Financial Analysis on Meyer Holdings limited as well as Harvey Norman Holdings Limited - Case Study Example

Executive summary Financial ratio analysis is one of the major tools used by potential investors in comparing potential investment opportunities and hence making informed investment decisions. In this case, the investors select, manipulate and compare financial data from various investment options along with other relevant information before making an investment decision. This paper is aimed at carrying out a financial analysis on Meyer Holdings limited as well as Harvey Norman Holdings limited with an intent to advise potential investors on the best investment option. In this regard, an analysis on the two companies’ profitability, efficiency and long term and short-term financial stability has been carried out. The paper concludes by advising potential investors to invest in Harvey Norman since it has higher profitability and is more financially stable. However, the investors would have to influence management to improve on its financial efficiency if it is to maintain its profitability and financial stability. In addition, the paper outlines the weaknesses associated with using financial ratio analysis in making investment decisions and hence suggests that the method should be used along with other relevant information if financial investment decisions are to be accurate. Financial ratio analysis Financial ratio analysis is of paramount importance to potential investors as well as the management as it aids in evaluating the overall financial condition of the organization both in the short run and the long run. As such, potential investors/ shareholders can use financial ratio analysis to evaluate the company’s financial strength and hence decide whether to invest in it or even make a comparison between two or more companies financial performance and hence be able to make informed investment decisions where multiple options for investment exist (Janet, 2010). This is because all other factors held constant, a rational investors would choose to invest in a company that is financially sound and with a potential for higher returns on investments. In this paper, we compare financial performance of Myer holdings and Harvey Normans holdings limited for the six years between 2007 and 2012 with an aim of advising potential investors on the better investment option between the two companies. In this regard, we have addressed profitability, efficiency and financial stability. The financial data for the year 2007-2010 has been attached as appendix in an excel format. a) Profitability analysis Potential investors find profitability analysis to be of significant importance since it shows the extent to which the company is able to generate profits through comparison of profits to costs during the period in consideration. As such, potential investors look for companies with high profitability ratios all other factors held constant. In the case of the two companies, the following profitability ratios have been considered; Gross profit margin- Gross profit margin tells us how good the company is in controlling its input costs/cost of sales which are then passed to the consumer (Karen, 2008). Myer holdings limited’s gross profit margin has been on the increase since 2007 when it was 42.67% to 46.80% in 2012. However, there was a slight decline between 2009 and 2010 when gross profit margin was 39.18% and 39.64% respectively, the decline could be attributed to increasing cost of sales. However, this level of gross profit margin is high and therefore desirable for potential investors as it could translate into higher profitability levels if the company is able to have minimal operational costs. On the centrally, Harvey Norman holdings limited has witnessed a mixed trend in its gross profit margin over the six year period under review. The company’s gross profit margin gradually increased from 25.91% in 2007 to 27.98% in 2010 before gradually declining to 27.14% in 2012. Similarly, the decline is attributed to increasing cost of sales. It should however be noted that the company’s gross profit margin is very low compared to that of Myer holdings and as such has a potential of resulting in low profitability for the company incase its cost of operations take a similar trend. As such, considering gross profit margin as the only factor, it would be advisable for a potential investor to invest in Myer holdings on the account of the favorable gross profit margin which is on a rising trend while that of Harvey Norman has declined over the last two years. Net profit margin- in this regard, net profit after tax is compared to sales revenue hence showing how much is contributed to profit after tax by each dollar of sale after expenses have been subtracted (Bob, 2007). Myer holdings net profit margin has taken a mixed trend where it increased from 2.45% in 2007 to 3.34% in 2009 before declining to 2.02% in 2010 after which it increased to 9.65% in 2011 before declining again to 8.80% in 2012. This ratio