Analytical and Comparison of ABC Mining and JPhones

Published: 2021-06-26 07:30:04
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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.

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