Financial Statement Analysis and Security Valuation - Burberry and Guess - Case Study Example

Financial Statement Analysis and Security Valuation Student’s Name: Institution’s Name: Tutor’s Name: Date of Submission: Table of Contents Introduction………………………………………………………………………………………3 1.1Overview of the Burberry……………………………………………………………………..4 1.2 Overview of the Guess……………………………………………………………………….4 2.1 The analysis methodology……………………………………………………………………5 2.2 The Analysis Process…………………………………………………………………………6 3.0 Comparison of Burberry with its median market indicators………………………………….7 4.0 Comparison of Guess with median market indicators………………………………………...8 5.0 Comparison between Burberry and Guess…………………………………………………….9 6.0 Conclusion…………………………………………………………………………………...10 Bibliography……………………………………………………………………………………..11 Introduction Financial analysis is where the financial information is obtained from the books of accounts for decision making purpose (Dodd & Graham, 2008). In financial analysis involves the application of valuation models which provides basis for understanding and examining the information in the financial statements. For the purpose of producing plausible forecast these financial analysis model should be used appropriately to ensure correct prediction is made about the company performance. Currently there are many companies which are in the market and therefore investors need to know the company that is able to make them achieve their profit and wealth maximization goals (Dyson, 2007). The investors also need to understand the price level of securities in the market before they make actual purchase decision. The investor is to ensure that they make correct decision about their investment so that they cannot regret of making irrational investment decision. The main purpose of financial analysis is to examine and make a constructive comparison between two or more financial portfolios to determine their viability (Dodd & Graham, 2008). This kind of analysis involves the use of previous year’s financial records to predict possible future performance of the company or investment project. The analysis is done based on the information received from the financial statement such as balance sheet, income statement and cash flow statement. These are very important in determining profitability, liquidity, efficiency and gearing level of different companies to determine which is most appropriate to invest in by the investor (White G& Fried, 2008). The information in the balance sheet can be used to determine liquidity position, efficiency and gearing level while income statement is essential in finding the company profitability while cash flow statement show the movement of cash in and out of the company. This report is therefore contains the result of financial analysis of Burberry and Guess and their results compared to determine the company which has the highest performance level. 1.1Overview of the Burberry This is a UK based company which involve in the production of luxury goods. It produces and sells women and men apparel and accessories and beauty products. This company has a number of distribution networks with 497 stores. It also has online website called burberry.com which customers can buy the products. 1.2 Overview of the Guess This is a company that deals in production of fashions wears in the global market. It is considered as a market leader in fashion industry. This company is located in America and it produces clothing and other fashion accessories which are sold in the global market. The process and Methodology 2.1 The analysis methodology To effectively analyze the financial information for these two companies, five consecutive years are used starting from 2010-2014. The information used in the financial analysis was obtained from financial statements such as balance sheet and income statements. There are only three types of financial evaluation which are used in this paper namely profitability, common size analysis and trend analysis (Dyson, 2007). The results of this analysis are used to make a comparison between these two companies and the results are used to make appropriate investment decision. Profitability Analysis This is the process of determining the ability of the business organization to produce high investment returns to investors. It involves the use of Return on capital employed, profit margins and return on assets. It highlights the ability of a business organization to generate returns on its assets, its capital employed and the extent to which the sales revenues can cover the cost of operating activities of the company (White G& Fried, 2008). It is also important to use profitability analysis to evaluate return on common equity and the overall operating performance of the firm. ROCE = RNOA + [FLEV × SPREAD] This profitability analysis model uses three different factors namely: Profitability of operations: RNOA Financial Leverage: FLEV = NFO/ CSE Operating Spread: RNOA – NBC Common –Size Analysis This is an analysis which is important in reduces the effect of size (Dodd & Graham, 2008). For the sake of income statement, all incomes and cost of operating activities are subdivided by revenues to determine percentage change in income and expenses over revenues as a percentage. In the case of balance sheet, assets and liabilities are divided by the total of assets and liabilities to determine percentage change in each of them. Trend Analysis This is a very important analysis which helps a firm to project its future performance using information in the financial statement over a given period of time. It is done by dividing each financial statement item the value of the item in the base year. In this case, it is important to use 2010 as the base year to determine relative change in the item’s value over time as a percentage. 2.2 The Analysis Process The analysis process of this report involves three consecutive stages which includes reformulation of the financial statement of each of the companies into operating or financial activities. It is then followed by profitability examination for all the companies and finally drivers for ROCE are broken down to determine the most appropriate factor that contributes to the resultant ROCE. The main drivers of ROCE factors for the two companies are the only factor that is broken down. At the end both common-size and trend analysis are used in both companies to determine future variation in size and performance. 