Analysis of Financial Statements of Bogus Limited For the Year-ended 30 June 2004-2005 - Essay Example

SECTION A Part Overview of the Annual Report Answer Page No. Part 2 - Contents of the Annual Report Page No. s to the Financial Statements 33-39 Changes in accounting policies 33 Top 20 Shareholders listing 59 Adoption of the International Financial Reporting standards (IFRS) 34 Directors' remuneration 43 Auditor's report 58 Segment Reporting 37-39 Discussion of 'Corporate Social Responsibility Committee' 25 Part 3 - Financial Information (Use 2005 figures only) Answer Page No. What is Total Gross Profit $8,898.4 million 30 How much is Borrowing Costs 74.0 million 30 How much is Net Profit 624.5 million 30 How much is Total current assets 4,294.4 million 31 How much is Total Equity 3,730.0 million 31 How much is Net Cash Flow from Operating Activities 1,157.1 million 32 How much is Receipts from Customers as shown in the Cash Flow Statement 39,251.4 million 32 How much is Retained Profits 1,160.7 million 31 What item in the balance sheet is the exact same amount as 'Cash at the end of the Year' in the Cash Flow Statement "Cash" 31 How much is Intangibles 610.9 million 31 SECTION B Analysis of Financial Statements of Bogus Limited For the Year-ended 30 June 2004-2005 NAME SUBJECT Executive Summary The two-year financial results posted by Bogus Limited are analysed. The company's financial performance, efficiency and stability are evaluated through the use of relevant ratios. Findings show that the company's financial performance improved as exhibited by steadily increasing sales, profit margins and bottom line earnings. The firm's inventory turnover also shows net improvements in its efficiency. In terms of stability, although there is marked recovery in the leverage and liquidity ratios, Bogus Limited's debt ratios imply that the firm is still highly leveraged and may possibly encounter liquidity problems in the future as a result of its financial positioning. Given these outcomes, a potential shareholder is recommended to invest in the company and take advantage of the firm's bright earnings prospect. In light of the firm's highly-leveraged position, a potential creditor is recommended to prudently extend credit line to Bogus Limited. Table of Contents Executive Summary 4 Introduction 4 Body of Report 6 Performance 6 Efficiency 7 Stability 8 Per-share Performance 9 Limitations 9 Recommendation 10 Appendix-Ratio Calculation 11 Works Cited 13 Introduction Prior to arriving at an investment decision, potential shareholders and creditors must initially analyse the financial position and health of a particular company. This report provides an overview of the financial standing of Bogus Limited as at year-end 30 June 2005. It intends to aid a potential shareholder in assessing the feasibility of investing in the company's stocks by reviewing the overall and per-share performance of the firm in the past two years. Moreover, this report aims to assist a potential creditor in evaluating the company's financial health by looking at the efficiency and stability of Bogus Limited as indicated by the liquidity, leverage and turnover ratios posted in the given period. Body of the Report Performance Based on the income statement of Bogus Limited for year-end 2005 and 2004, the firm's sales increased by 26% or $554.4 million, from $2,124.1 million to $2,678.5 million. This signals that the company has sustained its earnings growth from operations in the last two years. This assertion on the firm's profitability is supported by the net profit margin posted that rose to 13% as at year-end 30 June 2005 from 11% in the previous year. Although the company's cost of goods sold substantially increased resulting in lower gross profit margin, Bogus Limited is able to control other expenses, thus, showing an improvement in company's performance as evidenced by the escalation in the return on assets and return on equity generated. The firm's return on assets, which reveals the profitability of the firm relative to its capital structure (Brealey, Myers & Marcus 2004), increased to 7% from 5%. Similarly, return on equity, which is deemed as the ultimate measure of accomplishment of desired performance (Horngren, Sundem & Elliot 2001), grew to 10% from 8%. These figures send positive signals to a potential investor since the ratios indicate that there is a great likelihood that steady growth in the rate of return on investment in Bogus Limited may be reaped. Efficiency How efficiently Bogus Limited is utilising its assets is denoted by the firm's turnover ratios, which include the accounts payable turnover, inventory turnover and accounts receivable turnover (Brealey, Myers & Marcus 2004). Given the company's accounts payable turnover, which increased to 1.13 as at year-end 30 June 2005 from 0.98 in the same period last year, it took a shorter time for the firm to pay its suppliers. This generally indicates an improvement in the firm's efficiency in terms of settling its accounts with suppliers. It should also be highlighted that this ratio is indicative of the firm's short-term liquidity (Investopedia.com). In this regard, this shows that in 2005 Bogus Limited has enhanced its ability to service short term debt to suppliers at a shorter time frame. This information is vital for a potential creditor in examining not only