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Analysis of the financial statements

Discuss about the Financial Management for Wesfarmers Limited.

Wesfarmers limited is one of the biggest conglomerates of Australia. Its headquarters is situated in Perth, Western Australia. The company mainly deals in retail, chemicals, fertilizers, industrial, and safety products and also coal mining. In the year 2015 it became Australia largest revenue making company with the revenue of AU$62.7 billion. In this race it overtook its rival Woolworths limited and also the mining giant BHP Billiton. Also Wesfarmers if Australia’s largest private employer, employing about 205,000 people in its business. Wesfarmers was initially a co-operative concern, which used to provide supplies and services to the farmers in Western Australia (Wesfarmers Limited, 2015). In the year 1984 it got listed. It has a shareholders base of about 500,000.  After it got listed, the company started acquiring other businesses, increasing its business and divisions.

In our task below, we have summed up the qualitative and quantitative data of the company so that its performance can be analysed.

Analysis of the financial statements

Following is the five year data of the income statement of Wesfarmers:

Summarised Income Statement

2015

2014

2013

2012

2011

Sales revenue

62,129

59,903

57,466

57,685

54,513

Other operating revenue

318

278

283

395

362

Operating revenue

62,447

60,181

57,749

58,080

54,875

Operating profit before depreciation and amortisation, finance costs and income tax

4,978

3,877

4,486

4,544

4,155

Depreciation and amortisation

-1,219

-1,082

-1,033

-995

-923

EBIT

3,759

2,795

3,453

3,549

3,232

Finance costs

-315

-346

-417

-505

-526

Income tax expense

-1,004

-939

-908

-918

-784

Profit after tax from discontinued operations

-

1,179

133

n/a

n/a

Operating profit after income tax attributable to members of Wesfarmers Limited

2,440

2,689

2,261

2,126

1,922

We see that the operating revenues of the company has increased every year for the last five years, this is due to operational efficiency of the company. Also the operating profits of the company have maintained a level of 3% to 5%, which is moderate in the industry in which the company operates. The company has shown financial efficiency by decline in finance costs of the company over the period of five years (Wesfarmers Limited, 2015). Overall performance of the company is good and it depicts growth prospects.

Following is the five year data of the Balance Sheet of Wesfarmers:

Financial Position Aa At 30 June

2015

2014

2013

2012

2011

Total assets

40,402

39,727

43,155

42,312

40,814

Total liabilities

15621

13740

17133

16685

15485

Net assets

24,781

25,987

26,022

25,627

25,329

Net tangible asset backing per ordinary share

$4.85

$6.14

$4.69

$4.45

$4.12

Net debt to equity

  0.25

 0.13

0.20

0.19

0.17

Total liabilities/total assets

  0.39

0.35

0.40

0.39

0.38

The assets of the company have increased over the period of five years, except for the year 2014. This was due to a divestment policy of the company. Also the company classified its insurance division as a discontinued operation in 2013.

Capital and Dividends

2015

2014

2013

2012

2011

Ordinary shares on issue (number) 000's as at 30 June

11,23,753

11,43,275

11,57,194

11,57,072

11,57,072

Paid up ordinary capital as at 30 June

21844

22708

23290

23286

23286

Fully-franked dividend per ordinary share declared (cents)

200

200

180

165

150

Capital management: capital return and fully franked dividend components

100

50

-

-

-

We see that the company is regular in paying dividends. In the last five years the company has paid an average of 179 cents per share. The current market price that exists in the market is average of $40. Also the average earnings per share in the last five years have been 199.5 cents. This gives us average PE ratio of 20 times. Therefore, we see that the performance of the company is very good and the financial stability of the company is also proper (Northington, 2011). The investor can take help of the following ratios also in order to determine if he can or he cannot invest in the shares of this company.

Balance Sheet of Wesfarmers

Ratio analysis is a tool of financial statement analysis which helps us to have a quick view of the financial performance of the company in various aspects.

Liquidity Ratio Current Ratio

Current ratio is a liquidity ratio which helps to measure the company’s ability to meet its obligations. The most acceptable current ratio depends from on industry, but mostly it lies within 1.5 to 3. But the current ratio should not fall below 1; this indicates low liquidity for the company (Albrecht et. al, 2011). Let us now calculate current ratio of Wesfarmers for the last five years.

