Activity or Working Capital Efficiency Ratios - Term Paper Example

Running Header: FINANCIAL RATIO ANALYSIS FOR HR OWEN PLC Financial Ratio Analysis for HR Owen Plc in APA Style by University Word Count: 1417 1.0 Financial Ratio Analysis: An Introduction Financial ratio analysis is a very essential tool in assessing the financial health of a business entity. It enables a financial analyst to spot trends in a business and to compare it with the performance of similar business enterprises within the same industry. This tool is currently utilized by business managers, investors, creditors, suppliers, and other decision makers in order to determine the financial performance and well being of a business organisation. Financial ratios are grouped into five categories, each showing a different aspect of a company's financial operations. These are profitability ratios, financial leverage ratios, liquidity/solvency ratios, efficiency ratios, and investor ratios. This report will look at the financial performance of HR Owen Plc.. In order to fully asses its financial health, the financial ratio analysis will look at the company's well-being during the fiscal years 2005-2006 and benchmark it with its key competitor, Antonov Plc 2.1. Profitability Ratios Profitability ratios measure the ability of the company to generate income from its investments less the costs incurred. Return on capital employed is a variant of return on investment. Return on capital employed (ROCE) is a measure how well the company is utilizing its capital. The computed sales profit margin, which is the ratio of operating income to sales measures as a percentage of sales, the excess revenue from sales over cost of normal operation excluding financing. Asset turnover measures the amount of sales generated by every pound in the company's assets. Net profit margin, on the other hand, is the ratio of net income to sales showing the company's ability to efficiently manage cost and turn its revenue into profits. Logically, higher performance ratios indicate a healthier financial condition. Appendix 2 shows the profitability ratios of HR Owen Plc during the fiscal years 2005 and 2004 together with that of its competitor, Antonov Plc. Based on year on year performance, it can be seen that HR Owen Plc's profitability has significantly declined evidenced by the decrease in the two computed ratios namely ROCE and net profit margin. During 2004, HR Owen reports ROCE of 4.72% which has gone down to negative 77% in the following year. The company's ability to transform its revenue into profits has also suffered which indicates its inability to efficiently manage its operating costs. It should be noted that HR Owen has boost its ability to utilize its assets in order to generate sales. This is indicated by leap in the company's asset turnover from 19.46 times to 36.78 times in just a span of one year. Gross profit margin has also improved by 0.3%. However, amidst this increases in turnover and margin, HR Owen is not able to manage costs efficiently. Net profit margin for 2004 is 0.014% and dropped to as lows as negative 2.40% to reflect the company's net losses. Even though HR Owen's year on year profitability is in a decline, it is still superior compared to Antonov Plc. Antonov recorded negative ROCEs during 2004 and 2005. It should be noted that the company's ratios cannot be properly computed because of their inability to report sales for 2005 and cost of sales for 2004 and 2005. Nonetheless, the other ratios still imply that HR Owen is in a better profitability position. 2.2. Activity or Working Capital Efficiency Ratios Activity ratios are operating efficiency measures, which determine the ability of a company to maximise its output given a certain level of resources. These ratios significantly gauge the asset, investment, and cost management performance of the business entity. Ratios under this category are inventory, creditors' and debtors' ratio. The inventory ratio measures the number of days the inventories stay in the company's distribution center or warehouses. The debtors' ratio reveals the efficiency of a business organisation in collecting its account receivables while creditors' ratio shows the umber of days the company is able to pay its suppliers. Lower numbers are typically preferred in this ratio classification as they signify speed and efficiency of the business organisation in dealing with its different transactions. Appendix 3 shows the working capital efficiency of HR Owen Plc and Antonov Plc. It should be noted that in general, HR Owen is able to boost its efficiency as indicated from the improvement of its inventory and trade creditor ratio. The company is able to reduce the number of days the stocks sits on its warehouse from 84 to 65. HR Owen is also more responsible for its debts it is able to pay its trade creditors in just 12 days. However, HR Owen should still concentrate on its efforts of collecting its receivables from customers. The company reports that it became relatively slower I collecting receivables by three days compared to the 12 days recorded in 2004. The performance of Astronov is again inferior to HR Owen evidenced by its higher debtor's ratio. The other ratios cannot be computed as the company does not record revenue and cost of sales for the periods considered. 