Analytical and Comparison of ABC Mining and jPhones - Free Essay Example

Sample details Pages: 11 Words: 3290 Downloads: 8 Date added: 2017/06/26 Category Business Essay Type Analytical essay Did you like this example? Before progressing on to the analysis of the companies given, a general introduction on asset allocation needs to be satisfied before progressing on this line. Let us see what asset allocation is why it is important for us during this exercise. Before giving any advice on asset allocation certain things needs to be kept in mind or followed so that the exercise will yield good results for the advisor and client. This not only ensure that all client requirements are met but also safeguards his interest against any unforeseen financial difficulty. Fundamental Analysis This involves checking basic financial information about a company going back a few years to check the major financial trends of companies so that a decision can be arrived at. Various investment gurus stand by this method of analysis as they firmly believe that this method of analysis yields results on the long run. The basic information that is sought out to accomplish this are the balance sheet and cash flow statements. Don’t waste time! Our writers will create an original "Analytical and Comparison of ABC Mining and jPhones" essay for you Create order As we are going to adopt a fundamental analysis approach as a first step balance sheet and cash flow statement of ABC Mining corporation and jPhone Ltd are listed below. Following this various financial analysis of various components will be calculated and analysed. The data then gathered would help any financial advisor the best decision that can be taken. ABC Mining corporation balance sheet Profitability Ratio: This ratio measures the profit generating capacity of a company. More frequently it can relate assets utilised, equity present to the sales that has been generated by the company. It gives an overview on the companys ability to generate wealth to its investors, owners, etc. It can be used for comparison against various timelines for the same companies and also across the industry. Return on Capital Employed Commonly denoted as ROCE, this ratio compares the net profit against the capital used to generate that profit. The formula for calculating the ratio is as follows: Return on Capital Employed = Net Profit x 100% Capital employed (including long term loans) Return on Capital Employed = 6195 x 100% = 15.56% Year 2002 39820 Return on Capital Employed = 5214 x 100% = 15.43% Year 2001 33789 Comments: For both the years, the values are quite similar and the change is very marginal. One things that needs to be kept in mind is that the low values can be affected quite quickly during economic downturns. Care needs to be entertained when coming across companies with such low values as investment in such companies will yield very poor returns. Another such ration used to calculate the profitability of an organisation is return on owners equity the formula for calculating the same is below. Return on Owners Equity = Net Profit before Tax x 100% Owners Equity Return on Owners Equity = 8725 x 100% = 23.28% Year 2002 37320 Return on Owners Equity = 5214 x 100% = 22.28% Year 2001 33789 Asset Turnover or Asset Utilisation Ratio As business use assets to generate income, a look at how assets are utilised actually give a pretty good idea of how efficient a company is in generating value using its assets. A better asset turnover actually proclaims an efficient business. Asset Turnover = Sales Net Assets Asset Turnover = 35000 = 0.94 Year 2002 37320 Asset Turnover = 29634 = 0.88 Year 2001 33789 A point to note is the trend in this ratio. An improving ratio denotes improving efficiency. Companies that are becoming more efficient as they mature will exhibit this trend. When compared to the year 2001 to 2002 the ratio has shown marginal improvement. This is a good sign that operational efficiency is improving within the organisation. Net Profit Margin This is the most utilised margin calculation that gives an overview of a firms financial position. If this ratio is poor investors do not usually go beyond this. Gross Profit Margin Gross Profit Margin = Gross Profit x 100% Sales Gross Profit Margin = 9100 x 100% = 26.00% Year 2002 35000 Gross Profit Margin = 7705 x 100% = 26.00% Year 2001 29634 Net Profit Ratio Net Profit Ratio = Net profit x 100% Total Sales Net Profit Ratio = 6195 x 100% = 17.70% Year 2002 35000 Net Profit Ratio = 5214 x 100% = 17.59% Year 2001 29635 Liquidity Ratio Liquid cash is the blood that drives the organisations to function. As such this ratio gives a clear idea of how well an organisation is positioned to handle day to day financial requirements. Liquidity is like a grease applied to a machinery, if applied to an optimal level it maintains an optimal working condition of the machinery. The ratio should be higher than one to denote a healthy status. In case of low values the organisations ability to service its short term debt and operating expenses are under questions. Current Ratio Current Ratio = Current Assets Current Liabilities Current Ratio = 71800 = 2.25 Year 2002 31980 Current Ratio = 53000 = 2.76 Year 2001 19211 Management Efficiency Ratio Stock turnover ratio Stock Turnover = Cost of Sales Stock Stock Turnover = 25900 = 4.31 Year 2002 6000 Stock Turnover = 21930 = 3.66 Year 2001 6000 Common-Size