Plume and Arrow: Ratio Analysis Financial Ratios

Plume and Arrow: Ratio Analysis

Financial ratios are regarded important decision making tools for financial analysts, business owners, investors and lenders. In addition to helping users determine the stability or profitability of a given entity, ratios can also be used to diagnose the underlying problems of a given business. This text seeks to determine which company between Plume and Arrow is healthier and hence less risky from a financial perspective based on the interpretation of the ratio computations provided.

To begin with, Plume's ROE happens to be higher than that of Arrow. This effectively means that Plume's shareholders are better off than those of Arrow given the ability of the former to earn a higher profit than the latter for each invested dollar. When it comes to ROA, Porter and Norton (2010) define the same as "a measure of a company's success in earning a return for all providers of capital." In the presented scenario, Plume's ROA is higher than that of Arrow. This means that Plume's assets are in one way or the other used more efficiently than those of Arrow in the generation of profits. The gross margin of Plume is also higher (although minimally) than that of Arrow meaning that when it comes to covering administrative as well as selling costs, the former is more efficient that the latter.

Arrow has a higher inventory turnover than Plume. In basic terms, this ratio seeks to determine the number of times a given entity 'turns over' its stock. Thus Arrow's stock is essentially sold out and subsequently restocked more times than that of Plume. However, when it comes to the collection period, the same seems to be higher in the case of Plume. This ratio according to Besley, Besley and Brigham (2011), "is used to evaluate the firm's ability to collect its credit sales in a timely manner." Hence in our case, Plume is more efficient in the collection of its credit sales than Arrow. Next, the fixed asset turnover of Arrow is significantly higher than that of Plume. This ratio as Besley, Besley and Brigham (2011) point out measures how effective an entity is in the utilization of its equipment and plant to generate sales. With that in mind, Arrow can be considered more efficient than Plume in the utilization of its equipment and plant for profit generation purposes. Next is the debt to asset ratio. In our case, the same happens to be relatively higher (though minimally) at Arrow. This ratio helps in the determination of the proportion of a given entity's assets financed through the utilization of debt. Thus more of Arrow's assets are financed through the utilization of debt.

The debt to equity ratio on the other hand helps bring out the mix between shareholder's equity and debt. With that in mind, it is likely that Arrow has a higher cost of capital than Plume given its high debt to equity value. Next, Arrow's current ratio happens to be significantly higher than that of Plume. This effectively means that Arrow is in a better position than plume to settle its obligations if and whine they fall due. Similar conclusions can be drawn when it comes to the acid test ratio. The same is similar to the current ratio but with the figure of inventories deducted from the actual current assets figure.