Executive Summary
This report provides a comprehensive analysis of the financial performance and standing of Westfarmers Company for the 2010 and 2011 financial years using Financial Ratios. The report uses the annual reports the company published in 2011, which covers its annual reports for the two consecutive fiscal years. Annual averages are used in order to remove the effect of seasonal fluctuations. The financial analysis shows that the company is financially healthy, highly efficient, and profitable and creates value for its investors.
Introduction
Background
This report provides a comprehensive analysis of the financial performance and standing of Westfarmers Company for the 2010 and 2011 financial years using Financial Ratios. To achieve this, the report will use the annual reports the company published in 2011, which covers its annual reports for the two consecutive fiscal years. Annual averages will be used in order to remove the effect of seasonal fluctuations. In this case, the report focuses on the company’s financial performance based on five key financial aspects:
The company’s liquidity ratios are calculated to determine its ability to meet its short-term liabilities. Secondly, efficiency ratios are calculated to determine the effectiveness of the company in managing its inventories and payments. Thirdly, profitability ratios are calculated to demonstrate the company’s overall performance in the two consecutive fiscal years. Fourthly, the company’s ability to manage its long-term solvency will be determined through financial ratios. Finally, investment ratios will be calculated to provide a clear indication of whether investing in the company’s stock is worth and the possible direction of the company in the future.
Aims and objectives
When determined, the five classes of financial ratios will indicate how well Westfarmers Company performed, which will provide insight into the changes that took place between the two fiscal years. They are also important in showing areas with available opportunities required to overcome challenges and threats in the industry. In addition, it makes the investors understand the company and the value attached to its stock in the stock market.
Scope of the report
The report will cover the financial aspects of the company. It will base the report purely on the company’s annual report published in 2011, which covers its performance for the two consecutive financial years 2010 and 2011. In addition, the report will provide a detailed explanation of each of the five financial aspects covered. The report is organized into three major sections. In the introduction section, a brief background of the report is provided, together with its aims and objectives, the purpose and scope.
In the body section of the report, a detailed analysis of the company is provided. It starts with a brief examination of the company’s background, including a brief history. Secondly, the calculations of the five classes of rations are determined. Each of the classes is followed by a brief but detailed evaluation of the figures. In the last section, a brief but detailed conclusion is made based on the findings.
Financial Analysis
Background to the company
Registered in Australia as a public limited company, Wesfarmers traces its origins in 1914 when the Western Australian Farmers’ Cooperative was established in Western Australia. Initially, a farmers’ cooperative union, the company has grown to become a major company dealing in diverse business activities, including supermarkets, coal mining, home improvement and office supplies, departmental stores, insurance, farm fertilizers, energy, chemicals, safety and industrial products. Its products are distributed throughout the country and beyond. Currently, the company is one of the country’s largest employers. In addition, it is publicly listed as a public limited company on the Australian Securities Exchange (ASX) according to the Australian corporate law, with more than 500,000 shareholders.
The company’s objective states that it seeks to remain committed to providing its shareholders with a satisfactory return. Its expansion is based on its slogan of “proud history, strong future” Westfarmers (2011), p.
Ratio Analysis
Liquidity Ratios (Short-term solvency ratios)
Liquidity ratios measure a company’s ability to meet its short-term obligations, implying that they measure the organization’s financial health.
Current Ratio
The current ratio is the most basic form of liquidity measurement. It signified the ability of a company to meet its short-term liabilities using the short-term assets in its disposal Helfert (2008), p. 54. When the current ratio is greater than or equal to one, there is a clear indication that the company can meet its short-term liabilities using its short-term assets Ehrhardt and Brigham (2008), p. 129. A current ratio of less than one provides an indication that the company’s current assets are not enough to meet its short-term liabilities Ehrhardt and Brigham (2008) p. 131. The following ratio is used to determine the current ratio.
Current Ratio= current assets Ă· current liabilities
Quick Ratio
In financial accounting, the quick ratio is one of the strongest measures of liquidity. Unlike quick ratio, it ignores assets like inventories prepaid because it is difficult to convert them into cash. Like the current ratio, the size of the current ratio determines the company’s ability to meet its short-term obligations. When the quick ratio is equal to or greater than one, it indicates that the company can effectively meet its short-term obligations Ehrhardt and Brigham (2008) p 138. On the other hand, a small quick ratio suggests that the company is less capable of meeting the short-term liabilities.
