Financial Ratios: Woolworth Limited - Case Study Example

Financial Ratios: Woolworth limited Your name Name of Assignment 24th May , 2012 Executive Summary The financial statements of Woolworth limited have disclosed that the company is profitable and has strong capital structure. The company`s short term liquidity position is weak which requires the management to improve in working capital management policies. The company efficiently manages the use of assets of the company to generate the revenue and income. Table of Contents I Executive Summary 2 II Table of Contents 3 III Introduction 4 IV Findings 4 A). Liquidity ratios 4 B). Leverage ratios 6 C). Asset management ratios 8 D). Profitability ratios 9 E). Market value ratios 11 V Recommendation and Conclusion 12 Reference List 13 Appendix 14 Introduction The selected for evaluation is Woolworth limited which is the most successful Australian retailer. The company has evolved over time in to various diversifications and store formats to capitalize in changing business environment. The analysis is based on ratios as indicators of performance. The ratios that have been analyzed are grouped into five categories those are liquidity ratios, leverage ratios, asset management ratios, profitability ratios and market value ratios. Findings Liquidity ratio: These ratios show the ability of the company to pay off short term liabilities without torching fixed assets. Liquidity implies the ability of an organization to pay its debts in the short run. This ability can be measured by the use of liquidity ratios. Short-term liquidity constitutes the relationship amid the current assets and the current liabilities of the organization. If a firm has sufficient net working capital i.e. excess of current assets over current liabilities, then the firm is assumed to have enough liquidity (ICFAI Center for Management Research, 2004). The current ratio and the quick ratio are the two ratios, which are commonly used to measure liquidity directly. Hence, if the current ratio is lower it means that the short-term liquidity of the firm is also lower. 2009 2010 2011 current ratio 0.76 0.73 0.80 quick ratio 0.24 0.25 0.35 An important liquidity ratio is the current ratio reflecting current assets available to satisfy current liabilities. A moderately high rate of current ratio in comparison to other organizations in the same industry indicates that the organization is having a very high liquidity and is conservatively managed by its management. However, the higher current ration may tend to yield nominal profits (Jan, Susan and Mark, 2005). Woolworth`s current ratio of 0.76, 0.73 and 0.80 for 2009, 2010 and 2011 implies there are $0.76, 0.73 and 0.80 of current asset available to meet each $1 of currently maturing current liabilities. Amore stringent test of short-term liquidity, based on the acid- test ratio, uses only the most liquid current assets cash short term investments, and accounts receivable. Woolworth has $0.24, $ 0.25 and $ 0.35 for 2009, 2010 and 2011 of liquid assets to cover each $1 of current liabilities. Both of these ratios suggest a tight liquidity situation at Woolworth. Still, we need more information to draw definite conclusions about liquidity. Results of this preliminary liquidity analysis suggest that Woolworth has little cushion in meeting its current obligations out of current assets. The graph below shows the trend of two liquidity ratios; From the graph above we note that apart from the slight fall in the year 2009- 2010 there is an upward trend. Leverage ratio: To assess Woolworth’s long-term financing structure and credit risk, we examine its capital structure and solvency. Long term debt to equity ratio show to what extent the owner’s equity can cushion creditor’s claims in the time of liquidation. In both years they are showing high risk. The organization’s long term solvency ratios present unpleasing sight to the company’s shareholders (Ormiston, 2004). The debt to total equity ratio of the firm shows that the firm has recently decreased their debt. This a less risky capital structure to have and the company would be advised to focus on raising funds though Equity rather than debt to remain less risky. Its total debt to equity ratio of 51.2%, 44.98% and 63.2% for 2009, 2010 and 2011 indicates that for each $1 of equity financing, another $ 0.512, $0.4498 and $ 0.632 of financing is provided by creditors. 