Accounting Ratio Analysis for Hysan Development Company Limited - Essay Example

Accounting Ratio Analysis for Hysan Development Company Limited of Introduction.This paper seeks to evaluate the financial performance of Hysan Development Company Limited (or “Hysan”) for the past five years based on its financial statements for the purpose of makings suggestions that can be proposed in the end to assist further improvements of the company. The financial analysis will take off from the point of view of financial ratios including profitability, efficiency, liquidity and solvency then linking the same with wealth maximization objective of the company using investment or valuation ratios. 2.1 Brief Company Background of Hysan Hysan, together with its subsidiaries, is into property investment, management and development. The company has three segments in operating as such in the industry. First, is has its Office segment, which is in charge of leasing of office space and related facilities to various customers from office users. Second, it has its Retail segment, which takes charge of the leasing of space and related facilities, this time to a wide range of retail of retail and leisure operators. Third, it has its Residential segment, which takes charge of the leasing of luxury residential properties and related facilities. The company has continued to expand over the years and as of December 31, 2012, its investment property portfolio has reached an approximate level of more than 4 million gross square feet of office, retail and residential space in Hong Kong. The Companys subsidiaries as of 2012 included HD Treasury Limited, Admmore investments Limited, Hysan China Holdings Limited, Hysan Corporate Services Limited, Hysan (MTN) Limited and Hysan Leasing Company, among others (Reuters, 2014a). . 3.1 Profitability Analysis Profits are created from the surplus of revenues over expenses. This would require a way to gauge revenues and expenses which are extracted from the financial statements of the companies under study. Various categories of expenses according to functions, get deducted from the revenues for purposes of computing profit or income. First is the direct cost or called cost of sales or revenues is deducted first from revenues to arrive at gross profit. From gross profit, operating income will be derived after deducting further selling and administrative expenses will be deducted to arrive at operating income. From the operating income, net income determination will follow after non-operating incomes or expenses are added/deducted accordingly from the operating income (Johnson, et al, 2003). After producing the various categories of income --- gross profit, operating income and net income, each result can be related by dividing each by the total revenues to determine how the company is performing. Net Income can be related by dividing the same by total assets or by total equity to determine the profitability level of Hysan . Hence, Hysan’s profitability ratios include gross margin, operating margin, net profit margin, return on assets and return on equity . Profitability with the meaning of having surplus of revenues over cost and expenses of doing business, can in effect increase the book value of the company. Theoretically this should mean increased wealth of shareholders as the profits are accumulated overtime and are termed as retained earnings in the financial statements of Hysan (Brigham and Houston, 2011). Table A below summarizes the comparative financial ratios of the companies for the past five years and compares the same with industry averages. Table A: Summary of Financial Ratios (Hysan, 2014a,2014b, 2014c, 2014d; Reuters, 2014b) By examining the gross margin of Hysan, the company reflected a five-year average of 86% as against industry average of 46%. This is indicative of higher profitability for Hysan, which is validated by having very much higher average operating margin of 305%, or about ten times more as against industry average of 33%. Higher five-year average net profit margin for Hysan of 287% further confirms the higher profitability of the company as against industry average of 23%. The difference this is time is more than ten times than average competitors in the industry. The very significant difference between Hysan operating margin and net profit margin could be attributed to the presence of very non-operating income for the last five year. This means that the company was earning very high profit from its investments outside the company in addition to its operations. Please refer to See Table An above together with Appendices A and B for the formula and summary of extracted data from the financial statements Hysan. As Hysan delivers goods and services to its customers and its other stakeholders, the company needs to know how through its various ratios it is performing in the same way that persons consult their doctors about their health a certain points in time. Knowing its financial wealth will enable the company to maintain or improve its present level of performance Gross profit margin which relates to gross income to sales indicates the extent how much can the companies can get from selling the products and services by comparing