Quota Summaries Support Value Direct and Turnout Bunch - Assignment Example

How Ratio Analyses Can Assist Value Private and Public Company Student’s Name Course Instructor Date How Ratio Analyses Can Assist Value Private and Public Company Introduction Ratio analysis is a process by which the finance department identifies the company’s financial performances by comparing the entities in the statement of financial position and those in the income statement. The reason for this is because statement of financial position entities are usually responsible for those to be found in the P&L i.e. assets shown in the balance sheet are responsible for sales, revenue and expenses to be found in the P&L (Sasal &Sen 2012, p.132). This analysis is important to various stakeholders of the company. This is because they have to protect their interests in the company. These stakeholders include the shareholders, creditors and potential investors. In ratio analysis, past record of performance is used to assess the progress of the company. These trends are useful in forecasting the profitability of the company. Ratio Analysis of Publicly Traded Company: Tesco Company Return on Shareholders’ Funds The ratio is used to evaluate the amount of profit that is available to the owner. In the case of a public company, the owner is the shareholder while for the private company the owner is the proprietors. The profit that is available to the owner can either be given out as dividends or reinvested in the company. The return on shareholders’ funds is 15.8%. The company’s shares indicate an increasing trend for the past three years. There is a relationship between this ratio with the overall price of the company’s shares. This is based on the fact that investors are very interested in the level of returns on their investment. Therefore, when the percentage returns on shareholders’ wealth increases, the demand for shares also increases. Gross Profit Margin This is a profitability ratio. It assesses the efficiency of the company as expressed through the profits that the company is making. From the gross profit margin ratio, the private company is more profitable than the public company. In fact, the private company is 3 times better than the public company in relation to profitability. This indicates that the private company is selling its products at a higher markup as compared to the public company. Some of the implication of selling the products at a very high markup is reducing the inventory turnover rate (Bull 2007, p.98). Therefore, in as much as the company may be selling at a higher markup, it may not make a lot of profits. Net Asset Turnover This ratio measures the efficiency at which the company utilizes its assets and all available resources in the generation of revenue. The larger the net asset ratio, the more efficient the firm is. Tesco’s ratio is 10.8. The larger the net asset ratio, the more efficient the firm is. In this case, the ratio of the public company is almost 5 times the equivalent value for the private company. This indicates that the public company is investing its resources appropriately. There are a number of reasons that explain why some companies can be more efficient than others. In all the cases, the top leadership is very significant. The managers are charged with providing guidance to the rest of the company. Failure for these managers to provide leadership will lead to inefficiencies in the undertaking of the various responsibilities in the company (Gupta 1990, p.63). In the case where the leadership is committed to ensuring adherence to policies and regulations, the company shall be built around a philosophy that will ensure the success of the company. Return on Net Assets The ratio provides information about how the company utilizes net assets to produce profits. The public company’s ratio is 47.52%. The public company is definitely doing really good. This is in relation to utilization of net assets for generation of profits required to drive the company. The ratio indicates that there is excellent management performance in the public company. This may be attributed to the oversight and regulatory bodies charged with the responsibility of overseeing the management of any public company. At the same time, the public companies are subjected to statutory audit of their financial statements. At the end of it, investors will prefer investing in the company that utilizes well its resources. Current Ratio Current ratio measures the ability of the company in relation to meeting its short-term maturing financial obligations (Shall & Haley 1998, p.212). The larger the current ratio, the better the company is in terms of meeting the maturing financial obligations. This concept is derived from the fact that most companies use their current assets to settle current liabilities. Tesco has a current ratio of 0.32. This shows that the company’s current assets are less than current liability. This is very tricky for the company as the company risks falling into liquidity problems. The company may be forced to advance short term loans and overdrafts in order to raise the required cash. Debt to Equity Ratio The debt equity ratio of Tesco is 55.8%. The debt to equity ratio compares the company’s fixed charge capital and shareholders’ equity. The ratio provides information concerning the proportion of resources that have been invested by creditors, suppliers, lenders as compared to those provided by the shareholders (Fridson & Alvarez 2002, p.49). Similarly, the