Long Term Investment In Amari Plc - Case Study Example

 Long Term Investment In Amari Plc Executive Summary This report covers the financial analysis of Amari plc for the period 2005 to 2009. Purpose of the analysis is to provide an advice to a client on the feasibility of a long term investment to the company. Present financial status of the company is not healthy as it has suffered losses in 2009 said to be due to the economic crisis and recession. The economic crisis is far from over and based on observations will take more years to recover. The study looks at the possibility of investment in Amari plc using the financial tools of ratios and comparison to find the status of the company as compared to its closest competitor. Study showed that aside from recession, there are other reasons why the company has failed. Analysis of an investment The Amari plc Background information. Client has requested for a financial advice on the feasibility of making a substantial long term investment in Amari plc. Amari plc is a company that supplies financial consultancy services to the UK banking and financial services sector. The banking and financial services sector is among those businesses that suffered economic losses in 2008. Financial institutions have adopted tight credit policies and have reduced lending transactions. The recession has affected the volume of Amari’s business but management of the company is being optimistic for the upturn of the business as they are now seeing a slight improvement in the economy. Amari’s closest competitor is Braemar plc that is operating worldwide. Braemar has been able to cushion the effect of recession as shown in their financial highlights. A financial analysis is done thru the computation of analytical ratios from financial statements and interpretation of these ratios to determine their trends as a basis for management decisions The reference points here are the financial year 2009 and 2008 as a basis for historical value. To be meaningful, ratio is compared to the values of Braemar because it has the same operational goals. Ratios become significant when they are combined with others as it shows indicators that could show the firm’s financial situation Analysis of the financial statements of Amari provides us a picture of its profitability, efficiency and portfolio quality. Analysis of Amari plc The result of financial analysis in the study is provided below. Calculations are attached as an appendix. An interpretation is also given, and an explanation for the limitations of the ratios used with reference to the information in the case is presented. Analytical tools used are growth rates, price earning ratio, profit margin, financial conditions, liquidity, investment returns. And management efficiency I. Growth Rates. The fluctuation of sales and net income are seen on growth of sales and net income over the years. Movement and changes are indicative of operations and could be described by the two historical figures. The sales growth rate of Amari for 2009 and 2008 showed a negative -0.20 rate meaning the company has been unprofitable in 2009. Similarly, the growth of its net income slowed and was zero in 2009. 2. Price Earning Ratios Price earning ratio is defined as a valuation ratio of a company’s current share price compared to it’s per share earnings, and is calculated as “market value per share divided by earnings per share. The present market value per share of Amari is 230 pence half the price two years ago. An earning per share, as stated in the financial statement is 0.50 pence. P/E ratio = (market value per share divided by Earnings per share ) is 0.46% This is considered to be very low as the typical price earning ratio for this sector is 12% (Investopedia n.d.) 3. Profit margin This is defined as earnings expressed as a percentage of revenues. It is the percentage of sales left for the company as profit after paying all expenses. (Money Chimp n.d.) a. Gross profit margin Gross profit is what remains after the company pays out the cost of goods sold. In 2009, gross profit margin is 26% and 35% in 2008. which is higher than Baremar’s 25% in 2009. This ratio indicates that Amari will be able to pay its operating and other expenses. A gross profit ratio, as a rule, should not fluctuate much from one period to another. Fluctuation in gross profit means there has been changes in the cost of goods sold or pricing policies. (Investorwords n.d.) As shown, there is a big fluctuation in the gross profit margin of Amari for the 2 year period that indicated an underlying problem in the operation. b. Net profit margin is calculated by getting the net profit divided by net revenues, often expressed as a percentage. A high net profit margin indicates the company can effectively convert revenues into actual profit. It also shows the efficiency of the company in cost control. The net profit margin is an effective way of gauging business conditions of the companies in the same profiles. The higher the net profit margin, the better it is for the company. In 2009, Amari has a negative -0.079 profit margin, that contrast to 2008 0.084 profit margin. In comparison, Braemar has a 15.4% profit margin and 18.0% in 2008. Conditions of both companies suffered a slow growth in net profit margin, and even negative growth for Amari. 