The Performance Potential for Boomaloo Pty ltd - Case Study Example

EXECUTIVE SUMMARY This report was written to determine the best option for Ian to invest his retirement benefits in between purchasing Boomaloo Pty ltd and investing in 3-5years term deposit. A very much extensive study regarding Boomaloo Pty ltd’s performance has been carried out. An analysis to determine the benefits of both the options was carried out. The study on the potential of both the options was aimed at arriving at the option that would give the best returns for Ian’s investments in terms interest or profitability achievable in each option. The performance potential for Boomaloo Pty ltd was determined by performing vertical, horizontal as well as trend analysis on the business’s profitability, liquidity as well as financial stability for the last three years. Furthermore, ways of improving the performance of Boomaloo were considered. The potential of the business was then compared with that of term deposits. The report also considered other non financial factors such as the prevailing economic conditions as a determinant of the best option for Ian. The results obtained were of crucial importance for determining the best option that Ian should take advantage of. Based on the findings, it was concluded that purchasing of Boomaloo Pty ltd remains the best option for Ian as long as he comes up with strategies aimed at improving the company’s performance. Contents Introduction Ian is a retired teacher who has an option of investing his retirement benefits by purchasing Boomaloo Pty ltd or investing the money in a term deposit. The main challenge that Ian faces is the increased competition from a newly established competitive business that affected the Boomaloo performance in 2009. However, Ian has the ability to reduce cost of sales by 3-5% and also engage in boat renting business that is likely to add to Boomaloo profitability. on the other hand, term deposits have fixed terms after which they lapse and they also have fixed returns with no room for improvement although one is assured of his returns after the period lapses. The purpose of this report is to advise Ian on the best option for him to invest his money in. in so doing; the report focuses on Boomaloo performance for the last three years although the report is constrained by lack of information other than financial information Profitability A look at the Boomaloo Pty Ltd profitability reveals a general upwards trend from the year 2008 to 2010 although the company does not seem to have performed well in the year 2009 compared to the other two years. The common size analysis for gross profit shows an improvement in gross profit from 28.57% in 2008 to 29.03% in 2010. Trend analysis shows a similar trend during the same period while vertical analysis shows an upward trend in gross profit from the year 2008 to 2010 from -30% to 5.88% in 2010. A look at returns on assets ratios and returns on share holders’ equity ratios also reveals an upward trend from the year 2009 to the year 2010.A similar upward trend is observed in the common size analysis, trend analysis and vertical analysis of the profit after tax. Although the gross profit margin is slightly below the industry one, the net profit margin (12.58%) is much higher than the industry net profit margin (10%).this means that if the company was to reduce its costs of good sold, it can have even greater profitability. since Ian is able to reduce the cost of sales by about 3-5%, it means that the business will even perform better if he purchases it. The company’s price earning ratio increased from 0 times in 2009 to 5.9 times in 2010. Although the divided payout ratio decreased from 147.89% in 2009 to 73.08% in 2010, this is an improvement compared to 67.90% in 2008. This means that if the trend was to continue, the company is likely to perform even better in 2011. In fact, the company’s performance seems to be on track as far as profitability is concerned when compared to the industry average. Comparison of the investment to a term deposit Term deposits usually have fixed interest rates meaning that the amount of return is fixed and can not be increased even if economic conditions improve. However, unlike the investment, is assured of the interest and the money invested after the end of the period. On the other hand, the investment highly depends on the economic conditions prevailing in the sector and hence one is not guaranteed of his money and interest during the period of investment. Investing in Boomaloo Company will also give Ian immediate returns from the investment and hence he can continue having access to his money during the entire period of his investment. The amount of return he can get from this investment is also not fixed and can be as high as 15% as opposed to a fixed rate of say 7% per year in case of a term deposit. However, during bad economic times like the recent economic crisis, an investment may not have favorable returns that would sustain his expenses. Sub conclusion about profitability of the business From the information obtained above, one can conclude that the business is performing well as far as profitability is concerned owing to the fact that its profitability has been increasing over the years. The business is also doing better than most firms in the industry since its profitability (net and gross profit margin) is higher than the industry average in 2010. If profitability alone is considered, Ian should go ahead and invest in Boomaloo Pty Ltd. Liquidity Both the company’s quick ratio and current ratios are lowest in 2009 and highest in 2008. However, both the ratios are lower than the industry average. The company’s quick ratio is lower than one in all the three years and although the current ratio is greater than one in all cases, it is still lower than the industry average. This means that the company’s liquidity position is wanting and much should be done to correct the situation so that the company does not run into liquidity problems. Current assets and liabilities During the three years, the current assets are more than double the amount of current liabilities. For example in 2010, current assets are 42% while current liabilities form just 20percent of the total assets. This is reflected in the current ratio which is greater than two in all the cases apart from 1999 when it is lower at 1.84.the fact that inventory form a very big percentage of the current asset explains the reason why the current ratio is lower than one in all the cases. This makes the company’s liquidity to be wanting. Percentage analysis and accounts receivable ratio of the business Accounts receivable ratio is the ratio that deals with the efficiency of a business in collecting debts arising from credit sales i.e. the number of times average debtors are turned over during a year. The company has a debtor percentage of 3.57% in 2008, 3.42% in 2009 and 3.60% in 2010.on the other hand the business had an accounts receivable ratio of 7.0 in 2008, 6.54 in 2009 and 6.89 times in 2010. Although these figures are acceptable, they could be further improved upon by reducing the debtors’ collection period to 40 days similar to the industry average. Inventory turnover ratio Inventory forms a great part of the company’s assets. This explains the low inventory turnover ratio for the company which ranges from 4.58 times time in 2009 and 5 times in 2008 compared to the industry average of 7 times. If the company can improve on the number of times inventory is turned over to at least be the same as the industry turnover ratio, then the company can perform better since less money will be