Comparative Financial Analysis - Croda vs Synthomer - Assignment Example

Contents Introduction to Companies 4 Review of Financial Accounting and Reporting Standards 4 Procedures 5 Financial Analysis 5 Liquidity Ratios 5 Current Ratio 5 Quick Ratio 6 Activity Ratios 7 Inventory Turnover in days 7 Receivable Turnover (in days) 7 Payable Turnover (in days) 8 Leverage Ratios 8 Debt to Equity Ratio 8 Borrowing Ratio 9 Gearing Ratio 10 Coverage Ratio 10 Profitability Ratios 10 Marketability Ratio 11 Strengths and Weaknesses of the Report 12 Conclusion 13 Reflective Report 14 Introduction 14 Part 1 15 Part 2 15 Part 3 16 Appendices 17 Appendix A: Financial Analysis and Summary of Financial Information for Synthomer 17 Appendix B: Financial Analysis and Summary of Financial Information for Croda 18 Introduction to Companies Croda International Plc is a UK based company founded by Mr Crowe and Mr Dawe in 1925. The business works to produce products and technologies for the improvement of consumers’ life and entering into different markets to keep the customers at ease. The company works in three mains segments including Consumer Care, Performance Technologies and Industrial Chemicals. Consumer Care segment aims at providing consumers with personal, health and crop care products to make their lives better. Performance technologies, on the other had involve stat-of-art Home care, geo-tech offerings along with additives, lubricants and coatings that touch the contemporary tastes and fashion of the day. Industrial Chemicals, lastly, provide scientifically enrich and tested chemical products. All in all, the company makes use of the best talent in the sector to keep up with the innovative and unique features it provides. Synthomer also works in the chemical industry and deals mainly in production of polymers. Synthomer was established in 1952 with headquarters in Harlow, UK. Both companies keep innovation and technology at the heart of their operations and compete greatly in the global business market. This paper aims at analyzing and comparing the financial performance of the companies using ratios and external research. Review of Financial Accounting and Reporting Standards Both the companies have followed International Accounting Standards (IAS) and International Financial Reporting Standards (IFRS) to prepare the financial reports. They use different accounting policies for the accounts, for instance, Synthomer calculates depreciation on straight line basis over the estimated useful life of an asset and Croda values tangible fixed assets at cost or valuation less depreciation. The accounting policies differ for each account but they remain compliant with the UK accounting standards and companies law 2006. Procedures For the purpose of this assignment, the financial statements of both the companies are extracted from their official website. The information important for the analysis is extracted and summarized in the excel sheet for clarity and ease of use. The analysis covers information from three recent years i.e. 2011, 2012 and 2013. Both the companies belong to the same industry and work in more or less the same product lines. For financial analysis, ratio analysis was used. Ratio analysis is done under 5 main heads namely Liquidity, Leverage, Coverage, Activity and Profitability. The analysis involves comprehensive assessment of the results measured. An analysis is made using personal knowledge and understanding about the issues. The report ends by concluding on the results of comparative analysis. Financial Analysis Liquidity Ratios Current Ratio Current ratio is the measure of a company’s capability to meet its immediate or upcoming obligations (i.e. current liabilities) through its current assets. Stating the obvious, companies intend to keep this ratio higher as it lightens up the pressures of meeting immediate obligations. However, higher ratio may suggest that the company has invested too high an amount in current assets which could otherwise be invested elsewhere to earn profits or capital gains. The current ratio of Croda and Synthomer ranges between 1.2 and 2.2 in the three year period. Generally speaking, a current ratio of more than 1 suggests a satisfactory face of the company. The current ratio of both the companies seems to increase in 2012 but reduce in 2013. Generally and broadly comparing, Croda seems to be in a more lucrative position than Synthomer in the 3 years period under review. The reason for the changes in current ratio is a change in current assets and current liabilities. An increase in current assets and/or a decrease in current liabilities