Financial and Managerial Accounting - Assignment Example

BUS 5203 Financial and Managerial Accounting 1 Ratio Formula 2006 2005 Current Ratio Current assets/current liabilities =1,135//1300.4=87.28% =974.5/1,185.1=82.22% Quick ratio (Current assets-Inventories)/current liabilities =(1,135-472.1)/1,300.4=50.98% =(974.5-423.8)/1,185.1=46.47% Average Receivable Collection Period =(Days× Average receivables ) /Credit sales =(365*200.9)/5,175=14.17 days (365*157.3)/4,749.4=12.09 days Average Number of Days Inventory =(Days ×Inventory)/Cost of sales =(365*472.1)/3,604.0=47.81days =(365*423.8)/3,334.9=46.38 days Average Number of Days Payable =(Days ×accounts payable)/ cost of sales =(365*1,219.6)/3,604.0=123.52 days =(365*1,116.9)/3,334.9 =122.24 days Similarly Long Term Debt to Equity = long-term debt/Equity =663.3/328.3 = 202.04% =615/243.1=252.98% Gross margin =Gross profit/Revenue =1,571/5,175=30.36% =1,414.5/4,749.4 =29.78% Operating Profit Margin =Operating profit/Revenue =233.8/5,175 =4.52% =232.5/4,749.4=4.9% Net Profit Margin = Net profit/Revenue =211/5,175=4.08% =206.6/4,749.4 =4.35% Return on Total Assets =EBIT/Total assets =233.8/2,126.6 =10.99% =232.5/1,832.6=12.69% Return on Equity = Net income/Shareholders equity =211/328.3 =64.27% =206.6/243.1=84.99% Earnings per Share = Net profit/Average outstanding shares =210,800,000/1,342,900,000 = 16 cents 205,300,000/1,338,200,000=15.3 cents Price Earnings Ratio =MPS/EPS =3.37/0.16 =21.06% =3.03/0.153 =19.80% Dividend Yield =DPS/MPS 0.094/3.37=2.8% 0.085/3.03 =2.8% 2 The following has been observed regarding the company’s ratios. Liquidity: Generally, the company’s liquidity improved in 2006 as compared to 2005. The company’s current ratio improved from 82.22% in 2005 to 87.28% in 2006. While it’s quick ratio improved from 46.47% in 2005 to 50.98% in 2006. However, the company’s performance as far as Average Receivable Collection Period, Average Number of Days Inventory and Average Number of Days Payable slightly declined during 2006. The company’s average receivable collection period slightly increased from 12.09 days in 2005 to 14.17 days in 2006. Its Average number of day’s inventory increased from 46.38 days in 2005 to 47.81 days in 2006. This implies that the company could have had more cash had it been more efficient in collecting receivables like it was in 2005 meaning its liquidity would have been better. Similarly, the company could have made more sales should its days in inventory remained in the same level as in 2005. On the other hand, its average number of days increased from 122.24 days in2005 to 123.52 days in 2006. Leverage: there was a marked improvement in the company’s leverage since its long-term debt to equity ratio improved from 252.98% in 2005 to 202.04% in 2006 implying its level of longterm relatively declined. Profitability: Generally, the company reported a slight decline in profitability in 2006. Its gross margin ratio however improved slightly from 29.78% in 2005 to 30.36% in 2006. Its operating margin declined slightly from 4.9% in 2005 to 4.52% in 2006. Similarly, its net profit margin slightly declined from 4.35% in 2005 to 4.08% in 2006. The company’s returns on total assets significantly declined from 12.69% in 2005 to 10.99% in 2006. This was similar to the decline noted in the company’s return on equity which declined from 84.99% in 2005 to 64.27% in 2006. Return to investors: The Company’s returns to investors however improved slightly from the previous year’s levels. The company’s earnings per share slightly improved from 15.3 cents in 2005 to 16 cents in 2006. This was similar to the company’s price earning ratio which improved from 19.80% in 2005 to 21.06% in 2006. Similarly, the company’s dividend yield remained stagnant at 2.8% in both years. Conclusion: based on the above ratio analysis, the company has recorded mixed signs having improved in liquidity, solvency and returns to shareholders. However, its profitability declined as stated above. As such, it would be prudent to conclude that the company slightly deteriorated in 2006 as compared to 2005. This is because the company’s profitability as well as many of the other aspects addressed in the ratio analysis have recorded a decline although there has been slight improvements in other aspects. 