Financial Performance at Woolworths Limited - Case Study Example

WOOLWORTHS 2004 FINANCIAL PERFORMANCE ANALYSIS 2005 Executive Summary Financial ments are shareholder’s and creditor’s tool of assessing corporate performance within a certain period. Despite served with abundant information, shareholders and creditors actually narrow down their attention onto certain points of the financial statements. They believe that these points hold the key of assessing management’s performance and corporate condition over the period. Within this report, we are evaluating the financial performance of Woolworths Limited using several financial ratios. These ratios had shown us that over the financial year of 2004, the company presents an acceptable profitability performance, acceptable solvability ratios, good efficiency performance and a rather unpreferable liquidity performance. We believe that management is able to maintain stability of the business. Shareholder should give good evaluation points to the management and their performance, but nevertheless, should also be aware of the nature of the industry which present the possibility of only providing the corporation with no more than 3% profit (out of sales). Table of Contents Executive Summary 1 Table of Contents 2 Introduction 3 Evaluation of Woolworths Financial Performance 4 Performance 4 Stability 5 Efficiency 6 Per Share Performance 6 Limitations 7 Recommendation 8 List of Reference 9 Appendixes 10 Woolworths 2004’s Financial Performance Analysis I. Introduction 1 There are several important emphasizes relating to the significance of financial reporting. We already know that the main purpose of providing sound and viable financial report is to satisfy current shareholders and investors, and attract future ones. But what are the significant points that drive shareholders and investors to finalize their financial investment decisions? According to Financial Management (2005), investors seldom read trough business plans or financial statements thoroughly. They already know what they want. According to the article, most investors want to see business that will grow rapidly and someday will provide a handsome profit. Investors generally does not invest on products, instead, they invest on business. Thus, long term investors generally want to see good profitability ratios and prospects, more than other indicators within financial reports. Joseph Stiglitz (2002), on the other hand, stated that only 10% of today’s new capitals has been raised via equity markets. This condition rises because shareholders do not generally have enough access to corporations to ensure themselves that their investments are safe and growing. For major shareholders (present and future ones), the most influential factor in terms of investment is risk. Future shareholders are generally reluctant to finance businesses that present considerably significant or uncertain risks. They have also been wanting to have more ‘control’ over company operations, but monitoring expense are expensive. Thus, we should consider that shareholders pay attention to solvability, as well as performance efficiency ratios. Within this report, we will observe Woolworths Limited. Trough its 2004 financial report we will assess corporation’s financial performance over the year. II. Evaluation of Woolworths Financial Performance II.1 Performance 1 There are several main components of financial statements. Balance Sheet, Income Statement and Cash Flow are three examples of inseparable parts of a financial report, that describe management performance over the financial period and describe present condition of the company. However, according to Vernon Kamp, one part of the financial statement could have more significance compare to others, according to the purpose of the report user. As we are focusing on evaluation of management performance rather than describing current condition of the company, then the Income Statement deserves more attention. Income statement is the profitability indicator that will better describe how well management uses their assets to make profit. According to Woolworths’s 2004 Income Statement, the company experienced considerable increase in profitability. The statement is based on increased sales, earnings before interest & taxation (EBIT), and other individual posts. However, the financial profitability ratios displayed that profitability performance of the company shows only relatively small changes. The Gross Profit ratio decrease by 0.23%, but the Net Profit ratio increase by 0,15%. Return on Assets increases by 0.84%, but Return on Equity decreases by 0.08%. These ratios indicate only a small tendency toward positive changes in managerial performance. Increase in Net Profit and decrease in Gross Profit shows that for current financial period, the company manages to slightly reduces operating expenses1, compare to the previous year. Increase in Return on Asset ratio is caused by 12% increase in Net profit and only 4% increase in Total Asset. As the Net Profit increase in larger quality than the Total Asset, the ROA experience a slight upward trend. II.2 Stability 1 In assessing the stability of a business, it is important to note that we are performing for the shareholders. Shareholders prefer companies with low risk and good chance of development. Business risk is actually depends on the nature of the industry. Different industry would have different tendencies of financial structure. However, we could define stability as corporation’s ability to meet