Financial case study on Orbital Corporation Limited

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Part A

a. Stakeholders

Following are five categories of shareholders of Orbital Corporation Limited:

  • Customers:

Orbital Corporation serves in multiple segments like systems sales, Synerject joint venture, Remsafe Pty Ltd joint venture and consulting services etc. and it has significant customer base, who is direct stakeholder for the company. Diverse customer base of Orbital Corporation includes customers like BHP Billiton, Rio Tinto and FMG etc. These customers would be interested in company’s financial statement as the profitability of Orbital Corporation can directly impact the pricing of goods they procure through the company, so they would carefully monitor company’s financial statements to review company’s next steps.

  • Government:

Government is significantly involved in the business of Orbital Corporation as it provides various grants to company from time to time for various functions like building of infrastructure and facilities for new plant etc. So government would be more interested in company’s projects that may prove to be more massive potential to revolutionize the automobile industry; for instance company recently tapped into unmanned aerial vehicle industry, apart from that another joint venture of REMSAFE for which government had also funded, aims to provide world-class remote electrical isolation systems

  • Shareholders:

Shareholders of the company would be keenly interested in the financial statements of Orbital Corporation limited, since they have invested their money into securities of company, they will carefully monitor the cash cycles of company and other technical elements of financial statements which may impact the prices of its security

  • Creditors:

Creditors like banks and third party creditors will be key stakeholder for the company and will carefully analyze and monitor the profitability and operations of company as they have provided debt to company and there is risk involved and in order to gauge their risk, they will timely evaluate the financial statements of Orbital Corporation Limited to safeguard their interests

  • Employees:

Employees come under internal stakeholders for the company, they will also be interested in the financial statements of Orbital Corporations, since their financial success and growth is highly pivotal to financial health of company and apart from that most of company’s rewards are announced in the form of stock options, so employees would also monitor the company’s financial statements to safeguard their interests.

b. Corporate governance and Ethics

Orbital Corporation has comprehensive policy and strategy for corporate governance and ethics and to comply by all applicable regulations and developing corporate governance, top management has defined a comprehensive corporate governance statement, which is monitored and evaluated. The Company abides and gives careful consideration to eight fundamental principles and recommendations provided in Australian Stock Exchange (ASX) Good Corporate Governance Principles (ASXCGC). Below is provided the justification of how Orbital Corporation complies by each of these eight principles and recommendations:

  1. Principle 1

Orbital Corporation has well defined charter of roles and responsibilities for its board and entire management. Board has laid solid foundation for management and it oversights the job and performance of management. There is a well-established system of all the processes including the process to evaluating the performance. In order to ensure the implementation of eight principles, management has a detailed and comprehensive guide to reporting on principle 1. Management has also provided these instructions in its annual report and on its website.

  1. Principle 2

Orbital Corporation is being administered by properly defined board, whose primary function is ensure protection of shareholders’ value and enhance it by providing strategic and productive guidelines to group. The Board also oversights the managements for ensuring the ethics at company and in order to do so Board is responsible to look after corporate governance. Board at Orbital Corp has an effective composition of independent directors, selected through established nomination committee and adequate size to fulfill the delegated duties effectively. In order to scrutinize entire chapter, board is chaired by an independent director, who oversights that each director in board performs his/her assigned duties to add value in operations of Orbital Corporation.

  1. Principle 3

In order to maintain desired level of integrity and transparency at workplace, management at Orbital Corporation encourages ethics at workplace and also ensures that only responsible decision making is done. Board and management has defined a clear set of policies and practices for whistleblowing and maintaining the ethical conduct. Management has set up a proper committee to serve this purpose, for instance audit committee, human resource, remuneration and nomination committee. These committee operate on a certain well defined mandate that is consistently reviewed and each committee’s effectiveness to fulfill that mandate is monitored. Apart from that Board has adopted an integrated and strategic framework, which standardizes internal control and establishes required and desired ethical standards.

  1. Principle 4

Board has setup a proper audit committee to safeguard integrity in financial reporting and the role of this committee at Orbital Corporation is to ensure that quality and reliability of financial statements. Audit committee is based on independent and non-executive directors and it functions on a documented charter made by board. Apart from that audit committee forms a liaison with external auditors and monitors its performance as well

  1. Principle 5

At Orbital Corporation, it is the responsibility of board of directors to ensure that all shareholders of company are aware of all the major developments that may directly or indirectly affect the group’s operations. For that purpose board has drafted a policy to identify matters, which may impact share price of company’s shares. In order to make continuous disclosure and manage the market communication, board has adopted respective policies, for instance this policy on release of sensitive information that is monitored by company’s secretary; similarly company is also responsible for all the communications with ASX.

  1. Principle 6

At Orbital Corporation limited, Shareholders are regarded as ultimate owners of the company and board of directors makes sure that they get highly relevant and high quality information about their investment in a timely pattern. Apart from realizing the rights of shareholders, board encourages them to participate in Annual General Meeting to ensure desired level accountability and stakeholders’ identification with strategy of company.

