Financial Ratios Analysis of Brickworks - Example

Running header: Financial Ratio analysis Student’s name: Instructor’s name: Subject code: Date of submission: Overview This report presents financial ratios analysis of Brickworks limited. In so doing, five classes of ratios are used to exhaustively analyze the company. This can be seen in the appendix attached at the end of the report .The report also gives recommendations to both the internal and external users of financial information based on the analyses. It is hoped that the stakeholders will find the analysis useful in making various types of decisions. Introduction Business Ratio analysis is a useful tool in analyzing a company’s performance. Interpretation of such ratios is helpful in helping various stakeholders in making various types of decisions (Fernando, 2002). Such decisions may include investment decisions, financing decisions, and management decisions among others. This report uses ratio analysis to perform trend analysis on Brickworks limited. Brickworks limited is a public limited company listed on the Australian stock exchange. The company is composed of a number of companies that specialize on production of building products.. The analysis is based on five classes of ratios which include analysis of profitability, liquidity, activity, leverage as well as the market value of its shares. The report also gives recommendations based on the ratios interpretation. Rationale In order to adequately analyze Brickworks Limited’s performance, it was necessary to divide the ratios into five groups which include liquidity analysis ratios, profitability ratios, activity ratios, leverage ratios and market analysis ratios. By so doing all aspects of the company’s performance have been adequately covered. This means that the needs of the insiders who include the management as well as those of outsiders who include creditors and investors among others have been adequately considered. Interpretation a) The company’s liquidity Current ratio Brickworks limited had a current ratio of 3.308 in 2010 which dropped slightly in 2011 to 3.191. This implies that for every dollar of current liability the firm had it had 3.308 and 3.191dollars of current assets with which it could meet the liabilities when they fall due in 2010 and 2011 respectively. The slight drop in 2011 can be attributed to the drop in the company’s current assets during the year. Quick ratio Due to the nature of the company’s business, its inventory may not be readily turned into cash in a bid to meet its current financial obligation. Hence, the quick ratio was found a better means of analyzing the firm’s liquidity. The company’s quick ratio dropped from 1.9 in 2010 to 1.55 in 2011. The company’s management is charged with the responsibility of ensuring that the company is able to meet its short-term obligations. Similarly, creditors need to assure themselves that the company will be able to meet its financial obligations before advancing any more financing to the company (James, 2010). A good liquidity position for the company is therefore desirable by both the management and the creditors. However, although the company’s liquidity is generally good being greater than 1 in both 2011 and 2010, the downward trend if sustained is not healthy for its performance. This is because the company may eventually not be able to meet its current obligations. This would lead to declining confidence by creditors on the company’s ability to pay them and hence they may no longer be willing to extend credit to the company. As such, most of the company’s day today operations may be hampered. Therefore, the company’s management should come up with measures to ensure that the company’s liquidity does not decline further so as to ensure the company’s future success. b) The company’s profitability Return on assets (ROA) The company’s return on assets increased slightly from 6.13% in 2010 to 6.26 in 2011. This implies that for every dollar of total assets, the company made 6.13cents in 2010 and 6.26 cents in 2011 respectively. Return on Equity The company’s return on equity ratio increased slightly from 8.42% in 2010to 8.5% in 2011. This implies that for every dollar of shareholders equity, the company made 8.42 cents in 2010 and 8.5cents in 2011. Net profit margin There was a slight improvement in the company’s net profit margin from 21.14% to 22.43%. This implies that for every dollar of sale, the company made 21.14 cents in net profit in 2010 which improved to 22.43 cents in 2011. Earnings per share The company’s earnings per share was stagnant in both 2011and 2010 despite the increase in net income. This is however attributed to the issuance of more shares in 2011. The management should however come up with measures of increasing the EPS in future so as to increase value to the shareholders. The company’s profitability is of great concern to both management and other stakeholders such as shareholders and creditors. Potential investors may also be interested in knowing the company’s liquidity before they decide on whether to invest in the company or not. Therefore, the management ought to come up with ways of increasing the company’s profitability even further in order to maximize value to the owners and attract more investors. By so doing, creditors will also have more confidence in the company’s ability to meet its obligations to them when they fall due. c) the company’s activity analysis asset turnover ratio The company’s asset turnover ratio dropped slightly form 29% in 2010 to 28% in 2011. This implies that each dollar of total assets generated 29 cents in 2010 as opposed to 28 cents in 2011. The management should therefore implement measures intended to rectify this situation. Accounts receivable turnover ratio The company’s accounts receivable turnover ratio improved from 6.65 times in 2010 to 7.6 in 2011. This implies that the company’s became more efficient in collecting its debts in 2011. This is a trend that ought to be upheld by the management. Inventory turnover ratio The company’s inventory turnover ratio declined slightly from 3.33 in 2010 times to 2.95 in 2011. This is an issue of concern as the management ought to increase its efforts in turning over its inventory to ensure more sales are generated. Ability to utilize the company’s assets effectively in generating income is of paramount importance to both shareholders and the management (Diana ,2003). Mangers want to know how effective the company is in using