Financial Analysis for Rio Tinto Ltd - Assignment Example

FINANCIAL ANALYSIS FOR RIO TINTO LTD Name University Course Tutor Date Financial Analysis for Rio Tinto Ltd Executive Summary This report gives a financial analysis of Rio Tinto which is a mining and metals company with headquarters in London, UK. The paper will provide a ratio and trend analysis of the company by analyzing the annual reports for period between 2011 and 2014. Ideally, this report has the objective of assisting users of Rio Tinto’s financial reports to better comprehend the information contained in the reports. Ideally, Rio Tinto’s trend analysis of income statements reveals an outstanding position of the business operation and profit of the company. From the balance sheet of Rio Tinto Ltd, it can be said that the company has demonstrated a similar rate of decline for both current assets and liabilities. From the company’s ratio analysis there was a significant reduction of profitability between 2011 and 2012 as indicated by the ROE and ROA-these two ratios showed significant decrease between the financial years 2011 and 2012. In addition, the company is characteristic of a reduced asset turnover ratio and days debtors ratio. Therefore, Rio Tinto has different directions when it comes to its debt collection efficiency, and the efficiency in generating sales revenue from company’s assets. Strong market performance demonstrated by the company between 2011 and 2014 is a sufficient indication that investors have growing confidence in Rio Tinto Ltd. Table of Contents Executive Summary 2 Table of Contents 3 Introduction 4 Rio Tinto Ltd 4 Trend Analysis 6 Income Statement 6 Balance Sheet 8 Ratio Analysis 11 Profitability 11 Efficiency 12 Liquidity 13 Capital Structure 14 Market Performance 14 Conclusion 15 Introduction The financial statements of Rio Tinto could have much essential information with the capability of helping financial reports’ users to come up with outstanding management decisions. This report analyses the financial reports of Rio Tinto Ltd on grounds of the annual financial reports of the company between 2011 and 2014. The report is inclusive of three parts: company’s background information; trend analysis of the company-based on the income statement and balance sheets; the ratio analysis of the company will be carried out with an objective of determining Rio Tinto’s current profitability, liquidity, market performance, capital structure, and efficiency. At the end of the report, a summary of the report’s key findings will be provided. The progress of a company significantly depends on the management decisions of the company; on the other hand these decisions are found to draw an immense deal of influence from the company’s financial performance. Therefore, the analysis of income statements and balance sheets of a company are of much essence towards the achievement of ideal company decisions. Rio Tinto Ltd Rio Tinto Ltd is a British-Australian international mining and metals company headquartered in London, UK, and with a management office in Australia’s Melbourne. The establishment of the company came in the year 1873 following the purchase of a Rio Tinto River mine complex (by an international consortium of investors) from the government of Spain. Initially, the company exhibited specialization in mineral extraction; however, it now demonstrates operations in the production of such commodities as diamonds, uranium, aluminium, iron ore, coal, and copper. The company is also characteristic of refinery activities especially in iron ore and bauxite. Upon its establishment, the company made use of mergers and acquisitions to grow to one of the industry leaders in the globe. Operations of the company are present in six continents; however, the main operating centers are in Canada. After the purchase of the Rio Tinto Mine, the group of investors resolved in the construction of several processing facilities, the innovation of new techniques of mining, and the expansion of mining activities. The period between 1877 and 1891 saw the domination of the Rio Tinto Mine as the leading copper producer in the globe. Notably, the open-pit Corta Atalaya formed a constituent of the Spanish original operations of the Rio Tinto. Between 1870 and 1925, the company demonstrated an inward focus on the full exploitation of the Rio Tinto Mine; there was negligible emphasis on the exploration or expansion of mining activities outside Spain. Ideally, Rio Tinto recorded strong financial success until the year 1914; during this period, the company colluded with other private agencies in the industry for the control of prices in the market. The dominance of the firm, however, declined after the World War I as its effects eliminated the viability of US market for pyrites from Europe. In addition, the decline of the company during this period resulted from its failure to diversify its operations; consequently, the company’s international ranks dropped significantly. There was, however, a change of this trend in the year 1925 following the assumption of power by Sir Auckland Geddes as the company’s chairman. The new management team engaged in the diversification of the operations and investment of the company, thus reforming its strategy. The new management led Rio Tinto Ltd into several joint mergers with product consumers thus the development of emergent technologies alongside the exploration of new mines in regions outside Spain. The investment of the company in Rhodesia’s copper was arguably the most significant move by Rio Tinto in its diversification efforts. As a result, the company made a bold move from the Spanish Rio Tinto mine to other regions. Trend Analysis It is worth noting that not all the users of the financial reports are conversant with standard accounting principles and procedures. Therefore, the trend analysis of the performance of Rio Tinto Ltd has the capability of assisting users of the financial reports have a better understanding of the changes taking place in the financial reports of the company. Through the study of the trend analysis, users of the report also have the capability of understanding changes taking place in the accounts