Accounting and finance:Easter Gate Scientific Supplies Inc - Essay Example

Table of Contents Table of Contents Part 2 Easter Gate Scientific Supplies Inc - A Background 2 Profitability Ratios 3 Liquidity Ratios 6 Working Capital Ratios 7 Long - Term Solvency Ratios 9 Part 2 11 Q1 Easter Gate's Growth Strategy 11 Q2 Meeting all Needs - An Expensive Policy 12 Q 3 Financial Advantage of Good being sent from Manufacturers to the Customers 12 Q 4 Ways to increase their Market Share 13 Q 5 Improvement in Profitability 13 Q 6 Raising of additional $ 100 Million 14 Appendix I 14 Calculation of Various Key Financial Ratios 14 Appendix II 17 Formulae for Working out the Ratios 17 Bibliography 18 Accounting and Finance: Easter Gate Scientific Supplies Inc Part 1 Easter Gate Scientific Supplies Inc - A Background Easter Gate Scientific Supplies Inc is one of the leading global suppliers of instruments, equipments and services to the scientific community. Research organizations, educational establishments, government departments and healthcare organizations are their major customers. The company operates on a higher sales turnover and low margin policy. At the end of the year 20X6 the company had a market share of about 17.5 percent and the company has estimated it to grow at the rate of 5 percent per annum during the next 5 years. Axel Scientific Ag, the German based company is one of the major competitors of Easter Gate, holding a market share of about 5 percent. This paper intends to analyse the financial performance of both the companies over the three year period 20X4, 20X5 and 20X6.The Key Financial Ratios for both the companies for the analysis period is presented below: Profitability Ratios "Profitability ratios offer several different measures of the success of the firm at generating profits." (Net MBA) Particulars Easter Gate Scientific Axel Scientific Ag 20X6 20X5 20X4 Average 20X6 20X5 20X4 Average Gross Profit to Sales (%) 26.97 26.94 26.95 26.95 22.09 22.22 21.27 21.86 Operating Profit to Sales (%) 4.41 3.70 3.62 3.91 4.20 2.50 1.87 2.86 Return on capital Employed (ROCE) %) 13.39 8.53 9.97 10.63 6.66 2.89 5.75 5.10 Earnings per Share 2.16 1.60 1.11 1.62 1.05 0.30 0.45 0.60 Gross Profit to Sales % Although there is a significant increase of 124.09 percent in the year 20X6 over the year 20X4, over the three year period Easter Gate was able to maintain the gross profit to sales percentage more or less at a constant level. This implies that the company has a strong presence in the market and was able to maintain the prices at constant level. The company was in the three year period was also able to maintain the costs under control to maintain the gross profit percentage. Despite the increase in the sales of about 108.58 percent from the 20X4 level to 20X6, the company Axel Scientific could not increase its gross profit to the level of Easter Gate. This implies that the company is not able to work on comparable cost of materials and labour as that of the Easter Gate. Since the average cost of sales is more by 5.09 percent the company's gross profit is lower than that of Easter Gate. Operating Profit to Sales % Despite the consistency in the gross profit to sales percentage, the operating profits of the company has been lower in the first two years 20X4 and 20X5. The percentage is showing an increasing trend during the year 20X6. As the company has operating on the policy of higher turnover and lesser margin principle, the higher sales (72.36 percent increase in the year 20X6 from the 20X5 level) has contributed to the increase in the operating profit to sales percentage. Axel Scientific also appears to be following the same principle of higher turnover/low margin principle and with an increase of 55 percent in the turnover in the year 20X6 as compared to the year 20X5 has resulted in an increase in the operating margin to sales. Return on Capital Employed (ROCE) The return on capital employed shows how efficiently the company has used the company's funds to increase the profitability. Easter Gate has registered a growth of 3.42 percent in the year 20X6 over the year 20X4. The return on capital employed should always be more than the rate at which the company borrows from the external sources. If the ROCE is lower, then any increase in the borrowings of the company will reduce the earnings of the shareholders and this will be indicated by the movements in the ROCE over the periods. The movement in the ratio from the year 20X4 to 20X6 implies that the company has improved upon the effective utilisation of its funds. In comparison with Easter Gate, the ROCE of the competitor Axel is not only inconsistent but also not impressive. The company has faired very poorly in the year 20x5 and had managed to show an increase in the ROCE during the year 20X6. But still the company's ROCE as compared