Wesfarmers and Woolworths Limited - Profitability and Financial Stability Ratios - Example

Contents Executive Summary 2 Introduction 3 Financial Analysis 3 Financial Stability Ratios 3 Profitability Ratios 9 Asset Efficiency Ratios 13 Conclusion 17 Limitations 17 Recommendations 17 References 19 Appendix 20 Executive Summary Woolworths Limited and Wesfarmers Limited are two retail giants operating in almost similar lines of business. Market growth rate has been good in their operating fields as reflected by their increasing sales and which further shows opportunities for expansion of their market share. The financial analysis further shows areas where each company needs improvements and areas where one has an edge over the other. The ratios has been analysed in three parts profitability, efficiency and stability with distinguishing features being highlighted by each and discussed later individually. Recommendations highlights the areas where both the companies needs to improve and grab its opportunity to capture a larger market share. Woolworths has been better in performance in comparison to its rival Wesfarmers which indeed provides a much higher return to its equity shareholders which makes the company more lucrative and indicates a better growth and efficiently handled management system. Introduction Wesfarmers is regarded as a retail giant. The company deals in numerous fields such as office supplies, insurance, coal, food, home improvements, liquor and other products. Thus the company captures a larger market share and provide quality service and design products which meet the basic necessities of life (Wesfarmers Limited, 2011) Woolworths Limited is also similar to Wesfarmers limited and regarded as a retail giant and deals in similar lines of business. The company deals in wide range of products of basic necessities and thus covers a large market share and further design and regularly update its products as per customer specifications ensuring a higher customer satisfaction among its targeted audience. (Woolworths Website, 2011) The financial statement of both the companies has been analysed as under which indeed helps in understanding a better comparison between the two companies and shows the better off company to be invested upon. Financial Analysis Financial analysis plays a major role in every concern. It helps in better understanding of the performance of the company and analysing the reasons of its performance. The following is the comparison of ratios for Woolworths Limited and Wesfarmers Limited. Financial Stability ratios: Short Term Current Ratio: It helps to identify the liquidity position of a concern and shows a concern commitment to meet its short term liabilities with the help of its short term assets (Current Ratio, 2011). The current ratios for both the companies are discussed as under: 2010 2011 Woolworths Ltd 0.73 0.8 Wesfarmers Ltd 1.23 1.17 The above table and chart clearly indicates a rising current ratio for Woolworths and a slight decline in the ratio of Wesfarmers limited. The ratio indicates a better liquidity position for Wesfarmers limited but a decline in 2011 is a major concern for it which shows that even though the company has better strategies and polices in comparison to Woolworths but a decline in 2011 indicates an inefficient implementation of the same. Woolworths on the other hand has shown sign of improvements but is much lower in comparison to its rival who shows an urgent need for better policies and strategies to improve its liquid position and ensure that investors don’t stay away from the company due to liquidity crunch. Quick Ratio: Similar to current ratio its shows the ability of a concern to meet its short term obligations but it does not considers inventory as a part of current assets as it may take some time to convert inventory into cash (Working Capital, 2011). The ratios for both the companies are as 2010 2011 Woolworths Ltd 0.21 0.32 Wesfarmers Ltd 0.64 0.59 The above ratio of Wesfarmers indicates a slight decline in 2011 even though it is certainly in a better position in comparison to Woolworths. A decline in Wesfarmers indicates an inefficiency to meet its immediate obligations. Woolworths on the other hand strictly needs an improvement in the quick ratio to sustain its business in the long run. Even Wesfarmers need to improve on the same and ensure better implementation of its policies and assure itself to get rid of the decline also indicates that Financial Stability ratios: Long Term Debt to Equity Ratio: It is very closely looked upon by the investors as it shows the leverage (debt) effect on the concern. It shows the company’s ability to borrow and repay its money. The ratios are discussed as under: 2010 2011 Woolworths Ltd 136.48% 168.46% Wesfarmers Ltd 58.89% 61.14% The ratios indicates increase in the trend of debt equity in both the companies with a significant increase in the proportion of debts of Woolworths limited which indicate a higher risk on insolvency in the company. Woolworths should try to bring out better management policies to ensure a correct leverage (debts) position in the concern with better management of its debts. Debt Asset Ratio (total debts): It is the company’s total assets being financed by debts; a higher ratio indicates greater risk associated with the concerns operations. The ratios have been discussed as under: 2010 2011 WESFARMERS LIMITED 57.71% 62.81% WOOLWORTHS LIMITED 37.06% 37.94% The ratio for both the companies has increased in 2011 in comparison to 2010 which in turn indicates a greater risk associated with the concerns. Both companies should try to make policies and strategies to lower the same in near future. Wesfarmers on the other hand indicate a much higher risk in comparison to its rival and has