Bega Cheese Limited's Ratio Analysis (2014-2016) Essay.

Based on your analysis of relevant information relating to Bega Cheese Limited, you're required to prepare a structured report (see recommended structure detailed below) with focus on the profitability, efficiency, liquidity and gearing.

Business entities like Bega are accountable for generating profits with the assets employed. In addition, they must pay their debts when they fall due, and plan for future profits. As part of your assessment of Bega, you're required to calculate specific ratios for each of the years being considered using data from the financial statements in the annual reports. The ratios should support your analysis.

Your report should cover a three year period for the years ending June 30th 2014 to 2016, and should be sufficiently broad in scope to demonstrate your understanding of your findings following the analysis. The 2017 annual report has recently been released, however your ratio calculations and the focus of your report is to be based on the 2014, 2015 and 2016 annual reports. Detailed requirements and mark allocations are shown below.

Background of Bega Cheese Limited

The financial statements of the entity are prepared to meet the information needs of its various stakeholders. Particularly, the providers of the finance are always keen to know about the financial performance of the company in which they have invested their funds in order to earn return on their investments. For the purpose of evaluating the financial strengths as well as weakness of the company use of various tools and techniques can be made. Ratio analysis is one of those important financial management techniques, which can be used to assess the financial health of the business. In the present report, ratio analysis is conducted on the financial statements of the Bega Cheese Limited for the years 2014, 2015 and 2016. As a part of ratio analysis, the key components of financial statements are taken into account and ratios in relation to such components have been determined and analysed by making comparative study of all the three years.

Bega Cheese Limited is an Australian leading producer and supplier of cheese and other associated food products. It was incorporated in 1899. It is specialised in supplying the cheddar cheese in the local as well as international retail and service market. Bega Limited exports its dairy and other food products to around 40 different countries such as Middle East, North East, Pacific Island, Southeast Asia and Central as well as South America (Bloomberg, 2018). It contributes positively to the national economy of Australia by exporting its products for more than $100 million annually. Bega operates within the dairy industry of Australia. Dairy farming is regarded as one of the main sectors in Australian economy (Dairy Australia, 2017). Australian dairy was ranked third largest agricultural commodity in farmgate value in 2016-17. Australia’s dairy farms are primarily owner operated Small Medium Enterprises (ACCC, 2017). Bega Limited has two main segments: Bega Cheese segment and Tatura Milk segment. In 1993, it had set up its 1^st spray dying plant at Tatura which produced large quantities of childhood nutritional powder. Bega is also involved in the activities of contract packaging for various private proprietor brands, supermarket brands and products of other dairy firms into their own brand packages. Bega Limited has gained a sound reputation in the market as one of the most trusted iconic brands in Australian company for its cheese products.

Profitability is the most important aspect of the business because only a profitable business can survive and grow for the long term (Tracy, 2012). A firm must have considerable amount of earnings left after meeting all its expenses and costs in order to achieve sound profitability. To assess the profitability position of the business, various profitability ratios have been calculated such as Return on Equity (ROE), Return on Assets (ROA) and Net Profit Margin (NPM).

Profitability Analysis

The Return on Shareholder’s Equity is the total amount of net profits earned as a percentage of the shareholder’s equity. It simply reflects the level of profit that the firm generates for its shareholders by applying the funds invested by them (Higgins, 2013). In the present case of Bega Cheese Limited, there was significant decline in the level of net profit generated in 2015 and 2016 as compared to 2014 (Figure 1). In 2014, Bega had paid out 22.9 cents to the shareholders for every dollar invested by them. However, in 2015 only 3.96 cents were paid by the company for each $1 investment made by its shareholders (Bega Cheese Limited, 2016). In spite of increased sales due to ever increasing demand of Bega’s products had to face steep downfall in its profitability as depicted by the declining key profitability ratios. The declining level of ROE in the last 3 years reflects Bega’s weak strategies in respect of reinvestment decisions which did not offer sufficient income. However, in 2016, an increase in ROE was reported as compared to 2015 and this shows that Bega is improving the quality of its reinvestment decisions. Bega had distributed profits of 8.99 cents as the dividend for every $1 of shareholder’s investment. The profit distribution in 2015 was quite lower than distribution of 22.9 cents which was made in 2014. Bega’s profitability condition in 2016 was not as satisfactory as it was in 2014 but it was better than that of 2015. In 2014, Bega had also earned a profit on sales of shares which had significantly contributed to its total earnings.  

Further, Return on Asset (ROA) ratio has been calculated in respect of all the 3 concerned years. This ratio generally takes into account two features of the business i.e. its wealth creation level and its efficiency to utilise its total assets. ROA reflects the level of profits earned by the business by utilising its total assets effectively in the business (Tracy, 2012). In 2015, there has been reported a significant fall in Bega’s ROA as compared to that of 2014. The major reasons behind the fall were decline in Bega’s net profit and the rise in the level of company’s total assets. A large proportion of assets owned by the company have remained idle during the year (Higgins, 2012). However, in 2016, the ROA had improved slightly due to widened business operations of Bega (Bega Cheese Limited, 2017). There was an increase of 4.03% in company’s ROA of 2016 as compared to 2015 due to increased revenue and profits.

