In the previous article we discussed how a business leader can use liquidity and solvency ratios to assess the performance of a business. The other key ratios that can be used are those ratios that show the profitability, efficiency and investment potential of a business.
Profitability ratios indicate how a business is performing in terms of its ability to generate profit.
These ratios show how well a business is achieving profits from its operations. The profitability ratios focus on a business’ return on investment in inventory and other assets in order to judge whether it’s making enough operational profit from its assets.
Some of the key ratios that entrepreneurs, investors and other financial analysts consider when judging how profitable a business should be are gross profit margin, net profit margin, return on assets, return on capital employed and return on equity.
The gross profit margin compares the gross profit of a business to the net sales. Gross profit is the net sales less cost of goods sold and it’s that profit that goes to pay for operating expenses.
The ratio measures how profitable a business is selling its inventory and it’s calculated by dividing gross profit by net sales.
A business should aim to have a higher ratio because it means it will be able to cover its operating expenses and in turn make a net profit.
The net profit margin measures the amount of net income earned with each dollar of sales generated. It shows what percentage of sales are left over after all expenses are paid by the business.
The net profit margin is calculated by dividing net income by net sales. This ratio is very important because it measures how effectively a company is converting sales into net income.
Investors would want a high net profit margin because this will ensure that there is enough profits to cover for dividends and for reinvesting into the business. This will show that the company is running efficiently. If the ratio is too low it would indicate that the expenses are too high and management should manage, control or cut the expenses.
Net profit margin is affected by declining gross profit, increasing or falling selling price or rising or falling administration costs. It’s advisable to look at the trend and see how this ratio has been behaving.
The return on assets ratio (ROA), or return on total assets, is a profitability ratio that measures the net income produced by total assets during a period.
The ROA measures how efficiently a company is managing its assets to produce profits during a period. The ROA ratio is calculated by dividing net income by average total assets.
The higher the ratio the more favourable it is to investors because it shows that the company is effectively managing its assets to produce net profits.
ROA is most useful for comparing businesses in the same industry since different industries use assets differently.
The next set ratios measure how efficiently the business is being run. Some of these ratios are debtors’ days outstanding, asset turnover and inventory turnover.
The debtors days outstanding calculation, or the average collection period, measures the number of days it takes a business to collect cash from its credit sales.
This calculation shows the liquidity of the business and the efficiency of a business’s collections department.
If the business can collect cash from debtors earlier it will improve the liquidity of the business and will release cash for use in other business operations.
The debtor’s days outstanding ratio is calculated by dividing the ending accounts receivable by the total credit sales for the period and multiplying it by 365 days.
The debtor’s days outstanding shows investors and banks how well a business can collect cash from its customers by showing number of days it takes a company to convert its sales into cash.
A lower number of days is more favourable because it means companies collect cash earlier from customers and can use this cash for other operations.
The next efficiency ratio is the asset turnover ratio which measures a business’s ability to generate sales from its assets by comparing net sales with average total assets.
The asset turnover ratio shows how efficiently a business can use its assets to generate sales. If a company has a ratio of 0.5 it means that each dollar of assets generates 50 cents of sales.
A higher ratio is more desirable because it means the company is using its assets more efficiently.
Like with most ratios, the asset turnover ratio is based on industry standards so to assess the performance of a business the ratio must be compared with other companies in its industry and with a trend.
The last of the efficiency ratios is the inventory turnover which shows how efficiently inventory is managed by comparing the cost of goods sold with average inventory for a period. The ratio measures how many times inventory is sold or turned during the year. Thus the ratio measures how efficiently a company is controlling its stocks.
The aim should be to have a high turnover ratio because if a company can turn its inventory many times it means it’s making sales from its stocks rather than holding too much stocks thereby incurring storage and other stock holding costs.
This ratio also shows that the business can effectively sell the inventory it buys and also that the company’s inventory is liquid, that is, it’s being turned into cash fast. Inventory turnover ratio is also vary with the type of industry.
I will continue with the ratio analysis in the next article.