the selling price and the cost of the product. It may be pointed out that Hysan has 86% average gross margin but the rest of competitors are having above 46%. This would indicate on the hand a very high profitability level, implying possible limitation for the company to become more profitable. This was further observed in the relationships with net profit margins and net operating margins of in relation to the industry, where differences became bigger. It would mean that profits from operations were further improved from profits from non-operating activities. See Table A above. A deeper way to check of profitability of Hysan is to use the decomposition framework. To apply the same framework to the analysis at hand, would require the breakdown of the companys profitability ratios particularly the return on equity. ROE is actually broken down in return on assets (ROA) and equity multiplier (EM). The formula for ROA is to divide net income by the average total assets , while EM is computed by dividing total assets to divided total equity. Observe from the effect of the formula that the higher the equity multiplier, the higher would be the effect on the resulting return on assets. This indicates that high equity multiplier, would mean more debts than equity to finance the activity of Hysan. Simply said, this would mean higher risk by the company. The implication would be that the higher ROE was caused by effective or strategic financing by the company. In other words it would indicate that it could be able to take advantage of higher leverage by increased borrowing and benefiting from the tax shield as a result of the deductibility of interest expense in the computation of the net income of the company. However, the result of this would only be confirmed in the gearing ratio analysis. ROA is actually broken down into return on sales or net profit margin (NPM), computed by having total net income divided by total sales, and multiplying the same by total assets turnover , which is also computed by having total revenues divided average total assets. The higher the asset turnover, the higher would be the resulting ROA (Helfert, 2011). As applied now to Hysan, it could be observed that ROA was increasing from 2009 through 2012 and a decline only happened from 2012 to 2013. See Table A in relation to Appendices A and B. 3.2. Liquidity ratios Profitable companies are not assured that business will not get bankrupt. There must be a way to measure whether a company could go bankrupt and this through liquidity (Helfert, 2011) .Companies need to have good liquidity ratios to show that they are able to pay current obligations. Capable management of companies needs to demonstrate its ability to meet currently maturing obligations to prevent the fear or actual bankruptcy which is bad for said investors. Good liquidity is similar to having a well-conditioned car which can convince its owner freedom from trouble at least in a given period of time, which is usually one year. If a company can pay timely the salaries of its employees, then the latter could continue rendering services to the company as they assist management in delivering value to customers. If accounts payables with outside suppliers are paid on time, then the latter would continue delivering goods and services to customers. Liquidity also presupposes that other accrued expenses are settled at the right time to assure continued flow of activities in a regular manner. As to whether the company has higher average liquidity, the ratios should confirm the same. Hysans average current ratio for the past five years at 1.70 was lower than Industry average with 3.19 while its average quick ratio registered at 1.79 as against industry average of 1.69. Although lower than industry average, the company is evidently capable of meeting its obligations to creditors. See Table A above. 3.3 Gearing A company may be profitable yet may be too risky. One way to measure risk is the use of gearing ratio. Said gearing ratio is similar to solvency which measures the financial leverage of entities by signifying the degree of how the company is funded from shareholder as against creditors (Higgins, 2007). Companies basically manage assets as they engage in producing profits which are partly financed by shareholders and creditors. The need to borrow or have additional investment from stockholders is two competing options for every company. Companies get managed via the board of directors and shareholders, with the latter electing the former. The board of directors sometime may sometimes require additional investment from these owners but they can opt to incur debt or loan agreement, by borrowing funds to have more assets to be used in business. The increased in assets is geared toward increasing revenues pursuant to growth strategies of companies. Companies need grow overtime as proof if they successfully address through correct strategies the industry threats and that they can take advantage its industry opportunities. The choice to borrow or have stockholder make additional investment must be associated strategically to wealth maximization as may be evidenced by increasing prices of companies’ stock in the stock market. This will be discussed