Analytical and Comparison of ABC Mining and JPhones Essay

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.

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 company’s 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 owner’s equity the formula for calculating the same is below.

Return on Owner’s Equity

=

Net Profit before Tax

x

100%

Owner’s Equity

Return on Owner’s Equity

=

8725

x

100%

=

23.28%

Year 2002

37320

Return on Owner’s 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 firm’s 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 organisation’s 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 company’s 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 Owner’s Equity

Return on Owner’s Equity

=

Net Profit before Tax

x

100%

Owner’s Equity

Return on Owner’s Equity

=

95575

x

100%

=

18.67%

Year 2002

511794

Return on Owner’s 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 firm’s 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 firm’s 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 Owner’s 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 organisation’s 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 feeling 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 analysis with application of sound decision making can go a long way in putting the organisation in the right path to success.