Financial Ratio Analysis of Harvey Norman Limited - Case Study Example

Running header: Harvey Norman Student’s name: Instructor’s name: Subject code: Date of submission Executive summary This report presents the financial ratio analysis of Harvey Norman Limited with an aim of advising potential investors on whether to invest in the company. The report starts with introducing the financial ratio analysis topic and its usefulness to investors in making sound investment decisions. Then the Harvey Norman limited in terms of the activities it is involved in with an aim of giving the readers of the report an overview of what Harvey Norman is all about. The report then introduces the various ratios calculated in financial ratios calculated in the analysis including their importance and implication to the company and the investors. The report then compares Harvey Norman Limited’s performance in the ratios over the years 2013 and 2014 as well as the implications of the performance. The report then concludes by advising the potential investors that it would be good to invest in the company. The appendix presents the calculations for the various ratios under consideration. Table of contents Table of Contents Executive summary 1 Table of contents 3 Table of Contents 3 Introduction 4 Harvey Norman Limited 4 Explanation of ratios 4 Analysis of performance 6 Net tangible assets per share 8 Conclusion and Advice to investors 8 References: 9 Appendix 10 Introduction Investors need to base their investment decisions on sound bases if they are to succeed in their investments. Such bases may be qualitative or quantitative. One of the quantitative measures commonly used by investors in gauging the worthiness of an investment decision is the financial ratio analysis (Jamie, 2014). Measures tested in financial ratio analysis include profitability, asset efficiency, liquidity, capital structure and market performance ratios. Using these ratios, investors are able to know how well an investment option is performing and hence decide whether or not to invest in it. This report performs a financial ratio analysis of Harvey Norman Limited with an aim of advising potential investors whether to invest in it. Harvey Norman Limited Harvey Norman Limited is an Australian based retailer dealing with various types of goods including computers, furniture, electrical, bedding and entertainment goods. The company is a franchise with its main brand being owned by Harvey Norman Holdings Limited. The company also has operations outside Australia and has more than 230 stores or branches in Australia, Slovenia, Ireland, New Zealand, Northern Ireland, Croatia, Malaysia and Singapore (Harvey Norman, 2014). The company also owns many other Australian retail chains that include Space Furniture, Domayne, Joyce Mayne and Ariston Appliances. Explanation of ratios Profitability ratios They give an indication of whether the company has been performing profitably or not. Return on assets ratio indicates how profitable the company is relative to its total assets and hence how efficient the management has been in using the company’s assets to generate earnings. On the other hand, return on equity gives an indication of how much profit the company generates using the money invested by the shareholders and hence is an indication of the management efficiency in using shareholders’ funds to generate earnings (Joe, 2009). By measuring and comparing each of the above ratios, the management as well as other stakeholders is able to gauge whether the company’s efficiency in using either the assets or equity to generate returns has increased or declined. This would help in making various decisions such as decisions on policy to increase efficiency and hence profitability or decisions on whether to invest on a particular company depending on its efficiency levels and hence profitability. Asset efficiency ratios They give an indication of how efficient the company is in using its assets and liabilities internally. Debtors’ turnover ratio indicates the company’s efficiency in giving credit and collecting debts as well. On the other hand, inventory turnover ratio measures the number of times the firm’s inventory has been turned over or sold and replaced during the period in question. As such, the asset efficiency ratios by being compared can help the company make various asset related decisions. For instance, if the debtors’ turnover is low or has declined, the management can make decisions to tighten the company’s credit policy or increase discounts in a bid to boost collection. On the other hand, comparing debtors’ turnover ratio would help the company make decisions that would lead to increased sales and hence revenue resulting to increased profitability. Liquidity ratio They measure company’s ability to repay short term debts using short term assets. By calculating and comparing the ratios, the company is able to make decisions that would either increase or reduce liquidity depending on the liquidity risk posed. On the other hand, creditors and lenders are able to base their lending decisions based on whether the company is facing greater liquidity risk. Capital structure ratios They indicate how the company has been using debt in financing its assets and the combination of debt and equity in the company’s capital structure. Hence by comparing the ratios over different periods, the company is able to make informed financing decisions that would either increase debt levels or reduce it (Larry, 2011). On the other hand, lenders of finances would make their lending decisions based on whether the company’s gearing/liquidation risk has increased beyond or reduced to acceptable levels. Market performance ratios They indicate how well the company has been performing in the market as far as bringing returns to the company’s shareholders is concerned. Earnings per share measures the dollar return per every share held and hence by calculating and comparing EPS, the management makes informed decisions regarding increasing the value of the company’s shares through increased returns. On the other hand, investors make investment decisions based on the market performance ratios. Analysis of performance Profitability