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
LEC to switch off households over debts
MASERU – The Lesotho Electricity Company (LEC) will from Tuesday next week begin switching off clients who owe it money.
The LEC issued a seven-day ultimatum to all customers who owe it on Tuesday last week. The deadline ends on Monday.
It is expected that the LEC will begin switching off households that have defaulted.
The state-owned power company, however, is not going to touch any government department or business entities that owe it on grounds that they are in payment negotiations.
The LEC move comes barely two weeks after it cut electricity supplies to the Water and Sewerage Company (WASCO) thus causing it to fail to pump water to communities countrywide for more than two days.
The LEC says it is owed close to M200 million by government departments, businesses and individuals.
The LEC spokesman, Tšepang Ledia, told thepost that the government and the businesses will not have their electricity cut because they are in negotiations.
“We are in negotiations with the government and businesses and hopefully they will pay,” Ledia said.
“We advise the ordinary people to pay their debts before the 20th of March 2023 or else we cut the services,” he said.
The LEC says it is running short of funds for its daily operations.
In December last year the company increased power tariffs by 7.9 percent on both energy and maximum demand charges across all customer categories for the Financial Year 2022/23.
Last week the LEC boss, Mohato Seleke, said postpaid consumers and sundry debtors owe the company M169.4 million.
He said unless the debtors pay he will be unable to buy electricity from ’Muela Hydropower Project, Eskom in South Africa and Mozambique’s EDM.
This, he said, could cause serious load shedding in the country and could be devastating for businesses.
Seleke said the LEC spends M630 million monthly to buy electricity.
“If postpaid consumers do not settle their debts this could prevent the LEC from being able to buy electricity which can lead the country to encounter load-shedding,” Seleke said.
Seleke said collecting debt from government department ministries was a challenge as there is an understanding that since LEC is a state-owned company, it will continue supplying government agencies with electricity and they will settle their bills when they have funds to do so.
Seleke said the LEC has lost M21 million to vandalism during this financial year.
Bumper payout for former mineworkers
MASERU – AT least 11 316 current as well as former mine workers are set for a bumper payout after Tshiamiso Trust began disbursing the first billion Maloti to workers who are suffering from silicosis and tuberculosis.
The payment comes two years after Tshiamiso Trust began processing claims for the historical M5 billion settlement agreement between mineworkers and six gold mines in South Africa.
Speaking at the payment announcement in Maseru last week, the Trust’s CEO, Lusanda Jiya, said it has been two years since they officially began accepting claims.
“Our people come to work every day with the mission of impacting lives for the better, and the first billion rand paid out to over 11 000 families is just the beginning,” Jiya said.
“We know that there is no compensation that will ever be enough to undo the suffering endured by mine workers and their families,” he said.
“However, we are committed to deliver our mandate and ensure that every family that is eligible for compensation receives it.”
Jiya said the Trust is limited both in terms of the time in which they can operate, and the extent to which they can assist those seeking compensation.
Broadly speaking, the eligibility criteria include among others that the mineworker must have worked at one of the qualifying gold mines between March 12, 1965 and December 10, 2019.
Secondly, living mineworkers must have permanent lung damage from silicosis or TB and deceased mine workers representatives must have evidence that proves that they (the deceased) died from TB or Silicosis.
Tshiamiso Trust has a lifespan of 12 years, ending in February 2031.
Over 111 000 claims have been received to date, through offices in South Africa, Lesotho, Botswana, eSwatini, and Mozambique.
The Trust is working with stakeholders in these countries and others to mobilise its efforts and expand operations.
The history of silicosis in South Africa goes back to the late 1880’s when the first gold mines began operations.
The gold was stored and locked in quartz, a special rock that contains large amounts of silica.
Crystallised silica particles can cause serious respiratory damage if inhaled.
In the earlier days of gold mining, dust control, health and safety standards and the use of PPE (personal protective equipment) were not as advanced as they are today.
Tshiamiso Trust was established in 2020 to give effect to the settlement agreement reached between six mining companies.
The companies are African Rainbow Minerals, Anglo American South Africa, AngloGold Ashanti, Harmony Gold, Sibanye Stillwater and Gold Fields.
The settlement agreement was reached and made after a ruling by the Johannesburg High Court as a result of a historic class action by former and current mineworkers against the six gold mines.
Justice for Miners is a coalition of interested parties in the mining sector launched at the Nelson Mandela Foundation in Johannesburg in 2020.
The Johannesburg High Court approved the setting up of the Tshiamiso Trust to facilitate payment by the companies to affected miners.
Farmers cry over cost of livestock feed
MASERU – Lehlohonolo Mokhethi is a farmer who has been running a successful poultry business, thanks to a small loan he got from a local bank.
He now has 300 chickens.
He says his vision is to rear 5 000 chickens by 2025 and employ 30 youths. But he is now grappling with a new challenge: the ever increasing cost of chicken feed.
That is threatening the viability of his business.
“The biggest challenge is that food prices increase every day, feeding is expensive,” Mokhethi said.
“It is quite difficult to make profit in business if each and every day food prices increase. Today I am buying a bag of food with a certain amount then the next day the price has increased,” he says.
“Our customers fail dismally to understand that food has increased and the Chinese are taking our market because they sell at a low price thus I run at a loss.”
Last week, a top attorney in Maseru who is also a prominent farmer, Tiisetso Sello-Mafatle, called a meeting for farmers to discuss these challenges.
She says the government must regulate the prices of livestock feed.
That is critical if the farming business is to succeed, she says.
Attorney Sello-Mafatle says farmers must come up with a structure for livestock feed prices which they would present to the government for gazetting.
“We should state our regulations and give them to the government to make everything easy for both parties because we cannot wait for the government to make regulations for us,” Sello-Mafatle says.
She adds that “farmers should be bullish about what they want and never have fear endorsing new things”.
“I will not be challenged or cry (because of) what life throws at me but I will cry when things are not happening the right way,” she says.
Mafatle says farmers need to know who they are and know the capabilities they have.
“This will help a farmer in becoming the best in any field they are in once they are confident about themselves,” she says.
Karabo Lijo, another participant, said they have to influence the cost of inputs in agriculture, especially livestock feed.
“We have to go back to cost-price analysis where as farmers we are able to derive the selling price and the break-even point in our production,” Lijo said.
“We can also derive the stable or constant mark-ups on our products,” he said.
“We need to do research to increase the ability to produce byproducts which are likely to have the longest shelve life,” he said.
The meeting urged farmers to diversify their products by introducing such things as mushroom farming. They said mushrooms can grow very well in Lesotho due to its favourable climate.
The farmers also demanded that there should be regulations on how land can be sold or borrowed in Lesotho.
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