Application of Assessment Criteria - Billabong International Limited - Case Study Example

Application of Assessment Criteria By Student’s names: Class Institution: City, state: Date: Executive summary The need for businesses to operate in sound financial environment cannot be underrated. It is due to this factor that directors and business managers have been forced to accurately to ensure that books of accounts are well maintained, since they are crucial tool in financial analysis. For Billabong International Limited (BBG), the sustainability of the basically lies in sound financial system as well as the strive to ensure production of high quality sports and surf accessories, to be sold locally and internationally. In this paper, analysis of financial ratios of BGG will be exhaustively carried out. The following areas will be carefully analysed: Profitability, efficiency, liquidity, gearing and investment Ratios. From the analysis it will be evident that the net profit margin for BBG declined by 5.4% to 14.6% in 2009. From the report it can be seen that the ROE, based on based on year-end equity and based on average equity significantly dropped by 9.3 and 7.2% respectively. This indicates the low level of amount of profit earned by the firm in comparison to the shareholders equity. It is also evident that the average inventory turnover period based on year-end inventory and average inventory reduced by 7.3 days and 6.1 days respectively. This can be attributed to the firms’ aggressive marketing policies and reduction price for some of its products. Further, the efficiency of cash flows from operations ratio reduced in 2009 by 19.7%, a factor that may significantly affect the clearance of current liabilities. For BBG to survive both in the short and long-term there is an urgent need to invest in the area of research and development. In conclusion, BBG should invest more in production of high quality products to be sold at reduced price, thus raising the sales turnover, which is a crucial determinant of profitability level. Introduction In the recent times the businesses environment has become extremely competitive. This is due to the high levels of globalization arising from technological improvements and increased know how among many potential customers. To be able to cope with these competitions businesses must position themselves effectively as the market leaders they want to remain relevant both in short and long run. One of such businesses which have made tremendous achievement not only in the Australian market, but also globally is the Billabong International Limited (BBG). The firm, which was established in 1973 by Rena and Gordon Merchant, specializes in the manufacture and selling of sports and surfware accessories and accessories for skate, surf as well as snowboard markets. Besides the Billabong brand name, the firm also sell s accessories and surfware under Swell.com, Plamers Surf, Honolua Surf, Von Zipper, Kustom (footwear), Nixon, Tigerlily and Xcel Wetsuits brands and Element skate clothing and hardware. All these brands are available at numerous skateboards and surf stores locations across the globe. Williams (2008) indicates that BBG brand has targeted both active participants in extreme sports and surf as well as those people who wish to be associated with its image. To tap in the non-traditional markets, such as Africa, Latin America among other parts of Asia, the firm has in most instances produced and sold high quality products at a subsidized price, thus encouraging these targeted groups to buy its products. Further, BBG has actively engaged in social activities like tree planting, educating needy children, a factor that has enormously enabled the firm to spread to more than 60 countries globally. Over the years, the firm has employed various strategic policies that have enabled the firm to remain profitable despite the current economic times. InvestSMART (2012) argues that BBG strategies are mainly aimed at differentiating its products and services through novel design, branding and quality. Initially, the management build up core niche brand that was slowly differentiated to appeal to broader markets devoid of diluting the core niche brand. Over the years, this strategy has proved successful, especially in moving designs away from surfwares targeting men, to the general apparel markets. Currently, the firms’ management is duplicating these strategies with its reduced mature skate market, thus tap latent demands for services and markets within the broader international markets. In the year 2011, the firms’ NPAT (Net Profit after Tax) dropped by at least 18%. This can be attributed to the reduced performance of the global market, as a result of the economic meltdown. Further, the reported Net Profit after Tax was substantially impacted by unfavourable effects of appreciation of the Australian dollar, in particularly against the U.S. dollar and