Quick Ratio = (Cash + Accounts Receivable + Short-Term or Marketable Securities) / (Current Liabilities)
Cash Ratio
This is a highly conservative ratio because it measures the ability of a company to pay its short-term obligations using its cash and the investments that are easily converted into cash. It considers cash, marketable securities or short-term securities in determining a firm’s ability to meet its current liabilities as follows:
Cash Ratio = (Cash + Short-Term or Marketable Securities) / (Current Liabilities)
Cash flow from operations to current liabilities
This ratio determines how well an organization’s current liabilities can be covered by the cash flow generated from the operations of the organization in a given fiscal year. Unlike other liquidity ratios, this ratio gauges the company’s liquidity based on cash flow instead of cash Helfert (2008) p. 48.
OCF Ratio = Cash Flow from Operations / Current Liabilities
Figure 1: A table showing the liquidity ratios for Westfarmers Company Australia for the 2010 and 2011 fiscal years. The ratios are obtained through calculations based on the formulas and the figures provided in the company’s annual report for 2011 Westfarmers Annual report (2011) p. 83
Efficiency Ratios
Inventory turnover
This ratio is used to show the ability of a firm to manage the levels of its inventories. This is also an indication that the company is having problems or difficulties when selling its products to the customers Helfert (2008) p. 64. Therefore, a high inventory turnover ratio is an indication of a financially healthy company.
Inventory Turnover = (Cost of Sales) / (Average Inventory)
Average day’s sales uncollected
The days’ sales uncollected ratio is a type of efficiency ratio that creditors and investors use to estimate the time in days a company takes to collect its accounts receivable. In this case, the ratio measures the amount of time the customers take to meet the balances on their credit cards Helfert (2008) p. 64
Day’s sales uncollected = (accounts receivable/ net sales) 365
Debtor’s turnover
This ratio determines the ability of an organization to manage the debts held by the customers who have taken credit sales. It is the ratio of credit sales to average debtors. It determines the number of days the debtors take to pay the company.
Debtors turnover ratio= credit sales/ average debtors
In this case, Average debtors = (opening debtors balance Ă· closing balance) /2
Inventory turnover in days
This is the average number of days needed for a firm to sell the inventory. It is based on inventory turnover, which measures the number of times a company sells inventory Kieso and Weygandt et al. (2007) p. 136.
Inventory Turnover= Cost of Goods Sold/ Average Inventory
Therefore,
A verage days to sell the inventory=365 days/ Inventory Turnover Ratio
Profitability ratios
Net profit margin
This ratio is the percentage of a firm’s revenue that is remaining after all the interests, taxes, operating expenses as well as preferred stock dividends are deducted from the revenue in a given fiscal period Fridson and Alvare (2011) p. 66.
(Total Revenue – Total Expenses) /Total Revenue = Net Profit/Total Revenue = Net Profit Margin
Interest cost as percentage of sales
This ratio indicates the interest cost expressed as a percentage of the total sales in a given trade period. It is used to measure the ability of an organization to make interest out of the sales for a given fiscal period.
Interest cost as percentage of sales= (Interest cost Ă· sales) * 100
Asset turnover
This ratio measures how well a firm is utilizing its assets to achieve revenue. It is the ratio of the sales revenue to total sales made in a certain trading period.
Asset Turnover= Sales Revenue/ Total Assets
Return on sales
The purpose of this ratio is to measure a company’s efficiency of operation. It is the firm’s operating profit margin. It is calculated as follows:
(Net profit + interest + income tax) Ă· Average total assets
Return on ordinary shareholders’ equity
Return on ordinary shareholders’ equity is the ratio used to measure a firm’s success in generating income to benefit the stockholders. It is expressed in percentage as shown below:
Return on common stockholder’s equity= (net income- preferred stock) / (average common stockholders’ equity) *100
Market-based investment and other ratios
Price/earnings (P/E)
This ratio measures the company’s current share price in comparison to its per-share earnings.
Market Value per Share / Earnings per Share (EPS)
Dividend yield
The dividend yield is a ration that shows how much an organization is putting out in dividends every fiscal year relative to the share price.
= Annual Dividends Per Share/ Price Per Share
Dividend cover
The ratio states the number of times that a company is able to pay the dividends to its shareholders from the profits it has earned during a given fiscal period.
