Financial Analysis of David Jones - Case Study Example

Executive Summary This report presents a complete financial analysis of David Jones for the year ended 2013 and 2012. Horizontal, vertical and ratio analysis has been done to make year 2012 as the base year and then make a comparison of the performance of David Jones from its previous year performance. The company has been affected with declining sales which is the real concern for the management as with declining sales the profitability of the firm has been negatively impacted which has resulted in lower net profits and earnings attributable to its equity shareholders. Furthermore, the company is at the verge of facing a liquidity crunch which is quite clearly evident from its current and acid test ratios along with other liquidity ratios. However, on the brighter side the gearing ratios indicate opportunity for the company to introduce more debts for its future business opportunities and gain leverage effect. In a nutshell, the management should seriously look towards new promotional and marketing tools to ensure a rise in its sale of goods so as to ensure a better financial position in future years to come. Table of Contents Particulars Page No 1.0 Introduction 3 2.0 Horizontal Analysis 4 3.0 Vertical Analysis 7 4.0 Ratio Analysis 9 5.0 Conclusion 14 6.0 Appendices of Calculations/Data 15 7.0 References 19 1.0 Introduction This report has been drafted in a comprehensive manner to focus on the financial analysis of David Jones. The report looks to focus on a complete financial analysis through financial instruments or tools such as vertical analysis, horizontal analysis and ratio analysis. The report presents a vertical and horizontal analysis of David Jones by taking financial year 2012 as the base. Furthermore different accounting ratios are grouped as profitability, liquidity and gearing ratio to further analyse the current year performance of David Jones and reflect on its pitfalls and achievements so as to make a better financial strategic decision for future. Finally a conclusion is provided to ensure a complete understanding of the entire analysis and ensuring that readers are equipped with both theoretical and practical understanding of the entire topic under study. 2.0 Horizontal Analysis Horizontal analysis is a tool for analyzing the financial statements which reflects the absolute change and percentage change in the value of each separate line item of the financial statements which is calculated for one or more accounting period. A horizontal analysis of the financial statement of David Jones is performed and explained as under. Horizontal Analysis of Balance Sheet for the period 2012 and 2013 BALANCE SHEET 2013 2012 - ---------- ---------- ASSETS Current Assets: Cash and Cash Equivalents 67.57% 100.00% Non Current Assets Held For Sale - 0.00% Receivables 116.49% 100.00% Inventories 90.13% 100.00% Financial Assets 3920.83% 100.00% Other Current Assets 92.63% 100.00% ---------- ---------- Total Current Assets 91.17% 100.00% Long-Term Assets: Property, Plant and Equipment 102.19% 100.00% Intangible Assets 101.52% 100.00% Financial Assets 100.00% 100.00% Deferred Tax Asset 111.75% 100.00% Other Assets 167.51% 100.00% ---------- ---------- Total Long-Term Assets 102.77% 100.00% Total Assets 99.75% 100.00% LIABILITIES AND EQUITY Current Liabilities: Accounts Payable 98.96% 100.00% Interest Bearing Liabilities 3.27% 100.00% Current Tax, Provision and Financial Liabilities 127.65% 100.00% Other Liabilities 282.29% 100.00% ---------- ---------- Total Current Liabilities 98.54% 100.00% Long-Term Liabilities: Interest Bearing Liabilities 80.00% 100.00% Reserves 103.37% 100.00% Provisions 119.02% 100.00% Other Long-term Liabilities 99.23% 100.00% ---------- ---------- Total Long-term Liabilities 90.77% 100.00% Total Liabilities 95.18% 100.00% Shareholders' Equity: Common Equity-incl. Ret. Earning. 