Financial Statement Analysis - Report Example

Financial ment Analysis Table of Contents Introduction 3 Corporate Failure Models for Inditex SA and Gap Inc 3 Evaluation of Share Price Movements for Inditex SA and Gap Inc 6 The impact of Credit Crunch on Inditex SA and Gap Inc 9 Corporate Governance Issues of Inditex SA and Gap Inc 10 Recommendation and Conclusion 11 References 13 Introduction This study encompassed a relative examination of two major fashion retail companies across the world, the Inditex SA and Gap Inc. For a broad evaluation of the two companies, the study initially focuses on the Altman’s Z score of Inditex SA and Gap Inc on the basis of their latest reported financial figures so as to judge their position in context of susceptibility to corporate failure. Consequent to this, the share price movements of Inditex SA and Gap Inc over the past one year are analysed, following which the impact of credit crunch on both the retail firms are discussed. It also confers on their corporate governance issues in detail. Finally, the paper offers recommendations for both Inditex SA and Gap Inc with the purpose of improving their financial as well as operational situation in the upcoming years. Corporate Failure Models for Inditex SA and Gap Inc The findings from the previously conducted financial statement analysis of Inditex SA and Gap Inc suggest that both the companies are financially stable and fit. However, though the present financial position of both the retail companies is stable in comparison to the overall retail industry, it is imperative to assess the susceptibility of these companies to corporate failure or bankruptcy. This can be accomplished by computing the Altman’s Z-score of Inditex and Gap. This is because the Z-scores of the business organizations enable one to forecast the extent of financial distress encountered by the business. It also assists in assessing whether a particular organization is vulnerable to bankruptcy in the upcoming years. The Z-score model formulated by Edward Altman in the year 1968 comprises if five different ratios, such as Working Capital/Total Assets (Ratio 1), Retained Earnings/Total Assets (Ratio 2), EBIT/ Total Assets (Ratio 3), Market Value of Equity/Total Liabilities (Ratio 4) and Net Sales/Total Assets (Ratio 5). It can be expressed as follows: Z= 1.2*(Ratio 1) + 1.4*(Ratio 2) + 3.3*(Ratio 3) + 0.6*(Ratio 4) + 1.0*(Ratio 5). (Rachlin, 1997). In the above equation, Working Capital/Total Assets ratio determines the net value of liquid assets of the organization in relation to its total assets, while the Retained Earnings/Total Assets gauges the profitability of the organization over time. The EBIT/ Total Assets ratio is the most vital constituent of the equation as it determines the earning capacity of the company. The Market Value of Equity/Total Liabilities ratio determines the organization’s potential to endure a decline in its asset value, where as Net Sales/Total Assets ratio identifies the sales generating competence of the organization’s assets (Rachlin, 1997). The Z-score of Inditex SA and Gap Inc have been computed as follows: Financial Year 2011 Inditex SA (in millions Euro) Gap Inc (in millions US$) Current Assets 5202.51 3926 Total assets 9826.08 7065 Net Sales 12526 14664 Interest 3.56 0 Total Liabilities 3402.91 2985 Current Liabilities 2674.91 2095 Market Value of Equity 42105.97 14212.29 Earnings before Taxes 2321.59 1982 Retained earnings 6272.3 1086 (Source: Gap Inc., 2011; Bloomberg (a), 2012; Bloomberg (b), 2012) Z-Score of Inditex SA Z= 1.2*(0.257) + 1.4*(0.638) + 3.3*(0.237) + 0.6*(12.374) + 1.0*(1.275) = 10.682. The elevated value of Z-score for Inditex is mainly due to the high value of Market Value of Equity to Total Liabilities ratio of the company. The company has much less liabilities in comparison to its large market capitalization value. Z-Score of Gap Inc Z= 1.2*(0.259) + 1.4*(0.154) + 3.3*(0.281) + 0.6*(4.761) + 1.0*(2.076) = 6.387. The decent z-score for Gap Inc is mainly due to the high value of Market Value of Equity to Total Liabilities and the Net Sales/Total Assets ratios of the company. This indicates that Gap Inc has much less liabilities in comparison to its large market capitalization value and it also utilizes its assets optimally to generate maximum revenues from them. As per the Altman’s z-score model, an organization whose Z scores is less than 1.8 is highly susceptible to financial failure and bankruptcy. Furthermore, an organization whose Z score is greater than 1.8 but less than 3 has a possibility of encountering bankruptcy in the near future. While, on the contrary, an organization having a Z score of more than 3 is not likely to encounter any sort of bankruptcy or financial failure in the coming years (Rachlin, 1997). The Z-scores of Inditex SA and Gap Inc. as computed from the above mentioned z-score formula, was derived as 10.682 and 