Euro. Generally, the success of this company has not come up by chance, but it is through careful evaluation of the macro economical factors and the careful evaluation of the current and the past market trends. It is based on these arguments that, the paper will critically evaluate some financial ratios for the firm in the year 2008 and 2009. Importance of Financial Statements to the Billabong International Limited (BBG) The significance of financial statements to any given firm can not be underrated. According to InvestSMART (2012), financial statements indicates the way business is doing, thus are crucial for internal and external use. They are important to the employees, managers, labour unions, stakeholders among other notable groups. Externally, they are crucial to all prospective investors, government agencies, who are responsible for regulations as well as taxation. Other external users include lenders, such as the credit rating agencies and banks, stockbrokers and investment analyst. Dodd (2008) argues that for any given company to achieve its short and long-term goals comprehensive analysis of the fundamental principles should be carried out. Fundamental analysis involves analysing the companies’ financial statements, competitive advantages management and financial health. This can not be possible without the use of financial statements, which are mostly prepared quarterly or semi-annually or annually. Fundamental analyses are carried out on past and current data all in an aim of making future financial estimations. For many companies, such as Billabong international Limited, they carry out this analysis to help them in stock evaluation, project on future businesses performances, calculate credit risk and evaluate the management among other uses. For large corporations, such as the BBG, financial statements are usually complex and include extensive set of notes, with an aim of explaining the financial statements. These notes describe every item as it appears on the income statement, balance sheet among others. Based on the 2008 and 2009 BBG financial statements, the following areas will be carefully analysed: Profitability, efficiency, liquidity, gearing and investment Ratios. Profitability ratio In many instances profit has always been the yardstick for measuring the success of any company. However, it is important to compare the company profits earning capacities in relation to the capital employed with this in mind financial experts have developed ratios that measures ability of a company to convert the sales to profits and then earn profit on the asset employed. Dahlquist (2008) argues that profitability ratios are one of the most used tools of financial ratio analysis, which clearly indicates the firm’s bottom line. Profitability ratios significantly indicate on the overall performance and efficiency of a given firm. These ratios can be divided into two major categories namely returns and margins. Ratios, which shows the margin presents the ability of a firm to translate sales into profits at numerous stages of production. On the other hand, ratios, which indicates returns presents the ability of a firm to measure the entire efficiency of a firm towards the generation of returns to the stakeholders. Margin Ratios Gross profit margin This is the ratio which indicates the margins of sales as compared to bought or factory cost. It indicates the efficiency of the business in using its labour and materials in the production processes as well as giving the indications of cost structures, production efficiency and pricing among other factors. The gross profit ratio is given by Gross profit ratio = (Gross profit/sales) * 100 (Roppelli 2000). Where gross profit = (Sales revenue - cost of goods sold). For BBG, the gross profit ratio for 2008 and 2009 can be calculated as follow 1,669,062 – 780,436 2009: ---------------------------- x 100 = 53.24% 1,669,062 1,347,618 – 608,040 2008: ---------------------------- x 100 = 54.88% (Bloomberg Businessweek, 2011). 1,347,618 The higher the percentage, the higher the amount of money being left for operating expenses and the net profit. Low levels of gross profit margins indicate that business is generating low levels of revenues for paying operating expenses as well as net profit. Further, it shows that the price set for the products re low or the business is unable to control the inventory or production. For BBG, the reduced gross profit ration in 2009 can be attributed to reduced efficiency in labour and materials in the production processes, raised cost of raw materials among other notable causes. If the trend continues, the firm may significantly reduce its net profit, due to reduced gross profit margin in the long run. Net Profit Margin Net profit is obtained by deducting the company’s overheads from the gross profit.Net profit are the money, which is left after all expenses are paid. For large organizations, determining the