2.6. Financial Analysis
AP Moller Maersk is one of the renowned company in its industry and has been known to provide sustainable returns to the investors. However, the main aim of the financial analysis is not only to provide analysis relating to the company’s profitability, but also to provide an exploratory analysis and evaluation of the performance of APMM. More specifically, the analysis is based on four key qualities affecting the market value of a business, assessed by using traditional financial indicators. The analysis evaluates performance of APMM in liquidity, profitability, leverage and activity over the past 5 years. Below is a list of the financial ratios used to assess financial performances and evaluate the company’s financial performance:
2.6.1. Profitability
Profitability is a key factor in the growth of a company (Dun, 2011). The profitability rate portrayed by APMM show how effective and efficient their system is in their attempt to accrue high profits as we compare the gross margin, net margin and earnings per share of both the companies (Troy, 2015). The figures and rates of their growth in profitability indicate a good rate of growth in their profits on an annual basis.
2.6.1.1. Return on Total Assets
Return on Total Assets (ROA) is a ratio indicating the profitability of a company relative to its total assets and demonstrates how effectively a company utilizes its asset base to generate net income. The higher the return, the more efficient management is in utilizing its assets. The ROA ratio is calculated by comparing net income to average total assets, and is expressed as a percentage (Investopedia,)
ROA = Net Income / Average Total Assets
Our calculation revealed that over the years, the ROA multiple of the company has seen a tidal trend where beginning with 3.54% return in 2011, the company witnessed the peak at 5.09% in 2014,followed by 4.33% in 2015. The declining trend in the latest year was largely attributed to higher proportion increase in the asset base compared to the net income growth during the year. In other words, during 2015, the company was unable to generate higher return on its asset base.
.6.1.2. Return on Equity
Return on Equity (ROE) is a measure of how effectively a company is managing the contributed equity of their shareholders.
ROE = Net Income / Average Shareholders Equity
Referring to the table above, we can see that just like the ROA multiple, the company is unable to generate a consistent trend in the ROE multiple, and is witnessing a tidal trend. Beginning with 6.88% in 2011, the company did manage to increase its ROE multiple to 9.03 during 2012, however, post that period, on account of the lower proportionate increase in the net income compared to the increase in the shareholder equity, the company is unable to generate higher ROE.
2.6.1.3. Net Profit Margin
Net margin represents the percentage by which a company’s net profit or net income is divided by its net sales or sales revenue. Net profit margin measures the costs controlled by a company and how well they are controlled. Investors always use these margins to determine the profitability of companies (Troy, 2015). A higher the percentage represents how profitable a company is. It is due to effective cost controls and appropriate pricing structures that a company increases its output. Net margins are represented in percentage (Dun, 2011).
Net Margin = Net Income / Sales
Referring to the above table, we can see that until 2014, the company generated consistently high net profit margin. However, during 2015, the profit margin was down from 7.67% to 7.04% on account of significant fall in the revenue figures, which plummeted by -15.26% during the year, and halted the increasing momentum in the profit margins.
2.6.2. Liquidity
Liquidity Ratios are a class of financial metrics that evaluate one company's ability to meet its short-terms liability obligations. It also shows a company's ability to turn its current assets into cash, which is very important when creditors are seeking payment. Bankruptcy analysts and mortgage originators frequently use the liquidity ratios to determine whether a company will be able to continue as a going concern (Liquidity Ratios, 2012) (Liquid vs. Illiquid, 2012).Usually, the higher the value, the larger the margin of safety that the company possesses to cover its short-term debts.
Liquid assets can be converted into cash quickly and with minimal impact to the price received. Liquid assets are generally related to as cash because their prices are relatively stable when they are sold on the open market. Liquid assets are very easy to convert into cash. Examples of liquid assets include stocks, government bonds, money market instruments, and, the best assets, cash (Liquid vs. Illiquid, 2012).
