Financial System and Ratio Analysis - Assignment Example

Financial system and ratio analysis Students Name: Institutional Affiliation: Department Course: Date: Question One a) Financial system Financial system encompasses a system that permits the reallocation of money from investors who have saved their money for investment purposes to borrowers of funds. In developed countries, the financial system can function in a global, regional or a firm set-up[Ali13]. The allocation of resources in the modern world is crucial and derives it dependency in the financial system. The primary elements of a modern financial system in a developed country will include; i. The modern financial systems and policies that have been adopted should remain consistent over a long period of time. ii. It should create a sense of accountability in that, the modern financial system can be able to provide an explanation and also be able to demonstrate to all the shareholders how resources they have provided have been used and the achievements it has accrued. iii. The modern financial system should conceptualize the aspect of integrity. The concept lies in the opinion that it should operate with outmost honesty and decency. iv. Financial stewardship should be derived from a modern financial system. It follows that good care of financial resources must accrue and also ensure that the financial resources is used to accomplish the purpose it was intended[Bar14]. v. The modern financial system adopted must observe the accepted accounting standards in keeping of financial records and also in documentation. Functions of a modern financial system in the developed world i. It allows for the pooling of funds from the investor to the borrower. The availability of funds will enable the borrowers provide better goods and service and hence improves the standards of living[Bal061]. ii. It allows the concept of capital formation to be actualized. Borrowers need funds and thus lenders will mobilize their savings to create capital. iii. A modern financial system facilitates convenient mode of payment for goods and services by the consumer. iv. Modern financial systems provides an avenue where investors are able to liquidate their investments into cash. v. A modern financial system takes into account the short term and long term needs of borrowers and lenders. vi. It assists in the protection against occurrence of risks in aspects to do with life, income and health. vii. The modern financial system aids in provision of information about various financial assets. Such an aspect will therefore assist investors compare different investments available and choose the most productive. viii. It assists the government in borrowing of vital funds which finance the government budget both in the aspect of recurrent expenditure and development expenditure. ix. The modern financial system assist the government implement policies that promote economic growth[Bar14]. b) Primary and secondary markets Primary market is defined as a market where new securities are sold in the exchange. The market is facilitated by underwriters who set the initial price of a security then supervise its sale directly to interested investors[Cho]. The purpose of primary markets includes the following; i. Organization of new issues which requires an analysis on the feasibility and predictions of new projects. The knowledge about suitability and composition of financial arrangements is an important element in determining issuance of new shares. ii. Underwriting of new issues which involves a guarantee to purchase a stated amount of the new issue at its fixed price. iii. Distribution of the new issue which essentially means the new securities are sold to the public. A secondary market is a market where previously issued securities are bought and sold. The investor will purchase a given security from the other investors rather than from the company that has issued the security. The purpose of a secondary market include the following; i. The market measures the economic conditions of the country where a changes in the country is reflected by the security prices. ii. It helps in valuation of securities on the basis of supply and demand concepts. iii. The market contributes to economic growth from the aspect of capital formation. iv. Provides a ready market for purchase and sell of securities[Cho]. The presence of the market will thus provide to investors assurances that investments will be easily converted to cash when the need arises. v. The market offers attractive opportunities for investment of diverse securities. Eventually a culture of savings and investing is realized. c) Categories and types of financial instruments A contract that brings about a financial asset to an individual or business entity and a financial obligation or equity to another individual or business entity is referred to as financial instrument