Accountancy - Financial analysis


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Accountancy - Financial analysis

  1. 1. Financial Analysis The analysis of financial statements is critical for the variousstakeholders of an entity. For instance, investors compare variousfinancial statements of different companies so as to be able to make anobjective decision on where to invest. In this regard, investors carry outa comparison of financial statements (audited) for the companies theyare interested in using a number of approaches including but not limitedto ratio analysis as well as comparative analysis. Successful investorsalways insist on ‘doing their homework’, that is, carrying out a detailedindustry as well as company analysis before making investments.In this text, I choose two companies in the retail industry and come upwith a comprehensive, detailed ratio as well as trend analysis of bothcompanies in addition to comparing the two companies against industrynorms. I also come up with a detailed analysis of the industries thecompanies operate in and compare the two countries in terms of businessas well as legal environment amongst other issues. The CompaniesThe identified companies for analysis in this case include the Wal-Martstores which are based in the U.S and the Dashang Group in china. Bothof these companies are in the retail industry and they are recognized asmarket leaders in the jurisdictions they operate in.Though headquarteredin the US, Wal-Mart stores operate globally through franchises. Wal-Mart was founded by Sam Wal-Mart in 1945 and since then, it hasgrown to be one of the biggest retailers in the world with an annualturnover of 405,046 million U.S dollars as at 31st March 2010.When itcomes to the Dashang Group, it was established in 1960 and with itsheadquarters in Dalian, it is taken to be one of the largest retail chains inchina. For the financial year ended 31st March 2010, Dashang registereda turnover of 76,733 million US dollars. Industry analysis
  2. 2. The companies I consider for analysis in this case, that is, the DashangGroup and the Wal-Mart Stores are both in the retail industry. Accordingto Boone et al. (2009) the retail industry is made up of companies thatoffer for sale to consumers finished products. With a big chunk of theGDP in most countries around the world being informed by retailconsumption, the retail industry performance has come to be taken to bean indicator of the performance of the economy of a given company. A brief analysis of the operating environmentAccording to Finne et al. (2009), the U.S business environment isconsidered to be among the world’s best when it comes to the legalstructures in place. However, those who with to successfully do businessin this environment must first of all appreciate the country’s diversity.When it comes to the legal dimension, the Federal governments as wellas county and state governments are responsible for enforcement of thebulk of laws that govern the country. Taxes are imposed by theresponsible jurisdiction and all the businesses operating in a givenjurisdiction must comply with a variety of taxes in a given jurisdiction.With the U.S. recovering steadily from the global economic slump,analysts estimate that the potential of companies to perform well shall beenhanced.When it comes to china, the business environment has beenregarded as ‘highly inviting’ and by dint of being the second largesteconomy in the world as far as the PPP or what is known as thepurchasing power parity is concerned. In the recent past, we have seenthe Chinese government going ahead to enhance the country’s investingclimate and in this regard, there has been a commendable infrastructuralimprovement in china over the last few years. The US retail industryBoone et al. (2009) notes that the total U.S. retail industry sales totaledto about 4.1 trillion U.S dollars as per the 2009 data released by the U.S.Census bureau. However, this was a significant drop from theperformance of the industry the previous year. The fall was blamed onthe downturn in economic activity that started off in 2009 and informed
  3. 3. one of the worst recessions since the Great Depression of the 1920s. Theaggregate decline was also registered in the various retail stores.However, with the recovery of the economy that has been informed bythe stimulus program offered by the government, major retail stress haveseen an increased profitability going by the interim statements for 2010.It is important to note that when growth is considered, the retail industryremains to be the second amongst the various US industries. The U.Sretail industry has also been taken to be one of the largest employers inthe marketplace and with that in mind, we have global brands includingDisney store, Apple as well as Wal-Mart based in the U.S. In the U.Salone, we have close to 400,000 individuals deriving their livelihoodfrom Wal-Mart. Boone et al. (2009) notes that close to 11% of the U.Semployment opportunities are derived from the retail industry.According to Finne et al. (2009), single-store businesses characterize theU.S retail industry. The Retail Industry in ChinaAccording to Finne et al. (2009), for a long time, the growth of theChinese retail has been largely inhibited by the tendency of the Chinesepeople to execute purchases from small stores as well as shops located intheir neighborhoods. However, in the last two decades, there has been asignificant shift in this and this has been reflected by the growth of retailchains in the same period. A look at the data released by the ChinaChain Store and Franchise association shows that the Chinese retailmarket continues to grow by close to 13% annually. Analysts estimatethat in the next one or so decades, the growth of the same shall hit 17%per annum. A comparison of Wal-Mart and DashangAccording to Walton (2000) ratio analysis is one of the most importantas a well as effective tool as far as a company’s financial statementsqualitative analysis is concerned. On computation, ratios provide a validas well as reliable comparison of the performance of a single companyover time, the industry or even a number of companies operating in the