of the company over a specified period of time. The case of Rio Tinto Ltd presents an outstanding example of how the analysis of the performance of a company, over a period of time, can lead to appropriate conclusions on what is happening around the organization. The case of Rio Tinto Ltd makes use of a period of 4years: 2011-2014. From the trend analysis of Rio Tinto Performance, a strong financial performance can be seen; however, the company has not been consistent for most of the financial indicators over the five years. Indeed, for most of the indicators, there is a sharp drop form the year 2010 to 2011, with gradual improvement being noted between 2012 and 2014. However, on average, Rio Tinto has a strong financial position matching the status of an international company of its reputation. Income Statement Rio Tinto’s trend analysis of income statements reveals an outstanding position of the business operation and profit of the company. There is a high return on equity ratio with the only drop being between 2011 and 2012. However, as form the year 2012, the figures are progressive with the figure transforming from 0.03684 to 0,079853 from between 2012 and 2014. Figure 1: Return on equity ratios of Rio Tinto from 2011-2014 The company is also doing well with respect to return on assets for the period between 2011 and 2014. There is, however, a decline of performance between 2011 and 2012, after which a subsequent gradual increase follows. The company, however, exhibits a progressive decline in sales revenue against an increase in the cost of sales. This has the implication that the company’s gross profit margin ratios decreases gradually with the years. Ideally, from the analysis it is revealed that the year 2011 had the highest sales revenue with the year 2014 having the lowest. From the company’s income statement, it is, however, evident that the profits are stable. The decline of profits on the company’s income statement is only noted between the year 2011 and 2012. The years that follow, record significant gains of profits as indicated in the income statements of Rio Tinto Ltd. The improvements in the company’s profits are remarkable considering the company’s outsized business operation. There are, however, declines especially in the year 2012; this could highly be attributed to weak economic conditions in most parts where Rio Tinto Ltd operates. This either left consumers looking for cheap products or completely eliminated their purchasing power for some time. This is why the company records significant declines of sales revenue between 2011 and 2012. Indeed, even after the recovery, the 2014 figure of sales revenue is not as high as the figure of the year 2011. Balance Sheet From the balance sheet of Rio Tinto Ltd, it can be said that the company has demonstrated a similar rate of decline for both current assets and liabilities. This is an indicator of a healthy performance considering that as the current assets decline, the current liabilities also decline. Figure 2: Current Assets and Current Liabilities of Rio Tinto Ltd. From the figure above, the progressive decrease in current assets and liabilities of Rio Tinto Ltd is evident. Ideally, this trend can be attributed to the progressive decrease of the company’s sales revenue through the same period of time. It is worth noting that, the decrease in the company’s current assets, liabilities, and sales revenue could be as a result of reduced operations. As the mining industry becomes more competitive, a number of challenges are emerging thus the possibility of a decline in operations. For instance, the industry significantly deals in the extraction of non-renewable resources that could face the risk of depletion. There are thus substantial challenges in finding new mines for sustainable extraction activities. In addition, strict government and environmental policies have also been implemented in various regions of the globe leading to significant reduction in the extraction activities of mining companies. The company, therefore, ought to enhance its investment in current assets in order to open up its operations base. This could be encouraged by the company’s good performance in profit; this has the implication of the accumulation of retained earnings with the capability of helping Rio Tinto Ltd to finance the principal sections of its new capital investment. There is thus a possibility that, in years to come, the company will record a faster growth rate of owner’s equity considering the ease of new investment and declining current liabilities. There is also a high probability that Rio Tinto Ltd will record a faster growth rate of non-current assets than current assets; this would significantly be attributed to long-term investments. Ratio Analysis From the company’s ratio analysis there was a significant reduction of profitability between 2011 and 2012 as indicated by the ROE and ROA-these two ratios showed significant decrease between the financial years 2011 and 2012. In addition, the company is characteristic of a reduced asset turnover ratio and days debtors ratio. This has the translation that the company has been spending less time in the collection of its debts alongside utilizing its assets less efficiently. In the course of the four years, the performance of the company’s liquidity was stable; there was, however, a progressive decrease of the company’s quick and current ratios. This has the implication that, holding all things constant, the company could soon be facing significant risks. This is because, from the current trend, the company’s quick and current ratios will sink further in years to come, if all conditions remain constant. It is also evident that the company has undergone a reduction of financial leverage between 2011 and 2014; however, the main source of funds for the company would still remain to be debt financing. From the trend analysis of the ratios, it can also be seen that Rio Tinto Ltd could be faced by the challenge of long-term financial stability. Profitability   2011 2012 2013 2014 ROE 0.066693 0.03684 0.045221 0.079853 ROA 0.05659 0.026212 0.0301 0.051015 Table 1: Profitability Ratios of Rio Tinto As indicated