net profit becomes more complex as the accountants or the bookkeeper must allocate and itemize expenses and revenues adequately to the particular working scope to get the required net profit of an organization. Net profit margin indicates the amount of profit generated by a company out of $ 1 generated as sales or revenues. Profit margins vary from one industry to the other, although higher values of this ratio or percentage are highly encouraged.Net profit Net profit before interest and taxation Net profit margin = --------------------------------------------------- x 100 (Roppelli 2000). Sales Where Net profit before interest and taxation = Profit before income tax’ + ‘finance cost. For BBG, the net profit margin for 2008 and 2009 can be calculated as follows 206,047 + 38,561 2009: ---------------------- x 100 = 14.6% 1,674,434 245,562 + 24,986 2008: ---------------------- x 100 = 20.0% 1,354,419 From the above figure it is clear that the net profit margin for BBG declined by 5.4% to 14.6% in 2009. This can be attributed to the firms’ failure to control costs, thus resulting to lower levels of converting sales into real profit. Unless BBG reverses this trend, it will loose its competitive edge over other well-established firm as the company aims to expand and improve its operations. Return Ratios There are various return ratios, which can be used to explain the profitability of BBG. Return on owners’ equity Return on owners’ equity is the amount of net incomes, which are returned as percentage of the shareholders equity. ROE indicates the profitability of an organisation by revealing on the approximate profit a firm generates out of the money invested by the shareholders. ROE can be obtained as follows: Net profit after taxation and preference dividend (if any)* ---------------------------------------------------------------------------- X 100 (Roppelli 2000). Average ordinary share capital plus reserves Based on year-end equity: 152,839 2009: --------------- x 100 = 12.99% 1,176,936 176,380 2008: --------------- x 100 = 22.2% 795,103 Based on average equity: 152,839 2009: ------------------------------- x 100 = 15.5% (795,103 + 1,176,936) / 2 176,380 2008: ------------------------------- x 100 = 22.7% (759,683 + 795,103) / 2 Based on the above calculations, it is evident that ROE, based on based on year-end equity and based on average equity significantly dropped by 9.3 and 7.2% respectively. This indicates the low level of amount of profit earned by the firm in comparison to the shareholders equity. Consequently, BGG may not be in a position to generate more cash internally, a factor that may affect short-term borrowing. Return on total assets Return on total assets, which is also known as ROI (Return on Investment) indicates the earnings in relations to firms’ total asset. Return on total assets can be calculated as follows Net profit before interest and taxation --------------------------------------------------- X 100 (Roppelli 2000). Average total assets Where Net profit before interest and taxation=Profit before income tax + finance costs Based on year-end assets: 206,047 + 38,561 2009: ----------------------- x 100 = 11.0% 2,220,512 245,562 + 24,986 2008: ----------------------- x 100 = 16.6% (Bloomberg Businessweek, 2011). 1,625,461 Based on average assets: 206,047 + 38,561 2009: ---------------------------------------- x 100 = 12.7% (1,625,461 + 2,220,512) / 2 245,562 + 24,986 2008: ---------------------------------------- x 100 = 17.9% (1,390,578 + 1,625,461) / 2 From the above figures, it is clear that the ability of company to convert investment for generating growth earning significantly dropped in 2009. Williams (2008) argues that ROE, which is between 15-20%, is highly recommendable, an indicator that BBG may be on the heading to lower profit levels in 2009 and subsequent years. This can be attributed to the inability of the firms’ revenue to generate net earnings back to BBG. Efficiency Ratios Efficiency ratios are those ratios, which measures the quality of receivables in business as well as how efficiently the business use and control the assets. Other uses include measuring how the firm pays the suppliers and whether an organisation is under or over trading on its equity. Average inventory turnover period This is the ratio, which indicates the number of times inventory in a business is sold as well as replaced in a given duration. This is calculated as follows Average inventory held ------------------------------- x 365 (Roppelli 2000). Cost of sales Using year-end inventory: 253,670 2009: ------------ x 365 = 118.6 days 780,436 209,701 2008: ------------- x 365 = 125.9 days 608,040 Using average inventory: (253,670 + 209,701) / 2 2009: ------------------------------- x 365 = 108.4 days 780,436 (209,701 + 171,833) / 2 2008: ------------------------------- x 365 = 114.5 days (Bloomberg Businessweek, 2011). 