2009 2010 2011 Debt –to-total assets ratio 58.69% 57.71% 62.81% Debt to equity 51.2% 44.98% 63.2% Times interest earned(time) 14.88 12.92 10.92 The debt to total assets shows how much protection there is for creditors. The ratio shows the total liabilities divided by total assets, the higher the ratio the higher the risk (Rich, Jones, Mowen and Hansen, 2009). Its debt to assets is 58.69%, 57.71% and 62.81% revealing $ 0.5869, $ 0.5771 and $ 0.6281 for 2009, 2010 and 2011 of long term creditor financing to each $1 of equity financing. The debt to total assets ratios demonstrates that the company has enough assets to cover for potential insolvency to cover its debt sufficiently. These two ratios suggest some degree of solvency risk given the relatively large amount of creditor financing in Woolworth`s capital structure. However, the times interest earned ratio shows Woolworth`s earnings are more than 14.88 times its fixed interest commitments. This implies Woolworth is in no danger of reneging on its fixed commitments. a large portion of Woolworth`s creditor financing is in the form of operating or trade credit. This form of credit is noninterest bearing, meaning there is no explicit interest cost recorded for this balance sheet debt. Woolworth carried a large portion of interest bearing debt, the times interest earned ratio might still look fine because of Woolworth healthy earnings level. This ratio is important in indicating whether accompany has sufficient cash to finance its debts. Thus higher interest coverage is desirable to interested investors. This ratio is however limited in that it does not guarantee that the cash flow from operating activities will increase and this is the main concern for the investor (Soffer, 2003). Asset management ratios: Looking at asset turnover ratios, both fixed and total asset turnover ratios we note the company has low ratio of sales to assets, implying that the assets of the company are under-utilized thus they are not used efficiently(Bragg, 2007). These two ratios measure the management efficiency in using the asset of the company. 2009 2010 2011 Average trade receivable 7.728 3.98 3.93 Collection period(days) = 365 Average trade receivable 48 92 93 fixed asset turnover ratio 1.04 1.01 0.97 average inventory turnover 11.23 11.41 11.2 Days to sale in inventory = 365 Average inventory 33 32 33 total asset turnover ratio 0.75 0.72 0.67 One additional piece of information useful in assessing liquidity is the length of time needed for conversion of receivables and inventories to cash. Woolworth`s collection period for receivables is approximately 48 days, 92 days and 93days for the years 2009,2010 and 2011. Also there are approximately 33 days, 32days and 33days for the 2009, 2010 and 2011 respectively between purchase and sale of inventories. These figures imply an operating cash to cash cycle of 81 days, 124 days and 126 days for the years 2009, 2010 and 2011 respectively. The following graph shows the trend of efficiency ratios for the company. Profitability ratios A profitability ratio shows how the company generates return on assets utilized (Ross, Westerfield and Jaffe, 2005). The following table shows profitability ratio calculated from three years financial statements Woolworth limited. 2009 2010 2011 Profit margin 14.98% 15.22% 15.19% Return on total assets 11.16% 11.02% 10.15% Return on equity 27.01% 26.07% 27.28% The profitability ratio shows a mixed trend as shown in the graph below. The company shows some stability in the profit margin while return on equity appears to have downward trend as return on assets makes a downward move in the year 2009 to 2010, however in the year 2010 to 2011 it makes an upward move. Although this ratios appear to be having stable like trend it can be concluded that the company`s position is weak when it come on return on assets. Moreover return on assets shows that the company utilizing the assets of the company well by maintaining a return of more than 10%. The profit margin seek assess profitability of revenue which is a critical event for any company. This ratio varies from company to company and industry to industry because of the accounting policies adapted. In overall the company as performed well however it needs to be compared with other competitors. Market value ratios It is generally acknowledged that the market value of ordinary shares is closely related to the earnings per share. Hence, this ratio is used as a basis of predicting the future value of ordinary shares, and may assist also in formulating forecasts of future dividends. This ratio does not; therefore provide a reliable tool for comparing the financial performance of firms (Alexander and Britton, 2004). The following are market value ratios which have been calculated from the financial statement and market price at end of each financial year. These ratios will help investors make informed decision about the viability of the stock to generate returns. 