  4. 4. marketplace.It is however important to note that for ratios to be entirelyeffective as far as the analysis of financial statements is concerned, theyshould be utilized for the comparison of companies operating in thesame industry (Walton 2000). It should be noted that the ratio analysis Icarry out below with regard to both Dashang and Wal-Mart is derivedfrom the most recent financial statement for the companies i.e. for theyear ended 31st March 2010. Wal-Mart and Dashang: An analysis of ratios Current ratioThe current ratio concerns itself with solvency. It shows the ability of acompany to settle its short term obligations. The current ratio is given bydividing the current assets with the current liabilities. For our twocompanies;The current ratio of Wal-Mart = current assets/current liabilities= 48,331/55,561 = 0.87What this essentially means is that for every 1 dollar of short termobligations Wal-Mart owes to the outsiders, it has 0.87 with which tosettle the same. This essentially means that as at the moment, Wal-Martcannot be able to settle its obligations (short-term) as they fall due.For Dashang, current ratio = current assets/current liabilities= 7450/7714 = 0.96This essentially means that for every 1 dollar of short-term obligationDashang owes to outsiders, it has 0.96 with which to settle the same.From the perspective of current ratio, it is clear that Dashang is in abetter position to settle its short term obligations as compared to Wal-Mart. Quick ratioQuick ratio is a basic measure of an entities liquidity. It is given bydividing the summation of cash and accounts receivable by the currentliabilities.Quick ratio = cash + accounts receivable/ current liabilitiesFor Wal-Mart = (7907+ 4144)/ 55,561 = 0.21
  5. 5. For Dashang = (424+ 909)/ 7714 = 0.17For the case of Wal-Mart, a quick ratio of 0.21 essentially means that forevery 1 dollar of short term obligations Wal-Mart has to settle, thecompany has 0.21 cash and cash equivalents with which to settle thesame. For the case of Dashang, a quick ratio of 0.17 essentially meansthat for every 1 dollar of short term obligations Wal-Mart has to settle,the company has 0.17 cash and cash equivalents with which to settle thesame. This essentially means that Wal-Mart is better placed to settleshort term obligations without putting so much reliance on inventory. Debt to worth ratioThe debt to worth ratio concerns itself with the measurement of financialrisk and it is derived by dividing the total liabilities figure with the networth of a firmDebt to worth ratio = total liabilities / net worthFor Wal-Mart = 99,957/170,706 = 0.58For Dashang = 18,261/23093 = 0.79A debt to worth ratio of 0.58 for the case of Wal-Mart essentially meansthat for every 1 dollar of net worth that the stockholders have invested,Wal-Mart owes $0.58 debt to all its creditors. On the other hand, a debtto worth ratio of 0.79 for the case of Dashang essentially means that forevery 1 dollar of net worth that the stockholders have invested, Dashangowes $0.58 debt to all its creditors. It is hence clear that Dashang owesless to its creditors than Wal-Mart for every single dollar invested. Net margin ratioThe net margin ratio is a basic measure of the net profit level. It isderived by dividing the net profit before tax with the sales figure. Thatis;Net margin = net profit before tax/ salesFor Wal-Mart, = 22,066/405046 = 0.05For Dashang, = 2967/76733 = 0.03This essentially means that in the Case of Wal-Mart, for every $1 dollarof sales made, Wal-Mart produces 0.05 dollars of profit (Net). Similarly,in the Case of Dashang, for every $1 dollar of sales made, Dashang
  6. 6. produces 0.03 dollars of profit (Net). A look at this gives brings one to aconclusion that Wal-Mart earns more of net profit for every dollar ofsales made. Sales to assets ratioSales to assets ratio concerns itself with charting the efficiency of totalassets as far as generation of sales is concerned. It is given by dividingthe total sales with the total assets.Sales to assets = sales/total assetsIn the case of Wal-Mart = 405046/ 170,706 = 2.37In the case of Dashang = 76733/ 23093 = 3.32In the case of Wal-Mart, sales to assets ratio of 2.37 essentially meansthat for every $1 invested in total assets, the entity a sales value of $2.37.However, when it comes to Dashang, a sales to assets ratio of3.32essentially means that for every $1 invested in total assets, the entitya sales value of $3.32. It is clear therefore that for every single dollar ofcurrent assets invested, Dashang generates more in sales. Return on assetsThe return on assets ratio charts the efficiency of total assets as far as thegeneration of net profit is concerned. It is therefore a measure of howmany dollars of net profit are generated for each single dollar invested inassets (Total). It is derived by dividing net profit with the total assets.Return on assets = net profit before tax/ total assetsFor the case of Wal-Mart = 22,066/170,706 = 0.12For the case of Dashang, = 2967/23093 = 0.12Surprisingly, both Wal-Mart and Dashang have the same return onassets. This therefore means that for both Dashang and Wal-Mart, a netprofit before tax of 0.12 cents is generated for every single dollarinvested in assets. Return on investmentThe return on investment is said to be an efficiency ratio and with that inmind, it is concerned with charting how efficient the net worth is as far
