Executive Summary
This report covers the ratio analysis of Sharjah Cement and Industrial Development Company for the last three financial years. The company operates in the manufacturing and investment sectors. Among the ratios analyzed are the profitability, liquidity, asset utilization and debt utilization ratios. In addition, the degree of operating leverage and the degree of financial leverage ratios have been calculated for a period of the three most recent financial years of the company.
The analysis concludes that the company was profitable during the three-year period and is likely to increase its profitability levels in future financial periods. Its liquidity position over the period was also good, and the trend is positive. The management of the company’s assets was also consistent over the years and yielded good returns. The gearing level of the company was low since Sharjah Cement and Industrial Development Company was mainly financed by equity.
The high degree of operating leverage ratios of the company over the three-year period suggest that a large proportion of operating costs incurred by the company was fixed. The degree of financial leverage ratios were low and consistent over the period; suggesting lower finance costs in the company.
This report concludes by giving recommendations to two stakeholders of the company; the shareholders and potential lenders or creditors. To the shareholders, they are advised to maintain their stake in the company as the rate of return on their investment is likely to increase due to the swelling profitability levels. Debt-holders should consider advancing funds to the company when called upon to do so since its low leverage ratios suggest low financial risks.
About Sharjah Cement and Industrial Development Company
Sharjah Cement and Industrial Development Company is a cement manufacturing company incorporated in the United Arab Emirates. The company is 25 kilometers away from Sharjah city on the way to Dhaid. It mines limestone at quarries near Sharjah. It also manufactures and distributes paper sacks, cement as well as synthetic ropes (Sharjah Cement & Industrial Development Company 2014).
The company invests the surplus cash from its operations in real estates and securities. It was incorporated in 1977 and has grown in size over the years (Arabian Business 2014). The main markets for the company’s products are in Africa, Middle East, and the Gulf Cooperation Council countries.
Sharjah Cement and Industrial Development Company operates in the manufacturing and investment sectors. Its manufacturing division is primarily involved in making cement. Furthermore, production of ropes and sacks forms part of the company’s manufacturing portfolio. The investment division lets out property and invests in equities and funds, both private and public (The Wall Street Journal 2014).
The cement manufacturing industry in the Middle East is very promising due to the high rate of growth of the housing and construction industries in the region. The prices of cement in the UAE region have remained relatively stable because of agreements between cement and construction companies. However, the situation might change in the future because of the increasing operational costs and the market forces of demand and supply (Sharjah Update 2014).
North Africa, Yemen, and Iraq are markets for the products of Sharjah Cement and Industrial Development Company that have been very rewarding (Sharjah Update 2014). Investment income has also contributed towards the growth of the company by generating high profits.
Ratio Analysis of Sharjah Cement and Industrial Development Company
The maintenance of financial records is one way of ensuring that the performance of the company is monitored. The preparation of financial statements becomes necessary so as to give summarized reports to the stakeholders of the company (Chartered Institute of Management Accountants 2000).
The balance sheets and the income statements are the most common books of accounts. However, in their crude form, the financial statements do not give sufficient performance information to the stakeholders for purposes of decision making. It is at this point that the financial analysis becomes inevitable. The most common form of financial analysis carried out on financial statements is ratio analysis.
Ratio analysis is performed on the income statement and balance sheet items in order to produce smaller figures with decision-making significance. A comparison of these figures with the benchmarks set shows the relative performance of the company, thus providing a good ground for stakeholders to make decisions. The stakeholders who benefit from these ratios include the company’s management, shareholders, creditors, and lenders.
Ratios are classified into different categories depending on what they are used to measure about the company. The categories include profitability, liquidity, asset utilization, and leverage ratios. The profitability ratios measure the company’s ability to generate financial returns (Gibson 2009, p. 177).
