Appendix 4
Solutions to Case Studies
Case study 1: Paramount Services PLC
It is important to remember that ratio analysis is really only useful to identify trends
and comparisons. Trends require more than two years’ data, while comparisons
require either budget data or industry/competitor results that can be used as a
performance benchmark.
Nevertheless, although the two years’ data is limited, some conclusions can be
drawn from the ratios.
Sales growth is high (17.2%) but expense growth is greater (26.9%), suggesting
the need to control expenses. Consequently,profit growth (9.4%) has not been
maintained at the same level as sales growth. Interest cost has increased due to
higher long-term borrowings and consequently the interest cover has fallen, a
slightly more risky situation for lenders.
All profitability measures (PBIT/Sales, ROCE and ROI) have fallen, as a result
of the above-mentioned reasons. However, dividend payout has increased in total
(and consequently per share for a constant number of shares) while the yield has
increased, predominantly a result of the fall in the share price. For the same reason
(a reduced share price) the price/earnings ratio has fallen.
Asset efficiency is constant at 1.2, although Paramount does appear to have a
very high level of investment in fixed assets in relation to its income from services.
Days’ sales outstanding have increased significantly from 60 days to 76 days, a
reflection of a credit control problem. Although creditors have also increased, the
working capital ratio has increased and is adequate at 1.7. Gearing has increased,
but the level of long-term debt is quite low in comparison to the fixed asset
investment, an indication that a substantial part of the capital and reserves has
been invested in fixed assets, possibly real estate.
Perhaps the major area of concern is whether the large fixed asset investment
can be justified in terms of the business services that the company carries out.
Case study 2: Swift Airlines
By separating the controllable and non-controllable costs for the route, which the
route manager has not done, we can see the true position (Table A4.1).