Financial Statement Analysis - Case Study Example

Running Head: Vodaphone v. France Telecom Financial ment Analysis of Vodaphone v. France Telecom of of Professor 8 April 2008 1. Introduction This paper seeks to analyze and discuss the financial position and performance of Vodafone over the four financial years from 2003 to 2006 in comparison with its major competitor France Telecom. The analysis will consider all related qualitative and quantitative information that may include both past official announcements and company related news and financial ratios extracted from the companies’ financial statements. 2. Analysis and Discussion 2.1 Profitability Vodafone’s profitability is obviously less desirable than France Telecom. Based on net profit margin for years 2006, 2005, 2004 and 2003, Vodafone had -30%, -37%, -24% and -30% respectively as compared with France Telecom’s 3%, 12%, 6% and 8% for the same years respectively. Please see Appendix A. The same behaviour may be observed in terms of operating margin and gross margins for the same years respectively. These are all relevant evidence of poor performance for the poor performance of Vodafone. It was only for the years 2004 and 2003 that the company had positive gross margin. In other words, the company has in fact been losing money for the years 2003 through 2006. For purposes of comparing the company’s operating margin of the two companies against the industry average, Vodafone is performing poorly compared France Telecom where average for operating margin 17% as taken from MSN (2008) under the telecommunication services. France Telecom had actually the same 17% average for the last four years while Vodafone’s average for the same period, was -29%. Please see Appendix A. Even in terms of Return of Assets (ROA, Vodafone had -8%, -7%, -7%, and -7% for the years 2006, 2005, 2004 and 2003 respectively which faired poorly again compared with France Telecom’ s 6%, 23%, 19% and 32% for the same years respectively. The results of these ratios further confirmed earlier observation in negative net profit margin for Vodafone. The same less desirable or profitability is further observed in terms of Return of Equity where Vodafone showed -6%, -5%, -6%, -6% for the years 2006, 2005, 2004 and 2003 respectively which are definitely lower than that of France Telecom which showed -6%, 2%, 5%, 3% and 4% for the same years respectively. Please see Appendix A. Although France Telecom also reflected negative ROE for 2006, it may be pointed out that years before the company were indeed clearly more profitable. It may be asserted that two ratios have different purposes. ROA measures how efficient management of company was in terms of assets employed in business while ROE measures how much management is compensating resources invested by stockholders. By comparing the two ratios, it would seem that the management of Vodafone has shown also shown low leverage in using company’s assets as well as compensating its investors as against France Telecom which has managed well. Generally, every business should have profitability (Ross et. al ; 1996) as its primary goal in all of its business ventures for without which the business will not survive in the long run, thus the need to measure current and past profitability as well us making projection of future profitability. Basically profitability is only measuring income and expenses. A company as a rule must have higher income than expenses. The relationships of the two accounts are not actually as simple as being defined since it could happen that expenses become higher than income. Before comparing the two it must be made clear that income is money generated from the activities of the business but said activities had cost and they are called expenses. Before expenses could be incurred however, the business entity must have assets. Assets are either generated from the investment of the owners or from the assets provided by the company creditors. Profitability is therefore simply measured in the income statement with the desired effect of having more revenues over expenses. The said accounting information could however be further manipulated by converting them into ratios as used in this paper. 2.2 Liquidity The company’s liquidity shows the capacity of the company to meet currently maturing obligations (Meigs and Meigs, 1995) and the same could be measured by the quick ratios and current ratios. Vodafone’s quick ratios which were showed at 0.37, 0.48, 0.62 and 0.34 for the years 2006, 2005, 2004 and 2003 respectively or an average of 0.45, are better as against the France Telecom’s quick ratios of 0.46, 0.44, 0.40 and 0.28 for the same years respectively or an average of 0.40. Please see Appendix A. Quick asset ratio is which is measured by dividing quick assets by the total current liabilities. The same behaviour may be observed in the current rations of the two companies. Vodafone’s current ratios reflected 0.49, 0.64, 0.88 and 0.60 for the years 2006, 2005, 2004 and 2003 respectively or an average of 0.65 as against France Telecom’s current ratios of 0.54, 0.50, 0.46 and 0.45 or an average of 0.49. Please see Appendix A. In comparing quick ratio from current ratio, it may be noted that quick ratio is better measure for liquidity since the same excludes inventory in the composition of the quick assets. It may be observed however that the results of the profitability analysis appear to create some inconsistency in the resulting liquidity ratios of the Vodafone and France Telecom on the premise that better profitability should contribute to better liquidity. As how the seeming inconsistency could be explained is matter of financing strategy which would be determined latter in the succeeding subsections. As a general rule for a company to have a good liquidity, the ratio of current or quick assets to current liabilities (Bernstein, 1993) should be at least one since this would mean that a company must be able to match 1 British pound sterling from it current assets to every pound sterling of its currently maturing obligations. Failure of a company to do this could mean bankruptcy and may force the company to stop operation. This must be so since the salaries of its employees which must come every payday cannot wait longer for people need to have their living expense. Quick assets that include cash, marketable securities, short term investments, accounts receivable and notes receivable must be ready to match maturing obligations. Using this knowledge therefore in the case of the Vodafone and France