Financial Statement Analysis
Part 1 – Financial Analysis
One of the methods to evaluate the financial performance of a company is to perform ratio analysis. By calculating the ratios for Soule Company for 2013 and 2014, we can not only conclude on the current situation in the company’s finances but also understand its performance in dynamics.
The analysis starts with the current ratio. The company’s current assets slightly increased in 2014 comparing to 2013 but so did its current liabilities. Therefore, the current ratio in 2013 was 1.66 and it decreased in 2014 to 1.5. Nevertheless, there are no liquidity issues since the ratio is higher than one and the company is able to repay all its current liabilities using its current assets in the next year. Although there was a decrease in the current ratio, it does not create any problems for the company yet.
The next ratio is inventory turnover. The year-end inventory for 2012, 2013 and 2014 was respectively £326, £390 and £430. At the same time, in 2013 and 2014 the company’s sales and cost of sales increased. The inventory turnover ratio in 2013 was 2.5 and it decreased slightly in 2014 to 2.4. It is hard to make any conclusions based on this ratio alone since the only way to understand whether this number is high or low is to compare it to inventory turnover of its peer companies. Still, such inventory turnover implies that the company managed to sell its entire inventory in 152 days.
The company’s profitability can be assessed using such ratios as profit margin, return on assets and return on common stockholders’ equity. The profit margin in 2013 was 0.06 and it increased in 2014 to 0.09. This is clearly a positive sign indicating that the company not only managed to increase its sales but also became more cost efficient.
The company’s return on assets in 2013 was 0.05 and it increased to 0.16 in 2014. This also indicates that the company is doing well as it managed to generate much more profit using its assets. Similarly, return on equity increased from 0.21 in 2013 to 0.35 in 2014.
Another set of ratios is used to evaluate how much of the company’s assets were financed with debt and whether the company has problems servicing it. The company’s both short-term and long-term debt amounted to £1,203 in 2013 and increased to £1,290 in 2014. Therefore, the debt to total assets ratio was 0.54 in 2013 and 0.56 in 2014, meaning that slightly more than half of the company’s assets are financed with debt and that its financial position practically did not change in 2014, comparing to 2013. Another ratio, times interest earned, was calculated to evaluate whether the company is able to make all interest payments. The interest expense in 2013 and 2014 was 20 and 10 respectively and EBIT in 2013 amounted to 375 in 2013 and 616 in 2014. Times interest earned, therefore, was 18.75 in 2013 and as much as 61.6 in 2014.
All the above allows to conclude that the financial performance of Soule Company improved in 2014, especially in terms of profitability. Although the company issued slightly more debt, as indicated by the debt to total assets ratio and current ratio, it does not have any problems servicing it.
Part 2 – Evaluation of Gulf Warehousing Company Q.S.C. Performance
Gulf Warehousing Company Q.S.C. is a logistics company incorporated in Qatar. The primary segments of its business are logistics operations and freight forwarding, but the company also engages in trading activities (Gulf Warehousing Company Q.S.C., 2015).
The financial statements used for the purpose of analysis are consolidated financial statements for the year ended 31 December 2014. These statements were audited by KPMG, which issued Independent auditors’ report with the unmodified opinion. The functional currency is Qatari Riyals.
The financial performance of the company can be evaluated looking on several aspects: company’s growth, profitability, financial health and activity.
The company’s revenue in 2014 increased by 27.7% and amounted to QR 673,332,762. The revenue increased in all segments of the company’s business, but especially in logistics operations. The company’s operating profit also increased by 39.91% while its net income grew by 38.03%. The growth levels are high and suggest that the company is dynamically evolving. According to the statement of financial position, as at 31 December 2014, the company’s total assets increased by 11.84% comparing to the previous balance sheet date, mainly due to the increase of property, plant and equipment. This account is the largest one in the structure of assets while the segment of logistics operations is also the largest segment by the amount of its assets.
The company has been profitable in the last two years. The gross margin, calculated by dividing gross profit by the total revenue, remained quite stable at the level of around 36% (36.26% in 2013 and 35.93% in 2014). Other than direct costs, the company incurs such expenses as general and administrative expenses and staff costs. The amount of general and administrative expenses decreased slightly but staff costs actually increased. The company also continuously recognizes income from the increase in fair value of investment property leased to third parties (Gulf Warehousing Company Q.S.C., 2015). Still, while in 2013 the company received net other income in the amount of QR 1,005,648, in 2014 the company recorded other expenses.
Nevertheless, the company’s revenue increased more than the expenses resulting in operating margin of 26.16%. To compare, operating margin in 2013 was 23.88%, slightly lower. The net income of the company amounted to 140,272,150 Qatari Riyals as it increased by 38.03%. The net margin also increased but not significantly: it was 20.83% in 2014 comparing to 19.27% in 2013. The earnings per share in 2014 amounted to QR 2.95, having increased by 38.9% comparing to the previous year.
