Financial Analysis of Oman Chromite Company - Example

FINANCIAL ANALYSIS: OMAN CHROMITE COMPANY Prepared by (students name) Institutional Affiliation Date Professor’s Name Unit Name Introduction The focus of this paper is on conducting a five year financial analysis for Oman Chromite Company. In conducting the financial analysis, the paper focuses on such important ratios as liquidity, profitability, efficiency, capital structure and market ratios to establish whether or not it will be a good idea to invest in it. Oman Chromite was founded in 1991 and it is a joint stock company by both the government of Oman and other notable private stakeholders. It was established for the purpose of exploring mineral treasures within the country and especially the Chromite ore. Financial Ratio Analysis I. Liquidity Ratios Ratio/ Year 2010 2011 2012 2013 2014 Current Ratio: current assets/current liabilities 3,944,767/490,803 = 8.04 4,441,178/576,278 = 7.71 3,721,875/ 350,725 = 10.61 4,167,878/399,812 = 10.42 3,867,931/372,923 =10.37 Quick Ratio= (current assets-inventories)/current liabilities 3,944,767-695,326 /490,803 = 6.62 4,441,178-1,007,800/576,278 = 5.96 3,721,875-1,045,872/ 350,725 =7.63 4,167,878-1,158,416/399,812 =7.53 3,867,931-1,296,976/372,923 =6.89 II. Profitability Ratios Ratio/ Year 2010 2011 2012 2013 2014 Net Profit margin=net income/sales*100% 819,314/2,276,731 = 35.98% 620,235/2,273,881 =27.27% 200,708/2,010,922 =9.98% 553,838 /2,171,218 =25.51% 310,801/1,941,267 =16.01% ROA =net income/total assets*100% 819,314/5,238,715 = 15.64% 620,235/5,350,271 =11.59% 200,708/4,728,021 = 4.69% 553,838/ 4,969,558 = 11.14% 310,801/ 4,779,602 = 6.51% ROE=net income/total stockholder’s equity *100% 819,314/4,686,850 = 17.48% 620,235/4,707,085 = 13.18% 200,708/4,307,793 = 4.66% 553,838/4,501,631 = 12.30% 310,801/ 4,362,432 = 7.12% III. Efficiency Ratios Ratio/ Year 2010 2011 2012 2013 2014 Inventory turnover=sales/inventory of finished goods 2,276,731/695,326 = 3.27 2,273,881 /1,007,800 = 2.26 2,010,922/ 1,045,872 = 1.92 2,171,218/ 1,158,416 = 1.87 1,941,267/1,296,976 = 1.49 Total assets turnover=sales/total assets 2,276,731/ 5,238,715 = 0.43 2,273,881/ 5,350,271 = 0.43 2,010,922/ 4,728,021 = 0.43 2,171,218/ 4,969,558 = 0.44 1,941,267/ 4,779,602 = 0.41 Accounts receivable turnover= accounts receivable/sales 471,305/2,276,731 =0.21 209,038/2,273,881 = 0.09 220,694/2,010,922 = 0.11 462,254/2,171,218 = 0.21 343,852/1,941,267 = 0.18 IV. Gearing Ratios Ratio/ Year 2010 2011 2012 2013 2014 Debt-to-total assets ratio= total debt/total assets -/5,238,715 129,193/5,350,271 =0.02 -/4,728,021 -/4,969,558 -/4,779,602 Debt-to-equity ratio=total debt/total-stockholder’s equity -/4,686,850 129,193/4,707,085 =0.03 -/4,307,793 -/4,501,631 -/4,362,432 V. Market Ratios Ratio/ Year 2010 2011 2012 2013 2014 EPS= net income /no. of shares 819,314/ 3,000,000 =0.27 620,235/3,000,000 = 0.21 200,708/3,000,000 = 0.06 553,838/ 3,000,000 = 0.18 310,801/ 3,000,000 = 0.10 Dividends per share= dividends paid to shareholders/ No. Of shares 433,857/ 3,000,000 = 0.14 600,000/ 3,000,000 =0.2 600,000/ 3,000,000 =0.2 360,000/ 3,000,000 = 0.12 450,000/ 3,000,000 = 0.15 Literature Review Fisher, Heinekel and Zechner (1989) define financial analysis as the selection, evaluation as well as the immediate interpretation of a company’s overall financial data, together with other relevant information, in order to help with the investment and financial decision making processess. It is mostly adopted in order to analyse such important internal aspects as employee performances, efficiency of operations as well as notable credit policies. Externally, it is embrace for the purpose of evaluating possible investments as well as the credit-worthiness of such important stakeholders as borrowers and suppliers of finances (Benninga & Oded, 1997). Benninga and Oded (1997) indicate that liquidity ratios are used for the purpose of determining a company’s immediate capacity to execute its short term commitments. Profitability ration provide useful information on the immediate amount of income that is availed by each dollar of sales. Efficiency rations determine the manner for which a company management team manages its overall resources like assets in a more efficient manner (Benninga and Oded, 1997). Gearing rations provide pertinent information that relates to the capacity of a company in meeting its overall