Gillette Company as a Large Manufacturer of Personal Care Products - Case Study Example

Financial analysis of Gillette Ratio assessment Liquidity ratio The liquidity ratios are also referred as short-term solvency ratio of a corporation which indicates that financial stability thereof for a time period equivalent to or less than a year. Liquidity ratio mainly consists of current ratio and acid test ratio (White, 2003; Gibson, 2001). Current ratio Current ratio, also referred as working capital ratio, is used for evaluation of short term financial stability of a business concern. Current ratio represents a firm’s capability in meeting short term obligations equivalent to current liabilities. The current ratio has been calculated for 2002 and 2003 so that a comparative outlook is presented. The respective current ratios for 2002 and 2003 are 1.09 and 1.00. In 2003, the current assets of the company has declined with liabilities thereof has increased resulting to decline in overall ratio. If the current situation persists, then the company will face liquidity problem while discharging the short term obligations (White, 2003). Liquid ratio The liquid or acid test ratio is considered relatively more liquid than current ratio and it indicates the immediate discharging capability of the concern with respect to current liabilities. Inventories are not included in liquid ratio as they are relatively illiquid in nature. Although liquid ratio should not be high but 1:1 is considered appropriate. In that context, the liquid ratios of Gillette for 2002 and 2003 are 0.82 and 0.70. The possible reasons for drop in liquidity position of the company can be increase in inventory and decrease in trade receivables. The company need to improve its liquidity in order avoid working capital shortage (White, 2003). Long term solvency Long term solvency reflects the leverage condition of a corporation where various ratios such as debt-equity ratio, interest coverage ratio and other similar ratios are measured and assessed with respect to non-current liabilities of a firm. Debt equity ratio The ratio expresses proportionate relationship between shareholders’ fund of a company and its long term debt such as loans, debentures and others. Debt equity ratio is very useful in determining financial leverage or gearing position of the firm as well as its capability of meeting the long term liabilities thereof. Correspondingly, the respective debt equity ratio of Gillette for 2002 and 2003 are 1.44 and 1.32. it was gathered that Gillette is a high geared company where the dependency is more on long term debt and unless the firm earns sufficient net profit, it will face financial difficult while paying interest and principle related to the debt (Helfert, 2002; Kaplan, Atkinson and Morris, 1998). Interest coverage ratio The interest coverage or debt service ratio represents relationship between interest expenses of a corporation and its net earnings before tax and interest. The ratio indicates whether a firm is capable of paying off its interest expenses by means of its operating earnings. Accordingly, the debt service ratio was determined as 21.54 in 2002 and 37.09 in 2003 for Gillette. It was also gathered that the interest payable of the concern has reduced significantly indicating that the company is improving its lever position. Cash interest coverage ratio Cash interest coverage ratio, as the name suggests, takes into account the relationship between cash generated from operations for a specific period of time and the interest expenses. This ratio can be considered as a short term perspective where the management tries to determine if the generated cash from operations are sufficient to the meet the interest expenses. In this regard, it was determined that the ratio for 2002 and 2003 are 24.73 and 48.89 respectively. The ratio has improved as a result of increase in cash flow and decrease in interest expenses and this is considered healthy for the company (Kaplan, Atkinson and Morris, 1998). Asset management Asset management focuses on appropriate utilisation of assets for generation of revenue. Net asset turnover ratio Net asset turnover ratio indicates financial relationship between a firm’s total asset and its revenue. In other words, the ratio aims at establishing the extent to which assets are being utilised for revenue generation. In context of Gillette, the turnover has improved from 86 percent in 2002 to 93 percent in 2003. This suggests that company is making optimum utilisation of the resources and assets for revenue generation (Kaplan, Atkinson and Morris, 1998). Profitability Profitability indicates the capability of a firm to earn profit. There are several ratios which can be implemented to determine profit of a firm. Gross profit margin Gross profit is referred to the profit that a firm earns after deducting its cost of sale from the revenue of the firm. The gross profit margin represents proportionate relationship between the profit and its corresponding sales value. The margin reflects overall profitability of the firm. High gross margin is always considered healthy as higher returns helps firm in meeting various operating and non-operating expenses. The gross profit of the company has improved from 58 percent in 2003 to 60 percent in 2003. This indicates that the company will have more funds to meet various investment and expenses (Kaplan, 1992). Operating profit margin Operating profit implies the residual profit that remains after paying off the operational cost from the gross profit. Operating profit margin is a relatively more efficient measure of organisational performance. Operating profit helps in