Exodus Venture Capital Ltd: Investment Decision - Case Study Example

Exodus Venture Capital Ltd: Investment Decision of the Registration Number of the Submitted Exodus Venture Capital Ltd: Investment Decision Table of Contents S. No. Topic Description Page I. Introduction 2 II. The Importance of Financial Ratios 2 III. Types of Financial Ratios 3 IV. Evaluation of Brindley Ltd. & Haines Ltd. Using Ratio Analysis 3 V. Limitations of Financial Ratios 7 VI. Additional Information That May Help in the Investment Decision 8 VII. Recommendation 8 VIII. References 9 Exodus Venture Capital Ltd: Investment Decision Introduction Every business that comes into existence has some objective. While for non-profit organizations, these might be service to humanity and meeting basic needs of communities, for commercial enterprises it is most certainly the profit motive that is the focus of attention for the owners and management. We see that both Brindley Ltd. and Haines Ltd. are in the same industry sector of building materials. It thus makes sense to compare results of those companies that are in the same industry sector and therefore are faced with the same opportunities and threats from the external environment. Meanwhile the internal structure and organization of a particular firm would signify its strengths and weaknesses. Industry averages as computed by financial dailies like the Financial Times and rating agencies such as Dunn & Bradstreet, Standard and Poor and Value Line can also serve as a good baseline by which to compare and contrast the results of a particular firm (Weston et al, 2006, 73). The Importance of Financial Ratios In the absence of further information, financial ratios are a good way of determining the financial health and viability of a business enterprise. In other words, they give us a picture of the status of the business at a certain point in time. It has been agreed by the business and financial community that certain types of ratios are important to different stakeholders the world over. Thus we have different types of ratios as well such as liquidity ratios, profitability ratios, investment ratios etc. Debtors, creditors or investors, all these parties are interested in whether the business enterprise in question will be able to repay them their outstanding or give suitable returns on the capital invested in the business. Ratio analysis not only gives us a good idea of this possibility but also a comparative picture of how the firm is doing in comparison to others in the same industry sector (Meigs & Meigs, 1993, 793). Thus popular websites such as Yahoo Finance not only have details of stock prices, fluctuations and ratios but also a comparison with industry averages. Such comparisons help us reflect not only on company performance but policy as well. For example the company might have too lenient a credit policy which might create stuck up loans and liquidity problems. It may find it difficult to attract additional funds from the public via share issue if it has a poor record of dividend declaration and payment. Types of Financial Ratios The most common types of financial ratios are as follows: 1. Short Term Solvency/ Liquidity Ratios 2. Long Term Solvency/ Debt Equity Ratios 3. Profitability Ratios 4. Asset Utilization Ratios 5. Investment Ratios (Rao, 1992, 112) Evaluation of Brindley Ltd. & Haines Ltd. Using Financial Ratio Analysis Short Term Solvency/ Liquidity Ratios 1. Current Ratio= Total Current Assets / Total Current Liabilities For Brindley Ltd. : £ 910,000 / 520,000 = 1.75: 1 For Haines Ltd. : £ 1050,000 / 600,000 = 1.75: 1 Incidentally, both companies have the same liquidity ratio so it seems both are equally preferred from the viewpoint of ratio analysis. 2. Quick/ Acid Test Ratio= Total Current Assets – Inventories – Trade Rec./ Total Current Liabilities For Brindley Ltd. : £ 60,000 / 520,000 = : 0.115: 1 For Haines Ltd. : £ 50,000 / 600,000 = 0.083: 1 Here we can see that Brindley Ltd. is in a slightly better position than Haines Ltd. However both firms would be unable to settle their short term liabilities using the acid test formula. Long Term Solvency/ Debt Equity Ratios 1. Debt Equity Ratio= Total Liabilities / Total Equity For Brindley Ltd. : £620,000 / 1,100,000 = 0.563: 1 For Haines Ltd. : £ 1,100,000 / 1,300,000 = 0.846: 1 We see that Brindley Ltd. is in a much better position in terms of debt equity structure than Haines Ltd. Brindley has taken on only 56 pence of debt per pound of equity compared to 84 pence assumed by Haines. 2. Debt To Asset Ratio= Total Liabilities / Total Assets For Brindley Ltd. : £620,000 / 1,720,000 = 0.36: 1 For Haines Ltd. : £ 1,100,000 / 2,400,000 = 0.45: 1 Once again Brindley Ltd. is in the better position here as it has only 36 pence of liability per pound of assets, compared to 45 pence of liability per pound of assets undertaken by Haines Ltd. Profitability Ratios: We now move on to the Income Statements of the two firms to calculate these ratios. 