  1. Principle 7

At Orbital Corporation Limited, management has adopted a reliable system to identify and monitor potential risks and establish effective internal control. Board administers implementation and monitoring of risk management system that is used by company, this system helps management in identifying, assessing, monitoring and managing financial, operational and other forms of risks linked to compliance and reporting. Senior management is responsible to design risk management strategies along with support of audit committee

  1. Principle 8

Management at Orbital Corporation Limited aims to ensure a transparent system of remuneration based on performance, for that purpose a designated human resources, remuneration and nomination committee based on independent directors has also been established. The primary objective of this committee is to advise board on remuneration packages and policies, which can be implemented for Chief Executive Officer, senior executives and directors.

c. Profitability Analysis

  1. Return on equity:

Return on equity is calculated by dividing net income by average shareholders’ equity. ROE for last three years has been calculated and provided in table below:

ROE = Net income / Average Shareholders’ equity

Ratio

2014

2013

2012

Net income (million)

1.68

0.36

-3.05

Average Shareholders’ equity (million)

20.314

18.27

18.37

Return on equity

8.27%

1.97%

-16.54%

""

It can be analyzed that ROE for Orbital Corporation limited (ASX: OEC) has been improving over last three years, the reason form improvement has been because of significant increase in the denominator value of calculation, which is net income. Net income of the company has been increasing over last three years. Net income has grown roughly by 366% over last year.

  1. Return on assets:

Return on asset is calculated by dividing net income by company’s average total assets for the year. The return on assets of Orbital Corporation limited has been calculated for past three years as follows:

ROA = Net Income / Total Assets

Ratio

2014

2013

2012

Net income (million)

1.68

0.36

-3.05

Total Assets (million)

37.67

36.13

40.20

Return on assets

4.54%

0.95%

-7.54%

""

By plotting the data for annualized return on asset for company for last three years, it can be analyzed that the figure has improved over the period of time and the reason behind improvement has been because of significant increase in the net income for the company. Company’s profitability has improved over the last three years, leading to impressive figures for profitability ratios.

  1. Net Profit Margin:

Net profit margin is calculated by dividing Net income by company’s annual revenue. Net profit margin for Orbitals Corporation limited has been calculated as follows:

Net profit Margin = Net income / Sales

Ratio

2014

2013

2012

Net income (million)

1.68

0.36

-3.05

Sales (million)

18.34

26.70

22.36

Net Profit Margin

9.14%

1.36%

-13.65%

""

Upon analyzing the net profit margin of company for last three years, it can be analyzed that company’s profitability has significantly improved over the given tenure. The reason for improvement has been identified as based on the impressive increase in the net income for company over last three years. The jump in net profit margin for FY 2014 has been because of double impact of increase in Net income and decrease in total revenues for the company.

  1. Cash flow to sales:

Cash flow to sales ratio is calculated by dividing operating cash flow by annual sales. For Orbital Corporation limited, cash flow to sales ratio is calculated and provided as follows:

Cash flow to sales = Operating Cash flow / Total Sales

Ratio

2014

2013

2012

Operating cash flow (million)

-1.91

-1.72

-4.25

Sales (million)

18.34

26.70

22.36

Cash flow to sales

-10.4%

-6.44%

-19%

""

The figures for cash flow to sales ratio has been negative over the last three years because of involvement of negative element of changes in working capital, which caused the operating cash flow to be negative and in result the ratio also was calculated as negative. Changes in working capital have been negative over the period of last three years.

d. Analysis of financial position

Liquidity ratios

ï‚· Current ratio

Current ratio is calculated by dividing company’s total current assets by company’s total current liabilities; for Orbital Corporation current ratio for last three years has been calculated as follows:

Current ratio = Total current assets / Total current liabilities

Ratio

2014

2013

Current Assets (million)

15.84

15.48

Current Liabilities (million)

7.53

7.29

Current ratio

2.10

2.12

""

Current assets of the company has grown over continuously over the last three years, whereas current liabilities had declined from 2012 to 2013 but then increased to a certain percentage in 2014, which led to decline in current ration during the year.

Quick ratio

Quick ratio is calculated by dividing company’s total current assets excluding inventory by company’s total current liabilities for the period. For Orbital Corporation, quick ratio for last three years has been calculated as follows:

Quick Ratio: (Total Current Assets – Inventory) / Total Current liabilities

Ratio

2014

2013

Current Assets (million)

15.84

15.48

Inventory (million)

3.33

3.16

Current Liabilities (million)

7.53

7.29

Quick ratio

1.66

1.69

""

Quick ratio for the company has also increased from FY 2012 to FY 2013 on the basis of decline in total current liabilities but has declined for FY2013 to FY2014 due to increase in the number of total current liabilities.