  7. 7. as the generation of net profit is concerned. It is derived by dividing netprofit before tax with the net worth of the entity.Return on investment = net profit before tax/net worthFor the case of Wal-Mart, = 22,066/170,706 = 0.13For the case of Dashang, = 2967/23093 = 0.12What a return on investment of 0.13 means for Wal-Mart is that theentity generates a total of 0.13 cents for every single dollar invested innet worth. On the other hand, a return on investment of 0.12 means thatin the case of Dashang, the entity generates a total of 0.12 cents forevery single dollar invested in net worth. For an investor looking for ahigher return on assets, then he or she would consider investing in Wal-Mart for it generates a slightly higher return on investment thanDashang. Inventory turnoverThe inventory turnover is classified as a measure of specific efficiencyand it is derived by dividing the cost of goods sold with the inventory. Itbasically measures inventory usage rate expressed in annual terms.Inventory turnover = cost of goods sold /inventoryFor the case of Wal-Mart, = 304,657/ 33160 = 9.18For the case of Dashang, =58958 /4902 = 12.02In the case of Wal-Mart in the above scenario, it essentially means thatfor every single fiscal year, the average dollar inventory volume is usedup a total of 9.18 times. On the other hand, when it comes to Dashang,an inventory turnover of 12.02 time essentially means that for everysingle fiscal year, the average dollar inventory volume is used up a totalof 12.02 times. It is therefore clear that inventory is used up more timesin Dashang than in the case of Wal-Mart. It is important top note thatthough this ratio may not be important for service companies, it ends upbeing real useful in the case of companies operation in the retailmarketplace like Wal-Mart and Dashang as it charts the efficiency ofeach as far as inventory usage is concerned. Accounts payable turnover
  8. 8. The accounts payable turnover is a measure of the accounts payablepayment rate per year. It is given by dividing the cost of goods sold withthe accounts payableAccounts payable turnover = cost if goods sold/ accounts payableFor the case of Wal-Mart = 304,657/ 30451 = 10.00For the case of Dashang, = 58958/ 3890 = 15.15For Wal-Mart, an accounts payable turnover of 10 essentially means thatpayment for the accounts receivables average dollar volume is done 10times in the fiscal year concerned. On the other hand, for the case ofDashang, an accounts payable turnover of 15.15 essentially means thatpayment for the accounts receivables average dollar volume is doneabout 15 times in the fiscal year concerned. A brief analysis of the companies going forwardAnalysts estimate that the U.S retail industry shall continue to growgoing forward. Further, the retail industry is expected to grow theeconomy by availing close to 14% of the total employment opportunitiesin the U.S by the year 2015. Finne et al. (2009) further notes that thosecompanies that embrace ecommerce shall increase their revenues goingforward. Already, Wal-Mart has restructured for purposes of enhancinge-commerce. This has been through the establishment of Global.comwhich is a business unit within Wal-Mart that is charged with foreseeingthe company’s eCommerce growth both at the home front as well asinternationally. Analysts note that if the platform is to be fullysuccessful, then Wal-Mart shall have a potential to increase its revenuesby up to 75% in the next five years.However, when it comes to Dashang, efforts are yet to be made as far asthe establishment of an ecommerce strategy is concerned. Finne et al.(2009) notes that based on the fact that ecommerce shall be one of themain drivers of growth for players in the retail industry, Dashang needsto focus less on its “bricks-and –mortar” outlets and instead focus moreon the utilization of the ecommerce platform to boost sales.It is alsoimportant to note that when it comes to Dashang, it is set to encounterstiff competition from other retailers from around the world making
  9. 9. forays into the Chinese marketplace. This according to Boone et al.(2009) is because Global Retail Players continue to see the Chineseretail marketplace as a profitable marketplace in which to do businessgiven the growth rate of the country. ConclusionFrom the analysis carried out for both Dashang and Wal-Mart, eachinvestor would have a specific aspect to look out for. However, asalready noted, mot investors are interested on the return on investmentas they are most interested in a company or entity that shall give them ahigher return for every single dollar of investment they make dependingon their risk appetite. However, all the other ratios are useful on theirown as they give an important insight on the efficiency as well as theability/likelihood of a given company to continue doing business goingforward.
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