3 2006 2005 Sales 5,175.0 100% 4,749.4 100% Cost of sales (3,604.0) 69.64% (3,334.9) 70.22% Gross margin 1,571.0 30.36% 1,414.5 29.78% Other operating income 13.7 0.26% 32.0 0.67% Selling and distribution costs (1,155.2) 22.32% (1034.8 21.79% Administration and other operating expenses (195.7) 3.78% 179.2 3.77% Operating profit 233.8 4.52% 232.5 4.9% Financing charges (23.0) 0.44% (25.7) 0.54% Financing income 17.0 0.33% 16.3 0.34% Net financing charges (6.0) 0.12% (9.4) 0.20% Share of results of associates and joint ventures 27.7 0.54% 28.5 0.6% Profit before tax 255.5 4.94% 251.6 5.3% Tax (44.5) 0.86% (45.0) 0.95% Profit for the year 211.0 4.08% 206.6 4.35% Attributable to: Shareholders of the company 210.8 4.07% 205.3 4.32% Minority interests 0.2 0.01% 1.3 0.03% 211.0 4.08% 206.6 4.32% 2006 2005 Net operating assets: Intangible assets 226.1 10.63% 226.8 12.39% Tangible assets 540.0 25.39% 463.4 25.32% Associates and joint ventures 113.9 5.36% 106.6 5.82% Deferred tax assets 94 4.42% 7.0 0.38% Other non current assets 62.2 2.92% 54.3 2.97% Non-current assets 991.6 46.63% 858.1 46.88% Stocks 472.1 22.2% 423.8 23.15% Debtors and prepayments 200.9 9.45% 157.3 8.59% Current tax assets 5.0 0.24% 2.1 0.11% Bank balances 456.5 21.47% 389.1 21.26% 1,134.5 53.35% 972.3 53.12% Non current assets classified as held for sale 0.5 0.02% 2.2 0.12% Current assets 1,135.0 53.37% 974.5 53.24% Creditors and accruals (1,219.6) 62.11% (1,116.9) 54.66% Current borrowings (47.0) 2.39% (35.9) 1.76% Current tax liabilities (33.7) 1.72% (31.8) 1.56% 1,300.3 66.22% (1184.6) 57.98% Liabilities directly associated with non current assets classified as held for sale 0.1 0.01% (0.5) 0.02% Current liabilities 1,300.4 66.23% (1,185.1) 58% Non current liabilities (165.4) 7.78% (210.6) 10.31% Long-term borrowings (389.5) 18.32% (352.1) 17.23% Deferred tax liabilities (41.3) 1.94% (34.9) 1.71% Other non current liabilities (67.1) 3.16% (17.4) 0.85% 328.3 15.44% 243.1 11.9% Total equity Share capital 74.7 3.51% 74.5 3.65% Share premium and capital reserves 27.8 1.31% 26.1 1.28% Revenue and other reserves 221.5 10.42% 123.5 6.04% Shareholders funds 324.0 15.24% 224.1 10.97% Minority interests 4.3 0.20% 19.0 0.93% 328.3 15.44% 243.1 11.9% 4 What additional observations about the company can you make now? 10 marks A look at the company’s income statement reveals a deteriorating performance of the company within the two years as far as profitability or income is concerned. There has been a slight decline in the company’s cost of sales which was 70.22% of sales in 2005 compared to 69.64% in 2006. This results in a slight improvement in the company’s gross margin from 29.78% in 2005 to 30.36% of sales in 2006. It should however be noted that the company’s income slightly declines from 4.35% of sales in 2005 to 4.08% of sales in 2006. This is attributed to the general increase in the company’s levels of operating expenses as well as financing expenses which are noted to have increased from 25.43% of sales in 2005 to 26.28% of sales in 2006. On the other hand, a look at the company’s statement of affairs reveals a mixed picture regarding the company’s state of affairs within the two years. The company’s total current assets have slightly improved from 53.24% of total assets in 2005 to 53.37% of total assets in 2006. On the other hand, the company’s long-term assets slightly decline from 46.88% of total assets in 2005 to 46.63% of total assets in 2006. The company’s current liabilities however significantly increased from 58% of total liabilities and owner’s equity in 2005 to 66.23% of the company’s total liabilities and owner’s equity in 2006. The company’s total owner’s equity has on the other hand improved from 11.9% to 15.44% of the company’s total liabilities and shareholders equity in 2005 to 2005 respectively. Based on this financial statements analysis therefore, one can only conclude that the company recorded mixed performance improving in some areas while deteriorating in other areas. 5 To a large extent, the company’s financial statements are consistent with what the company says about itself in the financial statement. From what the company presents about itself, one will easily conclude that the company is performing very well in all its aspects which is not reflected in the financial statements analysis. The company’s claim that the sales have increased from the 2005 figures is consistent with what has been displayed on the financial statements. The company’s claim that the operating profit margin ratio increased during the year is also consistent with what has been presented in the financial statements. In addition, it is true that the dividends per share have increased according to the financial statements just as the annual report has claimed. There has been an increase in the company’s total asset expenditure according to the annual report which is still the case on analyzing the financial statements. However, it should be noted that this explains the decline in the company’s return on total assets as has been portrayed in the financial ratios. Just as the financial statements analysis reveals, there has been an increase in the company’s net operating assets excluding cash in comparison to 2005 figures. The company’s borrowings have also increased in 2006 when one analyses the financial statements just as the annual report reveals. Similarly, the company’s interest income increased according to the company’s annual report which is also revealed by the financial analysis. However, it should be noted that financial ratio analysis does differ with the annual report in a number of ways. For instance, while the annual report portrays everything as having improved between 2005 and 2006, the company’s liquidity ratios and profitability ratios show declining performance. This is largely attributed to the fact that the annual report is based on raw figures while the financial ratio analysis has modified this figures into ratios thus showing how the company performed in various aspects in respect to the previous year’s performance. It should however be noted that both the financial statements and the annual reports agree to a large extent regarding what the company has reported about itself. 