fixed financial commitments as well as its ability to satisfy them altogether. Consequently, market ratios ascertain the financial situation of a company in relation to the shares of stocks held at any given moment in time. It is important to understand that market ratios help a lot in enlightening a potential investor on whether or not to invest with a particular company (Benninga and Oded, 1997). Zaimah et al (2013) ascertains that the financial soundness of a company postulate the subjective perspective and objections indicators of their overall financial condition. Numerous researches conducted identify financial responses as well as financial practices as two core elements of strategies needed by companies in order to attain a satisfactory level of financial well-being. Notably, prior researches adopted a distinctive set of techniques in order to measure the overall financial soundness of a company with emphasis put on objective measurement. It is noted that objective measurement is perceived as being a very fundamental tool that is needed for conducting quantitative measurement by way of observation of current financial performance mechanisms and statuses. Delen, Kuzey and Uyar (2013) indicate that the process of financial ratio is able to provide such benefits as; availing pertinent information relating to the performance of management team for the purpose of executing rewards, evaluating different departments in the case of multi-level companies, projection of future condition through supply of prior information to both existing and potential stakeholders and, also availing important information to creditors and suppliers of materials. Consequently, it is argued that financial ratios is further embraced for the purpose of predicting future company performances like in the case of developing distinctive models that is necessary for predicting financial distress or even failures for a given company. Analysis 1. Liquidity Analysis The company’s current ratio improves significantly in the five-year period between 2010 and 2014 from 8.04 to 10.37 respectively. The increase indicates a good financial condition in regards to the manner for which it can pay for its short term obligations whenever they fall due. Oman Chromite seems to be operating under a favorable liquidity position. This can also be perceived with its relatively stable quick ratio that improves from 6.62 to 6.89 within the same period. The improvement in quick ratio further stipulates that Oman Chromite can still meet its short-term obligations even without the sale of its existing inventories. Following this line of analysis, Oman Chromite can be said to be positioned in a fair position within the industry for which it operates in terms of incurring and meeting short term commitments. II. Profitability Analysis The company’s net profit margin ration decreases within the five-year period from a high of 35.98% to 16.01% in 2010 and 2014 respectively. The decrease in the level of the ratio indicates a bad health state of the firm since it means that the capacity of the firm to translate net income from the posted sales revenues is weak. This might relate to poor prices for the mineral in the global market as well as poor marketing campaign strategies for the end product. Subsequently, the return on assets ratio also decreases significantly from 15.64% to 6.51% within the same period. The decrease is an indication that Oman Chromite operates under a weakened capacity to use the existing asset base to post efficient net income within a certain period. This might be related to poor asset replacement policies especially by the management. Furthermore, there is a significant level of decrease in the level of return on equity ratio that decreases from 17.48% to a low of 7.12% in 2010 and 2014 respectively. The decrease can be related to poor use of shareholders’ funds to post profits, which might be also linked to weak management policies in the manner for which these funds should be used in the course of making sales. III. Efficiency Ratios The firm’s inventory turnover ratio decreases within the period from 3.27 to 1.49 in 2010 and 2014 respectively. The decrease in this ratio value is an indication that the company does not possess capacity to translate existing stock into sales revenues. This inefficiency might be related to poor marketing campaigns or even a lack of commitment