have led to an increased current ratio as shown by the results of Croda and Synthomer in 2012 as an increase from 1.78 to 2.22 and from 1.20 to 1.22 respectively. A more meaningful analysis could be made if industry averages were provided for comparison. However, both companies seem to be reasonably safe in terms of meeting their maturing debts without any difficulty. Quick Ratio Quick ratio is a relatively more accurate measure of liquidity as it excludes inventory from the calculation which can be difficult to convert into cash. The quick ratio of both firms show similar trends, however, any significant difference between current and quick ratio may call for an investigation into the levels of inventory kept by the firm. The quick ratio remains below 1 which shows that the companies are not able to meet their current debts without liquidating a portion of inventories with an exception of 2012 results of Croda where quick ratio remains over 1. However, industry averages may provide a better guide and insight into the matter on the need of the companies to maintain levels of current assets as per the industry requirements. It is worth mentioning that the companies’ inventories levels are rising that may show their inability to convert inventories into sales or the changing industry trends causing this upward trend in inventory levels. There is a need to investigate it further and identify any loss of earnings due to tied up capital in the inventories. Activity Ratios Inventory Turnover in days The inventory Turnover in days has increased from 29 days in 2011 to 35 days in 2013 of Synthomer and from 87 in 2011 to 92 in 2013 of Croda. This suggests that Synthomer holds its inventory for approximately 35 days in 2013 and Croda converts its inventory into sales after holding it for 92 days. Inventory Turnover ratio should be lower as the cost of holding stocks are high and the opportunity cost for the funds stuck up may also be a strain on the company’s profitability. The ratio of increasing inventory turnover is in line with the increasing inventory levels in the three years period under review. It needs to be analyzed, however, if the companies are facing any trouble in making sales, if so, is the trouble internally generated or is it an external factor like recession, economic changes, demographic changes etc. A further analysis is needed to identify the reasons behind this trend. Receivable Turnover (in days) The receivable turnover (in days) shows that Synthomer has slightly decreased its average collection period which is a good sign apparently and Croda has decreased it to a comparatively larger degree. The collection period has reduced from 48 days to 46 days for Synthomer in the three year period and from 51 days to 46 days for Croda. Although the decline is perceived good, it should be compared with the trends in sales. It is quite possible that Synthomer has tightened its debtors’ policy leading to early settlement but may be causing a strain on its revenues as the debtors switch to competitors for credit benefits. On the other hand, Croda may be using cleverly created policies whereby customers are settling the debts earlier to either pursue early settlement benefits or the like as the revenues continue to grow rather than decline. Payable Turnover (in days) Unlike receivable turnover, businesses want to extend payable turnover period for obvious reasons. Firstly, the cash that is being paid up to settle creditors’ accounts could be used for short-term or medium-term investment benefits. Relaxing credit term reveals better relationship of the business with its suppliers and/or a trusting relationship accompanied by higher credibility of the business in the industry. The Payable turnover, however, is declining for both the companies under consideration. The payable turnover declined from 77 days in 2011 to 74 days in 2012 and further to 71 days in 2013 for Synthomer. On the other hand, the average payment period declined from 84 days in 2011 to 71 days in 2012 and further to 62 days in 2013 for Croda. The decline in payable period can either be due to the credit policies of the suppliers, early settlement discounts availed by the companies or the lower credibility of the company to its suppliers. Further insight into the matter can reveal the reasons behind the declining trend. Moreover, it may also be an effect of general industry trends towards keeping a lower payable period due to limited suppliers or higher bargaining power of the creditors. Leverage Ratios Debt to Equity Ratio The debt to equity ratio shows the reliance of the company on external financing