GEMINI ELECTRONIC CASE STUDY:

FINANCIAL RATIO ANALYSIS

The financial ratio was divided into four parts:i.

Liquidity
particularly interesting to short-term creditors
it is focus on current assets and current liability
General rule for the current ratio should be at least 2:1
For the Gemini Electronic the current ratio is consistent and it is increase in year 2006. But
we note that Gemini Electronics is slightly less liquid than the average firm in the industry
because the current ratio is lower than the industry average.

ii.

Assets management

Both fixed assets turnover and total asset turnover are less than industry average,
indicating that Gemini Electronics is using its asset inefficiently than the industry
average in generating sales.
In term of collecting receivables (your sales money), Gemini Electronics was becoming
slow during year 2009. One of the causes is many retailers (clients) demanded more
generous credit terms than net 30 days, which standard in the industry.
Besides that, interest was also not charged on overdue account.

iii.

Long-term debt paying ability

Gemini Electronics debt ratio and debt equity ratio indicate that Gemini Electronics
is more leveraged than the average firm in industry.
[Leverage means the amount of debt used to finance a firm's assets. A firm with
significantly more debt than equity is considered to be highly leveraged.]
The higher leverage explains Gemini Electronics poor financial performance relative to
the electronics industry because the leverage commits Gemini Electronics to interest
payments that must be paid regardless of economic and market conditions.

iv.

Profitability
The ratios indicated that Gemini Electronic has a higher cost of sales than the average
firm in the electronics industry, resulting in a lower gross profit margin, and higher
indirect costs, resulting in lower net profit margin performance relative to the electronics
industry.
Revenue
(-) Cost of sales
= Gross Profit
(-) Operating cost:Direct cost
Indirect cost
= Net profit

When referring to the Gemini Electronics cases the leverage was high because of all the
assets were financed with term loans. This is the factors of the leverage becoming high.

DEFINITION of 'Leverage Ratio'

Companies rely on a mixture of owners' equity and debt to finance their operations. A leverage ratio is any
one of several financial measurements that look at how much capital comes in the form of debt (loans), or
assesses the ability of a company to meet financial obligations.

BREAKING DOWN 'Leverage Ratio'

Too much debt can be dangerous for a company and its investors. Uncontrolled debt levels can lead to
credit downgrades or worse. On the other hand, too few debts can also raise questions. If a company's
operations can generate a higher rate of return than the interest rate on its loans, then the debt is helping to
fuel growth in profits. A reluctance or inability to borrow may be a sign that operating margins are simply
too tight.
There are several different specific ratios that may be categorized as a leverage ratio, but the main factors
considered are include debt, equity, assets and interest expenses.

Leverage Ratios for Evaluating Solvency and Capital Structure

The most well known financial leverage ratio is the debt-to-equity ratio. It is expressed as:
Total debt / Total Equity
For example, if a company has $10M in debt and $20M in equity, it has a debt-to-equity ratio of 0.50 =
($10M/$20M). A high debt/equity ratio generally indicates that a company has been aggressive in financing
its growth with debt. This can result in volatile earnings as a result of the additional interest expense, and if
it is very high, it may increase the chances of a default or bankruptcy.
The financial leverage ratio is similar, but replaces debt with assets in the numerator:
Avg. Total Assets/ Avg. Total Equity

Leverage
While some businesses pride themselves on being debt-free, most companies have had to borrow at one
point or another to buy equipment, build new offices or cut payroll checks. For the investor, the challenge is
determining whether the organizations debt level is sustainable.

Is having debt, in and of itself, harmful? Well, yes and no. In some cases, borrowing may actually be a
positive sign. Consider a company that wants to build a new plant because of increased demand for its
products. It may have to take out a loan or sell bonds to pay for the construction and equipment costs, but
its expecting future sales to more than make up for any associated borrowing costs.

The problem is when the use of debt, also known as leveraging, becomes excessive. With interest
payments taking a large chunk out of top-line sales, a company will have less cash to fund marketing,
research and development and other important investments.

Large debt loads can make businesses particularly vulnerable during an economic downturn. If the
corporation struggles to make regular interest payments, investors are likely to lose confidence and bid
down the share price. In more extreme cases, bankruptcy becomes a very real possibility.

For these reasons, seasoned investors take a good look at liabilities before purchasing corporate stock or
bonds. As a way to quickly size up businesses in this regard, traders have developed a number of ratios
that help separate healthy borrowers from those swimming in debt.

LIQUIDITY
A class of financial metrics that is used to determine a company's ability to pay off its short-terms debts
obligations. Generally, the higher the value of the ratio, the larger the margin of safety that the company
possesses to cover short-term debts.
A company's ability to turn short-term assets into cash to cover debts is of the utmost importance when
creditors are seeking payment. Bankruptcy analysts and mortgage originators frequently use the liquidity
ratios to determine whether a company will be able to continue as a going concern.
3 Example Ratios:
i.