Financial health, that is, the ability to repay short-term advances, is measured using liquidity ratios. The effectiveness of managers in exploiting the fixed and variable assets at their disposal to generate revenue is measured using asset utilization ratios. Leverage ratios show the capital gearing of the company (Gibson 2009, p. 177). This report shall analyze some of these ratios for Sharjah Cement and Industrial Development Company.
Profitability ratios
The profitability ratios analyzed for Sharjah Cement and Industrial Development Company include the two margins (gross profit and net profit), return on assets (ROA) and return on equity (ROE).
Gross profit margin is a profitability ratio obtained by expressing the gross profit as a fraction of net turnover. It shows the efficiency with which the firm undertakes its production process, that is, its ability to control the direct costs of production (Moyer, et al. 2012, p. 82). A high gross profit margin is preferred to a lower one.
The gross profit margin of 8.42% in 2013 for Sharjah Cement and Industrial Development Company suggests that most of the costs incurred by the company were direct costs. However, the trend over the three-year period is positive as there was a consistent increase in gross profit margin.
The net profit margin is a percent expression of the revenue left after the direct and overhead costs are met (Khan & Jain 2007, p. 62). For Sharjah Cement and Industrial Development Company, a net profit of 7.86% for the financial year ended 31st December 2013 was an improvement from the two previous years of operation. This improvement is considered positive since the company is a growing organization. However, this performance was below the benchmarks set.
The return on assets, also referred to as return on investment, expresses the net profit from operations as a percentage of the total assets of the company (Rich, et al. 2012, p. 610). It measures the ability of the managers to utilize the assets at their disposal to generate returns for the company (Moyer, et al. 2012, p. 82). A higher ratio indicates superior performance. The trend of return on assets for Sharjah Cement and Industrial Development Company is positive. However, the ratios were not satisfactory as the benchmarks were higher than those achieved by the company.
The return on equity ratio shows the net profit as a percentage of shareholder-generated funds (Stowe, et al. 2007, p. 88). It measures the amount of returns generated by each monetary unit attributable to the owners of the company. The return on equity ratio for Sharjah Cement and Industrial Development Company increased consistently over the three latest financial years, which is commendable. However, it was still below the official benchmarks, thus not very impressive compared to similar ratios of most companies in the same industry.
Liquidity ratios
The liquidity ratios analyzed for Sharjah Cement and Industrial Development Company are the current ratios and the quick ratios. The current ratios measure a company’s short-term liquidity, hence its ability to offset short-term debts by paying its creditors using the current assets held by the business (Moyer, et al. 2012, p. 82).
A current ratio of below 1 shows the inability of a firm to pay back amounts owing to its creditors in case they fall due soon. The current ratios for Sharjah Cement and Industrial Development Company over the three-year period under consideration were above 1. The trend identified is towards improvement in the liquidity position of the company over the three-year period. However, the figures were still below the official benchmarks, except for the market benchmark.
The Quick ratio measures the short-term liquidity of the company (Healy & Palepu 2012, p. 423). In the calculation of quick ratio, we subtract the inventories from the total current assets since inventories are the least liquid in that category (current assets). The quick ratios of Sharjah Cement and Industrial Development Company were above both the company’s and the market averages during the three-year period considered. However, it was below the industry’s benchmark for the period. The annual increase in the quick ratio shows a trend towards increasing liquidity of the company.
Asset utilization ratios
The asset utilization ratios analyzed for Sharjah Cement and Industrial Development Company are the total asset turnover and inventory turnover. The Total asset turnover ratio calculates sales to total assets percentage (Healy & Palepu 2012, p. 424). The total asset turnover ratios of Sharjah Cement and Industrial Development Company over the last three financial years were almost constant between 33-35%. These almost ratios suggest that the company maintained its operations at a constant efficiency level over the three-year period.
Inventory turnover is an asset utilization ratio that measures how efficiently the stock levels were managed by an organization. It shows the frequency with which inventory batches were produced during the period. The more the number of times the batches were produced and sold by the company, the better it is for the company as it results to more revenue creation. According to the inventory turnover figures derived from the financial statements of Sharjah Cement and Industrial Development Company, inventories were ‘turned’ about two times during each financial year.
