Applied financial accounting

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Abstract

This paper seeks to discuss the Capital budgeting analysis of four companies in the food production industry. In arriving at their growth estimate over the last two years the, paper will explore the firms' solvency and liquidity as well as efficiency in the use of economical resources available at their disposal. Finally, the paper will address both trend and cross-sectional ratio analysis with an aim of determining the trends in specific companies over the years as well as growth in comparison with other firms in the same industry.

Introduction

Capital budgeting entails analysis of long term projects that require high initial capital to determine their viability. This process involves comparing the costs (cash outflows) with the expected benefit and/or returns. A project is considered viable if the sum of present value of expected cash inflows in future are greater than the initial cash investment. Capital budgeting analysis is important before undertaking an investment decision because the projects require high start up capital and thus have long-term implications and/or effects for any firm. Similarly, capital decisions are known to carry a high degree of risks compared to other financial decisions because they are irreversible. In deciding on capital projects to undertake, an investor needs to carry out a thorough analysis of the financial statement to gauge the liquidity, long-term solvency, growth and hence the ability to undertake the projects (Peterson & Fabozzi, 2002).

Findings and Discussion

Financial analysis

Economic performance of the food industry segment in the recent past has been recording a decline in profits and sales turnover in most national and regional chains. The decline has been mainly attributed to overall trend under the perceived global-economic turmoil. However, international chains continued to record profits margin due to comparative advantages of dealing with diverse economies. Decisions involving a large capital outlay require careful evaluation of their viability before undertaking them. A firm that undertakes capital budgeting analysis acts in the best interest of the common stockholders and /or shareholders by ensuring the objectives of wealth maximization is met. This is because only profitable projects and /or investments are undertaken. These decisions involve examination and/or analysis as to whether introducing a new product in the market to compliment or add to a company's product line is really viable or profitable. Capital budgeting also involves decisions when venturing into new market and/ or investment in fixed assets. Analysis of Burger King Holdings, Inc, Starbucks Corporation, McDonald and Yum! Brands companies' financials is carried out to base viable advice on investment decision. Trend analysis is given below for the four companies:

McDonald and Yum! Brands company financial ratios for 2007/ 2008 accounting period.

As evidenced from the ratio calculations above, current ratio for all the companies except Starbucks Corporation is seen to be decreasing across the two fiscal periods under investigation. For instance, Burger King Holding's corporation current ratio is decreasing from highs of 0.93 in 2007 to a figure of 0.86 in fiscal 2008. Current ratio is used to indicate the ability of any firm to meet its short-term debts and/or obligations as they fall due (Black, 2004).Therefore, the decrease in the ratio between the two periods under investigation depicts a decrease in the firm's ability to cover debts which are short-term thereby making this trend negative.

Similarly, the quick ratio is decreasing from fiscal 2007. Quick ratio is used to indicate the capacity of a company to cover its short-term debts as they fall due out of its most liquid assets (i.e. cash in hand, accounts receivable and cash in bank). Decrease in this ratio over the period is therefore unfavorable as it indicates decrease in this ability. Also, though Starbucks Corporation shows an increase of both current and quick ratio across fiscals 2007 and 2008, the ratios figure is far below the acceptable industry average. Current assets should cover the short-term obligations at least twice and the most liquid assets at least once.

Therefore, the liquidity position of the four companies is relatively low and therefore the management should increase investment of short-term assets to enhance future profitability of the firms. Cross-sectional analysis shows McDonald as the best performer in terms of current assets management. This is because though the ratios are below the industry average, the company has the highest ability to meet its short - term obligations relative to others. Similarly, Yum! Brand Corporation has low ability in management of current assets as both liquidity ratios are lower the other companies under investigation (Dayananda, 2002)..

Efficiency employed in the use of economic resources at the company disposal is seen to be increasing from 2007 except for, McDonald Incl. For example, Stock-turnover for the, Yums! Brand Incl is increasing from a figure of 78.87 to a figure of 81.38 in 2008.According to Houston & Brigham (2007), Stock turnover indicate the rate of turning stock to sales by a company. A lower rate is preferred as it indicates a high rate of converting stock to sales hence the trend in three companies is negative. Similarly, day's inventory has decreased from 2007. This ratio indicates the average number of days taken to turn convert stock. Higher number of days represents a high rate of stock turnover. Hence the trend portrayed by Burger King Holdings, Inc, Starbucks Corporation and Yum! Brands companies firm is negative as it indicates decrease of the firm's efficiency in the utilization of assets. Similarly receivable-turnover shows a decline for all the firms except McDonald Corporation for the two fiscal years under investigation. For instance, Burger King Holdings shows a decline of this ratio from the highs of 17.87 Times in 2007 to lows of 17.66 in 2008 Times as evidenced from the ratio calculations above.

Receivable-turnover indicates the rate at which a firm turns-over its debtors. Decrease in this ratio is negative as it indicates low rate of turnover. Similarly, this ratio also indicates the frequency at which the firm collects debts from its credit customers. Day's receivable ratio is increasing across the two periods under investigation except for McDonald firm. Day's receivable indicates the average number of day's firm's takes to collect its debts, lower number of days is preferable as the capital tied up could be used in short-term investment thus increase revenue for the firm (Jennings, 2001). Therefore, increase in the number of days is unfavorable for the firm because of the opportunity loss as cash which could otherwise be invested in Short-term marketable securities to generate revenue is tied up in these assets.

