Cover Page AGL Energy Annual Report and Financial Statement Analysis - Case Study Example

Cover Page AGL Energy Annual Report + Financial ment Analysis Task Table of Contents Table of Contents 2 Introduction 3 Financial statement analysis 4 Profitability ratios 4 Efficiency ratios 6 Short-term solvency ratios 8 Long-term solvency ratio 9 Market based ratios 10 The Company’s financial strength and weaknesses 10 Recommendations 10 Introduction AGL, established in 1978, is among the renewable-energy-solution providing companies in Australia. The company is listed in Australia stock exchange and has been in operation for a period in excess of 175 years. AGL has developed its roots deeper into the market through retail and merchant business that it manages in Australia. The company owns portfolios of assets used in the generation of power. Due to its strong base of power generating assets, AGL is considered among the companies with large customer base. The company has divers power generating assets that suits different points of the business cycle (AGL: Annual report 2014 2014). The energy production methods explored by the company are the traditional method (thermal generation), biomass, landfill gas, hydroelectricity, and wind generation. AGL is committed to creating clean energy that is environmentally friendly in order to champion the concept of sustainable development. In addition, the company is dedicated to improving the stakeholders’ current and future well-being. AGL is one of the most successful companies in Australia. Its persistent efforts towards innovation are its fundamental success factor. For that reason, AGL is currently the largest developer, owner and operator of assets for renewable energy generation in Australia. On that note, this report presents analyses of the company’s financial statement for 2014 and 2013 using ratios such as profitability, efficiency, short-term solvency, Long-term solvency and market based ratios. Based on the result of the ratio analyses, the company’s strengths and weaknesses will be analysed. Last, a recommendation, to the company’s management, will be provided concerning the appropriate strategies to improve the company’s performance (AGL: Annual report 2014 2014). Financial statement analysis The analysis of financial statements involves the application of various tools and methods such as the trend analysis (horizontal analysis), vertical analysis and ratio analysis of the financial statement items in order to uncover the relationship between them, the changes in the items, the reason for the changes and the impact of the change on the company’s performance. Ratio analysis is commonly used as a benchmark for formulating better financial strategies for the company. Profitability ratios Net profit margin- this ratio shows how well a company manages its operating expenses such as the administrative costs and interests on debt. The higher the ratio, the lower the operating expenses of the company. Concerning AGL organization, the net profit margin for the year, 2013 and 2014 has been determined to be 3.86% and 5.97% respectively. The ratio interpretation for the fiscal year 2013 means that only 3.86% of the company’s revenue were net profit, whereas, remaining 96.14% were consumed by the operating expenses. A similar interpretation applies to the year 2014 but with different figures. The ratio increased between the two periods due to an increase in the company’s net profit. Based on the analysis, the company’s operating expenses are excessively high, which indicates the ineffectiveness of the company’s cost management methods. Therefore, it is justified to mention that the company’s value creation effort is dwarfed by high level of operating costs (Khan & Jain 2007, 6-40). Operating profit margin- the ratio shows the level of a company’s profitability after meeting the operational and costs related to sales. It also shows the capability of a company to service the cost of capital and pay taxes. A higher operating profit margin signifies a higher capability of the company to pay interest and taxes. Concerning AGL Company, the ratios for the year 2013 and 2014 have been determined to be 6.68% and 10.26% respectively. The interpretation of the 2013 ratio means that only 6.68% of the company’s sales were operating profit. The remaining 93.32% were consumed by cost of sales and operating costs. A similar interpretation applies to the year 2014 but with different figures. The trend of the ratio shows an increase, between the two years, due to an increase in the earnings before interest and tax. From the analysis, the company’s capability to pay interest and tax expenses is moderate (Khan & Jain 2007, 6-40). Return on capital employed- capital employed can be simplified as the total assets – current liabilities. Therefore, return on capital-employed ratio indicates the return generated by every pound invested as capital employed. Concerning the AGL organization, the return on capital employed in the fiscal year 2013 and 2014 has been determined to be 3.36% and 4.76% respectively. The ratio interpretation for the year 2014 means that 4.76% of the company’s net profit was generated by the company’s capital employed. A similar interpretation applies to the year 2013 but with a different figure. The return on capital employed between the two periods increased, based on the analysis. The increase is attributed to an increase in the company’s net profit. Based on the analysis, the utilization rate of the company’s capital employed should be increased in order to generate more returns (Khan & Jain 2007, 6-40). Return on Investment- this ratio measures the return on profit from investments made in the company’s total assets. Based on the financial statements, the return on investment for the