Efficiency Analysis

Furthermore, the net profit margin has been calculated to assess further the profitability position of business. The net profit margin ratio shows the percentage of earnings left after meeting all the expenses of business. It is observed that there was a downfall in the Bega’s net profits of 2015 because of more operating expenses as compared to that of 2014. In 2014, the NPM of 9.35% shows that each dollar of sales had generated 9.35 cents of profit before interest and tax for Bega. However, in 2015 only 1.80 cents could be earned as profit from each dollar of revenue from sales. This was due to increase in the operating expenses of the business. Therefore, it can be said that the profitability position of the business had faced a downfall over the 3 yeas reported in the report (Tracy, 2012).

Secondly, the efficiency state of business has been analysed using various ratios such as Inventory Turnover Ratio (ITR), Asset Turnover Ratio (ATR) and by determining the period that was required to settle down the accounts receivables of the company. The efficiency ratios are applied to assess the firm’s efficiency to manage its different assets.

The inventory turnover ratio measures the company’s efficiency in converting its inventory into sales (Fridson & Alvarez, 2011). It measures the number of times a firm sold its average inventory. As depicted from the graph above in Figure 2, inventory of Bega Cheese Limited had slightly increased after 2014 and this shows that Bega had taken few more days to convert its inventories into sales. Generally, it is preferred to maintain shorter inventory turnover periods so as to avoid excessive inventory holding costs (Nissim & Penman, 2001). Even, the length of settlement period of company’s accounts receivable had also increased since 2014. It is the reflection of company’s liberal trade credit policies due to which it was not able to quickly convert its credit sales into cash.

An asset turnover ratio of the firm reflects the level of efficiency with which the assets of business are deployed in order to generate sales (Penman & Penman, 2001). The declining asset turnover period shows company’s efficiency in managing its total assets to generate higher sales revenue. Greater the number of days of asset turnover period, lower the percentage of asset turnover ratio and generally higher ratio is preferred. Since the asset turnover days have declined since 2014, Bega’s efficiency in managing its overall assets can be said to have improved in 2016 (Annual Report, 2016). 

Liquidity Analysis

Thirdly, the liquidity position of the business has been analysed using the two main liquidity ratios: current ratio and liquid ratio. Liquidity in business is achieved when the company is capable of meeting its short term financial obligations as and when they become due, out of its current assets without having the need to dispose-off its fixed assets. The ideal current ratio is considered as 2:1, which implies that the firm must at least have the current assets of twice the amount of its current liabilities so as to maintain its liquidity state in the market (Higgins, 2013).

 In the present case, the current ratio of Bega Cheese Limited in all the three years under consideration was below the ratio of 2:1 as shown in graph above in Figure 3. This indicates that Bega’s liquidity position was not satisfactory in all the 3 years. But, at the same time it could be observed that liquidity state of its business had improved at the fluctuating rate in 2015 and 2016. In 2014, liquidity position was weakest among all the periods reported. In 2015, there has been reported a slight improvement of 0.32 times in the current ratio and this shows that Bega had improved its working capital management practices. But, in 2016, the current ratio had again declined to 1.65:1 and this shows that Bega would have to struggle to meet its current liabilities in total using its current assets. It must improve its current assets management so as to achieve liquidity position in the market (Papadopoulos, 2011).

The quick ratio reflects the proportion of quick assets available with the business to the current liabilities of the business (Foster, 2004). It measures the ability of the firm to pay out its current liabilities through the use only those assets that are readily and conveniently converted into cash. The ideal quick ratio is 1:1 which means that the company must at least have quick assets of value equivalent to the value of its current liabilities so that such liabilities could be met, whenever they fall due without facing any sort of cash crisis in meeting those obligations. Looking at current and quick ratios in all the 3 years under consideration, it can be said that Bega had not held sufficient amount of current assets in the business which were required to meet its current financial obligations (Innocent, Mary & Matthew, 2013).

Lastly, the solvency position of the business has been analysed using the gearing ratios and by evaluating the appropriateness of company’s capital structure. Solvency aspect of the financial performance is important for the key stakeholders of company such as investors and creditors. The gearing ratio determines the quantum of contribution made by long term creditors of the business to the total capital structure of the business (equity as well as non-current liabilities) (Fridson & Alvarez, 2011). The gearing level of the business represents the financial leverage of the company. Higher the financial leverage, higher are the chances of firm’s insolvency in the market because if more external debt is comprised in the capital structure, the company has more legal commitments towards meeting the financial obligations such as principle and interest costs on the regular basis (Higgins, 2012).