6 As indicated above, Dairy firm’s current position and performance displays a mixed picture. This implies that some aspects of the company’s performance including profitability and liquidity have deteriorated. Although raw figures indicate that the company has performed well in all aspects, the financial ratio analysis as well as the horizontal assessment of the financial statements portrays a different picture. For instance, the company’s efficiency in converting inventory to sales has deteriorated. Its efficiency in collecting receivables as well as that of repaying debts owed to others has also declined slightly. In fact, had the company’s efficiency in these aspects remained at 2005 levels, most probably the company would have performed better in all other aspects. The company’s liquidity ratios also remain very low at below one implying there is a high risk of the company’s normal operations being interrupted in case the company is unable to meet its current obligations. The company’s profitability has similarly declined with the exception of gross margin which indicates that the company was able to control its costs of sales which is why they reduced but was unable to bring down the level of other expenses thus draining on its profitability. The only aspects of the company that improved are its efficiency implying that it accumulated debts at a lower rate in 20065 than it did in 2006 as well as its returns to shareholders. in essence, one would conclude that the company’s performance and position generally stagnated in 2006 compared to 2006. The company almost remained in the same level it was in 2005. However, its decline in profitability and its efficiency indicators makes one to conclude that the company’s performance deteriorated in 2006 compared to 2005. Looking at the financial report however, the company has reported having undertaken many investment projects in 2006. It is hoped that this investments will result in better performance in 2007 given the industry that the company operates. This explains why the company might have slightly deteriorated in 2006. Based on the fact that the company made investments in 2006 while its level of profits when raw figures are compared showed some improvements, one can only conclude that the future looks bright for the company and that the company is expected to perform better in future. However, the company needs to bring down its operating expenses which are eating into its profits given that its gross margins improved. In addition, there is need for the company to improve its efficiency in converting inventory into sales. This way, its revenues and hence profits will improve. Finally, the company should increase its efficiency in collecting receivables. This way, it will be able to improve its liquidity levels. Given the investments it undertook in 2006 as well as the suggestions for improvement above, the company is assured of better future performance. 7 a) Comparison with Tesco: There is a great difference between the two company’s balance sheets both in terms of components, presentation and units of currency. While Dairy Farm presents its balance sheet in US dollars, Tesco does it in pounds. Secondly, the balance sheets differ in terms of assets, liability and capital. While majority of assets for Dairy firm are current assets, majority of assets for Tesco are fixed assets. For instance, the 2006 balance sheet reveals that Total current assets for Tesco were only 17.4% of the company’s total assets while the rest were long-term assets. Similarly, the company’s level of current liabilities is much lower compared to that of Dairy firm. The company’s total current liabilities were 33.3% of total liabilities and equity in 2006 compared to dairy firm’s 66%. The company’s financing through debt and equity also differs with that of dairy firm. For instance, its level of shareholders equity was 41.9% of the company’s entire liabilities and equity in 2006 compared to that of Dairy farm which was only 15.44%. As such, the two balance sheets differ greatly in terms of assets composition as well as financing. Comparison with Sobeys’s Just like Tesco, Dairy farm’s balance sheets greatly differ with that of Sobeys. While Dairy Farm presents its balance sheet in US dollars, Sobeys does it in Canadian dollars. Secondly, the balance sheets differ in terms of assets, liability and capital. While majority of assets for Dairy firm are current assets, majority of assets for Tesco are fixed assets. For instance, the 2006 balance sheet reveals that Total current assets for Tesco were 33.0 % of the company’s