Finance And Accounting For Business Economic Profit: A Ratio Analysis

Step 1: Ratio analysis and economic profit

Discuss about the Finance and Accounting for Business Economic Profit.

This report analyses the various ratios trend for AEFFE and finds out the company’s economic profit. Further, a capital budgeting project is evaluated for the case company. Finally, a review is presented of the work received from the three fellow students.

Ratio analysis:

It is the analysis of financial statement data such as income statement, trading account, cash flow and balance sheet. Ratio analysis finds the company’s profitability, liquidity, efficiency, financial structure, and company’s solvency. The ratio analyses of the AEFFE are as followed.  

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RATIOS
Years ended 31 December
		2015	2014	2013	2012
Profitability Ratios
Net Profit Margin	Net profit after tax/sales	1%	1.59%	-0.78%	-1.27%
Return on Assets	Net profit after tax/total assets	0.5%	1.1%	-0.5%	-0.9%
Efficiency (or Asset Management) Ratios
Days of Inventory	Inventory/av.daily cost of goods sold	60.06%	57.96%	52.06%	54.12%
Total Asset Turnover Ratio	Sales/total assets	0.71	1.55	0.69	0.68
Liquidity Ratios
Current Ratio	Current assets/current liabilities	1.12	1.06	1.01	0.95
Financial Structure Ratios
Debt/Equity Ratio	Debt/equity	152.3%	97.8%	155.2%	153.5%
Equity Ratio	Equity/total assets	39.6%	39.6%	39.2%	39.4%
Market Ratios
Earnings per Share (EPS)	Net profit after tax/number of issued ordinary shares	0.16	0.38	(0.19)	(0.31)
Dividends per Share (DPS)	Dividends/number of issued ordinary shares	0.00	0.00	0.00	0.00
Price Earnings Ratio	Market price per share/earnings per share	187.00	26.33	(22.33)	(20.67)
Ratios Based on Reformulated Financial Statements
Return on Equity (ROE)	Comprehensive Income/shareholders’ equity	0.0007%	0.0027%	-0.0014%	-0.0020%
Return on Net Operating Assets (RNOA)	Operating income after tax (OI)/net operating assets (NOA)	0.71%	1.13%	-0.57%	-0.90%
Net Borrowing Cost (NBC)	Net fin. expenses after tax/net financial obligations	1.80%	3.65%	4.99%	2.56%
Profit Margin (PM)	Operating income after tax (OI)/sales	0.64%	1.59%	-0.78%	-1.27%
Asset Turnover (ATO)	Sales/net operating assets (NOA)	1.12	1.07	1.06	1.04
Economic profit	(RNOA – cost of capital) x net operating assets (NOA)	(2,680,580.0)	(2,859,300.0)	(2,332,640.0)	(3,007,770.0)

Profitability ratio: profitability ratio shows the profitability and earning capability of the organization. The major ratios that include in this are net profit margin and return on asset ratio (Tracy, 2012). The AEFFE net profit margin in year2012, 2013, 2014, 2015 are -1.27%, -.78%, 1.59% and 1%. It shows that the net profit of the company is in positive in last 2 years; only in year 2012, 2013 it was in negative. The return on assets of the AEFFE in the year 2012, 2013, 2014 and 2015 are -.09%, -.05%, 1.1%, .5%. These all ratio indicates that the companies earning was not good in the year 2012 and 2013 but now it is good in last two years.

Efficiency Ratio: The efficiency ratio shows how efficient organization is to do the productive work. The efficiency ratio includes the various ratios such as days of inventory, total asset turnover ratio (Edmonds et al, 2015). The day of inventory ratio of the AEFFE is increasing consistently. In year 2012, 2013, 2014, 2015 day of inventory ratio is 153.5%, 155.2%, 97.8% and 152.3%. This all data shows that only in year 2014 there is the dip, otherwise it consistently increasing. It shows that in every year, there is a hike, which is good for the company. Along with this, the total asset turnover ratio, which shows the efficiency of the sales over total asset are .68, .69, 1.55 and .71 between year 2012 to 2015.The efficiency ratio of the company shows that the overall business efficiency of the company is average.

Liquidity ratio – The liquidity ratio shows the company’s total liquidity and represents the company’s ability to meet short-term obligations. Every company wants that there liquidity position should be good. The major ratio that includes in the liquidity ratio is current ratio and the quick ratio. The current ratio shows the current liquidity position of the company, it shows that presently how much liquidity company have and is they able to do the current day to day operations smoothly (Warren et al, 2013). The current ratio of the AEFFE in year 2012, 2013, 2014 and 2015 is 0.95, 1.01, 1.6 and 1.12. This data shows that AEFFE current liquidity position is good, it has a sustainable growth in the last four years. Therefore, the liquidity position of the company is good; company is able to meet all the obligations perfectly.

