Executive Summary
After carrying out extensive financial research on aerated concrete industries, and Gulf Cement Company I have gathered important information and made necessary conclusions for the current users of financial statements of the three companies. The paper is beginning by giving the company overview of aerated concrete industries followed by the data that has been used and the financial statement analysis.
Through the financial statement analysis, I was able to compute and conclude on the performance of the company using different financial ratios and this helped with comparing the ratios with the other three companies with the same ratio. I was able to calculate and determine the liquidity level of the company, solvency level efficiency level, and market-based level for the company. These ratios helped me to determine if this company is performing above the industry players. This paper concludes with my recommendation based on my findings as to whether or not the company is performing will in the industry for potential investors to look into.
Introduction
In the face of growing industrialization in Kuwait and modernization of lifestyles along with changes in consumer demand trends, one could be interested in observing the cement manufacturing industry which will give us an idea regarding the change in the development of a country. The cement manufacturing industry is the core source of development of any country. Without cement, there will be no permanent buildings where industries are housed. Homes are constructed from cement and it is this cement that will determine whether the country is making progress in development. This paper undertakes to compare the financial importance of three companies in the cement industry operating in the Middle East. The companies are; aerated concrete industries company limited, gulf cement company, and UMM Al-QAIWAIN.
Company overview
Aerated concrete company is a Company with its headquarters in Kuwait and currently, it has many projects that they are undertaking amongst them construction In the public and private sector, they also have 50,000 housing units which they are constructing for the government. The company has various strategic plans. These plans have made the company grow from what it used to be since its establishment in 1990 to a major player currently.
The companies main activities include establishing plants for the production of concrete of all types, owning, selling, and buying real estate and land for the benefit of the company. They also buy and deal with other industry shares and bonds with an aim of making profits. They also engage in managing companies with similar activities. The company’s strategic plans for growth include expansion to include
new activities, concentrate on the main activity, and expand through strategic alliances and diversification and through integration. The company currently is among the few companies that have engaged in these activities with success.
Data
For comparison purposes of the same industries data for 2004, 05 and 06 has been used for all the companies. This will make financial statement analysis a little bit meaningful although one of the companies has a different ending financial period.
Analysis of the balance sheet and income statement shows that I need to consider several important issues which relate to this company. The Gross profit has remained almost the same figure although sales have increased cash and equivalent also increased by big margin. This same applies to other expenses except depreciation and selling expenses which seems to have decreased. Investment shot up drastically. This needs to be analyzed as we carry out the analysis of this company. The returns of assets and equity have also both changed over time while the net income has had slight changes between the three years. Total current assets have had a slight increase as well as total assets. However current assets seem to have increased. Therefore financial statement analysis will help in discovering which areas performed well. The data from the balance sheet for the years will have been used to derive these ratios for the years.
Financial statement analysis
Liquidity ratios
Looking at the liquidity of this company, it has the trend as shown in the graph 1 below. Liquidity ratios are used by many stakeholders who are interested in the performance of firm such as suppliers, government, environmentalist and shareholders. This is because this ratio is used to measure the short term ability of a company to pay creditors over short periods without straining failure by the company to pay the creditors on time they may face technical defaults which may result in bankruptcy therefore short-term liquidity is of paramount importance to companies. These two ratios, current and quick ratio are the best way to measure the immediate ability of aerated concrete industries to pay their creditors.
The average quick ratio and current ratio is 0.98 and 1.08. Quick ratio considers the most liquid assets therefore it looks at the most immediate ability of the firm to clear short term debts. This is because inventory is considered the least liquid current assets. In the year 2004, the ratios were up before they went down as shown in the graph above. The quick ratio changed from 0.98 in the year 2004 to 0.85 in 2005 before going up to 1.12. The ratio is still good in relations to the industry since the average for the year is 0.98 almost one.
However I should note that this ratio shows that the firm does not have enough resources to meet short term obligations in case of any problem of average. For every one dollar, of current liabilities there is an average of 0.98 for the three years. However there is a high current ratio which means that some money is being tied up in some non-productive activities in the eyes of shareholders. The current ratio has fluctuated the same as the quick ratio and it is this fluctuation that raises doubts about the ability of the management to stable quick assets that will offset current liabilities when they fall due. However I should note that the company has a healthy liquidity ratio.