over internal financing. The debt-equity ratio reveals that Synthomer was majorly financed with debt arrangements as of 2011 with a debt to equity ratio of 1.4. However, year on year analysis reveals that its reliance on debt financing is reducing showing a debt-to-equity ratio of 1.3 and 1.05 in the year 2012 and 2013 respectively. This decreasing trend toward debt financing can be questionable as debt is a relatively cheaper source of financing. On the other hand, the company is positive in achieving enough equity funding to finance its business which shows its worthiness in the market and in the perception of investors. However, if the company is not able to attain loans or debt arrangements, the reasons behind need to be analyzed closely so as to ensure the company’s credibility as per the records of its finance payments and debt settlement history. Similarly, Croda shows a declining trend in debt to equity ratio. It had a debt to equity ratio of 2 approimately in 2011 which reduced to 1.4 in 2012 to a further declined result of 0.9 in 2013. Although it depends on the industry to which a company belongs and the general market trends to finance through debt or equity along with the vision and policies of the company individually, such a transition is dubious. There is a need to further evaluate the issue and understand the reasons behind this rationale of changing financing policy of the company. When comparing Synthomer and Croda, one can easily identify similar trends of switching from a debt financing philosophy to equity inclined financing policy. The rationale of choosing a more expensive financing arrangement, however, remains a point of discussion. Borrowing Ratio The borrowing ratio includes short term debts in the calculations. It is a more meaningful measure of a company’s leverage position. However, the shortcoming of this ratio is the exclusion or ignorance to the related finance costs which are usually higher for short-term debts. The borrowing ratio declined from 71% in 2011 to 65% in 2013 for Synthomer and from 73% in 2011 to 59% in 2013 for Croda. The declining borrowing ratio for both companies, however, suggests that the company’s debt obligations are also reducing simultaneously and the company would be more likely to meet its debt obligations with the generated funds. However, on the other hand, both the companies are failing to avail the profits they may generate by financial leverage opportunities that they might be avoiding. Gearing Ratio This ratio reveals that 59% of the capital structure of Synthomer comes from debt providers in 2011. The percentage of debt in the capital structure reduced to 59% and further to 56% in 2012 and 2013 respectively. On the other hand, Croda’s capital structure had 67% of debt in 2011 that reduced to 58% and further to 49% in 2012 and 2013 respectively. This ratio provides an aid to measurement of financial risk as the higher it measures the lower is the residual income for distribution among equity holders. Coverage Ratio This ratio reveals the financial safety of the business in terms of meeting its financial costs or interest payments. On the basis of interest coverage, the closer is the ratio to 1, the higher are the chances of financial distress. Although both firms are able to meet their financial obligations in the three year period under consideration, Croda seems to be in a more lucrative position being able to pay its interest about 17 times in 2013. This means that Croda can take 17 times of the current debt it holds and earn more profits by reinvesting these funds. On the other hand, Synthomer has a coverage ratio of 3 times which can be improved if the usual coverage ratio in the industry is significantly higher than this. Profitability Ratios Both companies are profitable; however, Croda seems more pfotable compared to Synthomer as per the Gross profit Ratio, Operating profit margin, Return on Equity and Return on Capital Employed. However, the Asset Turnover seems higher for Synthomer than Croda which shows that Synthomer is more efficient in utilizing its assets. On a closer and individual view on ratios reveal that the Return on Equity and Return on Capital Employed results have declined in 2013 for both Synthomer and Croda showing their inability to properly maintain and manage earnings per the capital and equity base. The companies might be missing on the opportunities to utilize the equity and asset base as efficiently as they were in the previous year. Marketability Ratio The dividend information reveal that Synthomer gives out 0.06 dividend per share in 2013 compared to 0.645 of