an urgent need to draft suitable policies for the same. Time’s interest earned: It is one of the solvency ratios which is used to determine the long term viability of a concern to pay off its debts. The ratios for both the companies are as follows 2010 2011 Woolworths Ltd 12.92 10.92 Wesfarmers Ltd 4.39 6.14 The above table and chart clearly indicate that Wesfarmers has shown sign of improvements in 2011 as in 2010. With a growth in interest coverage it shows that the concern has been able to pay off its debts in a better way in 2011.however it still needs to improve further to compete with its rival. On the other hand Woolworths enjoys a higher ratio in comparison to its rival but a sharp decline in 2011 indicates failure on part of management to manage its policies and strategies well. Dividend Earnings per Share: This ratio helps to demonstrate the manner in which dividend has been distributed based on each share. The ratios are as   2010 2011 Woolworths Ltd 13 14.5 Wesfarmers Ltd 12.5 13.2 The perfromance of both Woolworths and Wesfarmers have improved which will make more investors look towards investing in the company as it provides an avenue to earn more in the long run. Dividend/ Earning Yield: This ratio helps to understand the manner in which the dividend gets reflected and changes based on the earning yield and is as follows   2010 2011 Woolworths Ltd 18.67 19.7 Wesfarmers Ltd 19.5 20.3 The ratios shows that both the company have been able to improve their performance which has ensured that both the organization are able to attract investors and provides a good avenue for investors to invest in. Profitability Ratios Profitability ratios play a major role in ascertaining the true profits of the concern from various factors contributing to the overall profits. Comparison with the previous year results and further comparing with its competitors helps in analysing the pitfalls and growth of the concern with itself and its competitors. The profitability ratios has been discussed as follows Gross Profit Margin: It indicates the profit earned by a concern by considering only the direct expenses attributable to its cost of goods sold (Gross Profit Margin, 2011). The ratios for both the companies are as follows   2010 2011 Woolworths Ltd 25.73% 25.78% Wesfarmers Ltd 30.99% 30.96% The ratios are almost consistent in the two years; Woolworths enjoying a higher gross profit margin certainly indicates soundness in its manufacturing activities with a small decline in its gross profit margin indicating lower sales or higher direct expenses. On the other hand Wesfarmers need to improve on its sales to have an edge over its competitor. Net Profit Margin: It is the profit generated by a concern after considering both direct and indirect expenses of the company. Companies prefer this ratio on the higher side as it demonstrates higher earnings (Net Profit Margin, 2011). The ratios for both the companies are as   2010 2011 Woolworths Ltd 5.96% 6.05% Wesfarmers Ltd 5.76% 6.11% Growth in the net profit ratio of Wesfarmers limited has been better than in comparison to Woolworths. Both the company’s has indeed shown good net profits in the span of complete one year. Wesfarmers has clearly outperformed in comparison to Woolworths with a higher gross profit and net profit margins. Inspite of the fact that Wesfarmers limited gross profit margin ratio has declined but the net profit margin ratio has increased with a good rate clearly indicates that the strategies adopted by the company for managing its indirect expenses such as marketing, distribution and other expenses has been rightly managed although the company should look forward to manage its manufacturing expenses similarly and try to increase its gross profit in the long run. Return on Assets: It helps to identify the proper utilisation of its assets by a concern. It basically indicates the profit generated by the use of assets in an efficient and effective manner. The ratios for both the companies are as   2010 2011 Woolworths Ltd 16.68% 15.54% Wesfarmers Ltd 7.31% 7.94% The above chart clearly shows that the return on assets has improved for Wesfarmers limited but has declined for Woolworths limited which indicates that assets of Woolworths has not been utilised in an effective manner. Even though Woolworths enjoy a much higher return on assets in comparison to Wesfarmers but a declining trend is a major threat for the concern which if not corrected on a timely basis will ultimately lead to blockage and inefficient utilisation of its resources. Return on Equity: It is expressed as the percentage of profit earned for the equity shareholders of the company and plays a major role in determining the intrinsic value per share of the company. The ratios for both the companies are as follows   2010 2011 Woolworths Ltd 26.07% 27.28% Wesfarmers Ltd 6.34% 7.94% We find that return on equity for both the companies has increased from the year 2010 to 2011 which is indeed a sign of good prospects for both the companies. However, Woolworths enjoy a much higher return on equity in comparison to Wesfarmers which indicates that investors would love to invest in Woolworths due to its strategies being implemented in a better way and higher returns on their shares. This is indeed a worrying factor for Wesfarmers who needs to design suitable strategies to ensure a higher return on equity for its shareholders and further ensure that investors don’t move out of their company to invest their money in their competitors. Asset Efficiency Ratios Efficiency ratios helps to understand the efficiency of management in dealing with the company’s capital and the efficiency by which company’s decisions and policies has been successfully implemented by the management. They are as under: Asset Turnover Ratio: