Accompanying Balance Sheet of Frater ltd - Case Study Example

Crombie & Company Xxxx For Global PLC To Crombie &Company Financial Advisors RE: FINANCIAL BRIEF FOR FRATER LTD FINANCIAL STATUS I have reviewed the accompanying balance sheet of Frater ltd as of 31st December 2012, and the related statements of income, retained earnings, and cash flows for the year then ended. A review includes primarily applying analytical procedures to management’s financial data and making inquiries of company management a brief is substantially less in scope than an audit, the objective of which is the expression of an opinion regarding the financial statements as a whole (Braswell, Daniels, Landis & Chang, 2012). And to help your firm find out areas of concern and probable sectors that more information need to be further scrutinized have therefore laid the foundation for you inside this document and I do hope that you will find this information of utmost importance. The supply of private companies is driven by many business owners who do believe that their company needs to be part of a larger company to reach its full potential, in the face of world globalization and the need for efficiencies (Fustec and Faroult, 2011). This increasing trend does suggests that companies are analyzing their operations more closely and are making increasingly complex business decisions in order to maximize market presence. The increasing demand for private companies has been driven by a strong economic environment and access to low-cost financing. Lately, purchasers have been able to raise good amounts of equity and debt capital a fairly low amounts. This less cost of capital makes buyouts an ever increasing and attractive substitute (Fustec and Faroult, 2011). The desire for private organizations is also motivated by public organizations that feel obligated to mature through getting hold of small companies to meet the expansion expectations of their shareholders (Berkman, 2013). Prior to embarking on an active search, Global PLC should conduct a thorough needs analysis (as described above) to ensure that the solicitations are likely to yield appropriate acquisition candidates (Yates & Hinchliffe, 2010). In most scenarios, industry owners have not contemplated a sale, and an unwanted call from a prospective purchaser can be a channel for such consideration (Fustec and Faroult, 2011). In such conditions, purchasers must be geared up to take action swiftly in order to get hold of the opportunity devoid of raising undue concerns for the seller (Spalding, 2012). Usually, this is best performed through a rather easier approach, which begins with informal meetings and progresses gradually to information revelation (Depamphilis, 2011). If properly conducted buyers often can avoid an auction and structure, a deal that benefits both the buyer and seller (Boakye-Agyei, 2011). Company introduction Frater Ltd. is a privately owned business, its family oriented and it does operate in the electronics industry and specifically the current owners do perceive a market opportunity in developing new circuitry for flight control systems, new robotics and related technology it has been in existence for eight years now and operates as going concern. The founders are two brothers whose noble intention was to exploit the novel ways of manufacturing electronic circuits Startup capital came from a legacy inherited and also through the selling of shares to family members. For the year ended 31st December 2012 turnover was British pounds 8756,000 against a turnover of pounds 5941,000 for the year ended 31st December 2011. Overview Operating in the aerospace industry also faces the various threats and risks as well as competition as depicted in the porters five model forces. Porter’s five forces include the threat for new entrants to enter the market, the threat for substitute products or services, the extent to which suppliers are able to influence the company and the intensity of rivalry among existing competitors. Financial statement analysis and the ratio analysis, gives managers good information for analyzing a company’s performance and for making better decisions (Frankel, 2013). It helps investors and managers alike to make decisions on how to gauge the profit level of a company as well as how to interpret the financial strength of an organization. According to Fustec and Faroult (2011), because growth and profit is the major objective of any firm, the financial statement analysis, and the sister ratios analysis is so critical for the managers of any company. The forecasted economic conditions are also detailed in this report to enable the company adopt correct strategies and actions that can enable it succeed in the ever dynamic financial market (Yan & Guoqiang, 2013). The specific conditions have been