1. Gross Profit Margin = Gross Profit / Sales x 100 For Brindley Ltd. : £1,230,000 / 4,100,000 x 100 = 30 Percent For Haines Ltd. : £ 1,460,000 / 5,240,000 x 100 = 27.86 Percent We see that the Gross Profit percentage on sales for Haines Ltd. at 27.86 percent is slightly less than the 30 percent recorded for Brindley Ltd. 2. Net Profit Margin = Net Profit Before Interest & Tax / Sales x 100 For Brindley Ltd. : £240,000 / 4,100,000 x 100 = 5.85 Percent For Haines Ltd. : £ 260,000 / 5,240,000 x 100 = 4.96 Percent We see that the Net Profit percentage on sales for Brindley Ltd. at 5.85 percent is higher than the 4.96 percent recorded for Haines Ltd. Asset Utilization Ratios 1. Return on Assets= Net Profit Before Interest & Tax / Total Assets For Brindley Ltd. : £240,000 / 1,720,000 = 0.0139 Percent For Haines Ltd. : £ 260,000 / 2,400,000 = 0.0108 Percent We can see that Brindley Ltd. fares slightly better in the use of assets compared to Haines Ltd. This is because its ratio is slightly higher than that of Haines Ltd. 2. Return on Equity = Net Profit Before Interest & Tax / Total Equity For Brindley Ltd. : £240,000 / 1,100,000 = 21.81 Percent For Haines Ltd. : £ 260,000 / 2,300,000 = 11.30 Percent From the above, it is clear that Haines Ltd. has a higher return on equity than Brindley Ltd. In fact the percentage return is almost double that of Brindley Ltd. Investment Ratios 1. Earnings Per Share (EPS)= Net Income Available to Common Stockholders / Number of Ordinary Shares For Brindley Ltd. : £160,000 / 900,000 = 0.17 per share For Haines Ltd. : £ 150,000 / 800,000 = 0.18 per share Here we see that the EPS for Brindley Ltd. is one cent less than for Haines Ltd. So there is not much that separates the two firms on this account. Limitations of Financial Ratios Following is a summary of the ratios calculated: BRINDLEY LTD. HAINES LTD. Current Ratio 1.75: 1 1.75: 1 Quick Ratio 0.115: 1 0.083:1 Debt to Equity 0.563: 1 0.846:1 Debt to Assets 0.36: 1 0.45:1 Gross Profit Margin 30% 27.86% Net Profit Margin 5.85% 4.96% Return on Assets 0.0139 0.0108 Return on Equity 21.81% 11.30% Earnings Per Share 0.17 0.18 We can see from the underlined figures that Brindley Ltd. has a comparatively better performance in terms of the majority of ratios that have been calculated. Therefore it would be wiser to invest in the shares of Brindley Ltd. compared to Haines Ltd. A limitation in using ratios is that the accounting methods for valuating assets and liabilities may be different for two diverse firms even in the same industry. For example inventories may be valued using LIFO, FIFO or Weighted Averages, Marketable Securities may be valued on Replacement Cost basis and so forth. Secondly one never knows the formulas used to calculate Industry Averages by the financial websites, so even this may be unrepresentative or misleading (Pocock et al, 2002, 32). Additional Information That May Help in the Investment Decision Actually it is not only the figures and financial ratios that tell the whole story. It has been known that a good and effective management makes a whole lot of difference to the investors and other stakeholders of a corporate enterprise. If the CEO is a true visionary with a pragmatic outlook, and his top management is a well picked group of people who have been known to bring results and achieve business turnarounds, then even some finicky investors will be willing to take a bet on the firm and its fortunes. There may be a waiting period for the firm to come out of its present troubles, but once this is past and the firm begins to show consistent growth in revenues and profitability, it will attract investors in the shape of both shareholders and bondholders for its equity and debt offerings. A change of strategy that is more in line with the current environment, reaping advantages of its innate business strengths and circumventing its weaknesses is sure to send good signals to the stakeholders (Wood & Sangster, 2011, 512). Recommendation From the above it is recommended for Exodus Ltd. to invest in the share capital of Brindley Ltd as the above ratio analysis (see the underlined figures) shows that this firm is in a better position than Haines Ltd. in terms of returns on the investment of Exodus Ltd. References Meigs, R. & Meigs, W. Accounting: the basis for business decisions, 9th ed. McGraw Hill, 1993. Pocok, M. & Taylor, A. Handbook of Financial Planning and Control, 3rd ed.: Gower Publishing Company Limited, 2002 Rao, R.K.S. Fundamentals of Financial Management, 8th ed, McGraw Hill, 1992. Weston, J, Beasley, S. & Brigham, E. Essentials of Managerial Finance. Macmillan Publishing, 2006. Wood, F. & Sangster, A. Business Accounting Volume 1 (12th ed.) Financial Times/Prentice Hall, 2011. Woodcock, C. Raising Finance: The Guardian for the Small Business. Great Britain: Kogan Page Limited, 1985. Read More