Task 1: Financial Performance and Financial Position
The below table presents the calculation of different ratios including profitability, liquidity, efficiency, capital structure and investment ratios of Woolworths and Wesfarmers in the FY 2017:
|All figures in ($’M)||Formulas||WOOLWORTHS||WESFARMERS|
|Net profit margin||Net income / Net sales||2.86%||4.20%|
|Return on assets||Net income / Total assets||6.95%||7.16%|
|Return on equity||Net income / Average shareholder equity||17%||12%|
|Current ratio||(Current Assets/Current Liabilities)||0.79||0.93|
|Liquid ratio||(Liquid assets/current liabilities)||0.33||0.30|
|Total asset turnover||Net sales /Average total assets||2.40||1.69|
|Average total assets||23209||40449|
|Inventory turnover ratio||Cost of sales /Inventory||9.74||8.73|
|Cost of sales||39,739.70||57,019|
|Receivable turnover||(Avg. account receivable /SALES)*365||0.518||8.69|
|Average account receivable||79||1630|
|Capital Structure Ratios:|
|Times interest earned||EBIT / annual interest expense||153.17||58.67|
|Annual interest expense||193.6||264|
|Dividend Yield Ratio||DPS/MPS||3.31||5.56|
|Price earnings ratio||Market Price per share/Earnings per share||21.24%||15.75%|
From profitability analysis, it can be interpreted that profitability ratios including net profit margin and return on assets of Woolworths are less than those of Wesfarmers.
However, return on equity is greater for Wesfarmers as compared to Woolworths. Overall, it can be stated that Wesfarmers is in more profitable situation in comparison of Woolworths in FY 2017 (Brigham and Houston, 2012).
At the same time, current ratio of Woolworths is less than Wesfarmers indicating less ability to meet the current obligations. But at the same time, the current ratio and quick ratio for both companies are less than ideal ratios (current ratio-2:1; quick ratio-1:1) showing less ability of both firms to meet their current obligations in FY 2017 even in contingencies (Petty et al., 2015).
In perspective of efficiency ratio, Woolworths is performing better than Wesfarmers. Woolworths is showing better total asset turnover and inventory turnover ratio means the firm’s management is more efficient to utilize and convert the assets and inventory in sales.
At the same time, Wesfarmers takes more time to collect debtors than Woolworths showing better ability of Woolworths to maintain cash position (Kramer, 2012). However, it can affect the sales of Woolworths due to strict credit policy to the customers.
From capital structure ratio, it can be determined that debt/equity ratio of Woolworths is 0.43 while for Wesfarmers, it is 0.24. It implies that Woolworths uses more debt as compared to Wesfarmers in its capital structure. Wesfarmers is more dependent on its equity shareholders for capital.
However, debt/equity ratio of both firms is less than 1 indicating their strategy to keep the debt amount low in their capital structure to reduce the costs of capital and enhance creditworthiness in the future contingency (Bevis, 2013).
Apart from this, times interest earned ratio is higher for Woolworth in comparison of Wesfarmers showing its ability to meet its interest obligations in better way. Woolworths is able to generate sufficient cash to pay its interests.
Apart from this, dividend yield ratio of Wesfarmers is better than that of Woolworths means the firm is more efficient to provide dividends to the investors to attract them easily.
Analysis of Statements of Cash Flows:
Both Wesfarmers and Woolworths use direct method in the preparation of cash flow statement. This statement discloses gross cash receipts and gross cash payments. However, a proper reconciliation is also reported in notes to the accounts.
Both firms present reconciliation of net profit after tax to net cash flows from operations in their cash flow statement (Annual Report, 2017). There is proper clarification about the changes in operating accounts on the basis of accrual accounting and cash basis of accounting.
The following table presents horizontal analysis of the statement of cash flow of Woolworths:
|2017||2016||Change ($M)||% Change|
|Net cash provided by operating activities||3,122.00||2,357.50||764.50||32.43%|
|Net cash used in investing activities||-1,431.40||-1,266.70||-164.70||13.00%|
|Net cash used in financing activities||-1,729.30||-1,474.90||-254.40||17.25%|
|Net (decrease)/ increase in cash and cash equivalents||-38.70||-384.10||345.40||-89.92%|
|Cash and cash equivalents at the end of the period||916.7||956.00||-39.30||-4.11%|
(Source: Woolworths, 2017)
On the basis of the above table, it can be determine that there is a significant change in net cash provided by all activities including operating, investing and financing.
However, the positive change in investing due purchasing property, plant and equipment and sale of subsidiaries and investments and financing activities because of repayment of borrowings is more than that of operating activities leading to decline in net cash and cash equivalents with 89.92% in year 2017 (Annual Report, 2017).
Overall, net cash used in investing activities and financing activities is higher than the net cash provided by operating activities that is not a good sign for the company in performance terms.
At the end of the period, it can be noticed that cash and cash equivalents declined by 4.11% in year 2017 as compared to year 2016.