2.6.2.1. Current Ratio
The current ratio is used by investors and creditors, to assess the company’s ability to pay back its short-term liabilities with its current assets. The higher the current ratio number is, the more capacity the company has to pay of its obligations. The current ratio provides one with the information that gives a sense of the efficiency of a company’s operating cycle or its ability to turn its product into cash. Companies that have trouble getting paid on their receivables or have lower inventory turnover can run into liquidity problems because they are unable to alleviate their obligations.
Current Ratio = Current Assets/Current Liabilities
Referring to the above figures, we can see that after witnessing consistently high momentum in the current ratio until 2014, the company witnessed declining trend in 2015 with the current ratio multiple falling from 1.69 to 1.16 on account of higher proportion increase in the current liabilities relative to the current assets.
2.6.2.2. Quick Ratio
Quick ratio is an indicator of a company’s short-term liquidity. The quick ratio measures a company’s ability to meet its short-term obligations with its most liquid assets. For this reason, the ratio excludes inventories from current assets. The quick ratio measures the dollar amount of liquid assets available for each dollar of current liabilities. The higher the quick ratio, the better is the company's liquidity position.
Quick Ratio = (Cash + Marketable Securities + Current Receivables)/Current Liabilities
Or
Quick Ratio = (Current Assets – Inventories)/Current Liabilities
Quick ratio is a more stringent measure to analyze the liquidity measure. Our calculation revealed similar trend to what we noticed in the current ratio. After witnessing an appreciable trend until 2014, the company witnessed declining quick ratio multiple from 1.57 to 1.08 with increase in the current liabilities surpassing the increase in cash and receivables amount.
2.6.3. Leverage
Leverage position helps us in decomposing the capital structure of the company and the level of risk embedded in it. Following an indepth analysis, analysts are able to judge whether the company is financially capable to handle the debt amount it owes.
2.6.3.1. Debt/Assets
Debt to Assets ratio measures the total amount of total debt related to total assets. Furthermore, it demonstrates shows the percentage of a company’s assets that are provided via debt (Investopedia ). If a company has a ratio greater than 1, it typically means that most of the assets’ part are funded by their debt. On the other hand, a company with a low Debt/Assets ratio, indicates that a large part of the assets are covered by equity.
Debt/Assets = Total Debt/ Total Assets
The above table indicates until 2014, the company was consistently funding lower asset proportion with the debt amount, however, during 2015, the proportion of asset funded with debt, increased from 17.90% to 20.42%.
2.6.3.2. Debt/Equity
Debt / Equity is a measure of financial risk that indicates what proportion of equity and debt the company is using to finance its assets, and can be found by using the following equation:
Debt / Equity = Total Liabilities / Stockholders Equity
A company with a higher debt/equity ratio indicates the company has been using debt to finance its growth. A company with a lower debt/equity ratio is less of an investment risk. There are circumstances where using debt to grow is necessary for a company to succeed and be the best in its industry. Incurring this debt could generate earnings that were not possible with taking this debt on. On the other hand, there could be some cases where the earnings do not surpass the debt. In this case the company could be at major financial risk as the debt and interest from that debt could lead to bankruptcy.
The above table confirms that while 2014, the company was opting for lower levered capital structure, this proportion increased from 0.63 to 0.75 as the firm added more debt to the capital structure during 2015.
2.6.3.3. Long-Term Debt/Equity
Long-Term Debt to equity ratio determines a company’s leverage, and shows the amount of capital a company is able borrow over a long period of time. It is calculated as follows:
Long-Term Debt/Equity = Long-Term Liabilities/Equity
The above ratio indicates that while the proportion of long-term liabilities to the equity was decreasing consistently, during 2015, this amount increased to 0.32 as the firm borrowed additional debt during the year
2.6.3.4. Times Interest Earned
Another measure of financial risk is times interest earned. Times interest earned can be found by using the following calculation.
Times Interest Earned = EBIT/Interest Expense
Times interest earned measures a company’s ability to meet its debt obligations. It states how many times a company can cover its interest charges on a pretax basis. A high ratio is preferable. A low ratio might indicate a company will not be able to meet its debt obligations and/or is using earnings to pay back interest when these earnings could be used to fund growth. A ratio of less than 1 means a company may not be able to pay its interest payments and still have enough for day-to-day operations.
