Financial Analysis Plays a Critical Role in Evaluating Company’s Performance
Financial analysis plays a critical role in evaluating company’s performance. When we analyse the financial statement, there are two ways, ratio analysis and cash flow analysis. With the financial statement of company Gunting Ltd, I will use the ratio analysis to discuess the poor side of Profitability, Liquidity, Efficiency of the asset useage and Leverage of Gunting Ltd from 2006 to 2008. Profitability ROE is comprehensive indicator of an organisation’s performance since it provides an indication of how well managers are employing the funds invested by the organisation’s sharehoulders to generate funds.
From the ratios in the previous table, Gunting Ltd’ s Reture on equity ratios slumped from 11. 2% to 1. 89% from 2007 to 2008. The company experience a dramatic decline during the GFC period and the managers didn’t generate efficient funds to its shareholders. In addition, compare with other companies, Gunting Ltd’s ROE ratio is suitable in the bottom, all the two year ratio is quite low, especially in 2008.
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Furthermore, there are three drivers for the Return on equity of an organisation, the net profit margain, asset turnover and financial leverage will be discuessed later. Net profit margin is the first driver of an organisation’s Return on equity and it shows the profitability of the company’s operating activities. From the table, net profit margin declined from 9. 73% to 3. 6% in 2008(only about one third of that in 2007), it seems that the company has operaing problems from 2007 to 2008 and only able to ratain 3. cents in net operating profits for each dollar of sales. Compare to EBIT margin, the Gunting Ltd’s EBITDA margain which excludes depreciation and amortisation expense is larger which indicates that the depreciation and amortisation expense plays a important role of the operating process of Gunting Ltd. The EBITDA margin also experience decline from 18. 67% to 6. 53%. Profit slump is maybe result of the cut price strategy to boost the sales during the Global Financial Crisis. Efficiency of asset useage
Asset turnover is the second driver of an organisation’s ROE since organisations invest considerable resources in their assets and using them productively is critical to overall profitability. Asset turnover allows the analyst to evaluate the effectiveness of an organisation’s investment management. From the table, the asset turnover of Gunting Ltd declined from 84. 38% to 75. 38% which indicates that the asset useage in 2008 is not that much efficient than that in 2007. In addition, investment management also concerns the utilisation of an organisation’s long-term assets.
For the long-term, the net long term asset turnover of Gunting Ltd declined as well. All these may be is attributable to a downturn in inventory management between 2007 and 2008 of Gunting Ltd. Leverage Financial leverage enables an organisation to have an asset base larger than its equity. Financial leverage increase an organisation’s ROE so long as the cost of the liabilities is less than the return from investing these funds. Adjusted financial leverage indicates how organisation can use leverage to increase ROE returns flow to its shareholders.
The Adjusted financial leverage is the combinition of two ratios: common earning leverage and capital stucture leverage. Asset to shareholders’ funds is the third driver of an organisation’s ROE and it measures the extent of leverage used to acquarie the assets which is how much greater the assets ate than the equity contributed. From the table, the Asset to shareholders’ funds decreased from 1. 69 to 1. 37 which shows a little magnification of returns by leverage. The interest coverage can measure an organisation’s ability to measure all fixed financial obligations such as interest payment and tax payments.
Gunting Ltd records a erosion in its leverage with its interest coverage decrease dramatically from 2006 to 2008 from 10. 76 to 1. 77. In addition, an organisation’s leverage is also influenced by its debt financing policy since debt is typically cheaper than equity , in most countries, interest on debt financing is tax deductible whereas dividends to sharehoulders is not tax deductible, debt financing can impose discipling on the organisation’s management and motivate it to reduce wastful expenditures and it can reduce organisation’s cost of capital with efficient communication.
However, if an organisation’s operating cash flow are highly volatile and its capital expenditure needs are unpredictable, such as the Gunting Ltd, may have to rely primarily on equity financing. Liquidity However, while financial leverage can potencially benefit an organisation’s sharehoulders, it can also increase their risk. Unlike equity, liabilities have predefined payment terms and the organisation faces risk of financial distress if it fails to meet these commitments. There are several useful ratios to evaluate the risk related to an organisation’s current liabilities.
The current ratio is a key index of short-term liquity since it is more than one to be an indication that the organisation can cover its current liabilities from the cash relised from its current assets. From the table, Gunting Ltd’ s overall liquidity situation is acceptable when measured in terms of current ratio, and has improved consistantly from 2006 to 2008. This is maybe a result of the company pursued a policy of sales promotions and reducing the sale price of own brand items. However, its overall liquidity is a little below than the average level.
Despite current ratio does not take into account the timing of the cash payments and recipts, quick ratio and cash ratio capture organisation’s ability to cover its current liabilities from liquid assets. Operating cash flow is another measure of organisation’s ability to cover its current liabilities from cash generated from operaions of the organisation. With Gunting ltd’s financial statement, there there ratios would be at a low level which indicate a bad overall liquidity of the Gunting Ltd.
There is another ratio in the previous table, P/E ratio. P/E ratio is shorthand for the ratio of a company’s share price to its per-share earnings. It gives an idea of what the market is willing to pay for the company’s earnings. Although P/E ratio is a measure of a company’s past performance, it also takes into account market expectations for an organisation’s growth. The higher the P/E ratio, the more the market is willing to pay for the organisation’s earnings and the better of investors’ expectation of the organisation.
Organisations expected to grow and have higher earnings in the future should have a higher P/E ratio than corganisations in decline. Conversely, a low P/E may indicate a vote of no confidence by the market or it could mean the market has overlooked it. From the table, Gunting Ltd’s P/E ratio declined a little from 2006 to 2007 to 8. 8, however, in 2008, it boost to 50. 50 which indicates that investers didn’t satisfied its performance during the Global Financial Crisis, however, they anticipant there will be a significant improvement since 2008.
However, with such a big P/E ratio in 2008, it will be a great challenge for Gunting Ltd to meet market’s expectation. In conclusion, from 2006 to 2008, although there is an improvement of liquity (still in low level), the profitability and leverage of gunting Ltd declined a lot and the asset useage efficiency decreased as well. Since the three driver of ROE moved down together, the Gunting Ltd experienced a big downturn during the Global financial Crisis.