its obligations, allowing it to be eligible for further capital generating activities. Having so, the corporations would present a level of assurance that they are still capable of surviving within the industry for a reasonable amount of time. The definition above would lead to the observation of liquidity ratios, as well as solvability. In Woolworths, liquidity performance is somewhat non-reassuring. Most financial advisors would recommend that business have a current ratio that larger than one, and less than two. Woolworths Ltd, on the other hand, has larger current liabilities compare to current assets, which means, current assets would not be sufficient to cover for company short-term obligations in terms of bankruptcy. Despite the 0.4% increase for the debt to equity ratio1, the ratio also present less preferable condition as total debts is in average twice the amount of total assets. Woolworths seem to have significant amount of short-term account payable that drags down liquidity performance. However, while this fact is common in business, we should turn our attention to the development of the liquidity performance2. Unfortunately, the year 2004 only bring an increase of 0.04% to the liquidity ratio. Nevertheless, the Debt to Asset ratio provides better perspective of the company. Despite the fact that the ratio decreases by 0.02% during the year, the trend to have 1 assets to vouch for each 0.6 debts should be seen as a positive sign of corporate strength. Interest ratios are also supporting the assessment. II.3 Efficiency The term efficiency means the ability to make the most of limited resources. Efficiency is an indicator that relates to other indicators. For example, positive signs of efficiency would lead to positive prospects of future profitability performance, thus, would also lead to good prospect of future solvability performance. This logic causes several investors to use efficiency performance as main indicator of overall future performance of the company. In the case of Woolworths, the company seems to have promising prospects as activity ratios indicate that management maintains high rate of inventory and accounts receivable turnover. Inventory would be ‘restocked’ in average of 12 times a year, which means that average products stayed in the warehouse for no more than one month. The amount of account receivables also display positive signs of efficiency as they are so small in percentage and so quickly paid by customers. These conditions could well be related to the fact that the company sells fresh food among other products. As we all aware of, fresh commodities sells immediately and produce more cash transactions rather than credit ones. Among other things, it would help the efficiency performance. Compare to last year, the positive trend has experience enhancements as inventory turnover and receivable turnover increase considerably. II.4 per Share Performance Market Ratios are the most commonly used ratios to assess shareholders value. It displayed the value of the corporation as seen by the market. The Earning per Share ratio for example, provide the knowledge of how much a company is producing income compare to the amount of its outstanding shares. The ratio is important as it display to current and future investors jut how much they would actually result by buying a single share of the company. Despite the fact that the amount of distributions to shareholders would never be as large as the entire earning per share, but the ratio helps shareholders to define company profit making ability. In order to assess just how much cash money they would get out of their investments, shareholders should pay attention to the dividend per share ratios. Another important market ratio is the dividend pay-out ratio. The ratio is a reflection of how much of the earning would be distributed to shareholders. A company with low dividend pay-out ratio is said to have high level of growth, while companies with high dividend pay-out ratio are generally experiencing a low level of growth. Woolworths present moderate performance according to the market ratios. Dividend Pay-out ratio remain constant during the year. However, the number is relatively high, which indicates that the company is growing, but not at an exceptional rate. The company’s Earning per Share is decreasing during the year, but management’s policy increases distribution to shareholders as Dividend per Share ratio is increased. For several experts, some of these conditions might pose as a sign that the business is currently having a low degree of growth. Relating to the previously assessed positive efficiency performance, the lack of optimum growth might be connected to circumstances of the industry. III. Limitations This assessment in entirely based on financial terms and does not incorporate market and social considerations, and other perspectives. This assessment also does not use any other analysis to help reach its conclusions. Thus, any statement regarding the company’s performance should not be taken as customer’s or market’s point of view, but rather as interpretation of what management has written in its financial statements. For example, a viable assessment of corporate financial performance should incorporate industry analysis, which contains comparisons between company financial ratios with the best companies in the industry. These comparisons are actually needed to properly justify the assessment, regarding to the qualitative nature of verbal assessments. What is ‘bad’ in several