The study analysis of the financial statements of a company helps to determine the overall condition of a business. Analysis of statements helps put financial statement into perspective, helping out to spot financial patterns and trends that may threaten the very existence of that company.
The study can be done using different methods, ratios being the best and most simplified. The information gathered from such an analysis is used by different parties for different purposes:
The shareholders make use of financial data to determine whether their investments are worthwhile or not. It also enables the shareholders who are the owners to evaluate the performance of the management team of such a company
The top managers use that information to determine the overall performance of the company. It helps them make sound decisions to enhance profitability and growth of the firm
Financiers especially the banks which advance credit to these companies are interested to know the financial status of such companies for them to determine whether or not to advance credit to such a company. They are mostly interested with cash flow status of such companies.
People who are seeking to invest their funds also look out for financial data of such companies to make well informed decisions as pertains to their investments and where they will get best returns.
Methodology and sources of data
The data used in the evaluation of a company’s performance is obtained from the different financial statements of the company involved. These include
This is one is mostly used to analyze an overall performance of company. It shows the net worth of a business and also it shows the shareholders equity and such.
The income statement more or less shows the different activities that the company was involved in. the different activity ratios are shown by the income statement.
Cash flow statement
Cash flow statements show the liquidity status of the company and actual flows of cash in and out of the company. This is mostly of much interest to financiers.
Scope and limitations
The scope of studying of financial statement depends on the type of user of these statements. The limitations of the financial statements are mostly due to the users’ ability to interpret and understand the financial data. In many cases it requires that the interpreter be a person who understands some aspects of accounts and finance. Therefore for the laymen interpretation and use of financial data so analyzed becomes a problem.
Production and Cost analysis
Nature of product line and underlying technology
Saudi International Petrochemical Company (Sipchem) actively develops and invests in petrochemical and chemical industries both basic and intermediate to produce chemicals used to manufacture many products. Therefore the product line that Sipchem deals with is a high profit area as they deal with oil and oil products. The products dealt with are also a high risk area in terms of health and environmental risk.
Production capacity and output volume
The production capacity and output volume of the company was enhanced by the acquisition of new plants and site. This in turn had a direct bearing on increased profitability.
Break even analysis
Break even point is the point at which a company makes neither a profit nor a loss. This is where the contribution equal to the fixed costs of the company
B.E.P = Fixed cost = 48494/821720 = S.R
Degree of operating leverage
This is a type of leverage ratio that helps to determine the effect that a given level of leverage has on earnings potential of the firm. For the year 2006 the company made less use of debt financing than previous, but still the income grew to show that the current level of leverage is optimum.
Financial Ratio and Trend Analysis
Liquidity ratios analyze the ability of a company to meet the short term obligations as they fall due. The commonly used ratios are:
- Current ratio = Current Assets/Current liability = 1764109/601237 = 2.934
- Quick Ratio = Current assets – Inventory/Current liability= 1764109-59962/ 601,237
The above ratios show the company’s liquidity = 2.834
Is sound = 2.834:1
Activity ratios measure the operating characters of the firm. They include such ratios as inventory turnover rate, average collection period. Fixed asset turnover ratio, total asset turnover ratio
|APP = Accounts payable |
It shows the average payment period
|Fixed Assets turnover = sales |
Net fixed Asset
Fixed assets turnover ratio measures how effective company uses its fixed assets to generate sales. The higher the fixed asset ratio the better
Inventory turnover – cost of Goods/Total inventory – the higher the better
Also referred to as Debt to Equity Ratio
It includes the extent to which a business relies on debt financing upper acceptable limit is 2:1
Debt leverage ratio = Total debt/Total shareholders equity= 2856701/2405505 = 1:187
Since the company has not reached upper limit it is in safe ground.
