The Capital Structure of Broome Port Authority - Case Study Example

Executive Summary Broome Port Authority ration trend analysisindicates a positive trend meaning that the firm has adopted effective marketing strategies as well as employing the services of top notch and skilled personnel needed for optimising the current asset and shareholder’s resources. Consequently, the firm’s liquidity position indicates an unfavourable trend pattern, which means its ability to meet possible short term commitments and obligations has continued to fall below the expected standard and industry averages. The firm’s capital structure does not postulate a favourable trend pattern. Despite the fact that the firm is able to meet its interest expense payments, it has resorted to relying intensively on the debt funds as opposed to equity. The overreliance on debt funds is a risky affair since it exposes the company to possible loss of ownership and control to suppliers of funds. It also means that the firm cannot easily make decisions on which investments to focus on without having external interferences from these suppliers of credit funds. Introduction Ratio analysis provides relevant and potential stakeholders with reliable information pertaining to the immediate performance of a company for a certain period of time. It ensures that potential investors access relevant information from analysts in order to ensure that they make informed decisions on whether or not to invest. Broome Port Authority is an Australian listed company that provides deep-water port services in Western sections of the country. These operations are offered mostly to the Kimberly region of Western Australia where shipping services are offered at a 24 hour basis(Broome Port Authority, 2015). The focus of this paper is to examine the ratio analysis of Broome Port Authority over a five year period in order to ascertain the causes of its performance. The ratio analysis involves ascertaining the firm’s performance in regards to profitability, liquidity, efficiency and capital structure ratios. Operational Environment Analysis The company has continued to suffer overall decrease in the level of vessel visits in the port in the period between 2013/14 due to the subsequent completion of the Gorgon project logistics support emanating from Broome. Subsequently, the decrease in the visits, which also led to decreased cash receipts from customers and revenues, resulted from a distinctive decline in the demise of coastal trade services. Most importantly, the company’s positive profitability level can be associated with the current’s Wharf extension and optimal use. The increased profitability also resulted from subsequent increase in export trades especially livestock trades to Indonesia. Analysis i) Profitability Ratios The company’s return on shareholders’ equity has decreased over the five year period especially in the period between 2010 and 2011 where the ratio reduces significantly into the negative ratios as well as in 2013/2014 financial period. The decrease in the ratio within these periods is attributed to the subsequent decrease in the level of net income, which depicts a loss and an almost zero value respectively. Thus, the overall decrease in the ratio indicates that the firm has failed to ensure that itoptimizes its current level of net income with the current shareholders’ equity, which indicates unfavourable health of its operations. In fact, the shareholders’ equity is not being put into effective and efficient use, which might be attributed to inefficient and less-skilled personnel(Fisher, Heinkel and Zechner, 1989). The company’s return on assets ratio portrays a different perspective. The ratio deecreases in the period between 2010 and 2011 but later increases in the subsequent periods to at least 7.2% up from 5.2% in 2014 and 2011 respectively. The pattern postulates a favourable operational environment for the firm. It means that Broome Port Authority has ensured to optimize the level of its total assets base in order to affect substantial profits for each dollar of amounts spent on purchasing assets. The decrease in the ratio in 2011 is as a result of the company making a substantial loss within that period of about $210million. It can also be attributed to inefficiency of the management to use the assets due poor expertise or even due to the failure to replace worn out equipment within that period (Marshall, McManus, & Viele, 2008). The failure to replace worn out equipment needed for shipping might have been the direct cause of the loss due to poor productivity. The company’s profit margin ration portrays an increasing trend within the five year period. The margin increases from 11.7% to 14.8% in 2010 and 2014 respectively. However, there is a relative decrease in the period between 2011 and 2012 by -1.5%. Notwithstanding, the overall increase in the profit margin is a favourable phenomenon for the current and future operational environment. The increase is attributed to improved sales volume that increases from $13.173M to $20.184M in the period between 2011 and 2014 respectively. ii) Liquidity Ratio The company’s immediate current ratio decreases significantly within the five year financial period from 3 to 0 in 2010 and 2014 respectively. The decrease in the ratio is