ratios Return on equity The company’s return on equity increased significantly from 6.11% in 2013 to 8.52% in 2014. The increase was occasioned by the increase in the company’s net profit. As such, this ratio indicates that the company’s efficiency in using equity to generate returns for the shareholders is increasing. Return on assets The company’s return on assets increased significantly from 3.55% in 2013 to 5.02% in 2014. This is an indication that the company’s efficiency in using assets to generate returns increased over the same period. Asset efficiency ratios Debtors’ turnover The company’s debtors’ turnover improved slightly from 1.28 times in 2013 to 1.39 times in 2014. This is an indication that the company’s ability to collect debt is increasing though it is very low at just slightly above one time. Inventory turnover The company’s inventory turnover slightly increased from 3.55 times in 2013 to 3.76 times in 2014. This indicates improved performance as far as turning over inventory is concerned. However, the company’s turnover is very low given the kind of products it deals with. Liquidity ratios Current Ratio The company’s current ratio greatly declined from 1.84 times in 2013 to 1.27 times. This decline is attributed to the increase in the company’s current liabilities. However, the level of current ratio is still acceptable since it is still above one. However, it does imply increased liquidity risk over the two years. Quick Ratio The company’s quick ratio declined from 1.51 times in 2013 to 1.04 times in 2014. This decline is attributed to the increase in the company’s current liabilities. However, the level of current ratio is still acceptable since it is still above one. However, it does imply increased liquidity risk over the two years. Capital structure ratios Debt Equity ratio There is a slight decline in the company’s debt to equity ratio from 8.72 times in 2013 to 0.70 in 2014. The decline is attributed to the increased total equity over the two years. However, this is an implication of an improvement since it indicates that the risk associated with holding too much debt has declined over the two years. Debt ratio The company’s debt ratio slightly declined from 0.42 in 2013 to 0.41 in 2014. The decline resulted from the increased level of assets for the company. This is an improvement since it implies that the liquidation risk posed by the company holding too much debt reduced over the two years period. Market Performance ratios Earnings per share The company’s earnings per share significantly improved from 13.38 cents per share in 2013 to $19.91 cents per share in 2014. This implies that the company was better in maximizing returns for the shareholders which is the ultimate goal of shareholders. As such, this is a worthy improvement. Net tangible assets per share The company’s net tangible assets per share slightly improved from $2.17 in 2013 to $2.27 in 2014. This was caused by increased levels of equity in 2014. This is an improvement for shareholders since it implies that their wealth improved over the two years period. Conclusion and Advice to investors Arising from the above analysis, it is clear that the company’s performance improved over the two years period in all the aspects being examined. It should however be noted that the company’s performance in the above measures is very low apart from on liquidity and capital structure. As such, there would be need for the company to improve on its asset usage efficiency and profitability and hence its market performance ratios. If these areas are improved, the company is likely to be on the right course (Jared, 2014). However, that notwithstanding, I would advise potential investors to invest in the company. This is because despite the low levels of returns, the above analysis reveals that there is a very great room for improvement meaning that shareholders are much likely to grow their wealth through capital gains if they invest in the company. References: Harvey Norman, 2014, 2014 annual report, retrieved on 27th May 2015, from; http://www.harveynormanholdings.com.au/pdf_files/2014-Annual- Report_021014.pdf Jamie, P2014, Financial accounting in an economic context, New York, John Wiley & Sons. Joe, B2009, Financial accounting, London, Rutledge. Larry, W2011, Principles of accounting, Sydney, Prentice Hall. Jared, B2014, Advanced Financial accounting, London, Rutledge. Appendix Profitability ratios Return on Equity = Net income/Shareholders equity 2014 =$212,238,000/2,491,106,000 =8.52% 2013 = $144,477,000/2,363,855,000 =6.11% Return on Assets =Net income/Total assets 2014 = $212, 238,000/4,225,336,000 =5.02% 2013 = $144,477,000/4,065,031,000 =3.55% Asset efficiency ratios Debtors’ turnover = Credit Sales/ Average Debtors 2014 = $1,513,662,000/ (1,119,393,000 + 1,054,402,000)/2 =1.39 times 2013 =$1,323,481,000/ (1,054,402,000 + 1,017,973,000)/2 = 1.28 times Inventory turnover = Cost of goods sold/ Average inventory 2014 = $1,064,892,000/ (297,670,000+ 268,781,000)/2 = 3.76 times 2013 = $944,229,000/ (268,781,000 +263,421,000)/2 = 3.55 times Liquidity ratios Current Ratio =Current assets/Current Liabilities 2014 = $1,607,167,000/1,262,232,000 = 1.27 2013 =$1,531,913,000/834,057,000 =1.84 Quick Ratio = (Current Assets-Inventory)/Current liabilities 2014 = ($1,607,167,000-297, 670,000)/1,262,232,000 = 1.04 2013 = ($1,531,913,000-268,781,000)/834,057,000 = 1.51 Capital structure ratios Debt Equity ratio = (Total liabilities/ Total equity) 100 2014 = (1,734,230,000/2,491,106,000)100 =0.70 2013 = (1,701,176,000/2,363,855,000)100 =0.72 Debt ratio = (Total liabilities/total assets) 100 2014 = (1,734,230,000/4,225,336,000)100 =0.41 2013 = (1,701,176,000/4,065,031,000)100=0.42 Market Performance ratios Earnings per share = Net profit available to ordinary shareholders/Weighted number of ordinary shares on issue 2014 =212,238,000/1,062,316,784.00 = 19.91 cents per share 2013= 44,477,000/1,062,316,784.00 = 13.38 cents per share Net tangible assets per share (Equity- Intangible assets/Number of ordinary shares on issue at year end) 2014 = (2,491,106,000 -77,888,000)/ 1,062,316,784.00= $2.27 per share 2013 = (2,363,855,000-58,903,000)/ 1,062,316,784.00 =$2.17 per share Read More