Croda. This means that investors would be more likely to opt for Croda if their concern is to gain immediate monetary results. The dividend stream, however, over the three year period shows that both the companies have improved their payout per share in the three year period. The rate of increase differs specially for Croda that is efficiently utilizing its assets as the ROE and ROCE suggests. The dividend yield provides information to the investors on how their investment in stock is bringing cash flows to them. The higher is the ratio the more satisfied are the investors. Both companies are more or less equally performing in this area. The dividend cover times, however, are better for Synthomer compared to Croda. The major reason may be low dividend per share than Croda which leads to higher dividend cover ratio. The share prices of Croda are way above Synthomer ranging between 17 to 26 pounds per share during the three year period. The share price is further showing an increasing trend and has increased by about 53% from 2011 to 2013 for Croda which is a very high pace of growth. This increase in price and the apid acceptance of it in the market shows the trust and high worth of the company’s shares in the market. The higher the demand, the greater are the chances of increasing prices for the shares of the company. This further reveals investors’ satisfaction wtiht he company’s performance, hence, Croda seems to be better off in the market. On the other hand, Synthomer’s shares are valued at 1.64, 1.89 an 2.55 in 2011, 2012 and 2013 respectively. The prices are considerably lower than Croda and shows that the company is either not considered well in the market or there is some significant trust issues on the company’s performance. There can be a lot of other reasons behind, but whatsoever the reasons are, the comparison of the companies keep Synthomer at the lower end and disadvantageous on marketability grounds. The price/Earnings Ratio is higher for low-risk companies. In the case of Croda, the ratio is significantly higher at 20 compared to Synthomer’s ratio of 12 in 2013. The investor’s as a result are willing to pay 20 times for each pound of earnings in the equity market for Croda which is enough to prove its performance. Strengths and Weaknesses of the Report This written report has a number of strengths and weaknesses that needs to be addressed. The strengths include the fact that this report is an unbiased evaluation and assessment of financial information available on the companies. It does not compare the figures as they are presented on the face of the financial reports but rather ratios are measured to eliminate the company size and other constraints. The report does not form conclusions based on a single year but rather takes a 3 year period to make comparison more reliable. The report follows a cohesive pattern and is divided in sections for better reader understanding. The report is written in simple language and provides reasoning to support every point. On the other hand, the weaknesses of the report include the fact that the report compares companies of different sizes which has obvious affects on their operations and financials. The report does not make use of press reports, industry averages and the like to form opinions. The report does not incorporate secondary research about the perceptions prevalent in the market about the companies. The report does not pay heed to the fact that Croda is working in the industry far before the existence of Synthomer. The report provides limited insight to the management and other business operations that may impact a company’s financial position. Conclusion Both the companies show increase in sales and are increasing the profits in real terms. However, Croda seems to be in a far better position when it comes to asset utilization and market perception about the company. The share prices reveal that Croda is highly regarded in the market as the price is more than 900% of Synthomer’s shares in 2013. The reason may be higher dividend payout ratio, better investment decisions, better performance and higher sales that Croda achieves year on year. The results of both companies, when independently assessed, seem satisfactory but on comparison, Croda seems to have a better grasp over its finances and financial performance. Synthomer is advised to gain knowledge on how Synthomer has achieved such drastic positive results. This obviously is not a matter of a day but would take changes in policies and a continuous effort to evolve and maintain or improve the performance of the company. Further investigation may reveal