Financial statement analysis of NZ Transport Limited

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Q 1.1 Purposes of financial statement analysis of NZ Transport Limited

Financial statements are analysed in order for different users to make a sound economic decisions in a business. The users can be the owner of the company, shareholders, investors, creditors or government entities. These analyses provide useful information about the performance of the company over a particular period of time, its financial position and also show how the company performs compare to the companies in the similar industries. Specifically, financial statement analysis, will help NZ Transport Limited and any company to: (Accountlearning.blogspot.co.nz, 2014)

  1. Assess past performance - The previous performance of the company will be an indicator on how the company will perform currently and decide on the future. For example, if during the past year, the company net profit is lower than the current year, the company can take a look at the expenses being incurred. In the comparative income statement presented by NZ Transport Limited, the operating expenses were lower 2012 as compared to 2011. The company can consider the decrease in the operating expenses as the major factor in increasing the net income.
  2. Assess current financial position – NZ Transport Limited balance sheet will show how much of its assets is owned by the company and as well as its liabilities. It will show the company’s liquidity (ability to pay short term liabilities) and its solvency (the ability of the company to survive for a long period of time). This shows the company’s capacity to pay due obligations and will help the creditors to decide whether to lend capital to the company.
  3. Predict profitability and company’s growth – NZ Transport Limited income statement will show the company’s performance through the income it generates. The gross and net profit margin will give the idea especially for investors both current and potential, if the company is able to generate income.
  4. Predict failure of the company – Through the analysis of the financial statements of NZ Transport Limited, the users can see whether the company can survive for a long time or will collapse over a short period of time. For example, it the reported figures in the net income for more than five years are consistently negative, meaning the company is operating continuously at a loss and you can tell that the company will be bankrupt and close down.

Q 1.2 Financial Statement Analysis (AccountingCoach.com, 2014)

  1. Profitability ratios:

i. Gross Profit Margin

2011

2012

Industry

Gross Profit*

Sales

*sales-cogs

77,000

175,000

= 44%

90,000

155,000

= 58%

39%

The gross profit margin has an increase of 14% from 2011 which is 44% and 58% for 2012. In both year, the company is above the industry standard which is 39%. The gross profit margin of NZ Transport Limited shows that it can sell its product or services above the cost of purchasing it. One of the reasons that the gross margin in higher in 2012 is that the cost of sales is lower as to its proportion to sales compared to 2011. Looking at the income statement, 2011 sales of 175,000 cost the company 98,000 or 56% while in 2012 the sales of 155,000 cost the company 65,000 or 42%.

ii. Net Profit Margin

2011

2012

Industry

Net Profit

Sales

23,298

175,000

= 13.3%

44,200

155,000

= 28%

5.5%

The net profit margin also has an increase 15% from 13% in 2011 to 28% in 2012 which is a lot higher than the industry standard which is 5.5%. The factors that have contributed to the increase in the net profit margin was an increase in the gross margin in 2012 of 14% and the operating expenses for 2012 decreased compared to 2011.

iii. Return on total assets

2011

2012

Industry

Net Profit

Total Assets

23,298

122,050

= 19.08%

44,200

126,550

= 34.93%

5.8%

This ratio shows the profit earned on every assets of the company. This shows how efficient NZ Transport Limited in using its assets to generate income. In 2011 the company has 19% ROA and around 35% for 2012. This indicates that the company is more profitable in 2012. The company performed well compared to industry standard of 5.8%.

iv. Return on Equity

2011

2012

Industry

Net Income

Total Equity

23,298

62,600

=37.21%

44,200

65,050

=67.98%

11.8%

The ROE for NZ Transport Limited for both year is above the industry standard. In 2011 it has 32.21% return while in 2012 it has a very high return of 67.98%. This means that the company has high return available to its investors. The results were high compared to the industry standard of 11%.

  1. Financial stability ratios:

i. Current ratio

2011

2012

Industry

Current Asset

Current Liabilities

31,750

29,750

=1.067:1

42,450

33,500

=1.267:1

1.84:1

As defined, current ratio is a method of measuring liquidity of a company. It is the proportion of current assets to the current liabilities. Current ratio will determine the availability of current assets that will cover liabilities that will fall due within a year or twelve months. NZ Transport Limited has available current assets available for every current liability that will fall due. In 2011, the company has 1.067 current asset for every 1 current liability. In 2012, it has improved its current ratio to 1.267 current asset for every 1 current liability. The may be able to settle its current obligations but its position is below the industry standard of 1.84 current asset for each 1 current liability.

ii. Quick ratio/Acid test ratio

2011

2012

Industry

(Current Asset-Inventory

Current Liabilities

(31,750-18,000)

29,750

=0.46:1

(42,500-28,500)

