Financial Management Analysis - Associated British Food Plc - Essay Example

Financial Management Analysis Introduction Woolworths Ltd. is a Australian based company in the sector of Food and Staple. In this assignment an analysis is made of financial statements of the company through ratio analysis. The purpose of this assessment to analyze performance, liquidity, efficiency, and capital structural position over a period of previous three years, and then comparing this analysis with a selected benchmark company. Selection of Benchmark Company Associated British Food Plc.is the selected bench mark company. Being in same food industry, ABF Plc. includes all necessary ingredients for the purpose of providing standardized comparisons to Woolworth Ltd. Also, ABF Plc. being a low geared capital structured company as Woolworth Plc, it would create the similar circumstances for assets exploitations in both companies. This is so as the basic idea of both companies is to protect their equity holders. Performance Analysis The performance of Woolworth Ltd. is analyzed on basis of profitability and rate of return ratios. For the purpose of this analysis Gross Profit ratio, Net profit Ratio, Return on Total Assets (ROA), and Return on Equity (ROE) has been selected. Profit Margin ratios show the relation between profit and sales. Since profit can be measured at different stages, there are several measures of profit margin. The most popular are Gross Profit, and Net Profit ratio. The Rate of Return ratios, that are also performance analyzers, reflect the relationship between profit and investment. The Return on Assets ratio and Return on Equity ratio have used for the purpose so that a perfect performance analysis is made fro Woolworth Ltd. These ratios are calculated in attached annexure. The Gross profit ratio for Woolworth Ltd. has been impressive over the years. It has risen from 24.89% in 2005 to 25.03% in 2006 and finally to 25.32% in 2007. The basic reason for such steadily rise is effective use of operational resources by Woolworth Ltd., keeping pace with increasing turnover during this period. The company’s revenue is $ 42477.1m in 2007 as compared to 37734.2m and 31352.5m in 2006 and 2005 respectively. Normally it is seen that gross margins go down whenever there is a continuous increase in revenue. But Woolworths has maintained its cost of goods sold completely in control to reflect the increasing gross margins. The success shown by Woolworths in gross margins has been effectively repeated in net margins. The company’s net profit ratio was 4.15% in 2005, and that has risen to 4.56% in 2006, and to 4.19%. This is rise is good but the gap between gross profit and net profit is huge. From 25.32% of gross profit in 2007 to a mere net profit of 4.91% shows that the company has to bear huge non operative overheads. If a control is exercised in this area, the company can show brilliant net profit margins. Return on assets shows how effectively the company uses its assets for generation of profits. Woolworths Ltd. has returned back in 2007 the performance achieved by it in the years 2005. The year 2006 was not a good year for the company so far as utilization of assets is concerned. In 2006 ROA slumped down to 13.59% as compared to brilliant 15.81% in 2005. Either the company underutilized its assets or those remained unutilized as blocked investment. However, in the year 2007 the company has bounced back and the ROA ratio came back to 15.91% and that a little better than 15.81% in 2005. The company must make an in-depth inquest to identify unutilized assets, so that capital blocked in those assets may be used for buying assets useful to the company. The company has dropped its performance on return on equity front. ROE ratio is coming down from a huge 40.81% in 2005 to a low 23.83% in 2006 and now a lower 23.46% in 2007. ROE actually expresses the profitability of an enterprise in relation of long term funds provided by equity shareholders. The equity holders are concerned as their share comes after meeting all fixed obligations on debts. They have taken a risk to be the last recipient in case profits as well as capital. Accordingly Woolworths Ltd. has to devise ways to improve ROE so that faith of equity holders remain maintained in the company. Coming to benchmark company ‘Associated British Food Plc.’, its performance has gone down in 2007 as compared to 2006. The comparison between on gross margins is difficult task as normally gross margins are different for companies even in the same industry. However ABF has maintained a very healthy net profit ration despite very low gross margins as compared to Woolworth Ltd. From a low 7.91% of gross profit in 2007 the ABF Plc. has realized 7.6% of net profits. That means it has very low overheads or other income has helped ABF ltd. to maintain such respectability. Again ABF Plc has increasing ROE to give a boos to equity holders, Its ROE in 2006 of 7.36% has risen to 8.96% in 2007. So the Bench Mark Company is keeping the interest of its shareholders intact in the company. Liquidity and Solvency Analysis Current ratio has been used to evaluate the liquidity and solvency of the company. In fact, Current ratio of an enterprise measures its short term solvency, i.e., its current health and ability to meet its short term obligations . Liquidity ratios are generally based on the relationship between current assets (the sources for meeting short term obligations) and current liabilities. Current ratio is most popular and widely used ratio to analyze liquidity of a company. Higher the current ratio, higher is the ability of the company to meet its current obligations. In a way current ration indicates the safety of funds due to short term creditors. Thus, current ratio is a measure of margin of safety to the creditors. The current ratio of 2:1 is considered optimum in general for all businesses and industries, but this standard also differs from industry to industry. Current ratio for Woolworths is a great cause of worry. Its ratio in all the three