Party Perishables Financial Ratios

Mr Prem Chugani is the owner of the business Party Perishables. After a meeting with the bank, he learns that his business is quite inefficient compared to similar businesses, and that to continue their rate of financing, Prem needs to increase his current ratio to 2.5. This report will go into detail about how ratio analysis can help to evaluate the efficiency of a business and what the ratios reveal about Party Perishables, why the bank may require a current ratio of 2.5, and also will include recommendations Mr Chugani should take to improve the profitability of Party Perishables.

There are many ways ratio analysis can help to evaluate the efficiency of a business; one of which is that it makes it much simpler to compare similar businesses

The current ratio shows the relationship between current assets and current liabilities and is a key indicator for the short run liquidity of the business. Liquidity is a measure of how quickly a business can convert its assets to cash to cover its expenses. This is an important characteristic of a successful business, as to remain solvent, a business must have cash to run its operations and pay their debts as they fall due. For example, Party Perishables current ratio for 2018 was 2.08, which means that Mr Chugani has $2.08 of current assets to cover every $1 of current liabilities/short term debts. Compared to the industry average of a current ratio of 3:1, Mr Chugani’s business is far more inefficient. The main reasons for the negative trend in Party Perishable’s current ratio from 2.61 in 2017 to 2.08 in 2018 is due to Mr Chugani opening a bank overdraft of $21,700, and secondly, in 2018 the current asset of Cash at Bank decreased from $56,000 to $0. A way Party Perishables can satisfy the banks demands and increase its current ratio to 2.5 is to either increase the value of their current assets, for example by increasing the amount of Cash at Bank they have, or to decrease their current liabilities, for example by paying off some of their accounts payable ($92,000 in 2018), which would also improve the cash flow for Mr

This is the average time it takes for the business to collect its accounts receivable from its credit customers. Party Perishables had a negative increasing trend from 16.8 days in 2017 to 28.08 days in 2018. The 2017 figure was reasonably close to the industry average of 16 days. A collection period of 28.08 days however, means that Party Perishables is not effective in converting accounts receivable into cash. If Mr Chugani can reduce the number of days in the collection period to a figure closer to the industry average of 16 days, Party Perishables’ cash flow will increase, meaning that the business may become relatively more