Analysis (CSA) One of the disadvantages of looking at balance sheets is that due to varied methods that are used by a company or companies in different industry one will at a superficial level tend to bias us towards a company that has large values. To overcome such disadvantages a common approach to both the companies needs to be done. One such method is CSA. This compares the same components against a set of data and gives a ratio for comparison of various companies. The formula for CSA is as follows Common Size Ratio = Item of interest Reference Item If the formula above is to be modified for inventories then it can be stated as follows Common Size Ratio for Inventory = Inventory Total Assets Limitations: As companies use different accounting principle the values can be misleading if used carelessly. Care must be taken to ensure that such practises are identified and noted before embarking on any such ratio analysis. The same principle applies accounting calendars practises that may change for various countries of the world. Trend Analysis This form of analysis tries to predict future movement of various components that are being analysed. Though trends analysis gives a clear cut information on the trends, questions remains regarding its ability to predict future trends. Also it does not address operational strategic decisions that are required to be taken, thus even a correct trend analysis can fail simply due to the fact that it is not backed up by operational decisions. Individual Components ABC Mining jPhone Company Change in Value Change in Value % of Change % of Change 2002 2001 2002 2001 ABC Mining j phone ABC Mining jPhone Net sales 35000 29634 412500 350000 5366 62500 18.11% 17.86% Dividents issued 3450 2900 58500 31000 550 27500 18.97% 88.71% retained earnings 5059 2314 116794 79719 2745 37075 118.63% 46.51% fixed asset 49300 38000 169000 180000 11300 -11000 29.74% -6.11% equity finance 54559 43314 531794 399719 11245 132075 25.96% 33.04% Comparative Statement Analysis Funds Flow Analysis Fund flow analysis involves categorising stratifying the changes in various financial components between two time periods for an organisation. It enables decision makes to have knowledge and analysis the organisations use of funds for various activities. The management also uses the results to decide on how much and when to give dividends. As the statement gives a detailed analysis of funds and its utilisation it serves to be an invaluable tool for fund allocation planning and budgeting. Cash Flow Analysis This analysis is on the similar lines to fund flow analysis excepting the fact that it considers only cash and records the inflow/outflow of funds to various components within an organisation. Some countries have a legislation that make this analysis mandatory. For eg, in India all listed companies are required to prepare and make this available for all stakeholders on a periodic basis. Used in conjunction with fund flow this can give a very clear view on the financial aspects, financial principles that are in vogue within an organisation. Comparison between Fund Flow Analysis and Cash Flow Analysis Fund Flow Analysis Cash Flow Analysis Mainly concerns itself with working capital It is mainly concerned with cash and ignores other aspects of workign capital Though it tracks funds it does not specifically record opening and closing positions Records specific closing and opening positions for a time period Records specific sources of funds and where and how it is utilised within an organisation Records only inflows and outflows Does not have a standard format that needs to be incorporated and can show considerable differences between companies or within departments Presentation should be in a standardised format as prescribed by statutory bodies Balanced Score Analysis This was a concept that was put forth by Kaplan and Norton. The balanced score card concept was a new idea where managers were made to focus on both short-term trends and solutions and how they can be aligned to meet the companys long term strategies. The concept depended upon identifying four parameters which can be measured and targets set and points allotted according to performance. It gave an overview of the performance and did not include any other details which was heavily criticised by some researchers. However, it is an important tool that can be used. Balanced score card after its first publication has undergone around three modifications and at present followed widely in English-speaking countries and Scandinavian companies. The designing process involves choosing components that represent the long term goals of an organisation along with a target set against each value. Once the actual performance is noted down, the balanced score card will give an overall picture on how a particular department or a particular manager has performed against his metrics. Posted below is an example of BSC for Financial analysis, as we are mainly concerned about financial aspects, we will concentrate on four important aspects that are the pillar of financial stability for any organisation. Balanced Score Card ABC Mining Corporation 2002 Component Goal Weightage Performance Target Profitablity Ratio ROCE 2 15.56% 20% ROOE 2 23.28% 25% Asset Turnover Ratio 2 0.94 1 Gross Profit Margin 2 26% 30% Net Profit Ratio 2 17.70% 20% Liquidity Ratio Current Ratio 10 2.25 2.8 Management Efficiency Ratio Stock