/>
Investment Potential:
In the business world it tends to be a financial investment that makes a good profit. In order to invest in the company, one should consider the return on capital employed by the business.
The two company’s income statements (profit and loss account) were evaluated as below in order to decide on the better investment. To invest an amount like 50,000 GBP, one should assess the company’s profitability, gearing and investment potential of the companies.
The data can be converted from accounting statements in to statistics (ratio).These statistics can be use to examine an entities performance over a given period of time. They may also be used to compare the current year’s performance with the previous year’s or that of a similar entity.
As we look in to the profit and loss statement (Appendix: Table 1.1 & 1.2) of NBC Mining Corporation & Kphones Ltd, in order to assess the performance, I would like to consider the Gross Profit ratio, which will enable us to judge how successful the entity has been at trading.
Calculation for Gross Profit Ratio:
Previous Year: (values in Million)
(Gross Profit / Total sales revenue) * 100 = (8000/9500) * 100 = 84% (Appx)
Current Year: (values in Million)
(Gross Profit / Total sales revenue) * 100 = (3500/9500) * 100 = 37% (Appx)
Kphones ltd:
Previous Year: (values in GBP)
(Gross Profit / Total sales revenue) * 100 = (262969/350625) * 100 = 75% (Appx)
Current Year: (values in GBP)
(Gross Profit / Total sales revenue) * 100 = (309375/412500) * 100 = 75% (Appx)
As we look in to the profitability ratio of two companies at trading, we can clearly see the overheads in NBC Mining Corporation because there is no proper trading compared to previous year. But when we look in to the Kphones Ltd the trading was sustainable in both the years.
NBC Mining Corporation
Previous Year: (values in Million)
(Net Profit before Taxation/Total sales revenue) * 100 = (6255/9500) * 100 = 65% (Appx)
Current Year: (values in Million)
(Net Profit before Taxation/Total sales revenue) * 100 = (1995/9500) * 100 = 21% (Appx)
Kphones ltd:
Previous Year: (values in GBP)
(Net Profit before Taxation/Total sales revenue) * 100 = (234456/350625) * 100 = 67% (Appx)
Current Year: (values in GBP)
(Net Profit before Taxation/Total sales revenue) * 100 = (198375/412500) * 100 = 50% (Appx)
As we look in to the statistics of the NBC Mining Corporation both the net/gross profit ratios shows that the company were not able to maintain the business. But Kphones ltd seems to have better sustainability over previous years. Even though there is little fluctuation in Kphones ltd controlling cost and other overheads they were able to maintain the rhythm in the business.
In my opinion as a financial adviser I would suggest the investment to Kphones Ltd will give you sustainable return in long run because the nature of business they do is consistent. The good business is one which should see incremental profit and consistency in all aspects over years.
Methods of Analysing Company’s Performance:
Businesses should constantly review their operations to remain competitive in their industry. In order to analyse the real performance of the company. The following are the two methods that are widely used in order to access the performance of any the company.
- Financial Ratio Analysis
- Gap Analysis
Financial Ratio Analysis
‘A tool used by individuals to conduct a quantitative analysis of information in a company’s financial statements. Ratios are calculated from current year numbers and are then compared to previous years, other companies, the industry, or even the economy to judge the performance of the company. Ratio analysis is predominately used by proponents of fundamental analysis ‘.
Financial ratio analysis is useful for understanding of accounts, allows comparison, shows trends over times and provides additional information.
Financial ratio analysis can be divided in to five main categories:
- Profitability ratios
- Liquidity ratios
- Efficiency ratios
- Investment ratios
- Gearing Ratios
Profitability Ratios:
Profitability ratio helps investor to access a businesses ability to generate earnings compared with its expenses and other relevant costs incurred during a specific period. There are four main profitability ratios: they are Return on capital employed, Gross profit ratio, Net profit ratio and Mark up. It is important to note that one should understand the company and its business before making decisions that are based solely on ratios.
Liquidity Ratios:
A liquidity ratio measures a company’s ability to pay its bills. There are two types of liquidity ratios, short term and long term. Liquidity ratio, expresses a company’s ability to repay short-term creditors out of its total cash. The liquidity ratio is the result of dividing the total cash by short-term borrowings.