is considered very low given that the gross profit margin was very high. This implies that the company has very high costs of operation which greatly eat into its profitability. On the other hand, Harvey Norman’s net profit margin has declined from 24.87% in 2007 before increasing to 25.44% in 2008. In 2009, its net profit margin decreases to 15.22% before increasing to 17.70% in 2010. This later decline to 14.07% in 2012. Although, there has been a decline in the net profit margin, it is desirable given the lower gross profit margin the company has experienced. This implies the company’s ability to control its costs of operation and hence rational investors would rather invest in Harvey Norman than Myer Holdings. Return on equity – this is of vital importance to potential investors as it may give insight into the company’s ability to pay higher dividends and still invest for future growth given that it shows the company’s ability to generate good returns from the capital investment by the shareholders. As such, a wise investor would invest in a company with higher returns on equity other factors held constant. Myers return on equity increased from 21.03% in 2007 to 45.32% in 2008 before declining to 7.84% in 2010 after which it improved to 16.04% in 2012. On the other hand, Harvey Norman’s return on equity has consistently declined from 19% in 2007 to 8.85% in 2012. The changes in these ratios are attributable to changes in the level of liabilities for the companies over the years hence affecting the level of equity. However, investors would rather invest in Myer holdings as it has consistently had higher returns on equity despite the huge decline in 2012. Return on assets –this is important to potential investors as it will show how the company is good at using its assets to generate profits. In other words, it shows how much profit is generated from each dollar of assets. Myer’s return on assets increased from 4.05% in 2007 to 5.47% in 2008 before declining to 3.44% in 2010. This later improved to 9.59 in 2011 and 8.55 in 2012. On the other hand, that of Harvey Norman has declined from 10.36% in 2007 to 5.93% in 2012. However, both companies seem to have experienced similar trends in returns on assets and hence other factors would need to be considered before making a decision on where to invest. b) Analyzing efficiency These ratios depict the efficiency of a company in using its available assets to generate profit hence maximizing shareholders value. The ratios under this consideration include; Inventory turnover (days) –the ratio evaluates the firm’s ability to turnover inventory so as to generate profits. Rational investors invest in companies that have higher inventory turnover rates as this generates more profits. Myer’s inventory turnover improved from 75 days to 72 days before declining to 77 days in 2010. However, this later improved to 52.5 and 53.9 days in 2011 and 2012 respectively. On the other hand, that of Harvey Norman increased from 247 days in 2007 to 257 days in 2011 before improving to 240 days in 2012. The high turnover (days) in the case of Harvey Norman can be related to its industry of operation. However, this is in no doubt undesirable to potential investors and hence they should choose to invest in Myer Holdings in this regard. Debt turnover (days) – the ratio depicts how good the company is in correcting debts its owed by its customers and investors prefer companies that have high efficiency in debt collection so as to provide funds for running the company and hence generate profits. Myer’s debt turnover increased from 2.41 days in 2007 to 4.06 days in 2008 before declining to 0.64 days in 2012. On the contrary, that of Harvey Norman declined from 282.29 days in 2007 to 255.81 days in 2012 before increasing to 293.65 days in 2011 after which it improved to 240 days in 2012. Although this high number of days in the case of Harvey Norman is associated with its industry of operation, a rational investor would in no doubt choose to invest in Myer holdings which is more efficient. Credit turnover- the ratio is important to investors as it tells them how good the company is in meeting its obligations to creditors. Investors would prefer investing in a company that promptly meets its financial obligations. Meyers Holdings credit turnover has declined from 60.3 in 2007 to 47.9 days in 2012 implying improved efficiency. On the contrary, that of Harvey Norman has been on the increase from 153.64 days in 2008 to 212 days in 2012 depicting a declining efficiency. As such, new investors would prefer to invest in Meyers holding if the decision was to be solely based on credit turnover. c) Financial stability Financial stability analysis is of importance to potential investors as it will depict the firm’s ability to meet its financial obligations both in the long term and short term. Investors would prefer investment opportunities that are financially stable as they will promptly meet their financial obligations hence averting the risk of liquidation posed by