Profitability Ratios

Financial Structure Ratios – financial structure ratios are one of the main ratios that shows the financial structures strength. The ratio that includes in the financial structure ratio are debt/ equity ratio and equity ratio (Edmonds et al, 2015). The debt equity ratio shows the relationship between debts and equities. The company’s debt equity ratio between years 2012 to 2015 are 152.3%, 97.8%, 155.20% and 153.50%. Along with this, the equity ratio shows the relationship between equity and total assets. The equity ratio of the company is 39.4%, 39.2%, 39.6% and 39.6% between year 2012 to 2015.The financial structure ratio of the company shows that in year 2014 and 2015, the conditions improved.

Market ratio – Market ratio shows the market condition of the company. This ratio includes earning per share, dividend per share and price earnings ratio. The earrings per share ratio shows the total earnings of the shareholder, means what are the earnings on shares that they get. The earnings per share ratio of the AEFFE in year 2012, 2013, 2014 and 2015 is -.31, -.19, .38 and .16. In the year 2012 and 2013 the company shareholder had not get any earnings but in year 2014 and 2015 shareholders get sufficient amount of returns (Yahoo finance, 2016). Along with this, the price earnings ratio that show the relationship between the market per share and the earning per share are -20.67, -22.33, 26.33 and 187 between year 2012 and 2015.

There are some ratios, which are calculated based on reformulated financial statement. These ratios are return on equity, return on net operating asset, net borrowing cost, profit margin, and asset turnover ratio. Return on equity shows the actual return that come out from the equities and it shows the relationship between comprehensive income and the shareholder equity (Drake and Fabozzi, 2012).  The return on equity of year 2012, 2013, 2014 and 2015 are.0020%, .0014%, 0027% and .0007%. The return on equity of the company is average, there is no such a big negativity as well as high positivity are there in the data. Along with this, the return on net operating asset is -.90%, -.57%, 1.13% and .71%. This shows that return on net operating asset of the company was not good in the year 2012 and 2013 but in the year 2014 and 2015, it comes positive. Additionally, the asset turnover ratio in the year 2012, 2013, 2014 and 2015 are 1.04, 1.06, 1.07 and 1.12. The asset turnover ratio shows the net operating asset and the sales of the company. The net borrowing cost of the company in year 2012, 2013, 2014 and 2015 are 2.56%, 4.99%, 3.65% and 1.805. Moreover, the profit margin ratio shows the margin of profit. The profit margin of the company between year 2012 to year 2015 are -1.27%, -.78%, 1.59% and .64%.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    

Efficiency Ratio

The gap between the profit from sales and the opportunity cost input is term as economic profit or loss. If value comes positive then it is profit and if not then it is loss.

economic profit
particular	2012	2013	2014	2015
comprehensive operating income	8821	6029	12029	5884
net operating assets	356268	346220	353554	359617
return on non operating assets	2.475945075	1.741378314	3.402309124	1.636185164
less: cost of capital	10	10	10	10
	-7.524054925	-8.258621686	-6.597690876	-8.363814836
multiply: net operating asset	356268	346220	353554	359617
economic profit or loss	-2680580	-2859300	-2332640	-3007770

The gap between the profit from sales and the opportunity cost input is term as economic profit or loss. If value comes positive then it is profit and if not then it is loss. The AEFFE has economic loss in the year 2012, 2013, 2014 and 2015, which is -2680580, -2859300, -2332640 and -3007770. It shows that there is a big gap between the actual and the desired results. This will effect negatively on companies growth.

Brief commentary:

Honestly I had difficulty in calculating the economic profit because I am first time calculating the ratios and economic profit. First time I had a chance to show my knowledge as well as experience with this assignment. I had an issue in calculation of the comprehensive income that poked my nerves. However, I feel great working on this assignment that helped me to improve my knowledge and skills that will help me in my future career. Through the assignment, I have learnt the basic concept of the ratios and use of ratios in financial statement analysis.

Development of Capital Investments

	Payback period	NPV	IRR
Project A	4.2	309009	13%
Project B	3.75	530277	15%

The capital investment or budgeting techniques can aid the company in identifying the best profitable amongst different investment options from two or various alternatives available before it . This shows the risk and profits associated with the investment options clearly and concisely that helps in selecting the best option (Pratt, and  Grabowski, 2010). There are two-investment proposal for the AEFFE each will be assessed in terms of profitability and risk associated with them. The AEFFE proposed to invest in new fashion products to extend the product lines and market growth. The company assessed two proposals using payback period, NPV, and IRR. The assessment result of the projects given below:

In the above table, the assessment findings have been shown. The payback period in recovering the investment is higher for the project A (4.2Years) but the same is lesser for the project B comparatively (3.75 Years). Along with this, the net present value of the investment in project A is 309009 that is lesser than the Project B of which net present value is 530277. Furthermore, the internal rate of return for the project A is 13% and project B is 15%. It means project B is more flexible than project A and the provide minimum return of 15% on the investment that is higher than the Project A. 