Dividend Cover Ratio = (Profit after tax – Dividend paid on Irredeemable Preference Shares) / Dividend paid to Ordinary Shareholders
Net tangible asset backing
This ratio refers to the net physical assets that shareholders in a company own at a given time Fridson and Alvare (2011) p. 114. It is used to show the asset value per share.
Net Tangible Asset Backing= (Total Assets- Intangible assets-total liabilities) / Total Number of securities on issue in the class
Evaluation
Evaluation of solvency
Between 2010 and 2011, the company faced a slight reduction in its solvency, with the current ratio reducing slightly from 1.232 to 1.172. A similar trend was observed in other solvency ratios, which reduced by a slight margin. However, with ratios close to or more than one, the company’s ability to meet its current liabilities using its current assets is relatively strong. This means that the company’s solvency is good, which further means that it is financially healthy in regards to its ability to meet its short-term obligations.
Evaluation of Efficiency Ratios
Westfarmers Limited’s efficiency remained relatively strong between 2010 and 2011. In particular, inventory turnover experienced a slight drop of about 3 units, while days sales uncollected increased by a slight margin of about 0.01. A slight increase was also observed in the debtors’ turnover ratio. However, the company achieved a significant increase in the inventory ratio, which rose from 13.24 to about 48.21, a more than 67% increase. It is worth noting that the company’s efficiency ratios remained strong throughout the period, suggesting that it was able to manage its levels of inventory.
Evaluation of profitability
Profitability ratios achieved increased growth between 2010 and 2011, indicating that the company was making gains from its operations. In fact, the company’s major profitability ratios increased significantly in 2011 as compared to 2010. For instance, the net profit margin increased from 5.12 to 4.44. This is an indication that the company obtained increased growth its profits, which further shows that its operations were successful.
The sales turnover ratio also supports the evidence that the company’s profits were increasing. There was an increase in sales turnover ratio from 1.0 to 1.5. This indicates that the company was able to utilize its assets to achieve revenue. The company was able to expand its operations in 2011 compared to 2011 because its return on sales increased by more than 1% from 5.53% to 6.765 in 2011. An almost similar trend was observed in the Return on common stockholder’s equity, which increased by more than a single digit in 2011.
Apart from the increments, it is worth noting that all the profitability ratios were strong because they were all positive. This is an indication that the company was making progress in its ventures, especially its operations. It is an indication that the operations were successful, resulting in profits.
Evaluation of Market-based investment and other ratios
Noteworthy, Westfarmers’ PE ratio increased significantly, but other ratios such as dividend yield, dividend cover and net tangible asset backing ratios decreased slightly. It is an indication that the company did not make major changes in its focus on market-based investments, which remained relatively strong because none of these ratios was weak. In fact, all of them were slightly over 1.0, which means that the company was still placing emphasis on its market-based investments.
Conclusion
This financial analysis provides a strong indication that Westfarmers Limited of Australia is able to handle its short-term liabilities using its short-term assets. This shows that its solvency is credible. It is clear that the company’s performance remained strong, with the liquidity ratios, profitability ratios, efficiency and market-based ratios remaining strong. The company is not only able to meet its obligations, but it is also making profits, increasing the efficiency of performance and the value of its shareholder’s investments.
Therefore, it is advisable that the company’s managers continue focusing on growth in sales, investments and shareholder value. It is also advisable that the company focus on improving its ability to meet obligations and focus on the future, including expansion because the current state of financial health allows it to focus on these issues.
Finally, it is advisable for investors and those willing to invest in the company continue with the initiative because the value of their investments is likely to continue improving because the company has achieved and maintained the desired level of financial health.
References
Ehrhardt, M. and Brigham, E. (2008). Corporate Finance: A Focused Approach, Learning, Mason, OH: Cengage, p. 129-138.
Fridson, M. and Alvare, F. (2011). Financial Statement Analysis: A Practitioner’s Guide, Sydney: OUP, p. 66-115.
Helfert, L. (2008). Techniques of Financial Analysis: A Mode. Sydney: McGraw-Hill, p. 48-64.
Kieso, D., Weygandt, J. and Warfield, T. (2007). Intermediate Accounting. Hoboken, NJ: John Wiley & Sons, p. 136.
Westfarmers Limited. (2011). Westfarmers Annual Report 2011. Sydney: Ross Barr & Associates Pty Limited, p. 1-180.