in the table above, the company did not do well in terms of profitability between the year 2011 and 2012. For instance the company’s ROE reduced from 0.066693 in 2011 to 0.03684 in 2012. This could have the implication that the company had less capability of earning profit from every dollar of its equity. This represents the same margin by which the company’s profit obtained from one dollar of equity is reduced. The period between 2011 and 2012 has a similar trend of the company’s ROA, with a gradual increase from 2012 to 2014. This has the implication that the earning from one dollar of the company’s assets reduced by the same margin as the decrease of ROA within the same period of time. The company has recorded a stable performance in profitability against a progressive decline in sales revenues. Indeed, the sales revenues of the company have been decreasing progressively from the year 2011 all the way to 2014. This has the implication that, there could have been economic stresses in countries with heavy presence of the company’s operations. Efficiency   2011 2012 2013 2014 Asset turnover 0.50639 0.400556 0.372495 0.322041 Days debtors 36.52593 100.5397 96.53081 73.52512 Table 2: Assets Turnover and day debtors of the company The company has had different directions of efficiency for the period between 2011 and 2014. From the analysis, it is clear that the company asset turnover reduces progressively from 2011 to 2014; on the other hand, there is a sharp rise in days debtors between 2011 and 2012 followed by a gradual decrease to the year 2014. It is evident that the efficiency of the company with respect to the generation of sales revenue from assets has been on a downward trend. This lack of efficiency can also be reflected by the company’s sales revenue that has also been on a downward trend in over the same period of time. There is a high possibility that the company’s asset base has increased thus the reduced efficiency in converting its assets into sales revenue. Generally, there is a slight increase in the efficiency of the company with regard to the collection of its debts. From the trend analysis of the ratios, it is clear that the ratio of days debtors reduces gradually towards the end of the period under study; this has the translation of some improvement in the company’s efficiency to collect debts. Liquidity   2011 2012 2013 2014 Current ratio 1.463183 1.463215 1.463338 1.463352 Quick ratio 1.108579 1.067832 0.982831 0.935799 Table 3: Liquidity Ratios of Rio Tinto Ltd There has been some improvement in the liquidity of Rio Tinto between 2011 and 2014. There has been an increase of the company’s current ratio from 1.463183 to 1.463352 between the years 2011 and 2014. This could have the implication of reduced short-term borrowing by the company thus a shift to long-term borrowing. Ideally, there is a tendency of companies shifting from short-term to long-term borrowing in order to enjoy low interest rates accompanying the markets at times. The analysis of the company’s liquidity also has the indication that Rio Tinto Ltd is characteristic of an extremely small ratio of non-inventory, short-term assets to provide a means of covering current liabilities of the company. The company has high quick ratios implying that it does not face liquidity risks in the near future. Capital Structure   2011 2012 2013 2014 Debt Ratio 50.47 47.28 40.37 38.0005 Debt Coverage Ratio 2.263505 2.06046 1.887661 1.738819 Interest Coverage 16.7685 1.667353 2.69408 10.43934 Table 4: Market Structure Ratios for Rio Tinto Ltd As indicated in the table above, there is drop of the company’s debt ratio from 50.47 to 38.005 over the four years under study. There is a possibility that, over the last four years, the company has been gaining enough profits on products for the accumulation of large quantity of retained earnings. As a result, the company has great potential towards its financing of new capital investment parts. This has the implication that there would be a much faster growth rate of the owner’s equity of the company than the rate of growth of the total liabilities of the company. It is, however, worth noting that debt financing would still form the major source of funds for the company considering the high debt ratios of Rio Tinto Ltd. Market Performance   2011 2012 2013 2014 Earnings per share 3.029 1.606196 1.983977 3.607273 Table 5: Earnings per share of Rio Tinto Ltd As indicated in the table above, Rio Tinto Ltd has a general increase in the ratio of earnings per share thus strong market performance. This is attributed to the strong performance of the company, in terms of profitability, and has the implication of growing confidence of investors in the company. Conclusion It can be concluded that Rio Tinto has had strong performance in its EBIT and profitability thus a growth in the financial position of the company. Ideally, Rio Tinto’s trend analysis of income statements reveals an outstanding position of the business operation and profit of the company. From the balance sheet of Rio Tinto Ltd, it can be said that the company has demonstrated a similar rate of decline for both current assets and liabilities. From the company’s ratio analysis there was a significant reduction of profitability between 2011 and 2012 as indicated by the ROE and ROA-these two ratios showed significant decrease between the financial years 2011 and 2012. In addition, the company is characteristic of a reduced asset turnover ratio and days debtors ratio. Therefore, Rio Tinto has different directions when it comes to its debt collection efficiency, and the efficiency in generating sales revenue from company’s assets. Generally, despite a sink between 2011 and 2012, the company has demonstrated strong financial performance between 2011 and 2014. References Askew, D. (2011). Financial Planning and Systems. Acton: Australian National University. Bambra, C., Joyce, K., & Maryon-Davis, A. (2009). Strategic review of Financial Trends (Marmot Review). Task group, 8. Dheensa, S., Williams, R., & Metcalfe, A. (2013). Business and Financial Principles. Journal of Business, 0192513X13484274. 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