Liquidity Ratios

Based on the above assessment of two projects available with AEFFE, it can be recommended that the AEFFE should go with the Project B. Because the project B is providing the higher expected return as well as is having the higher net present value. Based on this rationality, the project B can be recommended to the AEFFE to invest in.

Strength of analysis:

The NPV considers the present value of the return to be earned in the future and represent clearly the potential of the investment in the project and it evaluates which project is having more potential to generate more revenue against other project (Riley et al, 2015). IRR indicates the minimum rate of return on the investment, which helps in selecting the best feasible project over others. The payback period states the time under that the investment in the project is possibly recovered. It helps in determining which project has the potential to cover the investment in lesser period. 

The NPV does not consider the duration, complexity of the project in the analysis. At the same time, the internal rate of return does not take the extra cost of the project into consideration while assessing the project. Any contingency or uncertainty can give the huge cost to the project that may affect the return from the project. It is not considered in the IRR assessment of the projects (lara et al, 2011). Along with this, payback period provides the information of the time span to be required in recollecting the investment amount but does not consider the time value of the money invested.           

Feedback to Thien Quoc Huynh:

Thein, I liked your work as you have provided the basic concept of the calculation and interpretation of the ratios, economic profit, and capital investment decision. You have covered all the ratios that are able to provide the basic and important information of the performance of the company. The assignment includes the proper calculation of the ratios, and states that what they represent about the company performance. It encompasses the meaning, concepts of the ratios. The calculations of all the ratios are correct and the commentary is outstanding too. Your followed a good format in representing your ideas.  Apart from this, you have well assessed the two projects for the capital investment. You genially explained your thoughts in the step 2 of the capital investment decision. You have calculated NPV, IRR, and Payback that gives the good base for selecting the project. You nicely calculated the NPV, IRR, payback period and assessed them. But you have not shown the economic profit calculation and commentary well. You should separate it from the ratio calculation.  The commentary of the economic profit is missing in the assignment. Apart from this, you should assess the strength and analysis of the capital investment techniques that will make your assignment better.

Financial Structure Ratios

Overall, you have expressed good ideas and thoughts in the assignment and concluded very well of your study that gives the brief ideas about the analysis. I think the work you have done can be recited as a “great work”.

Feedback to Brook Todd:

Brook, if I assess your work overall then it appears good about the clarity of the concepts of ratios, economic profit, and capital investment techniques and their calculations too. Your calculation of the ratios is correct and presentation seems outstanding. Nevertheless, you can make it more attractive and give it more rationality by benchmarking the ratios of CALIDA Group with other firms for its comparison. Else, you have done nice job in clearing the concept, calculation and presentation of the ration analysis in the assignment. Along with this, in economic profit you have shown your creativity and presentation skill that is truly appluadable. Moreover, one thing I would say that you could add on some commentary about your calculation and presentation of the economic profit that would brief your efforts.

Lastly, your capital investment decision you provided to the CALIDA Group is correct that you have provided the assessment you made. The calculation is good and presentation too. However, you should analyze the weakness and strength of your analysis that make aware the company about the risk associated with decision that helps them in making effective decision.

Overall, your performance is “outstanding”.

Feedback to Nicole Hinton:

Nicole, I think you have done good analysis of the ratios in first part but the calculation is missing that weaken your presentation. Apart from this, the economic profit and capital investment decision are missing in your assignment. You should have calculated the economic profit to shows the performance of the company. Along with this, you should have presented an investment proposal for newzulu and provide a recommendation about the best project. Overall, the several things are still missing in the assignment, which you have to put into.

References:

Yahoo finance (2016).  historical prices. Retrieved from https://uk.finance.yahoo.com/q/hp?s=AEF.MI&b=24&a=06&c=2007&e=8&d=09&f=2016&g=m  

Drake, P., and  Fabozzi, F. (2012). Analysis of Financial Statements.  USA: John Wiley & Sons.

Edmonds, T., Nair, F., Olds, P. and Edmonds, C. (2015). Fundamental Financial Accounting Concepts. USA: McGraw-Hill Higher Education.

Warren, C., Reeve, J. and Duchac, J, (2013). Corporate Financial Accounting. USA: Cengage Learning.

Tracy, A. (2012). Ratio Analysis Fundamentals: How 17 Financial Ratios Can Allow You to Analyse Any Business on the Planet. Australia: RatioAnalysis.net.

Pratt, S. and  Grabowski, R. (2010). Cost of Capital: Applications and Examples. USA: John Wiley & Sons. 

Riley, D., Ahmed, I., Debray, T., Willis, H., Noordzij, P., Higgins, J. and Deeks, J., (2015). Summarising and validating test accuracy results across multiple studies for use in clinical practice. Statistics in medicine,34(13), pp.2081-2103.

 Lara, G., Osma, G. and Penalva, F.,(2011). Conditional conservatism and cost of capital. Review of Accounting Studies, 16(2), pp.247-271.