The analysis of the company’s profit and loss statement reveals that the company’s profitability increased mainly due to the increase of revenue but not due to the significant improvement in cost efficiency. The gross margin remained at the same level, and although revenue grew more than operating costs, the positive impact from that was completely offset by the increase in finance costs. In 2014, the company’s finance costs increased by 31.2% and amounted to QR 35,883,893 (Gulf Warehousing Company Q.S.C., 2015).
Other profitability ratios that should be taken into account are the return on assets and return on equity. The company’s return on assets in 2014 was 7.05%, higher than in 2013 when it was 5.88%. It may be explained by the fact that the company heavily invests in assets that are the main source of its revenue, in particular, in the construction of new buildings for warehouses. Although it may seem that the amount of projects in progress remained unchanged, there was a movement as finished construction in the amount of QR 230,668,858 was transferred to property, plant and equipment, and new construction worth QR 251,639,759 was started (Gulf Warehousing Company Q.S.C., 2015). After construction is over, some of these buildings are leased to third parties and transferred to the investment property.
The company’s return on equity also increased as it was 16.71% in 2014 comparing to 13.42% in 2013. It is also worth noting that the company’s share capital has not changed. The amount of shares outstanding as at 31 December 2014 was 47,560,975, but bonus shares were issued during 2013. Still, the increase in equity in 2014 was mainly due to the increase of retained earnings, and the company did not pay dividends until 2014. Moreover, there is a legal requirement in Qatar to transfer the amount equal to 10% of the net income to the legal reserve until this reserve amounts to 50% of the company’s share capital (Gulf Warehousing Company Q.S.C., 2015). This reserve is disclosed in the financial statements as equity, and, currently, the 50% requirement is met.
Another aspect of the company’s financial performance is its financial health that can be analyzed using such ratios as current ratio, quick ratio, debt-to-equity, debt to total assets and times interest earned ratios.
The ratios used to assess whether the company can repay its current liabilities are called liquidity ratios. The most widely used are current ratio and quick ratio. The current ratio of Gulf Warehousing Company in 2014 was 1.76 while it was 1.44 in the previous year. The increase in the ratio is caused by the decrease of current liabilities that happened mainly due to the repayment of current loans and borrowings. In fact, current loans and borrowings decreased by 58.9%. In turn, current assets remained practically at the same level. As the company’s business is mainly providing services, the company does not hold high levels of inventory and, therefore, the quick ratio, which assesses the short-term liquidity and for this purpose excludes inventory from the current assets, is practically the same as the current ratio: it was 1.73 in 2014 and 1.41 in 2013.
Both current and quick ratio suggest that the company does not have any issues with liquidity as the level of its current assets allows it to repay its current liabilities.
Another thing is the company’s financial health. The debt-to-equity ratio in 2014 amounted to 1.12 while in 2013 it was 0.96. The company’s long-term debt is growing. The company obtained a term loan facility in the amount of QR 1,075 million to finance the constructions of warehouses (Gulf Warehousing Company Q.S.C., 2015). Although this debt has to be fully repaid in 2020-2023 and its current portion is rather small, the increase of debt may eventually constitute a problem for the company. Still, as debt is used to finance the construction that eventually results in the increase of the non-current assets, the debt to total assets ratio remained practically unchanged on the level of around 0.5.
Another financial health ratio, times interest earned, is used to evaluate whether the company is able to service its debt. As the company’s profitability substantially increased in 2014, the times interest earned ratio was 4.9, in spite of the fact that finance costs became much larger. To compare, the same ratio in 2013 was 4.6.
The company’s activity can be analyzed by calculating and interpreting such ratios as receivables turnover and inventory turnover. As at 31 December 2014, net accounts receivables increased by 16.8% comparing to the date of the previous balance sheet. The receivables turnover ratio in 2014 was 2.78 that automatically suggests that average duration of accounts receivables is 131 days. Nevertheless, as indicated in the Notes to the consolidated financial statements, currently only 23.8% of accounts receivables are past due for more than 90 days. In the previous year, the receivables turnover ratio was even lower, 2.28, and the average duration of accounts receivables was 160 days. The situation clearly improved. Still, the company pays its suppliers almost within the same number of days, as the average duration of accounts payables is 124 days.
As to the inventory turnover, it was noted above that the company does not hold large amounts of inventory. Therefore, inventory turnover ratio is 52.87 in 2014 while it was 35.68 in the previous year. While inventory levels practically did not change, the increase of revenue and subsequently of the cost of sales caused the increase in the ratio. The average inventory days were 6.90 in 2014. However, activity ratios related to inventory are not very relevant since the sale of goods is not the primary activity of the company.
The above analysis reveals that the Gulf Warehousing Company financial performance is quite impressive. The company is growing at a high rate in terms of increase in its revenue and assets. The analyzed year was very successful in terms of profitability as the company’s revenue increased by 27.7%. In 2013, in contrast, the revenue was falling. The company’s operating margin increased while gross margin remained at the same level, which may suggest that the business benefited from the economy of scale.
References
Gulf Warehousing Company Q.S.C., (2015). Consolidated financial statements 31 December 2014.