attributed to increased liabilities with a decreased asset base within that period. In fact, the significant decrease of the ratio is perceived in the financial years between 2013 and 2014 whereby the ratio decreases from 4 to 0 respectively. The decrease is attributed to reduced current assets. The current company’s position postulates that it is unfairly positioned to meet any of its short term obligations or rather the commitments. iii) Capital Structure Ratios The company’s cash flows from operations increases insignificantly from 0.1 to 0.2 in 2010 and 2014 respectively. The insignificant increase in the ratio is a result of the company’s loss of substantial levels of cash resource due to reduced cash receipts from customers as well as a falling government grants and subsidies. Thus, it means that the company’s finances capital structure is mostly funded by cash receipts from customers, which is a risky affair should the receipts reduce in the future(Benninga, and Oded, 1997). Broome Port Authority debt levels increases within the five year period from 38.4% to 43.8% in 2010 and 2014 respectively. The increase in the level of debt is unfavourable for the future operational environment of the company since it means that it will always strive to pay-off interests to suppliers of these loans as well as exposed to risks attributed to loss of control of operations. In essence, the firm’s immediate interest bearing borrowings increases significantly within these period indicating that the entity’s inability to access government grants and subsidies has resulted to it relying on external forms of financing(Graham, 2000). It is important to note that the decrease will likely cause a significant imbalance between equity and debt finance structure of the company. The entity’s total interest cover ratio increases within the five year period from a negative value to 3.1 in 2010 and 2014 respectively. The relative increase in the ratio is a favourable phenomenon since it postulates that the firm is fairly positioned to meet its interest burden. The strengthened ratio can be attributed to increased sales revenues within these periods. A standard ratio of 1.5 is always emphasised in order to ascertain that a firm will meet its interest burden on time. The company’s total debt cover reduces significantly within the five year financial period from 5.2 to 3.4. The decrease in the ratio does not however; falls below the recommended industry and standard average ratios, which means that Broome Port Authority is fairly positioned to secure future loans as it enjoys sufficient cash generation needed for paying-off possible future loans(Green and Hollifield, 1999). Overall Ratio Analysis From the discussion above, it can be ascertained that Broome Port Authority’s profitability ratio indicates a positive trend meaning that the firm has adopted effective marketing strategies as well as employing the services of top notch and skilled personnel needed for optimising the current asset and shareholder’s resources. Consequently, the firm’s liquidity position indicates an unfavourable trend pattern, which means its ability to meet possible short term commitments and obligations has continued to fall below the expected standard and industry averages. In consequent, the firm’s capital structure does not postulate a favourable trend pattern. Despite the fact that the firm is able to meet its interest expense payments, it has resorted to relying intensively on the debt funds as opposed to equity. The overreliance on debt funds is a risky affair since it exposes the company to possible loss of ownership and control to suppliers of funds(Kokemuller, 2012). It also means that the firm cannot easily make decisions on which investments to focus on without having external interferences from these suppliers of credit funds (Kokemuller, 2012). Conclusion To sum up the ratio analysis above, it can be ascertained that Broome Port Authority has continued to make efforts relating to improving its profitability position, which is attributed to optimization of underlying personnel and marketing strategies. However, the firm lags behind in terms of ensuring it meets it short term commitments due to unstable liquidity position. Furthermore, it has always relied on debt funds as a form of additional financing model, which poses risks related to losing control of operations in the future. References List Broome Port Authority. 2015. 2010-2013 Annual reports. Retrieved from http://www.broomeport.wa.gov.au/corporate-information Benninga, S, and Oded S, 1997, Corporate Finance: A Valuation Approach, McGraw-Hill, New York Fisher, E, Heinkel, R and Zechner, J. 1989, Dynamic capital structure choice: Theory and tests, Journal of Finance, 44, 19–40 Graham, R, J.2000. How big are the tax benefits of debt? The Journal of Finance, vol.LV, no.5: pp 1901-1942. Green, R and Hollifield, B. 1999, The personal tax advantages of equity, Working Paper, Carnegie Mellon University. Kokemuller, N. 2012.The advantages and disadvantages of debt and equity financing, Chron. Retrieved on May 21, 2014 from http://smallbusiness.chron.com/advantages-disadvantages-debt-equity-financing-55504.html Marshall, DH, McManus, WW& Viele, DF, 2008.Accounting: what the numbers mean, 8th Ed. McGraw-Hill/Irwin, New-York. Read More