Financial instruments is categorized by form and asset class[Dep] Category by form Under this category financial instrument is either a cash instrument or a derivative instrument. A cash instrument value is determined directly by market forces. Derivative instrument on the other hand derives its value from the value and characteristic from one or more underlying asset, index or interest rate. Category by asset class The classification will depend on the basis the financial is either equity based that is, it reflects ownership of the issuing individual or business entity or debt based that is, its reflects a loan the investor has made to an individual or business entity. Types of financial instruments i. A share which is a financial instrument issued to a shareholder as evidence of ownership in a limited company. It’s issued as either as written instrument or electronically through the central depository system. The shareholder is only liable to the extent of capital contributed[Bar14]. ii. A bond is a written declaration where the issuer has a unilateral and unconditional obligation to make specified monetary payments after an agreed time. Bonds are usually issued by the government and business undertakings. iii. Mutual funds is a financial instrument whereby investment funds accept funds from the public for collective investment in a given instrument to diversify risk. iv. A contract whereby settlement clause is dependent on a change in certain factors is referred to as a derivative. Derivatives is a collection of the following items a) A forward contract that calls for obligation of contacting parties to either purchase or sell a given asset for a specified price at a given time. b) An option which gives the contract parties a right but not an obligation to buy or sell a specific asset at a given price and time. c) Futures which is an agreement to either purchase an underlying item at a future date with predetermined price. Question two a) Advantages of the publically listed corporate form Public listed corporate refer to the company trading under the requirement stipulated by the stock exchange. Publicly listed corporate enjoy the following advantages i) Ease of accessing unlimited funds from public Publicly trading corporations are eligible to raise funds from public through shares hence raising enough ability to raise more capital required expansion. ii) Increase regulatory oversight The publicly listed corporation are govern by the supervisory state agencies which regulate the significant managerial incentive hence promoting oversight controls to achievement the corporate objective as well as reducing shareholders risk[Cha10]. iii) Investor confidence The listed corporations operates under pragmatic rules and procedures stipulated under stock exchange in compliance with regulatory bodies thus ensuring investor confidence since the standardized policies and procedures are followed. iv) Fast growth space The publicly listed corporation are eligible to sell the shares or us as collaterals in borrowing huge amounts that eases the efficiency in growth as compared to the privately own corporation which have limited access to fund for expansion[Cho]. v) Trading of shares in stock exchange Publicly listed corporations are eligible to market their shares in stock exchange hence giving the broad access to the standardized share prices as well as subjecting the corporate share to broader markets. vi) The publicly listed corporations have certain management controls which substantiate managerial ability to retain highly professional and skilled employees to meet the delegated functions. The publicly listed corporation is also disadvantage in the following ways; i) The publicly listed corporation is usually controlled by decentralized management structures where management are not owners of the business hence poor motivation towards the corporate visions and missions. ii) Listing the business publicly is expensive to adopt the reporting requirement stipulated under exchange act. Also the cost attached to issuing the Initial Public Offer is expensive to the company[Bar081]. iii) Listing of the corporate in stock exchanges subject to legal stringent restriction provided in the exchange act which depress corporate advancement. iv) The publicly listed corporation are subjected to significant accounting policies and procedures which reduces the corporate flexibility in adopting accounting strategies. v) Listing of the corporate in public subjects the business to significant heavy corporate tax and double taxation which are depresses the shareholders returns. vi) Listing of the corporate in public also requires that the corporate financial statement to be publicly published which increase the corporate management liability in case of deceptions in financial statements. b) Importance of accurate and timely information flow for stock market