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a) Compare and contrast how the two companies generate shareholder wealth.

b) Using ROA data from the Morningstar reports as a measure of how well a company uses resources to generate wealth, evaluate and compare the two companies’ ROA performances;

c) Discuss the limitations of the accounting information used in (b). Do this by applying the discussion in the Appendix of this Guide;

d) Discuss how your opinion in (b) is altered by the limitations you identified in (c).

Similarities and dissimilarities between the companies

a.Similarities and dissimilarities between the companies

Advance Nano Tek is manufacturer and specialist developer of the advanced materials those are used by the manufacturers for personal care, industrial and chemical sectors for adding competitive advantage to the end products. On the other hand, Sci dev is engaged in designing for wastewater treatment all over the industrial sectors that include beverages and food, power generation, gas and oil production, cardboard and paper manufacturing, personal cosmetics and products manufacturing and paint manufacturing. Therefore, the similarities in operation is the personal care product manufacturing and the dissimilarity is that Nano tek deals in manufacture of metals like aluminium oxide powder, zinc oxide powder and zinc oxide dispersions whereas Sci Dev is engaged in treatment of waste water.

Comparing the shareholder’s wealth generation efficiency

ANO Advance Nano Tek Limited

SDV Sci DEV Ltd

Ratio

2015

2016

2017

2015

2016

2017

Return on assets

9.17

7.05

7.67

-26.53

-19.36

-22.14

Asset turnover ratio

0.56

0.49

0.53

0.38

0.49

0.66

Net profit margin ratio

17.75

14.45

14.98

-62.01

-35.58

-36.92

Net profit margin ratio – it is most basic ratio for measuring the profitability of a company that is generated through the sales. It states the percentage of sales that is left with the company after meeting the required expenses from the sales revenue. It is also used for determining the potential of earning the profits of the company. However, the profit is also depended upon various other factors like competition, demand elasticity and product differentiation. Looking into the net profit margin of Nano Tek Limited and Sci Dev Ltd it is observed that for all the 3 years under consideration that is 2015, 2016 and 2017, Sci Dev Ltd could not generate any positive earnings which in turn led to negative net profit margin. On the other hand, the net profit margins of Nano Tek were 17.75%, 14.45% and 14.98% respectively for 2015, 2016 and 2017.

Asset turnover ratio – it measures the asset generating capacity of the company from the sales of the company. It is identified that the asset turnover ratio of Nano Tek is ranged from 0.49 to 0.56 whereas the same for Sci Dev is ranged between 0.38 and 0.66. However, except for the year 2017 other 2 year’s ratio for Nano Tek is better as compared to Sci Dev.

Therefore, taking into consideration above facts it can be considered that Nano Tek is more efficient in generating shareholder’s wealth.

b.Return on assets

Key data

ANO Advance Nano tek Limited

SDV Sci DEV Ltd

Ratio

Formula

2015

2016

2017

2015

2016

2017

Return on assets

Net income / Total assets

9.17

7.05

7.67

-26.53

-19.36

-22.14

ROA in terms of profitability

It is a profitability ratio that measures the company’s net income generation capability from the sales of the company. it is the net income ratio available after tax as compared to total assets of the company. To be more specific, ROA is the efficiency metric that explains the efficiency of the company with regard to usage of its assets for generating the profits (Alghifari, Triharjono & Juhaeni, 2013). The percentage of the assets varies from industry to industry, however, higher level of ROA is considered better for any company. it creates a problem where the ROA of the company falls, however, the analysts and investors shall keep in mind the fact that ROA does not takes into consideration the outstanding liabilities of the company and may state higher profit than the actual.

Comparing the shareholder’s wealth generation efficiency

Data analysis using DES

It is observed from the ROA of both the companies that the ratio of Nano Tek has no specific trend and it reduced to 7.05% in 2016 from 9.17% in 2015. However, the company was able to increase the ratio to 7.67% in 2017 from 7.05% in 2016 (Advance Nanotek Limited, 2018). On the contrary, the return on assets for Sci Dev for all the 3 years that is 2015, 2016 and 2017 is in negative. The reason behind this is that for all the 3 years the net income of the company was negative. Therefore, the ROA of Nano Tek is significantly better as compared to that of Sci Dev (Sci Dev Limited, 2018).

ROA states the money earned by the company against each dollar of the assets. Therefore, the company prefers higher level of ROA that signifies that the company is operating its business more efficiently and more profitably. ROA is also measured to evaluate the asset-intensive status of the company (Cook & Glass, 2014). If it is identified that the company has higher ROA it will signify that the company is less asset intensive. On the other hand, if the company has lower ROA it will signify that the company is highly asset-intensive. However, ROA is considered as a useful metric to compare between two or more companies rather than comparing it with the previous year’s result of the company. Further, ROA is useful tool to the analysts for analysing the performance of the company against another company. As it is used to compare the performance of companies it is considered as an important tool to the analysts and investors (Grant, 2016).   

Real world example – Case study of Biogen Inc

Biogen Inc. is the global biopharmaceutical company and it develops the treatment-therapies for the diseases related to neurodegenerative, autoimmune disorder and hematologic conditions (Wright, 2017).

It can be seen from the above that the ROA of the company significantly increased over the last 4 years from 2011 to 2014. However, it fell to 21.2% from 22.5% over the years from 2014 to 2015. The reason behind the increase was the rapid growth in sales level that led to higher net income. In fact, the company extended the credit terms to generate additional sales. It had an impact on the inventories and working capital that had adverse effect on the earning quality of the company. It led to the following situations –

  • Collection cycle of the company became slower than the normal
  • The company could not maintain strong collection record that led to increase of bad debts.
  • Increased amount of bad debts led to lowering the net income which in turn reduced the ROA.

