Financial Analysis of Gowns of Envy Pty Ltd - Article Example

SOUTH AUSTRALIAN INSTITUTE OF BUSINESS AND TECHNOLOGY ASSIGNMENT COVER SHEET (Please fill in all details clearly and staple to the front of your assignment) Course Name: ___________________________________ Course Code: ___________________________________ Lecturer’s Name: ___________________________________ Assignment No/Title: _____________________________Due Date: ____________ Student Name: Student ID Date 1. 2. [ENTER THE TITLE OF THE REPORT INCLUDING THE NAME OF THE BUSINESS BEING INVESTIGATED] for [Enter the name of the client] [Enter the date of submission] prepared by [Enter your name/s] Executive Summary This report is a financial analysis of Gowns of Envy Pty Ltd. It is an exploration on its liquidity, financial stability and profitability using ratio analysis and other key financial indicators. The analysis has been undertaken since its formation in 2008 till to date. The trade since 2008 has been used to try and forecast the future. Towards the end of the report, a conclusion has been made, and some recommendations proposed in regard to the findings. The purpose of the report is to forecast the future performance, and establish whether, if a loan is accorded to the company, it can be able to service it accordingly. The reliance of the report is however subject to some limitations of ratio analysis. More investigations are required to supplement this report. The report is basically a ratio analysis of the company financial information, intended to find out the status of the company’s financial stability, liquidity and profitability. Contents Executive Summary 1 Introduction 1 Profitability 2 Liquidity 3 Financial Stability 4 Conclusion 6 Recommendation 6 Works Cited 8 Vandyck, Charles. Financial Ratio Analysis. New York: Trafford Publishing, 2006. Print. 8 Gallery Industry Averages 10 Introduction Gowns of Envy Pty Ltd is a wholesale business which deals with imported Wedding Gowns and fabrics. They supply some of the leading Australia retailers. This business was started in 2008 and has now been operating for the past three years. To achieve its growth strategies, the business want to open up to new line of business-by supplying an alternative line of product. This project would require substantial modifications of the existing facilities- which inspired the owners to seek bank credit to finance the expansion (Vandyck 20). The purpose of this report is to analyze liquidity, profitability and financial stability of the business, with the aim of establishing whether its credit worthiness is does justify its credit application. To achieve this purpose, an extensive analysis of financial information since the business was started has been undertaken. In particular, the report has analyzed financial ratios and percentages, and tried to establish the implications of the trends. The reliance on the information on the analysis is however limited due to some factors. It is difficult to categories the business in various industries due to diversification. This makes the inter-business comparison very difficult. Also, different firms use different accounting policies and methods such as depreciation, provision and other estimates which again make comparison of the business with other in the industry a very difficulty affair. The other limitation is that ratios are used for short-term planning because they are compiled at a point in time and may be affected by shorter changes. Finally, ratios are computed from historical data and therefore are not very good future indicators. This report begins with analyses of the company’s profitability. This is achieved by comparison the firm’s profitability rations such as return on assets and price earnings. This is followed by liquidity analysis which uses ratios such as quick ratio and current ratio among others. The last area of analysis is the financial stability which uses ratios such as the debt ratio and interests rates to establish the ability of the firm to remain financially stable in the future. Finally, the report ends by a conclusion and recommendations based on the findings of the report. Profitability Profitability ratios measure the efficiency with which the firm uses various funds to generate profits or returns. They also measure the management ability to control the various expenses in the firm. Return on assets has been increasing since 2009. Since this ratio measures the efficiency of assets in contributing towards the returns of the company, the increase is encouraging. It shows that the management has been improving on efficiency of assets in generating income since 2009. Similarly, return on shareholders equity which measure the efficiency in which the shareholders funds is being used in generating income has remarkably increased after 2008, and slightly after 2009. This shows that the shareholders funds have been increasingly used to generate income. Being the owners of the firm, the shareholders would want this value to go up as it reflects a positive expectation on their returns.EPS has increased in 2008 but dropped in 2009. Since it is a sign of profitability, its declining is alarming as it could be reflecting the fact that the company is becoming less profitable. The management should strive to ensure that these ratios improve as they also reflect the overall performance of the firm. Price earnings of 3 times suggest that the investors should expect a growth of 3 times in future. The percentage is somewhat substantial, and can give confidence to potential investors. Earnings yield of 32.2% shows makes substantial returns for every unit of common stock invested. The allocation of dividends particularly depends on the level of income generated in a particular period. The good price earnings and earnings yield shows that the management has been able to efficiently use the available funds to generate returns. Similarly, to achieve the better results, the management must have implemented adequate strategies to control the cost structure in the business. The company has reduced the dividends distributed to shareholders from $264,000 to 254,000. This is mostly attributable to a reduction in returns in the current year. The management may also have decided to cut on the amount distributed as dividends so as to retain more funds in the business for possible investments. Divided yield shows how much the investor is expecting for every dollar invested. Whether 39.08% dividend yield in 2010 is adequate will depend on comparison with the industry or the previous years. Dividend payout ratio has dropped from 120% in 2009 to 118% in 2010. This may reflect the fact that the company is unwilling to distribute more profits to investors as dividends as the company’s profitability level has declined during the current year. In summary, the business has been generating substantial profits since 2008. However, the year 2010 appears to be a challenging year as the profitability level has plummeted (Vandyck 13). Liquidity Low liquidity ratios tries to recognize the fact that stakes may not be easily converted into cash. The higher the ratio, the better for the firm as it reflects an improved liquidity position. At 4.1, the current ratio was too high but has seen reduced to acceptable levels in 2009 and 2010. Quick acid ratio has followed a similar trend. The previous too high value meant that the business level