33,500

=0.42:1

0.66:1

The quick ration of the company for 2011 and 1012 is 0.46:1 and 0.42:1 respectively. These are below the industry standard of 0.66 quick asset for every current liability. The inventory being the biggest component of the current assets affected the quick ratio. Inventory being the least liquid in current asset was not considered in calculating the quick ratio.

iii. Working capital

2011

2012

Industry

Current Asset-Current Liabilities

31,750-29,750

=2,000

42,450-33,500

=8,950

Not given

NZ Transport Limited has a working capital of 2,000 and 9,000 for 2011 and 2012 respectively. This indicates the available capital over a short period of time. The main factor of the higher working capital for 2012 is the inventory. The company is holding more inventory as compared to 2011. The other components of current assets and current liabilities are of relative level.

iv. Gearing ratio

2011

2012

Industry

Total Liabilities

Total Assets

59,450

122,050

=48.71%

61,500

126,500

=48.60%

55%

The gearing ratio shows how much of the total assets were acquired or funded through liabilities. In 2011 is 48.71% of its total assets were funded through loans and 48.60% of the assets in 2012 were funded by liabilities. This percentage is better than the industry which has 55% standard which means that the assets acquired by companies in the same industry have acquired their assets through loans.

v. Debt to equity ratio

2011

2012

Industry

Total Liabilities

Stockholders’ Equity

59,450

62,600

=95%

61,500

65,060

=94%

Not given

The company has a very high debt to equity ratio at 95% and 94% for 2011 and 2012 respectively. This means that the business relies on creditors to fund its assets and almost half of the assets were financed by lenders.

vi. Times interest earned

2011

2012

Industry

EBIT

Interest Expense

26,350

5,000

= 6.27 times

50,650

4,000

=12.66 times

3.6 times

NZ Transport Limited has 6.27 times interest expense coverage by its operating income in 2011 and 12.66 times in 2012. Its performance is better than of the industry which is only 3.6 times. This means that the company has the ability to meet interest payments when it fall due because it can be covered by the operating income the company generates from its operation.

vii. Shareholders’ equity ratio (SHE)

2011

2012

Industry

SHE

Total Assets

62,600

122,050

=51.3%

65,050

126,550

=51.40%

Not given

These ratios of 51.30% for 2011 and 51.40% in 2012 show the extent of the contributions of the shareholders on the total funds of the business. The result shows that in both years, the shareholders contributed almost the same percentage of 51% on the total company’s total funds. The balance was financed by lenders.

  1. Asset utilisation ratios:

i. Inventory turnover

2011

2012

Industry

Cost of Goods Sold

Inventory

98,000

18,000

=5.44 times

65,000

28,500

=2.28 times

2.8 times

In 2011 the company performed well and was able to sell fast at 5.44 times but in 2012 it slowed down to 2.28 times only. The factors that affected the inventory turnover were: firstly, the cost of goods sold is higher in 2011 and the remaining inventory was also lower thus resulted to higher turnover; secondly, in 2012 the cost of goods sold was lower and the inventory at the end was higher resulting to low inventory turnover. In 2011 the company performed higher than the industry standard of 2.8 times but a bit lower in 2012.

ii. Accounts receivable turnover

2011

2012

Industry

Sales

Accounts receivable

175,000

7,950

=22.01

155,000

7,600

=20.39

Not given

NZ Transport Limited can collect its sales on account for 22.01 times during 2011 and slower in collection in 2012 by having AR turnover 20.39. Another reason for the decrease in the turnover is the decrease in sale and accounts receivable is also lower during 2012.

iii. Average collection period

2011

2012

Industry

365 days

Accounts Receivable TO

365 days

22.01

= 17 days

365 days

20.39

= 18 days

20 days

In 2011 the average collection period is 17 days which means the company is efficient in collecting credit sales. In 2012, the average collection period is about 18 days or one day more than 2011. In both years, the company collects faster than the industry which is 20 days.

iv. Non-current assets turnover

2011

2012

Industry

Sales

Non-Current Assets

175,000

90,300

=1.94 times

155,000

84,100

=1.84 times

1.8 times

The non-current assets turnover for 2011 is 1.94 times and 1.84 times in 2012. The company’s turnover in a bit higher on the industry standard which is 1.84. This means that the company has the effective in utilizing its fixed assets in generating sales.

v. Total assets turnover

2011

2012

Industry

Sales

Total Assets

175,000

122,050

=1.43 times

155,000

126,550

=1.22 times

1.6 times

The company has total assets turnover of 1.43 times and 1.22 time for 2011 and 2012 respectively. It is below par the industry’s performance which is 1.6 times but it still shows that the company was able to use its total assets to generate revenue.

