Myer Holdings Ltd. and Harvey Norman Holdings Ltd - Essay Example

? ASSIGNMENT – TRIMESTER THREE, 13 ANALYSIS OF FINANCIAL MENTS OVER A TWO YEAR PERIOD AND ACCOUNTING FOR DECISION MAKING LECTURER’S NAME: _________ TUTOR’S NAME: __________ Date: 8th January 2013 Executive Summary This report sets out a detailed ratio analysis of the financial statements of Myer Holdings Ltd. and Harvey Norman Holdings Ltd. by comparing the ratios of both companies for the years 2011 and 2012 individually and among each other in order to arrive at recommendations regarding the best entity for making investments. Myer Holdings Limited is one of the largest department stores groups of Australia being in the fashion industry since last 100 years. However, Harvey Norman Holdings is involved in the sale and distribution of goods under Harvey Norman brands via different independent franchises. The paper also outlines the limitations in the ratio analysis of the financial statements of these Companies. Table of Contents Executive Summary 2 Table of Contents 3 1.0 Introduction 4 1.1 Ratios Analysis 5 1.1.1 Liquidity Ratios Analysis. 5 1.1.2 Leverage Ratios Analysis. 6 1.3 Recommendation and Conclusion 11 References 12 1.0 Introduction This report outlines the ratio analysis of the financial statements of Myer Holdings Limited and Harvey Norman Holdings Limited for the periods 2011 and 2012. The paper also highlights the limitations of evaluations using ratios analysis. As outlined in the Harvey Norman corporate website the Harvey Norman Holdings Limited is involved in giving the franchise agreements to independent business entities for the supply of household and office equipments under the banner of Harvey Norman. It deals in a wide variety of goods and the business is spread over many geographical regions. (Harvey Norman Company 2008) As per the Myer holdings official website the company claims to be ‘Australia’s largest department store group, and a leader in Australian retailing’ involved in the management and running of departmental stores and retail business especially of fashion goods all over Australia. (Myer Holdings Company 2012) 1.1 Ratios Analysis Accounting ratios are calculated in a way that relationships between two or more figures of the financial statements are evaluated. In this part the ratios provided for Myer Holdings Limited and Harvey Norman Holdings Limited for 2011 and 2012 are compared. 1.1.1 Liquidity Ratios Analysis. Liquidity is defined as the ability of a company to realize value in money. The liquidity ratios are used to evaluate the financial stability of a company in short term. (Kishore 2009, p.62). The following liquidity ratios are provided in the question: Myer Holdings Limited Harvey Norman Holdings Limited Key Ratios 2011 2012 2011 2012 Current Ratio 0.81 0.88 1.64 1.63 Quick Ratio 0.12 0.11 1.3 1.35 As per Kishore current ratios are defined as a measure of the short term solvency of a company. (Kishore 2009, p.62). It indicates the amount of current assets that are available to discharge every $1 of current liability. The current ratio of 1 or more shows that a company is in a solvent position indicating having enough assets to discharge its liabilities. As per the given ratios it is quite evident that the solvency position of Harvey Norman with a current ratio of 1.63 in 2012 is much better than that of Myer Holdings with a current ratio of 0.88 in 2012. It can also be concluded that the solvency position of Myer Holdings Limited have improved by 0.07 from 2011’s 0.81 to 2012’s 0.88. As far as Harvey Norman Holdings is considered there is an extremely minor deterioration in the year 2012 by 0.01. Quick ratio is used to evaluate the ability of a company to discharge its current liabilities from the realization of quick assets (current assets – inventories). This ratio gives out the amount in $ of the quick assets available with the company to discharge current liabilities worth $1. (Kishore 2009, p.63). As evident from the given data, Harvey Norman Holdings Limited seems to be highly stable in this regard with a quick ratio of 1.35 against Myer Holdings’ 0.11 in the year 2012. As far as the yearly performance of both the companies’ is considered it can be said comfortably that where there was an increase in the quick ratio of Harvey Norman Holdings Limited by 0.05 from 1.3 in 2011 to 1.35 in 2012, Myer Holdings Limited witnessed a decline of 0.01 from 0.12 in 2011 to 0.11 in 2012. 1.1.2 Leverage Ratios Analysis. This set of ratios is calculated and evaluated to analyse the long term stability of an entity. (Kishore 2009, p.63). As per Drake’s article leverage ratio is an indicator of the ‘degree of a company’s fixed financing obligations and its ability to satisfy those obligations’. (Drake 2005). The following leverage ratios were provided in the question for comparison purposes: Myer Holdings Limited Harvey Norman Holdings Limited Key Ratios 2011 2012 2011 2012 Debt Asset Ratio (Total Debt) 56.36% 54.29% 42.63% 44.34% Debt Equity Ratio (Total Debt) 1.29 1.18 0.743 0.7967 Times Interest Earned (Times) 7.25 times 7.73 times 9.969 times 5.59 times Debt Asset Ratio, as explained by Drake, is a ‘component-percentage financial leverage ratio that indicates how much a company is reliant on debt financing’. (Drake 2005). As a percentage this ratio indicates what percent of the total assets of the company are its total debts. As explained in the accounting explained website, value of debt to asset ratio is an indicator of the ‘portion