further in the valuation or investment ratios to be discussed later. Companies have to know its limits when to resorts to borrowings or debts from creditors by the use of gearing or solvency ratio. This can be accomplished through the debt to equity ratio computed by dividing total liabilities with the total equity of the corporation. Using said ratio, Hysan reflected an average debt to equity ratio for five years at 0.19 as against Industry average at 0.81. See Table A above. This means the Hysan is better in leverage compared with competitor Industry average and the rest. Note that the higher the ratio, the higher is the leverage and hence Hysan is less risky. To complete the analysis in relation to high ROE, it may be noted that its gearing suffered only slight fluctuations with the range of 0.18 to 0.22, which indicates that company was almost stable for its gearing in the past five years. This would now not confirm the higher ROE of the company which was earlier speculated to have been caused by increasing gearing. The better explanation of the ROE was the very non-operating income which consistently earned for the past five years. 3.4 Investment or valuation ratios Companies aim not only for profitability, they also aim for wealth maximization (Brigham and Houston, 2011). While there is normally a direct relationship between generating more profits generating more wealth, looking at the ratios may say otherwise. The factor that would explain the exception is attributable to assessment of long-term risk from the investors. Finance theory supports the claim that the higher the return, the higher would be risk and vice versa. As to how these happen, a comparison of the profitability and investment ratios must be done in the case of Hysan. How investors’ responded to profitability is measurable investment ratios which include price-earnings ratio, price to sales, price to book ratio, price to tangible book and even price to cash flow. Please refer to Table B below. It was found earlier that Hysan was more profitable than Industry average, but it has less liquidity than the latter. In terms of gearing, Hysan was also less risky. As to whether investors trust one company over the other is measured in terms of valuation ratios and investors gave less favour to Hysan as against that of its average competitors in the industry. In terms of P/E ratio for the last five years Hysan reflected lower average ratio of 10.02 as against industry average of 81.31. This means that despite higher profitability of Hysan compared with Industry average, investor could assume a higher risk with Hysan’s average competitors over that of the company. This means that there are rooms for more increase in stock price of the company. Please refer to Table B below. Table B- Comparative Investment Ratios (Reuters, 2014b) 4. Conclusion This paper has found better profitability and less risky position of Hysan compared to that of Industry average. However, in terms of wealth maximization strategies, what is employed by Hysan appears to be not better than that of Industry average on the average for the past five years. In addition, it has shown higher liquidity as against Industry average and its other competitors in the industry. Its more superior financial leverage compared with Industry average, was not well taken positively by investors as investors are less than willing to assumed risk with Hysan compared with Industry average. Hysan has not responded better to its strategic issues. Although it appears that between Hysan and Industry average , the latter is better than the former in terms only in terms investment ratios of the former raises a question as to weight of relevance of ratios for profitability and solvency ratios alone. Compared however with rest of competitors in the industry is has lower price-earnings ratios. The higher ratios of the industry point to the non-maximized wealth-generation potential of the Hysan. It is not enough that it the company has very high profitability and acceptable level of liquidity and less risky position if the response of investors is not at maximum. Hyan needs therefore to convince investors of being capable to deliver higher values than competitors in support of this higher profitability and less risky leverage position. Appendices References: Brigham and Houston (2011). Fundamentals of Financial Management, Concise Edition. Cengage Learning Helfert, E. (2011). Techniques of Financial Analysis: A Mode. McGraw-Hill Education (India) Pvt Limited Higgins (2007). Analysis for Financial Management, Eighth Edition. The McGraw−Hill Companies Reuters (2014a). Company Profile. Retrieved 23 March, 2014 from < http://www.reuters.com/finance/stocks/companyProfile?symbol=HYSNF.PK > Reuters, (2014b). Industry Ratios. Retrieved 23 March, 2014 from < http://www.reuters.com/finance/stocks/financialHighlights?symbol=HYSNF.PK> Hsan (2014a). Annual Report year 2012. Retrieved 23 March, 2014 from Hsan (2014b). Annual Report year 2011. Retrieved 23 March, 2014 Hsan (2014c). Annual Report year 2010. Retrieved 23 March, 2014 from Hsan (2014d). Annual Report year 2009. Retrieved 23 March, 2014 from Hsan (2014e). Annual Report year 2008: Retrieved 23 March, 2014 from Read More