by management to promote enough sales activities within a certain period. The total assets turnover also decreases within the same period from 0.43 to 0.41, which is an indication that not enough assets are utilised to post enough sales. This might relate to poor pricing mechanism and also, weaker asset management policies- an integral aspect that is needed for ensuring that sales revenues remains high within a given operational period. Consequently, the accounts receivables turnover remains below the recommended industry average standards since it decreases slightly from 0.21 to 0.18 within the five-year period. The decrease can be linked to inefficient management policies on how accounts receivable should be allowed and collected from the customers within any given moment in time. IV. Gearing Ratios The company’s gearing ratio indicates that Oman Chromite does not depend on any form of debt to conduct its operations. The only period for which there was debt involved the financial period 2011 and later on the debt was paid in full prior to commencing the following financial period. As a result, the company’s gearing ratio cannot be effectively determined hence an indication that most of its projects and other day-to-day operations are only dependent on the existing stakeholder’s equities funds. While it might look satisfying that the company does not need any form of debt financing, it is important to note that this is a very risky affair should it need these form of funds in the future (Covas & Haan, 2006). Suppliers of debt will require a relevant and satisfactory gearing ratio in order to avail funds in the future period. V. Market Ratios The company’s earnings per share decrease significantly within the five-year period from 0.27 to 0.10 in 2010 and 2014 respectively. The decrease in the ratio value postulates that the existing shares attract little earnings as compared to five years ago. On the contrary, however, the Oman Chromite dividends per share increase slightly within the same five year period from 0.14 to 0.15. The increase is a good aspect as it indicates that the company level of dividends pay-out continues to improve. With this improvement, the shareholders are likely to enjoy increased dividends in the future. C. Recommendation As a financial analyst, I think it will be safe to purchase shares belonging to Oman Chromite Company. This is due to the following reasons; first, the liquidity position is stable and way above the industry standard averages. This means that by investing in the company, the money will be used to trigger more sales as opposed to trying to meet short term obligations. Secondly, it can be seen that Oman Chromite market ratios, although relatively smaller, are positive in value. It thus means that there is a prospect of continuing to enjoy future dividends with the company. In fact, the fact that the firm opts to pay dividends to shareholders as opposed to withholding income as retained earnings is a good indication to invest with it since it values the shareholders’ interest. Lastly, the firm’s gearing ratio postulate that it does not pay any form of debt due to nil debt funds base. It thus goes without saying that the firm will be positioned fairly to utilise potential investments to improve on its current profitability standings as opposed to using it to pay off interest costs and other unnecessary charges that do not add value to shareholders’ wealth. Question 2 Question 2(a) Ahmed has opted for a short payback period and higher average rate of return on selecting the most viable investment projects from the two; Commercial Centre and New Cottages due to the existing levels of inflation within the GCC region as well as the underlying high cost of capital. It is important to understand that high inflation rates within a given economy prevents businesses to plan for their future operations since it becomes a real challenge to ascertain the level of demand needed for their products at the higher set of prices they will need to charge for purposes of covering their overall costs ( Chen & Boness, 1975). With the higher level of inflation in place, it will be a challenge for Ahmed to predict the exact level of occupancy rate hence might result to loss of revenues. Subsequently, the high cost of capital is also another factor that has prompted Ahmed to go for a project with a higher rate of returns