the changes in leadership; company’s marketing expertise, relationship building, and management policies that may have a noticeable impact on the financial results of the companies. Reflective Report Introduction The course undertaken provided us in-depth information about the financial statements, the figures and accounts presented thereof and the meaningfulness of the relationship between them. The comparative financial analysis of two UK-based companies provided us with firsthand knowledge on the assessment and use of financial statements, the information and the relationships thereof. The use of financial statements could have been chaotic if the real financial statements were not used. The aim of the project was to compare the financial performance of the two companies and form opinion about their financial position in comparison with each other as well as in the market. The marketability ratios reflected well on how the companies performed and were perceived of in the market. Other ratios including activity, liquidity, leverage and profitability ratios provided better insight into the companies’ ability to stay in business and perform better than the competition. The objective of the learning experience was to provide us with an experience to analyze real and legitimate financial statements of registered companies. The companies that followed IAS and IFRS could obviously provide better information as their reporting style and standards gave better flow of information and the standardized reporting format would further help the students on analyzing any company following standards easily in future. The task clearly was not only related to gaining information and knowledge but rather was a practical experience to deal with real business data and financial information. Part 1 The course and specifically this task resulted in an enhanced knowledge about financial terminologies and concepts. The concept of capital structure is vivid now as the capital structure of the companies used was evaluated. The different modes of financing that were previously discussed in theory were identified when calculating leverage ratios. The firm’s financial performance was understood which previously was mistaken as only a mechanism to be profitable and increase sales. The activity helped in understanding that profitability and increasing sales are only parts of the bigger picture. The real performance involves excellent utilization of resources, increasing market worth, increasing dividend yield, higher Return on Capital employed and better control on creditor and debtor periods. The activity further helped in implementing the theoretical knowledge which was previously seemed as unusable or easily forgettable. The activity also helped in understanding the reporting standards and provided insight to the ease for users of financial statements by the use of IFRS. The activity also helped in learning about the financial changes that companies make over time like the change from debt to equity financing, reduction or increment of assets and so on. After this activity, the theoretical knowledge made sense in its real essence since most of what we had learnt applied o the companies under consideration well. Part 2 After the learning experience, my knowledge about finance and financial information has been greatly enhanced. The review of financial statements provided information on how the companies break down their information, provide notes to almost every account presented on the face of the financial statements for user understanding and have a transparent year-on-year data available. The analysis of financial statements provided a deeper understanding on what could have done if the reporting standards and accounting standards were not followed. The fraudulent activities and the decline in profits can be identified if standards are followed as they are made. I have learnt to analyze and read real financial statements along with an experience to create meaningful relationships between different accounts of the financial statements like Return and Capital Employed or Current assets and current liabilities and so on. I have learnt that finance is not only about being profitable but it is more about staying profitable and efficient. The use of finances is not to build a short-term profit but have a far reaching perspective to stay in business and to keep the world informed about the company’s operations. The statements do not only include information about financial results but also highlights the ethics and social responsibility initiatives and other information about prospects that help