determination of increase or decrease in the operational expenses of a firm. Improvement in operational profit margin indicates that the firm is optimising its operating cost. Contextually, operating profit of the company has improved from 21.4 percent in 2002 to 21.6 percent in 2003. The improvement is very low and firm should make effort to increase the profit (Kaplan, 1992). Return on total asset Return on total asset is capital oriented measure of profitability where the operating profit is compared with total asset to determine the share of total asset that the firm successful employed for earning profit. A high return is generally expected which implies appropriate utilisation of assets. The return on asset of Gillette has improved from 18.3 percent in 2002 to 20.1 percent in 2003. This suggests that the firm is improving regarding utilisation of asset for earning maximum profit. Return on capital employed The ratio is also known as yield on capital and is said to project overall profitability of the firm. The ratio evaluates the operating profit level with respect to net capital employed by the firm. The return on capital employed is predominantly important to lenders for determining the borrowing policy of the company. The ratio has improved fairly for Gillette between 2002 and 2003 indicating healthy capital management policy (Kaplan, 1992). Return on equity Return on equity is of great interest particularly to the investors because the ratio measures profitability with respect to the equity capital. The return on equity suggests the extent to which the net profit is being maximised by employing the equity capital. A healthy return on equity attracts shareholders for investment purpose while poor returns may force investors to reduce their share. In Gillette, the return on equity has improved from 53.8 percent in 2002 to 62.3 percent in 2003 suggesting that the firm presently has more funds to pay the shareholders as dividend (Otley1999). Additional information required for better analysis Besides, liquidity, solvency, profitability and asset management, activity ratios can prove useful for appropriate analysis of the financial statements of Gillette. The activity ratios mainly comprise of stock turnover ratio, debtors turnover ratio, creditors turnover period and working capital turnover period. The activity ratios are useful in determining the efficiency with which the available resources are being utilised for meeting organisational objectives. The stock turnover ratio depicts sales efficiency while debtor turnover period indicates towards the effectiveness of the credit policy of the company. The financial statement and the financial standing of the company will be best analysed if financial data for few more accounting periods were available. As more data would have helped in determining the appropriate growth rate of the firm (Otley1999; Kaplan, 1992). Advantages and risks Advantages: Gillette is a retail business organisation and therefore it has strong opportunity of expanding business in various retail activities. The company is a high geared firm but has stable interest cover, this indicates that the company is appropriately utilising the available resources for value and profit maximisation. The level of asset utilisation suggests that the company has strong resources in various fields such as human resource, marketing, production and finance (Hambrick, 1983; Helfert, 2002). Risks: Retail giants such as Gillette are susceptible to three kinds of risks in a broad sense, namely, operational risk, market risk and credit risk. In liquidity analysis, it was determined that the company has low working capital. Shortage of working capital and excessive current liabilities can result in credit risk and illiquidity. The market risk is prominently related to entry of substitutes and other competitors in the market, consumers’ acceptance towards the product and market condition. The operational risk is largely internal and comprises issues such as operational breakdown, personnel issues and others (Kale, Noe and Ramirez, 1991). Reference list Gibson, C. H., 2001. Financial Reporting Analysis. Connecticut: Cengage Learning. Hambrick, D. C., 1983. High profit strategies in mature capital goods industries: A contingency approach. Academy of Management journal, 26(4), pp. 687-707. Helfert, E. A., 2002. Techniques of financial analysis: a guide to value creation. New York: McGraw-Hill Professional. Kale, J. R., Noe, T. H. and Ramirez, G. G., 1991. The effect of business risk on corporate capital structure: Theory and evidence. The Journal of Finance, 46(5), pp. 1693-1715. Kaplan, R. S., 1992. The evolution of management accounting. US: Springer. Kaplan, R. S., Atkinson, A. A. and Morris, D. J., 1998. Advanced management accounting (Vol. 3). Upper Saddle River, NJ: Prentice Hall. Otley, D., 1999. Performance management: a framework for management control systems research. Management accounting research, 10(4), pp. 363-382. White, G. I., Sondhi, A. C., Fried, D. and Aiello, E., 2003. The analysis and use of financial statements. New York: Wiley. Bibliography Burns, J. and Scapens, R. W., 2000. Conceptualizing management accounting change: an institutional framework. Management accounting research, 11(1), pp. 3-25. Damodaran, A., 1996. Corporate finance. New Jersey: John Wiley & Sons. Drury, C., 2008. Management and cost accounting. Mason, OH: Cengage learning. Ross, S. A., Westerfield, R. and Jordan, B. D., 2008. Fundamentals of corporate finance. New Delhi: Tata McGraw-Hill Education. Tirole, J., 2010. The theory of corporate finance. Princeton: Princeton University Press. Appendix Read More