Executive summary
This paper carries out a comparison of financial performance of two companies in the same industry. The analysis uses financial data for Premier Investment Limited and David Jones Limited for a two-year period that is, from 2010 to 2011. The study concentrates on the background of the companies and ratio analysis (ratios on profitability, efficiency, financial stability and Liquidity). It interprets the results in comparison with ideal situations and makes recommendations based on the findings. Further, it discusses the drawbacks of ratio analysis as a way of monitoring financial performance.
Background of the company
Premier Investments Limited is based in Australia. The company is listed on the Australian Securities Exchange (ASX). This is as from 15 December 1987. Premier Investment Limited was established “as an investment company to maximize growth in capital returns to shareholders through the acquisition of controlling or strategic shareholding in premier Australian companies with a particular concentration on the areas of retailing, importing and distributing” (Premier Investment Limited 2012b). Currently, the company owns “brands Just Jeans, Jay Jeans, Portmans, Jacqui E, Peter Alexander, Dotti and Smiggle, Coles Myer Limited, and Just Group” (Premier Investment Limited 2012b). The entity operates a number of “specialty retail fashion chains within a specialty retail fashion market in Australia, New Zealand and in South Africa via Joint Venture” (Premier Investment Limited 2012a). It also has an investment in listed securities and money market deposits.
David Jones is also an Australian-based company. The mission of the company is to “sell the best and most exclusive goods and to carry a stock that embraces the everyday wants of mankind at large” (David Jones Limited 2012a). The company offers a wide range of services such as corporate services, insurance, gift cards, flowers, food hall, interior decorating, and the rose clinic among others (David Jones Limited 2012b). Both companies are in the same industry. This paper attempts to compare the financial performance of the two companies.
Analysis of performance
Various stakeholders of a company such as shareholders, government, employees, community, and creditors among others use the audited financial statements of a company. However, published financial statements give the potential users a narrow insight into the actual performance, strengths and weaknesses of an entity. This is because the reported financial statements do not give an in-depth depiction of the performance of an entity (Siddiqui 2005). Such a comprehensive view of a business is necessary because they influence users’ decisions on whether to continue their association with an entity. In addition, it would give potential investors adequate information that can aid them in decision-making. Therefore, it is necessary to carry out an analysis of the financial statements so as to have a clear understanding of the performance of a company and trends over time. This brings us to the concept of financial analysis.
Ratio analysis
Financial analysis is the process of evaluating businesses, projects, budgets, and other finance-related documents to determine their suitability for investment. It is necessary to carry out comprehensive financial analysis so as to establish the stability, solvency, liquidity, or profitability of an entity (Vance 2003). In carrying out financial analysis, a financial analyst focuses on the statement of income, statement of financial position, cash flow statement, and statement of changes in equities (Melicher & Leach 2009). Ratio analysis is a key technique for financial analysis. While inferring the current performance into the future, the time value of money should be taken into consideration. This section compares the financial performance of Premier Investment Limited and David Jones using ratio analysis for the years 2010 and 2011. Profitability
Profitability is the ability of an entity to earn income and sustain growth in both the short term and long term. It measures how well an entity uses its resources to generate profit. It also measures the efficiency of managing resources. An analyst uses various ratios such as gross profit margin, operating profit margin, net profit margin, the return on assets (ROA) ratio, and the return on equity (ROE) ratio to check for profitability (Melicher & Leach 2009). Analysis of the income statement gives an insight into the profitability of the two companies. Appendix 1 below gives ratios of profitability of the two companies.
