A Financial Analysis of LookinGood - Term Paper Example

Case Study College: Name: Students ID: Date: Course Name: Unit Code: Time: Instructor: Executive Summary Financial analysis of a company is crucial to each and every one manager. This report presents a financial analysis of LookinGood with an intention of advising Gillian whether to acquire the business or not. LookinGood posted declining profitability, liquidity and solvency. Its performance is also, for the most part, way below the industry average whereas Luscious has had a good performance beating the industry average. However, amid declining interest rates we recommend that Gillian acquires the business and takes advantage of this to revamp the business. In addition, the consumer price index is declining and unemployment rates are quite low, meaning that people can afford the extra income to spend on fashion clothing. This indicates that there is a possibility of LookinGood picking up. Table of Contents Executive Summary 1 Table of Contents 2 Introduction 3 Profitability 4 Liquidity 5 Solvency 6 Conclusion and Recommendations 7 References 9 Appendices 10 Introduction Financial analysis of a company is crucial to each and every one manager. It eases the process of managerial decision making, which in turn has an effect on the overall strategy of the company (Chiappetta et al., 2009). This report captures the financial analysis of LookinGood Pty Ltd. It entails the analysis of the company’s profitability, liquidity, and financial stability over a three year period: 2011, 2012, and 2013. The company’s performance is weighed against the performance of Luscious Ltd as well as the women’s retail fashion boutique industry. Current information is as well drawn into the analysis including the interest rates and other trends. At the end of the report is a conclusion and recommendations followed by a list of the referenced material and the appendices. Profitability Profitability ratios review earnings performance relative to sales. The ratios try to gauge management’s abilities as well as the company’s actions by assessing their performance based on the profits generated by the business. This paper analyses two key profitability ratios; the gross profit margin and the operating profit before tax margin. The gross profit margin weighs up the gross profits generated by a company against the total sales. The operating profit before tax margin is a ratio of the operating profit before tax to the total sales of the company (Steven, 2006). Table 1: 2013 Profitability Ratios Comparison Ratio LookinGood Luscious Industry Average Gross profit margin 30% 36% 34% Operating profit before tax margin 7.0% 14.2% 11.4% LookinGood’s profitability has been declining across the three year period. In 2011 the company had a gross profit margin of 36 per cent, this declined to 33 per cent in 2012 and 30 per cent in 2013. Also the operating profit before tax margin declined from 10 per cent in 2011 to 7 per cent in 2012 and 2013. In 2013, LookinGood’s profitability is lower, weighed up against Luscious profitability along with the industry average. The company’s gross profit margin is less by 6 points and 4 points respectively. The operating profit before tax margin is less by 7.2 points and 4.4 points respectively. Liquidity Liquidity ratios evaluate the ability of a company to meet up its short-term obligations by means of its current assets. The two key liquidity ratios are the current ratio and the quick (acid-test) ratio. The current ratio compares an entity’s current assets to its current liabilities whereas the quick ratio compares an entity’s current assets less inventory to its current liabilities (Steven, 2012). Table 2: LookinGood Liqidity Ratios 2011 - 2013 Ratio 2013 2012 2011 Current ratio 2.02 1.91 2.11 Quick ratio 0.44 0.43 0.55 LookinGood’s current ratio is within the industrial norm of 2:1 despite a slight decline in 2012. This means that the company can make use of its current assets to meet its short term debt obligations. However, the quick ratio has been declining from 0.55 in 2011 to 0.44 in 2013. Also, the ratio is below the industrial norm of 1:1. A comparison of the current ratio and the quick ratio, it is clear that the bulk of the company’s current assets are tied up in inventory. Solvency Solvency ratios are measures of how well assets are made use of by a company. The ratios can be used to assess the gains produced by specific assets such as inventory, assets or debtors or all a company’s assets together. In this case, we analyse LookinGood’s solvency based on inventory and total assets. Day’s inventory is the number of days inventory is held within the warehouse while the asset turnover is the number of times the assets generate the sales (Martin & Fernando, 2002) Table 3: 2013 Solvency Ratios Comparison Ratio LookinGood Luscious Industry Average Asset turnover 3.15 times 3.5 times 2.9 times Inventory turnover (days) 48 days 39 days 43 days Equity ratio 18% 63% 61% On the whole, LookinGood’s solvency has been declining across all measures analysed. The company’s asset turnover ratio declined from 3.37 times in 2011 to 3.15 times in 2013. In 2012 the asset turnover was 3.33 times. Similarly, the equity ratio went down from19 per cent in 2011 o 18 per cent in 2012 and 