Financial performance report on queenstake Resources ltd - Essay Example

FINANCIAL PERFORMANCE REPORT ON QUEENSTAKE RESOURCES LTD Introduction: Queenstake Resources Ltd, a Canadian Corporation based in Denver Colorado, has traded on the Toronto Stock Exchange for over twenty years. In mid 2003, it acquired the Jerritt Canyon Gold Mines from Meridian/Anglo Gold Joint Venture, which drastically changed its corporate future. The mine produced 302,000 ounces of gold in 2003 alone and half of it went to Queenstake account. During the third quarter of 2005 the company announced a redevelopment designed to optimize operations and to reduce operating cost in response to development and production shortfalls at Jerritt Canyon and rising commodity cost. There was a steady increase in gold price during 2005 from an average of $ 445 to $ 537 per Ounce. These internal and external developments have influenced the financial stability of the company. Financial Statement Analysis: Financial statement analysis is a meaningful study of the financial statement, the balance sheet and the profit and loss account, relating to a specific period of a business, to ascertain the prevailing state of affairs and reasons thereof (Metcalf and Titard.1976, 157). The list of categories of readers and users of accounts includes: investors, lenders, managers of the organization, Employees, Suppliers and other trade creditors, Customers, Governments and their agencies, Public, Financial analysts, Environmental groups and Researchers: both academic and professional. Ratio Analysis: Analysis of Financial performance. Ratio Analysis is a significant tool of financial management. It presents facts on a comprehensive basis and enables the drawing of inferences regarding the performance of a firm, assessed in respect of the aspects like: liquidity position, long-term solvency, operating efficiency, overall profitability, etc. Ratio analysis is defined as “the systematic use of ratio to interpret the financial statements so that the strengths and weakness of a firm, as well as its historical performance and current financial condition can be determined.” (White. 1998, 160). Profitability Analysis: The profitability of a firm can be measured by the profitability ratios. Such ratios can be computed either from sales or investment. The profitability ratios based on sales are: gross profit ratio, net profit ratio, operating profit ratio, cost of goods sold ratio, administrative expenses ratio, selling expenses ratio, operating expenses ratio, operating ratios. The profitability ratios related to investment include: return on assets, return on capital employed and return on shareholders equity including earnings per share, dividend per share, dividend pay-out ratio, earning and dividend yield. The overall profitability (earning power) is measured by the return on investment which is computed as a combined product of net profit margin and investment turnover. (Helfert. 1972, 53). It is a central measure of the earning power and operating efficiency of a firm. (a) Ratios related to sales: 1. Rate of Return on investment (ROI): The profitability ratio can be computed by relating the profits of a firm to its investments. ROI combines in itself the net effect of all types of performance ratios. The rate of Return on Investment (ROI) = (earnings after taxes / sales) OR (sales / total assets) OR (earnings after taxes / total assets) 2005 2004 -19671 / 93339 (-) 0.21 - 22126 / 87931 (-) 0.25 P 17, P 16 It can be seen that Return on Investment registers an increase by decreasing the net loss percentage from (-) 0.25 in 2004 to (-) 0.21 in 2005 which is good. It manifests the efficiency of the management to some extent. However, the shareholders will still be concerned as the company is making huge loss which will result in dilution of investment and difficulty in repaying dues of creditors in time. Gross Profit Ratio: Gross Profit Ratio indicates the relationship between gross profit to net sales of the company. The Gross Profit Ratio = Gross Profit / Net Sales 2005 2004 9906 / 90174 0.11 15048 / 100394 0.15 P 17 Analysis: On analysing the above figures it can be seen that the Gross Profit Ratio, which is otherwise low, has further decreased drastically. This indicates that the cost of sales has increased by 4%, which ultimately, will reduce the profitability of the company. Operating Profit Ratio: It is calculated by comparing earning before interest and taxes on net sales and measures the percentage of operating profit from sales. Operating Profit ratio = Earnings before Interest and Taxes / Net Sales 2005 2004 (-19671 + 413) / 90174 (-) 0.21 (-22126 + 4917) / 100,394 (-) 0.17 P/17 Analysis: The operating ratio of – 0.21 of sales is very high and it manifests the inefficiency of the management. From the point of view of the shareholders the performance is not encouraging as the operating loss has increased, and outsiders will be reluctant to invest funds in the company. 4. Net Profit Ratio (NPR): Net Profit Ratio expresses the relationship between net profit (after interests and taxes) to sales (Spiller. 