Similarly, the increase in the number of days is unfavorable to the company because debts which take long time to collect usually turn to be bad and/or uncollectible. Lengthy period of collection leads to higher cases of bad-debts. Thus, high collection period is worse for any firm because lengthy period leads to allowance for unnecessary costs such as excess provisions for uncollectible debts and untimely write-offs. Moreover, net- profit margin are decreasing from 2007 for McDonald and Starbucks firms are seen to be decreasing across the period .For example, in 2007 Starbucks the Net profit ratio was 7.15%while in fiscal 2008 the ratio stood at 3.04% .profit-margin ratio depicts the amount of Net-income earned given a certain volume of sales. This ratio shows the amount of revenue earned from a company's operations.

The trend in these ratios is bad and/or alarming as it indicates decrease in earnings generated from sales. Measures to prevent further decline should be taken as the trend could perhaps affect the credibility of the company especially to the major stakeholders. Similarly, net -profit ratio is seen to be increasing across the period for Yums! Brand, and Burger King Holdings. Net-profit indicates the income and/or profit generated from sales after deducting all the operating expenses. According to Barry (2008), such a trend is positive as it indicates increase in these earnings over the period.

Return-on-assets ratio and return-on-equity shows a decrease over the period for all the companies under investigation. For instance, Return-on-assets for Starbucks Corporation is for decreasing from a figure of 19.72%in 2007 to a figure of 8.80% in fiscal 2008. According to Mclaney (2008), Return-on-assets ratio shows a firm's earning in relation to all the economic resources owned by the company. This ratio also shows how much the firm generates from the utilization of assets. This trend is unfavorable because it indicates a decrease in the ability of all the firms under analysis to generate returns on the economic resources at their disposal. Additionally, return-on equity s evidenced to be decreasing from 2007 from the ratio calculations. Return-on-equity measures company's earnings (i.e. profit) relative to the amount of shareholder equity employed in the firm. Higher figure for this ratio is preferred as it indicates that the company the return to ordinary shareholders is favorable. Therefore, the trend portrayed from 2007 to 2008 fiscal year is negative as it indicates decrease in returns for the ordinary and /or common stock-holders.

Additionally, debts ratios are seen to be increasing for McDonald and Yum! Brands Company between 2007 and 2008 financial periods For example, debt/assets ratio has increased for an average of 0.25 in fiscal 2007 to 0.31 in 2008 for Mc Donald firm .Similarly, this ratio is seen to be decreasing for Burger King Holdings, Inc and Starbucks Corporation across the same period. These ratios indicate the use of debt-financing relative to equity in a company (i.e. gearing). Also, these ratios are used to indicate the solvency of a given firm in the long-run. The trend depicted by McDonald and Yum! Brands corporations are negative as it indicates increase of the degree of leverage or use of debt financing by the firm over the period. Though use of debts to finance a business leads to higher returns to company owners, the degree of risk associated with the investment is very high (Weetman, 2006). This is because high level of debts can cause a company to liquidate especially during recession when the interest rates are considerably high.

However, trend indicated by the Burger King Holdings, Inc and Starbucks Corporation is remarkably good. This is because the trend indicates decrease in the degree of leverage or use of long-term borrowing by the company. A low leveraged company has a high degree of long term solvency as compared to a company with high leverage or gearing ratios. This is because a capital structure with more equity than debt financing is less risky especially during inflation when the rates of interest are reportedly high. Market ratios also indicate a decrease in the company value of share over time. This ratio indicates shareholders earnings per every share held. Therefore, a decrease in these earnings depicts unfavorable trend in shareholders returns over the period. Tulsian, 2006)

Conclusion

Liquidity position for the select companies in the food industry is alarming. First for the three sample companies the ratios are decreasing across the period under investigation. Also, though Starbucks Corporation shows an increase over the period, the ratio is far below the acceptable industry average. This implies that the ability of the firms in the industry to cover its short-term obligations as they fall due is at stake. Thus firms in the industry should increase their investment in the current assets to ensure sustainable growth at the industry level. Similarly, long-term solvency of the industry is alarming as evidenced from 75% of the results in debt ratios from the sample companies. Debt total assets are seen to be increasing across the two fiscal years under investigation. Also efficiency in the use of assets is decreasing over the period. Therefore according to trend and cross-sectional analysis, the four companies are not in a position to comfortably undertake high profile investments.

Recommendations

The firms in the industry should endeavor to increase use of equity financing than debt financing to ensure long-term solvency of the firm. I would also recommend that more efficiency to be employed in the use of assets especially account recievables to ensure increased returns. This is because capital that would otherwise be tied up in these receivables could be used for investment in short-tem marketable securities and thus earn remarkable interests. Finally, measures to improve the overall profitability in the industry should be put in place to avert future cases of insolvency and/or liquidation of firms under this industry.

References

Barry, E. (2008). Financial accounting and reporting. New York, USA: Prentice hall publishers

Black, G. (2004). Applied financial accounting. Oxford, England: Oxford University Press publishers

Dayananda, D. (2002).Capital budgeting: financial appraisal of investment project. Cambridge, England: Cambridge University Press publishers

Houston, J & Brigham, E. (2007). Fundamentals of financial management. Mason, OH: Cengage Learning publishers

Jennings, R.(2001). Financial Accounting .London, United Kingdom: Cengage Learning EMEA publishers

Mclaney, A. (2008). Financial accounting for decision makers. Los Angeles, USA: Prentice hall publishers

Peterson, P& Fabozzi, F. (2002). Capital budgeting: theory and practice. Hoboken, New Jersey: Wiley and Sons Publishers

Tulsian. (2006). Introduction to accounting. London, UK: Tata McGraw-Hill publishers

Weetman, P. (2006). Financial and Management accounting .Upper Saddle River, NJ : Prentice hall publishers

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