efficiency A stock market is characterized as efficient in the context that it reflects all information that has been made available to participants in the market at any given time. Stock market efficiency dictates that all the stocks are perfectly priced in accordance to their properties and participants in the market have equal amount of knowledge[Bar14]. The purest and most important form of information is derived from prices of a stock. Investors will depend on accurate and timely information generated from prices in order to optimize their resources to productive use. Accurate and timely information flow is an essential element for existence of a competitive world on the supposition that all factors of production are efficiently utilized by entrepreneurs. The market to become efficient, the participants of the market perceive it to be inefficient and likely to beat it. Investment strategies which are intended to take advantage of the perceived inefficiency will actually keep the market efficient[Cha10]. The stock market has some characteristics to define it. First, accessibility of the information is widely available and the information is released to investors at the same time. Second, the transaction costs of the investment strategy should be cheaper than the expected profits. Third, enough funds should be available to the investor for them to take advantage of the inefficiency. Fourth, the market should be large and liquid that is investors can convert their stocks into cash in the shortest time possible. Three degrees of market efficiency have been advanced. They include i. Weak form efficiency where the current prices of stocks reflect past information obtained. ii. Semi-strong efficiency that dictates current prices are a reflection of past and present that has been obtained. iii. Strong form efficiency which encompasses the consideration of all information that is past, present and future in determination of current price of a stock. c) Roles played by Australian Security and Investment Commission (ASIC) and Australian Security Exchange (ASX) in the Australian stock market. ASIC The Australian Securities and Investment Commission (ASIC) is a body that regulates the corporate, market and financial services industry in Australia[Dep]. The body is formed under the Australian Securities and Investment Commission Act of 2001 and carries out its mandate under the Corporation Act 2001. Roles that ASIC play in the Australian stock market. i. The financial system and its components are maintained, facilitated and performance improvement are the responsibility of ASIC. ii. ASIC has a mandate in the administration of laws in an effective manner and ensure that there is minimal procedural requirements in the stock market. iii. The body avails to the general public information about companies and other bodies in quick and timely way. iv. The entity promotes investors and consumer confidence and also ensures they have informed participation on matters pertaining to the financial system. v. ASIC enforces laws that pertains to financial system and ensures rules and regulations are followed in its entirety. vi. ASIC ensures it has adhered to concepts of market efficiency. This is through efficient and quick processing and storage of information it has received. Australian Security Exchange (ASX) ASX is an Australian public company which operates the country’s primary security exchange market. ASX was created in July of 2006 with the merger of Australian Stock Exchange and the Sydney Futures Exchange. ASX is ranked among the world top-10 listed exchange with a daily turnover of $ 4.685 billion and around A$ 1.6 trillion in market capitalization. Roles of the ASX in Australia exchange market i. ASX is a market operator where securities are bought and sold. ii. It is a clearing house of securities and also a facilitator of the payment system. iii. The company monitors and enforces the compliance of its own rules and regulation in the market. iv. ASX promotes standards of corporate governance among the companies that has listed in its bourse. v. ASX in its operations helps educate the retail investors in matters pertaining to exchange of securities. Part 3 Current ratio Current ratio refer to the liquidity measure used in evaluating the ability of the company in meeting short term financial liability in utilizing its current assets. The current ratio is not more appropriate since it does not put into consideration the timing of the cash flows therefore this ratio can mislead the users. It is calculated as follows = current assets / current liabilities   2014 Avg Industry Ratio Current assets $3,765,864   Current liabilities $2,594,496 Current ratio 1.45 1.43 Kiwi Yachts Ltd current ratio indicate higher ability of the company to meet the outstanding obligation in financing short term liabilities since the 2014 current ratio of 1.45 is more