of the total assets of the company that will be claimed by the creditors’. (Accounting Explained Website, 2012). The given set of ratios indicates that Harvey Norman is less risky as compared to Myer Holdings by a clear 10% as Debt Asset Ratio of Harvey Norman for the year 2012 is 44.34% (indicating that the total debts of the company are 44.34% of the total assets of the company) as compared to Myer Holdings’ same ratio of 54.29% (indicating that the total debts of the company are 54.29% of the total assets of the company). Further, this can also be concluded that where Myer Holding’s debts to asset ratio has reduced from 56.36% in 2011 to 54.29% in 2012 showing a step towards the betterment of the company’s assets and liabilities balance, on the other hand this ratio of Harvey Norman has increased from 42.63% in 2011 to 44.34% in 2012 indicating a slight worsening of the debt conditions of the Company. Debt Equity Ratio of a company is an indicator of the gearing of any company which means ‘the relationship between the loan funds and net worth of the company’. (Kishore 2009, p.63). The high debt to equity ratio indicates the instability of the shareholders returns as more percentage of the company’s returns might be required to pay off the creditors and less would be retained to increase the net worth. The given ratios show that as compared to a 0.7967:1 debt equity ratio of Harvey Norman in the year 2012 Myer Holdings ratio in the year 2012 was 1.18:1, indicating that the returns of Myer holdings shareholders in the form of value addition or dividends would be less and more volatile than those of Harvey Norman’s. Times Interest Earned, as per Drake, is a coverage financial ratio that ‘captures the ability of the company to satisfy its debt obligations’, this ratio is used to compare the available earnings of the company with the interest obligations of the company. (Drake 2005). As per the given data it is quite evident that the interest obligations of Myer Holdings in the year 2012 are 7.73 times its earnings before interest and tax as compared to Harvey Norman’s interest obligations that are 5.59 times its earnings before interest and tax. However, as far as the yearly performance is considered it can be seen that the Times interest earned ratio of Myer Holdings increased in the year 2012 to 7.73 times as compared to 2011’s 7.25 times. As far as Harvey Norman is considered the times interest earned ratio in 2012 showed a huge decline to 5.59 times as compared to 9.69 times of the year 2011, which is an indicator that during the year 2012 the company took either a material long term loan or was highly dependent on overdrafts. 1.1.3 Profitability Ratios Analysis. Profitability ratios, as per Drake, are the ratios that ‘provide information on the amount of income per $1 of sales’. (Drake 2005). However, Kishore in his book explains profitability ratios as a mean of evaluating the profits earned by a company and to identify the trend of profits over the period of time. (Kishore 2009, p.68). The following profitability ratios are given in the question: Myer Holdings Limited Harvey Norman Holdings Limited Key Ratios 2011 2012 2011 2012 Gross Profit Margin 44.07% 46.80% 27.43% 27.14% Net Profit Margin 27.14% 8.80% 15.05% 14.07% Return on Equity 19.05% 16.04% 10.68% 8.85% Return on Assets 9.59% 8.55% 6.66% 5.93% Gross Profit Margin as per Kishore is a ratio that measures the Gross Profit earned by a company as a percentage of the total sales of the Company. (Kishore 2009, p.68). As per the given data it is quite evident that the GP margin of Myer Holdings in the year 2012 being 46.8% is much higher than that of Harvey Norman Holdings’ 27.14% in the same year indicating that the cost of goods sold of Myer Holdings is less than that of Harvey Norman Holdings and that for each $1 sale $0.468 are left after cost of goods sold with Myer Holdings and $ 0.27 are left after cost of goods sold with Harvey Norman Holdings. Net profit Margin, as per Drake, calculates the percentage of sales represented by the net income of a company. (Drake, 2005). As per the given data it can be said that despite of having a higher Gross Profit Margin the Net Profit Margin of Myer Holdings in 2012 being 8.8% is quite less than that of Harvey Norman Holdings being 14.07% in 2012, indicating that the amount left from a $1 sale of both companies after all the expenses in case of Myer Holdings is $0.08 while in case of Harvey Norman Holdings is $0.141. This clearly points out that the expenses (Operating and other operating) as a percentage of sales of Myer Holdings are higher than those of Harvey Norman Holdings. Return on Equity, as per Kishore, is the measure of the profits earned on the amount of capital employed / investments made. (Kishore 2009, p.70). As per the given data the Return on Equity of Myer Holdings being 16.04% in the year 2012 is much higher than that of Harvey Norman Holdings being 8.85% in the year 2012. It indicates that the Net profit of Myer Holdings is 16.04% of the shareholders equity and the net profit of Harvey Norman Holdings is 8.85% of the shareholders equity. Further, as far as the yearly performance is considered there is an evident decline in the return on equity ratios of both companies in the year 2012 as compared to the year 2011. Return on Assets, as per Kishore, is the measure of the profits earned on the amount of total assets of the company. (Kishore 2009, p.71). As per the given data the Return on Assets of Myer Holdings being 8.55% in the year 2012 is higher than that of Harvey Norman Holdings being 5.93% in the year 2012. It indicates that the Net profit of Myer Holdings is 8.55% of the total assets and the net profit of Harvey Norman Holdings is 5.93% of the total assets. Further, as far as the yearly performance is considered there is an evident increase in the return on asset ratios of both companies in the year 2012 as compared to the year 2011. 