The decline in net cash and cash equivalents shows that the firm may face liquidity problems in future due to lack of adequate cash to meet its obligations. The reasons behind this may be reducing debtors’ collection period, low sales, increasing payments to suppliers in year 2017 as compared to year 2016 (Annual Report, 2017).
The below table shows the horizontal analysis of Wesfarmers by analysing the information given its cash flow statement:
|2017||2016||Change ($M)||% Change|
|Net cash flows from operating activities||4,226||3,365||861||25.59%|
|Net cash flows used in investing activities||-53||-2132||2,079||-97.51%|
|Net cash flows used in financing activities||-3,771||-1,333||-2,438||182.90%|
|Net decrease in cash and cash equivalents||402||-100||502||-502.00%|
|Cash and cash equivalents at end of year||1013||611||-100||-16.37%|
(Source: Wesfarmers, 2017)
Based on the above table, it can be stated that net cash flow from operations is increased from $3365m to $4,226m by 25.59% because the firm paid higher amounts to suppliers and employees in 2017 in comparison of 2016.
In addition, the less investment in acquiring subsidiaries and purchasing property, plant and equipment and intangibles also caused a decline in net cash flow used in investing activities (Annual Report, 2017).
However, there is a significant increase in net cash in financial activities due to high repayment of borrowings. Apart from this, the firm also shows a net decrease of 502% in cash and cash equivalents that may lead to liquidity problem in future (Bevis, 2013).
When the performance of Woolworths and Wesfarmers is compared, it can be evaluated that cash and cash equivalents at the end of year for Wesfarmers are higher than Woolworths but there is higher decline in its value in Wesfarmers.
Task 2: Historical costs versus Fair Value
The valuation of the financial statement according to the IASB (International Accounting Standards Board) is increasing the value of financial statement with the use of its different techniques.
The valuation technique helps the organization to estimate the price of an assets or liability and it the basic accounting issue for the financial statement. On the basis of IASB conceptual framework, there are several techniques for valuation like historical cost analysis method, fair value model, market value approach (Christensen and Nikolaev, 2013).
The market value approach provides the valuation of the assets on the basis of the market transaction and it gathers the information from the market transaction and compares them with the current value.
In this method, the value of the business changes according to the growth rate of the market. The estimation of the value of the enterprises is calculated on the basis of industry growth, company performance, equity value, enterprise value and future growth opportunity.
On the other hand, historical cost analysis method is also a valuation technique that calculates the original cost that was incurred in past. In other words, the economic principle is also used by the firm to estimate the fair value, in which the buyer will pay the sum of amount approximately cost of replacement of assets.
In this method, the value of assets and liability is calculated on the basic accounting of original cost and the current market value not acquired by the firm (Blankespoor et al., 2013). The values of the asset are provided in the accounting books and evaluate or estimated in the carrying amount.
The historical cost is reliable and useful for the financial statement that provides the historical cost of the assets. So the cost and price of the asset never change in the market changes and inflation in the economy.
In this, liabilities are recorded at the same amount that was received that is satisfactory for the business. It is the basis of measurement that measures the elements of the financial statement.
In addition to this, this method is very simple so this method is commonly used by the accounting experts. But, this method is not much effective due to change in price level because it creates the inappropriate picture of financial position (Christensen et al., 2012).
Moreover, it does not present real value of assets and liabilities for preparing the financial statement. In this method, the non-monitory items are not fairly presented on the balance sheet during inflation.
Similarly, the fair value approach is also highly used by the financial accountant to the firm. The main objective of the fire value approach is to provide the proper estimation of the cost of the assets and liability.
It provides the value of assets according to market analysis and current price according to the market condition. In this model, the valuation of non-financial assets is based on premise that creates the most appropriate value. It is analyzed that it is a measurement that is based on the market, not on equity (Ettredge et al., 2014).
According to IASB conceptual framework, in the fair value approach, the market information and market transactions are observed for some assets and liabilities. In this method, the measures are assumed on the basis of market participants that provides the fair value or price of the assets and liability for the financial statement.
The fair value is the primary subject of measurement of financial information so it highly concentrates on the original value of assets and liabilities. The fair value can be calculated on the basis of the price of similar assets, present value cash flow of future and price of the last transaction in case of the inactive market (Kothari and Lester, 2012).
The objective of the fair value is to analysis the price of the assets by defining the cost of the close substitute, replacement costs etc. It helps to provide information about expected benefits of assets or liabilities about the debts and current economics.
The fair market value of assets is more useful to provide the reliable financial statement to the organization. So, most of the organizations are using this method for preparing financial statement because it provides relevant measures to the assets and liability and helps to provide valid data to the organization.
Annual Report 2017. Wesfarmers. [Online] Available at: https://www.wesfarmers.com.au/docs/default-source/reports/j000901-ar17_interactive_final.pdf?sfvrsn=4 (Accessed: 28 November 2017)
Annual Report 2017. Woolworths. [Online] Available at: https://www.woolworthsgroup.com.au/icms_docs/188795_annual-report-2017.pdf (Accessed: 28 November 2017)
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Academic Research Writing Arm of Global Research Services.