Liquidity ratios measure a company’s ability to meet its maturing short-term obligations. In other words, can a company quickly convert its assets to cash without a loss in value if necessary to meet its short-term obligations? Favorable liquidity ratios are critical to a company and its creditors within a business or industry that does not provide a steady and predictable cash flow. They are also a key predictor of a company’s ability to make timely payments to creditors and to continue to meet obligations to lenders when faced with an unforeseen event. Current Ratio Current Assets/Current Liabilities
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This ratio reflects the number of times short-term assets cover short-term liabilities and is a fairly accurate indication of a company’s ability to service its current obligations. A higher number is preferred because it indicates a strong ability to service short-term obligations. The composition of current assets is a key factor in the evaluation of this ratio. Depending on the type of business or industry, current assets may include slow-moving inventories that could potentially affect analysis of a company’s liquidity how long could it potentially take to convert raw materials and inventory into finished products?
(For this reason, the quick ratio may be preferable to the current ratio because it eliminates inventory and prepaid expenses from this ratio for a more accurate gauge of a company’s liquidity and ability to meet short-term obligations. ) The current ratio for Hershey Company is 1. 44 indicates the company’s ability to service short-term obligations is satisfactorily. However, the value of the quick ratio will provide a clearer indication of the company’s success in this area. Quick Ratio (Cash + Marketable Securities + Trade Accounts Receivable)/ Current Liabilities
This ratio, also known as the acid test ratio, measures immediate liquidity – the number of times cash, accounts receivable, and marketable securities cover short-term obligations. A higher number is preferred because it suggests a company has a strong ability to service short-term obligations. This ratio is a more reliable variation of the Current ratio because inventory, prepaid expenses, and other less liquid currentassets are removed from the calculation. The quick ratio for Hershey Company is 0. 81 indicates the company’s ability to service short-term obligations is unfavorable. Accounts Receivable to Working Capital
Page 2 Financial Analysis of The Hershey Company Essay
Trade Accounts Receivable / (Current Assets – Current Liabilities) This ratio measures the dependency of working capital on thecollection of receivables. A lower number for this ratio is preferred, indicating that a company has a satisfactory level of working capital and accounts receivable makes up an appropriate portion of current assets. The accounts receivable to working capital ratio for Hershey Company is 0. 72 indicates that the company’s performance is sufficient in this area. Inventory to Working Capital Inventory / (Current Assets – Current Liabilities) This ratio measures the dependency of working capital on inventory.
A lower number for this ratio is preferred indicating that a company has a satisfactory level of working capital and inventory makes up a reasonable portion of current assets. The inventory to working capital ratio for Hershey Company is 0. 99 indicates that this ratio is in line with company goals. Long Term Liabilities to Working Capital Long Term Liabilities / (Current Assets – Current Liabilities) This ratio measures the degree to which a company’s long-term debt has been used to replenish working capital versus fixed asset acquisition. The long-term liabilities to working capital ratio for Hershey Company is 3. 42 indicates the value of this ratio is meeting the company’s expectations. Sales to Working Capital Sales / (Current Assets – Current Liabilities) This ratio measures a company’s ability to finance current operations. Working capital (current assets – current liabilities) is another measure of liquidity and the ability to cover short-term obligations. This ratio relates the ability of a company to generate sales using its working capital to determine how efficiently working capital is being used. In general, a lower number is preferred because it indicates a company has a satisfactory level of working capital.
However, an exceptionally low number may indicate inadequate sales levels are being generated. The sales to working capital ratio for Hershey Company is 10. 34 reveals that the company’s level of working capital is strong. The company may want to make an effort to generate additional sales using the available working capital. Activity ratios provide a useful gauge of a company’s operations by determining, for example, the average number of days it takes to collect on customer accounts and the average number of days to pay vendors.
A key point to keep in mind when evaluating these ratios is that seasonal fluctuations are not necessarily reflected in the numbers that are derived from these calculations based on an account balance on one single day. Accounts Receivable Turnover Sales / Trade Accounts Receivable This ratio measures the number of times receivables turn over in a year and reveals how successful a company is in collecting its outstanding receivables. A higher number is preferred because it indicates a shorter time between sales and cash collection. The accounts receivable turnover for Hershey Company is 14. 40 suggests this ratio may be on target with company objectives. Days Sales in Receivables Trade Accounts Receivable / (Sales / Days) This ratio measures the average number of days a company’s receivables are outstanding. A lower number of days is desired. An increase in the number of days receivables are outstanding indicates an increased possibility of late payment by customers. Companies should attempt to reduce the number of days sales in receivables in order to increase cash flow. The general rule used is that the collection period should not materially exceed the credit period.
The days sales in receivables for Hershey Company is 25. 35 days that indicates the company is effective in collecting outstanding receivables if the credit terms is 30 days. Inventory Turnover Cost of Sales/Inventory Inventory turnover is a measure of the number of times a company sold its average level of inventory during the period. A high rate turnover indicates relative ease in selling inventory. However, a high value can mean that the business is not keeping enough inventories on hand, and thus may result to lost sales.
The inventory turnover ratio of Hershey Company is 5. 98 indicates increased company profitability since the company can use the cash normally tied up in inventory for higher return investments. Days Cost of Sales in Inventory Inventory/(Cost of Sales/Days) Average age of inventories provides a rough measure of the length of time it takes to acquire, sell and replace inventory. Days cost of sales in inventory ratio of Hershey Company is 61. 08 indicates that the company is efficiently moving its inventory. Operating Cycle Days.
