Financial Analysis Of ABC Retail Company Essay.

1.Use the above information to answer the following questions:

A)  At what price did ABC’s shares trade on the 30th June 2018? ?

B)  What was the market capitalisation of the company at this date? ?

C)  Compare ABC’s most recent Price/Earnings (P/E) ratio to the industry ?average and provide an explanation for any difference observed (remember to cite the source of your information). ?

2.Analyse the company’s current and quick ratios. ?

3. Evaluate the company’s working capital management over the three-year period. Use ratio analysis to support your conclusions. ?

4. Use ratio analysis to identify and explain the trend in the company’s profitability. ?

5. If you were a bank considering lending to ABC, what ratio(s) would give the best indication of the company’s solvency? Explain why you would or would not lend to ABC.

Part A

Requirement 1

Part A

In the below table the share price of ABC Retail Company is calculated by multiplying the P/E ratio with the EPS reported at 30^th June 2018.

Part B

Market capitalization reflects the overall market value of the company and is calculated by multiplying its current share prices with weighted average number of shares outstanding.  

Working notes:

Part C

Price to earnings ratio reflects the willingness of the investors in respect of paying a certain amount per dollar of earnings. It is also known as price-multiple which measures company’s current stock prices with its earnings per share. In case of ABC Retail, the current P/E ratio is 7.66 which is lower than the industry average of 17.4 (Linked In. 2017). As it is below the average it indicates that the shares of ABC are undervalued and the stock price trade lower. This will give an opportunity to the investors to buy the stock at low price and sell it later on at higher ones in order to book profit (Bragg, 2012). 

Requirement 2

Current ratio 

It is one of the liquidity ratios which measures the capability of the firm to meet its short term financial obligations with the use of its current assets. The standard ratio is 2:1 which means every entity must have its CAs double of its current liabilities (Zainudin, Zainudin, Hashim and Hashim, 2016).

The above table reflects an increasing trend in the current ratio of ABC Company. In 2016, it was 1.79 which increased to 3.34 in 2018. This was due to the fact that the despite having low cash balance, the company’s current assets has increased and are enough to meet its current liabilities worth $4,047,000 during the year 2018. However, comparing with 2017, the liabilities have been reduced which boosted up the ratio in the recent year.

Quick ratio 

It is also a liquidity ratio which determines the financial health of the company. The only difference is that it takes into account the most liquid assets of the firm which excludes inventory and prepaid expenses. The ideal ratio is 1:1 and is required to be maintained by the firms (Saleem and Rehman, 2011).  

Same trend has been noticed in quick ratio of ABC as it rose from 0.75 to 1.36 in recent year. Moreover, the ratio is also higher than the set standard. This is because of the reduction in the current financial obligations majorly contributed by company’s accounts payable. Along with this, the assets of the company have also increased over the years.

Part B

Requirement 3

It is very important for any company to properly manage its working capital. It is that amount which is required by every firm to fund is day to day activities and operations. Evaluation of working capital management can be justified with the ratios like inventory turnover ratio, collection ratio and current ratio. Inventory turnover is one of the efficiency ratios that determines how quickly a company can convert its stock into cash and generate revenue (Higgins, 2012). Referring to appendix, it can be said that the ITR of ABC was 5.74 times in 2017 which reduced to 5.34 times in 2018. This was due to a significant increase in company’s average inventory from $6839.5 to $7604.5.

Similarly, the collection period of ABC also increased from 43 days to 46 days in 2018. This was due to the reduction in receivable turnover ratio of the firm which ultimately affected its collection ratio. As discussed above, the current ratio has been constantly increasing over the three years along with the upsurge in company’s working capital. However, ABC still needs to improve its WCM by focusing on reducing inventories and debtors.

Requirement 4

The profitability ratios are an indicator of the company’s financial performance during the year. They guide the investors in taking correct decisions (Warren and Jones, 2018).  It can be observed that the profit margin of ABC has reduced from 0.24% to 0.10% in 2018. Also it was at 0.12% in 2016, less than the prior year. This was due to the constant reduction in company’s net income because of the high interest expense.

With the reduced net profit, the ROE and ROA also falls from 1.86% to 1.65% and 6.45% to 5.67 % in 2018 respectively. Despite having an increase in average assets and equity, the company is not to offer high returns due to low profits (Refer Appendix).

Requirement 5

The solvency of the company deals with the evaluation of its capital structure and the extent of debt taken by it during a specific time period. The interest coverage ratio shows the number of time a firm has made interest payments (Vogel, 2014). In 2016, it was 1.12 times which further reduced to 1.05 times in 2017 and 2018. This reduction was due to the fact that increase in ABC’s EBIT was less than the upsurge in its interest expense. Along with this, the debt equity ratio of the company has also shown a slightest reduction from 4.38 to 4.33. The ratio reflected that the company had heavy loan liability as compare to its equity.

As far as lending the credit is concerned, it will be better not to grant any sort of loan to ABC as it already has huge debt portion and is not able to make its interest payments quickly and timely. Moreover, the net profit of the company has also reduced in the past years.

Conclusion:

The above report concludes that the company has a strong liquidity position but it needs to concentrate on enhancing its profitability and solvency position. It has to reduce its debt portion by making its interest payments on time and relying more on equity. Also the company needs to improve its ROE in order to give high returns to its shareholders.

The report contains an overall financial analysis of ABC Retail Company for the past three years. It analyses its liquidity, profitability and solvency with the help of relevant ratios. Furthermore, it also concentrates on the calculation done for estimating the share price and market capitalization of ABC at the year end of 2018. Working capital management is also discussed in the report with the use of relevant ratios. At the last, the findings of the analysis are described in conclusion.  

References:

Bragg, S. M. (2012). Financial analysis: a controller's guide. New Jersy: John Wiley & Sons.

Higgins, R. C. (2012). Analysis for financial management. New York: McGraw-Hill/Irwin.

Linked In. (2017). Australian Retail Benchmark: Financial Ratio Assessment of ASX Listed Retailers. [Online]. Available at: https://www.linkedin.com/pulse/australian-retail-benchmark-financial-ratio-assessment-karthik-iyer 

Saleem, Q. and Rehman, R.U. (2011). Impacts of liquidity ratios on profitability. Interdisciplinary Journal of Research in Business, 1(7), pp.95-98.

Vogel, H.L. (2014). Entertainment industry economics: A guide for financial analysis. New York: Cambridge University Press.

Warren, C. S. and Jones, J. (2018). Corporate financial accounting. USA: Cengage Learning.

Zainudin, E.F., Zainudin, E.F., Hashim, H.A.  and Hashim, H.A. (2016). Detecting fraudulent financial reporting using financial ratio. Journal of Financial Reporting and Accounting, 14(2), pp.266-278.