June 23, 2021

This report discusses the current financial situation of the Peyton Baking Company, specifically about the company's profitability and liquidity in the years 2015, 2016, and 2017 and how it compares to industry standards. First, this paper discusses the importance of the ratios, the meaning of the numbers, then compares the numbers to the Industry Standards and what it means. This paper focuses on Profitability and Liquidity Ratios as these two illustrate how a company can "pay off its short-term debts…using the company's current or quick assets" and "how well a company can generate profits from its operations" (Bloomenthal, 2021a).

Financial statement analysis ratios of a business are essential to know because "they are useful indicators of financial position and performance, … [and are] used to compare a company's results over time and against its competitors to evaluate its effectiveness" (Wahlen et al., 2017). These values included in the table below are essential and considered because it shows how effectively a company is operating. These numbers also help investors make informed decisions whether to invest in the company.

The Quick Ratio tests a company's liquidity level and assesses how well a company can pay its current liabilities and is computed by dividing quick assets and current liabilities (Wahlen et al., 2017). The Gross Margin represents the revenue left after subtracting the costs of goods sold. It generally means "the higher the gross margin, the more capital a company retains on each dollar of sales" (Bloomenthal, 2021b). The Net Margin is the ratio of net profits to revenues. It "helps investors assess if a company's management is generating enough profit from its sales and whether operating costs and overhead costs are being contained" (Murphy, 2021). Return on Sales assesses a company's operational efficiency and can signal growth or financial troubles (Hayes, 2021). Finally, Return on Equity is essential, especially for shareholders, "as it measures a company's ability to earn a return on its equity investments" (Hayes, 2021).

Comparison Ratios:

Despite the other ratios below Industry Standard, the company is still in a good state. All the ratios are currently lower compared to the previous years, while only Return on Sales and Return on Equity remain within the Industry Standard. The current Quick Ratio is 1.66, and the typical quick ratio is one, and anything higher than one means how fast a company can quickly pay off its current liabilities (Seth, 2021).

According to Kokemuller from Small Business Chron (2019), the Gross Profit Margin may decline due to higher supplier costs, lower prices to generate sales, ancillary COGS, intense competition, and industry changes. The company may have decided to be competitive and lower its prices in favor of higher sales. Both Gross Margin and Net Margin are related to each other. The company's current gross margin is 0.59 or 59%, and net margin is 0.23 or 23%. A net margin above 10% is generally considered excellent (Bragg, 2021), while a gross margin of 41.7% is considered the standard for 2017, and any value higher than that is considered good (Ready Ratios, 2020).

There are several ways that the company can boost its' comparison ratio numbers. Improving net margin is every business's goal, and it gives them a competitive advantage over other companies (Investopedia Team, 2021). Improving net margin numbers can be quickly done by boosting revenues through increasing prices and reducing expenses. However, these two actions can bear negative consequences. For example, raising prices of goods may decrease sales and affect other ratio numbers, especially Return on Sales and accounts on the financial statements such as Net Sales. Reducing costs may also mean a lower Accounts Payable account because the company needs to buy fewer items. In turn, it leads to a higher Quick Ratio number because of the lower Accounts Payable account.

Because of higher prices, there is also a possibility that goods are not immediately sold, causing items to expire and a loss on profits that even lowers Gross Margin and Net Margin. Expired items can also affect the Quick Ratio since the formula for this ratio is based partly on Inventory. With these possible consequences in mind, the company must intensively evaluate whether they should raise prices.

In reducing costs, the company can consider substituting lower-cost materials, reducing waste, eliminating unnecessary product features, negotiating with suppliers and vendors, leveraging suppliers, buying needs only, trading time for discounts, buying bargains, bartering, and so much more (Lewis, 2012). These actions can lead to a lower balance in baking supplies, but if it minimizes costs without sacrificing quality, it is recommended. Reducing costs will lead to higher Gross and Net Margin ratios, ultimately giving the company a better financial standing. A higher Net Margin ratio will also automatically mean a higher Return on Equity, as these two ratios base themselves on Net Income.

The Peyton Baking Company is financially stable and is worthy of being considered by investors. As the Comparison Ratios table suggests, the company is liquid and profitable. There is more room for improvement, especially in the Quick Ratio, Gross Margin, and Net Margin ratios, so that the values would be within or higher than the Industry Standards. The company, as well, had good numbers from the previous years, signifying the company's stability. 

References

Bloomenthal, A. (2021, February 5b). Gross Margin Defined. Investopedia. https://www.investopedia.com/terms/g/grossmargin.asp

Bloomenthal, A. (2021, February 20a). Ratio Analysis. Investopedia. https://www.investopedia.com/terms/r/ratioanalysis.asp

Bragg, S. (2021, April 18). AccountingTools. AccountingTools. https://www.accountingtools.com/articles/what-is-net-profit-margin.html

Hayes, A. (2021, April 30). Return on Sales (ROS) Definition. Investopedia. https://www.investopedia.com/terms/r/ros.asp

Hayes, A. (2021, April 9). The Importance of Profitability Ratios. Investopedia. https://www.investopedia.com/terms/p/profitabilityratios.asp

Investopedia Team. (2021, May 3). How Can a Company Improve Its Net Margin? Investopedia. https://www.investopedia.com/ask/answers/040215/what-are-best-ways-company-improve-its-net-margin.asp

Kokemuller, N. (2019, January 25). Marketing Environment & Competitor Analysis. Small Business - Chron.com. https://smallbusiness.chron.com/marketing-environment-competitor-analysis-46985.html

Lewis, M. (2012, March 31). 14 Ways to Reduce Materials & Cost of Goods Sold in Your Business. Moneycrashers.com. https://www.moneycrashers.com/reduce-materials-cost-goods-sold/

Murphy, C. (2021, April 7). How to Calculate Net Profit Margin. Investopedia. https://www.investopedia.com/terms/n/net_margin.asp

Seth, S. (2021, March 31). Quick Ratio. Investopedia. https://www.investopedia.com/terms/q/quickratio.asp

Ready Ratios. (2020). All Industries: industry financial ratios benchmarking. Readyratios.com. https://www.readyratios.com/sec/industry/

Wahlen, J. M., Jones, J. P., & Pagach, D. P. (2017). Intermediate Accounting: Reporting and analysis (2nd ed.). Boston, MA: Cengage Learning.