Growth ratios
Looking at growth ratios i.e. the sales growth and net income growth one will note that between the three years there was fluctuation in both ratios. But net income grew at a higher rate in 2004 but reduced in the year 2005 and in the year 2006 the same time. More worrying in the year 2004 net income grew at a large margin which may be attributed to the reduction in expenses for the company. However, in both cases, sales growth and net income growth the year 2005 experienced the worst results as for the two years. The following graph shows how the sales and income growth faired in the three years and what trend they took.
From graph 2 growths took a downward trend between the year 2004 and the year 2005 although the net income trend was so steep. However it took an upward trend in 2006 as compared to the year 2005.
Efficiency ratios
This analysis we are considering asset turnover ratios of receivable turnover, inventory turnover and asset turnover. Assets turnover ratios are used to measure the efficiency of management of the company in using the assets at their disposal to generate revenue. From the ratios provided as shown below they indicate that the company was not consistent in managing the assets of the company.
The graph 3 above shows a trend where there was a decrease in efficiency in the year 2005. The management turned receivable 1236 in 2005 but declined to 0.78 in the year 2008. Inventory turnover also declined in the year 2005 from 21.14 to 12.94. However it went up in the year 2006 and to 21.74. It appears in all instances in the year 2005 was not a good year for this company because all this three ratios faced a downward trend as indicated by graph.
What is means is that for every Dirham of receivables there was 1.73, 0.78, and 1.06 Dirham of sales. This is quite too low for a company of this size and in this business. Inventory turnover shows that for every dollar of inventory there was 21.14, 12.94 and 21.74 Dirham of sales. It is a convincing figure because it means that a company with a high inventory turnover, there is huge sales of stocks. The turnover ratios give the pricing strategy of the company.
A company with a low asset turnover shows that a company is highly profitable. Therefore in this case this company appears to be profitable. And on that basis it will be prudent to mention that this company is among the most profitable in the industry in the Middle East. All this ratios indicate fluctuations, there is no consistency therefore the management is not consistent in managing the affairs of the company.
Profitability ratios
In this case I want to consider two important ratios, return on equity and return on assets because the profit margins on sales has been covered in the sales growth and net income growth ratios covered above. Return on assets is used to measure the overall performance of the company. However to make this ratio meaningful one must adjust for implicit interest which is extremely very difficult to estimate and make analysis very complicated. This ratio fro this company shows a fluctuation between the three years.
Return on equity, which also measures the firms performance from the shareholders point of view has taken a similar trend for the company. In the eyes of the shareholders the year 2005 was the worst performing year because return on equity declined from 37.51 to 19.51 in the year 2005 before going up to 27.91 in the year 2006. A higher ratio means a better result for the shareholders. If the return on equity is less than the cost of equity of the firm it is said to be destroying the shareholders wealth. From the above analysis it appears that the company is performing very well. The following chart shows how the ratios faired on.
The graph 4 above shows a fluctuating trend for the operations of the company in terms of generating profits. This ratios shows that the organization is profitable. Return on equity is at times called du point analysis. It is the most important analysis because it breaks down returns into operating efficiency, asset use efficiency and financial leverage. Operating efficiency measures the net profit margin while asset efficiency measures total assets turnover. Lastly financial leverage measures the equity multiplier. This formula is expressed as shown below.
ROE = (Net profit margin) x (Total Asset Turnover) x (financial leverage)
ROE = (Net income/Sales) x (Sales/Assets) x (Assets/Equity)
From the analysis above, I can state that aerated concrete industries has good financial leverage coefficiency therefore it makes better investment than other companies in the industry. Although it is fluctuating.
Solvency ratios
Looking at the solvency ratios of this company, it will be noted that it has a similar trend, for total liabilities to total equity and total liabilities to total assets. The ratios took an for all the years. The following graph 5 shows the trend they took. These ratios have shown an upward trend over the years. The two ratios measure the long term ability of a company to meet long term liability. These ratios are the one used to measure the solvency of a company. Aerated concrete industries, solvency ratios have been having an upward trend i.e. they are increasing which is a dangerous sign for the company. The company at all times should try to reduce this ratio to maintain a good financial stability.