highlighted in this paper and an insight of their impact on the company’s operations. Ratio Analysis A financial ratio can be described as a relationship between financial variables and helps ascertain the financial condition of the firm. Ratio analysis is a means of comparing and quantifying relationships between financial variables (Haw, Hu, Lee, & Wu, 2012). With ratios, financial statements can be interpreted and usefully applied to satisfy the needs of the users of financial statements I have found the following ratios to be important for valuing the net worth of Frater ltd and due consideration need to be given to the results (Herndon & Galpin, 2013). The following are some of the reasons why it is important that we perform ratio analysis The value of ratio analysis enables the equity on credit analyst evaluate past performance, assess the current financial position of the company and gain useful information for projecting future results Financial ratios will provide insight into; a) Micro-economic relationship within a company that helps analyst project earnings and free cash flows b) A company financial flexibility and ability to obtain the cash required to go and meet its obligations c) Management ability to utilize the company assets Liquidity Ratios This focuses on cash flows and measures the company ability to meet its short-term obligations. This is computed by dividing total current assets by total current Liabilities: Liquidity measures how quickly assets are converted to cash and the ability to set off short term obligations and in judging whether a company has adequate liquidity required (Haw, Hu, Lee, & Wu, 2012). Current Ratio Current ratio = Current assets Current liabilities 2012 2011 886/680 =1.30 537/422=1.27 1.30:1 1.27:1 Current ratio of more than one means that a company has more current assets than Current liabilities For Frater ltd the current ratio for the two years are within limits the higher the ratio the more liquid the firm is Acid-test or quick ratio Quick ratio found by dividing total current liabilities less stock by current liabilities. A firm with a satisfactory current ratio may actually be in a poor liquidity position when inventories form most of the total current assets. Acid test ratio = Current assets less stock Current liabilities 2012 2011 886- 554 /680=0.488 537-338 /422=0.471 0.488:1 0.471:1 The higher the ratio the better the firm as it means an improved liquidity position Boot (2007) Gearing or leverage ratios Debt ratio or capital gearing ratio Debt ratio measures the proportion of debt finance to capital employed by a firm. An organization is said to be extremely geared if the ratio is higher than 50%. Debt ratio = Total long term debt x 100% Capital employed 2012 2011 178/1000*100 158/1500*100 =17.8% 10.53% Debt equity ratio Measures the percentage of non-owner supplied funds to Owner’s contribution to the organization. A company is highly geared if the debt equity ratio is greater than 100%. Debt equity ratio = Total liabilities Equity or Net worth 2012 2011 858/2730 580/1850 =0.314 =0.315 Times interest cover This shows the number of times earnings cover current payments. The higher the ratio, the less the gearing position thus fewer financial risk. Times interest cover = Earnings before interest and tax + Depreciation Interest charged 2012 2011 748+1283/38 349+719/23 =53.44 =46.43 PROFITABILITY RATIOS This measures indicate whether the company is performing satisfactorily, it measures whether the managers are performing satisfactorily and whether the is a worthwhile investment Return on capital employed (ROCE). This measures the efficiency with which a company uses long term funds or permanent assets to generate returns to shareholders. ROCE = Profit before interest and tax or operating profit Total capital employed 2012 2011 748 /2908 349 /2008 =0.257 26% =0.174 17% Capital employed consists of shareholders funds (ordinary share capital, preference share capital, share premium, and retained earnings) and long term debts. Gross profit margin This basically is the ratio which clearly shows the percentage of the available revenue to cover cost of operation and other related expenditures. The higher gross profit on the other hand shows relative combination of slightly higher pricing of products and slightly lower cost of products and vice versa it shows how well cost of production has been controlled in relation to distribution and administration costs. Gross Profit Margin = Gross profit X 100% Sales 2012 2011 2643/8756*100 1373/5941*100 =30.18 =23.11 Net profit margin This measures firm’s ability to control its production, operating and financing costs.it offers a better view of the company’s potential future profitability since it involves the net income, which is calculated as revenue less expenses Net