Turnover 10 4.31 4.5 jPhones Ltd 2002 Component Goal Weightage Performance Target Profitablity Ratio ROCE 2 14.66% 20% ROOE 2 18.67% 25% Asset Turnover Ratio 2 2.15 1 Gross Profit Margin 2 35% 30% Net Profit Ratio 2 23.16% 20% Liquidity Ratio Current Ratio 10 2.19 2.8 Management Efficiency Ratio Stock Turnover 10 0.43 4.5 Financial statement of company j Phones Profitability Ratio Return on Capital Employed The formula for calculating the ratio is as follows: Return on Net Asset = Profit before interest and tax x 100% Capital employed (including long term loans) Return on Net Asset = 144375 x 100% = 75.39% Year 2002 191500 Return on Net Asset = 122719 x 100% = 42.46% Year 2001 289000 Return on Capital Employed Return on Capital Employed = Net Profit x 100% Capital employed (including long term loans) Return on Capital Employed = 95575 x 100% = 14.66% Year 2002 651500 Return on Capital Employed = 110719 x 100% = 25.2% Year 2001 439000 Return on Owners Equity Return on Owners Equity = Net Profit before Tax x 100% Owners Equity Return on Owners Equity = 95575 x 100% = 18.67% Year 2002 511794 Return on Owners Equity = 110719 x 100% = 36.94% Year 2001 299719 As the name goes this looks at asset utilisation i.e., how an organisation is utilising its assets to generate income. The formula for calculating the same is as below Asset Turnover = Sales Net Assets Asset Turnover = 412500 = 2.15 Year 2002 191500 Asset Turnover = 350000 = 1.21 Year 2001 289000 The value is not represented in percentage but in a ratio. A rising ratio usually denotes improving performance. Net Profit Margin This is the most utilised margin calculation that gives an overview of a firms financial position. If this ratio is poor investors do not usually go beyond this. Profit Margin = Profit before interest and tax x 100% Sales Profit Margin = 95575 x 100% = 23.17% Year 2002 412500 Profit Margin = 110719 x 100% = 31.63% Year 2001 350269 Gross Profit Margin Gross Profit Margin = Gross Profit x 100% Sales Profit Margin = 144375 x 100% = 35% Year 2002 412500 Profit Margin = 122719 x 100% = 35% Year 2001 350269 Comments: The company has maintained a good profit margin for both the years compared and has shown resilience in maintaining the same. But it would do good to improve the same. Net Profit Ratio Net Profit Ratio = Net profit x 100% Total Sales Net Profit Ratio = 95575 x 100% = 23.16% Year 2002 412500 Net Profit Ratio = 110719 x 100% = 31.57% Year 2001 350625 The company has shown a drop of 8.34% in its NPR. This is an alarming trend to note. Unless the company takes steps to arrest this growth it may result in value erosion for investors. Liquidity Ratio The ratio largely looks at a firms ability to repay its liabilities. The thumb rule is that the higher the ratio the better. Current Ratio Current Ratio = Current Assets Current Liabilities Current Ratio = 895000 = 2.19 Year 2002 408500 Current Ratio = 490000 = 2.12 Year 2001 231000 Comments: A very good and stable current ratio. But since it is consistently above 2, it also means that jPhones is not effectively utilising its assets or financing avenues properly. Acid Test Ratio = Current Ratio Stock (liquid assets) Current Liabilities Management Efficiency Ratio Stock turnover ratio Stock Turnover = Cost of Sales Stock Stock Turnover = 316925 = 0.43 Year 2002 730000 Stock Turnover = 239906 = 0.62 Year 2001 384000 Corporate Ratios Earnings per share: Measures the profit allotted to each share in the common stock category. Earnings per Share = (Net profit after tax + preference dividend + extraordinary items Number of shares in issue Market to book ratio Market to Book Ratio = Market Capitalisation x 100% Book value of equity Dividend Yield Dividend Yield = Dividend Declared x Dividend Rate Market Price of Share Financial Ratio Gearing Ratio Gearing Ratio = Total Assets x 100% Book Value of Assets Common-Size Analysis (CSA) One of the disadvantages of comparing balance sheet results is that the numbers give a quantitative weightage and no further information on efficiency. Common size analysis of balance sheets can be done by comparing two components of similar nature for the companies compared and based on the outcome a better company can be selected. The formula for CSA is as follows Common Size Ratio = Item of interest Reference Item If the formula above is to be modified for inventories then it can be stated as follows Common Size Ratio for Inventory = Inventory Total Assets Limitations: Different accounting principle used by different firms needs to be taken into consideration. The same applies for the difference in accounting calendars. Ratio Analysis Comparison of ABC Mining and jPhones Ltd: After the various ratio analysis undertaken for coming up with an advise to the investor the same is posted below ABC Mining Corporation jPhones Ltd Principle Component Sub Component 2002 2001 2002 2001 Profitablity Ratio Return on Capital Employed 15.56% 15.43% 14.66% 25.20% Return on Owners Equity 23.28% 22.28% 18.67% 25.20% Asset Turnover Ratio 0.94 0.88 2.15 1.21 Gross Profit Margin 26% 26% 35% 35% Net Profit Ratio 17.70% 17.59% 23.16% 31.57% Liquidity Ratio Current Ratio 2.25 2.76 2.19 2.19 Management Efficiency Ratio Stock Turnover 4.31 3.66 0.43 0.62 Source: Balance Sheet and Cash Flow Statement above From the table above it can be seen that jphones has added substantial values to its shareholders by generating higher income though