608,040 From the above information, it can be seen that the average inventory turnover period based on year-end inventory and average inventory reduced by 7.3 days and 6.1 days respectively. This can be attributed to the firms’ aggressive marketing policies and reduction price for some of its products. Average settlement period for debtors This is the total amount of days taken by debtors to clear their outstanding debts. It is give by Average trade debtors ------------------------------- x 365 Credit sales Using year-end debtors: 396,212 2009: -------------- x 365 = 86.6 days (Roppelli 2000). 1,669,062 300,313 2008: ------------- x 365 = 81.3 days 1,347,618 Using average debtors: (300,313 + 396,212) / 2 2009: -------------------------------- x 365 = 76.2 days 1,669,062 (252,023 + 300,313) / 2 2008: -------------------------------- x 365 = 74.8 days 1,347,618 From the above information one can see that the time taken by debtors to pay their debts have increased by 5.3 and 1.4 days based on year-end debtors and average debtors. This can be attributed to the reluctance of the firm on the debtors, hence longer days of payments. Average settlement period for creditors Average trade creditors -------------------------------- x 365 Credit purchases Using year-end creditors: 200,393 2009: ------------- x 365 = 94.1 days 777,000 161,568 2008: ------------- x 365 = 98.0 days 601,500 Using average creditors: (200,393 + 161,568) / 2 2009: ------------------------------ x 365 = 85.0 days (Roppelli 2000). 777,000 (161,568 + 136,461) / 2 2008: ------------------------------ x 365 = 90.4 days (Bloomberg Businessweek, 2011). 601,500 In 2009, it is clear that the firm was able to reduce, the time taken in paying the creditors for the goods bought. This is attributable to stiffer penalties by the creditors to the firm to clear outstanding debts or changed policies by BBG towards the creditors. This will drastically improve the relationship between the firm and creditors, hence improved profitability. Asset turnover Asset turnover indicates the total amount of sales that is generated for each dollar worth of the firms assets. It is obtained as follows. Sales ----------------------------------------- Average total assets employed For BBG, Using year-end assets: 1,674,434 2009: ----------------- = 0.75 times 2,220,512 1,354,419 2008: ----------------- = 0.83 times (Bloomberg Businessweek, 2011). 1,625,461 Using average assets: 1,674,434 2009: ---------------------------------- = 0.87 times (1,625,461 + 2,220,512) / 2 1,354,419 2008: ---------------------------------- = 0.90 times (1,390,578 + 1,625,461) / 2 This is a clear indication that BBG has less efficient pricing strategy, thus which has in turn contributed to reduced profitability ratio in 2009. Liquidly Ratios Liquidity ratios help a company to determine whether it can meet the short term financial obligation. These ratios are of great importance to the companies’ creditors since they can be able to determine the credit worthiness in the short run. Current ratio Current ratios indicate the ability of the company to pay current liabilities once they fall due. Current assets ------------------------ Current liabilities 1,020,781 2009: ------------- = 3.30 times 309,151 667,523 2008: ------------ = 3.07 times (Roppelli 2000). 217,102 The higher the ratio, the better it is for any given firm in meeting the current liabilities, such as short term creditors. Acid test ratio (quick ratio) Current assets (excluding inventory and prepayments ------------------------------------------------------------------------- Current liabilities 1,020,781 – 253,670 – 18,263 2009: -------------------------------------- = 2.42 times 309,151 667,523 – 209,701 – 17,724 2008: ------------------------------------- = 2.03 times (Bloomberg Businessweek, 2011). 217,102 From the above ratios it is clear that the company can be able to meet the need of the short term creditors. However the shareholders always prefer to when the ratio is low since more of firms assets are working to make the business grow. Cash flows from operations ratio It indicates on how well a firm is in covering the current liabilities out of the cash, which is generated from operations. It is given by Operating cash flows ---------------------------- Current liabilities 175,685 2009: ------------- = 0.57 times 309,151 153,207 2008: ------------- = 0.71 times 217,102 Using the above calculations, one can see that the efficiency of cash flows from operations ratio reduced in 2009 by 19.7%, a factor that may significantly affect the clearance of current liabilities. Gearing (leverage) ratios Gearing ratio This is a ratio that compares the owner’s equity to the borrowed funds. Total liabilities -------------------- x 100 Total assets 1,043,576 2009: ------------- x 100 = 47.0% 2,220,512 830,358 2008: ------------ x 100 = 51.1% 1,625,461 Taylor (2003) argues that the higher the degree of leverage, the more any firm is considered risky. From the above, the degree of risk reduced by at least 3%, thus BBG may considerably be able to attract new investors. Interest cover ratio This is a ratio that determines how a company can easily pay interest on all its outstanding debts. It is given by Profit before interest and taxation --------------------------------------------- Interest expense 206,047 + 38,561 2009: ----------------------- = 6.34 times 38,561 245,562 + 24,986 2008: ----------------------- = 10.8 times (Bloomberg Businessweek, 2011). 