103.26% 100.00% ---------- ---------- Total Equity 103.26% 100.00% Total Liabilities and Equity 99.75% 100.00% The horizontal analysis of David Jones Balance Sheet has been prepared by taking the accounting year 2012 as base. There has been a decrease in the cash and cash equivalents mainly on account of the fact of payment of long term interest on long term liabilities which indicates a threat for the liquidity position of the organization in terms of meeting its both short term and long term obligations as the firm may face a liquidity crunch in future and is an area of great concern. Furthermore receivables has increased with decrease in inventory clearly indicating faster short term credit sales with no substantiate increase in its emergency stock (Finance, 2011). Short term financial assets have increased significantly owing to the company engaging itself in more speculative financial instruments for long term profit booking. There has been increase in long term assets indicating more and more capitalization of its resources and expansion of business. Furthermore on the liabilities side David Jones has been able to churn its resources well as there has been fall in both long term and short term interest obligations with lower payables. Reserves and retained earnings show decent accumulation to ensure long term sustainability and feasibility of the business. Horizontal Analysis of the Income Statement for the period 2013 and 2012 INCOME STATEMENT 2013 2012 Revenue from Sale of Goods 98.78% 100.00% Less: Cost of Goods Sold 98.29% 100.00% ---------- ---------- Gross Profit 99.60% 100.00% ---------- ---------- Operating Income 99.60% 100.00% Less: Interest Expense 80.89% 100.00% (no capitalized interest) Other Income (Expenses) 102.15% 100.00% ---------- ---------- Income before Taxes 91.31% 100.00% Less: Taxes Related to Operations 84.62% 100.00% ---------- ---------- N.I. before Non-contr. Inc 94.15% 100.00% Non-controlling income (loss) 0.00% 0.00% ---------- ---------- N.I. before Nonrecurring Items 94.15% 100.00% ---------- ---------- Net Income (Loss) 94.15% 100.00% The horizontal analysis of the Income Statement of David Jones indicate a fall in the net sales which is quite a concern for the company however the cost of selling such goods has also decreased on account of lower sales which is quite justifiable. It is to be noted that various expenses and other income of David Jones has been clubbed together to reflect a better view of the impact on net expenses or sales on the profitability of the company. The real concern for the company currently can be viewed as increase in gross profit however with a decrease in net profit before tax owing to rising indirect expenses which needs to be managed at a faster and better manner. 3.0 Vertical Analysis Vertical analysis is a financial analyzing tool which acts as a comparable tool of different items to a single line item in the same accounting period concerned. It explains and identifies a relationship between different items in the same financial statement expressed as a percentage of the total amount. Vertical Analysis of Balance Sheet for the period 2012 and 2013 BALANCE SHEET 2013 2012 ASSETS Current Assets: Cash and Cash Equivalents 1.12% 1.65% Non Current Assets Held For Sale 0.21% 0.00% Receivables 1.54% 1.32% Inventories 20.32% 22.49% Financial Assets 0.08% 0.00% Other Current Assets 0.54% 0.58% --------- --------- Total Current Assets 23.81% 26.05% Long-Term Assets: Property, Plant and Equipment 67.49% 65.87% Intangible Assets 3.61% 3.54% Financial Assets 0.00% 0.00% Deferred Tax Asset 5.04% 4.50% Other Assets 0.05% 0.03% --------- --------- Total Long-Term Assets 76.19% 73.95% Total Assets 100.00% 100.00% LIABILITIES AND EQUITY Current Liabilities: Accounts Payable 21.15% 21.32% Interest Bearing Liabilities 0.03% 0.89% Current Tax, Provision and Financial Liabilities 3.14% 2.45% Other Liabilities 0.07% 0.02% --------- --------- Total Current Liabilities 24.38% 24.68% Long-Term Liabilities: Interest Bearing Liabilities 8.08% 10.07% Reserves 6.21% 5.99% Provisions 0.59% 0.50% Other Long-term Liabilities 2.22% 2.23% --------- --------- Total Long-term Liabilities 17.11% 18.80% Total Liabilities 41.49% 43.48% Shareholders' Equity: Common Equity-incl. Ret. Earning. 