Current Ratio ($m)

2015

2014

2013

2012

2011

Current Assets

9,093

9,311

10,586

10,911

10,218

Current Liabilities

9,726

8,229

9,572

10,747

8,722

Current Ratio (Current Assets / Current Liabilities)

0.93

1.13

1.11

1.02

1.17

Current Ratio

From the above data we can see that the company has maintained its current ratio for last four years, but in the current year the ratio has fallen below 1. This indicates low liquidity and that in the current year the company has diverted its liquid assets. The company needs to turn its assets into more liquid form so that it can meet up with its working capital requirements (Albrecht et. al, 2011). The major fall in current asset is due decline in cash balance of the company from $ 2,067m to $711m from year 2014 to year 2015. We see that major decline in current assets is witnessed in the year 2014; it is due to disposal of WesCEF’s interest in Air Liquidi WA Pty Ltd. Keeping this disposal by the company at bay, we can see that the financial position of the company has not much changed. The liquidity of the company is healthy.


Profitability Ratio

Net Profit Margin Ratio

The Net Profit Margin Ratio is a type of profitability ratio. It is calculated by dividing the net income of the company by revenue earned so that they can determine the level of profits earned. The net profit margin depends on industry to industry (Brealey et. al, 2011). For example, technology companies run at an average net profit margin of 15% to 20%

Net Profit Margin ($m)

2015

2014

2013

2012

2011

Net Income

       2,440

1,510

 2,261

2,126

1,922

Sales Revenue

     62,447

60,181

 59,832

58,080

54,874

Net Profit Margin [(Net Profit after tax / Sales Revenue) * 100]

3.91

2.51

3.78

3.66

3.50

Net Profit Mergin

For Wesfarmers Ltd we see that the operation of the company has increased every year for the last five years. Also the company has managed to maintain its profit margin of 3-4% every year. The company has also reported minor increases in net profit margins in the last five years. A similar company Walmart which is involved in retail business operates at a net profit margin of less than 5%. The companies which are able to expand their net profit margin witness share price growth which leads to high profitability levels.

Stock Price Movement

This is a type of profitability ratio. The return on total assets ratio helps to determine how effectively the company is using its assets to generate earnings. It is calculated by dividing the earnings before interest and tax by total assets of the company (Needles & Powers, 2013). Greater is the result of this ratio, the company is said to more effectively use its assets.

Return on Assets ($m)

2015

2014

2013

2012

2011

Net Income

2,440

1,510

2,261

2,126

1,922

Total Assets

40,402

39,727

43,155

42,312

40,814

Return on Assets [(Net Income / Total Assets)*100]

6.04

3.80

5.24

5.02

4.71

Return on Assets

In the given case of Wesfarmers we see that except for the year 2014 the net income of the company has constantly increased in all four years. The decline in 2014 is due to divestment plan, which has already been discussed above. The company has also shown a considerable increase in assets over the period of five years. We see that the return on assets ratio of the company has increased with time. This shows that company has with time learnt to more effectively utilize its resources (Brealey et. al, 2011). Therefore we can say that performance of the company, resource utilisation wise has improved over the period of five years.

Debt Ratio

Debt ratio is a type of financial ratio, which helps the investor to calculate what amount of assets of the company is financed by debt. Lower the ratio, better it is for the company. Higher the ratio, higher is the leverage, higher is financial risk (Davies & Crawford, 2012). Debt ratio is calculated by dividing the liabilities of the company by the assets of the company.

Debt Ratio ($m)

2015

2014

2013

2012

2011

Total liabilities

15,621

13,740

17,133

16,685

15,485

Total Assets

40,402

39,727

43,155

42,312

40,814

Debt Ratio

0.39

0.35

0.40

0.39

0.38

Debit Ratio

Wesfarmers maintain a rate of 35% to 40% for having its assets financed by outsiders. It is a moderate rate for the company. Since most of the assets, that is more than 50% of the assets are funded by own funds. This does not eliminate the financial risk of the company. A little variation in the ratio is acceptable taking into condition the other market conditions. The company just needs to maintain a steady cash flow so that it meets up with its debt obligations from time to time (Melville, 2013). The debt ratio helps the investor to determine the risk level; the risk level of Wesfarmers is relatively low as per the trend of five years.

The interest coverage ratio of the company helps the investor to calculate the interest burden on the company in comparison to the earnings of the company. It shows how easily the company can pay its interest expenses. It is calculated by dividing earnings before interest and tax of the company by interest expense of the company for the year. It is also called times interest earned ratio (Parrino et. al, 2012). It helps the company to measure the margin of safety a company has to pay its finance cost for a given period.