instability. In this case, the following ratios have been analyzed; Current ratio- this is an indication of the firm’s ability to meet its financial obligations in the short run and it shows how many times the firm’s current assets cover its current liabilities. In this case, investors choose investment opportunities with higher current ratios other factors held constant. Myer’s current ratio has declined from 0.95 in 2007 to 0.81 in 2011 before improving to 0.88 in 2012. On the other hand, Harvey Norman’s current ratio ranged from 1.7 to 1.62 during the period in consideration. In this regard therefore, Harvey Norman is more financially stable and would be more preferable to potential investors. Quick ratio - the ratio only uses the more liquid assets in measuring financial stability and is hence more preferable to potential investors than current ratio as a measure of short term financial stability (Kelly, 2007). A higher quick ratio depicts a greater ability to meet short call demand for payment from lenders and creditors without interference with the firm’s normal operations and is hence more preferable to potential investors. Meyer’s quick ratio ranged from 0.41 to 0.11 during the period under consideration while that of Harvey Norman ranged from 0.92 to 1.44 hence depicting a more stable position and would hence be more preferable to potential investors in this regard. Debt asset ratio (total debt) – this is an indication of the proportion of the company’s assets financed through debt. In this case, a lower ratio would be preferable to potential investor as a higher ratio would expose the firm to the threat of liquidation and takeover incase it is in difficulties in meeting both short term and long term financial obligations. In this regard, Myer’s debt asset ratio ranged from 21.49% to 56.36% during the period under consideration. On the other hand, Harvey Norman debt asset ratio ranged from 13.53% to 44.34% during the same period and hence would be more preferable to potential investors in this regard as it shows a more financial stable position. Debt equity ratio (total debt) – the ratio is important to potential investors as it shows the firm’s earnings available to meet its interest obligations to lenders and creditors. A higher ratio is preferable to potential investors in this case as it shows the company is more able to meet its interest obligation hence averting the threats of liquidations and take overs (Jameson, 2010). Meyers times interest earned ratio during the period under consideration ranged from 2.54 to 7.73 times while that of Harvey Norman ranged from 3.86 times to 16.77 times . In this case therefore, Harvey Norman would be more preferable to potential investors as it has greater ability to meet its interest obligations. Limitations of the above analysis Financial ratio analysis has its own shortcomings and as such should not be used alone in making financial investment decisions by potential investors. For instance; a) Financial ratio analysis fails to consider inflation since the figures shown on the balance sheet are historical and hence different from real values hence ignoring the effect of inflation on such items as depreciation, inventory as well as profits (Davidson, 2003). Therefore, investors should consider the extent of inflation before relying on the analysis in making their investment decisions. b) Financial ratio analysis does not reveal the real cause of the ratios presented. Revealing the cause of such figures would be of paramount importance to potential investors so that they can make informed investment decisions (Johansen, 2011). This is because some figures may be caused by changes in the operating economic environment, political or industry environment and hence may be temporary. If decisions do not consider such factors, wrong decisions are bound to be made. c) Different companies employ different accounting practices which may result in different valuations say of inventory. Depreciation methods may also vary from one company to the other and such variations may need to be considered before making investment decisions. d) Financial ratio analysis fails to consider the different operating environments between the companies as they may operate in different industries (Griffin, 2010). As such, this can have significant effect on the financial analysis results and hence basing decisions entirely on the financial analysis may turn out to be misleading. References: Janet, G2010, managerial accounting and decision making, Bookman, London Karen, B 2008, Investing wisely, Sydney, Prentice hall Bob, J2007, Informed investment decisions, Financial Management Journal, Vol.2, no.12, pp.5-7. Davidson, K2003, Financial management and decision making, London, Rutledge Griffin, B2010, Accounting and Finance, New York, John Willeys Johansen, G2011, Financial accounting, London, Rutledge Jameson, J2010, Accounting principles and basics, Oxford, Oxford university press Kelly, J2007, Accounting and finance for entrepreneurs, New York, John Willeys Read More