58.51% 56.52% --------- --------- Total Equity 58.51% 56.52% Total Liabilities and Equity 100.00% 100.00% Vertical analysis of David Jones highlights that there has been a fall in the total current assets which is mainly on account of lower cash and cash equivalents and decrease in inventory owing to the company clearing its old stock piling through short term credit sales. Furthermore financial assets are a new addition to the list on account on David Jones engaging itself in speculative business for long term profit realization. Fixed assets has shown considerable rise for ensuring its expansion strategy are implemented and dealt in a successful manner. Reserves including retained earnings show a rise indicating that the company is looking for ploughing back its profits in the future years (Lyroudi & Lazaridis, 2000). There has been a sharp fall in the interest bearing liabilities which includes both short and long term obligation indicating threat of creditors of their payments as the company may face liquidity crunch in near future. Vertical Analysis of the Income Statement for the period 2013 and 2012 INCOME STATEMENT 2013 2012 Revenue from Sale of Goods 100.00% 100.00% Less: Cost of Goods Sold 62.22% 62.53% Gross Profit 37.78% 37.47% Operating Income 37.78% 37.47% Less: Interest Expense 0.46% 0.57% (no capitalized interest) Other Income (Expenses) -30.20% -29.20% Income before Taxes 7.12% 7.70% Less: Taxes Related to Operations 1.96% 2.29% N.I. before Non-contr. Inc 5.16% 5.41% Non-controlling income (loss) 0.00% 0.00% ---------- ---------- N.I. before Nonrecurring Items 5.16% 5.41% ---------- ---------- Net Income (Loss) 5.16% 5.41% It is to be noted that here the various expenses and income as reflected in the financial statement of David Jones has been clubbed together so as to analyze the overall impact of the same on the profitability of the company. The real concern for David Jones is declining net profit owing to rise in its indirect expenses and declining sales. The gross profit for the company has shown slight improvement however when it comes to the real attributable profits for long term business and shareholders the company has been negatively declining which needs to be corrected on an urgent basis through more promotional tools and strict control over its indirect expenses. 4.0 Ratio Analysis Ratio analysis is widely used to evaluate a firm’s financial performance on several key areas. It largely involves comparison a firm with its own past track or its competitor in the similar industry to ensure a better and meaningful interpretation of its financial statements. Profitability Ratios Profitability ratios are unique tools which help in analyzing the overall efficiency and performance of a firm and are important for both company managers and owners alike. Let us have a look at the profitability ratios of David Jones for the year ended 2013 and 2012. Particulars 2013 2012 Rate of Return on Net Sales 5.16% 0.54% Rate of Return on Total Assets 7.69% 0.81% Asset Turnover Ratio 1.49 times 1.51 times Rate of Return on Ordinary Shareholder’s Equity 12.06% 13.04% Earnings Per Share (Basic) (Cents per Share) 18.0 19.4 The rate of return on net sales has increased significantly for David Jones from 0.54% in 2012 to 5.16% in 2013 which is due to lower indirect expenses, however in real terms the net income of the firm along with sales has gone done which is an area of real concern for the company (Saleem & Rehman, 2011). Similar to rate of return on net sales the rate of return on net assets has increased sharply however, profits of the firm have decreased and so has the sales with similar reductions in both direct and indirect expenses as justifiable. Furthermore a ratio of 7.89% in 2013 indicates that the assets of the company are used more effectively to generate better and higher profits. Asset turnover ratio indicates the efficiency of a firm in its ability to generate sales from its assets. David Jones has almost no or very little change in its asset turnover ratio for both the years under study. A slight decrease in 2012 in the asset turnover ratio is mainly on account of lower sales which presently does not poses much of a threat for the company apart from its declining sales. The rate of return on ordinary shareholder’s equity has decreased to 12% in 2013 from 13.04% in 2012 which indicates inefficient