within a short period given that it is likely to reduce the level of revenues in the event that payment is conducted in a longer period than it was anticipated. In essence, as a result of high inflation levels, there is a direct influence on the level of interest rates, which might increase significantly to unmanageable levels ( Chen & Boness, 1975). Question 2(b) Project 1: Commercial Centers Year Cash flows Cumulative Cash Flows 0 1 2 3 4 5 6 (840,000) 160,000 228,000 340,000 360,000 400,000 420,000 (840,000) (680,000) (452,000) (112,000) 248,000 648,000 1,068,000 Project 2: New Cottages Year Cash flows Cumulative Cash Flows 0 1 2 3 4 5 6 (440,000) 110,000 130,000 200,000 220,000 230,000 260,000 (440,000) (330,000) (200,000) 0 220,000 450,000 710,000 A. Payback Period i) Payback Period= A +B/C Whereby; A represents the very last period that has a negative cumulative cash flow B represents the absolute value of the underlying cumulative cash flow at the end of the period A C represents the overall cash flow for the period after A Project 1: Commercial Centers: 3+ (112,000/360,000) = 3.3 years Project 2: New Cottages 2+ (200,000/200,000) = 3 years B. Average Rate of Return AAR= Average Accounting Income/ Average Investment Project 1: Commercial Centers: Step 1: Annual Depreciation = (initial investment - salvage value)/ useful life of years = 840,000-0/6= 140,000 Step 2 Year 1 2 3 4 5 6 Cash flow 160,000 228,000 340,000 360,000 400,000 420,000 Depreciation -140,000 -140,000 -140,000 -140,000 -140,000 -140,000 Accounting Income 20,000 88,000 200,000 220,000 260,000 280,000 Step 3: Average Accounting Income = 20,000+88,000+200,000+220,000+260,000+280,000/6 = 178,000 AAR= 178,000/840,000*100%= 21.19% Project 2: New Cottages Step 1: Annual Depreciation = (initial investment - salvage value)/ useful life of years = 440,000-0/6 = 73,333 Step 2: Year 1 2 3 4 5 6 Cash flow 110,000 130,000 200,000 220,000 230,000 260,000 Depreciation -73,333 -73,333 -73,333 -73,333 -73,333 -73,333 Accounting Income 36,667 56,667 126,667 146,667 156,667 186,667 Step 3: Average Accounting Income = 36,667+56,667+126,667+146,667+156,667+186,667/6 = 118,333.7 AAR= 118,333.7/440,000*100% = 26.89% C. Net Present Value NPV= Cash inflows from investment- cash outflows or cost of investment Project 1: Commercial Centers: PV = CF/(1+r)n r=35% Year 1 2 3 4 5 6 Cash flow 160,000 228,000 340,000 360,000 400,000 420,000 Present Value 118,518.5 125,102.9 138,190.3 108,384.6 89,205.4 69,381.9 Total PV= RO 648,783.7 NPV = 648,783.7-840,000 = -RO 191,216.4 Project 2: New Cottages PV = CF/(1+r)n r=35% Year 1 2 3 4 5 6 Cash flow 110,000 130,000 200,000 220,000 230,000 260,000 Present Value 81,481.5 71,330.6 81,288.4 66,235 51,293.1 42,950.7 Total PV = RO 394,579.3 NPV= 394,579.3-440,000= -RO 45,420.7 Analysis From the above computations, it can be seen that only the payback period technique satisfies Ahmed criteria for selecting the most viable project to execute. Both the average rate of return and the net present value have all failed to meet his threshold. Given that there is uncertainty in the future operations of businesses as a result of uncertainty in inflation levels as well as the expected future high cost of capital, Ahmed should go ahead and select the project with the most viable rate of return within the shortest time period possible. He should therefore opt for project 2 that seeks to invest of new cottages since it has the highest rate of return at26.89% and is able to recover his initial cost within a period of 3 years. Question 2(c) Ahmed has used the three most relevant and reliable investment appraisal techniques all together to determine the most viable project to undertake. It is important that the three techniques have been used to formulate the most viable decision because depending on only a single one of them is deemed unreliable especially because the computations from the net present value all indicate a negative value as opposed to the RO 200,000 threshold. The payback period is deemed important because it establishes the exact period that is need for an investor to realize their respective investment in the project, which is usually repaid by the expected cash flows produced in periods to come (Oikonomikou, 2016). Ahmed has sought to use the technique since it is the most effective way of determining possible risks that might be attributed to a given proposed