Impressions Adco Corporation Inc - Assignment Example

Impressions Adco Corporation Inc. INTRODUCTION Impressions Adco Corporation Inc. (IAC) is a global IT company with its headquarters in New York, USA. The company is involved in the designing, development, manufacturing and distribution of computer systems. The company uses its subsidiaries around the world to offer its services and this report analyses the performance of two subsidiaries of IAC; Essakane plc and Westwood plc using financial ratios. This report uses the financial statements of two subsidiaries; Essakane plc and Westwood plc and then analyses their financial statements using financial ratios. Financial ratios are used to analyse the performances of companies (Beaver, 1966) as well as compare one firm with the other (Lev, 1969). This report, therefore, uses the financial ratios to identify the performance levels of these two subsidiaries. The report also highlights and comments on business performances of these companies. The last section of the report analyses the argument presented by Elliot and Elliot (2011) that financial ratios are important tools for the management but these ratios ignore important factors. The arguments presented by other scholars, authors and books have been used to comment on the argument of Elliot and Elliot (2011). RATIO ANALYSIS Financial ratios of the two subsidiaries have been calculated. Financial ratios can be categorized into different categories and therefore, the report analyses financial ratios category wise. Profitability Ratios: PROFITABILITY RATIOS Essakane Plc Westwood Plc (Westwood/ Essakane) -1 Return on Capital Employed (%) 10.45% 17.96% 71.9% Net Profit Margin (%) 35.64% 43.85% 23.0% Gross Profit Margin (%) 45.28% 55.05% 21.6% Return on Equity (%) 9.63% 16.75% 74.0% Return on Assets (%) 8.61% 15.88% 84.5% The profitability ratios show that the Westwood has performed better in comparison to Essakane. Return on capital employed of Westwood is almost 72% more than Essakane and thus it shows that Westwood has used its capital in a better way to earn profits. So, Westwood has been able to make more profits from each unit of capital. The net profit margin of Essakane has been less than the net profit margin of Westwood. It is indicating that the ratio of cost and expenses of Essakane are more in comparison to the ratio of cost and expenses of Westwood. Moreover, Essakane is able to generate less net profits from the total revenue in comparison to Westwood. Thus, the net profit margin of Essakane is less. Gross profit margin of Westwood is more than that of Essakane. It is indicating that the cost of goods sold of Essakane is more than Westwood thus it has a lower ratio of gross profit margin. Return on equity of Westwood is almost 74% more than the ROE of Essakane. Thus it is indicating that Westwood is using the equity in a better way to generate more profits out of it. The return on equity of Westwood is 16.75% whereas the ROE of Essakane is only 9.63% thus indicating a major difference in ROE of the two subsidiaries. Return on assets of Essakane is 8.61% in comparison to the ROA of Westwood which is 15.88%. The ratio indicates that Essakane is not able to use its total assets and not generate sufficient and comparable profits than Westwood. Activity ratio Activity Ratios Essakane Plc Westwood Plc Change Total Asset Turnover (times) 0.241 0.362 50.0% Inventory Turnover Period (days) 71.55 149.45 108.9% Inventory Turnover Rate 5.10 2.44 -52.1% Accounts receivable collection (days) 109.42 206.14 88.4% Accounts payable payment (days) 96.19 114.13 18.6% Asset utilization ratio shows how the company is able to use its assets in order to generate revenue (Gitman, 2003). Total assets turnover ratio has been used and it shows that Westwood is able to use its total assets better to make revenues. Therefore, Westwood is better utilizing its assets than Essakane. Inventory turnover period and rate indicates the time taken by the company rate to convert its inventory into revenue (Gitman, 2003). High ratio of Essakane shows that it is able to better convert its inventory and produce more sales from the inventory it has. Accounts receivable collection indicates the time the taken by the company in order to receive its receivables (Bodie, Kane, and Marcus, 2004). Essakane has a less time of receivables than Westwood and it is able to receive its receivables in almost half of the time of Westwood thus it is in a better position. On the other hand, account payable payment days indicate the time company takes to pay off its liabilities (Brealey, 2007). Essakane has a payable time of 96 days in comparison to 114 days of Westwood. Liquidity ratios LIQUIDITY RATIOS Essakane Plc Westwood Plc Change Current ratio 2.29 5.22 128.1% Quick (or Acid-Test) ratio 2.03 3.94 93.6% Current ratio of Essakane is less than Westwood thus it is indicating that the ratio of current assets to current liabilities of Essakane is less than ratio of current assets and current liabilities of Westwood. So, liquidity position of Westwood is better. However, when compared in isolation then the current ratio of both the subsidiaries look good, though too much high current ratio indicates that the company has too many current assets which can be used somewhere else (Gitman, 2003). So Westwood can reduce its current assets and invest somewhere else Quick ratios of both look good however ratio of Westwood is almost twice as of Essakane. The difference between the quick and current ratios indicate that level of inventory, company has on hand and the difference of two ratios of Westwood is higher thus it has more inventory on hand than Essakane. So, Westwood can reduce its level of inventory to save some cash and to have more liquid