Capital Structure

ï‚· Debt to equity ratio

In order to calculate debt to equity ratio, company’s total debt (Current portion of long term debt + Long term) is divided by total equity of the company. For Orbitals Corporation limited, Debt to equity ratio for last three years is calculated as follows:

Debt to equity ratio = Total debt / Total Equity

Total Debt = Current portion of long term debt + long term debt

Ratio

2014

2013

Total Debt (million)

8.33

8.23

Total Equity (million)

21.05

19.50

Debt to equity ration

0.40

0.42

""

The figures for debt to equity ratio have declined over the period of last three years because of consistent increase in value of denominator of the formula, which is company’s equity. Company’s equity for these periods of FY12-13 and FY13-14 has increased by rate of 11.87% and 7.94% respectively.

e. Analysis of cash flow

Data in millions

2014

Net operating Profit

-5.71

Cash flow from operation

1.68

The chart above provides Net operating profit and cash flow from operations for Orbital Corporations limited. Both of the entries differ significantly because of following reasons:

  • Net operating income, also known as EBIT (Earnings before income and tax) is a component that is calculated by subtracting all operating expenses from revenue generated via sales and it does not include components of interest and tax etc. whereas in calculation of cash flow from operations these elements are incorporated
  • Operating income doesn’t include components of changes in working capital, whereas while calculating cash flow from operation, component of changes in working capital is added back
  • Operating income includes gross income that firm has generated using continuing operations and doesn’t include component of cash flow from other operations, whereas in calculation of cash flow from operation, cash flow generated from other operations is also included in the calculation.

f. Funding analysis

The two main sources of company’s finance as obtained from its financial statements for fiscal year 2014 are as follows:

  • Revenue from multiple segments:

Preliminary source of finance for Orbital Corporation are revenues generated from multiple segments it operates in. The revenues generated from these segments are as follows:

Segment

Revenue for FY2014 (millions)

System Sales

$14.14

Synerject

$141.746

Consulting Services

$2.9

Royalties and Licences

$1.12

  • Revenue from government grants

Other source of finance for company includes grants that it receives from Government from time to time. For Fiscal year 2014, company received a total government grants worth of $225,000

  • Usage of financing

The finance acquired by company is mostly used in two functions which are operational expenditures and expansion activities.

Part B

Financial Ratios of Advanced Braking Technology Ltd (ABT)

  1. Profitability ratios
  1. Return of Equity (ROE)

ROE = Net income / Average Shareholders’ equity

Ratio

2014

2013

Net income (million)

-7.54

-0.92

Average Shareholders’ equity (million)

6.269

9.378

Return on equity

-120.26%

-9.81

  1. Return on assets (ROA):

ROA = Net Income / Total Assets

Ratio

2014

2013

Net income (million)

-7.54

-0.92

Total Assets (million)

7.94

11.06

Return on assets

-79.44%

-8.12%

  1. Net Profit Margin:

Net profit Margin = Net income / Sales

Ratio

2014

2013

Net income (million)

-7.54

-0.92

Sales (million)

4.45

5.98

Net Profit Margin

-169.47%

-15.39%

  1. Cash flow to sales

Cash flow to sales = Operating Cash flow / Total Sales

Ratio

2014

2013

Operating cash flow (million)

-3.62

-0.62

Sales (million)

4.45

5.98

Cash flow to sales

-10.4%

-6.44%

  1. Liquidity ratios
  1. Current ratio:

Current ratio = Total current assets / Total current liabilities

Ratio

2014

2013

Current Assets (million)

5.78

5.55

Current Liabilities (million)

2.00

1.50

Current ratio

2.90

3.70

  1. Quick ratio:

Quick Ratio: (Total Current Assets – Inventory) / Total Current liabilities

Ratio

2014

2013

Current Assets (million)

5.78

5.55

Inventory (million)

1.61

2.09

Current Liabilities (million)

2.00

1.50

Quick ratio

2.09

2.31

  1. Capital Structure
  1. Debt to equity ratio

Debt to equity ratio = Total debt / Total Equity

Total Debt = Current portion of long term debt + long term debt

Ratio

2014

2013

Total Debt (million)

3.41

0.65

Total Equity (million)

3.44

9.10

Debt to equity ration

0.99

0.07

Financial Decision:

Compare the ratios calculated in 1 above with those you calculated in questions 3 and 4 of Part A for 2013 and 2014 for your selected company. Based on the profitability, liquidity and capital structure of these two companies, in which company would you, buy shares? Justify your decision

Based on the financial ratio analysis of both companies, it can be observed that Advanced Braking Technology limited has been performing very poorly and have heavy debt to equity ratio, along with it the company’s hasn’t been making any profits over last two years, on the contrary it has been facing loss continuously; even if it is assumed hypothetically that company makes a profit before interest and tax in upcoming tenure, then major portion of its profitability will be eaten away into debt payments and no advantage can be issued to shareholders. While Orbital Corporation Limited has been making profits over the last three years and its debt to equity ratio is also equal to industry standards, company’s liquidity position is also good, thus a stable stream of future cash flows is also expected, which will directly be beneficial for shareholders through growth in prices of shares over the long run and dividend after couple of years, thus I shall opt for purchasing shares of Orbital Corporation Limited over Advanced Braking Technology limited.

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