to that of Easter Gate is less by 5.53 percent on an average over the three year period. Earnings per Share Because of the increased operating income Easter Gate was able to present higher earnings per share despite the increase in the year end number of shares from 16.250 million to 25 million. The company's earnings per share stood at $ 2.10 for the year 20X6 as against $ 1.60 for the year 20X5. The increase in the earnings per share over the period indicates that the company had performed financially well to improve the wealth of the shareholders. Despite more or less the same level of the operating income and lesser number of shares Axel Scientific is able to maintain only a lower level of earnings per share as compared to that of Easter Gate. This is due to the fact that the company's retained earnings is much lower since the company is paying a large amount of interest which reduces the retained earnings and consequently the earnings per share. Liquidity Ratios Liquidity ratio is defined "as a class of financial metricsthatis usedto determine a company's ability to pay off itsshort-terms debts obligations.Generally, the higher the value of the ratio, thelarger is the margin of safetythatthe company possesses to cover short-term debts." (Investopedia) Liquidity Ratios are the ones that exhibit the short-term liquidity of the company. Particulars Easter Gate Scientific Axel Scientific Ag 20X6 20X5 20X4 Average 20X6 20X5 20X4 Average Current Ratio 2.02 1.75 1.77 1.85 2.02 1.77 2.61 2.13 Acid Test Ratio 1.11 0.93 0.88 0.97 1.16 1.19 1.52 1.29 Current Ratio Easter Gate is maintaining a comfortable current ratio throughout the three year period. Especially in the year 20x6 the company has a strong current ratio implying that the company has very strong current assets situation that will enable the company to meet its current liabilities without any problem. Normally a current ratio of 1 and above is acceptable. Since the current ratio of Easter Gate is 2.02 the company can be regarded as to be in a sound short-term financial ability. In this respect the Axle Scientific is also in the same footing as that of Easter Gate and the short-term liquidity of the company can be considered to be very sound. Acid Test Ratio Over the three year period the acid test ratio of the company Easter Gate has increased from 0.88 to 1.11 implying that the company's debtors ratio to its current liabilities has increased. This situation is due to the increase in the sales of the company over the period and the situation is not alarming since the company's current ratio is strong enough. In the case of Axel Scientific the company, despite the increase in the sales is able to reduce the acid test ratio. This means that the company has managed to reduce the proportion of credit sales and consequently there is a reduction in the total debtors leading to a reduction in the acid test ratio. Working Capital Ratios The Working Capital ratios indicate how well the company is able to manage its working capital. "The asset management ratios are also known as working capital ratios or the efficiency ratios. The aim is to measure how effectively the firm is managing its assets." (Net Tom) Particulars Easter Gate Scientific Axel Scientific Ag 20X6 20X5 20X4 Average 20X6 20X5 20X4 Average Average Debtors (Days) 27 28 26 27 54 70 48 57 Average Creditors (Days) 18 19 19 18 34 38 25 32 Stock Turnover (Times) 15.67 20.98 19.79 18.81 8.06 10.57 10.29 9.64 Average Debtor The average debtor indicates how many days the company takes to collect its outstanding debtors in proportion to the total sales. Easter Gate while taking 27days on an average to collect its book debts, the company has more or less maintained consistent average debtors over its sales. In fact there is a marginal reduction in the average debtors during the year 20X6 which implies the company is well maintaining the average debtors position. In the case of Axel Scientific the average debtors over the three year period is at 57days which is much higher than that of Easter Gate. However the company has made good effort to reduce the average debtors from 70 in the year 20X5 to 54 in the year 20X6 which denotes that the company has put more efforts in collecting the outstanding debtors. Average Creditors Average creditors implies how many days on an average it takes for a company to pay off its creditors. Easter Gate has maintained consistent average creditors over the three year period. This implies that despite in the increased volume of business in the year 20X6 the company has been regular in making payments to its creditors to maintain them under control. In the case of Axel, the average creditors have increased by 36 percent from 25 days in the year 20X4 to 34 days in the year 20X6. However the company has reduced the average creditors from 38 days in 20X5 to 