Understanding Financial Ratios

This month we study a case example of how the ratios presented in Cooperative Grocer can be used to analyze a co-op's financial position and direction. We are grateful that Ocean Beach People's Food Co-op in San Diego has forwarded their ratio history for use in this project. You'll find their ratio results on the facing page.

As noted in the previous column, ratio analysis is both craft and art. The craft is assembling the information, as our San Diego friends did. The art part is spotting trends and relationships. In our look at Ocean Beach People's Food Co-op, we have highlighted (*) major variances and strong correlations.

Step one is to look at each ratio and notice which are getting stronger over time, which weaker, and which are relatively stable. This historical analysis provides context for what has been happening. It is not, however, a predictor of the future, since management can take actions to change course, and factors outside the co-op also have an impact. At Ocean Beach we find:

Stronger ratios:

Sales per Sq. Ft.
Sales per Paid Labor Hour*
Sales to Fixed Assets*
Return on Equity
Return on Assets
Gross Margin

Stable ratios:

Inventory Turnover
Debt to Equity

Weaker ratios:

Sales Trend*
Sales to Total Assets*
Current Ratio
Discount % of Sales
Labor % of Sales

Step two: examine how the co-op's ratios compare with its peers from the Cooperative Grocer survey. Here, primary attention is paid to ratios that are outside the upper and lower quartiles, and the focus is on the most recent results. Major variances s at Ocean Beach:

Above Upper Quartile:

Sales per Sq. Ft.*
Inventory Turnover
Current Ratio*
Debt to Equity

Below Lower Quartile:

Sales Trend*
Sales to Total Assets
Return on Equity

Next, relationships among the ratios are sought. Since each ratio is derived by dividing one financial component by another, the analyst examines ratios containing similar elements and looks for (in)consistencies in how they compare with other trends and variances.

Sales is a common element in nine ratios. At Ocean Beach, however, five of those are stronger while four are weaker over time. Sales ratios are also present on both sides of the variance line. The inconsistency here suggests that sales is not at the root oftheir strengths or weaknesses. Sales per Sq. Ft. is strong historically and compared to peers, and Inventory Turnover is high, so we can safely conclude that they are pushing a lot of product through their space. On the other side, we find that their Sales Trend is down, so perhaps they have peaked on what their present space can support.

The co-op owns its building, so its Sales to Net Fixed Assets ratio is actually stronger than it appears. Simultaneously, its Sales to Net Fixed Assets ratio is very weak. This suggests a significant variance from norm in the composition of its assets, and this is borne out by the exceptionally strong Current Ratio. Ocean Beach has a lot of cash.

The co-op's income statement ratios place it in the co-op mainstream, but its Return Ratios are weak, pulled down by the large amount of (relatively) nonproductive cash. It seems clear that the co-op has reached a strategic juncture that is has been planning for. They have a profitable operation that is at or near its sales capacity. With nearly $1 million in cash and little debt (Debt to Equity), the co-op is well positioned to expand if its market analysis suggests that there are additional sales dollars it can capture. If it persists in the status quo, it's likely that growth will continue to stagnate while upward pressure on the costs ofdoing business will erode its operating margins and result in even worse rates of return on assets and on the members' investment.

That's how it is done. Lay out the figures, compute the ratios, provide the appropriate industry context, and look for (in)consistencies and patterns among the ratios. Expertise grows with practice, but even a novice will gain a lot of insight simply by compiling this information in one place. Please, take us up on our offer to provide the spreadsheet template for this analysis and get busy deriving a clearer picture of your store's financial outlook.

YR-3YR-4YR-1YTDLg. Profitable Store (CG 7/1997)
7.40%4.80%9.00%-0.20%UQ 12.00%
MED 8.50%
25.226.428.7828.54UQ 21.18%
MED 13.45%
34.9933.6237.8652.79UQ 65.55%
MED 52.96%
LQ42.55% 6.93%
MED 5.36%
8.028.5512.5413.2UQ 19.59%
MED 9.50%
14.9314.3614.316.14UQ 15.91%
MED 13.73%
14.9314.3614.316.14UQ 2.40%
MED 1.69%
3.556.995.795.56UQ 0.47%
MED 0.75%
0.560.310.310.28UQ 30.80%
MED 15.80%
3.10%7.40%16.00%9.70%UQ 14.00%
MED 8.50%
2.00%5.60%12.30%7.60%UQ 14.00%
MED 8.50%
32.20%33.00%34.80%33.90%UQ 36.60%
MED 34.60%


See other articles from this issue: #074 January - February - 1998