held in inventory and greater sales are likely to be made. Sub conclusion on liquidity The company does not seem to be doing well as far as liquidity is concerned. The industry averages are better than those of the company. Therefore, much needs to be done to improve the company’s liquidity e.g. by reducing the amount of inventory and being more efficient in debt collection. Not unless Ian comes up with a strategy for improving the company’s liquidity, he should think of investing his money in term deposits since if the trend continues, the company may find itself in liquidity problems Financial stability The company’s debt ratio has decreased from 37.37% percent in 2009 to 33.42% in 2010. On the other hand, equity ratio shows an upward trend from 62.63% in 2009 to 66.58% in 2010. The company’s capitalization ratio shows a decreasing trend from 1.60:1 in 2009 to 1.50:1 in 2010. The decreasing trend in the company’s debt ratios as well as capitalization ratios can be attributed to the reduction in long-term debts as well as the improved profitability by the company. It is worth noting that the company’s equity ratio is higher than the industry average a sign of financial stability. Assets and liabilities There have been changes in assets and liabilities of the company with assets decreasing in 2009 from the 2008 figure which is greatly attributed to reduction in cash ad inventory. However, the company increased its asset base in 2010 mainly owing to increases in the current assets. However, there is a general decreasing trend when liabilities are considered. This explains the improvement noted in the company’s debt and equity ratio. Times interest earned ratio The ratio is not high. In fact, it is lower than the industry average. However owing to the reducing trends observed in interest bearing liabilities, the company may have improved times interest ratio in future. This will ensure sound financial stability for the company. Asset Turnover Ratio The company’s asset turnover ratio decreased to 1.53:1 in 2009 from 1.67 in 2008 before improving to 1.61:1 in 2010. However, the ratio is still lower than the industry average of 2.10:1. A look at the company’s revenue trend reveals improved performance in 2010 from a poor performance in 2009. However, the increase in asset level is not proportional to the increase in revenue and this explains the improving asset turnover ratio. Sub conclusion about financial stability of the business The company is generally financially stable although much needs to be done to improve its revenue and reduce its liabilities so as to improve its financial stability. In so doing the company will be a good option for Ian to invest in. Conclusion This report was aimed at advising Ian whether to invest his retirement benefits by acquiring Boomaloo Pty limited or investing his funds in a 3-5 years term deposit plan. An analysis of Boomaloo Pty limited revealed that the company is doing well as far as profitability is concerned although there is room for improvement by reducing cost of revenue by 3-5% .Furthermore; Ian has a chance to improve the profitability of his business by securing clients for boat owners where he can make a substantial amount of money. Although the liquidity of the business is wanting, Ian can come up with measures aimed at improving the company’s liquidity e.g. by reducing the amount of liability the company owes outsiders. The company was also found to be financially sound although there is still room for improvement. Ways of improving the company’s performance were observed to be reduction of debt collection period as well as cost of revenue reduction. On the other hand, it was observed that although Ian would be assured of his investment and interest after the period lapses in the case of a term deposit, the interest rate is fixed and hence there is no room for improvement. Furthermore Ian will be unable to access before the period lapses. Recommendation If Ian invests in the term deposit, he will get a fixed rate of interest for the investment period and he will be able to access his money after the period lapses. This option is assured of success. On the other hand, if he invests in Boomaloo ltd, he will be able to access interest (profit) immediately as long as the business is performing well. The amount of profit he gets will depend on how well the business performs and will be in operation as long as the economic environment is conducive. Owing to the observations made above, it would be wise for Ian to invest his money by acquiring Boomaloo Pty ltd since he has the ability to improve on the business’s performance owing to his background in the industry. He is able to reduce the cost of revenue by 3-5% and also take advantage of this company to involve himself in the boat renting business. All this is likely to give him better returns than a term deposit which has fixed returns. APPEDIX This report is solely based on financial statements analysis which may limit its reliability. The major shortcomings of basing financial decisions solely on the basis of financial statement analysis include the following; Financial statement analysis does not consider the possible changes in the economic /business environment that are likely to occur in the future since it is based on historical data. One can only estimate about future performance based on the trends observed in the past. If the environment in the past was turbulent, the financials are not likely to be favorable and hence this may discourage one from venturing into the business. On the other hand, favorable business environment in the future may mean better results for the business which may not have been reflected in the analysis. One should also consider other aspects of the business such as legal and political environment before making an investment decision. The methods of analyzing the financial results may differ from one business to another and from one analyst to another and there is no standard way of performing such an analysis. Figures may also be doctored to reflect good financial performance for the business in order to deceive potential investors. Furthermore, the amount of information may not be sufficient to fully base a financial decision solely on it. This is because some business are disposed off when they have just been in operation for a few years and this may not be sufficient time for one to conclude that the business has been performing well. Therefore such errors may affect the reliability of such reports if only based on financial performance analysis. Financial decisions should therefore be based on many factors and not just financial performance analysis. The financial results are a reflection of the management experience of the people involved in managing the business. Therefore, if a business has been producing good financial results owing to its good management strategies, the results may not guarantee good performance in the future since the investor may not be as competent in business management as the former managers. The vice versa is true. This shows the need to also consider the managerial efficiency of the investor as well as that of the current owners. In order to improve on my analysis, I would have to obtain information relating to the economic environment within which the business has been operating. I would also consider the management skills possessed by the potential investor and also ensure that the information availed to me is sufficient for me to base my Reference List Principles of accounting.com 2010, principles of accounting, Viewed 15 April 2010, http://www.principlesofaccounting.com/chapter%2010.htm Read More