Q 1.3

The following are the limitations of analysing financial statements of NZ Transport Limited: (Investopedia, 2008)

  1. Benchmarking of financial data - In the case of NZ Transport, its financial position and performance information will become more useful if it compared normally to the companies of the same industries, to the economy as a whole and also to its previous performance.
  2. Companies use different accounting practices which makes it difficult to come up with comparison. In case of NZ Transportation Limited, the company may use straight line method in calculating the depreciation of equipment and the other industry player used other method such as double declining method in calculating depreciation which may result to material difference in arriving at the net income.
  3. Companies may have peak seasons which make some period with significant difference in rations between two periods. For example, if during summer breaks, the demand is high on that period making some ratios significantly different from the rest of the accounting period.
  4. Costs are used in recording transactions in a company and the inflations are not considered that can impact the ratios to be calculated.
  5. Companies including NZ transport have different accounting cycles. They may use calendar year or fiscal year which makes it difficult to compare to other companies.

Q 2 Recommendations:

Palms Associates

Chartered Accountants

5D/208 Hobson Street

Auckland CBD

Phone (09) 12345678

Peter Parker

Chief Executive Officer

NZ Transport Limited

PO Box 123-45

Auckland

Dear Sir:

Report on financial year ended 31 March 2012

Please find enclosed our report to the management of NZ Transport Limited based on the completed financial statements and supporting analysis for the period April 2011 to 31 March 2012.

The report summarises profitability, liquidity and financial stability and management effectiveness as measured by the ratios shown in the schedule. Included in the report are the recommendations for the company.

Profitability.

The gross profit percentage has increased from 44% to 58% as a result of decrease in the cost of goods sold from 56% to 42%. The net profit margin also has an increase 15% from 13% in 2011 to 28% in 2012 The factors that have contributed to the increase in the net profit margin was an increase in the gross margin in 2012 of 14% and the operating expenses for 2012 decreased compared to 2011.

The return on owner’s equity for both year is above the industry standard. In 2011 it has 32.21% return while in 2012 it has a very high return of 67.98% which means that the company has high return available to its investors.

In 2011 the company has 19% Return on assets and 35% for 2012. This indicates that the company is more profitable in 2012.

Liquidity and financial stability.

In 2011, the company has 1.067 current asset for every 1 current liability. In 2012, it has improved its current ratio to 1.267 current asset for every 1 current liability. The increased current ratio is already within ideal range which is 1.2 to 2.0 for every current liability that will fall due.

The quick ration of the company for 2011 and 1012 is 0.46:1 and 0.42:1 respectively. These are below the industry standard of 0.66 quick asset for every current liability. The inventory being the biggest component of the current assets affected the quick ratio.

In 2011 is 48.71% of its total assets were funded through loans and 48.60% of the assets in 2012 were funded by liabilities.

The company has a very high debt to equity ratio at 95% and 94% for 2011 and 2012 respectively. This means that the business relies on creditors to fund its assets and almost half of the assets were financed by lenders.

The stockholder’s equity ratios are 51.30% for 2011 and 51.40% in 2012 show the extent of the contributions of the shareholders on the total funds of the business. The result shows that in both years, the shareholders contributed almost the same percentage of 51% on the total company’s total funds. The balance was financed by lenders.

The company has 6.27 times interest expense coverage by its operating income in 2011 and 12.66 times in 2012. This means that the company has the ability to meet interest payments when it fall due because it can be covered by the operating income the company generates from its operation.

Management Effectiveness.

In 2011 the company performed well and was able to sell fast at 5.44 times but in 2012 it slowed down to 2.28 times only. The factors that affected the inventory turnover were: firstly, the cost of goods sold is higher in 2011 and the remaining inventory was also lower thus resulted to higher turnover; secondly, in 2012 the cost of goods sold was lower and the inventory at the end was higher resulting to low inventory turnover.

It can collect its sales on account for 22.01 times during 2011 and slower in collection in 2012 by having AR turnover 20.39. Another reason for the decrease in the turnover is the decrease in sale and accounts receivable is also lower during 2012.

In 2011 the average collection period is 17 days which means the company is efficient in collecting credit sales. In 2012, the average collection period is about 18 days or one day more than 2011. In both years, the company collects faster than the industry which is 20 days.

The non-current assets turnover for 2011 is 1.94 times and 1.84 times in 2012. The company’s turnover in a bit higher on the industry standard which is 1.84. This means that the company has the effective in utilizing its fixed assets in generating sales.

The company has total assets turnover of 1.43 times and 1.22 time for 2011 and 2012 respectively. It is below par the industry’s performance which is 1.6 times but it still shows that the company was able to use its total assets to generate revenue.

Recommendations.

The company needs to improve its financial position. The management must not rely on external creditors in order to fund its assets and operations because they may end up paying more interest.

The liquidity ratios specifically the short term need to be improved. The company may have the capacity to pay its current obligations falling due but it is still below par of the ideal range.

The company’s performance is doing well and needs to continuously improve. The profit margin increased but it needs to take a look on the decline of sales on the current year. Kindly contact us to discuss the contents of this report and other concerns that may arise from it.

Yours failthfully,

Palms, CA

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