Shows how successful a company is in terms of generating returns or profits on the investment that it has already made in the business
- Returns on sales/profit margin = Net profit/Net sales X100
- Return on Assets = Net profit/Total assets
This seeks to show whether the company has made any significant improvement in the revenues as well as overall income. These are the indicators of whether a company is growing
- Net income = Current income – Previous years income/Previous income X 100
- Revenue/Sales Growth = Current sales – previous years sales/Previous year’s sales X 100
- Net income growth = SR 493,693,293 – 324960565/324,960,565 X 100 = 51.9
- Sales Revenue = 1,333,990,256 – 726,087,384/726,087,384 X 100 = 83.73
The company registered improved growth for year 2006 with Net income growing by more than 50% while sales Revenue grow by more than 80%
Profitability ratios continued
Returns on sales/Profit margin = S.R 519141/1,333,990 X 100 = D.389 = 38.9%
Return on Assets = 519141/5262206 X 100 = 0.09865 = 9.86%
Activity ratios continued
Fixed Assets turnover = 5262206/3199862 = 1.6465
Capital Investment and financing
Analysis of capital expenditure
Company Balance sheets of year ended 31/12/07 and year ended 31/12/06 shoes a great increase in the capital expenditure with an increase from SR 31991862 to SR 5416419. The expenditure was worth it since it resulted to an increase in net income of nearly S.R 100,000
Average rate of return on investment
The average return on investment is a ratio which seeks to compare the rate at which capital investment is making a profit. Shows how successful a company is in terms of generating returns on investment it has made in the business
Return on Equity (ROE)
= Net Income/Shareholders Equity X 100 = 519,140,921/2960007391 X 100
A return of 17.53 on capital investment is a good return since it is higher than the cost of acquiring capital
Short term vs long term Sources of financing
This seeks to compare the proportion in which a company mixes/makes use of long term loan facilities and short term facilities. It is a good indicator of a company’s liquidity status. A less liquidity company makes a lot of use of short term loans which are very expensive hence endangering the company’s worth and cash flows.
Short term loan/Long term liabilities
For year ended 31/12/06 the company did not make use of short term loans. The company is in sound liquidity position since it makes more use of long term debt rather than short term loans.
This is a ratio that measures a company’s capital structure. It measures how much a company is making use of debt capital in addition to Equity finance
Debt ratio = Total Debt/Liability/Total Assets
For the year ending 31/12/06 = 2,856,701/5,262,206= 0.5428
Debt to Equity ratio = Total Debt/Total Equity = 2856701/ 2,405,505 = 1.187
The % of debt capital is 70% which is quite high and this threatens the company with bankruptcy
New Common Stock issue
The Balance Sheet shows an increase/New stock issue. There was new issue of common stock worth more than 850 million Saudi Riyals. The capital increase was used to finance projects envisaged in the year 2005. Thus the increase in fixed assets
Dividend policy ratios provide insight into the dividend policy of the firm and prospects for future growth.
Different ratios used include:
Dividend yield = Dividends per share/Share price
Payout ratio = Dividends per share/EPS
For year ended 31/12/06 Saudi International Petrochemical Company did not declare payout dividends. This indicates that the liquidity position was not very good or that they retained all earnings for re-investment. This shows the company’s would attract long term investors whose wish is to see the net worth of company grow rather than receive dividends.
Sources and uses of funds
From the cash flow statements it shows that the company relies heavily on debt capital rather than owners’ capital. These funds are more used to finance the increased fixed assets of the firm and also to meet the increased company expenses. There is also an issue of common stock worth S.R 850 million. This also has been put into good use to finance the expansion activities.
Estimate of the cost of capital
The estimated cost of capital for Saudi International Petrochemical Company is 15%
Evaluation of stock price performance in the market
This is the original value of the share and this is the value that appears in the Balance sheet of the firm. The par value is S.R 50
The book value per share is the current value of the shares as regards the book value of the company. This is different from both the par value of market value of the shares. For Saudi International Petrochemical it is S.R 16.04 for year ended 31/12/06
The current market value of the share is far much higher than its par value or book values indicating that the company is doing well since the shares are trading at a premium
Earnings per share
This expresses the net income of a company in relation to the number of common shares of the company
EPS = Net income/No of common shares outstanding= 3.29
DPS – 0
Since the company did not declare any dividends for the year ended 31/12/06 the DPS is 0. This may indicate liquidity troubles within the company
P/E Ratio = Market price of common stock per share/Earnings per share= 17.60/2.47 = 7.12
Summary and conclusion
Weakness of Sipchem
A deep analysis of the financial statement of Sipchem shows some few weaknesses which need to be acted upon. These include
The company did not declare/nor pay dividends for the year ended 31/12/06. This might be a red flag that the finances of the company might not be in order especially its liquidity status.
Level of leverage
The company is highly geared up to a level of 70%. This is not very healthy for the company since it shows a heavy reliance on debt finance which puts the company on risk of bankruptcy.
Strengths of Sipchem
Sipchem according to the financial statements is a going concern basis.
From the liquidity ratios it is evident that the company at 31.12.06 was able to meet its short term obligation with a liquidity ratio of 2:9:1 thus a great strength.
The other strength of the company is that the revenues and net income of the company are growing. With growth in revenues and net income, it is a good indicator that in the next few years, profitability will increase to extent of even being able to pay out dividends.
Since an increase fixed assets increased profitability, it shows that the company is effectively and efficiently using the assets to generate profit.
Points of improvement
For the company to be in safe ground, management should consider using more of retained earnings to finance projects rather than heavily relying on debt capital which is costly and very risky.
To motivate investors the company should consider dividend payment however little or insignificant
Data and information lifted 2009. Web.