34 days in 20X6 showing a slight improvement in the situation. Stock Turnover Stock turnover shows how many times the company is able to roll over its inventory. From the analysis it appears that Easter Gate has an average stock turnover of 18.81 times which is a very good stock turnaround time. This again underlines the company's basic principle of high volume low margin principle where the stock turnaround times normally would be higher. Whereas Axel Scientific is able to turnaround its stock only 9.64 times on an average over the three year period, which implies a poor performance as compared to Easter Gate. The company should try to improve the stock turnover as this will enable it to keep stock for a short period. Chadwick (2003, page 124) states "a rapid rate of turnover equals fast moving stock and less capital tied up". Long - Term Solvency Ratios "Long-term solvency focuses on a firm's ability to pay the interest and principal on its long-term debt. There are two commonly used ratios relating to servicing long-term debt. One measures ability to pay interest, the other the ability to repay the principal." (Free Tutorial) Particulars Easter Gate Scientific Axel Scientific Ag 20X6 20X5 20X4 Average 20X6 20X5 20X4 Average Gearing Ratio (%) 67.45 68.29 68.38 68.04 67.43 68.18 68.75 68.12 Interest Cover (Times) 3.46 3.45 3.47 3.46 1.31 1.20 1.67 1.39 Gearing Ratio Gearing ratio explains the relationship between the long-term debts of the company and its equity. The company should be able to maintain a correct balance between the debt and equity so that the company can ensure a good return for the company's shareholders. In the case of Easter Gate, it may be observed that since the company has a higher gearing of 68.04 percent on an average the company is able to ensure a ROCE of 10.63 percent on an average over the three year period. Because the company is using a larger amount of debt funds the company has to pay larger interest payouts from the earnings and this reduces the retained profits of the company. Axel is also following the same trend in respect of the mix of debt as that of Easter Gate and so the company should strive to change the capital mix so that the gearing ratio can be brought down which means the company can have a better earnings per share. Interest Cover This analysis exhibits the ease with which the company is able to pay off its interest liabilities out of its earnings. From the figures it is observed that Eater Gate is in a strong position as far the interest cover is concerned since the company could cover up to 3.46 times on an average the interest payments over the three year period. As compared to the Easter Gate, Axel Scientific is in a disadvantageous position since the company has an interest cover of only 1.39 times on an average over the three year period. This goes to prove the lowest retained earnings and low earnings per share due to high interest payouts. Part 2 Q1 Easter Gate's Growth Strategy The highest market share of Easter Gate at 17.5 percent with the second one standing at 5 percent (Axel Scientific, Norsweda and Osterwiser) indicates the company is enjoying a good market reputation. The company should be able to cash in this situation by a pricing policy which increases the overall operating profit. The company because of its market position should be able to achieve higher percentage of gross and net margins by increasing the prices. It may so happen that there may be an immediate dip in the turnover but the overall profitability is bound to increase by the change in the pricing strategy. Since the customer base is institutions and research organizations which are mostly not-for profit organizations the company should be able to command more prices in terms of the quality of its products and efficient customer service. The pricing strategy of high volume low margin will not help the company improve its net operating margin. Q2 Meeting all Needs - An Expensive Policy The company's policy of meeting all needs of the customers may prove to be expensive, since the company may be supplying several products where there is only very low or no profit margins to the company. This will affect the overall profitability of the company. The company should have a thorough relook into the following areas to improve its profitability: Product mix of the company and the relative cost and profitability to eliminate those products which are not profitable A relook into the logistics of the company with a specific view to improve upon the costs incurred in accumulating various products into the company's stores and redirecting them to the customers' places. A review of other services in which the company is indulged to eliminate those services which cost loss of revenue to the company Q 3 Financial Advantage of Good being sent from Manufacturers to the