Financial Analysis the Current Ratios

Financial Analysis

The current ratios and quick test will be used in evaluating the liquidity and the short-term solvability of the two companies. A company that is in short-term financial difficulties may have difficulties in the long run as well, so it is important to assess the liquidity status for a judgement on the overall financial health of the two companies. The current ratio is calculated by dividing the current asset value to the current liabilities value and subsequently it is compared to 1. For a company not to be in trouble with its liquidities, its current assets must be greater in value than the current liabilities, so the current ratio has to be over 1.

At Arctic, the current ratio in 2004 was 2.6, while at Polaris this accounted for 1.15. If we compare these data to the current ratios in 2003 we will see that they have more or less remained at the same levels. Indeed, the current ratio at Arctic was 2.74 in 2003 and at Polaris it was 1.1, so we may conclude that the management has actually set some limits to the evolution of the current ratio indicator, in conformity with the financial approach at each of the two companies.

Indeed, as far as the current ratio and short-term solvability are concerned, the companies have values higher than 1, which shows that they will be able to honour any short-term liabilities from their current assets. On the other hand it is interesting to notice that the current ratio at Arctic is almost 2.5 higher in value than the one at Polaris. A more prudent choice from Arctic would be the best explanation, putting away all risk of short-term solvability problems.

The quick test is calculated in a similar way, except that we use instead of the Current Assets value the Current Assets minus the Inventory value. Arctic had a quick ratio of 1.87 in 2004, with a quick ratio in the same year of 0.72 for Polaris. Basically, these values are in concordance with the above conclusions and with close proportions of inventory values in the total current asset values for each company in part.

The solvency and debt management ratios will provide important information in terms of the financial leverage and the proportion of debt used by each of the two companies in their financial approach. The debt ratio and debt-to-equity ratios seem the best places to start, because this will show the amount of the total assets in each company financed by outside sources (debt). On the other hand, both companies have interesting situations in terms of debt usage for development and investment.

In the case of Arctic, the company is relying, in terms of long-term financing, almost exclusively on retained earnings. Retained earnings can be defined as earnings that are "retained by the company to be reinvested in its core business or to pay debt," basically, a form of not paying out dividend to the shareholders and reinvesting profit. Retained earnings amount for 65.1% of total asset value, a similar proportion as the one in 2003.

Retained earnings play the same role at Polaris as well. In 2004, these amounted up to 46.2% of total asset value. On the Polaris 2004 balance sheet, on the other hand, the retained earnings are accounted for as shareholders' equity.

As a conclusion in terms of debt usage, both companies use no or almost no long-term bank debts to finance their activity and there is no financial leverage worth analyzing. In both cases, the shareholders' equity (processed as retained earnings) amount to 40-50% of the total liabilities value.

We will be using three ratios to assess the companies' profitability: the gross profit margin ratio, the return on assets ratio and the return on equity ratio.

The gross profit margin ratio is calculated as (Sales - Cost of Goods Sold)/Sales and is perhaps the best measure of the company's profitability in terms of sales.

At Arctic, the gross profit margin was 21.4% in 2004, with 22.3% in 2003 (a slight decrease here). At Polaris, the gross profit margin was 23.9% in 2004 and 23.4% in 2003. As we can see from the above figures, the gross profit margins are comparative for the two companies and variations are minimal to the precedent year.