investors and analysts greatly. Part 3 After the experience I feel more comfortable with the use of financial statements of any company that has followed the financial reporting standards. The knowledge gained in this learning experience has made me more confident, knowledgeable and sensitive to the law and required professional excellence in maintaining records for any company. I feel motivated to report findings as per the standards wherever possible as I have learnt the need and ease of standardized documents when I went through the financial statements of two different companies. It was less haste and trouble identifying the relevant information and I feel such cohesive approach can lead to greater benefits in life and professional working environment either it is sued to maintain monthly records of managerial activities or maintaining a record of personal dietary habits. Such documentations and records can bring order in life and may be sharable with people needing the same information. I feel I could have done better in this learning experience by bringing in some external information through research. Appendices Appendix A: Financial Analysis and Summary of Financial Information for Synthomer Synthomer ￡m ￡m ￡m Dec-11 Dec-12 Dec-13 Revenue 1,116.8 1,111.8 1,054.9 Cost of revenue 907.6 900.5 819.3 Gross profit 209.2 211.3 235.6 Operating costs 154.8 136.4 160.6 Operating profit 54.4 74.9 75.0 Earnings before interest and tax 39.5 62.3 59.1 Financial expenses 14.9 12.6 15.9 Total comprehensive income for the year -49.4 32.3 40.2 Total Assets 939.4 885.9 862.1 Total Liabilities 664.3 599.3 559.6 Total shareholders equity 275.1 286.6 302.5 Total Liabilities and shareholders equity 939.4 885.9 862.1 Gross profit ratio 19% 19% 22% Operating profit margin 5% 7% 7% Return on equity 14.36% 21.74% 19.54% Return on capital employed 4.20% 7.03% 6.86% Asset turnover (times) 1.1888 1.2550 1.2236 Equity multiplier (times) 3.41 3.09 2.85 Debt-to-Equity Ratio 1.437 1.294 1.050 Borrowing Ratio 71% 68% 65% Gearing Ratio 59% 56% 51% Interest Coverage Ratio 2.65 4.94 3.72 Share price (end of the year) ￡ 1.64 1.89 2.55 Earnings Per Share (￡) 0.18 0.209 0.207 Price/Earnings ratio (times) 9.13 9.02 12.29 Earnings Yield 10.96% 11.08% 8.13% Dividends 0.035 0.055 0.060 Payout Ratio 19% 26% 29% Dividend yield (times) 0.0213 0.0292 0.0236 Dividend cover (times) 5.143 3.800 3.450 Current assets 323.8 279.5 283.9 Current liabilities 268.9 228.3 242 Inventory 73.8 78.1 79.4 Trade Receivables 146.7 139.0 133.3 Trade Payables 193.7 184.8 161.0 Non-Current Liabilities 395.4 371.0 317.6 Purchases (COS+EI-OI) 916.0 904.8 820.6 Current ratio 1.20 1.22 1.17 Quick ratio 0.93 0.88 0.85 Inventory Ratio (Days) 29.68 30.78 35.08 Receivables turnover 47.945 45.633 46.122 Payables turnover 77.184 74.549 71.612 Net change in cash and cash equivalents 50.1 -31.5 9 Appendix B: Financial Analysis and Summary of Financial Information for Croda Croda ￡m ￡m ￡m Dec-11 Dec-12 Dec-13 Revenue 1,028.0 1,051.9 1,077.0 Cost of revenue 687.7 694.6 713.9 Gross profit 340.3 357.3 363.1 Operating costs 102.6 101.9 99.8 Operating profit 237.7 255.4 263.3 Earnings before interest and tax 237.5 253.2 250.1 Financial expenses 10.2 17.8 14.5 Total comprehensive income for the year 104.8 149.4 148.0 Total Assets 997.5 1,003.5 1,017.0 Total Liabilities 731.3 659.2 597.6 Total shareholders equity 266.2 344.3 419.4 Total Liabilities and shareholders equity 997.5 1,003.5 1,017.0 Gross profit ratio 33% 34% 34% Operating profit margin 23% 24% 24% Return on equity 89.22% 73.54% 59.63% Return on capital employed 23.81% 25.23% 24.59% Asset turnover (times) 1.0306 1.0482 1.0590 Equity multiplier (times) 3.75 2.91 2.42 Debt-to-Equity Ratio 1.997 1.409 0.968 Borrowing Ratio 73% 66% 59% Gearing Ratio 67% 58% 49% Interest Coverage Ratio 23.28 14.22 17.25 Share price (end of the year) ￡ 17.89 24.27 26.76 Earnings Per Share (￡) 1.117 1.221 1.322 Price/Earnings ratio (times) 16.02 19.88 20.24 Earnings Yield 6.24% 5.03% 4.94% Dividends 0.550 0.595 0.645 Payout Ratio 49% 49% 49% Dividend yield (times) 0.0307 0.0245 0.0241 Dividend cover (times) 2.031 2.052 2.050 Current assets 354.6 387.2 367 Current liabilities 199.6 174.1 191.8 Inventory 164.6 170.5 192.8 Trade Receivables 145.7 162.9 136.7 Trade Payables 159.4 136.5 126.5 Non-Current Liabilities 531.7 485.1 405.8 Purchases (COS+EI-OI) 687.7 700.5 736.2 Current ratio 1.78 2.22 1.91 Quick ratio 0.95 1.24 0.91 Inventory Ratio (Days) 87.36 88.04 92.87 Receivables turnover 51.732 56.525 46.328 Payables turnover 84.602 71.124 62.717 Net change in cash and cash equivalents -22.8 13.4 -25.2 Read More