1977, 644). Net profit ratio (NPR) = Earnings after taxes / net sales 2005 2004 - 19671/90174 (-) 0.22 - 22126/100,394 (-) 0.26 (P 17) Analysis: There is a decrease in net loss margin as compared to the previous year. This shows that the selling price is increasing, and the decrease in net loss rate is not encouraging. However, the analysis of a two period statement cannot give a realistic evaluation of the actual state of affairs. Hence it calls for a detailed analytical study of expenditure over a longer period of time. (b) Ratios related to total investments: 1. Return on capital employed (ROCE): In ROCE ratios, profits are related to the total capital employed. It would provide sufficient insight into how efficiently the long term funds of owners and lenders are being used. Return on Capital Employed (ROCE) = Earning after taxes + interest / average total capital employed. 2005 2004 ( (-)19671+413) / (50931+2117) (-) 0.36 (-) 126+4917/38366+193) (-) 0.44 P 17, P 16 Analysis: The company management has not maintained stability in the utilization of funds and the efficiency of utilising resources has improved. While this may be encouraging to an extent, yet the shareholder stands to sustain loss. 3. Return on shareholder’s equity (ROSE) This ratio measures the return on the shareholders’ funds. Return on total shareholders equity (ROSE) = Earnings After Taxes (EAT) / average total shareholder’s equity 2005 2004 (-) 19671/50931 (-) 0.39 (-) 221216/38366 (-) 0.58 P17/P16 Analysis: The fall in the rate of loss looks favourable and gives some relief to the shareholders as it will resist the dilution of their capital. Since the company has been making steady loss, the creditors will not be interested for investment. LIQUIDITY ANALYSIS A liquid asset is one that trades in an active market and hence can be quickly converted to cash at the going market price, and a firm’s “liquidity ratios” deal with this question: Will the firm be able to payoff its debts as they come due over the next year or so? (P/75 Brigham) Current Ratio: The current ratio is the ratio of total current assets to total current liabilities. The current ratio measures its short-term solvency. Current ratio = Current assets / current liabilities 2005 2004 18179/13909 1.35 13283/22706 0.58 P16 Analysis: The rise shows a trend of increase in non-productive investment in current assets which from the point of view of the management is not satisfactory since it will diminish profitability. The creditors will be satisfied with the increase since it will increase the liquidity. 2. Quick ratio or acid test: The acid test ratio is the ratio between quick current assets and current liabilities. Acid test ratio= (Current assets – stock – prepaid expenses) / Current liabilities 2005 2004 (18719 – 6519 - 1499) / 13909 0.77 (13283-5084-1450) / 22706 0.30 (P 16) The significant rise is not encouraging since the product dealt is gold which is equivalent to cash and is tradable at any time. Funds locked up in cash and marketable securities are unproductive and reduce profitability. On the other hand the short term creditors will view it as encouraging since it shows improved liquidity. For the shareholders, increase in this ratio means tying up of more in unproductive assets and dilution in profitability. ACTIVITY RATIO (EFFICIENCY RATIO): The efficiency with which the assets are managed/used is reflected in the speed and rapidity with which they are converted into sales. (Davidson and Weil. 1977, 4-9). Total assets turnover: Total assets turnover represents the ratio of sales / cost of goods sold to total assets. Total assets turnover = cost of goods sold / average total assets 2005 2004 80268 / 93339 0.86 85346 / 87931 0.97 P 17, P 16 Analysis: The decrease shows under-utilisation of resources and implies the diminishing percentage of utilisation of assets in relation to the cost of goods sold. From a shareholders’ point of view it means decreasing profitability. i. Current assets turnover Current assets turnover indicates the efficiency with which the firm utilises its current assts to generate sales. Efficient utilization of current assets reflects in the higher rate of current assets turnover ratio. Current assets turnover = cost of goods sold / average current assets 2005 2004 80268/18719 4.29 85346/13283 6.43 P 17, P 16 Analysis: The rotation of current assets in relation to cost of goods sold indicates the better utilization, which, in turn, measures an improvement in the performance and efficiency of management. Thus the drastic decrease manifests the poor performance of the management in spite of redevelopment. This can also imply that the locking of funds in current assets/unproductive assets has increased resulting in decreased profitability. GEARING The capital structure or leverage ratios may be defined as financial ratios which throw light on the long term solvency of a firm. This is reflected in its ability to service the long term creditors. There are two types of such ratios: debt – equity: asset based and coverage: income based. 