 The graph in Figure 4 above shows that the gearing ratio of Bega had increased significantly in 2015 as compared to 2014, which means that the debt portion of Bega has increased in 2015. However, gearing ratio lower than 50% is considered normal as it shows that majority of company’s capital is raised through equity shareholders. However, gearing ratio in Bega’s case is showing upward movement since 2014 till 2016 which signifies that the proportion of company’s external debt was increasing in the subsequent years ahead of 2014. But, in 2016 the gearing level of Bega’s business had slightly declined as compared to that of 2015 which shows that company is trying to optimise its capital structure.

Debt to total asset ratio determines the proportion of total assets of the firm that are financed by the external debt (Fridson & Alvarez, 2011). In 2014 and 2015 around 43% of the total assets were financed through the use of funds of creditors and remaining 57% of the funds were financed through the internal sources such as equity capital and retaining earnings. However, in 2016 the debt to asset ratio of Bega had increased slightly. The debt to total assets ratio of 44% as reported in 2016 shows that company had acquired more assets through the use of external financing. Since the gearing ratios of company in last 3 years are below 50%, it can be said that the company is normally geared. But, if the trend of increasing debt to total asset ratio is further followed in the subsequent years Bega will have to face higher financial leverage (Kumbirai, 2010).

Conclusion

From the above analysis it can be stated that Bega Limited’s overall financial performance has degraded over the last three reported financial years. The profitability position of the company was highest in 2014 among all the three years. Bega Limited must invest its funds prudently in further acquiring its business assets so as to avoid the situations where assets remain idle throughout the year. Also, Bega Limited must make efforts to strengthen its liquidity position in the market in the upcoming years by employing effective working capital management practices such as making stringent trade credit policies, applying just in time approach for the inventory management, investing in liquid assets etc. The operating efficiency of Bega in respect of its assets like inventories and accounts receivables is not found to be sound because the amount that is invested in these assets is not generating any return for the business. It should rather minimise the duration of conversion of inventories into sales and then credit sales into cash through the implementation of strong asset management policies. The solvency position of Bega could be said to be normal as the proportion of external debt in the entire capital structure is lower than the proportion of equity. However, the increasing trend of gearing ratios must be controlled by the company in order to prevent itself from the exposure to higher financial risk.

References:

ACCC, 2017. The Australian dairy industry. Available at https://www.accc.gov.au/system/files/Farmer%2520Power_0.pdf Accessed on 12 September 2018

Bega Cheese Limited, 2016. Annual Report. Available at: https://www.begacheese.com.au/wp-content/uploads/2012/10/04-2015-ANNUAL-REPORT.pdf accessed on 12 September 2018

Bega Cheese Limited, 2016. Annual Report. Available at: https://www.annualreports.com/HostedData/AnnualReports/PDF/ASX_BGA_2017.pdf accessed on 12 September 2018

Bloomberg, 2018. Company Overview of Bega Cheese Limited. Available at: https://www.investing.businessweek.wallst.com/research/stocks/snapshot/snapshot_article.asp?ticker=BGA:AU accessed on 12 September 2018

Dairy Australia, 2017. The Australian dairy industry at a glance. 2016–17.Available at: https://www.dairyaustralia.com.au/-/media/dairyaustralia/documents/about-dairy-australia/key-publications/2017-in-focus.ashx?la=en&hash=701F2B1E4ACFC95F62FAE99E25AE5CA4B9F7585C. accessed on 12 September 2018

Foster, G., 2004. Financial Statement Analysis, 2/e. Pearson Education India.

Fridson, M.S. and Alvarez, F., 2011. Financial statement analysis: a practitioner's guide (Vol. 597). John Wiley & Sons.

Higgins, R.C., 2012. Analysis for financial management. McGraw-Hill/Irwin.

Innocent, E.C., Mary, O.I. and Matthew, O.M., 2013. Financial ratio analysis as a determinant of profitability in Nigerian pharmaceutical industry. International journal of business and management, 8(8), p.107.

Kumbirai, M., 2010. A financial ratio analysis of commercial bank performance in South Africa. African Review of Economics and Finance, 2(1), pp.30-53.

Nissim, D. and Penman, S.H., 2001. Ratio analysis and equity valuation: From research to practice. Review of accounting studies, 6(1), pp.109-154.

Papadopoulos, P. 2011. Investment Report - Fundamental Analysis/ Ratio Analysis. GRIN Verlag.

Penman, S.H. and Penman, S.H., 2001. Financial statement analysis and security valuation. New York, NY: McGraw-Hill/Irwin.

Tracy, A. 2012. Ratio Analysis Fundamentals: How 17 Financial Ratios Can Allow You to Analyse Any Business on the Planet. RatioAnalysis.net.