Telecom, it may be noted that quick ratios for both companies in 2006 were less than 1.0 for both companies, hence there is evidence to conclude the both have weak liquidity particularly since they had reached below 0.50 or half of the regular liquidity. It is only in current ratio that Vodafone managed to have above 0.50 but still below the normal 1.0 liquidity. As quick asset ratio is more refined ratio than current ratio, the same normally carries a lower figure than that of the current ratio, as confirmed in this analysis. What may be surprising to note is the better liquidity of Vodafone as compared with France Telecom despite the greater profitability for the latter as earlier analyzed. This could be an indication that France Telecom still failed in its liquidity management. This behaviour may be explained by the fact the Vodafone had liquidity as for the years 2003 and 2004 which were posted at 0.88 and 0.60 current ratios as compared with France Telecom whose current ratios at that time were posted at 0.46 and 0.45 for the same years respectively. This means the less profitability for Vodafone also caused a decline it its liquidity but not big enough to erode earlier liquidity. This could be proved by the fact that in 2006, Vodafone had lower current ratio of 0.37 as against 0.49rfor France Telecom. 2.3 Solvency Like liquidity, solvency is concerned about the ability of a firm to pay its debts with available funds like cash which is presumed to exist. However, this time this solvency is different from liquidity since solvency must be long term or it must speak for the financial stability of the company to survive short term problems. The company must have sufficient investment from stockholders (Van Horne,1992) to match long term debt of the company together with currently maturing obligation. To apply the concept in the instant case , debt to equity ratios for Vodafone are 0.48, 0.29, 0.31, 0.27 for the years 2006, 2005, 2004 and 2003 respectively or an average of 0.34 while France Telecom has reflected debt to equity ratios of 2.85, 3.40, 5.83 and 7.30 for the same years respectively or an average of 4.85. Please see Appendix A. The debt to equity ratios are considered better this time for the company if they are lower as compared to profitability and liquidity ratios. Hence in 2006, Vodafone has shown better solvency than that of France Telecom but for whole four year period because of lower ratios. The behavior in the solvency ratios appear to confirm the behavior of liquidity that was earlier described as Vodafone has shown better liquidity on the average despite the higher profitability of France Telecom for the said 4 years. But if this paper goes back again to profitability which should be the better source of funds, it would be more logical to expect better solvency for France Telecom. To explain therefore the seeming conflict, is the fact the France Telecom was already highly leveraged as early as 2003 where it started to 7.30. Hence the profitability that France Telecom had for the past four years had indeed resulted to reduce debt to equity ratio but it was not good enough to defeat the very good financial leverage of Vodafone in 2003 at 0.48, which was very much below a normal ratio of 1.0. At this point it may be observed that Vodafone was not profitable for the last four years, yet it has better liquidity and solvency ratios than France Telecom on the average for the years 2003 to 2006. As to which one is better investment option may be analysed further using stock price behavior in the next subsection. 2.4 Stock price analysis The behavior of the stock prices is also a good tool to determine where the company is going. The two separate graphs below would be explained what determined their price changes. Figure 1: Vodafone stock graph; Source: MSN (2008) Figure 2 – France Telecom stock graph ; Source : MSN (2008) It would appear from the graphs above that the stock prices of both companies fell sometimes toward the end of 2005 but rose again at the middle of 2006. They have almost behaved similarly. As to which one is better is a difficult choice to make but this researcher will choose France Telecom over that of Vodafone in terms of making one over the other as an investment option. 3. Conclusion Given the less profitability of Vodafone which was even proved worse than France Telecom but better liquidity and solvency as compared to that of France Telecom, it appears that that it is less riskier to invest at Vodafone rather France Telecom. However, for investment purposes, this paper recommends France Telecom for the simple reason that the company has proven profitability for the past four years and has improved its rather risky position from 7.3 to 2.85 debt equity. Vodafone will still have to prove profitability. Since profitability is the more immediate and compelling objective, the same must be considered as better basis for decision although liquidity and solvency are also important. The normal thing to happen is for profitability to build on liquidity and solvency. 4. Appendices Appendix A Vodafone 2006 2005 2004 2003 Average Net Profit Margin -30% -37% -24% -30% -30% Gross Margin -18% -30% 42% 41% 9% Operating Margin -37% -48% -13% -19% -29% Inventory turnover 94.70 63.19 42.49 49.03 62.35 Total asset turnover 0.19 0.15 0.23 0.19 0.19 Quick ratio 0.37 0.48 0.62 0.34 0.45 Current Ratio 0.49 0.64 0.88 0.60 0.65 Times Interest Earned 8.34 4.69 6.03 13.10 8.04 Debt equity ratio 0.48 0.29 0.31 0.27 0.34 Debt ratio 0.33 0.23 0.24 0.21 0.25 Return of Assets -8% -7% -7% -7% -7% Return on Equity -6% -5% -6% -6% -6% Appendix A France France France France Telecom Telecom Telecom Telecom average Net Profit Margin 3% 12% 6% 8% 7% Gross Margin 56% 59% 61% 63% 60% 14% 22% 19% 15% 17% Inventory turnover 61.26 56.30 70.32 89.38 6932% Total asset turnover 0.50 0.44 0.46 0.46 47% Quick ratio 0.46 0.44 0.40 0.28 40% Current Ratio 0.54 0.50 0.46 0.45 49% Times Interest Earned 291.17 524.90 302.41 27962% Debt equity ratio 2.85 3.40 5.83 7.30 4.85 Debt ratio 0.74 0.77 0.85 0.88 81% Return of Assets 6% 23% 19% 32% 20% Return on Equity 2% 5% 3% 4% 3% References: Bernstein (1993) Financial Statement Analysis, IRWIN, Sydney, Australia Brigham and Houston (2002) Fundamentals of Financial Management, Thomson South-Western, London, UK Meigs and Meigs (1995) Financial Accounting, McGraw-Hill, London, UK Van Horne (1992) Financial Management and Policy, Prentice-Hall International, London, UK Ross et. al (1996) Essentials of Corporate Finance ,IRWIN, London UK Read More