1.1.3 Efficiency Ratios Analysis. Efficiency ratios are calculated in order to evaluate and measure the efficiency of the operations of a company. As per Kishore, efficiency ratios ‘measure how effectively the firm employs its resources’. (Kishore 2009, p.66). The following ratios are given in the question: Myer Holdings Limited Harvey Norman Holdings Limited Key Ratios 2011 2012 2011 2012 Asset Turnover (Times) 1.35 times 1.36 times 0.387 times 0.3561 times Inventory Turnover (Days) 52.5 days 53.9 days 360/4.62=77.9 days 360/5.34=67.4 days Debtors Turnover (Days) 0.67 days 0.64 days 257 days 240 days Creditors Turnover (Days) 50 days 47.9 days 212 days 212 days As per Kishore, Asset turnover ratio indicates the number of times the total assets of a company are turned over (sold / changed). (Kishore 2009, p.68). As per the given data it can be said that Myer Holdings asset turnover ratio of 1.36 being greater than one shows that the assets are over utilised however in case of Harvey Norman the asset turnover ratio being quite less than one indicates that the total assets are underutilized. Inventory turnover ratio, as per Kishore, is used to measure the number of days in which inventory needs to be refurbished. (Kishore 2009, p.66). Inventory turnover ratios vary from industry to industry. The inventory turnover of Myer Holdings dealing in fashion items is relatively less than that of Harvey Norman Holdings dealing majorly in electronics, computers, furniture etc. Debtors’ turnover ratio measures the period of time in which trade debtors are realised and creditors’ turnover ratio indicates the number of days in which the company is required to pay its trade liabilities or to discharge its trade creditors. The debtors’ turnover period should ideally coincide with that of creditors’ turnover period for the effective settlement of dues. (Kishore 2009, p.67). However in the given scenario the creditors’ turnover period of Harvey Norman Holdings is less than that of debtors’ turnover period indicating that difficulties may arise at the time of payment of debt. 1.2 Limitations of Ratio Analysis. Ratios analysis is a highly effective means of comparing performance of a company as compared to prior years or as compared to industry standards. However, there are certain factors that affect this analysis. As per Kishore, these factors are: 1. Use of financial statements, based on hypothetical policies and estimates, for the calculation of ratios and which do not consider other non monetary performance affecting factors. 2. There is likelihood that management might manoeuvre the financial statements in order to improvise ratios. 3. After comparisons real cause of difference is difficult to pin point since ratios are calculated by dividing to different figures. 4. There are chances that proper standards are used for comparison purposes and changes in policies are kept in mind. (Kishore 2009, p.76) 1.3 Recommendation and Conclusion On the basis of above discussion the following can be concluded: 1. Harvey Norman Holdings Limited show a much better short term solvency position as compared to Myer Holdings Limited that is well evident from both current and quick ratios of both companies. Where Harvey Norman Holdings Limited has both ratios above the standard 1, Myer Holdings Limited’s both ratios are quite below 1. 2. Harvey Norman Holdings is in a more stable long term finance position as compared to Myer Holdings Limited. Further, Harvey Norman is also less geared as compared to Myer Holdings. However, the interest cover of Myer Holdings is better than that of Harvey Norman, but as far as the year 2011 is considered it is quite possible that it is a short term situation and will improvise over the period of time. 3. Myer Holdings is in a better profitability conditions as compared to Harvey Norman Holdings. 4. Myer Holdings is operating more efficiently than Harvey Norman Holdings. 5. Share prices as on 28 December 2012, of Harvey Norman Holdings is $ 1.885 while that of Myer Holdings is $2.13. (The Bull 2012). Therefore, it can be said that on the basis of credit stability and better short term and long term solvency positions, Harvey Norman Holdings is a better venture for investors than Myer Holdings. References Accounting Explained Website 2012, Debt Ratio, viewed 30 December 2012, < http://accountingexplained.com/financial/ratios/debt-ratio> Drake PP, 2005, Financial Ratio Analysis, Lecture Notes, James Madison University, viewed 30 December 2012, < http://educ.jmu.edu/~drakepp/principles/module2/fin_rat.pdf> Harvey Norman Company 2008, Harvey Norman Company Profile, Australia, viewed 30 December 2012, Kishore, RM 2009, Financial Management, 7th edn, Taxmann Publications (P.) Limited, New Delhi, India. Myer Holdings Limited 2012, Myer Holdings: About us, Australia, viewed 30 December 2012, < http://investor.myer.com.au/phoenix.zhtml?c=231681&p=irol-IRHome> The Bull 2012, Stocks to watch on Friday, Australia, viewed 28 December 2012, The Headliner 2012, Profit fall for Myer Holdings, Australia, viewed 31 December 2012, Read More