1. Debt - equity: asset based: It is computed from the balance sheet and reflects the relative contribution of stake of owners and creditors in financing the assets of the firm. i. Debt/equity ratio: Long term debt / shareholders’ funds (equity share capital + Preference share capital + reserves and surplus) 2005 2004 (2117/50931) 0.04 (1093/38366) 0.03 (P16) Analysis: The debt equity ratio has increased from 0.03 to 0.04, which shows that the outside debt is still very low indicating low leverage. This has to be viewed in the context that even after increasing the share capital the ratio has increased. Under the circumstances the company can go for obtaining finance, if needed, but the past performance of making losses will pose problems in raising funds on easy terms. ii) Proprietary ratio: Another variant of the debt equity ratio is to relate the owners/ proprietors funds with total assets. Proprietary ratio = owners’ funds / total assets 2005 2004 50931/93339 0.55 38366 / 87931 0.44 P 16 Analysis: In the context of new issue of share capital the upward increase in ratio is not satisfactory because the same was not based upon good performance. However, it signifies the solvency of the firm which in turn will boost the creditors’ margin of safety. STOCK MARKET ANALYSIS Return on equity funds measures the profitability of firm from the owner’s point of view and it is assessed in terms of the return to the ordinary shareholders. Return on equity funds = (Earning After Taxes – preference dividend) / average ordinary shareholders’ equity. 2005 2004 - 19671/ 50931 0.39 -2 2126/38366 (-) 0.58 P17, P16 Analysis: The company has been suffering continuous loss, but the rate of loss has been reduced as compared to the previous year. This may provide some solace to the shareholders. But when we consider the increase in gold price during the year, obviously the performance cannot be seen in a positive light. As details regarding other similar firms and industry are not readily available, it is not possible to comment the adequacy of the return. Comments on Financial stability of the company The financial stability of a company relies mainly on the sales it generates, and profit it makes. From the balance sheet point of view the combination of assets like long-term debts, short-term debts, and liquidity position reflects the solvency and credibility of the firm. For a shareholder the rate of return on his investment determines the share’s value in the market. Additionally assets turnover, which has a direct bearing on the profitability, also indicates the financial standing of the company. From an evaluation of the financial statements for the years 2004 and 2005, basing on multivariate analysis, it emerges that the company’s sales figures vary drastically during the last three years, as emerging from the given data (2003 – 55576, 204 – 100,394, and 2005 – 90,174) This illustrates the lack steadiness in sales. When compared to the cost of sales it reveals that the percentage of cost of production to sales is 73%, 85%, and 89% respectively, which clearly indicates that gross profit margins are unsteady. Furthermore, other operating cost also varies significantly over the three years. During the year under consideration the cost of energy has also increased substantially. The production of gold varied significantly from 243,333 in 2004 to 204,091 during 2005 which means 84% production has been achieved as compared to last year. But in sales only 83% could be achieved. Operating cost per ounce increased from 336 in 2004 to $ 386 in 2005, which will reduce the profit margin. Conclusion: On going through the balance sheet and comparing the current ratio there is substantial increase which indicates locking up of funds in current assets. Considering the product is gold, which is fast moving, the increased investment is not favourable from profitability point of view. The debt to total assets ratio has fallen low. This means, the company can raise long term funds if needed. But continuous loss making characterises the company’s history, which will prevent it from getting funds required on easy terms. On analysing the whole financial statement it can be understood that the turnover of financial assets, current assets, etc is found decreasing which means that the utilization of these resources is not up to the expectations. The whole problem seems to be attributable to the company’s ability to tone up production to the desired level, and the management’s inability to keep the escalating operating costs under control. Underutilization of resources in contrast to the ready marketability of the product, if the management were able to optimize production, there is a bright future for the company. Though the company is dealing with a fast moving and highly marketable product, it seems to lack a clear sense of direction in the utilisation of the available resources. The management machinery seems to need an overhauling to make it more efficient and result oriented. Graphical Representation. Graph showing Sales, Cost of sales, gross profit Share holder’s equity, Deficit, Current liabilities and other liabilities Chart showing Gold produced, Average sales prices, and Cash operating costs per ounce WORKS CITED Metcalf R.W and P.L. Titard. 1976. Principles of Accounting (W.B Saunders: Philadelphia) White, Gerald et al. 1998 The Analysis and use of Financial Statements. John (Wiley & Sons: New York) Davidson .S and R.L. Weil. 1977. Handbook of Modern Accounting. (McGraw Hill: New York). Helfert E.A. 1972. Techniques of financial Analysis. (Richard D. Irwin: Homewood). Spiller E.A. 1977. Financial Accounting. ( Richard D. Irwin: Homewood, Illinois.) 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