Return on Equity (ROE)
The firm increased the earning capability of each ordinary share by 2.5%. Thus, holders of such shares received 2 HK dollars and 5 cents more for each dollar invested compared in 2004. As a result, it is likely that the firm can fund itself due to reliance on its ability to generate cash requirements from operations with less option for either debt or additional equity financing. This fact is reflected on how it maintained zero balance under interest costs in 2005. Aside from its cost-effective strategy, the current year proved that it was able to stimulate its revenue capability with a record of at least HK0 million increase year-on-year.
Profit Margin
As the CEO said, even though turn-over was a record, this is partially offset by an increased in operational costs. In effect, there is only a slight increase in profit margin as staff costs (due to additional workforce in the opening of Shanghai branch), depreciation (partly caused by unsold inventories) and tax payments on top of cost of sales (which is beyond 50% of turn-over) rise year-on-year. Total deductions to the revenues are partially shielded by a surplus in revaluation of assets of the firm which rose by HK million. This is an indication together with other revenues of HK million posted in 2005 that the firm was able to capitalize on incidental and indirect benefits arising from its operations. For example, it was paid with compensation in a win of an infringement case in China.
Gross Profit Margin
The firm stabilized this account that indicated good financial health. Basing on this year-on-year performance, the firm succeeded to pass any increase in the price in merchandise or escalation in labor wages to end-users and obtain profit a volatile environment. It maximized the use of its brand name (which was the leader in cosmetics and beauty industry in Asia) to protect its revenues from the impact of inflation, interest rates and currency exchange. These factors have huge bearing in the business because most of its products are imported from foreign manufacturers. The stability can also be looked in a different manner. With minimal inventory turn-over, the rise of customer base sustain revenue targets as the fear of SARS decline while the number of tourists particularly in Hong Kong had increased.
Earnings per Share (EPS)
The firm has able to increase the attractiveness of its shares to potential investors and increase the assurance that it can resort to equity financing in future expansion. This is impacted by high turn-over for the year and low operational cost. As a result, the firm had resulted to more earnings attributable to shareholders. This increased the realized and unrealized profit gains of shareholders. In effect, it had expanded geographically in Shanghai, China and other parts of the world. It is also expanded its brand suppliers to 400 which suggested that it is confident on the diligence of its shareholders in its future undertaking especially when the firm does not use debt financing.
Common Size Analysis
With regards to cost of sales, the firm attained efficiency for 2005 with 0.4% success over lowering the cost of sales. This was an indication that its years of experience in the industry provided both operational and supplier expertise. Its non-operations’ revenue from asset revaluation rise in 2005 signaling that opportunities were properly exploited by accounting procedure which was best practiced by the firm. It also managed tax payments held constant that paved the way for smooth expansion and operational activities. As observed, remaining entities were very stable which indicated several strengths of the firm in the areas of operations, finance, auditing, purchasing, supplier relations, supply chain and other activities in the value chain. No wonder that its year-on-year net income increased by at least one percent.
Asset Turn-over
Comparatively, the firm became more efficient in 2005 increasing with 0.2 times productivity/ efficiency. It signaled how it utilize the inputs provided in buying merchandise, communication with suppliers and managing its health services units with cost efficiency. It can also indicate how well it implemented its pricing strategy especially in retailing industry in which competition is very stiff. In view of this, it could partially enhance its price-making capability as it holds rights to sell 400 global trademarks. This can be also credited to its marketing team and retail outlets. On the other hand, analyst should be cautioned by the fact that the result of high asset turn-over could be a short-sighted approach to increase firm’s attractiveness to investors by deferring plant, manpower and development investments. This financial make-over is good on financial books but is very risky in terms of the future of the business as poor quality, customer service non-reliability and even shutdown would result in the long-run.
Inventory Turn-Over
The drop of the rate of disposing the merchandise could likely mean that the firm had overestimated the 2005 demand. However, this slowdown positively impacted revenues (as 2005 set a record for this) which confirmed the success of marketing and pricing strategy of the firm. This performance was also rightful for credit as the firm is not selling perishable goods and high inventory for 2005 could only mean that it intended to provide product/ brand availability for each customer. This is crucial when suppliers have limited stocks for particular items and consumers urgently need the merchandise. In effect, the firm successfully secured the stock not only of bestsellers but also those with infrequent demand. Doing so, it concretized its reliability to its customers that can support its long-term expansion and growth.
Collection Ratio
In 2005, collection ratio is lower than the previous year which suggested that the firm had resolved customer complaints, built relationships with them and delivered the needed products on time. This can also indicate that it succeeded in communicating with customer’s banks which becomes crucial partners especially when customers pay via credit cards. In its health services division like the operations of its beauty and fitness specialist , this showed that clients are satisfied with the service and motivated to create long-lasting relationship with the firm. For example, many women were members of the service for over 20 years. As a result, the firm had resorted to add value in the service through some installment or deferred payments for client’s convenience. The collection period assures the firm cash-flows every 15th and 30th of every month which supported its product and geographical expansion including customer-driven incentives.
Debt/ Asset Ratio
This had slightly increased by 0.03 points in 2005 which can indicate that the firm required debt financing possibly to pay the receipts of its increased inventory and orders. However, as the ratio remains below 1, the firm resorted largely to its shareholders for needed investments and cash. It positioned away from volatile interest rates in order to avoid currency exchange looses as well as it was able to enter spot contracts provided by some suppliers. In doing so, it maximized its capability to develop its product/ brand line with less additional burden in paying the payment’s interests. This was reflected by minimal-to-zero finance costs. This also reflects that Equity/ Asset ratio would be high so it would not necessitate computation. Although it is generally good for the firm to stay away from solvency risks due to debt financing, this could also show that it was not a good debtor that could impair its future expansions.