than the industry ratio of 1.43. Quick ratio Quick ratio is a demanding ratio which sensibly endows the corporation’s assessment of the ability to meet its current financial obligation using its current assets without using the corporate inventory. It is evaluated as follows = (current assets - inventory)/current liabilities. Particulars/ FY 2014 Industry Ratio Current assets - inventory $3,765,864-$1,486,200   Current liabilities $2,594,496 Quick ratio 0.88 0.38 Kiwi Yachts Ltd quick ratio describes that the company is liquid enough in meeting the current obligation without utilizing the company’s inventory since the company ratio of 0.88 is higher than average industry ratio of 0.38. However, Kiwi Yachts Ltd management embraces substantive to increase its liquidity to meet current obligation. Cash ratio The current ratio is liquidity ratio which assesses the company’s ability to meet the current financial obligation[Ali13]. Cash ratio describes the firm’s ability to us cash and cash items to meet the current liabilities. It is calculates by diving the summation of cash and cash equivalents by current liabilities.   2014 Avg Industry Ratio Current assets $438,048   Current liabilities $2,594,496 Cash ratio 0.17 0.21 Kiwi Yachts Ltd cash ratio accentuates lower ratio of 0.17 ability to meet current obligation by using cash as compared to the average industry ratio of 0.21. This describes the company management needs to conceptualize on measures that increases the firms cash and cash equivalents. Total asset turnover Total asset turnover is an efficiency ratio which heightens on the company’s efficiency in utilizing its assets to generate revenue through the product sales. Total assets turnover ratio determines the company’s efficiency in generating profit attributable to the shareholders. It is calculated by dividing the revenue by the net assets.   2014 Avg Industry Ratio Revenue $24,092,400   Net assets $15,950,184 Assets turnover ratio 1.51 0.85 Kiwi Yachts Ltd assets turnover ratio depict higher ratio of 1.51 as compared to the average industry ratio of 0.85. However, this describes that the company is more efficient in utilizing the assets to generate revenue. Inventory turn over Inventory turnover ratio efficiency essential ratio which evaluates the period of time the business takes to sale its inventory within the financial period[Che06]. The higher the inventory ratio describes that the company is more efficient in turning its inventory into sales. It is evaluated as follows = average inventory / cost of goods sold x 365Particulars/ FY 2014 Industry Ratio Average inventory $1,486,200   Cost of goods sold 17,982,000 Inventory turnover ratio 12.10 6.15 Kiwi Yachts Ltd inventory turnover accentuates the company turn its inventory higher by 12 times as compared to average industry ratio of 6 time in a financial period. However, this describe the company management are efficiency enough in turning inventory into sales. Receivable Turnover rate Receivable Turnover refers to efficiency ratio which assesses the number of days it takes the company to collects the amount held by the debtors. The lesser the number of days defines the more efficient the company in collecting cash from the debtors. It is evaluated as follows = average trade debtors / sales revenue x 365Particulars/ FY 2014 Industry Ratio Average trade debtors $1,841,616   Sales revenue $24,092,400 Receivable Turnover 13.08 9.82 Kiwi Yachts Ltd debtor’s turnover ratio describes that Kiwi’s receivable turnover ratio of 13.08 times is higher than average industry ratio of 9.82 times in financial year. However, this describes that the company is more efficient in collecting the cash held by debtors within 2014 financial year. Total Debt Ratio Total debt ratio is a capital structure ratio which assesses the company’s total debt financing on the totals assets[Dep]. Total debt ratio more than 50% describes that the company’s finances its assets investments using debt than the firm’s equity. It is calculated as follows= total liabilities / total assets x 100Particulars/ FY 2014 Industry Ratio Total liabilities $7,184,496   Total assets $18,544,680 Total debt ratio 0.39 0.52 Kiwi Yachts Ltd total debt ratio describe lower ratio of 0.39 as compared to the average ratio of 0.52. This describes the company does not depend more on debt since the debt is lower than the company financial assets. Debt to equity ratio Debt-to-equity ratio divulges the worth of dollars of equity in every dollar of the company’s assets. When the debt to equity ratio is more than 50% it signifies that the company is more reliant on debt. It is calculated as follows = total equity / total assets x 100.Particulars/ FY 2014 Industry Ratio Total equity $11,360,184   Total assets $18,544,680 Debt-to-equity ratio 0.61 1.08 Kiwi Yachts Ltd debt to equity ratio accentuates that Kiwi has lower ratio of 0.61 as