ratio provides information on the leverage level of the company. This is exactly what investors look for whenever making investment decisions. The proportion of debt used by Tesco is almost half of equity. Therefore, the company that is financed majorly by equity will rarely issue dividends to its owners. This is because most of the earnings are ploughed back to the company. The company does so as means of reducing the level of gearing by the company. This is because high gearing is likely to lead to takeover risks by other companies. Earnings per Share Earnings per share represent the fraction of earnings of a publicly traded company that is allocated to the shareholder (Kumar 1991, p.90). The EPS of Tesco Company has improved for the last one trading year from 34.43 to 36.75 per share. There is a direct relationship that has been established between EPS and the market price of the shares of the company. For instance, we have already said that EPS increased over the last financial year of the public company. At the same time, the market price of the company improved significantly over the period. The market price of the company has had a bullish trend on the London stock exchange. This is true from October 2012 when the share hit its lowest price of 307. It has been rising ever since up to a high of 363 in February 2013. This is not surprising as it can be explained theoretically. The EPS is one of the tools used to calculate the price-to-earnings valuation model. In that regard, one is in a position to realize that there is a direct relationship between the EPS and the market price of a share. Similarly, the market capitalization of the company also rose over the period within which the EPS of the company increased. Therefore, it is quite obvious that the three market indicators, EPS, market share price and the market capitalization move in the same direction. The EPS determines the market share price, which later determines market capitalization. Therefore, it EPS can be used as a reliable tool to lay value on a publicly traded company. This is true from the sense that the increase in share price and subsequent increase in market capitalization leads to attraction of many investors. Price/Earnings ratio The price/earnings ratio has been on the rise for the previous financial years up to early 2013. The increase in P/E shows that investors will receive higher future earnings. In other words, growth in P/E is an indicator of overall growth of the company. Once again we can see the correlation between the share price, the EPS and the P/E. The trend is quite similar in relation to the performance of the company. P/E is a wonderful tool in analysing the performance of the company especially in relation to other companies in the same industry. It provides information that is crucial in strategically aligning to have a competitive edge over other players in the industry. Therefore, this is truly an amazing tool for evaluating the performance and subsequently the value of the company. Relationship between Share Price and Market Value of the Business There is a direct relationship between the investor ratios and the share price of the company. First, the investor ratios are used in valuation of businesses using various valuation methods. For a period of three years, the changes in the ratios like EPS and the P/E has been directly related to the increase in the company’s market share price. At the same time, the market capitalization has also been on the rise throughout the period under study. That is to mean, the share price is influenced by many factors while at the same time is essential in valuation of the business/company. Analysis of a Private Company: Williams Company Return on Capital Employed The company’s return on capital employed is 9.65%. This is very low especially when compared to public company. The private company may be employing less working capital as compared to fixed assets of the company. This could be caused by financial difficulties on the side of the private company. Comparing the two companies, one will easily realize that the public company is more efficient than private company. The possible reason for this is the limited funds putting in mind that means of raising funds for a private company are limited. Return on Shareholders’ Funds The company’s return on shareholders’ funds is 9.18% as compared to public company’s 15.8%. The private company’s the proportion of amount available to the owners is 9.18% of equity. These returns can therefore be awarded to the owner(s) or reinvested back to the company since this is a private company. Gross Profit Margin The company’s gross profit margin is 24.36%. This is higher compared to the public company’s 8.15%. This indicates that the private company is selling its products at a higher markup as compared to the public company. Some of the implication of selling the products at a very high markup is reducing the inventory turnover rate (Bull 2007, p.98). Therefore, in as much as the company may be selling at a higher markup, it may not make a lot of profits. Net Asset Turnover The company’s net asset turnover is 2.10. This asset is used to assess the efficiency of company in terms of utilizing available assets in the generation of optimum profits. The ratio is very significant for the company in order to find means of improving the productivity of the assets. This ratio is mostly used by the management for internal decision making needs. Nevertheless, the ratio can be used by