Financial Analysis of Marvel Toys Company - Research Paper Example

? Financial Analysis of Marvel Toys Company Teacher Contents Executive Summary 2 Answer to part A 4 Financial Analysis 4 Answer to Part B 10 Conclusion 12 Bibliography 15 Executive Summary Ratio analysis is a very accurate and reliable tool when it comes to analyzing the financial outlook of an entity.1 The primary reason to conduct a ratio analysis is to quantify the results of the operations of a company and compare them with that of the prior year(s) in order to assess different aspects of the financial feasibility. The ratios can be divided into various categories, such as profitability, gearing and liquidity, each focusing on a different area of the financial outlook of the organization and highlighting the company’s performance. These analysis form an integral part of the financial statement analysis, especially from the investors point of view who always strive to invest in countries having strengthen and stabilizing financial ratios and representing an upward trend. It is of great significance that the ratios must be benchmarked against a standard in order for them to possess a meaning. Keeping that into account, the comparison is usually conducted between companies portraying same business and financial risks, between industries and different time periods of the same company. The company under consideration is Marvel Toys, and in this report the analysis of the financial performance of the company over the last seven years has been conducted in order to draw attention to various financial trends and significant changes over the period. The analysis is divided into three main categories: namely Profitability, Liquidity and Gearing. Profitability ratios identify how efficiently and effectively a company is utilizing its resources and how successful it has been in generating a desired rate of return for its shareholders and investors. Liquidity ratios measure the ability of the company to quickly convert its asset into liquid cash to settle its short term liabilities. Whereas, the Gearing ratios identifies the extent to which the company is financed through debt and to what degree the operations are being conducted from the finance raised through raising equity capital or otherwise2. Following ratios have been used in order to evaluate the financial outlook of the company: Current ratio Acid-test (quick) ratio Collection period Inventory turnover Debt to total asset ratio Times interest earned Return on assets Return on Equity Fixed Asset turnover Total Asset turnover Gross Profit margin Net Profit Margin The profitability ratios of the company appear to be stable, but the company is facing liquidity problem as apparent from the ratios. Also, the company has more than 50% of its assets financed through debt. But the company has great earning potential based on which it has been decided to sanction the long term loan facility to the company. Answer to part A Financial Analysis Profitability Ratios   2011 2010 2009   Profitability Ratios Gross profit margin 20.18% 19.23% 20.14% Net profit margin 6.88% 6.15% 7.50% ROE 11.68% 12.20% 35.71% ROA 4.50% 4.36% 7.03% Fixed Asset Turnover (times) 2.04 2.27 2.53 Total Asset Turnover (times) 1.27 1.35 1.57 Gross profit margin is an analyzing tool which assists in identifying how effectively and efficiently the company is utilizing its raw materials, variable cost related to labor and fixed costs, such as rent and depreciation of property plant and equipment3. The ratio is calculated by dividing the sales revenue by the gross profit. The gross profit margin of the company was quite stable in the financial year 2009, but moving forward in the financial year 2010, the ratio has seemed to decline a bit. The decline in the ratio was primarily due to the decrease in the net sales of the company by 9% which caused the gross profit margin to decrease by around 0.91%. But the ratio appeared to show an inclining trend again the financial year 2011 as the company was able to curtail and manage its cost of sales although the quantum of its sales revenue remained almost the same as the financial year 2010. Net profit margin, on the other hand, analyzes the profitability of the company before deducting the taxation and finance charges from the earnings. The ratio is calculated by dividing the profit before interest and tax with the sales revenue of the current financial period. The ratio highlights how well the company is managing its selling and administrative expenses it also highlights the other income generated by the company during the course of its operations. Following the similar trend as that of the gross profit margin, the net profit of the company also took a downward plunge in the financial year 2010 but was able to improve the ratio in the financial year 2011. In order to further improve these profit ratios, the company should manage its operational and administrative costs. A comparison of these ratios with the industry average shows that these ratios are significantly better than the industry average. Return on equity (ROE) is, according to the analyst, is considered to be the most significant ratio in order to evaluate a company’s performance from an investor’s point of view. ROCE measures a company’s ability to earn a return on all of the capital that is being employed by the company. The ratio is calculated as net income upon total capital employed, which is the sum of debt and equity financings. The company had quite high return on capital employed in the financial year 2009 which was around 35.71% during that particular financial year. However, the ratio took a massive downward plunge in the financial year 2010 and 2011 due to the fact that the net profit of the company decreased by 34% and 28% respectively as compared to the financial year 2009. Although the ratio is better than the industry average of 5.7%, the company needs to manage its cost and enhance its revenue generating ability in order to increase its ROE. The return on assets evaluates the ability of the assets of a company to generate returns. The ratio is calculated by dividing the net profit with the total figure of the assets as appearing in the statement of financial position of the company. The ratio has shown a declining trend in the past three years. The main reason behind such trend is that the asset of the company has been increasing