Leverage ratios
The leverage or capital gearing ratios that were analyzed for the last three financial years of Sharjah Cement and Industrial Development Company include the debt to equity ratio, borrowing ratio, equity to assets and leverage ratios. Financial leverage or gearing is a very significant factor that investors such as shareholders and lenders put into consideration when making investment decisions. A highly geared company is not attractive to investors as its chances of insolvency are very high.
The debt to equity ratio measures the proportion of non-owner funds to shareholders’ contributions in the company’s capital structure. If this ratio exceeds 100%, the company is said to be highly geared as the amount of debt capital exceeds shareholders’ funds (Randall & Hopkins 2012, p. 234).
During the two financial years ended 31st December 2011 and 2012, Sharjah Cement and Industrial Development Company had no long-term debt, hence no gearing. However, the ratio increased during the financial year ended 31st December 2013 to 3.09%, which was below the benchmark ratios.
The equity to assets ratio shows the residual claim on assets by the shareholders of the company. It measures the proportion of owners’ equity in the total assets of the company (Healy & Palepu 2012, p. 424). This leverage ratio was high, about 75% during the three years under consideration for Sharjah Cement and Industrial Development Company. The ratio was higher than similar benchmarks for the company, industry, and the market. The high ratio was positive for the company as it was not at risk that arises from having a large proportion of its operations financed by external sources of funds.
Borrowing ratio refers to the total debt of a company expressed as a fraction of the net worth of the company (Gibson 2009, p. 177). In the years 2011 and 2012, Sharjah Cement and Industrial Development Company had no borrowed funds. Borrowing ratio was thus not applicable during that period. In 2013, the ratio was favorable for the company since it was below the official benchmarks. The leverage ratio was also positive for the company over the three years as it was below the benchmark figures.
Comments about the profitability, liquidity, asset utilization and debt utilization
Based on the figures discussed above, it is evident that Sharjah Cement and Industrial Development Company is a profitable company in that it generates positive returns on the capital invested. The trend shown in the profitability ratios towards an increase in profit levels is an indication that the company is likely to record more profits in the future financial periods. However, its failure to attain the desired profit levels as shown by the benchmarks over the three-year period raises concern.
The liquidity position of Sharjah Cement and Industrial Development Company was excellent over the last three financial years, which is an indicator of sound financial management in the company. The trend towards a continuous increase in liquidity is an indicator that the company is unlikely to fall into cash-flow problems in the future, thus promising a smooth flow of operations.
The turnover ratios of Sharjah Cement and Industrial Development Company indicate a consistent operational approach to asset management. Both the total asset turnover and rate of stock turnover were consistent over the three-year period. This consistency suggests that standard policies were adopted for the management of assets.
The leverage ratios portray to a large extent the company’s capital structure, which shows the relative amounts of equity and debt used to finance the operations of the company. The leverage ratios of Sharjah Cement and Industrial Development Company over the three-year period show that a large proportion of the company’s operations were financed by equity. In the year 2011 and 2012, the company had no long-term debt, meaning that it was only financed by equity.
The small proportion of external financing in the company in the year 2013 shows that the company was not highly geared, thus reducing the interest expenses and making the company attractive to investors such as shareholders and lenders.
Sharjah Cement and Industrial Development Company can be said to have a stable dividend policy as deduced from the dividend per share paid out to its shareholders. Since the financial year 2011, the management of the company has maintained the payment of a dividend per share of AED 0.05, regardless of the amount of earnings (or loss, as in the year 2011) made by the company in each financial year.
