Analysis of Profitability: Woolworths Limited - Case Study Example

WOOLWOORTH LIMITED Name: Lecturer: Course name: Course code: Date: Executive summary Financial analysis is the pragmatic process of evaluating the operations of the business in determining the going concern, stability and viability of the company. Company’s financial analysis reflects the profitability, solvency position, liquidity situation and stability of the company hence gives a better opinion to the potential investors and the company’s management. Profitability analysis ratios comprises of; return on equity, return on assets, and profit margin ratios. The Current ratio and quick asset ratio indicate the company’s liquidity position. Capital structure ratios include debt to equity ratio, debt ratio, equity ratio, interest coverage ratio and debt coverage ratio. Introduction Woolworths Limited is an Australia-based company which operates in five segments such as Australian Food and Liquor, Petrol, BIG W, Hotels, and New Zealand Supermarkets. Australian Food and Liquor section engages in procurement and resale of food and liquor and products Australian consumers (Report, 2012). The petrol sector intensively deals with purchasing and resale of petroleum products while New Zealand Supermarkets segment deeply deals in the purchase and resale of food and liquor products New Zealand consumers. Hotels segment provides leisure and hospitality service. Analysis of Profitability Profitability ratios show the company’s effective measures on an uproar of income generated from sales. a) Return on equity The shareholders of a business are concerned in the return on their funds. Return on equity is used to disclose the performance of the company in relation to owner’s equity. Return on equity ratio examines the level of net profit to the amount of owner’s equity contributed to the business. Return on Equity (ROE) = ROE for Woolworths Limited   2011 2012 2013 2014 Net profit 2,140.30 2,183.40 2264.6 2451.7 Average shareholder's equity 7,845.80 8,446.30 9300.5 10525.4 ROE 27.28% 25.85% 24.35% 23.29% From the table above, ROE for Woolworths Ltd increased from 2010 to 2011. This means that an investment of 1$ of owners’ equity in 2010 returned 26.07 cents of income available for sharing to owners. In 2012 an equivalent investment generated 25.85 of income available for division to owners. This means that an investment of 1$ of owners’ equity in 2010 returned 6.34 cents of income available for sharing between shareholders while the equal investment in 2011 the income distribution to owners was 7.59 cents and 9 cents in 2012. The ROE for the year 2013 and 2014 saw a drop in the returns. The ROE for Woolworths had higher figures as compared to that of company’s which had smaller figures but steady upward growth. b) Return on assets (ROA) ROA is a profitability ratio that examines a business’s earnings to the assets available to make the profits. ROA = ROA for Woolworths Limited   2011 2012 2013 2014 Earnings before interest and Tax (EBIT) 3,276.40 3,082.10 3653.2 3775.2 Average total assets 7,845.80 7,817.70 9300.5 10525.4 ROA 41.76% 39.42% 39.28% 35.87% It is revealed that the previous two years in Woolworth Ltd shows an increasing trend of ROA which was 38.53 cents and 41.76 cents. Since the trend was positive, it reveals that steady and increasing $ of income they gain from every $ of assets they control. It is evident that Woolworth Ltd level of ratio was higher than that of Wesfarmers Ltd.’s. This means that Woolworth Ltd. Had a weak capability to translate income into profits and make revenue from investment in assets. 2. Asset Efficiency Ratios a) Asset turnover ratio Asset turnover ratio shows the general efficiency of the company in making income per $ of the total assets investment. The capability of the business to make profits from sales determines its going concern. Asset turnover ratio = Asset turnover ratio for Woolworths Limited   2011 2012 2013 2014 Sales Revenue 54,142.90 55,129.80 58516.4 60772.8 Average total assets 7,845.80 7,817.70 9300.5 10525.4 Asset turn over 6.9 7.05 6.29 5.77 From the table above, it reveals that asset turnover ratio from 2010 to 2014 of Woolworth Ltd represented 6.12 times, 6.9 times, and 7.05, 6.29 and 5.77 times respectively. This company had an increasing trend, which reveals the efficiency in utilization of the company assets (Walton, 2006). This rise in the asset turnover ratio has led to the company’s enhancement in ROA. b) Days debtors Days debtors point out the average period of time it takes for a business to gather the cash for the trade debtors. Days debtors = Days debtors for Woolworths Limited   2011 2012 2013 2014 Average trade debtors 778 894.4 985.2 1033.9 Sales revenue 54,142.90 55,129.80 58516.4 60772.8 Days Debtors 5 days 6 Days 6days 6 days From the information above, it is evident that the 2 companies had related situation, they both had an increasing trend in day’s debtors. From 2010 to 2014, 4 days, 5 days and 6 days respectively. This means that the trade debtors for both companies held an upward trend. Liquidity Analysis The company’s inability to pay its liabilities when they are due can lead to creditors taking legal action against the company to give their investments back (Sheffrin, 2011). For