2.3. Liquidity Ratios Liquidity or solvency ratios are used as measures of the company's ability to finance its short-term obligations by its cash and near cash items. Included in these ratios are current and acid test or quick ratios. Current ratio expresses the "working capital' relationship of current assets available to meet the company's current obligations." The acid test is more indicative as it shows the company's ability to pay its current obligations without relying on the sale of its inventory. Higher ratios indicate more liquidity. Based on year on year liquidity ratios, HR Owen seems to be having a declining liquidity as both the current and acid test ratios have dropped. During 2004, the current assets of the company are more than enough to pay off its entire immediate obligation. In fact, HR Owen's liquid resources are more than twice its current liabilities. However, this ratio was reduced to 88.83%. It can also be seen that most of company's liquid assets are tied up in inventory as indicated by the wide gap between the current and the acid-test ratios. Compared to Antonov Plc, HR Owen is more liquid. It can be seen that the latter has higher nominal values in all aspects in all years than the former. However, in contrast to HR Owen, Antonov Plc's liquidity ratios are in an increasing trend. 2.4. Financial Leverage Ratios Financial leverage ratios provide an indication of the long-term solvency of the firm. They indicate the extent of non-owner claims on the firm's profits as well as the firm's operating capability to meet its obligation. Gearing is the long-term debt to equity ratio which assesses the balance between liabilities and equity in the firm's long term resource structure. Another is the interest coverage ratio which measures the extent to which earnings cover the interest obligation of the company. HR Owen's capital has a higher and increasing preference for debt which is a riskier financing option than equity. It is evidenced by the more than one gearing ratio reported during 2005 and 2004. Last year, HR Owen has a capital structure of 10:90 in favor of debt. Due to this high level of accumulated debt, the company is also obliged a higher level of interest payment. Sadly, the company's interest coverage ratio indicates that the company does not have enough profit to cover their interest obligations. Astronov Plc is in an even worse financial position. It can be seen that like HR Owen, Astronov is utilizing debt to finance its resources and operations. Worse, Astronov Plc has a negative shareholders fund to absorb the posted negative retained earnings. Astronov also has a negative interest coverage ratio. 2.5. Investor Ratios Investor ratios are financial ratios especially designed to convey to investors the profitability of the company's stock as an investment. The company's return on shareholders ratio shows the income generated by the business organisation through its utilization of the shareholders fund. It can also be as the profit attributatble to each share of common stock in the company. Return on shareholders fund is a very important measure of financial performance because the main goal of a company is the maximization of shareholder value. Earnings per share ratio show the return to common stock shareholder for each share owned. The fiscal year 2005 seem to be a bad year for both business organizations. Both companies have shown a slump in return on shareholders and losses per share. Investment wise, Astronov appears to be a better stock to hold than HR Owens. Appendix. 1 Appendix 2. Appendix 3. Appendix 4. Appendix 5. Appendix 6. Running Header: FINANCIAL ANALYSIS FOR BALTIC OIL TERMINALS PLC Financial Analysis for Baltic Oil Terminals Plc in APA Style by Student's Name Course Name University Word Count: 1262 1.0 Financial Ratio Analysis: An Introduction Financial ration analysis is a management tool utilized by business managers, investors, creditors, suppliers, and other decision makers in order to determine the financial performance and well being of a business organisation. Financial ratio analysis allows these stakeholders to diagnose the financial condition. Even if the analysis is purely quantitative, it reveals a lot of qualitative issues within the organization. It enables managers to find solution to the business organisation's internal problems. Financial ratios are grouped into five categories, each showing a different aspect of a company's financial operations. These are profitability ratios, financial leverage ratios, liquidity/solvency ratios, efficiency ratios, and investor ratios. This report will specifically look at the financial health and well being of Baltic Oil Terminals Plc. It should be noted that in comparison with other typical firms, Baltic Oil Terminals has not yet started its operation until 2007. Thus, in order to benchmark its performance, an appropriate competitor is chosen-Aurelian Oil and Gas Plc. The companies' financial ratios will also be compared side by side. 2.1. Profitability Ratios Profitability ratios measure the ability of the company to generate income from its investments less the costs incurred. Four ratios are computed for this category: return on capital employed; sales profit margin; asset turnover; and net profit margin. Logically, higher performance ratios indicate a healthier financial condition. Appendix 2 shows Baltic Oil Plc's computed profitability ratios for the business organisation during 2004 and 2005. It should be noted that the ratios computed for the oil terminal is very much different from a typical business organisation. Baltic Oil's unique situation justifies this condition. The company is not yet able to generate sales from its operations because as it notes in its annual report "revenue from transshipment throughput at the terminal is not yet expected before 2007." With this, the firm only manages to generate income from funds placed in deposit. This clarification is expected to clear out confusion on the company's profitability ratios. Baltic Oil's records losses as it still needs to cover operation costs even if it is not formally engage in transshipment