industries might be common for others. IV. Recommendations The company presents an acceptable financial performance. Operating sales and expenses display company profitability is growing within the last period. Nevertheless, the amount of growth is relatively small and could most likely turn to degeneration, in case of market incidences like decreasing market demand or sudden increase in prices. Efficiency ratios stated that management are performing well and should not receive negative evaluation result. It is my opinion that the nature of the industry is the main factor of the above conditions. If long term lenders are not discouraged by the small net profit margin, than they would be satisfied with management’s performance. However, creditors should be aware of market incidences that would strongly influence this particular industry. Powerful changes in the market might just shrink the profit margin even more drastic. The company presents good performance in terms of solvability. The company would still capable of obtaining additional long-term credit from creditors due to its financial leverage position. However, current ratio display bad performance as payable exceeds the amount of current asset. Judging from the positive performance on efficiency, profitability and solvability, it is most likely that the level of current ratio is common within the specific industry. If the assumption is true, than long time lenders should not take the current ratio into considerations. List of Reference ‘Financial Management’. Small Business. 2005. Retrieved September 30, 2005 from http://www133.americanexpress.com/osbn/Tool/biz_plan/faq/index.asp Kamp, Vernon. N.d. ‘Accounting Theory’. Second Edition. New York: John Wiley and Sons Stiglitz, Joseph. ‘Information’. The Concise Encyclopedia of Economics. 2002 Retrieved September 30, 2005 from http://www.econlib.org/library/Enc/Information.html Apendixes Financial Ratios calculation based on Woolworths 2004 Financial Statement Financial Ratios Formula 2004 ($m) 2003 ($m) Gross Profit Margin Gross Profit/Sales 24.91% 25.14% Net Profit Margin Net Profit/Sales 2.62% 2.47% Return on Assets Net Profit/Total Asset 11.89% 11.05% Return on Equity Net Profit/Equity 35.60% 35.68% Inventory Turnover Cost of Goods Sold/Inventory 11.67 10.96 Accounts Receivable Turnover Sales/Accounts Receivable 133.91 108.59 Current Ratio Current Asset/Current Liabilities 0.86 0.81 Cashflow Ratio Cash Flow from Operations/Current Liabilities 0.39 0.39 Debt to Assets Ratio Total Debt/Total Asset 0.67 0.69 Debt to Equity Ratio Total Debt/Equity 1.99 2.23 Times Interest Earned Ratio Earnings before Interest and Tax/Interest Expense 18.56 17.84 Interest Coverage Earnings Before Interest and Tax/Total Interest 18.56 17.84 Earnings Per Share Net Income/Common Shares Outstanding $0.72 $0.86 Devidends Per Share Devidend/Common Shares Outstanding $0.42 $0.36 Devidend Payout Cash Devidend/Net Income 0.59 0.59 Answer to Section B (Case Study): Adhering to the principle of internal control, we can assess that the condition within the case study is possible because combination of several errors. One of them is lack of viable internal control system. The system is incapable to prevent the actor to perform his scheme and continue to do it form a long time. We might as well stated that the scheme was allowed to happen by the operating manager. The second is lack of supervision to current internal control system. The internal system needed to be watch and adjusted in terms of scheme ‘developments’. Periodical evaluation of the system is necessary. The third is lack of security precaution. Valuable materials should not left with just anyone to take them in and out of the facility. Even authorized personnel should be examined for ‘over-carrying’. The system also does not use sufficient documents and notes. Logically speaking, there are several ways of preventing such a scheme. First, by using the ‘segregation of task’ principle we could use the following technique. Officers in charge of collecting the waste should not be the one to sell the mixed products, just like a receivable mail clerk who open payment letters from customers should not be the one to entry the record into journals. An officer should be in charge of collecting the mixed metals, but another person should be inspecting the scrap and sell them to Trash and Treasury. The inspector should be replaced periodically to prevent cooperation between the two functions. Second, in this special case where scraps have a considerable market value, management should use estimation to prevent over production of waste. The officer responsible for collecting the waste should report to another officer whose job is to match the actual amount of waste with managerial estimation. Considerable differences should not be tolerated and the estimation should always be adjusted to match real possibilities. Third, The company should provide a ‘production area’ where valuable materials are allowed to be circulated. Materials that come in or out of the production area should be accurately noted and unauthorized personnel should not be allowed to take materials outside the area. Management should assign an officer to be responsible for material circulation in and out of the production area. Distribution of material should be authorized by this officer, which would answer to the operating management. Periodical report should be submitted to management regarding the amount of materials coming in and out of the area within a single period. Read More