Stewart Jakarasi is a business & financial strategist and a lecturer in business strategy and performance management. He provides advisory and guidance on leadership, strategy and execution, preparation of business plans and on how to build and sustain high-performing organisations.
l For assistance in implementing some of the concepts discussed in these articles please contact him on the following contacts: email@example.com or +266 58881062 or on WhatsApp +266 62110062
Why invest for the future
AN investment plan forms a critical pillar of a financial plan, says Tokiso Nthebe, a local author and financial services adviser.
Nthebe, the founder of TKO Financial Wellness and Advisory, says when people invest, they can use their money to buy assets that will increase in value over the long term.
He says these assets can help them build wealth.
“When you invest, your money starts to work for you by providing returns that will beat inflation,’’ Nthebe says.
Nthebe says there is a huge difference between saving and investing.
He says investing requires that you take some level of risk in exchange for an expected return or growth.
Nthebe says Basotho should consider many factors before they decide to start investing.
“It is important to have a clear strategy that guides your investment decisions and to work with qualified professionals,” he says.
Nthebe says one should consider their growth mind-set, investment goals, and their risk tolerance.
In addition, one should consider what kind of growth or return they expect.
He says one should find out whether the institution they invest in is licensed or regulated and how long one should invest.
Nthebe says one should further consider what risks are associated with the investment option and whether there are any associated costs.
He says it is also important to remember that investments take time.
“There are no short cuts to building wealth. Do not fall prey to get-rich-quick schemes,” he says.
Moreover, Nthebe says the investment landscape comprises commercial banks, asset management companies, and insurance companies.
He says each provides different financial products and services.
Nthebe says the Central Bank of Lesotho (CBL) also offers investment solutions such as treasury bills and treasury bonds that Basotho can consider.
Depending on your investment goals, he says financial service providers have a wide range of investment solutions to choose from that cater for short, medium, and long-term goals.
“I encourage Basotho to do thorough research and seek professional advice before making financial decisions,” he says.
Vince Shorb, the United States National Financial Educators Council CEO, writes that “many of the financial problems people face today started when they were young and making their first financial decisions”.
Shorb further says taking on too much debt, not investing early, and failing to plan can take one decades to recover from such.
However, it takes financial literacy to make good decisions, he says.
Financial literacy has been perceived as a tool that gives you the opportunity to be confident and empowered to live the quality of life you have worked hard for.
Shorb says one of the wisest decisions one can make to prepare for the future is to invest.
Investment has been defined as the commitment of funds with a view to minimising risk and safeguarding capital while earning a return.
When Covid-19 hit and the government shut down all gatherings in April 2020, there seemed no way out for ICONICS (Pty) Ltd, a budding events management company based in Leribe district.
They had two options: shut down or innovate to keep the business going.
They chose the latter.
Three years down the line, ICONICS (Pty) Ltd has completely transformed itself from an events management and public relations company into a manufacturing company that is now the envy of Lesotho.
“The closing of events translated into the closing of our business,” Rapitso Mosebetsi, one of the co-founders of ICONICS (Pty) Ltd told thepost this week.
Mosebetsi established ICONICS in partnership with Tumo Mahapa.
Faced with collapse, Mosebetsi say they began buying Personal Protection Equipment (PPE) such as surgical gowns, disposal coveralls and safety apparel for resale.
Eventually they decided to manufacture the PPEs and safety clothing. That was the turning point.
But since the company was already down, Mosebetsi says diversification was a hard nut to crack.
“It became quite a long journey (for us),” he says. “We had to come up with something new for the industry.”
He says they had to overcome stiff competition from giant companies and come up with something unique that would set them apart.
“That was how thermal heating apparel was born,” he says.
“We are the first company to produce thermal heating apparel,” he says.
The company manufactures thermal clothing, which is electric clothing, using power banks of five voltages.
“The voltage is so low to electrocute a person,” he says.
The clothing also has a power button to turn it on and off.
Mosebetsi says the thermal heating apparel is on corporate clothing as well as high-visibility clothing.
Mosebetsi says they started the journey with the support of several organisations, such as the Lesotho National Development Corporation (LNDC) and the Basotho Enterprises Development Corporation (BEDCO), to build their capacity.
Mosebetsi says they also got mentorship support from organisations such as the Global Entrepreneurship Network.