project. Risks, in this case, are associated with the uncertainty levels in inflation within the entire GCC region as well as a probable future high cost of capital that might elongate the payback period as a whole. The only shortfall of this technique rests with the fact that it does not take into effect the aspect of time value of money, which might result to wrong or even inefficient investment decision making process. He has adopted the net present value appraisal technique since it is able to provide an imminent comparison of investment amounts made in the current period to the present value of the future cash receipts from that particular investment option (Oikonomikou, 2016). Therefore, by adopting this appraisal, Ahmed seeks to incorporate the aspect of time value for money; an aspect that is not provided by payback period. Notably, the average rate of return is another appraisal method adopted in order to establish the approximation of accounting income of a particular project in relation to the average investment conducted within the period (Oikonomikou, 2016). Following this line of reasoning, it can be ascertained that all of these techniques help to serve particular purpose that relates to time value for money and risks associated with making investments hence their overall incorporation ensures that relevant and realistic investment decisions are made at any given moment. Question 3 Question 3 (a) Profits= Total sales- Total Expenses i) Present plans; Total revenues = 7.5*200,000 = OMR 1,500,000 Total Expenses= 1,050,000 + 360,000= OMR 1,410,000 Thus; present profits = 1,500,000- 1,410,000= OMR 90,000 ii) Proposed Plans 20% reduction in selling price= 20/100*7.5 = 1.5 Proposed selling price= 7.5-1.5 = 6 Proposed Sales: 200,000+ (30/100*200,000) = 260,000 Total revenues= 6*260,000 = OMR 1,560,000 Total expenses = OMR 1,410,000 Thus proposed profits = 1,560,000-1,410,000= OMR 150,000 Question 3(b) In the event that the 30% sales increase is realised, then the business will likely record more profits as compared to the present situation. The decrease in the level of product price will results to a subsequent increase in the amounts of sales, which is later, translated to revenues for the company. The adoption of break-even analysis comes with a great stride of benefits that include; first, it helps with production planning processess especially because cost-volume-profit analysis being one of the tools ascertains in the planning the overall production of products that allows a maximum contribution in relation to profits posted and the underlying level of fixed costs incurred (Oikonomikou, 2016). It certainly fosters cost control mechanism since it is adopted to detect possible hidden costs that might not be visible while conducting operations. Break-even analysis seeks to promote the financial structure of a business because it avails a clear and concise comprehension of behavior of profits in regards to the output (Oikonomikou, 2016). In times of uncertain conditions, break-even analysis seeks to provide sound financial management with information that is deemed to helpful in the course of decision-making processess. Question 3 (c) Profits= total revenues- total expenses Let’s say A is the volume of sales required; Therefore; 90,000= (6*A)-1,410,000 6A=1,410,000+90,000 6A= 1,500,000 A= 1,500,000/6 = 250,000 References List Benninga, S, & Oded S, 1997, Corporate Finance: A Valuation Approach, McGraw-Hill, New York Covas, F & Haan, W, J. 2006. The Role of debt and equity finance over the business cycle, Bank of Canada Working Paper, Retrieved on March 7, 2016 from http://www.bankofcanada.ca/wp-content/uploads/2010/02/wp06-45.pdf Chen, A.H & Boness, A.J., 1975. Effects of uncertain inflation on the investment and financing decisions of a firm. The Journal of finance, 30(2), pp.469-483. Delen, D, Kuzey, C and Uyar, A. 2013. Measuring Firm Performance using Financial Ratios: A Decision Tree Approach, Expert Systems with Applications, XXX, XXX-XXX. Fisher, E, Heinkel, R and Zechner, J. 1989, Dynamic capital structure choice: Theory and tests, Journal of Finance, 44, 19–40 Oikonomikou, L.E., 2016. Introduction to Corporate Finance. In MBA (pp. 157-187). Springer International Publishing. Zaimah, R, Et al. 2013. Financial Well-being: Financial Ratios of Married Public Sector Workers in Malaysia, Asian Social Science, 9, (14), 1-6 Read More