AGL Company in the fiscal year 2013 and 2014 has been determined to be 2.81% and 4.08% respectively. The ratio interpretation for the year 2013 indicates that 2.81% of the company’s net profits were generated by the total assets. A similar interpretation is applied to the year 2014 but with different figures. Based on the analysis, the return on investment increased between the two periods. The increase is attributed to an increase in the company’s total assets. As a result, the company should increase the utilization rate of the total assets in order to further increase the return in the future (Kapil 2011, pp. 125-135). Return on equity- this ratio measures the proportion of a company’s profits attributed to the shareholder’s equity. The return on equity for the AGL Company for the fiscal year 2013 and 2014 has been determined to be 5.11% and 7.51% respectively. The ratio interpretation of the year 2014 means that a dollar of equity generated $ 0.751 toward the company’s profitability. The return on equity between the two periods increased. The increase is attributed to an increase in the company’s net profit. Based on the analysis, the return on equity is fairly attractive (Kapil 2011, pp. 125-135). Efficiency ratios Accounts receivable turnover – this ratio shows the number of times the accounts receivables are converted into cash during a financial period. Concerning AGL Company, the ratio for 2013 and 2014 are 5.138 and 5.334 respectively. The trend in the ratio shows an increase in the turnover between the two periods due to a decrease in the company’s trade and other receivables between the two periods. If the company reduces the collection period, the annual receivable turnover will increase. Therefore, the receivable turnover should increase rather than decrease in order to improve the company’s cash balance (Sarngadharan & Kumar 2011, pp. 121-135). Trade receivables collection period – this ratio shows the period it takes a company to collect all the accounts receivables. It is can also be referred to as the period within which all the company’s debtors must pay their dues. Generally, the shorter the period, the more the cash collected. Concerning AGL Company, trade receivable collection period for the year 2013 and 2014 have been determined to be 71.04 days and 68.43 days respectively. The ratio interpretation for the year 2013 means that during that year, the company’s creditors had 71.04 days, from the date of purchase, to pay their dues. The ratio decreased between the two periods due to an increase in the debtors turnover. Based on the analysis, AGL should implement stricter debt policy in order to reduce the debtors collection period and increase the amount of cash collected (Sarngadharan & Kumar 2011, pp. 121-135). Trade payable turnover – this ratio indicates the number of times the company bought goods and services on credit. Concerning AGL Company, the trade payable turnover for the year 2013 and 2014 has been determined to be 6.723 times and 7.586 times respectively. The trend of the ratio shows an increase in the turnover between the two periods due to a decrease in the company’s trade and other payables between the two periods. Therefore, the company should further reduce the turnover in order to reduce its liabilities (Sarngadharan & Kumar 2011, pp. 121-135). Net asset turnover- this ratio indicates the efficiency with which the net assets are utilized to generate revenue. Concerning AGL Company, the asset turnover for the year 2013 and 2014 were $ 0.8695 and $ 0.7974 respectively. The ratio interpretation for the year 2014 means that a dollar invested in the net assets was utilized to generate $ 0.7974 toward the company’s revenue. The trend shows a decrease in the ratio between the two years. The decrease is attributed to a decrease in the company’s revenue level and a simultaneous increase in the net profit. The company’s utilization rate of the net assets is weak. Therefore, the net asset’s utilization rate should be more aggressive in order to increase the company’s revenue (Khan & Jain 2007, 6-40). Short-term solvency ratios Current ratio- this ratio measures the ability of the business to meet its current obligations using the current assets. Generally, it is advisable for the ratio of current assets to current liability to be 2: 1. Concerning AGL Company, the current ratio for the year 2013 and 2014 are 1.294 and 1.62 respectively. Using the ratio for the year 2013, the company had $ 1.294 of current assets to cover every dollar of current liabilities. The trend for the ratios shows an increase in the ratio between the two periods. The increase is attributed to an increase in the current assets and a simultaneous decrease in the current liabilities. The ratio clearly shows that the company is liquid enough to sufficiently settle its short-term obligations using the current assets during both years. Therefore, the company should either maintain or increase the liquidity level. The appropriate strategy of increasing the liquidity level is by increasing the level of cash along side increasing the investment in marketable securities (Sarngadharan & Kumar 2011, pp. 121-135). Quick ratio or Acid test – the ratio is concerned with immediate liquidity therefore ignores the inventory. It measures the ability of a company to meet the short-term obligations using highly liquid assets. A highly liquid asset is that which is easily converted into cash. A company is considered financially healthy if this ratio is 1. Concerning AGL Company, the quick ratio for the year 2013 and 2014 has been determined to be $ 1.233 and 1.525 respectively. The trend shows an increase in the quick ratio between the two periods. The increase is attributed to an increase in cash and cash equivalents and a simultaneous