the efficiency but also the debt-paying ability of the firm. In the same way, the firm's inventory turnover jumped to 1.52 for the current period from 1.10 in the previous year. An increase in inventory turnover is deemed to by a sign of efficiency and stronger sales generated by the company. However, it may also be attributed to ineffective procurement system (Brealey, Myers & Marcus 2004). In the case of Bogus Limited, the increase in inventory turnover may be a result of an uptick in sales rather than inefficiency in buying function. It can be seen in the company's balance sheet that inventory is maintained at almost the same level in 2004 and 2005, although sales and cost of goods sold substantially increased. On the other hand, the company's accounts receivable turnover declined to 2.13 from 2.47 in the preceding period. This trend may have negative signaling effect particularly to a potential creditor. This ratio assesses the firm's ability to control accounts receivable (Horngren, Sundem & Elliot 2001). With this, a decreasing trend indicates a lower level of efficiency in the collection function of the company. Stability The stability of Bogus Limited is evaluated based on the leverage and liquidity ratios derived from the firm's financial statements. Note that it is critical for both the potential shareholder and creditor to know the firm's financial leverage. Debt, which primarily creates leveraging for a firm, affect shareholders since it places their returns on investment in the company at risk such that the firm's earnings are tied to making a series of fixed payments to meet long-term obligation. Similarly, creditors are concerned with the firm's leveraging as this indicates how much the company is already in debt and how much of its earnings are already restricted to service long-term debt. (Brealey, Myers & Marcus 2004) Given the debt ratios including debt-to-assets ratio and debt-to-equity ratio, the firm posted marginal improvements as its two-year financial results yield lower leverage ratios. This condition bodes well for both shareholders and creditors as the company decreases its reliance on debt financing. This may also mean that the rate of return on equity has become less risky. However, the heavy utilisation of debt to fund the firm's operations and investment activities remains notable. Other indicators of financial leverage are the times interest earned ratio and cash interest coverage. The former shows the extent to which interest is covered by earnings while the latter narrows down the coverage of interest by the cash flow (Horngren, Sundem & Elliot 2001). Due to the absence of depreciation, interest earned ratio and cash interest coverage yield the same result. These ratios slipped to 4.72 from 8.80 in the previous period. The reduction is mainly due to the escalation in interest expense of about 176%. Despite the decline, the company remains in good financial health since it has generated earnings far in excess of interest payments (Investopedia.com). In terms of liquidity, which is one of the primary considerations for potential creditors, Bogus Limited remains solvent as the firm's current ratio of 1.21 and 1.48 in the last two periods. This means that the company has more than enough current assets to back up current liabilities (Brealey, Myers & Marcus 2004). However, potential creditors should be on the lookout with regard to the company's liquidity given the declining trend of the current ratio and cash flow ratio, which remain at low levels of 0.22 in 2005 from 0.38 in 2004. Per-share Performance In view of the increase in the company's earnings per share, which grew from 0.12 to 0.18 annually, potential shareholders may derive benefits from investing in the firm. This is because Bogus Limited's earnings per share trend indicates that the bottom line earnings available to shareholders are steadily growing. Apart from this, this ratio is an important factor in determining market price of the firm's shares. As such, an increase in the earnings per share may somehow entail an increase in the share price of the firm. The dividend per share of Bogus Limited increased by 10% to 0.10 from 0.09 in 2004. Regularly paying out dividends signals profitable company operations. Furthermore, declaring dividends provides additional returns for shareholders. In this regard, dividend declaration sends positive signal to the market particularly potential shareholders. Limitations One of the limitations identified in the above analysis is the unavailability of data set pertaining to competitors on industry benchmarks. In evaluating the company using relevant ratios, it is imperative for potential shareholders and creditors to know more about industry competition so as to allow comparison of how the targeted firm fared relative to other companies engaged in jewelry wholesaling. Provision of such data may substantially affect the recommendation. Moreover, a time-series comparison of the company's financial ratios is limited to the financial results in the last two years. Normally, analysts utilise five-year financial averages in examining the ratios. Aside from this, other relevant non-financial information with regard to company's operations is not given. As in the annual reports published, the discussion of the firm's operations, governance and adoption of accounting