Financial Ratios
The financial ratios are valuable to the different stakeholders of the company especially the shareholders as they reveal the financial health of the company in terms of liquidity, efficiency, profitability and leverage. The management of the company is also able to analyze the cash and debt management practices of the company. This paper analyzes the various financial ratios of the Billabong International Limited.
Liquidity
The company has excellent working cash management policies. This refers to the current assets of the company which are used to settle short-term liabilities. In most industries the recommended ratio is 2:1 (Padachi, 2006). The company has however excess liquidity which could become an issue in the future. Working cash management is about strategically striking a balance between liquidity and profitability (Gill, Biger & Mathur, 2010). The excess liquidity represents cash that could have been invested in other securities to earn a profit.
The quick or acid-test ratio analyses the liquidity of the company like the current ratio however it is stricter in that the inventories are not included in the ratio. The liquidity of the company decreased however it is still at a manageable level and the company should not have a high risk in defaulting to settle its short term obligations.
There are ratios that the management of the company can use to analyze its cash management policies. These are the receivables turnover and the average collection period ratios. The receivable turnover measures the ability of the company to convert its debtors into sales. It analyzes the credit management policies of the organization (Shelton, 2002). The liquidity of the company increases when the rate is higher. The rate increased to 4.36 in 2011 from 4 in 2010 which is really a step in the right direction. The company should not hold a lot of funds in its accounts receivable which can be used for investment purposes (Appuhami, 2008).
It is about striking a balance between investment and sales. A credit policy that is too restrictive may also work against the company as they will low sales. Most companies buy supplies on credit and would prefer to have some time to settle its obligations.
The average collection period analyzes the time that the debtors are given to settle their obligations. In 2010, the credit policy was to give the debtors 90 days or three months to settle its obligations however the management in 2011, tightened its policy because on average the period was 84 days. This is a good sign as the company has reduced the funds held in the accounts receivable.
Cash management focuses on analyzing the inventory turnover, receivables turnover and the payables turnover. The company may enter into negotiations with its creditors to lengthen the payment time in order to increase its liquidity (Nazi & Afza, 2009). In overall the company’s cash management policies are appropriate.
Solvency Ratios
These are leverage ratios that are highly analyzed by the creditors and existing and potential shareholders. If the company is unable to settle its obligations then the creditors can cause the company to be wound up. The debt asset ratio is a ratio that analyzes the portion of the assets that has been financed through debt. The higher the ratio, the riskier it is for the company as it means it is highly leveraged.
Debt signifies interest payments that have to be paid yearly unlike dividends which can be postponed by the company retaining the profits. The company increased its debt in
2011 from 45% to 50%. The company may need to look at its debt management practices.
The solvency ratio is a ratio that analyses the profit of the company compared to the debt of the company. In most companies it is recommended that the management should maintain it at 20%. The company is performing badly when it comes to the solvency ratios. It was lower than the recommended rate at 20%. It was at 15%. In the next year, the management of the company did not address the situation. The rate deteriorated to 9.74%.
The profit of the company is what the company uses to settle its finance costs. If the company’s profit is much lower compared to the debt proportion, it is not a wise direction to take. The times interest earned ratio shows the creditors how many times the company is able to settle its interest obligations or finance costs using its pre-tax profit. The higher the ratio is, the more the creditors have confidence in the debt management policies of the company. The times interest earned ratio of the company decreased by 50% within in 2011.
This was caused by the reduction in the profitability of the company from $203,031,000 to 126,900,000. This was further compounded by the rise in interest costs in the two years from $25,164,000 to $37,448,000. The company should strategize on increasing the profitability of the company as this is what will raise the time interest earned ratio. Another ratio used to analyze the solvency of the company is the operating cash flows to total liability ratio. This analyzes the ability or the capacity of the company to settle its obligations using its annual operating cash flows.
This ratio is at times preferred to the times interest earned ratio since the capability to settle obligations is based on cash flows and not income. The interest payments are actually paid out from the cash account of the company. In the year 2011, the rate actually decreased showing the decrease in the operating cash flows. This was caused by the decrease in the difference in the operating cash flows from debtors and what the company paid to the creditors. In the year 2011, the company also had higher finance costs. This is an area that the management has to look it into and maintain a constant or upward trend.
Activity
The inventory turnover is a ratio used to analyze the frequency with which the company is able to convert its inventory into revenue. The ratio increased in the year 2011. A higher inventory turnover is preferred as it shows that the company has strong sales.
A low ratio discouraged as it shows that a company is holding high inventory. There are associated costs in holding excess inventory such as storage costs and insurance. These costs should be less than the costs of safety stock and stock-outs.
The company improved in this area and in 2012 even more effort can be applied. The management can also analyze its ability to utilize the fixed assets of the company to generate sales. Fixed assets are invested long-term compared to the current assets. This is a ratio that did not change in the two years. It remained constant at 1.12. The company should look into ways to increase the asset turnover in the 2013 year.
Profitability Ratios
There are several profitability ratios that can be used to scrutinize the company. The investors of the company are interested in the return on equity and return on assets ratios. Return on assets and equity analyze the efficiency of the company in terms of utilizing the resources that it has. The return on assets ratio decreased showing that the company efficiency reduced.