years under consideration is less than even 1. In 2007 it was 0.76, an all time low in three years, as compared to 0.85 in 2006 and 0.81 in 2005. The situation is very delicate, and there may arise a sort of cash crunch unless the Woolworths take a concreter effort to improve its liquidity. With regard to ABF Plc., its position is better than Woolworths as in 2007 the ratio was 1.57 and in2006 it was 1.26. But even this cannot be termed as good turnover ratio. Both companies are facing liquidity and solvency problems as reflected in their poor current ratios. The best approach to attain a comfortable liquidity level would be to reassess its accounts receivable and trade payable policies. Efficiency of working of Woolworths Ltd. Inventory turnover and average collection period are the suitable parameters to evaluate the efficiency of working of a company. Inventory turnover (ITR) measures the performance of an enterprise in so far as its inventory management is concerned. The higher the inventory turnover the larger will be profitability and smaller will be the amount tied up in inventory. This will also mean that the inventory of the company turn up fast with no accumulation of inventory and are not obsolete. A decreasing trend in the ratio indicates poor planning and coordination of procurement, manufacturing, and marketing activities of the company. In case of Woolworths Ltd. inventory turnover is just 0.09 times in 2007 as compared to 0.08 times in 2006 and 2005. The performance is highly poor and should be a matter of great concern for Woolworths ltd. On the other hand bench mark company ABF Plc. is performing very well, as the ratio is 8.19 times in 2007 and 8.8 times in 2006. Woolworths has review the entire inventory management in order to improve the inventory position, other usual problems of capital investment blocking with inventory may bring in more financial worries. This Average Collection period indicates the number of times the receivables have been turned over during the accounting period. It represents the number of days’ worth of credit sales that is locked into accounts receivable. The average collection period may be compared with the entity’s credit terms to judge the efficiency of credit management. An average collection period which is shorter than the credit period allowed by the entity need to be analyzed carefully. It may mean efficiency of credit management or excessive conservatism in credit granting that may result in the loss of some desirable sales. For Woolworths average collection period is 4.21 days in 2007, 11.36 days in 2006, and 7.12 days in 2005. The fluctuating nature of ratio is showing the instability in the sale recovery policy of Woolworth, otherwise the recovery period is very fast and appreciable. On the Bench mark company is performing poorly with 51.91 days of average collection period in 2007 and 54.54 days in 2006. It is not prudent for an entity to have either a very long or a very short collection period. A very long collection period, as in the case our bench mark company, indicates that the company is either not selective in identifying its customers or its management is poor. Average collection period should be maintained at a reasonable level, and this can be established as per prevalent circumstances in the industry in which the company is operating. Finance Structure In order to test the long term solvency and ability of a company to meet the fixed interest on long term debts as well as repayment of long terms loans, leverage ratios are used. Leverage ratios also determine the finance structure of a company, and are also called leverage or capital gearing. Capital gearing or financial leverage refers to the use of debt finance. While debt capital is comparatively cheaper source of finance, it is also the riskier source of finance. Financial structure ratios help in assessing the risk arising from the use of debt capital. These ratios depend upon the proportions of debt and equity in the financial structure of the company. The important capital gearing ratio is Debt- equity ratio that shows the relative contributions of debt and equity. With lower ratio the company is stated to be low geared, and with high ratio it is high geared and can be referred to as having unprotected equity capital. Woolworths Ltd. as well as the bench mark company, both are very low geared. The ratio for Woolworths is just 0.38, 0.5, 0.55 in 2007, 2006 and 2005 respectively. The company is highly protected and dependent a lot on equity contribution for its capital requirements. The company is not providing any gearing advantages to its shareholders. Similarly the position of ABF Plc. is lower in ratio concerning capital gearing. The ratio is only 0.19 in 2007 and 0.13 in 2006. That means ABF Plc. is highly protective of its equity contributions and is not taking any risk in capital structuring, whatsoever. Other Factors responsible for performances Woolworths Ltd.expansion policy is playing a big decisive role in its performances. During 2007, 152 new stores were started with a capital outlay of $222 million. The is reason of better performances on maintaining the rate of gross and net margins steady over last three years. This factor is also responsible for cash crunch resulting into poor current ratio and low asset turnover. Conclusion On important circuits Woolworth is standing at delicate position. Like it current ration defines its weaknesses in meeting with short term obligations. Assets are not being fully exploited. Another matter of concern is the company’s inventory turnover ratio. Expansions of strores are not bringing in immediate good results. But the positives are gross profit margins that are increasing at a reasonable pace even among such difficult financial positions. The company need to improve its liquid position may be by raising long terms debts and using the funds for reducing short period obligations. References: Associated British Food Plc., Annual Reports and Accounts, http://www.abf.co.uk/investors/reports.asp Ratios Read More