policies, among others, are also critical in arriving at an appropriate recommendation for potential investors and shareholders alike. Recommendation In view of the above discussion, a potential shareholder is recommended to invest in Bogus Limited's stocks. Given the company's performance in the last two years, a potential shareholder may take advantage of increasing returns to be derived from investing in the company. Similarly, a potential creditor may opt to open loan facility to the company. However, they should do so prudently. Although debt and liquidity ratios exhibited marginal improvements, creditors should note that the company is already highly leveraged. With this, there is a high probability that it may encounter financial problems in the future if it defaults in principal and interest payments as they come due. APPENDIX Bogus Ltd - Ratio Calculation (in millions) Formula Name Formula Calculation & Result 2005 Calculation & Result 2004 Gross Profit Margin Gross Profit 1,219.70 = 0.46 (46%) 1,072.80 = 0.51 (51%) Revenue 2,678.50 2,124.10 Net Profit Margin Net Profit 351.60 = 0.13 (13%) 232.30 = 0.11 (11%) Revenue 2,678.50 2,124.40 Return on Assets Income before Interest Expense 598.10 = 0.07 (7%) 404.10 = 0.05 (5%) Average Total Assets 9,132.70 8,458.40 Return on Equity Net Profit 351.60 = 0.10 (10%) 232.30 = 0.08 (8%) Average Shareholders' Equity 3,442.90 3,034.70 Accounts Payable Turnover Total Supplier Purchases 1,458.80 = 1.13 1,051.30 = 0.98 Average Accounts Payable 1,296.30 1,067.90 Inventory Turnover Cost of Goods Sold 1,458.80 = 1.52 1,051.30 = 1.10 Average Inventory 959.00 952.30 Accounts Receivable Turnover Credit Sales 2,678.50 = 2.13 2,124.10 = 2.47 Average Accounts Receivable 1,257.90 858.50 Current Ratio Current Assets 2,789.20 = 1.21 2,524.20 = 1.48 Current Liabilities 2,304.80 1,709.70 Cash flow Ratio Cash + Marketable Securities 518.20 = 0.22 646.30 = 0.38 Current Liabilities 2,304.80 1,709.70 Debt to Assets Ratio Total Liability 5,689.80 = 0.62 5,423.70 = 0.64 Total Assets 9,132.70 8,458.40 Debt to Equity Ratio Total Liability 5,689.80 = 1.65 5,423.70 = 1.79 Total Shareholders' Equity 3,442.90 3,034.70 Times Interest Earned Ratio Income before Interest & Tax 598.10 = 4.72 404.10 = 8.80 Interest Expense 126.70 45.90 Cash Interest Coverage Income before Interest & Tax + Depreciation 598.10 = 4.72 404.10 = 8.80 Interest Expense 126.70 45.90 Earnings per Share Net Profit 351.60 = 0.18 232.30 = 0.12 No. of Shares Outstanding 2,007.879 2,000.304 Dividends per Share Dividends Paid 195.20 = 0.10 185.20 = 0.09 No. of Shares Outstanding 2,007.879 2,000.304 Works Cited Brealey, R.A., Myers S.C. and Marcus, A.J. (2004). Fundamentals of Corporate Finance, 4th ed., McGraw-Hill Inc. Horngren, C.T., Sundem, G.L. and Elliot, J.A. (2001). Introduction to Financial Accounting, Prentice Hall. Investopedia.com. Available: http://www.investopedia.com (Accessed: 01 May 2006). SECTION C Based on case facts, the financial controller of the company had been found to embezzle company funds amounting to $2.5 million by forging chouse and depositing proceeds in his own bank. This crime was discovered by the newly hired accountant, who was tasked to examine the accounting books of the company. An internal control procedure that could be useful in this case is the separation of duties within the accounting function. This entails that no employee should be able to record a transaction from its origin to its ultimate posting in a ledger (Arenas & Lubbock 1991). There should be an independent performance of various phases to ensure accurate compilation of data and limit chances of fraud that would require the collusion of two or more persons. In this situation, the controller writes the chouse and keeps accounting records. The boss could have opted to assign one of these duties to another employee or conduct bank statement reconciliation every month to control errors since banks provide independent records of its transactions with the company. The scheme could have also been prevented earlier if the accounting system of the company is subjected to periodic review by both an independent public accountant and by an internal auditor. It should be noted that these people have a degree of objectivity that permits them to spot inconsistencies and weaknesses overlooked by the boss, who is pre-occupied with the daily operations (Horngren, Sundem & Elliot 2001). They examine numerous transactions of the company so as to determine if there are existing errors such that internal controls in place are not being followed. Should there be weak points resulting in errors identified, then the internal auditor my help enhance the design of the internal control system so that accounting controls would be adhered to by concerned persons. It can be seen that the scheming controller already got away with a substantial amount before a check by a newly-appointed accountant was undertaken. A periodic independent check would have facilitated the early detection of the fraud and new internal control procedure would have been immediately implemented in order to improve the existing system and help prevent scheme from happening again. Works Cited Arens, A and Loebbecke, J. (1991). Auditing, 5th ed., Prentice Hall. Horngren, C.T., Sundem, G.L. and Elliot, J.A. (2001). Introduction to Financial Accounting, Prentice Hall. Read More