of throughput. This, the company generates a negative ROCE. Asset turnover is zero as sales is still zero. There is no gross profit margin as well as net profit margin. However, the increasing ROCE is an indication of increasing profitability. The company also proudly states that, so far, it is performing as expected. Baltic Oil is performing at par with Aurelian Oil and Gas Plc, which is also in the same situation. Aurelian oil also has zero asset turnover and no net profit margin and gross margins. However, it should be noted that in absolute terms, Aurelian Oil's ROCE is also increasing but is relatively higher than Baltic Oil. 2.2. Activity or Working Capital Efficiency Ratios Activity ratios are operating efficiency measures, which determine the ability of a company to maximise its output given a certain level of resources. These ratios significantly gauge the asset, investment, and cost management performance of the business entity. Ratios under this category are inventory, creditors' and debtors' ratio. Lower numbers are typically preferred in this ratio classification as they signify speed and efficiency of the business organisation in dealing with its different transactions. As both companies are not yet fully operational and are not yet generating revenues from their operations, their working efficiencies cannot yet be fully assessed. It should be noted that their ratios in each category as shown in Appendix 3 are mostly zeroes or none at all. This is a firm indication that the Baltic Oil as well as Aurelian Oil's capacities to efficiently utilize their working capitals remain indeterminable at the moment. It is expected that it is only in the coming years that their efficiency ratios can be properly and appropriately tracked. 2.3. Liquidity Ratios Liquidity or solvency ratios are used as measures of the company's ability to finance its short-term obligations by its cash and near cash items. Included in these ratios are current and acid test or quick ratios. Current ratio expresses the "working capital' relationship of current assets available to meet the company's current obligations." The acid test is better indicator as it eliminates the inventory from the current assets. Higher ratios indicate more liquidity. Appendix 4 shows the current ratio of Baltic Oil during 2004 and 2005. The company's liquidity has significantly increased from 2004. In fact, the company's current assets have extremely ballooned with infusion of cash from the company's public offering. In fact, having a current ratio of more than 16 may mean excess liquidity. This is not good for Baltic Plc as this excess cash may be considered as withheld from other profitable opportunities present in the market. The company can use the fund in investing into financial instruments and projects which can generate more income while waiting for the terminal becomes operational. It can also be noted that the current and acid test ratios are the same since there are still no inventory at hand. In contrast to Baltic Oil, Aurelian Oil's liquidity is decreasing. It can be seen that in absolute terms, Baltic Oil is much more liquid than its competitor during 2005. There is also no discrepancy between the company's current and acid test ratios. 2.4. Financial Leverage Ratios Financial leverage ratios provide an indication of the long-term solvency of the firm. They indicate the company's capital structure as well as the business organisation's capability to meet its liabilities. Gearing is the long-term debt to equity ratio which assesses the balance between liabilities and equity in the firm's long term resource structure. Another is the interest coverage ratio which measures the extent to which earnings cover the interest obligation of the company. Appendix 5 shows both of the companies' financial leverage ratios. Baltic Oil has a higher preference for less risky financing which is equity. According to the company's gearing, it has a capital structure of 93:7 in favor of equity. The company has significantly lowered its debt after the public offering. This low level of debt to finance the company's assets leaves no interest obligation for Baltic Oil. This justifies the company's undefined interest coverage ratio. On the other hand, Aurelian Oil has a more risky financing structure. The company's gearing indicates a 31:69 capital structure in favor of debt. This is a massive improvement from the 6:94 capital structure in 2004. It should also be noted that the company seems to be in a perilous situation as it has negative interest coverage due to the losses it incurred. 2.5. Investor Ratios Investor ratios are financial ratios especially designed for investors who are seeking for possible profitable investments. The company's return on shareholders ratio shows the income generated by the business organisation through its utilization of the shareholders fund. Return on shareholders fund is a very important measure of financial performance because the main goal of a company is the maximization of shareholder value. Earnings per share ratio show the return to common stock shareholder for each share owned. Appendix 6 shows the companies' investors ratios. It can be seen that both organisations are not creating values for their shareholder. As discussed above, it can be traced to the losses that it incurs during the past two years. Though both have huge potentials in the market, it can be noted that the companies cannot yet justify their worth as investments. Baltic Oil has significantly lower return on investments as well as higher losses per share. Aurelian Oil, on the other hand, may be opted relative to its competitor. Appendix 1. Appendix 2. Appendix 3. Appendix 4. Appendix 5. Appendix 6. Read More