steadily over the past three years, mainly on account of the acquisition of property, plant and equipment, whereas the profit of the company has not been increasing with the same rate. This particular fact has caused the decline in the ROA ratio over the past three years. The ratio is marginally higher than the industry average. The company should indentify such asset which are non-earning assets and dispose them off in order to enhance the ROA ratio. The fixed asset turnover and the total asset turnover are calculated by dividing the sales with the total value of fixed assets and total assets respectively. This ratio analysis shows how well the assets of company are working in order to generate revenue. Unfortunately, these ratios are also showing a declining trend over the last three years. This is mainly due to the fact that sales decreased from 2009 to 2010 and 2011. As at the end of the financial year 2011, the industry average for both these ratio is better than the company which should be serious concern for the management. The best possible remedy would be to identify the non-earning assets of the company and dispose them off and also to devise a strategy according to which the resources of the company should be utilized in the best possible manner. Liquidity and efficiency Ratios 2011 2010 2009 Liquidity     Current ratio 1.67 1.79 1.62 Acid test ratio 0.95 0.97 0.95 Debtors turnover/ Collection period 38.51 35.38 29.40 Inventory turnover 6.07 6.52 8.43 The liquidity ratio measures the company’s ability to pay its short term liabilities. The ratio illustrates how quickly a company can convert its assets into cash and cash equivalent in order to pay off its short term liabilities 4. The most commonly used liquidity ratio, the current ratio is calculated by comparing the current assets and current liabilities. The strengthened the current ratio is, the more ability the company has to pay its debts and short term obligations over the next 12 months. An overall analysis of the ratio would portray that in all the years the company had enough assets to pay off its obligations and debts. The acid test, which is also regarded as the quick ratio, is calculated by subtracting the inventory balance from the total current assert balance. Out of the current assets mentioned, inventories are regarded as the one which takes comparatively more time to be converted into cash or cash equivalent. The current ratio and the acid test ratio have shown stability over the past three years which shows that the company is managing liquidity quite well also because of the fact that the ratio close to 1. The acid test ratio and the current ratio of the company is less than the industry average, but the company can enhance its liquidity through maintaining more cash in hand balance. Collection represents how quickly the cash is received from the debtors. The ratio is calculated by dividing the debtor balance with the credit sales and then multiplying the resultant with the number of days in the financial year. The lower the value gets, the more efficient the management is, or it could also mean that the debts are more liquid. It must be noted that the collection period has been showing an inclining trend which can be interpreted as the fact that the company is not able to recover cash from its debtors in a timely manner. One reason behind such trend would be the fact that the company is allowing excessive relaxation to its customer in order to enhance their sales level. The ratio is however better than the industry average of 45 days. Inventory turnover represents how quickly a company’s inventory is sold, which can be calculated by dividing the sales revenue by the average inventory balance as at the year end. High inventory level is not beneficial for the company as it represents that the company’s investment is tied in inventory and currently it is not generating any income. A lower inventory turnover period represents that the sales are poor and there is excess inventory in the storage. Whereas a higher turnover period might represents that sales are comparatively higher. An inventory turnover period can also decreased due to the shift in the operation policy of the management, e.g. if the management decides to increase the level of ‘safety stock’, then the balance of closing inventory would be greater; thus, inventory turnover period would decrease although the sales would have increased during the period. The inventory turnover of the company has been decreasing over the past three years which is in line with the decreasing sales of the company. The company needs to evaluate the situation by making sure that its cash is not tied up in inventory for long and should devise strategies to sell them as soon as possible. Gearing Ratios 2011 2010 2009  Gearing Ratios   Debt : total asset ratio 0.61:0.39 0.64:0.36 0.67:0.33 Times interest earned 3.75 4.00 6.75 Debt to total asset ratio is useful in identifying the amount of debt in the capital structure of the company. In other words, it identifies how much of the company’s assets are financed by the debt. The company has been able to reduce the amount of debt in its capital structure, but still it is quite higher than the industry average of 40%. As a consequence, higher level of debt is likely to create higher finance charge in the income statement of the company thus reducing the profitability. The company needs to generate funds either internally or through the issue of fresh equity in the stock market 5. Another useful ratio in determining the effect of debt on the company’s operation is the interest coverage ratio or times interest earned ratio. The ratio determines how well the company is able to bear and pay the finance charges. In this scenario, a lower ratio would mean that the company is not able to pay off the charges; thus, it is burdened by it. The ratio is calculated by dividing the earnings before interest and tax by the total interest expense. This ratio is also not satisfactory as compared to the industry average of 6.6 times. The company needs to lower its debt level in order to improve this ratio. As a long term creditor, the most important ratios to consider are the profitability ratios. Before lending to any business, the creditors are likely to assess the profitability of the company and how the business is going to make money in the future. The profitability ratios of the