The table graph below shows the interest coverage ratio of APMM, where, it can be seen that the interest coverage ratio has declined during 2015. It means that relative to the previous year, the company lost its interest paying ability during 2015
2.6.4. Activity
There are five activity ratios that will be used in following analysis: Inventory Turnover, Fixed Assets Turnover, Total Assets Turnover, Accounts Receivable Turnover and Average Collection Period.
2.6.4.1. Inventory Turnover
This ratio indicates how many times a company’s inventory is sold and replaced over a period. The days in the period can then be divided by the inventory turnover formula to calculate the days it takes to sell the inventory on hand or "inventory turnover days”. The general formula for inventory turnover ratio:
Inventory turnover ratio = Sales/Inventory
As noted from the above table, post 2013,the inventory turnover ratio of the company has been increasing consistently and this signals that it now takes less time for the company to sell its asset.
2.6.4.2. Fixed Assets Turnover
Fixed Assets Turnover ratio measures a company’s ability to generate net sales based on the fixed asset investments (mainly consisting of property, plant and equipment – net deprecation). A higher fixed assets turnover ratio is favorable as it shows that a company is effective in their use of the investment in fixed assets to generate revenue,
Fixed Assets Turnover = Net Sales / (Property +Plant + Equipment)
Referring to the above table, we can see that over the period of five years, the fixed asset turnover multiple of the company has been decreasing consistently. This indicates that the company is generating lower revenue per unit of the fixed asset available
2.6.4.3. Total Assets Turnover
Porter and Norton mentioned “the ratio is similar to both the inventory turnover and the accounts receivable turnover ratios because it is a measure of the relationship between some activity (net sales in this case) and some investment base (average total assets)”. In other words, the total assets turnover ratio shows how effectively a company is using its assets to generate sales. It is calculated as follows:
Total Assets Turnover = Net Sales / Average Total Assets
In general the higher the ratio, the better is the company’s performance, which means that the company effectively utilizes its assets in generating sales.
The trend witnessed in the above table spark concern as post 2011, the asset turnover of the company has been decreasing year-after-year, and this indicates lower revenue being generated per unit of the asset available.
2.6.4.4. Accounts Receivable Turnover
Accounts receivable turnover ratio measures a company’s ability related to how often (# times) a company is able convert its accounts receivable into cash during a year. According to Porter and Norton (2013), ”the analysis of accounts receivable is an important component in the management of working capital. A company must be willing to extend credit terms that are liberal enough to attract and maintain customers, but at the same time, management must continually monitor the accounts to ensure collection on a timely basis”.
Account Receivable Turnover = Net Credit Sales/ Average Accounts Receivable
A higher ratio is preferable as it shows a higher frequency of the collection of receivables in a year. It is also advantageous from the cash flow perspective because if a company that can collect its cash frequently is easier able to pay its bills and other obligations before their due dates.
Referring to the above table, we can see that after witnessing the decline in 2012, the receivable turnover of the company is on an increasing trend and signals that the company is now managing its trade receivables efficiently with low collection period.
2.6.4.5. Average Collection Period
An average collection period indicates how long time it takes for a company to collect the owed payments, such as receivables, from their clients. It is calculated the following way:
Average Collection Period = Number of Work Days / Receivable Turnover Ratio
A short collection period demonstrates a more effective management related to receivables. On the other hand, a long collection period would indicate that the company is likely less effective in paying their short-term debt.
The above table shows that the collection period of the company is declining since past three years.
References
Bank & finance manual. (2014). S.l.: Mergent.
Industry norms. (2011). S.l.: Dun & Bradstreet.
Troy, L., & Wilson, P. (n.d.). 2015 almanac of business and industrial financial ratios (46th annual ed.).
Troy, L. (2013). 2014 almanac of business and industrial financial ratios (45th annual ed.).
Englewood Cliffs, N.J.: Prentice-Hall.\U.S. Securities and Exchange Commission | Homepage. (n.d.). Retrieved from http://www.sec.gov