4. Financial condition It is the status of a firm's assets, liabilities and equity positions at a specific point in time, often described in a financial statement. a Debt-ratio. Unlike liquidity ratios which are concerned with short term assets and liabilities, the financial leverage ratios are concerned with the long term solvency of the firm. It is measured by debt- ratio which is found by dividing total debts over total assets. In 2008 and 2009. Amari has a ratio of 1 b Debt-equity ratio. It is a measure of total debt over total equity. The D/E of Amari in 2009 is 2.33%.and in 2008 2.48% Debt-equity ratio indicates what proportion of equity and debt the company is using to finance its assets and is calculated as total liabilities divided by shareholders equity. “A high debt/equity ratio generally means that a company has been aggressive in financing its growth with debt. This can result in volatile earnings as a result of the additional interest expense..” (Investopedia n.d) The ratio shows that a lot of debt is being used by Amari to finance its operations. This has two way results. First, investors will be happy because earnings will be spread to the same number of shareholders. However, if the cost of financing overweighs the returns the company gets on the debt used in the business, it becomes difficult to handle thereby pushing the company to bankruptcy. 5. Liquidity ratios The two ratios that provide information about the ability of the company of the company to pay its maturing debts are the current ratio and the quick ratio. Short-term creditors are particularly interested in these ratios to see if they could be paid at once by creditors. A higher current ratio indicates the company is liquid. a. The current ratio of Amari for 2009 is 1.9% which is higher than 1.4% of 2008; while that of Baremar is 1.8 times for a 2 year period. At this point, current ratio of Amari can support short term debts of the company.(netmba n.d.) There two diverging opinions set here. According to netmba.com, short term creditors are happy with high current ratio, while shareholders prefer low current ratio as this could mean that the company is using more of its assets to keep business growing. b. Quick ratio makes similar calculations, but does not include inventory in the process on the reason that inventory is not quickly liquidated. Quick ratio of Amari for 2009 is 1.45%, higher than 1.175% in 2008. Baremar has 0.9 and 1.0 for same period of comparison. I found that the current ratio of Amari is higher than its quick assets. According to Investopedia, if the current ratio of a company is higher than its quick asset, it is interpreted as the company’s current assets are dependent on inventory. (Investopedia n.d.) 6. Investment returns. Return on assets, return on capital and return on equity a. Return on equity. This is a ratio that measures the profits earned for each dollar invested by the shareholders in the firm’s stock. It is calculated by getting the net income divided by the shareholders equity. For 2009, AMARI has a negative ROI of -0.45, while for 2008, ROE is 0.6 b. The Return on Capital Employed (ROCE) Amari has -13.98% ROCE in 2009 and 23.18% in 2009. Braemars has 16% ROCE for 2009 and 20% ROCE for 2009. A ROCE is defined as “the ratio that indicates the efficiency and profitability of a company’s capital investments.” (Investopedia) Both companies suffered a reduction of ROCE and has an implication on its efficiency and profitability. c. Return on assets (ROA) A ROA is an indicator of how profitable a company is relative to its total assets. ROA gives an idea as to how efficient management is at using its assets to generate earnings. Calculated by dividing a company's annual earnings by its total assets, ROA is displayed as a percentage. Sometimes this is referred to as "return on investment". The formula for return on assets (net income divided by total assets) gives us an ROA of negative -0.11 for 2009 and 0.13 for 2009 for Amari. (Investopedia) 6. Management efficiency. Receivable turnover, inventory turnover and asset turnover. Asset Turnover ratios These ratios are good indicator of “how efficiently the firm uses its assets: The receivables turnover show how quickly the firm collects is accounts receivable. Amari has a turnover ratio of 1.45 in 2009, and of 1.61 in 2008. It is calculated by dividing revenue over assets. Average inventory period. Amari has an inventory turnover of 30.66 in 2009, a faster rate than in 2008 of 29.2 Braemar’s inventory turnover is 45 days in 2009 and 43 days in 2008 Conclusion and recommendation How sound is the financial condition of Amari? Based on the figures coming from the financial statements of Amari, the company has been hardest hit by the recession. Chart attached will show that Amari is at its best in terms of revenues in 2007. Revenues begin to decline in 2008, further going down in 2009. From the