This can be attributed to the company’s decrease in net profit. The total assets of the company increased however the net profit decreased leading to the low ratio. This ratio can be addressed by the company increasing its profitability. The investors of the company are also interested in the efficiency in utilizing the equity of the company.
The return on equity ratio also decreased which is not a good sign. This can also be attributed to the lower profits achieved in 2011.
The profit margin is a crucial ratio as it addresses the ability of the company to control its expenses or costs. It measures or compares the net profit and the revenue figures. The ratio decreased in the year 2011, showing that the company did not control its costs well. A look at the income statement shows that the costs increased in all the areas such as selling expenses, other expenses and the finance costs. Yet the net profit did not increase to justify the increase in costs. Instead the profits went down contributing to the reduction in profit margin.
The existing and potential shareholders of the company are interested in the earnings per share of the company. What is the gain on each share? This determines the dividends that the shareholders will receive once the management announces the dividend payout ratio. The basic earnings per share and diluted earnings per share information have already been availed by the company.
In 2011, the shareholders experienced a reduction in the basic earnings per share from 58.3 cents to 47.4 cents. This can be attributed to the reduction in the net income of the company from $148,988,000 to $119,139,000. The shareholders will be concerned. The role of the finance manager in any organization is to increase the share value or earnings which the shareholders are mainly concerned about. The diluted earnings per share also decreased from 57.8 cents to 47 cents.
Diluted earnings per share show the shareholders their earnings when all the convertible securities are taken into consideration. These could be the convertible preference shares, debentures, stock options and warrants. This measure is a conservative measure since it is highly unlikely that all the people holding their convertible securities will act on them. It is a ratio used to show in worst case scenario what the shareholders will get in terms of earnings.
An analysis of the company’s EPS and diluted EPS shows there is no big difference which is a good sign for the investors. A high difference is looked unfavorable by investors and analysts as it shows the high potential of the dilution of the company’s shares.
Conclusion
The Billabong Company financial ratios show that it was able to increase its liquidity and activity ratios. However due to the reduction in profits in 2011, the profitability ratio exhibited a downward trend. The company also took up more debt in 2011 to finance its investments. In the year 2011, profit and debt management should be the main focus.
Appendices
Liquidity ratios
Current ratio = current assets/current liabilities
- 2010 = 878,685/354,779 = 2.477
- 2011 = 908,854/389,208 = 2.335
Quick/Acid Test ratio = current assets-inventory/current liabilities
- 2010 = 878,685-240,400/354,779 = 1.799
- 2011 = 908,854- 348,738/389,208 = 1.439
Receivables turnover= sales/average accounts receivable
- 2010 = 1,487,527/365,657= 4
- 2011 = 1,687,733/386,377= 4.37
Average Collection Period= No. of days in accounting period*average accounts receivable/sales
- 2010 = 365*365,657/1,487,527= 90
- 2011 = 365*386,377/1,687,733= 84
Solvency ratios
Debt/Asset ratio= Total Debt/Assets
- 2010 = 992,740/2,210, 319 = 45%
- 2011 = 1,223,126/2,419,965= 50%.
Solvency ratio= after tax profit/total debt
- 2010 = 145,988/992,740 = 15%
- 2011 = 119,139/1,223,126 = 9.74%
No. of times interest earned ratio = EBIT/Interest
- 2010 = 203,031+ 25, 164/25,164 = 9.07
- 2011 = 126,900 + 37,448/37,448 = 4.39
Operating cash flows = operating cash flow/total liabilities
- 2010 = 187,247/992,740 = 0.19
- 2011 = 24,336/1,223,126 = 0.02
Activity Ratios
Inventory Turnover = revenue/inventory
- 2010 = 1,487,527/240,400 = 3.10
- 2011 = 1,687,733/348,738= 4.84
Fixed Assets Turnover = revenue/fixed assets
- 2010 = 1,487,527/1,331,634 = 1.12
- 2011 = 1,687,733/1,511,111= 1.12
Profitability ratios
Return on assets = net income/assets
- 2010 = 145,988/2,210,319= 6.6%
- 2011 = 118,045/2,419,965= 4.9%
Return on assets = net income/equity
- 2010 = 145,988/1,217,579= 12%
- 2011 = 118,045/1,196,839= 9.86%
Profit Margin = net profit/revenues
- 2010 = 145,988/1,487,527= 9.81%
- 2011 = 118,045/1,687,733= 7%
References
Appuhami, R. (2008). The Impact of Firms’ Capital Expenditure on Working Capital Management: An Empirical Study across Industries in Thailand. International Management Review, 4(1), 8-21
Gill, A., Biger, N. & Mathur, N. (2010). The Relationship between Working Capital Management and Profitability: Evidence from the United States. Business and Economics Journal, 1-9.
Nazir, M. & Afza, T. (2009). Impact of Aggressive Working Capital Management Policy on Firms’ Profitability. The IUP Journal of Applied Finance, 15(8), 19-30.
Padachi, K. (2006). Trends in Working Capital Management and its Impact on Firms’ Performance: An Analysis of Mauritian Small Manufacturing Firms. International Review of Business Research Papers, 2 (2), 45 -58
Shelton, F. (2002). Working Capital and the Construction Industry. Journal of Construction Accounting and Taxation November/December Issue, 23- 27.