24,986 From the above calculations, it is clear that in 2009, BBG was more overburdened by debt expenses as compared to 2008. This is attributable to low sales figures in 2009 as compared to 2009. Investment ratios Dividends per share (DPS) Dividends paid/provided in current year ------------------------------------------------------------ Weighted number of ordinary (equity) shares on issue 115,787,000 2009: ---------------- = $0.52 220,737,879 112,014,000 2008: --------------- = $0.52 215,572,428 The higher the ratio, the better it is for the shareholders, since it indicates the total returns for the money invested by them. Net tangible assets per share Net tangible assets is the total number of assets owned by a given firm, excluding all the intangible assets, such as the goodwill, patents and trademarks. Ordinary shareholders equity – intangible assets ------------------------------------------------------------ Number of ordinary (equity) shares on issue 1,176,936 – 999,491 2009: ------------------------- = .70 252,018 795,103 – 800,897 2008: -------------------------- = -.0.03 207,433 This is an indication of positive growth as compared in 2009, mainly due to increased shareholders investments among other notable factors. Operating cash flow per share This is used to measure the financial strength of a company as well as valuing stocks. It offers appropriate guide to the EPS (Earning per Share) as compared to earning data, which can easily be manipulated. Operating cash flows – preference dividends ------------------------------------------------------------ Weighted number of ordinary (equity) shares on issue 175,685,000 2009: ---------------- = $0.80 220,737,879 153,207,000 2008: --------------- = $0.71 215,572,428 In 2009, it is clear that the operating cash flow per share improved a clear indicator of raised cash flow levels. Price earnings ratio This is the valuation ratio of a firms current share price as compared to the per-share earnings. Market value per share ------------------------------- Earnings per share $8.75 2009: ------------ = 12.64 times $0.692 * Approximate share price at 30 June 2009 $10.80 2008: ------------ = 12.6 times (Bloomberg Businessweek, 2011). $0.857 * Approximate share price at 30 June 2008 From the above information, it is evident that the price earnings ratio improved by at least 3.2%, due to improved earnings per share in 2009. Recommendations For BBG to survive both in the short and long-term there is an urgent need to invest in the area of research and development. This will aid the organisation to come up with new and innovative ways to attract investors, increase sales revenues among other notable aspects, which ultimately leads to strong financial ratios. The other recommendation to the management regarding the financial ratios is the adoption of cost cutting measures. This way the firm will improve on the gross profit and net profit margins, hence higher values of returns to the investors (Andrew 2008). Conclusion From the above financial ratios, it is clear that the economic performance of BGG reduced in 2009 as compared to 2008. This can be attributed to reduced spending power by most customers as a result of 2008 economic melt down. To reverse this trend, there is need to invest in production of high quality products to be sold at affordable prices, thus higher sales turnovers (InvestSMART 2012). References Andrew, W. (2008). The Evolution of Technical Analysis: Financial Prediction from Babylonian Tablets to Bloomberg Terminals. London: Bloomberg Press. Bloomberg Businessweek. (2011). BILLABONG INTERNATIONAL LTD (BBG:ASX). Available at http://investing.businessweek.com/research/stocks/financials/financials.asp?ticker=BBG:AU Dahlquist, K. (2008). Technical Analysis: The Complete Resource for Financial Market Technicians. New York: McGraw-Hill. Dodd, D. (2008).An Introduction to Fundamental Analysis and the Australia Economy. Sydney: Cambridge University Press InvestSMART. (2012). Billabong International Limited (BBG). Available at http://www.investsmart.com.au/shares/asx/BILLABONG-INTERNATIONAL-LIMITED-BBG.asp Roppelli, A. (2000). Finance, 4th Ed. London: Barron's Educational Series, Inc. Taylor, M. (2003).The use of technical analysis in the foreign exchange market. Journal of International Money and Finance. Texas: McGraw-Hill. Williams, J. (2008). Financial & Managerial Accounting. London: McGraw-Hill Irwin. Read More