investors where necessary in analyzing the productivity of the company. In this case, it is true that this ratio is quite small as compared to the public company. This means that the level of efficiency in using assets of the private company is a bit lower. Similarities & Differences for Measuring Performance After analysing the two companies, there is definitely a lot of information that can be discussed. This discussion is geared towards finding out if the ratios calculated could be of any help in assessing the value of the company. Most of the values calculated revealed a lot of information whose trend was quite inconsistent. This challenge is very pronounced when dealing with ratios like profitability. The ratios do not provide adequate information that could lay the basis for assessing the value of the company. This is because these ratios are limited in their scope. They leave a lot of crucial information hanging. For instance, the fact that some of the differences between the two ratios were too huge leaves a lot to be investigated. Some of the differences are not called for when dealing with companies of almost the same size. At the same time, when companies are not consistent in closely related ratios also makes it difficult to draw conclusions. In other words, profitability ratios, turnover ratios, liquidity ratios and other related ratios are not sufficient to be used to value a company. This is because they only provide segments of information about the company which cannot be used to empirically draw conclusions. Other UK Companies with the Same Trend When we use another company from UK instead of Tesco, the results will still exhibit less variation. For instance, when we use a company like Sainsbury the trend is relatively the same. Sainsbury Company has most of its financial information on its website. Some of the ratios significant to this analysis have already been calculated. When one compares with a company like Williams Company, it is easier to notice that all the ratio have specific needs they address in the company. There is no single ratio that effectively evaluates the value of the company. These include the profitability, liquidity, asset turnover, gearing, etc. When it comes to private company, it is very difficult to assess the performance of the company. This is because only investor ratios provide the required information for valuation of the business. Nevertheless, the ratios provide information that is essential in assessing the performance of the company in various areas of the company. Analysis and Recommendation The investor ratios have been quite helpful in analysing the value of the company. The good thing about investor ratios is that they are as a result of several components of the company. The ratios reveal the overall efforts that have been invested in the company and are being manifested in the overall performance of the company. For instance, when one analyses the trend of the share price, there is one thing that is true. The growth in the price of the share is as a result of efforts that have been invested in the company and the investors are convinced that the company will yield. The same is applicable to all other facets of investor ratios. These are the ratios that portray the satisfaction of investors and therefore developing interest in the company. These ratios therefore provide reliable information that can be used to assess the value of the company. For instance, we have already recognised the role of EPS. EPS is very useful in developing price-to-earnings model that is used to value companies. The same is true with the dividend ratio. The information regarding dividends and EPS is also significant in analysing the value of the company. Conclusion From the survey undertaken, the ratios cannot be used to adequately evaluate the value of both private and public company. For the private company, the ratios are not sufficient to assist an analyst lay a specific value on the company. The ratios have been used only to expose the strength and weaknesses of the company in relation to particular areas. For instance, the liquidity ratios have been used to assess the company’s ability to deal with its short term cash demands. On the other hand, the investor ratios have been effective in evaluating the value of the public company. The ratios like EPS, P/E and other related investor ratios provide sufficient information that can be used to lay value on the company. Appendix: Calculation of Ratios Return on Shareholders’ Fund Return on Shareholders’ Funds = Profit after Interest and Tax x 100% (Equity) Share Capital and Reserves Williams Co. 9.18% Tesco Co. = x100 15.8% Gross Profit Margin Gross Profit Margin = Gross Profit x 100% Sales Revenue Williams Co. 24.36% Tesco Co. = x100 8.15% Net Asset Turnover Net Asset Turnover = Sales Revenue______________ Total Assets less Current Liabilities Williams Co. 2.10 Tesco Co. =  10.8 Return on Net Asset Return on Net Assets = Net Profit Margin (%) x Net Asset Turnover Williams Co. 7.6% Tesco Co. = Net profit margin =  4.4% Returns on net asset = 4.4% x 10.8 47.52% Current Ratio Current ratio = Current Assets Current Liabilities Williams Co. 1.46 Tesco Co. =  0.32 Debt to Equity Ratio Debt to Equity ratio = Borrowings (long and short term) Total equity (shares plus reserves) Williams Co. =  6.9% Tesco Co. =  55.8% References Agrawal, N.P 1983, Analysis of Financial Statement, National Publishing House, New Delhi, p.90. 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