Marvel Toys Company appear to be stable over the last three years, especially its gross profit margin and the net profit margin ratios which are quite better than the industry average. In addition, the return of equity and return on assets ratios also appear to be quite strengthened and showing an upward trend in the past few years. All in all, the earning capacity of the company appears to be in a fine state; from the past trend it can be forecasted that the same will be followed in the years to come. Answer to Part B Other aspects of an entity’s financial outlook that the creditors are mostly concerned about is its gearing. The gearing of Marvel Toys Company does not appear to be quite attractive for the long term creditors as most of its assets are financed through equity. This means that the majority of the company’s assets are financed through debt rather than through the internally generated funds or through the issue of equity. However, this could be due to the fact that the company is planning to expand its business to Oman and European Union countries; for the same purpose it has acquired debts from banks, financial institutions, and other long term creditors. As per the statement of the management of the company, the expansion plans are likely to generate revenue by the mid of the financial year of 2013; so it can be forecasted that the debt to asset ratio of the company will improve. The security offered by the Marvel Toys Company is their current land and building with the estimated current market value of around $50 million. The company proposes that in lieu of the security offered, the bank sanctions a long term loan facility to the company and also increases the overdraft limit to $7 million which would enable it to expand its export operations. The security offered by the company appears to be sufficient. However, in the loan agreement the company should include certain covenants: for example, the current ratio of the company should not decrease below 0.9, and the company should strive to lower down its debt to equity ratio by 40% at least. Conclusion The following is a comparison of the company’s financial ratios for the financial year 2011 with that of industry average: Marvel Toys 2011 Industry Average Current ratio 1.67 1.9 Acid-test (quick) ratio 0.95 1.1 Collection period 38.50917431 45 days Inventory turnover 6.07 8 times Debt to total asset ratio 61% 40% Times interest earned 3.75 times 6.6 times Return on assets 4.50% 3.20% Fixed Asset turnover 2.04 2.2 times Total Asset turnover 1.27 1.4 times Profit margin 6.88% 2.30% Return on Equity 11.68% 5.70% The current ratio of the company is currently less than the industry average which means that the company needs to allocate its resources prudently in order to have more liquid assets in the foreseeable future to pay off its liabilities which are likely to arise 12 months from the date of the balance sheet date. The acid test ratio of the company also suggests that the company is not doing well when it comes to managing the liquid assets of the company as the ratio is still lower than the industry of 1.1. Moving on to the collection period which represents that how well and quickly the company is working on the collection of its receivable balances. The company should monitor its receivable collecting process as it is showing an inclining trend in the past few years. Although the trend is lower than the industry average but the company has to give prompt attention towards this particular ratio otherwise it will rise above the industry average in the coming future. Another problem which the company might face is the amount of debt in its capital structure. The debt is around 60% which is creating burden on the profit and loss account of the company through additional interest charges 6. The company needs to curtail its debt exposure. On the other hand, the profitability of the company seems to be doing above the industry average, which is a good sign. All the ratios such as net profit margin, return on assets and return on equity are doing beyond the industry average. This shows that the company’s expansion plans are likely to bring positive results to the financial outlook of the company. If the profitability trend continues to be the same in the coming future, the company will do great and its share prices will show an inclining trend in the coming future. Based on the above financial analysis, it appears that although the company is currently facing certain liquidity problems, it is likely that the company will be able to further enhance its profitability and liquidity, based on stable financial history. Most of the financial ratios of the company are better than the industry average, and it is most likely that if the loan is sanctioned to the company, not only it will enhance its earning potential, but also the company will be able to pay off the principal and the interest within the predetermined term. Hence, the loan should be sanctioned to the Marvel Toys Company. Security Template In million $ New Loan 10.2 Overdraft 7 Total Loan 17.2 Assets Book Value Market Value % Security Value Existing Premises 41,000,000 50,000,000 60.0% 30,000,000 New Outlet 10,000,000 10,000,000 70.0% 7,000,000 Office Equipment 13,500,000 -     Motor Vehicles - -     Furniture and Fixtures - -     Inventory (Stock) 8,300,000 -     Debtors 6,900,000 -                     Total Value 37,000,000 Total Potential Borrowing 17,200,000 Total Security Value 37,000,000 The security covers the total potential borrowing Bibliography Investopedia.com (2012). Financial Ratio Tutorial. Investopedia US. Retrieved from: http://www.investopedia.com/university/ratios/ Investopedia.com (2011). Understanding Financial Liquidity. Investopedia US. Retrieved from http://www.investopedia.com/articles/basics/07/liquidity.asp Investopedia.com (2012). Equity Financing Definition. Investopedia US. Retrieved from http://www.investopedia.com/terms/e/equityfinancing.asp Peavler, R. (2012). Profitability Ratio Analysis. Retrieved from http://bizfinance.about.com/od/financialratios/a/Profitability_Ratios.htm Peavler, R. (n.d.). Debt and Equity Financing - Advantages and Disadvantages. Retrieved from http://bizfinance.about.com/od/generalinformatio1/a/debtequityfin.htm Qfinance.com (2010). Gearing Ratios - Definition of Gearing Ratios. Retrieved from http://www.qfinance.com/dictionary/gearing-ratios Read More