management if the company to generate revenue from its equity shareholder’s investment (Padachi, 2006). The decline in the same is mainly on account of lower sales however, looking at the retained earning the company has been able to retain more of its earnings from the year 2012 so as to ensure better ploughing back of its profits in future profitable ventures. The earnings per share has also decreased from 19.04 cents to 18.0 cents in 2012 which is on account of lower sales and lower return to its ordinary shareholder’s equity. Furthermore David Jones need to seriously look upon the same as the same may have a negative impact on its shares trading with more investors switching away their investment from the company to their potential rivals. Liquidity Ratios Liquidity ratios are financial ratio tools which are used to analyze a firm ability to pay-off its short term debt obligations as an when they become due for payment. Let us have a look at the various liquidity ratios of David Jones for the year 2013 and 2012 Particulars 2013 2012 Current Ratio 0.98 times 1.06 times Working Capital -$7125000 $16951000 Acid Test Ratio or Quick Ratio 0.14 times 0.14 times Inventory Turnover Ratio 4.56 times 4.18 times Days in Inventory 79.98 days 87.22 days Gross Profit Percentage 37.78% 37.47% Accounts Receivable Turnover 96.64 times 113.97 times Days sales in Receivable 3.78 days 3.20 days The working capital ratio or the current ratio has decreased from 1.06 times in 2013 to 0.98 times in 2012 which is again an area of concern for David Jones and for its creditors. Furthermore a current ratio of below 1 is a strong liquidity indicator of the company might face liquidity problems for making payment of its short term obligations in near future (Deloof, 2003). The working capital of David Jones is a negative figure for the year 2013 which makes a clear indication of serious liquidity problem for David Jones and the company has high chances of not meeting its short term obligations in near future (Deloof, 2003). Acid test ratio of David Jones seems constant for the company which is again an alarming threat for the firm as the same indicates very little liquidity for the firm and serious chances of the firm facing a liquidity crunch in future. The inventory turnover ratio has slightly increased for David Jones which indicates that the stock are managed effectively however a high inventory turnover ratio may be unhealthy in future as the same reflects an investment with nil returns and it further open ups trouble in future for any price rise (Gandy, 2011). Further the days in inventory has decreased which is a good sign for the company as chances of stock piling has reduced however with declining sales the same could not make a deeper impact on its liquidity position Gross profit margin has slightly increased for the company. However, in absolute terms the sales has declined owing to which there has been a correspondence decline in the cost of goods sold which has made the gross profit ratio to rise (Eljelly, 2004). The real concern still lies on the declining sales of David Jones. The accounts receivable turnover ratio has decreased which implies that the firm has reassessed its credit policies to ensure timely collection of its imparted credit sales which carries no associated interest along with (Filbeck & Krueger, 2005). Furthermore days sales in receivable has slightly increased which is again a inefficiency of the management to convert its credit sales into cash at a faster rate. Gearing Ratios Gearing ratios are ratios which are used to measure the leverage effect of the firm’s capital. Let us have a look at the different gearing ratios of David Jones for the year ended 2013 and 2012. Particulars 2013 2012 Debt Ratio 0.35 times 0.37 times Debt to Equity Ratio 0.17 times 0.20 times Times Interest Earned Ratio 15.50 times 14.15 times Debt ratio of David Jones has slightly decreased which indicates that a lower portion of firm’s assets are claimed by creditors and the business has opportunities to take more loans for future viable projects (Antony, 2004). Debt to Equity ratio also shows a small decline which indicates a good position of its debts being managed by its assets with lower associated risks. Times interest earned has increased from 14.15 times in 2012 to 15.50 times in 2013 which is again favourable for the company as the same indicate a better position of the firm in paying off its interest obligations from profit before income tax. There are low credit risks associated with the same (Antony, 2004). 