compared to the average industry ratio of 1.08. However, the lower debt equity ratio describe that the company finances it assets investment using the company equity as compared other company in the industry where they finances it investment using debt. Equity multiplier Equity multiplier is financial leverage ratio which asses the firm financial assets which are funded using the shareholders equity[Cha10]. Equity multiplier ratio is evaluated by dividing the assets by the total shareholders’ equity. Particulars/ FY 2014 Industry Ratio Total equity $18,544,680   Total assets $11,360,184 Equity Multiplier ratio 1.63 2.08 Kiwi Yachts Ltd equity multiplier ratio unveils a lower ratio of 1.63 as compared to the average industry ratio of 2.08. This describes that the company assets is relatively funded to by the shareholders equity as compared with the genera industry. Times Interest Earned Ratio Times interest earned ratio assesses the ability of the company in paying its interest obligation out of the operating profits earned over the financial period. It is calculated by dividing the Earnings before interest and tax by interest expense. Particulars/ FY 2014 Industry Ratio EBIT $2,445,600   Interest Expense $434,400 Times interest earned ratio 5.63 8.06 According to the times interest earned ratio chart above, Kiwi company ability to meet the interest expenses using earnings before interest and tax as compared to other competitors in the industry with an average of 8.06[Ali13]. The 5.63 interest times ratio describes that the management should restructures its efficiency to generate more income to gather the interest expenses. Cash coverage ratio Cash coverage ratio is liquidity ratio which assesses the company’s ability to meet the interest expense utilizing the earning inclusive of non-cash items. It is evaluated by dividing the EBIT and depreciation by the interest expenses. Particulars/ FY 2014 Industry Ratio EBIT 2445600+786000   Interest Expense $434,400 Cash Coverage ratio 7.44 8.43 Profit margin Profit margin ratio is used in determining sales revenue of a company relative to the earnings before interest and tax. It is calculated by dividing the company’s earnings before interest and tax by the total assets. Particulars/ FY 2014 Industry Ratio EBIT $2,445,600   Sales revenue $24,092,400 Net profit margin 10.15% 7% Kiwi Yachts Ltd signifies a substantive trend in generating revenue through sales in 2014 financial period since the company’s profit margin ratio of 10.15 is more that the industry ratio of 6.98%. Return on Equity Return on Equity is a profitability ratio which assesses the percentage returns on the shareholders equity contribution to the firm[Cho]. Return on Equity ratio equip the company’s stakeholders with profitability date used to determine the company’s returns on the equity invested. Particulars/ FY 2014 Industry Ratio Net profit $1,206,720   Equity $11,360,184 Return on equity 10.62% 10.53% Kiwi Yachts Ltd return on equity accentuates an average ratio of 10.62% which is close to the industry ratio of 10.53%. However, this describes that the company is ranked averagely from the other competitors. Return on assets Return on assets is profitability ratio which assesses the company’s ability to generate earnings generated by the invested assets. Return on assets = Earnings before interest and tax / Average total assets x 100. Particulars/ FY 2014 Industry Ratio EBIT $2,445,600   Total assets $18,544,680 Return on Asset 13.19% 16.54% According to the Kiwi Yachts Ltd return on assets ratio, the company reveals a lower ability in generating earning though assets invested in the firm. The industry ratio indicates an average of 16.54% which is higher than the kiwi’s ratio of 13.19%. However, the company should conceptualize on effective utilization of assets to generate earnings. References Ali13: , (Alisdair McGregor, 2013), Bar14: , (Barker, 2014), Bal061: , (Ball, 2006), Cho: , (Choi, 2009), Dep: , (Depree Jr, 2009), Cha10: , (Gibson, 2010 ), Bar081: , (Barnes, 2008), Che06: , (Chen, 2006), Appendix one Income Statement Sales $24,092,400 Less Cost of goods sold 17,982,000 gross profit $6,110,400 Other expenses $2,878,800 Depreciation $786,000 Total expense $3,664,800 EBIT $2,445,600 Interest $434,400 EBT $2,011,200 Tax $804,480 net income $1,206,720 Dividends $246,000 Retain earnings $960,720 Appendix two Balance Sheet Fixed Assets Net plant and equipment $14,778,816 current assets Cash $438,048 Inventory $1,486,200 Accounts receivable $1,841,616 Total current assets $3,765,864 Total assets $18,544,680 Liabilities Current liabilities Accounts payable $858,816 Notes payable $1,735,680 Total current liabilities $2,594,496 net assets Long-term debt $4,590,000 Total liabilities $7,184,496 Equity Retained earnings $11,180,184 Ordinary shares $180,000 Total Equity $11,360,184 Equity and liabilities $18,544,680 Read More