Real world example – Case study of Biogen Inc

Though it is tough to recommend any action under this situation and further information is required before recommending anything, it is suggested that the company should have ensured that it is recording the sales as per the requirement of GAAP and booking the sales accruals on the account (Wright, 2017).

c.Resources and wealth measurement with the profits and assets of the company

ROA is the type of return on the investment that is used to measure the company’s profitability as compared to the total assets of the company. It indicates the efficiency of the company through comparing its profit generating efficiency as compared to the capital invested in the assets. Higher return signifies that the company is more productive and the management is more efficient is using the economic resources (Graves & Shan, 2014). On the other hand, profit states the amount left with the company after paying off the expenses of the company. Further, it is stated for reducing the liabilities of the company and increasing its assets. Profit also signifies the resources available with the company for the purpose of investment (Heikal, Khaddafi & Ummah, 2014). On the other hand, the assets that include the cash, receivables, tangible assets like building, land and property signifies the wealth of the company.  the total assets of the company used for creating present income or the asset that is potential to generate future income also includes the natural resources and human capital. However, the money and securities are not included as these are the claims to the wealth (Li, 2015).

Limitation of ROA

  • Misleading – ROA can be misleading if analyzed without proper context. Various industries are asset-intensive and require large amount of investment for inventories, facilities or equipment for proper functioning. Therefore, if the net income is compared to the total assets of the company it will definitely look less profitable as compared to the company that is less assets intensive. Therefore, if the investor uses this metric it may mislead him as the company will look less profitable (Muhammad & Scrimgeour, 2014).
  • Net profit base – for calculating the ROA, net profit is taken as the base. However, different companies may use different approach to calculate net profit.  Moreover, the net profit may be manipulated to show the business as more profitable than actually it is. Therefore, ROA shall not be only considerable metric for the purpose of investment (Niresh & Thirunavukkarasu, 2014).
  • Borrowings – it only takes into consideration the assets of the company and ignores the borrowed capital that may have in the balance sheet of the company. Generally the capital structure any company includes equity as well as debt. Therefore, considering ROA metric solely will mislead the investor as the borrowed fund also plays important role in making decisions related to investment (Xiang, Worthington & Higgs, 2015).   

Incorporating above mentioned limitations in comparing the companies

It can be identified that both the companies are using different methods for computing the net income. Nano Tek is using the form of stating all the incomes and expenses together and finally the positive or negative result signifies that whether the company has positive income or negative income (Advance Nanotek Limited, 2018). On the contrary, Sci Dev presents the income statement as revenue less expenses that gives the amount of net profit or loss (Sci Dev Limited 2018).

For 2015

Nano Tek Limited

Sci Dev Ltd

Year 2016 and 2017

Nano tek Limited

Sci Dev Limited

It can be seen from above figures the both the companies uses different method for calculating the net income. Therefore, it is inappropriate to consider net income only and compare it to total assets while analysing and comparing 2 or more firms.  

Resources and wealth measurement with the profits and assets of the company

d.Likely impact of identified limitations

As there is difference in calculating method of the net of the companies, taking into consideration only ROA metric will mislead the investors while taking decisions of investment.

Judgement for revised opinion

Therefore, to minimize the impact of these issues the investors shall take into considerations other factors also. Further, the ROA shall be calculated by taking into considerations the liabilities also that is subtracting the liabilities from total assets or the net assets of the company. it will give the true picture of the company and the investors will be able to take appropriate decisions.  

References

Advance Nanotek Limited. (2018). Antaria.com. Retrieved 6 May 2018, from https://www.antaria.com/IRM/content/default.aspx

Alghifari, S., Triharjono, S., & Juhaeni, Y. (2013). Effect of return on assets (ROA) against Tobin's Q: Studies in food and beverage company in Indonesia stock exchange years 2007-2011. International Journal Of Science and Research (IJSR), 2, 108-116.

Cook, A., & Glass, C. (2014). Women and top leadership positions: Towards an institutional analysis. Gender, Work & Organization, 21(1), 91-103.

Grant, R. M. (2016). Contemporary strategy analysis: Text and cases edition. John Wiley & Sons.

Graves, C., & Shan, Y. G. (2014). An empirical analysis of the effect of internationalization on the performance of unlisted family and nonfamily firms in Australia. Family Business Review, 27(2), 142-160.

Graves, C., & Shan, Y. G. (2014). An empirical analysis of the effect of internationalization on the performance of unlisted family and nonfamily firms in Australia. Family Business Review, 27(2), 142-160.

Heikal, M., Khaddafi, M., & Ummah, A. (2014). Influence analysis of return on assets (ROA), return on equity (ROE), net profit margin (NPM), debt to equity ratio (DER), and current ratio (CR), against corporate profit growth in automotive in Indonesia Stock Exchange. International Journal of Academic Research in Business and Social Sciences, 4(12), 101.

Li, X. (2015). Accounting conservatism and the cost of capital: An international analysis. Journal of Business Finance & Accounting, 42(5-6), 555-582.

Muhammad, N., & Scrimgeour, F. (2014). Stock returns and fundamentals in the Australian market. Asian Journal of Finance & Accounting, 6(1), 271-290.

Niresh, A., & Thirunavukkarasu, V. (2014). Firm size and profitability: A study of listed manufacturing firms in Sri Lanka.

Sci Dev Limited. (2018). Leaders in the Development & Application of Polymers for Wastewater Treatment - SciDev. SciDev. Retrieved 6 May 2018, from https://scidev.com.au/

Wright, S. (2017). A Case Study: Using The Dupont Approach For Formulating Managerial Decisions [Ebook] (13th ed., pp. 38,39). State University of New York at Oswego, USA. Retrieved from https://9859-Article%20Text-36641-1-10-20161220.pdf

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