it has lower liquidity showing has higher risks when it comes to defaulting on settling short-term obligations. When it comes to both cash ratios the company should ensure they invest more time in cash management. This involves someone strategically analyzing the cash of the company to ensure that the right balance is maintained. It is the comparison of the liquidity of the companies and profitability. The company should not have excess cash so that it cannot invest; however; at the same time; it should not have insufficient cash holdings such that it cannot settle its short-term obligations.

### Accounts receivable turnover

The ratio is used to analyse the suitability of the credit policy of the organization.

Barcello accounts receivable turnover = revenue / average accounts receivable

Average accounts receivable = opening + closing accounts receivable / 2

= 88,746,332 + 69,266,059/2 = 79,006,196 (Barceló Group in figures, n.d.)

Accounts receivable turnover = 912,575,456 + 76,534,247 / 79,006,196 = 12.52

Sol Melia’s Average accounts receivable = opening + closing accounts receivable / 2

= 146,600,000 + 122,100,000/2 = 134,300,000 (Year End Results 2011, 2011)

Accounts receivable turnover = 1,250,700,000 / 134,300,000 = 0.931

The accounts are receivable for Sol Melia Company not advisable since it shows a low ability to convert debtors into sales. The management should take steps to ensure that the accounts receivable turnover are increased. The credit policies should be reviewed and an aging analysis carried out. The company should not hold a lot of its assets in accounts receivable. This money needs to be used in investment and other profit-making activities. A ratio that is too high may show that the company has a restrictive credit policy where it may affect the sales and profits of the company. The Barcello Company has a great ratio and should strive to maintain the same in the coming years.

### Average collection period

This ratio shows the time it takes for the company to receive its payments from its debtors. It is calculated by multiplying the number of days in a period and the average accounts receivable and dividing by the revenues or sales.

Barcelló = 365 * 79,006,196 / 912,575,456 + 76,534,247= 28,837,261,540 / 989,

109, 703 = 29.15

Sol Melia = 365 * 134,300,000 / 1,250,700,000 = 39.19

A lower ratio is preferred because the company needs money to settle its obligations in terms of interest expenses and operating expenses. Sol Melia needs to shorten the credit period for its debtors and continually carry out an aging analysis.

## Solvency

These are ratios that analyze the financial stability of a company in terms of the repayment of short-term and long-term debt

### Solvency ratio

In most industries, it is considered wise that a company maintains a percentage of 20%. The lower the ratio, the lower the probability of a company is to meet its obligations. It is calculated as a percentage, comparing the after-tax profit of the company less non-cash depreciation expense compared to the short-term and long-term obligations of the company as follows:

Solvency ratio = After-tax profit add depreciation / short-term + Long-term liabilities * 100%

Barcelló = 10,113,372 + 406,013,489 / 445,692,832 + 1,089,658,740 * 100%

= 416,126,861 / 1,535,351,572 * 100 = 27.1%

Sol Melia = 50,100,000 + 93,500,000 / 824,100,000 + 1,447,000 * 100%

= 143,600,000 / 2,271,100,000 * 100%

= 6.3%

The solvency of Sol Melia is quite low and not advisable to maintain at that level. The Barcello solvency ratio is high and the company should maintain it that way.

### Debt-equity ratio

This ratio is used by analysts to investigate what portion of the assets has been financed through debt or equity. It is calculated as follows:

Total liabilities/stockholder’s equity

Barcello debt / equity ratio = 1,535,351,572 / 904,962,455 = 1.7

Sol Melia debt / equity ratio = 2,271,100,000 / 1,091,100,000 = 2.08

This shows that a higher proportion of the Sol Melia’s assets have been financed through debt. This affects earnings because additional interest payments may be volatile. The Barcello company has a better debt equity ratio.

### Number of times interest earned ratio

This is a ratio estimated by dividing the profit before interest and taxes by the interest on bonds as well as other contractual agreements. It shows how many times a company can pay its interest obligations with its pre-tax profit.

No. of times interest earned ratio = EBIT / Interest

Barcello ratio = 11,896,356 + 65,270,696 / 65,270,696 = 1.18

Sol Melia ratio = 141,800,000 – 7,100,000 / 59,600,000 = 2.26

This shows that the Sol Melia Company can cover its interest payments more times than the Barcello Company.

### Operating cash flows to total liabilities ratio

This ratio measures if the company can pay back its total debt using its annual operating cash income. It is calculated by dividing the Operating Cash Flow/Total Debt

Barcello ratio = 105,762,153 / 1,535,351,572 = 6.88%

Sol Melia ratio = 90,900,000 / 2,271,100,000 = 4%

The ratio is better for Barcello Company than the Sol Melia Company.

## Activity Ratios

These are the financial ratio used to measure the ability of a company to convert several of its accounts into cash or sales.

### Inventory turnover

This shows the frequency that the company converts its inventory into revenue. It is calculated by dividing the revenue by the inventory.

Barcello ratio = 912,575,456 + 76,534,247/12,455,139 = 79.4

Sol Melia ratio = 1,250,700,000 / 90,100,000 = 13.88

A low inventory turnover is not encouraged as it shows that the company is holding excess inventory. It shows that it has poor sales. The Barcello ratio shows that the company has stronger sales.

### Asset turnover

This measures the ability of the company to convert its assets into revenue. It is calculated by dividing the revenue by the total assets.

Barcello ratio = 912,575,456 + 76,534,247 / 2,440,314,027 = 0.4

Sol Melia ratio = 1,250,700,000 / 3,387,000,000 = 0.369

The ratio is better for Barcello Company than the Sol Melia showing that the company is more efficient when it comes to asset turnover.

## Profitability

### Profit margin

This shows the amount of revenue that the company can convert into income. It is especially useful or appropriate when comparing companies that operate in the same industry. It helps the financial analysts to determine which company is more efficient in terms of controlling its costs. It is calculated by dividing net profit by the revenues.

Barcello ratio = 10,113,372/912,575,456 + 76,534,246 = 10,113,372 / 989,109,702 = 1%.

Sol Melia ratio = 50,100,000 / 1,250,700,000 = 4%

The Sol Melia performed better in that it has a higher profit margin than the Barcello Company.

### Return on assets

It is an indication of how efficient the company is in utilizing its assets to generate earnings. It is measured using the following calculations which involve dividing the net income by the total assets of the company.

Barcello ratio = 10,113,372 / 2,440,314,027= 0.414%.

Sol Melia ratio = 50,100,000 / 3,387,000,000 = 1.479%

The Sol Melia Company performed better as it achieved a higher percentage.

### Return on owners’ equity

This is a profitability ratio that shows the returns the company has generated using the shareholder’s funds. It is calculated by dividing the net income by the stockholder’s equity.

Barcello ratio = 10,113,372 / 904,962,455 = 1.12%

Sol Melia ratio = 50,100,000 / 1,091,100,000 = 4.59%

The Sol Melia Company performed better as it achieved a higher percentage. This is used to compare the profitability of firms in the same industry.

## Conclusion

Financial ratios are useful especially when it comes to the comparison of two companies in the same industry. An analysis of the two hotels, Barcello and Sol Melia shows that the Barcello Company is performing better when it comes to the solvency, liquidity, and activity ratios. However, Sol Melia performed better when it came to the profitability ratios.

## References

Barceló Group in figures. (2011). Web.

Year End Results 2011. (2011). Web.

Request for Removal

You can submit a removal request if you own the copyright to this content and don't want it to be available on our website anymore.