(Inventory / (Cost of Sales / Days)) + (Trade Accounts Receivable / (Sales / Days)) This ratio calculates the total conversion period for a company, or in other words, the average number of days it takes to convert inventory into cash from sales. It is calculated by adding together the days cost of sales in inventory to the days sales in receivables. Evaluating this ratio can be helpful in gauging the effectiveness of marketing, determining credit terms to extend to customers, and collecting outstanding accounts. The operating cycle days for Hershey Company is 86. 42 days indicates the company is successfully minimizing the amount of time it takes to convert products and services into cash. Sales to Assets Sales / Total Assets This ratio measures a company’s ability to produce sales in relation to total assets to determine the effectiveness of the company’s asset base in producing sales. A higher number is preferred, indicating that a company is using its assets to successfully generate sales. This ratio does not take into account the depreciation methods employed by each company and should not be the only measure of effectiveness of a company in this area.
Sales to assets for Hershey Company is 1. 40 indicates the company’s performance in this area is satisfactory. Sales to Net Fixed Assets Sales / (Property and Equipment – Accumulated Depreciation) This ratio measures a company’s ability to effectively utilize its fixed assets to generate sales. This ratio is similar to the sales to assets ratio, but it excludes current assets, long-term investments, intangible assets, and other non-current assets. A higher number is desired, indicating that a company productively uses its fixed assets to produce sales.
This ratio does not take into account the depreciation methods employed by each company and should not be the only measure of effectiveness of a company in this area. In addition, fixed assets that are almost fully depreciated, and labor-intensive operations may interfere with the interpretation of this ratio. Sales to net fixed assets for Hershey Company is 3. 97 indicates the company is efficiently making use of its fixed assets to effectively generate sales. Net Fixed Assets to Equity
(Property and Equipment – Accumulated Depreciation) / Total Equity This ratio measures the extent to which investors’ capital was used to finance productive assets. A lower ratio indicates a proportionally smaller investment in fixed assets in relation to net worth, which is desired by creditors in case of liquidation. Note that this ratio could appear deceptively low if a significant number of a company’s fixed assets are leased. Net fixed assets to equity for Hershey Company is 1. 60 indicates the company’s performance is adequate in this area. Profitability ratios measure a company’s ability to use its capital or assets to generate profits. Improving profitability is a constant challenge for all companies and their management. Evaluating profitability ratios is a key component in determining the success of a company. It is important to note that all profitability ratio calculations are based on earnings before taxes. Percent Gross Profit ((Sales – Cost of Sales) / Sales) * 100 This ratio measures the gross profit earned on sales and reports how much of each sales dollar is available to cover operating expenses and contribute to profits.
The percent gross profit for Hershey Company is 43. 04% is a good indication of financial health for the company. Percent Profit Margin on Sales Earnings before Taxes / Sales * 100 This ratio measures how much profit a company makes on each sales dollar received and how well a company could potentially deal with higher costs or lower sales in the future. The percent profit margin on sales for Hershey Company is 15. 29% indicates sales is contributing enough to the company’s bottom line. Percent Rate of Return on Assets Earnings before Taxes / Total Assets * 100
This ratio measures how effectively a company’s assets are being used to generate profits. It is one of the most important ratios when evaluating the success of a business. A higher number reflects a well managed company with a healthy return on assets. Heavily depreciated assets, a large number of intangible assets, or any unusual income or expenses can easily distort this calculation. The percent rate of return on assets for Hershey is 21. 36% indicates that the company remains competitive and continues operating successfully. Percent Rate of Return on Equity
Earnings before Taxes / Total Equity * 100 This ratio expresses the rate of return on equity capital employed and measures the ability of a company’s management to realize an adequate return on the capital invested by the owners in a company. A higher number is preferred for this commonly analyzed ratio. The percent rate of return on equity for Hershey Company is 99. 87% indicates management is effectively managing the profits earned based on the owners investment in the company. Coverage ratios assess a company’s ability to meet its long-term obligations, remain solvent, and avoid bankruptcy.
It measures how well a company’s cash flow covers its short-term financial obligations. Lenders evaluate coverage ratios to determine the degree to which a company could become vulnerable when faced with economic downturns. A company with a high level of debt poses a higher risk to long-term creditors and investors. Debt to Total Assets Total Liabilities / Total Assets This ratio measures what proportion of debt a company is carrying relative to its assets. A ratio value greater than one indicates a company has more debt than assets. Naturally, companies and creditors prefer a lower number.
The debt to total assets ratio for Hershey Company is 0. 78 indicates the company is able to withstand losses without harming creditor interests or could obtain additional financing if desired. Percent Owners Equity Total Equity / Total Assets * 100 This ratio measures what proportion of total assets was provided by the owners equity. The higher the number the more total capital has been contributed by owners and the less by creditors. The percent owners’ equity ratio for Hershey Company is 22. 05% indicates the company owns an adequate portion of its asset. Equity Multiplier Total Assets / Total Equity
This ratio measures the extent to which a company uses debt to finance its assets. The higher the number is, the more a company is relying on debt to finance its assets. The equity multiplier for Hershey Company is 4. 54 indicates a reasonable portion of the company’s assets are owned versus financed. Debt to Equity Total Liabilities / Total Equity This ratio measures the financial leverage of a company by indicating what proportion of debt and equity a company is using to finance its assets. A lower number suggests there is both a lower risk involved for creditors and strong, long-term, financial security for a company.
The debt to equity ratio for Hershey Company is 3. 54 indicates a solid performance in this area for the company. Times Interest Earned Earnings before Interest and Taxes / Interest Expense This ratio measures a company’s ability to meet interest payments. A higher number is preferred, suggesting a company can easily meet interest obligations and can potentially take on additional debt. Note that this particular ratio uses earnings before interest and taxes because this is the income amount available to cover interest. The times interest earned ratio for Hershey Company is 11. 63 indicates the company’s interest coverage is sufficient.See More on Finance