Fortescue Metal Groups Ratio and Trend Analysis - Example

Fortescue Metal Group’s Ratio and Trend Analysis Name: Institution: Date: A) Ratio Analysis. Ratio analysis is an examination of a business through its financial statements[Las13]. William R. Lasher points out that the exercise involves taking sets of numbers out of the financial statements forming ratios out of them and making inferences based on the results[Las13]. This report uses several ratios to analyze four key aspects of Fortescue metal Groups financial position and performance. The aspects under scrutiny are the profitability levels and asset efficiency, the liquidity position and the capital structure/ leverage position of the organization. Profitability ratios and asset efficiency (All currencies in $ 000). Profitability ratios measure a company’s performance by analyzing its ability to make profits from its operations[Thu07]. The ratios analyze a company’s profit earning capacity[Thu07]. They include, the gross profit margin, net profit margin, return on assets and return on equity[Axe12]. Gross margin The ratio is calculated by dividing the gross profits by the cost of sales. The ratios give the percentage of gross profits in the total sales revenue[Axe12]. As a general rule, the higher the gross profit margin is, the better it is for the organization as it signifies higher chances of net profitability[Axe12]. = Gross profits / sales revenue[Axe12]. 2010 gross profit margins (1094 /3,220) * 100 = 34% 2011 gross profit margins (2,684/ 5,442) * 100 = 49.3% 2012 gross profit margins (2666/ 6716) * 100 = 39.7% 2013 gross profit margins (2980/ 8120) * 100 = 36.7% Net profit margin The ratio gives the percentage of net profits in the total sales revenue[Axe12]. It is calculated by dividing the net profits with the sales revenue[Axe12]. As with the gross profit margins, higher net profit margins are also viewed positively[Axe12]. The ratio highlights the profitability levels. Therefore, the higher the percentage is, the more profits the organization is making. = Net profits / total sales * 100[Axe12]. 2010 net profit margins (580/ 3220) * 100 = 18% 2011 net profit margins (1019/ 5442) * 100 = 18.7% 2012 net profit margins (1559/ 6716) * 100 = 23.2% 2013 net profit margins (1746/ 8120) * 100 = 21.5% Return on assets The ratio measures the profits earned by a business entity through the use of all the assets at its disposal[Ric11]. High percentages in this ratio signify effective use of assets[Ric11]. It shows that the management is investing the resources prudently. The ratio is calculated by using the following formula = Net income/ Total Assets * 100[Ric11]. Return on asset 2010 (580/ 5303) = 10.9% Return on asset 2011 (1019/8627) * 100 = 11.8% Return on asset 2012 (1559/15063) * 100 = 10.3% Return on asset 2013 (1746/20867) * 100 = 8.4% Return on Equity The ratio measures the amount the organization is earning on stockholders investment[Her10]. As with the other profitability ratios, high returns on equity are favorable as they indicate that shareholders are getting good returns on their investments[Her10]. The ratio is calculated by dividing the earnings after taxes by the total equity[Her10]. = Earnings after taxes/ Total equity[Her10]. Return on equity 2010 (580/ 1476) * 100 = 39.3% Return on equity 2011 (1019/2434) * 100 = 48.9% Return on equity 2012 (1559/3762) * 100 = 41.4% Return on equity 2013 (1746/5289) * = 33% Liquidity ratios Liquidity ratios measure a firm’s ability to satisfy its short term liabilities as they come due[Gra111]. Low or declining liquidity ratios are indicative of financial distress/ cashflow problems[Gra111]. The liquidity ratios under scrutiny in this analysis are net working capital, quick ratios/ acid test ratio and current ratios. Net working capital. The net working capital is not a ratio in the traditional sense of the word[Kha07]. However, it is still used as a mechanism in determining the liquidity or solvency position of a business entity[Kha07]. The net working capital is the amount of capital a business has at its disposal in running the day to day activities[Kha07]. As a general rule, the working net working capital should be high as it signifies a high level of solvency. It is calculated by determining the difference between current assets and current liabilities[Kha07]. = current assets – current liabilities Net working capital 2010 (1645 -698) = 947 Net working capital 2011 (3494 – 1118) = 2376 Net working capital 2012 (3650 – 2116) = 1534 Net working capital 2013 (3662 – 1414) = 2250 Current ratio The current ratio measures an entity’s ability to meet its short term obligations[Kha07]. As a general rule, high current ratios indicate solvency. However, John Graham