Key Financial Ratios
Discussion
The financial ratio analysis presented in the table above reflects that the liquidity position of the company had improved in 2006 due to the improvement in the cash position of the company and the increase in the company’s receivables. The efficiency ratios indicate weaknesses. The company took more days to collect receivables in 2006 as compared to 2005. Moreover, it experienced delays in the conversion of inventory into sales as it held inventory for a longer period in 2006. Similarly, in 2006, the company took more days than 2005 to settle its creditors’ accounts. The company’s profitability improved in 2006 as compared to 2005 and it remained satisfactory. The company was able to generate high gross profit margins by lowering its cost of sales and charging high price premiums to its customers for its products.
However, it incurred high administrative, selling, and distributions expenses in both years, which lowered its operating profits. The company earned a low net profit margin of just 4.08% in 2006 and 4.35% in 2005. However, the company generated a significantly high ROE that was favorable for shareholders. The EPS remained above 15p that generated a P/E of 21.66 in 2006. The shareholders would have experienced an increase in the company’s share price in the future periods due to high P/E multiples. A major concern raised regarding the company’s performance was related to its long-term debt to equity ratio. The company had excessively high debt as compared to its equity. Despite efforts by the company to reduce its borrowing, the ratio value remained above 1.19 in 2006. The company paid small dividends to its shareholders in 2006 and 2005 that led to a dividend yield of 2.76% and 2.35% respectively.
Common Size Statements
Additional Information
The common size profit and loss statement reasserts findings of the ratio analysis suggesting that the major expense factor was selling, administration, and distribution expenses. The company needed to control its expenses in order to increase its net earnings. Moreover, the company was not efficient in managing payments to its suppliers. High creditors amount added to the concerns related to the company’s solvency position. There was also a sharp increase in the company’s other non-current liabilities. Furthermore, the company increased its revenue and other reserves that allowed the company to invest in other companies.
Consistency of Financial Information
The management report included in the annual report of the company provided business information that was consistent with the financial information presented in the consolidated financial statements. One area of concern that could be highlighted is related to the information provided by management pertaining to the company’s investments in different markets. These new stores or acquisitions have not contributed much to the company’s profits as they just indicated a small increase in 2006. The company might have been experiencing problems in managing its new stores (e.g., difficulties in paying creditors) that are not reflected in the information supporting financial statements. Furthermore, the analysis indicated that there are small differences in the values of KPIs provided in the annual report. For example, PBIT to sales ratio for the year 2005 as provided in the annual report is 4.70%; whereas, the ratio analysis based on the financial information indicated a ratio value of 4.90%.
Expected Performance
The company had shown improvement in its earnings in 2006, but it did not justify the expansion in the company’s business operations. The company increased its number of stores and also, invested funds to increase its holdings in associated businesses. The company expected that its strategy of expansion in new emerging Asian markets would put the company in a competitive position. It planned to open up new stores and also, refurbish its existing stores to attract customers. Furthermore, the company’s P/E ratio indicated possible growth in the share value that could generate capital gains for shareholders. Based on the analysis, the company was expected to perform better in the future.
Comparison with Tesco and Sobey’s
- The layout of the balance sheets of Tesco and Dairy Farm is the same as both companies are listed on LSE and report according to IFRS. However, the layout of Sobey’s is different.
- Based on financial ratio analysis, it is clear that Dairy Farm had a better liquidity position than Tesco. However, the current and quick ratios of Sobey’s indicated a comparatively stronger position in 2006 and 2005. Dairy Farm had operational inefficiencies as compared to the other two companies in terms of a longer period required for collection of receivables and payments to inventory suppliers and creditors. Overall profitability of Dairy Farm remained stronger as compared to Sobey’s.
- In comparison to Tesco and Sobey’s, Dairy Farm had a longer collection period. Moreover, it took more days to convert its inventory into sales and settle accounts of its creditors. In 2006, Dairy Farm’s gross profit margin was higher than Tesco, but Tesco had a higher operating profit margin. The reason for this sharp reduction in profits was higher administrative, selling, and distribution expenses incurred by Dairy Farm. In terms of ROA and ROE, Dairy Farm was a better performer than Tesco and Sobey’s. There was also a significant difference in ROE of all three companies. Dairy Farm had the highest ROE of 64.27% as compared to 17.60% of Tesco and 10.90% of Sobey’s.
- Based on comparative analysis, it could be suggested that Dairy Farm performed similarly well as Tesco in 2005 and 2006. However, due to the size of Tesco’s operations and its ability to overtake its competitors, I would prefer investing in its shares. I have major concerns regarding Dairy Farm’s aggressive borrowing and delays in payments. I feel that if the company does not improve its operational efficiency in the future that it could face major difficulties and possibly take over the move by its competitors.