6.387 respectively. Hence, it can be inferred that both Inditex as well as Gap hold fortified accounting statements and it is unlikely that both of them would face any sort of corporate failure in the near future, unless there is any instance of fraud or mismanagement or severe economic downturn. Evaluation of Share Price Movements for Inditex SA and Gap Inc The following graph illustrates the share price movements of Gap Inc. over the last one year (May 2011 to April 2012). It can be observed from the above graph that share price of Gap Inc had considerably risen during the past one year. The shares of the company were trading at $22.96 on May 2, 2011, whereas on May 1, 2012, the shares of Gap Inc were quoted at $28.53, which is an increase of approximately around 24.26% (Yahoo Finance (a), 2012). Figure 1: Share Price movements of Gap Inc. (Source: Yahoo Finance (a), 2012) During the identical time frame, the stocks of Inditex also underwent similar raise in their share prices. The following graph depicts the share price movements of Inditex over the past ten months (May 2011 to March 2012). The graph reveals that the stock prices of Inditex followed an upward trend from 60.21 Euro on May 2, 2011 to 70.20 Euro as on March 21, 2012. This rise in the share prices was equivalent to approximately around 19.91% (Yahoo Finance (b), 2012). Hence, it can be inferred from the above two figures that though the stocks of both the retail companies illustrated an upward trend, Gap Inc. accomplished the larger growth in terms of share value. Figure 1: Share Price movements of Inditex (Source: Yahoo Finance (b), 2012) The impact of Credit Crunch on Inditex SA and Gap Inc The customer environment in the large sized export markets, for instance the United States of America and Europe is extremely vague. General public have been impacted by the declining housing market as well as the elevated level of unemployment in the United States. The Stock-market has also become unstable partially owing to the latest demotion of the American debt by Standard & Poor. Additionally in the European region, the population have been engulfed by the sovereign debt catastrophe. As a result, presently the population across the world have become exceedingly price-sensitive. Furthermore, China, which is the principal producer as well as buyer of cotton across the globe, is encountering growth retardation. A rapid deceleration in the economic condition of China could diminish its demand for fashion retail products exported from companies like Inditex (Europe) and Gap (US). Such a scenario could also reduce the desire of 1.3 billion Chinese populaces for fashion products manufactured in the United States and Spain. This, as a result would hamper the economies of the US and Europe. Nevertheless, it is generally anticipated that there would be widespread improvements in the GDP growth rates across nations during the year 2012 against that of 2011. Conclusively, it can be inferred that the textile as well as the apparel sector is presently encountering a very unsteady world economy consequent to the rigorous downturn and financial calamity during the recent years. Conversely, this may correspond to a growth prospect for fashion brands like Inditex that have comparatively accessible prices (Pehlivan, 2011). Inditex has spread its business operations across 70 nations, consequent to which it generates about 60% of its revenue from its operations excluding Spain. Hence, it would assist Inditex to deal with the economic depression scenario at home by compensating for its domestic losses by its superior performance in the markets of Russia, Asia and the Eastern Europe. In this respect, Inditex is in a superior position then Gap Inc, since Gap relies mostly on the US market for its revenues. Additionally, Gap Inc does not possess a broad range of varied concepts and had been till recently relying on its Gap brand for its overseas operations. Inditex, on the other hand has many other store concepts other then Zara, giving it an edge over Gap during times of credit crunch. Hence, while Gap would have to make efforts to enhance its profit margins by accentuating on expenditure reductions, Inditex can improve its relative position banking on its widespread business operations (Data Monitor, 2008). Corporate Governance Issues of Inditex SA and Gap Inc The shareholding pattern of Inditex SA is such that 3.86% of its shares are held by individuals, 36.85% by institutional investors, while Partler S.L. and Gartler S.L hold 9.28% and 50.01% respectively. It should be noted that Amancio Ortega Gaona, the owner of Inditex, indirectly holds around 60% of its shares by means of Partler S.L. and Gartler S.L. as a result, Mr. Gaona holds the major percentage of the company’s voting rights, resulting in a situation of potential interest clash between the principle and the agent. Thus, the company is