It is expressed as the number of times total sales generated by utilisation of assets of the concern. The ratios for both the companies are as follows (Asset Turnover Ratio, 2011) 2010 2011 Woolworths Ltd 2.8 2.57 Wesfarmers Ltd 1.27 1.3 The ratio shows a decline for Woolworths in 2011wheareas Wesfarmers has been able to show some sign of improvements. However, Woolworths with a higher asset turnover ratio indicates efficient and sound utilization of assets to generate higher sales and Wesfarmers certainly needs improvement to match the standards set by its rival. Debtors Turnover Ratio (days): It is expressed as the no of days a concern takes to recover its dues from the credit sales affected by it. The lower it is the more better it is for the concern as it implies a faster collection of the credit sales. The ratio for both the companies are 2010 2011 Woolworths Ltd 1.5 2 Wesfarmers Ltd 10 11 The above figures show that Woolworths has been very efficient in its collection of the dues which clearly indicates a lesser chance of bad debts and an efficient system of management for collection of its receivables. However, Wesfarmers has a high debtor’s collection ratio in terms of days which might be a major problem for bad debts and liberal credit policies terms which should be checked immediately. Creditor Turnover Days: It is expressed as the number of days in which a concern makes its payment to its creditors. The ratios for both the companies are as follows 2010 2011 Woolworths Ltd 40 40 Wesfarmers Ltd 49 50 The above table clearly shows that Woolworths has been consistently maintaining its creditors turnover in the years 2010 and 2011 whereas Wesfarmers period of payment has slightly increased. Woolworths with a lower frequency of payment period certainly shows a better picture of maintaining relations with its creditors. Wesfarmers should also look for a better collection of its debts from its customers and try to make earlier payments to its creditors to show better performance. Inventory Turnover Ratio (days): It is expressed as the number of days in which the inventory of a concern is rolled over in a year. The ratios for both the companies are as 2010 2011 Woolworths Ltd 33 34 Wesfarmers Ltd 49 50 The above table clearly indicates that Woolworths has been in a better position of revolving its inventory during the year in comparison to Wesfarmers limited. However an increasing trend in the number of days of each company by one day shows inefficient management of strategies of revolving its inventory which should be checked in the years to come and ensure no wasteful blockage of funds of the company in inventories. Conclusion Both Wesfarmers Limited and Woolworths Limited have very similar lines of business and are regarded as retail giants. Both has scope for further improvement in their operating fields with the help of better management and sound and successful implementation of their policies and strategies. Analysis of the financial statements also shows how different policies and strategies are adopted by each and by converting their potential customers into real how both the concerns can increase their market share and enjoy a better growth and earning in years to come. Limitations Economical factors such as price change , inflation, GDP, industrial growth rates has not been considered while evaluating the ratio analysis. Concept of historical cost has been considered instead of fair value measurement. Figures might show a different result as technological changes for different operating process has not been considered. Recommendations Thus based on the above findings and recommendations an investor would love to invest in Woolworths limited for its better returns, proper management system, less risk, better management of its assets and higher sales generating capacity. Wesfarmers on the other hand has shown signs of improvements but need better implementation of its policies to stay in the competition. Also, the fact the Wesfarmersprovide better return and provides an avenue where the investor can earn both in the short and long run provides an opportunity to invest in Wesfarmer and earn a higher return on their investment. References Asset Turnover Ratio. 2011. Asset Turnover Ratio. Retrieved on December 28, 2011 from http://www.financeformulas.net/Asset_Turnover_Ratio.html Current Ratio. 2011. Current Ratio. Retrieved on December 28, 2011 from http://www.bizwiz.ca/liquidity_ratio_calculation_formulas/current_ratio.html Gross Profit Margin. 2011. Gross Profit Margin. Retrieved on December 28, 2011 from http://financial-dictionary.thefreedictionary.com/Gross+Profit+Margin Net Profit Margin. 2011. Net Profit Margin. Retrieved on December 28, 2011 from http://www.investorwords.com/3260/net_profit_margin.html Wesfarmers Website. 2011. Retrieved on December 28, 2011 from http://www.wesfarmers.com.au/ Woolworths Website. 2011. Retrieved on December 28, 2011 from http://www.woolworths.com.au Working Capital. 2011. Working Capital. Retrieved on December 28, 2011 from http://moneyterms.co.uk/working_capital/ Appendix Additional Information Wesfarmers and Woolworths have ensured that they improve their performance which is seen from the share price movements of both the company which has shown widespread improvement. Below is the share price movement for Wesfarmers and Woolworths Figure 1: Wesfarmer Share Prices The share price movement of Wolworth is as follows Figure 2: Woolworths Share Prices Thus, both Woolworth and Wesfarmers have seen a dip in shar prices which is mainly due to the recessionary conditions surrounding the economy and with the passage of time both the company will project better share prices as the fundamanetals of the organization are very strong and predicts such a grwoth. Read More