profit margin = Net profit X 100% Sales 2012 2011 380 /8756*100 184 /5941*100 =4.34 =3.1 Net assets turnover This gives a guide to productive efficiency i.e. how well assets have been used in generating sales. Net assets turnover = Sales Capital employed 2012 2011 8756/2908 5941/2008 =3.01 =3.0 Profit after taxation 2008 £175,000 2009 £210,000 2010 £190,000 2011 £ 268,000 2012 £ 484,000 2013 £ 500,000(Forecast) From the year 2008, there has been noted a steady increase in profit after taxation this can be seen that the margin increased to 210,000 in 2009 before a decline in 2010. Probably the company needs further investigation as why the profits dipped further, but in general the company has been performing well over the years the forecast profit of £ 500,000 for the year 2013 is welcome good news The cross sectional analysis Cross sectional analysis is the comparison of two or more companies in the same industry The purpose why you need to do the following analysis is because of the following Measure profitability Indicate the trends of achievement Assess the growth potential of Frater ltd Have a comparison analysis with other companies in the industry Assess the overall financial strength Assess the solvency of Frater ltd This analysis will provide important information regarding historical performance and growth given a sufficiency long history of accurate seasonal information; this will be of great help in assisting forecasting and knowing of crucial information to help you make prudent decision A plc B plc C plc Frater ltd Frater ltd DY PER DY PER DY PER DY PER Recent year 12 8.5 11.0 9.0 13.0 10.0 2.3 0.016 Previous year 12 8.0 10.6 8.5 12.6 9.5 Three years ago 12 8.5 9.3 8.0 12.4 9.0 Average 12 8.33 10.3 8.5 12.7 9.5 Key Risks Key risk here is the industry in which Frater ltd operates. This industry is marked by short product life cycles, which can make it hard for the firm to keep its head up. Inappropriate company scrutiny and industry analysis, Poor return on Investment, Corporate Integration risks i.e. the inability of the two firms to integrate and any Legal issues that may crop up. Other Considerations The corporate governance issues also need to be looked at because for the moment Frater ltd is managed wholly by the two brothers James and John Frater. More disclosures are needed to be as regards their expertise in running the company to a more successful venture. Further analysis that you need to perform are the following Equity analysis Labor negotiations Directors oversight External auditing Financial management Management and control Credit analysis Mergers, acquisitions and diversification Environmental factors on financial reporting Based on the analysis above Frater ltd is a high growth potential private company, there is growth supported by the fact that there is an upward profit trend. The company needs to inject more capital to realize its full potential (Carrington, 2008). The cash flow is good and the average debt collection period seems to look encouraging. According to Ramón-Llorens & Hernández-Cánovas (2012), the net assets turnover is stable for the two years and shows that the company has used its assets well to generate its revenue; the return on capital employed is suitable for a company that has been in existence for eight years. You are encouraged to engage an expert in forensic audit to undertake audit for the previous years. SHARE VALUATION METHODS Net Asset Valuation Net assets valuation means finding what all the liabilities and assets of a business are worth and then summing them up. According to Gadawska (2011), the Net Asset Value of a company is usually calculated and shown as a separate line in the Balance Sheet. Having found the Net Asset Value for the company, the figure is then divided by the total number of shares issued by the company to arrive at the net asset value per share or book value per share (Freeman, Koch & Li, 2011). This therefore tells us how much each share of the company is worth in terms of its assets and liabilities (Ironiuc, Carp, Chersan & Robu, 2012). This is then compared with the current actual share price to decide if the shares are overpriced or underpriced by the stock market. Limitations of net asset valuation include: Net assets value can understate the value of intangible assets e.g. goodwill. The method does not take into account future changes in sales or income.