2013. Inventory turnover (days) increased from year to year. The days increased from 43 days in 2011 to 46 days in 2012 then to 48 days in 2013. This indicates an increase in the rate at which inventory is converted to finished products; hence a decline in solvency. In 2013, LookinGood’s solvency is lower weighed up against Luscious. Luscious had an asset turnover ratio of 3.5 times whereas LookinGood had an asset turnover of 3.15 times. Inventory turnover (days) for the two companies was 39 days and 48 days respectively, equity ratio was 63 per cent and 18 per cent respectively. LookinGood posted a better asset turnover compared to the industry average at 3.15 times and 2.9 times respectively. However, the company’s performance was below the industry average in the inventory turnover (days) and equity ratio. Conclusion and Recommendations From the analysis above, it is evident that LookinGood’s financial performance has been on the decline in the past three years. The company’s profitability, liquidity and solvency are not strong enough. On the other hand, Luscious has posted a good performance that is well above the industry average. This means that the women fashion retail industry is still lucrative. Therefore, we recommend that Gillian acquires LookinGood. He then should focus on revamping the business. At the moment, the country has quite low interest rates; we also recommend that Gillian should take advantage of the low interest rates to acquire additional capital to enable him revive the business. We also recommend that Gillian hires a person to assist him in running the business. Ivy is a good option, but her salary is quite high. Gillian should consider finding and vetting someone else with experience in the women fashion retail industry to help him revive LookinGood. Gillian should also focus on reducing the operating expenses, selling and administrative expenses, which account for a large portion of the expenses and have been increasing. He should improve on the efficiency of the business. Also, the consumer price index has been reducing. Therefore people can afford the extra income to spend on fashion clothing. Unemployment rates are also quite low. This indicates that the demand in the market could go up. References Chiappetta, B., Shaw, K., Wild, J. 2009, Principles of Financial Accounting. 19th edn. McGraw-Hill/Irwin. Martin, S.F. and Fernando, A. 2002, Financial Statement Analysis: A Practitioner's Guide, 3 edn, John Wiley & Sons. Steven, M.B. 2006, Financial Analysis: A Controller's Guide, 2nd edn, Wiley. Steven, M.B. 2012, Business Ratios and Formulas: A Comprehensive Guide, 3rd edn, Wiley. Appendices Appendix 1 Financial ratio analysis is a widely accepted financial analysis approach for nearly all companies.  Even as financial ratio analysis can supply us with vital insight into a company’s performance, there are various limitations that have to be acknowledged when making use of financial ratios as an investigative means Different companies might employ dissimilar accounting policies. For instance, companies may adopt different methods to value inventory or different depreciation methods. As a result the ratio of one company cannot at all times be justifiably weighed against that of another company Financial statements merely show historical data. This exposes ratios to distortions by inflation. Price level variations make the evaluation of figures risky over durations of time. Inflation impinges on inventory values. Moreover, depreciation and profits are affected (Martin & Fernando 2002, p.48). Ratios are apparatus of quantitative investigation and do not take into consideration a number of important qualitative factors which are essential in decision making. Unless one endeavours to find out the root of the numbers they end up with, they may well be playing an unsuccessful fixture. Ratios do not mean mush if not judged against past performance (trend analysis) or industry data Ratios may be deceptive owing to effects of window dressing by preparers of financial statements. If the financial statements for a company are not fairly appealing as they ought to be to the company’s management, the management may bring into play window dressing to manoeuvre the figures in the financial statements to their own advantage (Martin & Fernando 2002, p.49). To overcome these shortcomings, financial statement analysis should be conducted along with the consideration of several other factors that may well have an effect on the company’s business. These factors include: the overall economic environment (gross domestic income, GDP per capita), the level of demand for the product in the market, the nature of the labour market given that it possibly will impinge on the wage levels (supply of labour, wage level, unemployment rate), the maturity of the particular industry the company operates in, as well as the capacity of the business to meet up the demand in the market, changes in consumer needs, emerging developments, change in competition within the industry, the impact of technology which could translate to online marketing and trading. It is also important to take account of the political environment and the socio-cultural environment. These two are very much likely to have an indirect impact of the business. Appendix 2 Read More