decrease in the current liabilities. Based on the ratio, the company is liquidity (Bowhill 2008, pp. 265-284). Cash ratio- the ratio measures the ability of the company to meet its current obligations using the cash and cash equivalent, banks and the marketable securities. Concerning AGL Company, the cash ratio for the year 2013 and 2014 has been determined to be $ 0.1282 and $ 0.2272 respectively. The ratio interpretation for the year 2014 means that for every one dollar of the company’s current liabilities there were $ 0.2272 worth of current assets. Based on the analysis, the company’s cash is not sufficient enough to completely meet the current obligations. The trend of the ratio shows an increase between the two years due to an increase in the cash and cash equivalent (Bowhill 2008, pp. 265-284). Long-term solvency ratio Debt/equity - ratio indicates the proportion of fixed charge capital in the capital structure of a firm. Concerning AGL, the ratio for 2013 and 2014 has been determined to be 41.74 % and 48.36 % respectively. For instance, in the year 2013, 41.74% of the company’s capital was fixed charge capital, whereas, the other 58.26% was equity. Based on the analysis, the ratio has increased from 41.74 % to 48.36 % due to an increase in the level of borrowings between the two periods. From the analysis, the company’s leverage level is low for the two periods. Therefore, AGL Company faces lesser debt risk (Bowhill 2008, pp. 265-284). Interest coverage ratio – this ratio evaluates a company’s ability to meet interest payments. It also indicates a company’s possibility of taking on more debt in the future. In general, the higher the ratio, the greater the company’s ability to pay interest charges. Concerning AGL, the ratios for 2013 and 2014 has been determined to be 3.181 and 4.47 respectively. The ratio interpretation for the year 2013 means that, the company could pay interest 3.181 times using the EBIT. The ratio increased between the two periods due to an increase in earnings before interest and tax. The increase means that the company’s capacity to pay interest charges also increased (Bowhill 2008, pp. 265-284). Market based ratios Dividend cover – this ratio indicates the number of times that dividends can be paid from earnings per share. The higher the ratio, the greater the ability of a company to pay its dividend from the EPS. Concerning AGL Company, the dividend cover for 2013 and 2014 has been determined to be 1.083 times and 1.622 times respectively. The ratio increased between the two years due to an increase in the EPS (Currie 2011, pp. 100-120). Earnings per share – the companys basic EPS for the years 2013 and 2014 has been determined to be $ 0.682/ share and $ 1.022/share respectively. The ratio shows the amount of earnings to every share held. Therefore, EPS is another criterion for measuring a company’s profitability. That is, the higher the ratio, the higher the company’s profitability (Currie 2011, pp. 100-120). The Company’s financial strength and weaknesses The following are the company’s financial strengths: first, based on the debt/equity ratio, the company’s leverage level is low thus reduces the default risk. Second, the analysis of the interest coverage shows strong capability of the company to meet interest charges on debt. Last, the company’s liquidity level is high based on the current and quick ratios. The two ratios indicate that the company is capable of meeting the current obligation using the current liabilities. On the other hand, the following are the weaknesses: first, the utilization rate of the company’s assets is low. Second, the company is unable to effectively control the operating costs. This is shown by the company’s thin profitability margin. Recommendations Based on the above analysis, the company should implement the following recommendations: first, the utilization rate of assets and capital employed should be increased in order to improve the company’s return. Second, the debtor’s collection period should be reduced in order to increase the cash availability. Last, AGL should formulate and implement more effective cost management strategies in order to sufficiently manage operating costs and enhance the company’s profitability. List of References AGL : Annual report 2014, Viewed 14 September 2014, http://www.agl.com.au/about-agl/investor-centre/reports-and-presentations Bowhill, B 2008, Business planning and control: integrating accounting, strategy, and people, Wiley, Chichester, England. Currie, M 2011, The search for income: an investors guide to income-paying investments, Harriman House Ltd, Hampshire, England. Khan, M. Y., & Jain, P. K 2007, Financial management, Tata McGraw-Hill, New Delhi. Sarngadharan, M., & Kumar, R. S 2011, Financial analysis for management decisions, Wiley, NY. Appendix 1: Ratio calculations Profitability ratios 2014 2013 Operating profit margin (EBIT/Sales)*100 10.26% 6.68% Net profit margin (Net profit/Sales)*100 5.97% 3.86% Return on investment (Net profit/Total assets)*100 4.08% 2.81% Return on equity (Net profit/Equity)*100 7.51% 5.11% ROCE (Net profit/Capital employed)*100 4.76% 3.36% Effeciency ratios Debtors turnover (Sales/ Average debtors) 5.334 5.138 Debtors collection period (365/Debtors turnover) 68.43 71.04 Creditors turnover (Sales/Average creditors) 7.586 6.723 Net asset turnover (Sales/Net assets) 0.7974 0.8695 Short-term solvency ratios Current ratio (Current assets/current liabilities) 1.62 1.294 Quick ratio (CA-stock)/Current liabilities 1.525 1.233 Cash ratio (cash/current liabilities) 0.2272 0.1282 Long-term solvency ratio Debt/equity ratio 48.36% 41.74% Time interst earned ratio (EBIT/Interest charges) 4.47 3.181 Market based ratios EPS (EAT/No. of ordinary shares) 1.022 0.682 Dividend cover 1.622 1.083 Read More