Financial Statement Analysis: A Comprehensive Overview

The main objective of this report is to conduct A Financial Statement Analysis of the financial statements using financial ratios and vertical analysis that have been provided in the assignment brief. This report commences with conducting a vertical analysis of the statement of financial position for the financial year ended 2021 and subsequently calculates the financial ratios using relevant financial information extracted from the provided financial statements. This report also looks to recommend areas of further improvement based on the financial analysis conducted and will look into the statement of cash flows with a rationale of understanding the main causes for the increase/decrease in the net balance of cash and cash equivalents in between the opening and closing financial year.

The profit margin ratio of an organisation is also referred to as the net profit margin ratio. This metric is one of the most common profitability metrics that gauges the overall profitability position of the company. It is interpreted as the measure of ultimate bottom line profits of an entity and the margin of revenue which is left behind after covering for the total expenses (direct expenses, indirect expenses and financial expenses) incurred during the financial period (Bahri, Pierre & Sakka, 2017). The metric is observed to have increased from 3.82% in 2020 to 5.68% in 2021. There are several reasons resulting in the marginal improvement in performance. An increase in the total revenue for the current financial period and a certain bit of savings in expenses such as occupancy expenses, administration expenses and finance costs when compared to prior period figures have resulted in an absolute and relative increase in profitability. The return on assets is another way of looking at profitability by gauging the overall profits that have been generated relative to the total assets owned by the entity (Davidson, 2020). It is the absolute profit earned by making use of every $ worth of resources which are owned and operated by the company. The metric has increased from 10.57% in 2020 to 15.80% in 2021 which indicates an efficiency in resource utilization when gauged through the end results. An increase in the absolute net income generated for every single dollar worth of average total assets is what has resulted in an increase in the metric.

These group of financial ratios provide an insight into an entity’s operating levels of efficiency. The two metrics selected under this category of financial ratios are the inventory turnover ratio and the day’s held in inventory. Both of these metrics ultimately help gauge the efficiency with which the entity manages their average inventory levels (Szyde?ko & Biadacz, 2016). Any entity which deals with inventories must strive for maintaining an optimal level of inventory which is because they must avoid circumstances of understocking that may result in lost sales and the circumstances of overstocking that translates to higher costs. The inventory turnover ratio is interpreted as the rate at which the average levels of inventory which is maintained by a company are sold and replaced. Another way to interpret the metric is the total number of times an organisation is able to sell their average stock levels to be replaced by newer stock levels (Shah, 2020). The metric has improved further from 7.66 times in 2020 to 8.27 times in 2021. Although the average inventory figure has increased in 2021 when compared to 2020, this increase is demand driven. It is compensated by an increase or surge in revenue in 2021 which is indicated by an increase in the cost of sales in the current financial year. There is however still a scope of further improvement as the closing balance of inventory in current financial year is greater than the previous financial year. The day’s held in inventory ratio is another interpretation of the inventory turnover ratio which is expressed in terms of time (Pernamasari, 2020). It is the total number of days for which a company has to hold on to its average inventory levels to be sold and replaced by newer inventory levels. The metric has favourably declined from 47.67 days in 2020 to 44.14 days in 2021 which is indicative of stronger sales in current year resulting in less holding costs for the company.

The term liquidity refers to short term financial solvency and is the availability of short-term resources for meeting the short-term obligations or debts. It is the reliance that an entity can place upon their current assets for meeting its current liabilities (McLaney & Atrill, 2020). The current ratio of an organisation is one of the most common measures of liquidity. It gauges the availability of total current assets vested with an organisation for meeting the total current liabilities (Griffin & Mahajan, 2019). The metric has improved considerably from 0.93 times in 2020 to 1.07 times in 2021. A current ratio that exceeds 1 indicates the entity to have sufficient total current assets for meeting all of their current liabilities. An improvement in the metric is because of a significant increase in total current assets. Although the current liabilities of the company has increased but the increase is marginal when compared to a considerable increase of total current assets. The quick ratio is another common and prudent measure of liquidity performance. The metric happens to consider only the assets which are quicker to liquidate among the total current assets (Robinson, 2020). The metric remains consistent throughout the two years at 0.35 times where an increase in total current liabilities are off set as a result of an increase in cash & cash equivalents. Although for inventory intensive entities in the retail sector this ratio is never equal to 1 because of funds invested in stocks, a further improvement in inventory management can help to derive more favourable results.

The solvency ratios of an entity helps gauge the dependence upon debt financing which provides an insight into a firm’s gearing position. The debt ratio is a metric that gauges the reliance a company places upon debt sources of capital for financing their assets. The metric has favourably declined from 64.92% in 2020 to 59.81% in 2021 despite an increase in total assets. This is because of a reduced reliance upon debts which in turn is because of a decline in total long-term liabilities. Furthermore, the debt-to-equity ratio evaluates the total proportion of debt and equity financing in the capital structure of the entity (O'Hare, 2016). The metric is also interpreted as the total amount of debt invested in capital structure for every $ worth of equity invested. This has also favourably declined from 185.10% in 2020 to 148.80% in 2021 because of an increase in total equity and a decline in total liabilities. This reduces the gearing of the company as well as exposure to financial leverage. Lastly, the interest coverage ratio is another common solvency ratio which measures the ability of the company to service the cost of debt. It is interpreted as the total number of times an organisation is able to meet its finance costs (interest expense) from their generated earnings before interest and taxes (Easton et al., 2018). The metric has increases favourably from 13.31 times in 2020 to 30.15 times in 2021 because of an absolute increase in EBIT and a decline in finance costs owing to redemption of lease liabilities.

On observing the statement of cash flows, one can easily comprehend the reason for the movement in net cash flows. It is worth mentioning that the closing balance of cash & cash equivalents have increased in current financial year to $263.2 million by $11.7 million from an opening balance of $251.5 million. Although the net operating cash inflows of the company has declined and the net investing cash outflows have increased in current year, the net financing cash outflows have declined when compared to prior year. This is because the entity has repaid borrowings in 2020 leaving no balance of borrowings in the current financial year to repay. As a result, total net financing cash outflows have declined from $805.8 million in 2020 to $489.3 million in 2021 causing an increase in the closing balance of cash and cash equivalents.

It is recommended based on the financial analysis conducted that the organisation should continue and strive for further increase in revenue keeping in check the cost levels to report even better profit margins in the near term. Alternatively, since the company’s gearing is low, it may consider any growth of expansion opportunities as well which in turn will help provide long term value to the shareholders. Lastly, although the efficiency metrics have improved because of higher sales, the closing inventory balance left behind is higher which may result in overstocking. A marginal cut down in average stock levels may be considered which helps to better manage inventory and also improve the quick ratio of the company.

Given the discussions that have been presented in the report it can be concluded upon that financial statement analysis is necessary for the end user of financial information for making effective and informed decisions. This is illustrated through this report where the overall financial performance has been analysed and overall recommendations have been made using the help of financial ratios.

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