The results of years of hard work are now all out for everyone to see.
In 2022, ICONICS won the M100 000 Business Plan Competition hosted by BEDCO.
This grant enabled them to acquire land and buy five more industrial machines.
This did not only enable the company to increase their production to 100 worksuits a week, but it further created permanent jobs for five people as well as three temporary workers.
Last year, the company took part in the Exporter of the Year event hosted by the LNDC in partnership with the Lesotho Post Bank and the United States Agency for International Development (USAID).
Mosebetsi says they won the award for Lesotho’s most innovative and versatile exporter.
He says this did not only put them in the spotlight, but it further encouraged them to do more.
ICONICS was announced as the best exporter of the year at an event hosted by the LNDC earlier this month.
Mosebetsi says this made them proud, as the award is aligned with their vision.
The award further gives the company an opportunity to participate in the regional competition.
He says this opportunity will further give the company a competitive edge in terms of production locally and globally.
“It will be an honour if we can win the regional competition,” he says.
In terms of markets, Mosebetsi says the company has had the opportunity to list their products in the African Trade Market since 2020 with the support of USAID.
This is an e-commerce platform that opens up the market for African countries to list their products.
Mosebetsi says the company did not only get publicity, but the client database also increased.
He says they moved from supplying individuals only to big companies, different organisations, and different government departments such as those involved in mining and health.
Considering the decline of the Lesotho textile industry, Mosebetsi says their secret to success has been their being innovative.
“Our sustainability is matched with innovation,” he says.
Mosebetsi says it also requires patience coupled with lots of investment in terms of time.
“Rome was not built in one day,” he says.
He says working as a team also plays a critical role.
Despite their achievements, Mosebetsi says the market for innovative industries is one of the hardest nuts to crack.
He says the company is in the process of not only making their products known but also educating people about their safety.
Mosebetsi says the other challenge is the decline of the South African Rand as compared to the US Dollar.
He says some of their materials are sourced from China.
Therefore, it is more expensive to buy such materials.
ICONICS is not only seeking to make their brand well known globally, but Mosebetsi says they are also seeking to create more jobs for our youths.
LetsGo and Win!
LETSHEGO Financial Service has launched the LetsGo and Win loan consolidation campaign where customers win weekly and monthly cash prizes of up to M150 000.
The campaign, which was launched yesterday, will end on November 8.
The LetsGo and Win campaign rewards customers for consolidating their loans.
It is aligned with Letshego Lesotho’s version to offer competitive products that cater for the evolving needs of its customers.
The financial services company operates in Lesotho, Botswana, ESwatini, and Zambia.
The Marketing Manager and Business Partner, Tšotetsi Seema, said Letshego Lesotho is committed to delivering increasing value and options to customers.
Seema said this programme is a testament to that commitment.
“The campaign invites customers to consolidate their loans into one low and easy repayment with reduced rates and they stand to win weekly and monthly prizes,” Seema said.
“The weekly cash prizes will be won by lucky customers randomly selected and notified through Letshego Radio shows,” he said.
Additionally, he said two lucky customers will be randomly selected each month and given a chance to spin the wheel of fortune with a chance to receive a maximum of M20 000 each.
“The loans consolidation campaign makes it easier for customers to choose Letshego Lesotho as their preferred financial services partner.”
He said this innovative campaign aims to help individuals streamline their debt payment while benefiting from reduced interest rates.
“Debt consolidation can help customers get a lower monthly payment, pay off their debt sooner, increase their credit score and simplify their life.”
Letshego Lesotho’s Head of Sales, Distribution and Marketing, Motebang Moeketsi, said managing multiple loans can often be overwhelming with varying interest loans due dates and terms.
“The campaign addresses this challenge by combining multiple loans into a single, easy to manage repayment plan,” Moeketsi said.
He added that this simplification not only eases the financial burden on borrowers but also potentially leads to significant savings over time.
Moreover the new consolidation campaign invites customers to take advantage of their best-in-class financial services provided through Letshego Lesotho branch network and digital platforms.
“Letshego Lesotho is committed to increasing financial inclusion through its efforts to serve underbanked communities, promoting financial literacy and delivering positive social impacts for its customers and communities.”
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