3.0 Comparison of Burberry with its median market indicators Figure 1 Burberry ROCE Burberry has a fluctuating ROCE. From 2010, there is an increase in ROCE by a small margin of 0.30 and then showed a constant growth rate of ROCE from 2011to 2013thereafter realized decline from 2013 t 2014. In comparison with industrial performance, it shows that this company performs below the industrial performance which is above it by 0.50. This shows that this company does not properly utilize its capital employed to produce returns on investment. This is because it performs below industrial average performance. This decline could have been caused by recession in UK which has a negative effect on the entire industrial performance. Figure 2 Burberry’s RNOA Burberry has a changing RNOA where from2010 there has been an increase in RNOA to 2011 and from 2011 the company has experienced a slight increase in RNOA with a small margin to 2012 but from 2012 to 2014 there is a slight increase in RNOA. This significantly show that this company is not making good use of its assets in the most profitable and efficient manner. The UK industry has shown that a steady decline in RNOA from 2010 to 2013 where there is an increase in RNOA by 0.5. The decline could have been caused by inflation or increase in systematic risk which makes the company to be more vulnerable to global financial crisis. Figure 3 Burberry’s FLEV The financial leverage for this company is very low showing that there is underperformance in the median market. Although this company has very many financial liability it is able to meet many of its financial obligations as those that can be met by shareholder’s equity. This is shown by FLEV as it seems less appropriate than that of the market. Figure 4 Burberry’s SPREAD SPREAD is the difference between return on net operating assets and net borrowing cost. It shows that Burberry experienced low performance in 2010 but started to gain an increase in performance in 2010 to 2011 from -1.0 0.04. It then showed a small decline from 2011 to 2014. It can be noted that this company has been underutilizing its net operating assets in 2010 but from 2011 it outperformed the industrial average SPREAD. This is significantly showing that it used its net operating assets than other industries from 2011 to 2014 but underperformed in 2010. This change resulted from the increase in cash balance which ensures that the company is able to meet its short term financial obligations better that the industrial average results. 4.0 Comparison of Guess with median market indicators Figure 5 Guess ROCE Guess has gradual decrease in ROCE from 2010 to 2015 and its market median ROCE had a persistent slow decrease but in 2014 to 2015 there was a sign of crash which coincides with the Global financial crisis. It is therefore important to note that ROCE of this company has less systematic risk than its competitors in the industry. This company therefore can be considered as one of the market leaders which is able to provide highest returns on its capital employed. Figure 6 Guess’s RNOA Guess has a positive increase in return on assets from 2010 to 2011 which starts to decline from 2011 to 2014. In comparison with its competitors it has shown a significant performance above them due to the fact that it has low systematic risk than them. It is also able to compete effectively in the market than its competitors because of its immunity of systematic risk in the market. It also utilizes its assets efficiently that the average industrial performance which has a fluctuating changes in RNOA. Figure 7.Guess’s FLEV The trend line of Guess Company is done by plotting FLEV against median market (White G& Fried, 2008). It shows that the leverage of Guess is lower than that of the market and this is a positive sign of having a strong financial position. From 2010-2014 there is no incidence where Guess’s FLEV and that of the market have the corresponding values and trend. This is a sign that it outperforms other companies it its group. Figure 8.Guess’s SPREAD In this analysis, Guess performs better than its rivals in the industry. This is shown by SPREAD measure which is the difference between return on net operating assets and net borrowing cost. It performs better than its peer median in 2010 and 2011 respectively. There has been a drop in performance in 2012 and subsequent increase in 2013 and 2014. The results show that it has a good performance as compared to others companies with the same age. 5.0 Comparison between Burberry and Guess Figure 9.ROCE In the comparison of Guess and Burberry based on return on capital employed, the two companies significantly show the different financial performance trend throughout the five years (White G& Fried, 2008). Burberry is able to produce higher return on capital employed than Guess and therefore it has high potential to provide more investment returns to its investors than Guess in both short and long term (Dodd & Graham, 2008). From 2010 to 2011, Burberry had underutilized its capital employed but has been growing at a constant rate while Guess had the potential to use its capital employed efficiently between 2010 and 2011. FROM 2011 to 2012 Burberry had a constant use of its capital employed to produce returns but Guess had a decline in ROCE at the same rate. From 2012 to 2013 Burberry also showed a decline in ROCE and starts to rise from 2013 to 2014. Guess on the other hand showed a decline as Burberry increases at the same growth rate. This therefore indicates that Burberry uses its capital employed more efficiently that guess to produce return on investments to its investors. Figure 10.RNOA This is a measure which is used to determine the difference between operating assets and operating liabilities. It is considered to be the main factor that drives ROCE for both Guess and Burberry. In relation to RNOA, it is evident that Burberry has better performance than Guess which supports the results of ROCE. From 2010 to 2011, Guess showed a better use of