5.0 Conclusion The report looks to highlight upon a critical analysis of the financial statements of David Jones for the year ended 2013 and 2012. In a nutshell, the real area of concern for the company is declining sales which had largely impacted its profitability. Furthermore there are threats of liquidity crunch owing to low current and acid test ratios. The leverage effect of the company seems in strong position and there are ample opportunity for funding its future ventures through the introduction of debt to make a leverage effect and improve upon its profitability and business performance. 6.0 Appendices of Calculations Profitability Ratios Particulars Formula 2013 2012 Rate of Return on Net Sales Net Income After Tax/Net Sales (95184/1845012)*100 5.16% (10103/1867817)*100 0.54% Rate of Return on Total Assets Net Income/Total Assets (95184/ 1237785)*100 7.69% (10103/1240897)*100 0.81% Asset Turnover Ratio Sales Revenue/ Average Total Assets (1845012/1237785) 1.49 (1867817/1240897) 1.51 Rate of Return on Ordinary Shareholder's Equity Net Income / Shareholder's Equity (96650/801096(*100 12.06% (101167/775704)*100 13.04% Earnings Per Share Net Income- Dividend on Preferred Stock/ Average Outstanding Shares 18.00 19.04 Liquidity Ratios Particulars Formula 2013 2012 Current Ratio Current Assets/ Current Liabilities 294705/301830 0.98 323249/306298 1.06 Working Capital Current Assets-Current Liabilities 294705-301830 -7125.00 323249-306298 16951 Acid Test Ratio (Current Assets- Inventory)/ Current Liabilities (294705-251543)/301830 0.14 (323249-279099)/306298 0.14 Inventory Turnover Ratio Cost of goods sold/ Average Inventory 1147968/ 251543 4.56 (1167987/ 279099) 4.18 Days in Inventory (Inventory/ Cost of Goods sold)*365 (251543/1147968)*365 79.98 (279099/1167987)*365 87.22 Gross Profit Percentage (Gross Profit/sales)*100 (697044/ 1845012)*100 37.78% (699830/1867817)*100 37.47% Accounts Receivable Turnover Net Credit Sales/ Average Receivables 1845012/19092 96.64 1867817/16389 113.97 Days sales in Receivable (Accounts Receivable/ Net Credit sales)*365 (19092/1845012)*365 3.78 (16389/1867817)*365 3.20 Gearing Ratios Particulars Formula 2013 2012 Debt Ratio Total Liabilities/ Total Assets 436689/1237785 0.35 465193/1240897 0.37 Debt to Equity Ratio Long Term Debt/ Equity (134859/801096) 0.17 (158895/775704) 0.20 Times Interest Earned EBIT/ Interest (140388/9057) 15.50 (154760/10938) 14.15 7.0 References Antony, T. (2004). Thin Capitalization: Issues on the Gearing Ratio. Journal on Australian Taxation, 7 (1), 39-57 Deloof, M. (2003). Does Working Capital Management Affect Profitability of Belgian Firms? Journal of Business Finance & Accounting, 30(3&4), 573-587. Eljelly, A. (2004). “Liquidity-Profitability Tradeoff: An empirical Investigation in an Emerging Market”, International Journal of Commerce & Management, 14(2), 48 - 61 Finance. (2011). Why business needs finance. Retrieved on August 18, 2014 from http://tutor2u.net/business/gcse/finance_why_needed.htm Filbeck, G., & Krueger, T. M. (2005). An analysis of working capital management results across industries. Mid-American Journal of Business, 20(2), 10-17. Gandy, M. (2011). Is a low current ratio bad? Retrieved on August 18, 2014 from http://www.markgandycfo.com/2011/03/is-a-low-current-ratio-bad/ Lyroudi, K., & Lazaridis, Y. (2000). The Cash Conversion Cycle and Liquidity Analysis of the Food Industry in Greece [Electronic Version]. EFMA 2000 Athens Padachi, K. (2006). Trends in working capital management and its impact on firms’ performance: an analysis of Mauritian small manufacturing firms. International Review of Business Research Papers, 2(2), 45-58. Saleem, Q. & Rehman, R. (2011). Impacts of Liquidity Ratios on Profitability. Interdisciplinary Journal of Research in Business, 1 (7), 95-98 Read More