during the later years the same has dropped. Even though the gross profit margin has stayed the same, ROCE has dropped by almost 10% while ABC Mining corporation has scored considerably on this count by maintaining a consistent value. This shows that the management is quite mature during various time scales to concentrate and generate a good return. Another point to note is the ability to generate dividend on a consistent basis. This is better suited to people who would expect continuous cash from time to time. Based on all the above parameters, the customer would do well to invest in jPhones Ltd as the company has generated higher profits and has also given better dividends over the same period. Provided no major changes are experienced in its stock prices it will prove to be a better investment for a year or two initially. Tools of Financial Analysis During the recent economic downturn that has gripped the world; one thought has come to the forefront of corporate financial managers. It has questioned the core value of accounting practise that are practise by auditing firms and various companies. With this backdrop financial managers the world over have their task cut for themselves to prove that they can add value and regulate themselves without any outside intervention. On one hand businesses do have a requirement to take calculated risk and grow their business but blind risk will put organisations future and reputation at risk that needs to be avoided. Organisations sundry and great now are taking steps to ensure that financial data collected, recorded, and analysed are actually reflecting the status of their companies as it is this information that is used to make strategic decisions. The situation has also renewed interest on failure prediction and financial models that proclaim to predict the start of a downturn financially. However, these tools though quite phenomenal in their performance do not give strategic suggestions but results are rather in the form of numbers and this once again underline the value of human mind that can make sense and give purpose to these numbers. The notion of recording financial transactions has been in existence from very old times. From a crude record of marking lines to denote data in olden days, financial information has assumed various forms and has undergone considerable standardisation to the present day. This standardisation has in effect brought a degree of transparency to all people who view this report as the reports to some extent are standardised by various governing bodies. A reason for such standardisation stands justified as the information may be given to two sets of people who are well versed with accounting principles and also by those who are have no idea of financial standards, managers and public. The same information is looked at from a different view by investors, financiers and tax departments. Thus it is quite clear that financial information and analysis serves a host of people intent on knowing about the status of an organisation. As such financial information and details is akin to a doctor feeli ng the pulse of a patient to elicit diagnosis. Analysis financial information is not as simple as it is believed mainly due to the varied group of people accessing the information. The information needs to be in a standardised format such that a varied group comes to the same conclusion after going through the information. A lot of studies have been undertaken to ascertain the effectiveness of financial analysis. Before making a judgement on the effectiveness, let us look at the parameters of analysis of performance. The following broad parameters are used for financial analysis of a company at any point in time. Profitability Ratio Liquidity Ratio Management Efficiency Ratio Corporate Ratio Financial Ratio Employee Ratio In addition to the above parameters, various other criterias are used mainly Balanced Score Card Cash Flow Analysis Fund Flow Analysis Trend Analysis Common Size Analysis. The presence of various tools means that there will always be a debate on how effective each of the component or a group can measure up as a tool to predict future direction. As predicting the future is a means to be better prepared, care needs to be exercised on how to analysis and what to analyse. Conclusion As mentioned earlier the main reason for looking at the ratios from time to time is to check the healthy nature of the organisation and take effective steps to improve the situation. However, great care needs to be emphasised during such analysis, as the outcome of the results only have values and do not suggest any alternatives. In a recent study on checking the effectiveness of ratio analysis in predicting an organisations failure led Johnson to conclude that there is no clear logical link between the results found in a ratio analysis to failure. Nonetheless, as the human mind links numbers to performance, ratio analysis is here to stay. The results need to be taken up with a pinch of salt with comparison of performance against other analytical methods to yield proper views and steps that needs to be taken from an organisational point of view. Another argument is that ratios do not given underlying economic turmoil or alternatives that can be taken by human mind. Thus ratio analysi s with application of sound decision making can go a long way in putting the organisation in the right path to success.