exposed to risks related to conflict of interest with respect to the minority shareholders (Pehlivan, 2011). While on the other hand, the board of Gap Inc comprises of the Chief Executive Officer and a Chairman. The board is accountable for supervision of the business operations as well as integrity of the organization, resolution of the organization’s mission, long-term policies and goals, and management of the organizational risks while appraising and directing execution of organizational controls and procedures. The members of the board are selected keeping in mince the best interests of the organization and its stakeholders. The company also makes sure that its board of directors comprises of a right mix of independent directors along with executive directors. This ensures that all the directors perform their responsibilities with integrity and abide by the Code of Ethics implemented by Gap Inc (Gap Inc (a), 2011). Recommendation and Conclusion The focus of corporate governance is related with the jobs and responsibilities of an organization’s Board of Directors in managing their business and their relationships with the organization’s shareholders in addition to other stakeholders. The conformity to the approved practices of corporate governance has always been a topic of debate in the corporate background. The observance to corporate governance norms assists a corporate organization to downsize its risks in addition to optimising its business performance at the same time (Samontaray, 2010). The current competitive business scenario calls for a strict regulatory setting, and hence conformity to corporate governance norms assists business houses to keep going in the long-term. Typically, in any organization the board of directors hold maximum powers in context of dealings and other issues of the business. However, though the directors are supposed to perform these responsibilities on behalf of the shareholders, they might not always bear the interests of the shareholders in their mind while performing their functions. This would be particularly true for Inditex SA, where the owner holds the major percentage of shares indirectly. In such cases, it would be advisable to appoint a certain percentage of independent or non-executive directors in the board of the company. Essentially, the role of a non-executive director is to offer a resourceful contribution to the company by presenting objective criticism to the board. The non-executive directors seek to bring in independent opinion on matters associated with strategy, resources and performance of the organization. Thus, the inclusion of independent directors in the board ensures that the rights and interests of the minority shareholders are taken care of. Finally, the assessment of Inditex and Gap in context of corporate governance, share price movements and corporate failure model reveals that both the retail firms are performing well and their strong financial position ensures that they are not vulnerable to any financial distress such as bankruptcy. Furthermore, it was observed that Inditex had expanded its operations across the globe and has positioned itself in a better position in comparison to Gap to encounter potential scenarios of credit crunch. References Bloomberg (a), 2012. Inditex SA. [Online] Available at: http://www.bloomberg.com/quote/ITX:SM/income-statement [Accessed on May 2, 2012]. Bloomberg (b), 2012. Gap Inc. [Online] Available at: http://www.bloomberg.com/quote/GPS:US/income-statement [Accessed on May 2, 2012]. Data Monitor, 2008. Inditex: never mind the Gap, Inditex is number one. [Online] Available at: http://www.datamonitor.com/store/News/inditex_never_mind_the_gap_inditex_is_number_one?productid=71D30F79-ACEB-4BD5-A69A-1E1A1E53E733 [Accessed on May 2, 2012]. Gap Inc., 2011. 2011 Annual Report. [Pdf] Available at: http://www.gapinc.com/content/attachments/gapinc/GapInc_AR_11.pdf [Accessed on May 2, 2012]. Gap Inc.(a), 2011. Corporate Governance Guidelines. [Pdf] Available at: http://www.gapinc.com/content/dam/gapincsite/documents/Corp_Gov_guide.pdf [Accessed on May 2, 2012]. Pehlivan, C. N., 2011. Financial Analysis and Valuation of INDITEX. [Online] Available at: http://www.grin.com/en/e-book/179701/financial-analysis-and-valuation-of-inditex [Accessed on May 2, 2012]. Rachlin, R., 1997. Return on Investment Manual: Tools and Applications for Managing Financial Results. M. E. Sharpe. Samontaray, D. P., 2010. Impact of Corporate Governance on the Stock Prices of the Nifty 50 Broad Index Listed Companies. International Research Journal of Finance and Economics, Issue 41. Yahoo Finance (a), 2012. Industria De Diseno Textil SA (ITX.MC). [Online] Available at: http://in.finance.yahoo.com/q/bc?s=GPS [Accessed on May 2, 2012]. Yahoo Finance (b), 2012. Gap Inc. (GPS). [Online] Available at: http://finance.yahoo.com/q/bc?s=ITX.MC+Basic+Chart [Accessed on May 2, 2012]. Read More