The table summarizes four profitability ratios. The first ratio is the profitability margin. It is the ratio of sales to the net profit that is, after deducting all expenses. It measures the earning power of a company. It is advisable to have high net profit margins. However, the net profit margin varies from one industry to another. From the table above, in 2010, it is clear that Premier Investment had a higher net profit margin than David Jones. However, in 2011 the net profit margin for David Jones was higher than that for Premier Investment Limited. The margin for Premier Investment declined from 16.11% in 2010 to 9.54% in 2011. On the other hand, the margin for David Jones increased from 12.11% in 2010 to 12.62% in 2011. It is that the net profit margin for David Jones is relatively more stable than that of Premier Investment Limited. Return on equity measures the return that owners receive on their investment. Investors expect high returns from high-risk companies. David Jones gave a high return of 22.91% in 2010 to its investors than Premier Investments limited which offered 9.24%. Both declined in 2011 to 4.35% for Premier Investment Limited and 21.45% for David Jones Limited. It is apparent that return on equity declined in 2011 for both companies. Return on assets indicates how effectively a company uses its economic resources. David Jones has a higher return on assets than Premier Investment Limited. This may not necessarily indicate favorable performance. This is because if a company has fully depreciated assets, then the denominator is likely to be small. This will result in high ratios. Therefore, when comparing the return on assets, it is necessary to consider the value of the assets (Nikolai, Bazley & Jones 2011). From the above comparisons, it is clear that the profitability of David Jones Limited is higher than that of Premier Investment Limited.
Efficiency ratios
Efficiency ratios provide an indication of how well a company manages its resources, that is, how well a company employs its assets and liabilities to generate sales and income (Brigham & Michael 2009). Further, it also shows the level of activity of an entity as indicated by the turnover ratios. Improvements in efficiency should help increase profitability and cash flow. Commonly used ratios are accounts receivable turnover, accounts payable turnover and days payable among others (Haber 2004). Appendix 2 below summarizes efficiency ratios.
From the table, asset turnover measures the utilization an entity obtains from investing in fixed assets. A high figure indicates that an entity is efficiently utilizing its assets. It also shows that an entity is getting high sales revenue from each unit of its assets (Tutor2u 2012). The asset turnover for David Jones was higher than that of Premier Investment Limited during the two-year period. However, there was a decline in asset turnover from 2010 to 2011. Inventory turnover measures the number of times in a year a company sells and replenishes its stock. That is the number of bundles of stock sold in a year. Stock turnover, in days, shows the number of days that stock is held awaiting sales. A high turnover indicates that faster release of stock. This in turn releases cash and profit faster (Vandyck 2006). It results in reduced stock holding costs and minimizes the risk of obsolescence. David Jones had a high stock turnover in the two-year period than Premier Investment.
Debtors’ collection period shows the number of days that an entity’s debtors take to pay the firm amount owing. A high ratio indicates that an entity is worse at getting its debtors to pay on time. A figure which is much higher than the 30 days payment period should be looked into so as to establish the problem. On the other hand, a low number of days indicate that a firm is efficient at collecting its debts (McDaniel & Gitman 2008). Debtors’ ratios above indicate that both firms are very efficient at collecting their debts. They are all below five. However, David Jones is more efficient than Premier Investment Limited. Therefore, from the comparisons above, it is clear that David Jones is efficient when compared to Premier Investment Limited.
Financial stability
Financial stability shows a company’s vulnerability to risk. For instance, it shows the degree of protection provided for the business’ debt. An analyst can use several ratios such as debt to equity to measure the stability of a company (Missouri 2011). Appendix 3 below shows a summary of ratios for financial stability.
Debt to equity is the ratio of capital injected by owners and funds advanced by creditors. A high ratio shows the increased risk to creditors (Missouri 2011). The debt to equity ratio for the two-year period for David Jones is higher than that for Premier Investment. This may indicate that Premier Investment is more stable than David Jones.
The debt to asset ratio shows the extent to which assets cover the debt. A high ratio is favorable because it indicates that the assets of the company cover the debts adequately. The debt to asset ratio for David Jones is higher than that of Premier Investment. Finally, times interest earned to show the number of times profits of an entity covers interest. It shows the ability of an entity to pay both the interest of the debt and the principal amount. A high ratio is a favorable indication. Times interest earned ratio for David Jones is higher than that of Premier Investment. Even though the debt to equity ratio of David Jones is lower than that of Premier investment, a debtor is safely covered at David Jones. This is because the assets and profits cover the debt and interest well. Therefore, it is clear that David Jones is more financially stable than Premier Investment.
Appendices
Appendix 1: Profitability ratios
Appendix 2: Efficiency ratios
Appendix 3: Financial Stability ratios
Reference list
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