long term existence, the company should depend on its ability to pay its liabilities when they are due a) Current ratio Current ratio reveals the dollars of current assets that the company has per each dollar of current obligations. Current ratio = Current ratio for Woolworths Limited   2011 2012 2013 2014 Current assets 4514.5 4592.7 5190.6 5727.1 Current liabilities 6778.8 6968.1 7166.1 7842 Current ratio 0.67 0.66 0.72 0.73 Woolworth Ltd had $0.64 of current assets for each $1 of current obligations in 2010. It increased to $ 0.67 of current assets for each $1 of current obligations in 2011. In 2012, the figure decreased slightly to $0.66 (Reports, 2012). The subsequent years also 2013 and 2014 represent an increase in the ratio. It revealed that Woolworth is in a better position to meet its financial obligations as compared to ltd which had more current liabilities in relation to its current assets. b) Cash flow ratio Cash flow ratio shows the company’s ability to meet its current liabilities by using cash flows from operating activities. Cash flow ratio = Cash flow ratio for Woolworths Limited   2010 2011 2012 2013 2014 Net cash flow from operating activities 2,752.00 2,991.10 2,873.80 2,719.90 3,472.70 Current liabilities 6409.2 6778.8 6968.1 7166.1 7842 Cash flow ratio 0.43 0.44 0.41 0.38 0.44 It is revealed from the tables above that both companies cannot efficiently meet its current liabilities by using cash flows from operating activities. The cash flow ratio of Woolworth ltd from 2010 to 2014 was 0.43, 0.44 .0.41 0.38 and 0.44 respectively. Capital structure analysis The company’s capital structure is the percentage of debt funding relative to equity funding, and it shows the company’s funding decision (Walton, 2006). Capital structure ratio is also referred to as gearing ratio and it is used to depict the percentage of debt to equity financing, and are important when assessing a company’s long term viability. a) Debt to equity ratio Debt to equity ratio reveals how many dollars of debt are there in per dollar of equity funding. If this ratio is more than 100%, then the company was more reliant on debt financing than equity financing. Debt to equity ratio = Debt to equity ratio of Woolworths Limited   2011 2012 2013 2014 Total liabilities 11,134.50 11,718.10 11664.4 12453.1 Total equity 7,845.80 8,446.30 9300.5 10525.4 Debt to equity ratio 141.92% 138.74% 125.42% 118.31% From the information in the tables above, it is evident that Woolworth ltd relied more on debt financing than equity financing in all the four years. The ratio articulates a drop from 141.92% in 2011 to 138.74% in 2012. It further decreased to 135.4 % in 2013 to 118.31% in 2014(Report, 2012). In contrast to Woolworth ltd, Wesfarmers ltd relied on equity financing more than debt financing even though the ratio had an increasing trend in all the three years. b) Debt ratio Debt ratio reveals how many dollars of liabilities are there per dollar of assets. If this ratio is more than 50%, then the company funded its investments in assets by depending more on debt relative to equity. Debt ratio = Debt ratio for Woolworths Limited   2011 2012 2013 2014 Total liabilities 11,134.50 11,718.10 11664.4 12453.1 Total assets 12,108.50 13,176.30 13798.8 15137.5 Debt ratio 91.96% 88.93% 84.53% 82.27% It is revealed from the tables above that Woolworth ltd relied so much on debt to finance its assets as compared to past years which relied on equity to finance its assets. Conclusion From the financial analysis of financial statements of Woolworth ltd for 2010 to 2012 financial periods, it is revealed that Woolworth ltd is doing better since it has increasing ltd in terms of profitability and asset efficiency. On the other hand Woolworth ltd is more stable and in good financial health in terms of liquidity analysis. Woolworth ltd is able to pay off its financial obligations efficiently as well as the Capital structure analysis reveals that Woolworth is more stable. This is because Woolworth is relying on equity to fund its assets as opposed to preceding year which rely on debt to finance its assets. Reference List Cecilia, D., 2007. Corporate Accounting in Austalia. UNSW Press. p.639. Michael Berrington, V.B., 2012. Pinnacle Financial Statements. IFRS SYSTEM. pp.42-46. Report, W.A., 2012. Woolworth Annual Reports. [Online] Available at: HYPERLINK "http://www.woolworthslimited.com.au/page/Invest_In_Us/Reports_and_Presentations/Reports/Annual_Reports/" http://www.woolworthslimited.com.au/page/Invest_In_Us/Reports_and_Presentations/Reports/Annual_Reports/ [Accessed 22 July 2013]. Reports, W.A., 2012. Wesfarmers Annual Reports. [Online] Available at: HYPERLINK "http://www.wesfarmers.com.au/2012-annualreports/" http://www.wesfarmers.com.au/2012-annualreports/ [Accessed 22 July 2013]. Sheffrin, S.M., 2011. Financial Accounting: Accounting for Investment Securities. Wisley & Sons. p.147. Walton, P.J., 2006. Global Financial Accounting And Reporting: Principles And Analysis. Cengage Learning EMEA. p.146. Appendix I Consolidated Woolworth Profit and Loss Statement Appendix II Consolidated Woolworth Statement of financial position Appendix III Wesfarmers consolidated profit and loss statement Appendix IV Wesfarmers consolidated statement of financial position Read More