Accounting Summary To Management Essay, Research Paper
1.1 Percentage Analysis 1.1.1 Trend percentages – see appendix 1.1 Profit and loss statement Net salesNet sales have increased by 5% in 1998 Cost of goods soldCost of good sold has also increased by 55 in 1998. this is an expected increase as their amount of sales has increased. Selling – General and AdministrativeThe cost of selling has increased by 4%. Once again this could be expected because the umber of sales has increased. Total ExpensesTotal expenses has increased by 5%. Operating profitthe operating profit of Andrews Ltd.. has increased by 12% Interest expenseThe interest expense has decreased dramatically by approximately 75%. This well help significantly in the generation of profit for the company. Profit before Income TaxProfit before income tax has increased by 14% this is mainly due to the decrease in the amount of interest to be paid. Income Tax ExpenseIncome tax expense has decreased by 20% This also will aid in the generation of larger profits. These trend percentages show quite clearly that Andrews LTD is doing much better in 1998 than they were in 1997 1.1.2 Common size statements -see appendix 1.2 and 1.3 Profit and Loss statementOperating ExpensesTotal operating expenses has reduced proportionally to net sales due to a decrease in each of the expenses. It has decreased by 5% of net sales. This shows that they are operating more economically than they were in 1997. Operating profitDue to a decrease in expenses the operating expense has increased by 1% of net sales. Interest ExpenseInterest expense has decreased dramatically compared to net sales. It has changed from 3% of net sales in 1997 to 0.08% of net sales in 1998 Profit before Income TaxAs a result in interest expense the profit before tax has increased by 1.4% of net sales in 1998 Income Tax ExpenseIncome tax expense has decreased by 2.1% of sales Net ProfitNet Profit has increased by 3.5%. This is due to the decrease in all of the above expenditures. Balance SheetTotal Current AssetsTotal current assets have increased by 3.4% of total assets. Total Non current AssetsTotal non current assets have decreased by 3.4%. This was mainly due to a rather large decrease in Other Assets. Total Current liabilities.Total current liabilities has increased by 2% in proportion to Assets. Non current liabilitiesNon current liabilities has decreased by 0.6% due to a decrease in long term debt. Total liabilitiesTotal liabilities has increased by 1.5% on the 1997 value. Share Holders EquityShare holders equity has decreased by 1.5% of total current assets from it s 1997 value. The common size analysis of Andrews Ltd. has shown that expenses have been reduced dramatically from their 1997 value. As a result of this their profit in 1998 is also much larger proportional to net sales. They have also liquefied their assets by eliminating some non-current assets and reduced non current liabilities. As a result of this they have more available funds if needed urgently. OVERALL SUMMARYBy analyzing the percentage trends of Andrews LTD, It seems as though the company is performing strongly, and has strengthened from the previous year. 1.2 RATIO ANALYSIS 1.2.1 Profitability Analysis Return On Assets: The return on assets for Andrews LTD is 18.1%, meaning that for every dollar invested in assets, 18 cents are earned. This figure is well above the industry average of 7.7%, indicating that Andrews LTD is performing strongly in this area. This cannot be compared to the 1997 financial year, as no data was available to determine an average assets figure for 1997. – see appendix 1.4 for calculations Net Profit Margin: 1997: 16.5% 1998: 17.5% Each dollar of sales in 1998 generated 17.5 cents of profit, which is up from 16.5 cents in 1997. These figures are also well above the industry average of 3.2%, indicating that the company is taking a healthy profit. -see appendix 1.5 Gross Profit Margin: 1997: 42.7% 1998: 43.1% The 1998 gross profit margin has increased slightly over the previous year, but not enough to be significant. This means that the relativity between selling and buying prices Andrews LTD s goods hasn t changed markedly. -see appendix 1.6 Operating Expense Ratio: 1997: 83.5% 1998: 82.5% In 1998, for every dollar of sales generated, 82.5 cents were used to cover expenses. This figure has decreased by 1 from 83.5% in 1997, which is a good sign as this means that the expenses are becoming proportionally less for each dollar of sales. -see appendix 1.7 Asset Turnover: For 1998, the asset turnover was 1.03, meaning that each dollar of assets generated 1.03 cents of sales. This figure is well below the industry average of 2.66, meaning that Andrews LTD is not making efficient use of its assets. -see appendix 1.7 Fixed Asset Turnover: To determine which area of asset management is suffering, more depth is required than just an asset turnover figure. The fixed asset turnover for Andrews LTD is 3.0 , meaning that 3 dollars of sales are generated for each dollar of fixed assets. There are no industry figures to compare this to, however this figure for fixed asset performance seems satisfactory. -see appendix 1.8 Receivables Turnover: Andrews LTD has a receivables turnover of 63 days, which is significantly above the industry average of 41.6 days. The figure for Andrews LTD assumes that it sells entirely on credit and that only the beginning and ending balances for receivables are available. The figure of 63 days means that recievables management is slipping – ie it is taking too long to collect money owing to the firm a further 50% longer. Considering the fact that most payment terms are 30 days, The figure for Andrews LTD is more than double this amount. Note: the overall significance of this figure depends upon when the invoices are sent – ie on the day of sale or at the end of the month. -see appendix 1.9 Inventory/Stock Turnover: The inventory turnover for Andrews LTD is 3.62 times per year, which is below the industry average of 4.5 times per year. The stock turnover rate ideally should be as high as possible, and the low figure for Andrews LTD means that they could encounter