its assets than Burberry but in terms of rate of asset utilization, Burberry had a sharp growth that Guess. From 2011 to 2012 Burberry showed an increase in RNOA while Guess showed a sharp decline which could be as a result of economic down turn in UK or World financial crisis. The decline in the asset utilization to produce return of Guess increases up to 2014 for both the companies but for Burberry was at a slow rate than that of Guess. This showed that Burberry is able to use its assets more economically and efficiently that Guess and therefore it worth investing. The decline could have been caused by systematic risk which currently affects the global business. Figure 11.FLEV The graph above showed that Guess is able to meet its financial obligations than Burberry. This low liquidity is experienced throughout the five years from 2010 to 2015. Burberry has showed sharp decline in FLEV as compared to Guess which decline slightly but maintains a stable position until 2013 before starting to increase at a constant growth rate (Dodd & Graham, 2008). Burberry showed the same level of FLEV from 2011 to 2012 and began to rise at a small growth rate until 2013. From 2013 to 2014 the graph OF Burberry showed that there is a sharp decline in FLEV which could have resulted from over investment in capital assets than current asset. Figure 12 SPREAD The above graph show that Burberry has higher potential to cover its borrowing cost that Guess. From 2010 to 2011, the two companies showed almost the same level of SPREAD but as from 2011 to 2012 there is a sharp drop in SPREAD for Guess while Burberry remained constant (Penman, 2012). It started to increase sharply from 2012 to 2013 and stagnates for the rest of the period. This showed that Burberry is more levered than Guess and this contributes significantly to high profit margin it had from 2010 to 2014. Figure 13.Profit Margin The graph showed that Burberry had an increase in profit margin from 2010 to 2011 while that of Guess remained constant in the same period but it was above that of Burberry. From 2011 to 2012, Guess experienced a decline in profit margin while Burberry increased significantly before it started to decline at a small margin to 2013 (Dodd& Graham, 2008). In 2013 to 2014, both the companies showed divergent change in profit margin since Guess showed a decrease while Burberry an increase in profit margin. The result showed was as a result in proper utilization of capital employed and current assets to produce return on investment to Burberry. In the contrary, Guess showed a lower profit margin as compared to Burberry. Figure 14.Assets turn over (ATO) These two companies have different trend line movement in their asset turnover ratio for five years. The trend line for Guess decreases gradually over tine while that of Burberry has a positive gradual increase (Dyson, 2007). This shows that Burberry has high asset turnover than Guess and therefore it is more efficient than Guess for the five years under the study. It is therefore important to note that Burberry is able to generate more sales revenues than Guess and this makes it to have high asset turnover than Guess. Figure 15.Inventories Inventory is also a very important factor that affects the asset turnover ratio (McLaney, 2012). Burberry has more inventory than Guess and this is significant in ensuring that Burberry has higher asset turnover. Burberry has a more stable inventory trends while Guess seems to have fluctuating inventory stability which is a symbol of high efficiency (White G& Fried, 2008). This is dictated by inventory policies which dictate its usage in the industry to generate returns on investment. Figure 16.Receivables Burberry showed higher level of receivables than Guess which is as low as 0.1 while that of Burberry is above 0.7 (Palepu et al, 2012). Receivables of Burberry fluctuates annually where from 2010 to 2011 there is an increase and from 2011 to 2012 it drops sharply showing a change in asset and capital employed utilization. Figure 17.Payables Guess showed higher account payable than Burberry throughout the five years period (Dyson, 2007). Both these tow companies showed a fluctuating account payable showing that Guess had more liability to offset than Burberry. 6.0 Conclusion The conclusion we can deduce from the analysis of the drivers of RCE being RNOA, FLEV and spread, is that there performance expressed by Ted is the most superior as measured by the ROCE components. Subsequent examination of the drivers brings it out clearly that RNOA acts as the key driver of the comparative advantage as far as performance is concerned. This is also supported by overall advantage in FLEV and Spread measures. Again, a keen study on the performance advantage of Ted also helps see a good return to the two items that is the cost structure and the volume of sales. These two greatly contribute to the superiority in RNOA measures. This is because they are the most important determinants of the level of returns to surplus assets over operating liabilities. Bibliography Dyson, R. 2007. Accounting for Non-Accounting Students. Financial Times/Prentice Hall. ISBN: 9780273709220 Dodd, D & Graham, B. 2008. Security Analysis. John Wiley HYPERLINK "http://en.wikipedia.org/wiki/John_Wiley_%26_Sons,_Inc."&HYPERLINK "http://en.wikipedia.org/wiki/John_Wiley_%26_Sons,_Inc." Sons, Inc. ISBN 0-07-013235-6 http://www.londoninternational.ac.uk/sites/default/files/programme_resources/lse/lse_pdf /subjec t_guides/ac3143_ch1-4.pdf McLaney, E. 2012.Business Finance: Theory and Practice, 9th edn, Financial Times Prentice Hall, chapters 1 and 2. Palepu et al 2012. Business analysis and valuation. (Mason, OH:South-Western College Publishing, 2012) fifth edition, Chapter 1. http://www.columbia.edu/~dn75/Ratio_analysis_and_equity_valuation_From_research_t o_practi ce.pdf Penman, S.2012. Financial statement analysis and security valuation. (Boston, MA:McGraw- Hill, 2012) fifth edition, Chapters 7, 8, 9 and 10. White, G & Fried, D. 2008. The Analysis and Use of Financial Statements. John Wiley HYPERLINK "http://en.wikipedia.org/wiki/John_Wiley_%26_Sons,_Inc."&HYPERLINK "http://en.wikipedia.org/wiki/John_Wiley_%26_Sons,_Inc." Sons, Inc. ISBN 0-471-11186-4. Read More