Efficiency Ratios:
It is used to review the efficiency. There are six approaches to review the efficiency. They are Stock turn over ratio, Trade debtor collection period, Trade creditor collection period, Total assets turnover, fixed assets turnover, Working capital turnover.
Investment Ratios:
Investment ratio is used to review the investment potential. The investment ratio provides the standard return on investor’s equity.
There are three approaches to review the investment potential. They are earning per share, Price/Earnings and Dividend cover. It is also the key ratio for investors.
Gearing Ratios:
Gearing ratio is used to describe the mix of loan finance and equity finance in a company. There are two main approaches: They are Debt/ equity and Interest cover. Different industries have different average levels. A low gearing percentage indicates a low exposure to financial risk because it means there is little difficulty in paying loan interest and repaying the loans as they fall.
Uses of Ratio Analysis:
The important feature of ratios is that they indicate trends and deviations from expected patterns. Ratios taken in isolation for a single company or a single period are of limited usefulness.
Comparisons could be made with any or all of the following:
- The company’s budget
- External observers prior expectations
- Previous year ratios
- Other companies ratios(current and prior year)
- Industry averages
Limitations of Ratio analysis:
Ratio analyses have the following limitations:
- No two companies are exactly alike in the nature of their operations. Comparisons must make allowances for differences in types if business.
- Many companies operate in more than one industry so that comparison with industry norms has to be treated with care.
- Ratios are based on financial statements and are therefore dependent on the quality of the financial statements.
Gap Analysis
A gap analysis strategy will help company management determine their current operating performance and how it measures to the best possible performance for their operations. This will then help focus improvements on the worst performing areas in order to raise the overall competitiveness of the company.
Gap analysis is basically used to determine the shortfall that may be occurring in the operation of the company when they are heading towards the pre-defined goals. Gap analysis can be used by several departments in a business, including marketing, production, and accounting. While the basic principles of gap analysis remain, each department will customize the process to their specific needs. Businesses will use gap analysis to ensure that they are maintaining their competitive edge in an industry; departments will measure how well they are staying on budget for their operations.
Usage
The usage of the gap analysis is a kind of qualitative and quantitative definitions can give gap analysis more perceived validity than other purely qualitative processes. Gap analysis is a technique which basically uses brainstorming and forecasting the nature of the likely business in future. It can be used to measure performance of any kind of the company.
Gap analysis and competition
Gap analysis can be used to objectively compare the performance of a company with its competitors. By looking at those variables most important to a company and comparing those to specific competitors, or even the industry-at-large, a company can determine its relative effectiveness. Also referred to as benchmarking, stock analysts frequently employ this technique and may even use benchmarking in company valuation.
The use of gap analysis internally
Gap analysis can be used basically used to measure the company’s
Performance against past forecast. This analysis is used to check the performance for several years of business, in order to compare the different growth and decline in the business. Based on the findings of the gap analysis, the company’s top management can derive a future plan to control the business in an efficient way. We can also measure the defined plan in future with the data from that particular financial year. This, in turn, creates a type of analysis loop, which can be very useful in spotting trends.
Appendix:
1) Table 1.1 Profit & loss account for NBC Mining Corporation:
|
Current Year |
Previous Year |
|
|
Turn Over Cost of sales Gross profit Operating expense Operating profit Interest Payable Profit before Tax Taxation Profit after Tax |
9500 (6000) 3500 (1030) 2470 (475) 1995 (253) 1742 |
9500 (1500) 8000 (295) 7705 (450) 6255 (231) 6024 |
2) Table 1.2 Profit & loss account for Kphones ltd:
|
Current Year |
Previous Year |
|
|
Turn Over Cost of sales Gross profit Operating expense Operating profit Interest Payable 8% of 16k and 15k 12% of 2040 Profit before Tax |
412500 (103125) 309375 (61875) 247500 (12800) (244) 234456 |
350625 (87656) 26296 (52593) 210375 (12000) 198375 |
Note: All values are in GBP.
References:
1) Accounting and finance for non-specialists Peter Atrill & Eddie McLaney.
2) www.opsalacarte.com
...(download the rest of the essay above)