4.1 Financial Ratios
3.1.1 Quick Ratio
A quick ratio of 2:1 will be maintained after year five quarter Policy Statement
one. During expansion we shall keep a quick ratio of at least 1:1.
To retain a financial position such that our company is able Objective
to meet short-term liabilities by converting assets to cash if required.
The quick ratio is a good measurement of the liquidity of the Rationale
company and gives the ratio of the amount of money we can obtain immediately by converting assets to cash per dollar
we owe. By using this ratio we are able to maintain a level of financial strength for our company and its position in paying off short-term liabilities. With this policy we are always in a position to pay off our short-term debts such as bank loans.
If the value were to fall below 1:1 then we would be relying on future sales to pay off liabilities.
The quick ratio gives a measurement on the company’s Measurement
ability to come up with cash to pay for liabilities on a short-
term basis and is given by the following formula:
Quick Ratio = (Assets – Inventory) / Liabilities
The effectiveness of this policy is measured in our ability to keep well above our minimum accepted ratios and pay off any bank loans if they are required for expansion.
3.1.2 Profit Margin
We shall retain a minimum net profit margin of five percent Policy Statement
To guarantee our company remains profitable by Objective
maintaining a profit ratio above five percent on a per quarter basis.
As our company mission states we aim to sell our product at Rationale
a price that would not be profitable to other companies. However, we must be careful to make sure our company is still selling our product at a level that is profitable. As a high sales low margin company we will use this ratio to ensure
RGC: Company 3, World 3 Page 1 of 5
that we sell our product at a reasonable but still profitable price.
The net profit is calculated using the income statement: Measurement
Net Profit = Net Income After Tax / Net Sales
Therefore before our quarterly decision making process this
will be calculated to ensure we selling our product and a sufficiently profitable price.
3.1.3 Long-Term Debt Ratio
A debt ratio below 1:2 will be maintained during expansion Policy Statement
and a ratio below 1:3 will be maintained after year five
To ensure our company remains in a strong financial Objective
position by retaining a maximum debt ratio such that our company never falls too far into debt such that we could potentially incur financial difficulty.
The debt ratio gives us a measurement on our ability to take Rationale
on more debt when required and hence also an indication of
how much money our company can borrow over a long period of time. By keeping it below 1:3 once our current expansion is complete, our company will be in a financial position to take on more debt if we decide that we need to further expand production to meet sales. Considering our company aim to maximize market share, the ability to expand is important. Hence having a maximum debt ratio
while not expanding will ensure we have the ability to expand when required.
The debt ratio is given by: Measurement
Debt Ratio = Bonds / Total Assets
A high debt ratio implies that we have taken on a large amount of debt to finance investments. The measurement of
this policy will be evaluated by our ability to finance investments such as plant expansion. This ratio will determine when we are in a financially viable position to expand our production.
3.1.3 Return On Equity
RGC: Company 3, World 3 Page 2 of 5
A return on equity (ROE) minimum of five percent will be Policy Statement
maintained. After year four quarter four we would expect to increase our minimum ROE to ten percent.
To ensure that we are generating sufficient return on capital Objective
for investors by maintaining a minimum return on equity.
Return on equity provides a measurement of how much Rationale
profit we generate from our assets. We believe that maintaining a minimum return on equity after year four quarter four (which is shortly after a new factory comes
online) of ten percent will provide sufficient return to pay generous dividends and still have sufficient earnings to motivate company growth. As our company expands and increases production our return on equity should increase. Therefore as we expand we should use a different minimum
return on equity to gauge company performance. We can increase our return on equity by increasing out net profit through expansion or increasing our profit margin, or reducing our equity through stock repurchase.
Return on equity is calculated using the relation: Measurement
Return on Equity = Net Profit (after tax) / Equity
This ratio gives the percentage return on capital invested by shareholders. We can measure the effectiveness of this policy roughly as increasing our ROE should result in an
increase in share price.
3.1.4 Inventory Turnover
An inventory turnover between five and fifteen percent shall Policy Statement
To minimize our inventory costs by efficient management of Objective
our inventory turnover.
Excess inventory is expensive whilst selling out in an area Rationale
not only loses our company sales but also potentially enables other companies to sell more of their product. Hence, inventory management is vitally important to our company due to our company aim of being the highest selling company. Using the inventory turnover ratio we aim
RGC: Company 3, World 3 Page 3 of 5
to minimize our inventory costs whilst never running out of stock in any of the areas.
Inventory turnover is given by the relationship: Measurement
Inventory Turnover = Cost of Goods Sold / Inventory
A low inventory turnover implies that we have excess inventory waiting to be sold whilst a high value tell us that we have low stocks left over at quarter end. The effectiveness of this policy is measured by how much we
can minimize inventory turnover while never running out of stock in any of the areas. This effectiveness will, however, be subject to environmental conditions.
4.1 Pro Forma Statements
4.1.1 Quarterly Forecasts
Pro Forma income statements, cash flow analysis and Policy Statement
balance sheets are to be completed prior to the decision making process. They will then be used to aid in our choice of selling price, inventory management and calculation of dividends per company policies.
To have financial data available to validate our company Objective
decisions and provide accurate predictions of our company’s financial situation, which will enable us to follow our other company policies.
By having Pro Forma statements available for our decision Rationale
making process we will be able to maintain confidence in the outcomes of our company decisions. We believe that accurate prediction of our income statement, cash flow analysis and balance sheet are vitally important to the operation of our company as they reduce uncertainty in our decision making process. We believe that the construction of these statements is an iterative process. Therefore we will endeavor to increase the accuracy of our Pro Forma statements continually and consequently manage our assets
better to obtain higher returns for our shareholders.
The effectiveness of our Pro Forma statements is Measurement
determined by comparing them to our quarter end income statement, cash flow analysis and balance sheet. If any discrepancies we shall attempt to build a better model.
RGC: Company 3, World 3 Page 4 of 5
Increasing accuracy is important, as maintaining other company policies are dependant on the values generated in these pro forma statements.
4.1.2 Scenario Forecasting
Pro Forma statements will be made available, in addition to Policy Statement
those stated in policy 4.1.1, that outline the specific scenario for a quarter in which poor sales result.
By modeling the scenario in which our company encounters Objective
a poor sales quarter we will not fall into a poor financial
position. It will also ensure that company policies dependant on our pro forma statements will not be dishonored if our sales are below our forecasts.
A quarter in which poor sales occur due to unforeseen Rationale
circumstances has high potential to reduce our income
significantly due to our companies approach with high sales and low margins. A quarter with low sales will change our income significantly due to lower net sales and increased inventory costs. By having Pro Forma statements for this
scenario our company shall be prepared if our forecasting is inaccurate due to factors which we cannot model. Consequently, these pro forma statements will enable us to keep other finance policies such as dividends (policy 2.1.1)
and quarter end cash balance (policy 2.2.1) within their
policy limits for this scenario.
The measurement for what constitutes a poor sales quarter Measurement
is iterative. Currently the ratio we are using is that a quarter with low sales is:
Sales(low) = Sales(expected)*0.9
Previously we were using a factor of 0.8. We expect this factor to increase due to our increased accuracy predictions and increasing net sales. As our number of units sold increases we expect that a market fluctuation would have less impact. We can measure the effectiveness of this policy if we have a poor sales quarter by checking that all our policies remained valid.
RGC: Company 3, World 3 Page 5 of 5