(increase or decrease) The firm’s Balance sheet may not accurately reflect all assets, as they should be (Gadawska, 2011). Price to Earnings Comparison In this method Profits of the company is multiplied by the number of years of earnings the company is thought to be worth. According to Almujamed, Fifield & Power (2012), this is done by comparing the (P/E) ratios of similar companies on the stock market to find out what typical companies of this kind have as a P/E Ratio. This is done to reflect the future prospects of the company (Frater ltd) compared with those of the reference companies in the market (Gadawska, 2011). The limitations of this method are as follows Earnings can be subjected to manipulation at the firm’s level, which means P/E can be distorted depending on how the company has accounted for particular item. The use of P/E method is particularly troublesome for investors in small cap stocks, and for example frater ltd is a fairly young firm (Freeman, Koch & Li, 2011). Discounted Cash Flow Method (DCF) Discounted cash flow does involve calculating Free Cash Flows of future years when a business is growing and a Terminal Value of the business when it has reached its steady state. In this method, there are a lot of complicated financial calculations and assumptions just to get those annual figures, which at the end of the day will surely make some sense (Ironiuc, Carp, Chersan & Robu, 2012). Limitations include; According to Freeman, Koch & Li (2011), it involves high degree of assumptions that must be in place for the ratio to be applied This method better operates best where there is a high degree of confidence about future cash flows. And can bring challenges to apply whenever it’s hard to foretell sales and costs with conviction. According to Almujamed, Fifield & Power (2012) the method is vulnerable to modification and constant check. Inputs and assumptions may need to be adjusted at some particular point. The model is not suited for short-term investing firms. It does focuses on long-term value (Gleich, Kierans, & Hasselbach, 2010). The homogeneity of company operating activities i.e. companies may have divisions operating in many industries (Gadawska, 2011). This makes it difficult to find comparable industry relations to use for comparison purposes. References ALMUJAMED, H.I., FIFIELD, S.G.,M. & .M. POWER, D. 2012, "Share Valuation Methods And Data Source-Based Accounting In An Emerging Stock Market: The Case Of The Kuwaiti Stock Market", The International Business & Economics Research Journal (Online), vol. 11, no. 7, pp. 713. BERKMAN, J., W 2013. Due diligence and the business transaction: getting a deal done. BOAKYE-AGYEI, K. 2011, "Approaching climate adjusted environmental due diligence for multilateral financial institutions", International Journal of Climate Change Strategies and Management, vol. 3, no. 3, pp. 264-274. BRASWELL, M., DANIELS, R.B., LANDIS, M. & CHANG, C. 2012, "Characteristics Of Diligent Audit Committees", Journal of Business & Economics Research (Online), vol. 10, no. 4, pp. 191. CARRINGTON, G 2008. Tax Accounting in Mergers and Acquisitions 2009. Cch Inc. DEPAMPHILIS, D., M 2011. Mergers and acquisitions basics all you need to know. Burlington, MA, Academic Press. FRANKEL, M. E. S 2013. Mergers and acquisitions basics the key steps of acquisitions, divestitures, and investments. Hoboken, N.J., Wiley. FREEMAN, R., KOCH, A. & LI, H. 2011, "Can historical returns-earnings relations predict price responses to earnings news?” Review of Quantitative Finance and Accounting, vol. 37, no. 1, pp. 35-62. FUSTEC, A. & FAROULT, T. 2011, "Mergers and acquisitions in the insurance sector: reducing information asymmetry", Journal of Intellectual Capital, vol. 12, no. 4, pp. 495-504. GADAWSKA, J. 2011, "EFFECT OF PROVISIONS ON THE VALUATION OF A COMPANY,” Equilibrium, vol. 6, no. 2, pp. 109-121. GLEICH, R., KIERANS, G., & HASSELBACH, T 2010. Value in due diligence: new risks, new mitigation. Farnham, Gower. HAW, I., HU, B., LEE, J.J. & WU, W. 2012, "Investor protection and price informativeness about future earnings: international evidence", Review of Accounting Studies, vol. 17, no. 2, pp. 389-419. HERNDON, M., & GALPIN, J 2013. The complete guide to mergers and acquisitions process tools to support m & a integration at every level. San Francisco, Calif, Jossey-Bass. IRONIUC, M., CARP, M., CHERSAN, I. & ROBU, I. 2012, "The Evaluation of the Investment Opportunity by Analyzing the Financial Structure Influence on Company Value,” Communications of the IBIMA, vol. 2012, pp. 1-16. RAMÓN-LLORENS, M.C. & HERNÁNDEZ-CÁNOVAS, G. 2012, "Classification and Analysis of Criteria Used in the Due Diligence Process,” International Journal of Business and Management, vol. 7, no. 6, pp. 81-89. SPALDING,ALBERT D 2012, "Auditing Due Diligence In Law And Ethics: The Ponzi "Feeder Fund" Cases", Review of Business & Finance Case Studies, vol. 3, no. 1, pp. 1-12. YAN, H. & GUOQIANG, L. 2013, "Due Diligence in Merger and Acquisition--With China Practice View,” International Journal of Business and Social Science, vol. 4, no. 4. YATES, G., & HINCHLIFFE, M 2010. A practical guide to private equity transactions. Cambridge, U.K., Cambridge University Press. Read More