its assets in revenue generation. Similarly, shareholders want to know whether the managers are effective in managing the company. However, the management’s efficiency seems to have declined in 2011 with the exception of debt collection efficiency. The management should therefore take advantage of its improved debt collection efficiency in generating more sales and hence income for the company. d) Leverage ratios Debt to equity ratio There was an improvement of the company’s debt to equity ratio from 37.23% in 2010 to 35.97% in 2011. This implies that for every dollar of shareholders equity, there were a corresponding 37.23 cents of debt in 2010 and 35.97 cents of dent in 2011. This is an improvement and is healthy for the company as long as it is maintained at desirable levels. Interest coverage ratio The company’s interest coverage ratio greatly improved from 5.56 in 2010 to 9.06 in 2011. This shows an improvement in the company’s ability to meet its interest obligations. The management should put in measures to maintain this trend. Potential and existing Creditors are greatly concerned on the company’s ability to generate enough cash to pay its interest obligations on its outstanding debts. This is part of the criteria they use in making decisions regarding provision of new debts or extending credit terms for existing debts. The company’s ability to generate cash for meeting its interest obligations have improved. This is a good trend and management should put in measures to maintain this so as to increase creditors’ confidence. e) Market value ratios Price earning ratio The company’s price earning ratio slightly declined from 11.62 in 2010 to 10.5 in 2011. This implies that investors are willing to pay less for every dollar of earnings in 2011 than in 2010. This is associated with the company’s share prices. The management should therefore take steps aimed at improving investor confidence in the company as it seems to be performing well. Dividend yield The company’s dividend yield increased from 24% in 2010 to 26% in 2011. Dividend payout ratio The dividend payout ratio slightly improved from 33.9% in 2010 to 34.03% in 2011. The increase is attributed to the increase in net income. Managers, shareholders as well as potential investors usually have a great concern for the market value of the company’s shares. The greater the value, the better for them as it implies greater returns and increased confidence on the company’s performance (Jane, 2005). However, the company’s share value in the market seems to be declining although the company seems to be performing well. This should trigger action by management to put in measures that will improve investor confidence in the company since it seems to be performing well. Conclusion and recommendations As can be derived from the ratio interpretation, the company performed fairly well in all the areas analyzed in 2011 compared to 2010. However, this was just a slight improvement and the management needs to put in more effort not only to maintain the performance but to also achieve greater achievement. The management will need to come up with strategies of improving the company’s liquidity as well as efficiency. This is because financiers desire to have confidence in the company’s ability to meet its financial obligations owed to them. Although the company seem to be performing well, its share prices reduced in 2011. Therefore, there is need to resolve any issued that might have made the share prices to reduce in 2011 so as investors can regain confidence on the company’s performance. By management maintaining the upward trend in performance, the shareholders should have confidence in their company and even invest more in it. Investors should have confidence in the company’s performance and invest in it especially based on the improvement Achieved in 2011. Furthermore, based on the ratio interpretation, investors should have confidence in the company’s ability to meet its financial obligations. However, all the stakeholders should not entirely base their decisions on the ratio analysis and interpretation above (Erich, 2007). Other factors such as the company’s internal environment as well as external environment should be considered in making any decisions. This combination of factors will enable them reach at quality informed decisions as opposed to just basing their decision on ratio analysis. References Fernando, A2002, Financial Statement Analysis: A Practitioner's Guide, New York, John Wiley. James, S2010, Financial accounting, London, Rutledge. Diana R2003, Corporate Financial Analysis: Decisions in a Global Environment. 4th ed, Chicago, Richard D. Irwin, Inc. Jane, E2005, Advanced financial accounting, Melbourne, Longhorn publishers Erich, B2007, Techniques of Financial Analysis: A Modern Approach. 9th ed, Chicago, Richard D. Irwin, Inc. Appendix: Ratio Formula 2011 $(000) 2010 $(000) Liquidity analysis ratios Current ratio Current assets/current liabilities $298703/93618 =3.191 326678/98740 =3.308 Quick ratio (current assets-inventory)/current liabilities $(298703-153575) /93618 =1.55 (326678-139265) /98740 =1.9 Profit analysis ratios Return on assets (ROA) Net income/average total assets $142551/2278486 =6.26% 138790/2264269 =6.13% Return on equity (ROE) Net income/average shareholders equity $142551/1675746 =8.5% 138790/1649934 =8.42% Net profit margin Net income/sales $142551/635615 =22.43% 138790/656538 =21.14% Earnings per share(EPS) Net income/common shares outstanding $142551/147482887 =96.70 cents 138790/143565083 =96.70cents Activity analysis ratios Asset turnover ratios Sales/average total assets 635615/2278486 =0.28 656538/2264269 =0.29 Accounts receivable turnover ratio Sales/average accounts receivable 635615/83639 =7.6 656538/98761 =6.65 Inventory turnover ratio Cost of goods sold/average inventory 452808/153575 =2.95 464231/139265 =3.33 Capital structure analysis ratios Debt to equity ratio Total debt/total shareholders equity 602740/1675746 =35.97% 614335/1649934 =37.23% Interest coverage ratio EBIT/Interest expense 191667/21155 =9.06 136161/24491 =5.56 Capital market analysis ratios Price earnings ratio(PE) Market price of common stock per share/EPS 10.15/0.967 =10.5 11.24/0.967 =11.62 Dividend yield Dividend per share/market price per share 0.27/10.15 =26.60% 0.27/11.24 =24.02% Dividend payout ratio Cash dividends/net income 48513/142551 =34.03% 47048/138790 =33.90% http://au.finance.yahoo.com/q/hp?s=BKW.AX&a=00&b=1&c=2010&d=11&e=29&f=2010&g=m Read More