problems concerning their inventory in the future, due to an excess of older stock. -see appendix 1.10 SECTION SUMMARY By analyzing the profitability of Andrews LTD, it is clear that the firm is experiencing problems with asset turnover, more specifically in the receivables and inventory turnover areas. Concerning the recievables turnover figure, the increased time period can cause many problems for the firm. If the recievables are large, this increases the asset base, and consequently reduces the rate of return and profitability. If sales are constant, but the number of recievables increases, this means that the time taken to collect payment for goods is longer, and thus the liquidity of the business is reduced. The increased recievables figure indicates that customers are not paying their accounts on time, therefore extra costs will be incurred by Andrews LTD associated with chasing up payments. The lower figure for inventory turnover is a bad sign for Andrews LTD, as they will eventually end up with a build up of older stock which may have to be sold at a loss or written off completely, thus reducing profits. Extra costs are also involved in the storage of inventory, meaning more money will need to be spent in this area, thus increasing expenses. Overall, Andrews LTD are using their assets more effectively and achieving much larger net and gross profit figures than other companies in the industry. Despite this, they are not turning over as many sales per dollar of assets than other companies. This may be due to the fact that they have purchased new equipment that has not yet peaked in terms of usage. 1.2.2 Working Capital Ratios: Current Ratio: 1998: 1.71 : 1 1997: 1.71 : 1 The industry average for current ratio is 1.8 : 1 , meaning that Andrews LTD is marginally below this, and is not in a particularly strong short term financial position. The value can be interpreted to mean that Andrews LTD has 1.7 times more assets than liabilities. -see appendix 1.11 Quick Ratio: 1997: 0.774 1998: 0.815 This ratio assumed that there were no marketable securities and bank overdraft. The Quick ratio for the industry was 1.0, and Andrews LTD s figure is below this. The quick ratio is a measure of a company s ability to generate cash quickly to repay urgent liabilities, and due to the fact that Andrew s figure is 0.815 it means that it has more liabilities than short term assets. – see appendix 1.12 Recievables Turnover: See profitability analysis Inventory Turnover:
See profitability analysis Operating Cycle: 1998: 163.8 days The industry average for operating cycle is 122 days, meaning that Andrews is much slower at changing inventories into cash than other businesses. -see appendix 1.13SECTION SUMMARY Working capital is essential for short term financial strength, and it is desirable to have just enough assets to cover everyday operations. The fact that Andrews LTD has more liabilities that short term assets, means that the company could run into serious cash flow problems. The current ratio is almost equal to that of the industry average and means that the company is reasonably efficient as they have enough assets so that in an emergency they can increase liabilities, without tying up too much money in assets. However, Andrews has a lot more non current assets as shown by the quick ratio, and would struggle to generate cash from assets quickly. The problem with the increased operating cycle for Andrews is that money would need to be found from other sources such as bank loans to cover expenses. If Andrews is to decrease its operating cycle, It needs to restructure both inventory and recievables turnover, as both are substandard. 1.2.3 Risk and External Evaluation Debt Equity: 1997: 1.06 1998: 1.12 This measures the relative proportions of each source of funds. A debt-equity ratio of 1 means that a company is financed by equal proportions of debt and equity. The 1998 figure of 1.12 is slightly better than the industry average of 1.15. Debt Ratio: 1997: 51.5% 1998: 53% This ratio is the proportion of assets that have been purchased from borrowed funds. The fact that Andrews has increased from 1997 to 1998, means that they have increased their reliance on borrowed funds. The 1998 industry average was 54.7% and Andrews is slightly below this. The increase in reliance of borrowed money increases the financial risk for Andrews Ltd. Equity Ratio: 1997: 48.5% 1998: 47% This figure is the proportion of assets purchased with equity. The Industry average for the equity ratio was not given, however since the equity ratio is simply the complement of the debt ratio, it can be calculated for the industry as being 1 – debt ratio which equals 45.3% Interest Coverage Ratio: 1997: 41.9 times 1998: 208 times This ratio indicates a firm s ability to pay interest from their earnings. There was a dramatic increase in this ratio from 1997 – 1998, and this can be attributed to the dramatic decrease in interest expense. There was no industry average to compare Andrews figure to, however this is an extremely good value as it means that only a small proportion of the company s gross profit is spent on interest. Return on Shareholders Equity: 1997: 14.2% 1998: 24.3% For the calculation of shareholders equity it was assumed that there were no preference shares or preference dividends as none were given in the data. Return on shareholder s equity is the proportion of net profit that shareholders are entitled to. Andrews experienced a dramatic increase in 1998 and as a result experienced a superior result compared to the industry average of 12% . Earnings per Share: 1997: $ 2.33 1998: $ 3.66 For this calculation, the preference dividends were assumed to be zero. Both of the EPS values are much higher than the industry average of $1.94/share. The larger return in 1998 can be partially attributed to the decrease in the number of shares on issue. The increase in EPS may seem positive for shareholders, but in terms of the company performance, a decrease in the number of shares means a reduction in the funds raised from the sale of shares and consequently less money for the following year. Earnings Yield: 1997: 