Current ratio

- measures whether or not a firm has enough resources to pay its debts over

the next 12 months.

Formula:

As of March 31, 2014, for example, Microsofts balance sheet listed the following:
Current Assets:

Current Liabilities:

Cash and cash equivalents

$11,572,000

Short-term investments

$76,853,000

Net receivables

$14,921,000

Inventory

$1,920,000

Other current assets

$3,740,000

Total current assets

Accounts payable
$109,006,000

Microsofts current
3.22

$9,958,000

Short-term debt

$2,000,000

Other current liabilities

$21,945,000

ratio = $109,006,000 / $33,903,000 =

The higher the ratio,

Total current liabilities
$33,903,000 the more able a company is to pay off
its obligations. While
acceptable ratios vary depending on
the specific industry, a
ratio between 1.5 and 3 is generally
considered healthy. Investors and analysts would consider Microsoft, with a current ratio of 3.22, financially
healthy and capable of paying off its obligations.
A ratio under 1= a company unable to pay off its obligations if they become due at that point in time. A ratio
under 1 does not necessarily mean that a company will go bankrupt however, it does indicate the company
is not in good financial health. A ratio that is too high may indicate that the company is not efficiently using
its current assets or short-term financing.

ii.

Quick ratio- measures the ability of a company to pay its current liabilities when they come
due with only quick assets. Quick assets are current assets that can be converted to cash
within 90 days or in the short-term. Eg: Cash, cash equivalents, short-term investments or
marketable securities, and current accounts receivable.

iii.

Operating cash flow ratio.- A measure of how well current liabilities are covered by the cash flow
generated from a company's operations.

Formula:

ASSET MANAGEMENT- measures how efficiently a firm uses its assets to generate sales, so a higher
ratio is always more favorable, mean the company is using its assets more efficiently. Lower ratios mean
that the company have management or production problems.
For instance, a ratio of 1 means that the net sales of a company = the average total assets for the year. In
other words, the company is generating 1 dollar of sales for every dollar invested in assets.
The total asset turnover ratio is a general efficiency ratio that measures how efficiently a company uses all
of its assets. This gives investors and creditors an idea of how a company is managed and uses its assets
to produce products and sales.
Formula

Example

Sally's Tech Company is a tech start up company that manufactures a new tablet computer. The investor
wants to know how well Sally uses her assets to produce sales, so he asks for her financial statements.
Here is what the financial statements reported:

Beginning Assets: $50,000

Ending Assets: $100,000
Net Sales: $25,000

The total asset turnover ratio is calculated like this:

As you can see, Sally's ratio is only .33. This means that for every dollar in assets, Sally only generates 33
cents. In other words, Sally's start up in not very efficient with its use of assets.

Debt Ratio

- the debt ratio shows a company's ability to pay off its liabilities with its assets. In other

words, this shows how many assets the company must sell in order to pay off all of its liabilities.
This ratio measures the financial leverage of a company. Companies with higher levels of liabilities
compared with assets are considered highly leveraged and more risky for lenders.
This helps investors and creditors analysis the overall debt burden on the company as well as the firm's
ability to pay off the debt in future, uncertain economic times.

Formula

Make sure you use the total liabilities and the total assets in your calculation. The debt ratio shows the
overall debt burden of the companynot just the current debt.

Analysis
A lower ratios is more favorable than a higher ratio.
A lower debt ratio: a more stable business with the potential of longevity because has lower overall debt.
Each industry has its own benchmarks for debt, but .5 is reasonable ratio.

A debt ratio of .5 is often considered to be less risky.

A ratio of 1: total liabilities = total assets. In other words, the company would have to sell off
all of its assets in order to pay off its liabilities. Obviously, this is a highly leverage firm. Once
its assets are sold off, the business no longer can operate.

Example
Dave's Guitar Shop is thinking about applying for a new loan. The bank asks for Dave's balance to examine
his overall debt levels.
The banker discovers that Dave has total assets of $100,000 and total liabilities of $25,000. Dave's debt
ratio would be calculated like this:

As you can see, Dave only has a debt ratio of .25. In other words, Dave has 4 times as many assets as he
has liabilities. This is a relatively low ratio and implies that Dave will be able to pay back his loan. Dave
shouldn't have a problem getting approved for his loan.

PROFITABILITYMeasures the amount of net income earned with each dollar of sales generated by comparing the net
income and net sales of a company. In other words, the profit margin ratio shows what percentage of sales
are left over after all expenses are paid by the business.

Analysis
The profit margin ratio directly measures what percentage of sales is made up of net income. In other
words, it measures how much profits are produced at a certain level of sales.
This ratio also indirectly measures how well a company manages its expenses relative to its net sales. That
is why companies strive to achieve higher ratios. The
Since most of the time generating additional revenues is much more difficult than cutting expenses,
managers generally tend to reduce spending budgets to improve their profit ratio.