Interest Coverage Ratio ($m)

2015

2014

2013

2012

2011

EBIT

          3,759

          2,795

          3,658

          3,549

          3,247

Interest Expenses

             315

             346

             432

             505

             526

EBIT/ Interest Expense

11.93

8.08

8.47

7.03

6.17

Ratio Analysis

Interest Coverage Ratio

We see that the interest coverage ratio of Wesfarmers has increased over the period of five years, which is good (Spiceland et. al, 2011). The earnings of the company have increased and the interest expense has decreased. This shows how the company is trying to reduce the financial risk and improve its operating efficiency. The performance of the interest coverage ratio of the company is improving every year. The investor can take this as a positive attribute of the company (Parrino et. al, 2012).

Price-Earnings Ratio

The price earnings ratio helps the investor to evaluate how much more is he ready to pay for the company as per the earnings of the company. The price earnings ratio of is calculated by dividing the price of the company’s share by its earnings per share during the year (Williams, 2012). This ratio sometimes is also called price multiple or earnings multiple ratio. It can also be interpreted as, the amount which the investor is willing to pay for the share of the company to earn one dollar of the company’s earnings.

Price-Earnings Ratio

2015

2014

2013

2012

2011

Price

39.03

41.84

39.60

29.90

31.85

EPS

2.16

2.35

1.96

1.84

1.67

Price/EPS

18.06

17.83

20.21

16.23

19.11

Price Earning Ratio

We see that the price trend of the company is not stable. Whereas the earning are relatively more every year. The above evaluations inform that the investor is willing to pay an average of $18 to earn $1 of the company’s earnings. The investor tends to invest in companies with a higher PE ratio than the companies with a low PE ratio. PE ratio is a great tool for comparing the financial position of two companies of same sector (Horngren, 2013).

As per the Constant Growth Dividend model the price of the stock can be calculated using the following formula:

P0 D1 Re-G

Where,

P0 = Price of the share today

D1 = Expected dividend

Re= Current market rate

G= Growth Rate

The Dividend paid by the company in 2015 was $2 per share, also the current rate of return is 9% and the growth rate is 4%. Taking this information we calculate the price of share today with the help of formula mentioned above:

P0

=

2*1.04

=

41.6

0.09-0.04

Therefore using the above formula we see that the price of share in today’s market should be near about $41.6, whereas the latest share price which is in the market is about $40 per share. We see that the expected price of the share is almost equal to the actual price of the company’s share (Choi & Meek, 2011). This is because the markets can very easily read the expectations from a company and then they incorporate the same information in the price of the share.

The performance of the company is at par with the performance of the industry to which it belongs. It has managed to become one of the best conglomerates of Australia with its effort and efficient work. If the investor desires he can invest in the share of the company. The price of the share of the company stays stable and also the company has the pats of paying regular dividends. So we would recommend the investor to invest in Wesfarmers Ltd based on the financials of the company of last five years. The last five years indicates a strong trend and hence must be considered as a strong buy opportunity.

Conclusion

Taking the above analysis of the profit and loss statement and balance sheet of the company along with the help of various ratios, we see that the financial position of the company is very good and it matches with the performance of the company. Therefore, from the above report it is clear that the company has a good track record and has a strong scope of future movements. Overall, it is a good buy because it has strong fundamentals and ability to surge in the coming future. Therefore, the trend will remain intact and hence, should be considered a great opportunity to derive returns.

References

Albrecht, W., Stice, E. and Stice, J 2011, Financial accounting, Mason, OH: Thomson/South-Western.

Brealey, R., Myers, S. and Allen, F 2011, Principles of corporate finance, New York: McGraw-Hill/Irwin.

Choi, R.D. and Meek, G.K 2011, International accounting,  Pearson .

Davies, T. and Crawford, I 2012, Financial accounting, Harlow, England: Pearson.

Horngren, C 2013, Financial accounting,  Frenchs Forest, N.S.W: Pearson Australia Group.

Melville, A 2013, International Financial Reporting – A Practical Guide, 4th edition, Pearson, Education Limited, UK

Needles, B.E. &  Powers, M 2013, Principles of Financial Accounting, Financial Accounting Series: Cengage Learning.

Northington, S 2011, Finance, New York, NY: Ferguson's.

Parrino, R., Kidwell, D. and Bates, T 2012, Fundamentals of corporate finance, Hoboken, NJ: Wiley

Spiceland, J., Thomas, W. and Herrmann, D 2011,  Financial accounting, New York: McGraw-Hill/Irwin,University Press

Wesfarmers Limited 2015, Wesfarmers Limited Annual Report and accounts 2015, viewed 2 July 2016, https://www.asx.com.au/asx/research/company.do#!/WEShttps://www.wesfarmers.com.au/

Williams, J 2012,  Financial accounting, New York: McGraw-Hill/Irwin.

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