3.85% 1998: 4.58% This is a measure of the earnings of shareholders compared to the price of shares. Both of Andrews figures for earnings yield are below the industry average of 6.25%. Coupled to this fact, 4.58% is a very small proportion compared to the price outlay of the shares, being $80.00 per share. Price Earnings Ratio: 1997: $25.97 1998: $21.85 This figure is a reciprocal of the earnings yield ratio. in 1998, a shareholder would have to outlay $21.85 to get a $1.00 profit. The price earnings ratio for the industry is $16 , meaning that there needs to be a significant outlay to receive a relatively small return. Dividend Ratio: The dividend yield is a measure of the returns actually received by shareholders. This was 2.4% for both 1997 and 1998 in Andrews Ltd. The industry average was only slightly larger at 2.8%. This is a poor return on investment , and you would be better off investing at bank rates of interest. Section Summary The analysis if risks is used to by prospective investors to find out whether it is wise to invest in a particular company. The risk analysis of Andrews Ltd. has returned rather mixed results. The company has a debt equity ratio slightly below that of the industry meaning they have less debt in proportion to equity than other comparable companies. Andrews Ltd. has spent less borrowed money on buying assets than other competitors, however they are increasing the amount of money borrowed and spent. In the next year they may out spend competitors. The interest coverage ratio on the other hand shows that compared to other companies, Andrews Ltd. is spending far less on interest expenses. Therefore they are justified in the decision to use more borrowed money. The risks associated with Andrews Ltd. seem to be similar to that of other companies in the same industry or slightly better. Returns to shareholders are also analyzed to see whether it is financially worthwhile to invest in the company. All of the financial aspects of Andrews Ltd. were better than that of its competitors except for dividend yield and Earnings Yield which were less than the average, and these are the important aspects for the potential shareholder. The dividend yield is only 2.8%, and this is a very small return for an investment meaning it would be easier to put your money into a bank to earn such a small return. The price of shares has increased dramatically and if shares were purchased in 1997 and sold in 1998 a tidy profit would be achieved. However, the share prices may have peaked at the 80.00 price tag, and may even drop in price in the future The risks associated with purchasing shares far outweigh the small return to be gained from dividends at this point in time. This is especially prevalent considering the high purchase price of the shares.. Summary of Ratio Analysis results:Profitability Analysis ratios for Andrews Ltd. showed little problems. the only issue that really needs to be addressed is that of receivables turnover. Apart form this one issue Andrews LTD is performing better than the industry average. They seem to have purchased new machinery as discussed for the asset turnover ratio so their profitability analysis next year should even show better results. From the working capital analysis that Andrews Ltd. on a whole is not performing well compared to other companies in the industry. They have a good current ratio indicating that they have a reasonably good level of working capital is essential for a companies short term strength and Andrews LTD is lacking in this area. The most crucial section of the ratio analysis of Andrews LTD proved to be the risk and external evaluation. The results of the risk analysis shows that the investor would not have to take much risk when investing to get a healthy return. The external analysis however, shows that returns to shareholders as compared to price of shares were less than that of the industry. This is far from an ideal situation especially as shares in Andrews Ltd. are 2.5 times more expensive than the industry average. The final result of the risk and external evaluation has shown that the dividend return to shareholders are not particularly high. However the price of shares has increased by a third and if shares were sold a large profit could be achieved. This indicates that short term investment may be profitable but that long term investment is probably not worth the risk. Ratio analysis has shown us that even though the percentage analysis demonstrated that Andrews Ltd. is producing high profits it is not clear as to whether investing would be wise. 2.0 Summary To Management From the in-depth analysis of Andrews Ltd. it becomes obvious that on the whole Andrews Ltd. is performing at a slightly better level than that of its competitors. They are doing very well financially when compared to the industry, however they have a lot of money tied up in assets. Investment in Andrews Ltd. seems to have a small risk associated with it but the dividend pay out per share is quite low, especially when the large price of shares is considered. There is however a large profit to be gained from selling shares, as the price of shares has increased dramatically over the past year. It is uncertain though whether this increase in share price will be sustained. As with the unpredictable nature of all shares, the can rise or fall in value at any time. It seems unlikely that shares will increase in price dramatically again and may well decrease, if other areas of company management are not addressed. I would advise against investing in Andrews LTD, simply because the profits received from dividend pay outs – yield- are not substantial enough. One could invest in a term deposit and earn a higher rate of return without the associated risk of share prices falling, the company going bust etc. The uncertainty of a further increase in the price of shares would lead me to advise against long – term investment as a option . For a better analysis of short term investment, an investigation of share market trends for the industry would need to be conducted. Therefore, for the at present, I would advise against investing in Andrews LTD.