total assets while the rest were long-term assets. Similarly, the company’s level of current liabilities is much lower compared to that of Dairy firm. The company’s total current liabilities were 32.9% of total liabilities and equity in 2006 compared to dairy firm’s 66%. The company’s financing through debt and equity also differs with that of dairy firm. For instance, its level of shareholders equity was 50.3% of the company’s entire liabilities and equity in 2006 compared to that of Dairy farm which was only 15.44%. As such, the two balance sheets differ greatly in terms of assets composition as well as financing. a) Comparison with Tesco Tesco’s liquidity is weaker than that of Dairy firm as far as current and quick ratio is concerned. However, Tesco performs better in terms of efficiency in converting inventory in sales, collecting debts and settling its payables is concerned. Tesco’s solvency is also far much better than that of Dairy farm when long-term debts to equity ratios are compared. While Tesco performs worse in terms of gross profit margin, its profitability in terms of operating and net margins are higher than those of Dairy firm. However, its returns on total assets as well as returns on equity are much lower than those of dairy farm. Dairy farm however performs better than Tesco as far as returns to shareholders are concerned. Comparison with Sobeys Sobeys performs better than Dairy farm on comparing all aspects of liquidity. Similarly, Sobeys performs far much better as far as solvency is concerned when the long-term debt to equity ratios are compared. However, Dairy firm has performed better than Sobeys when the profitability ratios are compared. Dairy firm also performs better than Sobeys when returns to shareholders are compared. b) It has been noted that performances of the three companies’ greatly differ when financial ratios and balance sheets are compared. The differences are mainly in terms of financing and profitability. These differences are mainly caused due to the nature of the markets the company’s operate in as well as specific issues that the companies face internally. In terms of financing, Tesco’s and Sobeys have more shareholder funds than dairy farm. On the other hand, much of Dairy firm’s assets are financed through debt. It also worth noting that Tesco and Sobeys have greater parts of their balance sheets being composed of fixed assets as opposed to current assets. This may have resulted from the company’s financing policies. This also affects the companies’ ratios as has been observed. The differences also occur as a result of the kind of products the companies offer. For instance, the products offered by Tesco entail a lot of cost of goods sold expenses while those offered by Sobeys do not require cost of goods sold expenses. This may explain why Sobeys doesn’t have gross margin while that of Tesco is so low compared to that of Dairy firm. The differences also arise out of the company’s level of efficiency. For instance, Tesco though having a very small gross margin manages to get a higher net profit margin than Dairy firm. This may have resulted from differences in the markets the companies operate for instance differences in cost of labour. c) A comparison of Dairy Farm International with Tesco and Sobeys has changed my mind about how I evaluated the company. The comparison has revealed that most of Dairy farm’s assets are current assets as opposed to the other companies whose most assets are long-term assets. In addition, it has been revealed that Dairy farm has a lot of its liabilities being current as opposed to the other companies which have considerably lower current liabilities. This means that Dairy Farm’s liquidity is wanting and hence puts the company at risk in the short term if and when it is unable to meet its short term obligations. This is a great threat to its short term operations. In addition, it has been revealed that Dairy farm has the lowest level of shareholders funds compared to the other companies. This means that Dairy farm international’s most assets are funded through debt thus increasing the risk for takeover if and when its unable to pay its obligations. However, the company seems to be performing normally on comparing its profitability with that of the other companies. However, its efficiency and control over expenses have been noted to affect its profitability when compared to the other companies. As such, while my opinion was that Dairy Farm international was performing quite normally before comparing it with Tesco and Sobeys, My opinion has now been affected. The company is not performing well and its future may be at stake owing to its having accumulated a lot of debt and having very low level of shareholders funds. The company needs to improve on its liquidity and raise funds through means that do not put its solvency at stake. However, the company’s profitability is normal when compared to the other companies. Jared, O2011, Introduction to corporate financial reporting, London, Rutledge. Read More