2009 2010 2011 Price earnings ratio 173.25 162.43 158.9 Book value per share 5.74 6.35 6.45 Market price to book value 4.55 4.2 4.3 From the table above it can be noted that the price-earnings ratio is 173.25 times in the year 2009, in the year 2010 the ratio 162.43 times while in 2011 it is 158.9. This means that the stock is overvalued since a low price earnings ratio means a low price thus a good investment. This stock is astronomically of a valued in all the year and consideration. However the price earnings ratio shows downward trend which is an indication that the price of the stock is being adjusted downward. Looking at the book value per share we can note that it is not stable although it shows some increase from the year 2009 to the year 2011. The same trend is taken by market price to book value. This ratio determines the changes of the investors wealth because it`s increase will show that the wealth of an investor has increased. The following graph shows the trend of these two ratios. Recommendation and Conclusion From the analysis we note that the company is profitable and has a strong capital structure however the company is efficiency in using assets is poor. This means the company needs to improve on it is sales by incorporating online stores. For an outside investor I will recommend to him to invest in this company because the market value ratios show that there growth in the ratios. The ratios shows that the investors fund are safe because of strong financial position. Reference list Alexander, D. & Britton, A., 2004. Financial reporting. Florence, KY: Cengage Learning. Bragg, S. 2007. Business Ratios and Formulas: A Comprehensive Guide. Hoboken: John Wiley and Sons ICFAI Center for Management Research, 2004. Financial Accounting & Financial Statement Analysis. Hyderabad: ICFAI Center for Management Research. Jan, R., Susan, F. & Mark, S., 2005. Financial and managerial accounting: The basis for business Decision. New York: McGraw Hill Companies. Ormiston, L. F., 2004. Understanding Financial Statements. New Jersey: Pearson - Prentice Hall. Rich, J., Jones, P., Mowen, M., & Hansen, D., 2009. Cornerstones of financial accounting. Mason, Ohio: Cengage learning. Ross, S., Westerfield, R., & Jaffe, J., 2005. Corporate finance. New York: McGraw Hill Company Soffer, C. L., 2003. Financial Statement Analysis: A Valuation Approach. Essex: Prentice Hall. Woolworths, (2011), “Investor Relations” Appendix- Income statement Woolworths Limited Woolworths Limited     2011 2010 2009 revenue 54,280 51784.8 49697.8 cost of sales 40186.3 38391.2 36974.4 gross profit 14,093 13,394 12,723 other revenue 226 179 148 branch expenses (8,584) (8,165) (7,800) administrative expenses (2,459) (2,325) (2,256) operating income before financing costs 3,276 3,082 2,816 finance income 39 27 46 finance costs (300) (239) (189)       profit before tax, restructure and other items 3,015 2,871 2,672 losses on restructure and closed out hedge contracts other closed out related cost foreign gain on US dollar borrowings business acquisition and integration cost       3,015 2,871 2,672 income tax expense 875 833 766 total income for the year 2,140 2,038 1,906 basic earnings per share 0.17464 0.16401 0.15071 diluted earnings per share 0.17360 0.16317 0.14969 market price at 27th June 27.750 26.640 26.110 Appendix – Balance Sheet Woolworths Limited   2011 2010 2009 Current assets Cash and cash equivalents 1,520 713 763 Trade and other receivable 1,122 917 664 inventories 3,737 3,439 3,293 derivative and other financial assets 94 37 37 other assets 121 93 103 Total current assets 6,593 5,199 4,859 Non-current assets trade and other receivables 15 13 3 other financial assets 119 132 155 property, plant and equipment 8,620 7,639 6,654 intangibles 5,237 5,071 4,933 deferred tax assets 510 433 481 Total non-current assets 14,502 13,288 12,226 TOTAL ASSETS 21,095 18,487 17,085 Current Liabilities trade and other payables 5,513 5,279 5,110 borrowings 1,471 872 189 Current Liabilities 205 199 280 other financial liabilities 239 25 99 provisions 861 779 737 Other current liabilities 0 0 0 Total current liabilities 8,288 7,153 6,415 Non-current Liabilities borrowings 3,374 2,670 2,986 other financial liabilities 916 237 78 provisions 465 416 362 other 206 193 186 Total non-current liabilities 4,960 3,516 3,613 TOTAL LIABILITIES 13,249 10,670 10,028 net assets 7,846 7,818 7,057 Equity issued capital 3,989 3,784 3,859 share held in trust (56) (41) (51) reserves (237) (28) (174) retained earnings 3,898 3,855 3,179 non controlling interest 253 247 245 TOTAL EQUITY 7,846 7,818 7,057 21,095 18,487 17,085 Number of shares (million) 1216.2 1232.1 1229.1 Read More