of current assets was too high compared to the level current liabilities. Although the business is free from the danger of being unable to pay its dues, too high ratios could suggest varied scenarios which can be counterproductive. The payment period could be too harsh for the creditors, which can keep away customer or the business could be clearing off its short term debts too soon; which can adversely affect its cash flow. The debtor’s turnover also shows that the business started off being too liquid in 2008, but the liquidity level has since reduced to a more healthy level (Steffy, Zearley, & Strunk 23). The collection period which has reduced to 50 since 2009 is stable and healthy. The period is neither too harsh nor too lenient to the creditors. This ensures that the business does not stand at a high chance of experiencing bad debts, and does not affect credit sales due to very strict credit policy. The inventory turnover has been maintained at an almost stable level. The owners of the business need to consider whether the inventory level is appropriate at the current level. Too high inventory level could be tying too much of the business funds which could be invested somewhere else, and risking loss as a result of obsolescence or expiry of stock. Again, too little stock turnover could be risking stock outage. In summary, the business liquidity level is healthy. Adequate liquid cash which can be used to meet the short term obligations has been maintained. It would be wise to examine the projected cash flows to see how readily the firms profit will improve its liquidity. There is however not enough information to say whether the satisfactory collection period is due to good credit control, or whether some sales are being made on shorter credit terms or for cash (Steffy, Zearley, & Strunk 17). Financial Stability Gearing ratios measures the financial risk of a firm or the probability that the firm will not be able to pay up its debts. The more debts a business have, the higher the financial risk. The debt ratio has slightly been increasing since 2009. This shows that the total debt in relation to total assets has slightly been increased. The level does not seem too low to miss investment opportunities or too high to risk high level of interest payments which can affect profitability. Equity ratio which is the proportion of capital held in equities follow the same trend as debt ratio. Capitalization which rose from 1.3 in 2009 to 1.4 is quite stable. It shows the share of equity holders in the business (Vandyck 32). The time interest earned has been maintained at between 11 and 18. Whether the figure is too high or too low will depend on the industry average. If the figure is above the industry average, then the business could be making substantial profits from interests. The debt ratio which has slightly increased could mean additional interests payable by the business. The fact that the asset turnover has increased is healthy for the business. It means that the available assets are being utilized more efficiently in generation of returns. This means that the business has been effectively released assets that have been unproductive and still maintained good profitability; assets that are not productively being used to generate income are better off being disposed. In summary, the business is adequately financially stable, and has little evidence to prove that the business could undergo financial strain in the near future. It is important to maintain good gearing level because if the company becomes too much geared, then it means that should the profits fall, they may not be in a position to pay the loan interest (Steffy, Zearley, & Strunk 88). Conclusion Having been introduced in the last three years, the business has shown remarkably good strides which is expected of a business which is headed for successful future. Surprisingly, the business has reported exceptional profitability during its introduction; when commitments were expected to remain high. Despite the remarkable performance, the business has also experienced sizable challenges, especially during the current year. Its reduced performance is however understandable considering that the business is still in its early years, and the management has rejuvenated its growth strategies- hence experiencing much expenditure. More encouraging is the fact that the business has been struggling to maintain a stable and effective liquidity levels as evidenced by the ratios. The trends shows that the business has tried to maintain enough current assets to meet its short-term liabilities, while at the same time trying offer the creditors better credit policies which is important to ensure growth in sales. In addition, the firm’s financial stability appears to be balanced and on the improvement (Keown 20). Recommendation The finding of this report shows that this business is healthy enough and deserves credit to spearhead its growth strategy. Although the analysis has found out that the business has experienced some challenges, it recommendable that the bank considers offering credit to this business as these challenges are typical for any business on its start-up. It is however important for the owners of the business to ensure the following: The business should ensure that the key ratios are always favorable as compared with the industry level. Since the business is on the start-up, the credit policies should be encouraging to its customers- but the business should be careful not to expose itself to the risk of bad debts. The managers should ensure that the business does not over rely on debts to finance growth. This is very important to avoid too much payment of interests which can significantly reduce the company’s profitability or expose it to the risk of bankruptcy. The company should ensure strict implementation of its growth strategies. Specifically, the timing should be adhered to. The management should ensure that proper feasibility study is undertaken on the proposed line of expansion to avoid engaging in projects that are not viable. Works Cited Keown, Arthur. Foundations of finance: the logic and practice of financial management. Tsingua: Tsingua University press, 2003. Print. Steffy, Wilbert., Zearley, Thomas., & Strunk, Jack. “Financial ratio analysis.” Journal of business accounting 32 (2007): 23-27. Print. Vandyck, Charles. Financial Ratio Analysis. New York: Trafford Publishing, 2006. Print. Appendices: Gowns of Envy Pty Ltd. Comparative Income Statement For the years ended 30th June 2010, 2009 and 2008. (In thousands of $'s) Gowns of Envy Pty Ltd. Comparative Balance Sheet as at 30th June 2010, 2009 and 2008 (in thousands of $'s) 2010 2009 2008 Assets: Cash at Bank 59 66 61 Accounts Receivable (net) 96 62 54 Inventory 97 77 68 Prepaid Expenses 26 28 22 Property, Plant and Equipment (net) 437 428 426 Total Assets $715 $661 $631 Liabilities: Current Liabilities 81 48 41 Non-Current Liabilities* 220 220 220 Total Liabilities 301 268 261 NET ASSETS $414 $393 $370 Equity: Share Capital 350 350 350 Retained Profits 64 43 20 $414 $393 $370 * Non Current Liabilities consist of a bank loan taken out at the formation of the business and is secured against the Company premises. Gallery Industry Averages Gross profit margin 51% Operating profit before tax margin 17.5% Equity ratio 67% Asset turnover 3.1 times ROA 41% Inventory turn over (days) 61 Read More