assets or even invest somewhere to attain returns from it. Gearing Ratios Essakane Plc Westwood Plc Gearing 0.494% 0.00 Interest Cover 89.518 97.437 Gearing ratio indicates the ratio of non-current liabilities in the total capital employed (Brealey, 2007). Essakane has a long term liabilities of 0.49% whereas Westwood does not have any long term liability in its capital structure. Both the companies are not taking advantage of leverage. So if these companies include some debt in their capital structure then they could improve their profitability and profit margin though higher debt means higher risk (McLaney, 2009). Interest coverage ratio shows the ability of firm to payoff interest or finance cost (McLaney, 2009). Both subsidiaries are in a comfortable position to pay off their debtors. Investment ratios Essakane Plc Westwood Plc Change Earnings per share (EPS) 0.11 0.26 140.7% Price / Earnings ratio 53.03 29.73 -43.9% Dividend Cover 8.72 61.35 603.7% Earnings per share of Westwood is almost 1.4 times of Essakane. Thus shareholders of Westwood are earning more than Essakane. Price to earnings ratio indicates the PE of Essakane is higher than Westwood and thus, investors of Essakane are paying higher price for the earnings than Westwood. However, higher PE ratio also indicates that investors are predicting higher growth earnings of the shares. Higher dividend cover ratio of Westwood shows that the company pays higher ratio of dividend to its shareholders from the net profits it has generated. Alternatively, lower dividend cover ratio of Essakane shows fewer dividends paid to the shareholders from earnings. Westwood has paid six times more dividends to its shareholders than Essakane. ANALYZING THE LIMITATIONS OF FINANCIAL RATIOS Elliot and Elliot (2011) have presented an argument regarding the financial ratios that these ratios ignore important factors that shape up the organization. Although, Elliot and Elliot (2011) have agreed that these ratios are important in analyzing the performance of one company with other. There are several other scholars and researchers that have commented on the positives and negatives of the financial ratios and this part of the report discusses about some of these scholars and researchers in order to compare the argument presented by Elliot and Elliot (2011). Financial ratios are the most widely used tool that management and investors use in order to compare the performance of one company with the other company (Brealey, 2007). Also these are used to compare with the overall industry performances (Bodie, Kane, and Marcus, 2004). These ratios are also used to compare the current performance with the performance of previous years. Therefore, these ratios give an idea of how the company has performed this year with respect to previous years (DeVaney, 1994). Moreover, it also guides the management on which areas they need to work on and therefore these are useful (Brealey, 2007). There are limitations with these ratios and the major limitation is that it ignores important factors. For instance, the gross profit margin of a company declines from 2011 to 2012, so it may reveal that the cost of production has increased. However it may be because of more input used to produce the material or more labour hours. But it may be because of increase in the price of goods being used to produce the good. Therefore, these ratios give an idea but ignore important factors that shape up the organization. So comparing the past performances of the company with the current performances may not reveal well-defined results of what is required or what is happening. Also the real factors are not identified by ratios that lead to the changes in the figures (Gitman, 2003). The accounting policies and practices used by one firm may differ from the other thus comparing such firms may not give comparable results (Houston, Brigham, 2009). Moreover, companies have been using the concept of window dressing which is to improve their balance sheets at a time when they are preparing their financial statements (McLaney, 2009). Therefore such a technique would inflate and improve the overall position of the company (Ross, Westerfield, and Jordan, 2009) and thus making the financial statements not truly represent the financial worth of the company and as a result ratios used would not reveal good results (McLaney, 2009). Besides the limitations, financial ratios are still used to compare different firms and current performance with the previous years’ performances. List of references Beaver, W. H. (1966). ‘Financial ratios as predictors of failure’. Journal of accounting research, pp. 71-111. Besley, S., & Brigham, E. (2007). Essentials of Managerial Finance, 14 edn. USA, Thomson Higher Education.  Bodie, Z., Kane, A., and Marcus, A. (2004). Essentials of Investments, 5th ed. London, McGraw-Hill Irwin. Brealey, R. A. (2007). Principles of corporate finance. New Dehli, Tata McGraw-Hill Education. DeVaney, S. A. (1994). ‘The usefulness of financial ratios as predictors of household insolvency: Two perspectives’. Financial Counseling and Planning, vol. 5, pp. 5-24. Gitman, L. (2003). Principles of Managerial Finance. Boston, Addison-Wesley Publishing. Houston, F., Brigham, F. (2009). Fundamentals of Financial Management. Ohio, South-Western College Pub. Lev, B. (1969). ‘Industry averages as targets for financial ratios’. Journal of Accounting Research, pp. 290-299. McLaney, E. (2009). Business Finance: Theory and Practice. Pearson Education: New Jersey. Ross, S., Westerfield, R., and Jordan, B. (2009). Fundamentals Of Corporate Finance Standard Edition. New York, McGraw-Hill. pp. 19-21. Weygandt, J. J., Kieso, D. E., & Kell, W. G. (1996). Accounting Principles (4th ed.). New York, John Wiley & Sons. Read More