and Scott Smart argue point out that the appropriate level of the ratios is dependent on the type of business entity and the predictability of the cashflows. They argue that businesses in the manufacturing industries or those with unpredictable cashflows have more pressure to keep the ratio high[Gra111]. The current ratio is calculated by dividing the current assets by the current liabilities[Gra111]. = Current Assets/ Current Liabilities Current ratio 2010 1645 /698 = 2.4 Current ratio 2011 3494 /1118 = 3.1 Current ratio 2012 3650 / 2116 = 1.7 Current ratio 2013 3662 /1414 = 2.5 Quick/ acid test ratio The ratio measures the ability of an entity to meet its current liabilities from its most liquid assets[Cha10]. In its calculations, inventories are excluded from the current assets[Cha10]. Quick ratio 2010 (1645 – 188)/ 699 = 2.1 Quick ratio 2011 (3494 - 416)/ 1117 = 2.8 Quick ratio 2012 (3650 – 617) / 2116 = 1.4 Quick ratio 2013 (3662 - 961)/ 1414 = 1.9 Capital structure/ leverage ratios The capital structure is the mixture of equity and long term debts that are used to finance an entity’s activities[Swa03]. The debt ratio and debt to equity ratio are used this analysis. Debt ratio The debt ratio measure the extent at which a company uses borrowed funds to run its operations[Hei07]. It is calculated by dividing the total liabilities by the total assets Debt ratio 2010 3770/ 5247 = 0.71 Debt ratio 2011 6192/ 8626 = 0.72 Debt ratio 2012 11301/ 15063 = 0.75 Debt ratio 2013 15578/ 20867 = 0.75 Debt to equity ratio The ratio relates long term liabilities to equity[Gra111]. It is calculated by dividing the long term liabilities by the stockholders’ equity[Gra111]. Debt to equity 2010 3071/ 1476 = 2.1 Debt to equity 2011 5074/ 2434 = 2.1 Debt to equity 2012 9185/ 3762 = 2.4 Debt to equity 2013 14164/ 5285 = 2.7 B) An interpretation of the ratios and trend analysis The profitability ratios all show good returns on investments. For example, the net profit margin has been growing gradually from 2010. Such a trend is positive despite the slight slump experienced in 2013. However, the returns on assets and returns on investments dropped considerably in 2013 despite the relatively stable profit margins. Such results suggest that the company increased capital base was not matched by a similar increase in productivity/ investments. In terms of liquidity, the ratios show that the organization is solvent. On average, the current ratios indicate that the current assets were twice as many as the current liabilities over the four-year period with 2011 and 2012 being the most solvent and least solvent financial periods respectively. The quick ratio reaffirms this conclusion. Moreover, the slight difference between the current ratios and the quick ratios in each financial year indicates that inventories constitute a large percentage of current assets. The biggest drop difference between the two ratios was experienced in 2013, and it is attributed to the drop in cash and its equivalents and the slight increase in trade receivables. In terms of capital structure, Forstesue Group is poorly leveraged. In 2010 and 2011, 71% of all the assets were financed by borrowed capital. The figure grew to 75% in 2012 and 2013. Consequently, the debt to equity ratio is also a source of alarm. In 2010 and 2011 the long term liabilities were 2.1 times more than the owners’ equity stake. The figure grew to 2.4 times and 2.7 times in 2012 and 2013 respectively. These ratios are alarming because they put the owner’s investments at risk. A large amount of borrowed capital/ long term liabilities means that the company has a considerable responsibility of financing the loans. The company cannot afford to default on the loans as it would compound the situation. In essence, the company has to maintain profitability over the loan period. Any slump in the sales or economic downturns puts the company puts the company at risk of action by the creditors. Despite this, the overall analysis is positive. The growth in profitability and the solvency levels indicate that the company is capable of financing the loans effectively. Moreover, the returns on assets and equity are still high despite the slight drop in 2013. References Las13: , (Lasher, 2013, p. 87), Thu07: , (Thukaram, 2007, p. 99), Axe12: , (Tracy, 2012, p. 11), Axe12: , (Tracy, 2012, p. 12), Ric11: , (Rich, et al., 2011, p. 610), Her10: , (Mayo, 2010, p. 284), Gra111: , (Graham & Smart, 2011, p. 41), Kha07: , (Khan & Jain, 2007, p. 55), Kha07: , (Khan & Jain, 2007, p. 56), Kha07: , (Khan & Jain, 2007, p. 57), Cha10: , (Gibson, 2010, p. 230), Swa03: , (Swanson, et al., 2003, p. 2), Hei07: , (Heitger, et al., 2007, p. 608), Gra111: , (Graham & Smart, 2011, p. 45), Read More