Working Capital Ratio
This calculation supported the 2005 expansion feats of the firm with a decrease in this ratio by 0.5 points although a slight effort to optimally use its assets. Failure to optimize aggravates when acid test (quick ratio) is applied. For the last two years, the firm exceeded the 2-point mark rule by coming-up with 3.9 and 3.4 results which was almost double. This can be connected to low inventory ratio identified earlier which ranked number 2 for the highest amount under current assets. Due to this, the firm was confronted with two problems in 2005 operations. First, it had difficulty in disposing the bulk of its inventory and was unable to maximize the use of its cash and bank balances to reverse the trend (the highest under current assets). Although the firm was evaluated as efficient in terms of operations, very high working capital ratio indicates its risk-aversion and consequently the refusal for debt financing becomes a problem not a strategy. In a different view, the firm might be intending to spend its excess assets in not-so-near future or would like to confront competition with a continuous and always-available product/ brand stocks.
Excluded Ratios
Average interest rate and interest coverage were not discussed and computed because the firm exemplified mainly equity financing that resulted to zero finance expense in 2005 which was similarly insignificant in 2004. The fact should be indicative that the firm’s cash flow and changes in interest rates are not directly pressured by debt and the attached interest rate.
Other Conclusion and Recommendation
The firm had recorded the highest turnover in its history which implies that its business can grow if only applied with strategy both in operations and investments. Although it is efficient internally as well as excellent in implementing marketing tactics, how it allocates its extra cash and bank balances should be more inclined towards risk-taking. It can expand geographically in developing countries in Asia to minimize its low inventory turnover or remain in its leadership areas like Hong Kong and use focused leadership strategy. In doing so, it should not be very cautious that leads to over risk-averse because it can use its borrowing integrity. However, if the firm would like to maximize its ability to borrow, it should start now to be able to go way with too much pressure on shareholders and gain from financial restructuring.
Appendices
Table 1: Comparative ratios
Crucial Ratios
2005
2004
Return on Equity
24.3%
21.8%
Profit Margin
9.4%
8.0%
Gross Profit Margin
42.9%
42.7%
Earnings per Share (basic)
16.6 cents
11.9 cents
Common Size Analysis
· Turn-over and other revenues
· Cost of Sales
· Other Revenues (except revaluation surplus)
· Staff Costs
· Depreciation
· Surplus from Asset revaluation
· Finance Cost
· Tax Expense
· Net Income
100%
56.2%
1.2%
15.7%
1.7%
0.4%
0.0%
1.8%
9.2%
100%
56.6%
1.2%
15.7%
1.7%
0.0%
0.0%
1.8%
7.9%
Asset Turn-Over
1.9
1.7
Inventory Turn-Over
3.6
4.1
Collection Ratio
14.3 days
15.3 days
Debt-Asset Ratio
0.33
0.30
Working Capital Ratio
3.4
3.9
Illustration 1: Ratio Computation
(Notes: Amounts are succeeded by ‘000)
ROE = Profit after interest & tax/ Ordinary shareholder’s funds (Ordinary share capital + reserves)* 100 = 216,607/892,656*100 (2005), 151,075/693,588*100 (2004)
Profit Margin = Net Income/ Revenue*100 = 216,607/2,313,706*100 (2005), 151,075/ 1,883,334*100 (2004)
Gross Profit Margin = (Revenue – Cost of Goods Sold)/ Revenue*100 = (2,313,706 – 1,321,817)/ 2,313,706*100 (2005), (1,883,334 – 1,079,020)/ 1,883,334*100 (2004)
EPS = (Net Income – Dividends on Preferred Stock)/ Average Outstanding Shares = already given in the financial books of any firm
Common Size Analysis = Entity/ Total Entity = Turn-over and other revenues/ Turn-over and other revenues = 2,350,853/ 2,350,853*100 (2005), 1,906,802/ 1,906,802*100 (2004); Cost of Sales/ Total Entity = 1,321,817/ 2,350,853*100 (2005), 1,079,020/ 1,906,802*100 (2004); Other Revenues/ Total Entity = 27,505/ 2,350,853*100 (2005), 23,268/ 1,906,802*100 (2004); Staff Costs/ Total Entity = 369,438/ 2,350,853*100 (2005), 299,492/ 1,906,802*100 (2004); Depreciation/ Total Entity = 39,502/ 2,350,853*100 (2005), 32,907/ 1,906,802*100 (2004); Surplus from asset revaluation/ Total Entity = 9,642/ 2,350,853*100 (2005), 200/ 1,906,802*100 (2004); Finance cost/ Total Entity = 0/ 2,350,853*100 (2005), 2/ 1,906,802*100 (2004); Tax expense/ Total Entity = 43,560/ 2,350,853*100 (2005), 34,087/ 1,906,802*100 (2004); Net Income/ Total Entity = 216,607/ 2,350,853*100 (2005), 151,075/ 1,906,802*100 (2004).
Asset Turn-Over = Revenues/ Total Assets = 2,313,706/ 1,217,765 (2005), 1,906,802/ 1,098,429 (2004)
Inventory Turn-Over = Cost of Goods Sold/ Average or Current Period Inventory = 1,321,817/ 363,684 (2005), 1,079,020/262,152 (2004)
Collection Ratio = Accounts receivables except trade receivables/ (Revenue/365 days) = 90,612/ (2,313,706/ 365) (2005), 78,920/ (1,883,334/ 365) (2004)
Debt-Asset Ratio = Total Liabilities/ Total Assets = 456,825/ 1,367,509 (2005), 367,537/1,217,121 (2004)
Working Capital Ratio = Current Assets/ Current Liabilities = 1,217,765/ 358,747 (2005), 1,098,429/ 281,478 (2004)
Credit:ivythesis.typepad.com
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