chart, it seems the company is not efficient in managing its costs, because despite of high revenues from 2005 to 2009, net profit before tax remains low. For 2009, the EBIT is at its lowest point ending up in negative profitability. It can also be seen from the historical graph that the capital employed in the business has not increased significantly and has even decreased in 2009. Let us look at Braemar for the same period of 2009 and 2008. Revenues of Braemar slightly fell in 2009 with corresponding decrease in earnings before interest and taxes. The capital employed for 2009 matches its revenue. From the chart, it could be interpreted that financial consulting business is capital intensive, has and has high administrative costs. Based on results of financial analysis using ratios and comparison as tools of measurement, investment at Amari plc is not feasible because of the following reasons: 1. Amari plc. has negative profitability in 2009. Recession is far from over and investing now means the investor has no assurance of recovery of its investment. Optimism of Amari management is not easily converted to cash, and there is a possibility of bankruptcy if losses continue. 2. The company is inefficient in managing its costs that affects profitability of the company. The return on assets and investments are negative and do not promise quick reovery 3. It has high debts and there is a possibility that costs of debts outweighs the advantages of the uses of the loan. The high cost of maintaining these debt payments both in short term and long term is a burden to the company. If losses continue the company could no longer pay creditors and this will create an impact to its operations. 4. It is evident that Amari plc and Braemar plc have been affected by the economic crisis but Braemar has been more efficient in its operations and least affected. 5. In the event that the client is a risk taker and goes ahead with investment at Amari, the odds are against his investment. Investor should wait until the coast has been cleared in the investment for Amari. Annex 1 Source: Amari’s financial statement Source: Braemar’s key facts Annex 2 RATIO CALCULATIONS 1. GROWTH RATES 2009 2008 Sales 3,400,000 4,250,000 -850 Sales Growth rate -0.2 NET INCOME -270,000 360,000 -90 0 2. PRICE EARNING RATIO (market value per share divided by EPS Market value per share 230p Earnings per share 0.50p P/E ratio 0.46 P/E ratio of sector 12% 3. PROFIT MARGIN Gross Profit margin Sales minus cost of goods sold divided by sales Revenue 3,400,000 4,250,000 Cost of goods sold 2,500,000 2,750,000 Gross sales 900,000 1,500,000 Gross Profit margin 0.264705882 0.352941176 Net Profit margin Net profit divided by net revenues, often expressed as a percentage. Option 1: Net Income After Taxes ÷ Revenue = Net Profit Margin Net profit -270,000 360,000 Revenue 3,400,000 4,250,000 Net profit margin -0.07941176 0.084705882 4. FINANCIAL CONDITION Debt ratio debt- ratio which is found by dividing total debts over total assets. Total debts 1,400,000 1,490,000 Total assets 2,330,000 2,690,000 Debt-ratio 1 1     Debt//equity ratio Total debt divided by total equity Total debt 1,400,000 1,490,000 Total equity 600,000 600,000 Debt/equity 2.33333333 2.483333333 5. LIQUIDITY RATIOS Current ratio current Assets 790,000 690,000 Current Liabilities 400,000 490,000 current ratio 1.975 1.408163265 Quick Ratio Current assets - inventory / current liabilities Current Assets 5 790,000 690,000 Inventory 210,000 220,000 580 470 Current Liabilities 400,000 490,000 Quick ratio 1.45 1.175 6. INVESTMENT RETURNS Return on equity Net income divided by shareholders equity Net income -270,000 360,000 Shareholders equity 600,000 600,000 ROE -0.45 0.6 60 Return on capital employed EBIT -270,000 510,000 Total Assets 2,330,000 2,690,000 Current Liabilities 400,000 490,000 1930000 2200000 ROCE -0.139896373 0.231818182 -13.989637 23.1818182 Return on assets net income divided by total assets Net income -270,000 360,000 Total assets 2,330,000 2,690,000 ROA -0.115879828 0.133828996 7. MANAGEMENT EFFICIENCY Asset turnover ratio Revenue divided by assets Total revenue 3,400,000 4,250,000 Total assets 2,330,000 2,690,000 Asset turnover ratio 1.459227468 1.615969582 Works Cited Investopedia (n.d). Asset turnover-definition. Available at http://www.investopedia.com/terms/a/assetturnover.asp [Accessed 02december 2009] Investopedia (n.d.) Debt-equity ratio definition. Available at http://www.investopedia.com/terms/d/debtequityratio.asp [Accessed 02 December 2009] Investorwords (n.d.) Gross profit margin definition. Available at www.investorwords.com/2250/gross_profit_margin.html - [Accessed 02 December 2009] Money Chimp (n.d.) Profit margin – definition. Available at http://www.moneychimp.com/glossary/profit_margin.htm [Accessed 01 December 2009] Netmba (n.d.) Financial ratios definition. Available at http://www.netmba.com/finance/financial/ratios/ [Accessed 02 December 2009] Investopedia (n.d.) Quick ratio definition. Available at http://www.investopedia.com/university/ratios/liquidity-measurement/ratio2.asp [Accessed 02 December 2009] Read More