Degree of operating leverage (DOL)
The degree of operating leverage ratio is a measure of the effect of operating leverage of a company on its probable earnings (Kolb & DeMong 1988). It stems out from the notion that if a firm incurs fixed operational costs, a change in sales revenue results to a larger change in operating profit. This direct relationship is because the fixed operating costs remain the same during the period. The uncertainty about the amount of operating profit is normally given by a high degree of operating leverage. The table below shows the degree of operating leverage of Sharjah Cement and Industrial Development Company during the last four financial periods:
The degree of operating leverage ratios calculated above shows that changes in sales result to more than proportionate changes in earnings before interest and taxes. The DOL has been changing over the years on a random basis, making it unpredictable to estimate similar future variables. For instance, in 2010, a 1% change in sales resulted to 1.75% change in EBIT in the same direction. In 2011, a 1% change in sales resulted to 103% change in EBIT in the opposite direction. In 2012 and 2013, a 1% change in sales resulted in 31.31% and 65.45% change in EBIT respectively.
It is, therefore, evident that the expenses of the company contained both fixed and variable operating costs, which resulted to fluctuations in the amounts of earnings before interest and taxes due to changes in the level of sales.
Degree of Financial Leverage (DFL)
The degree of financial leverage is a financial ratio that shows how sensitive the earnings per share are to changes in operating income as a result of changes in the capital structure of the company. It is a multiplier effect emanating from having fixed capital costs in the business, in which case a change in EBIT translates into a larger change in earnings per share. Capital costs include interest expenses on loans and debentures and preference dividends. The table below shows the degree of financial leverage ratios of Sharjah Cement and Industrial Development Company during the last four financial periods:
The degree of financial leverage ratios for Sharjah Cement and Industrial Development Company as calculated in the table above depict a small value for all the financial years under analysis. All the values can be rounded up or down to 1. This low value is an indicator that the company had little or no capital costs. It means that the company’s capital structure had no fixed interest rate capital sources such as preference shares, debentures, and long-term loans.
Hence, the company’s financial leverage was low, since a high proportion of the company’s capital is equity. A high proportion of equity capital in the company is a good signal to shareholders and lenders as the financial risks of the company are minimal.
Conclusions
The preparation of financial statements for companies is a paramount exercise. However, for purposes of decision making, the information relayed by the financial statements is not sufficient. Financial analysis in the form of ratio analysis produces summarized figures that have decision-making significance.
The ratios are categorized differently depending on their intended purposes. As such, there are the profitability, liquidity, asset utilization and debt utilization ratios. Other advanced ratios include the degree of operating leverage and the degree of financial leverage. The degree of operating leverage (DOL) is used when determining the degree to which fixed operational costs affect the relationship between the net profit and changes in the level of sales.
The degree of financial leverage (DFL) ratio shows the extent to which earnings per share change as a result of fixed finance costs. It is thus mainly affected by changes in the capital structure of the company.
The analysis of the ratios in respect of Sharjah Cement and Industrial Development Company shows that the company had a positive profitability trend over the last three financial years. The company had a strong liquidity position as depicted by the liquidity ratios. The asset management policies of the company were also consistent as communicated by the asset utilization ratios. The company’s degree of leverage was low, meaning that it was financed to a large extent by equity.
Recommendations
This report has several recommendations to the shareholders and other stakeholders of Sharjah Cement and Industrial Development Company. To the existing shareholders, it is advisable to maintain their shares in the company because of the following:
- The profitability of the company is not questionable as the company is currently making profits. Although the current profitability of the company as measured by return on assets is below the benchmarks, the trend in the ratios is promising.
- The company is a going concern since it has no cash-flow problems. It has a low financial leverage, thus making it less risky since the company is only financed by debt to a small extent.
- The company has a stable dividend policy, meaning that dividend payment is declared by the company during each financial year with no regard as to whether the company makes profits.
- The company’s area of operation has been expanding since the rate of growth of Sharjah and other towns in the United Arab Emirates is high.
To the company’s lenders and creditors, it is advisable to extend credit when called upon to provide external funding with no fear of default as the financial risks of the company are low. Being a financially sound company, Sharjah Cement and Industrial Development Company is in a position to repay its debt and the interest charges thereon.
References
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