Company Analysis and Valuation

This paper seeks to evaluate emgs using ratio analysis. This will be used to assess whether the company is fit to go public. The major ratio categories to be used in this analysis include profitability ratios, liquidity ratios, and gearing ratios will be used in this evaluation. Ratios only make sense when they are compared over a given period of time (Siddiqui, 2006).

Profitability ratios

Profitability ratios evaluate the earnings of the firm relative to a certain level of sales, assets, or the owner’s investment. The firm has to operate profitably in the long run for it to survive and, therefore, analysis of its long-run profitability becomes crucial. The ratios commonly used to measure profitability include gross profit margin, net profit margin, return on investment, and return on equity.

Ratio Formula 2003 2004 2005 2006
Gross profit margin (Gross profit/sales)*100 =(0.9/2.6)*100
= 34.62%
=(4.9/8.3)*100
= 59.04
= 1.8/8)*100
= 22.5%
=(2.4/18.7)*100
= 12.83
Net Profit Margin (Net profit/sales)*100 =(-0.6/2.6)*100
= -23.1%
=(0.7/8.3)*100
= 8.43%
=(-0.7/8)*100
= -8.75%
=(-3.0/18.7)*100
= -16.04%
Return on Investment (Net profit/total assets)*100 =(-.6/3.6)*100
= -16.67%
=(.7/24.7)*100
= 2.83%
=(-.7/18.5)*100
= -3.78%
=(-.3/18.5)*100
= -1.62%
Return on Equity (Net profit/
Equity)*100
=(-.6/3.2)*100
= – 18.75%
=(0.7/22.1)*100
= 3.17%
=(-.7/15.5)*100
= -4.52%
=(-.3/13.6)*100
= -2.21%

The trend shows that the gross profit margin that measures the company’s effectiveness in controlling the cost of sales increased between 2003 and 2004 but declined thereafter. The decrease in gross profit means that the cost of sales is increasing at a higher rate than the sales revenue (Siddiqui, 2006). A low level of gross profit means that the revenue to pay for expenses may be insufficient.

The net profit margin shows the ability of the firm to control its expenses within a given level of interest rate. The firm made a loss in 2003, 2005, and 2006 but the loss reduced within the period. There was a profit of 8.43% in 2004 meaning that expenses were less than profit in that period.

The return on investment was also poor. The firm recorded a loss in 2003, 2005, ad 2006 but made a gain on an investment in 2004. However, the loss on investment was reduced in 2006. The investment made on total assets did not payback for years return on investment is negative.

The equity funds invested in the firm also earned a loss in 2003, 2005, and 2006 but on a declining trend. There was again in 2004 of 3.1%.

The trend if it continues will make the company lose investor confidence in the future. This will affect the trading of shares in the stock market. The investors would feel that they are likely to lose. If the company makes losses continuously, it means that the investors will never earn dividends.

Liquidity ratios

These ratios indicate if the company is able to settle its short-term obligations when they fall due. They are calculated by comparing the items in the current assets and current liabilities. They are generally used to measure the company’s level of working capital. They include the current ratio, quick ratio, and cash ratio. If the working capital is insufficient, the company will not be able to operate in the short run. The data given will only allow the calculation of the current ratio.

Ratio Formula 2003 2004 2005 2006
Current ratio Current assets/current liabilities = 2.3/0.5
= 4.6
= 20.1/2.6
= 7.73
= 10.2/3.0
= 3.4
= 11.0/4.9
= 2.25

The current ratio of the firm was within the recommended level for the entire period covered by the financial statements. It should be at least 2.0 for a firm to have sound liquidity. A current ratio of 4.6 means that there are 4.6 units of current assets available to pay for a unit of current liabilities when its payment falls due. Investors feel safe when a company has stable liquidity. Low liquidity is a forerunner to bankruptcy.

Investor’s/Gearing Ratios

The ratios are used to assess the extent to which the company is financed using borrowed funds. A comparison of debt and equity is useful in this analysis. The debt to equity ratio and the debt ratio is used in this case.

Ratio Formula 2003 2004 2005 2006
Debt to Equity Long-term debt/Common Equity = 23/3
= 7.67
= 4/8
= 0.5
= 0.2/17
= 0.011
= 5/2
= 2.5
Debt Ratio Total Debts/ Total assets = 43/70
= 0.61
= 29/33
= 0.87
= 6.2/14
= 0.44
= 10/21
= 0.47

Investors are normally interested to know the capital structure of a firm before they invest. If most of the assets of the company are owned by lenders, then the firm is not a good venture for investment. For the firm in question, the debts were more than equity funds in 2003 and 2006. This means that the company had borrowed heavily to finance its assets. This translates to a higher interest burden and too little revenue left for the shareholders (Peterson and Fabozzi, 1999). The debt ratio, however, showed that total assets exceeded the debts during the period covered by the financial statements. The investors would feel safe that even if the company collapses, the asset value is enough to pay the debts the company owes them.

Conclusion

Based on the ratio analysis conducted, emgs would evoke mixed feelings among the investors. The existing investors would feel safe that the assets are enough to pay back for their investment. The new investors would fear that if the firm continues to suffer loss, they will never earn dividends on their shareholding. The company should employ a cost-cut strategy to reduce the level of expenses. When expenses are reduced, the firm will have more earnings to distribute to shareholders as dividends.

Reference List

Siddiqui, S 2006, Managerial Economics and Financial Analysis, New Age International, London.

Peterson, P and Fabozzi, F 1999, Analysis of Financial Statements, John Wiley & Sons, London.