Customers There are two fold advantages when the goods are sent directly from the manufactures to the customers directly. The foremost advantage is the potential saving in the freight costs. The second advantage may result in saving in the storage and investment cost in the goods on which the company will be earning meagre margins. The company would as well collect its overriding commission as revenue instead of showing the purchases and consequently an enhanced turnover. Q 4 Ways to increase their Market Share The following are some of the ways in which the company may be able to improve its market share: By revamping its product mix and identifying those products which move fast and which contribute more sales and profitability. This implies elimination of the products which are not profitable and focussing only on those products which are in hot demand and at the same time gives the company more profit margins. Enhance the research and development activity to bring to the market new and innovative products which are in hot demand. Expanding geographically to other markets Q 5 Improvement in Profitability The improvement in profitability can be achieved by: Elimination of products which are not contributing less or no profit Aggressive pricing with well defined higher profit objectives to take advantage of the established market position and standing Expanding customer base in to those areas where the company is sure to get more profitable orders Establishing new and innovative products through research and development and marketing those new products which is in demand and offer higher profitability Q 6 Raising of additional $ 100 Million With the current market share and standing the company is a good candidate for raising additional funds by making an Initial Public Offering of common stocks at a premium. The company's stock is sure to command a good response from the market and this would help the company to reduce the gearing also. Appendix I Calculation of Various Key Financial Ratios Profitability Ratios Particulars Easter Gate Scientific Axel Scientific Ag 20X6 20X5 20X4 20X6 20X5 20X4 Gross Profit 868 503 387 247 160 114 Sales 3,218 1,867 1,436 1,118 720 536 Gross Profit to Sales (%) 26.97 26.94 26.95 22.09 22.22 21.27 Operating Profit 142 69 52 47 18 10 Sales 3,218 1,867 1,436 1,118 720 536 Operating Profit to Sales (%) 4.41 3.70 3.62 4.20 2.50 1.87 Operating Profit 142 69 52 47 18 10 Total Assets 1060 808 622 706 622 174 Return on capital Employed (ROCE) (%) 13.39 8.53 9.97 6.66 2.89 5.75 Retained Profit 54 26 18 7 2 3 No of Shares 25m 16.250m 16.250m 6,666,667 6,666,667 6,666,667 Earnings per Share 2.16 1.60 1.11 1.05 0.30 0.45 Liquidity Ratios Particulars Easter Gate Scientific Axel Scientific Ag 20X6 20X5 20X4 20X6 20X5 20X4 Current Assets 430 266 205 285 205 120 Current Liabilities 212 152 116 141 116 46 Current Ratio 2.02 1.75 1.77 2.02 1.77 2.61 Debtors 236 142 102 164 138 70 Current Liabilities 212 152 116 141 116 46 Acid Test Ratio 1.11 0.93 0.88 1.16 1.19 1.52 Working Capital Ratios Particulars Easter Gate Scientific Axel Scientific Ag 20X6 20X5 20X4 20X6 20X5 20X4 Debtors 236 142 102 164 138 70 Sales 3,218 1,867 1,436 1,118 720 536 Average Debtors (Days) 26.76 27.76 25.93 53.54 69.95 47.67 Creditors 155 98 75 103 75 37 Sales 3,218 1,867 1,436 1,118 720 536 Average Creditors (Days) 17.58 19.16 19.06 33.63 38.02 25.20 Cost of Sales 2,350 1.364 1.049 871 560 422 Stock 150 65 53 108 53 41 Stock Turnover (Times) 15.67 20.98 19.79 8.06 10.57 10.29 Long - Term Solvency Ratios Particulars Easter Gate Scientific Axel Scientific Ag 20X6 20X5 20X4 20X6 20X5 20X4 Debt 572 448 346 381 345 88 Debt + Equity 848 656 506 565 506 128 Gearing Ratio (%) 67.45 68.29 68.38 67.43 68.18 68.75 Operating Profit 142 69 52 47 18 10 Interest Payable 41 20 15 36 15 6 Interest Cover (Times) 3.46 3.45 3.47 1.31 1.2 1.67 Appendix II Formulae for Working out the Ratios 1. Gross Profit to Sales (%) = Gross Profit Net Sales X 100 2. Operating Profit to Sales (%) = Operating Profits Net Sales X 100 3. Return on Capital Employed = Operating Profit Total Assets X 100 4. Earning per Share ($) - Data provided 5. Current Ratios = Current Asset Current Liabilities 6. Acid Test = . Debtors . Current Liabilities 7. Average Debtor Days = Debtors Sales X 365 8. Average Creditors Days = Creditors Sales X 365 9. Stock Turnover (Times) = Cost of Sales Stock 10. Gearing (Debt/Debt + Equity) = . Debt . Debt +Equity X 100 11. Interest Cover (times) = Operating Profits Interest Payable Bibliography Books Used: Leslie Chadwick (2002), Essential Finance and Accounting For Managers, Prentice Hall Publishers, ISBN 0=273-64648-6 Online Resources used: Free Tutorial 'How to analyse Financial Statements' Investopedia 'Liquidity Ratios' Net MBA 'Financial Ratios' Net Tom 'Session 14: Calculation of Ratio Analysis' Read More