The total assets ratio considers all debts and it shows how the assets of the company have been financed by debt. Infact, they are risk ratios. How risky the company is, the higher the ratio the higher the risk. Debt ratio also shows the companies overall financial situation and it has been increasing over time for this company.
Gulf cement company analysis
Short term liquidity position of Gulf Cement Company has been analyzed and a number of ratios were calculated during the last 3 years for analysis purpose. The current ratio from year 2004 to year 2006 fluctuating trend. This increase is due to rise in investment in debt securities and decrease in accrual expenses. The acid test ratio of the company also depicts the same picture. Overall short term liquidity as shown by current and acid ratio fluctuates but declines substantially during 2004 and 2005 compared to 2005 to 2006.
Receivable turnover ratio remains constantly reduces during the past 3 years. It saw its highest turnover during the years 2005 which result in day sales in receivable of 118 days only. Inventory turnover also came down during this period which remained as high during year 2004 and then drop substantially following years. It shows that company improves its performance in terms of converting its inventory into sales resulting in higher sales figure during the year 2006. The improvement in current ratio during the year 2006 is due to substantial investment in debt securities. During the year 2004, these two ratios were high.
The reason why these are so high during this year is due low investment in debt security which the company then increases steadily in the subsequent years. Working capital amount is quite adequate which increase consistently during the past three years. It shows that company is in good position to finance its short term financial needs.
Capital structure of the company show how much of the company assets are financed by the company through debt and how much from equity. The exhibit shows that company is increasing its reliance on creditor financing although fluctuating starting from 16.76% from 2004 to 19.77 percent during 2006. At the same time company is building equity finance during the same last two years. This increase in equity finance came mostly from increase in retained earning of the company. This decrease in current liabilities of the company, therefore, results in improved current and acid test ratio for the year 2007.
Return on invested capital analysis shows that this return fluctuated widely during the past three years. The company posted very high performance as far as ROA is concerned during the year 2004. This performance is due to less operating expenses on account of asset impairment and restructuring charges, coupled with higher NOA turnover. Also the company increases the size of its sales force and marketing cost associated with launching of new products. Gulf Cement Company ROE during 2005 was highest at 38.15 percent among these 3 years. This increase is primarily due to high RNOA and high spread during that year.
Asset utilization of the company has been shown in change over time. Sales to account receivable is increasing over the years showing that company is rapidly converting its receivable into cash. Same is the case with inventory. Company is converting its inventory into sales rapidly over these years resulting in higher sales. Sales to fixed asset and other assets show the same increasing trend during the past 3 years. Company has been quite effective in utilizing its assets quite efficiently as evident from the sales to total asset ratio.
Comparative analysis
Overall the company is in good shape with a few exceptions where its ratios where less than competitors. They have good growth ratio, profitability as well as other rations. The table below shows how this ratio has performed.
All the profitability ratios show good results overtime as compared to the industry player. In fact most of them show positive results for the years 2004, 2005 and 2005 and average which is higher than the competitor. As far as ROE is concerned the situation looks better than the competitor. So this is an illusionary impact again but the liquidity position shows a poor results as compared to the competitor.
When compared the two companies, one find that the competitor is much better off compared to where there is a fluctuation. The debt management ratio shows an improvement in creditworthiness, that is, lucrative from creditors’ point view from 2004 to 2004 and a fall in credibility from the managers’ perspective. This is in tune with the competitors as well.
DuPont analysis
In a DuPont analysis, the expression for ROE is broken up into three parts – profit margin, asset turnover and equity multiplier. The profit margin measures the operating efficiency of the firm concerned, asset turnover measures the asset use efficiency and the equity multiplier throws light on the financial leverage of the company under analysis. This identity helps one to understand where the superior or inferior return comes from.Therefore, we may express ROE as follows:
(Net profit / Sales) * (Sales / Assets) * (Assets / Equity) = (Profit margin) * (Asset turnover) * (Equity multiplier). (Groppelli and Nikbakht, 444-445)
If we look at the individual values of these components for the three companies we shall be able to find the origin of the fall or rise in returns on equity. The asset turnover has shown some growth except a fall in 2005 followed by a steady recovery. Therefore the use of assets has not been inefficient and we may say that operating efficiency and financial leverage is responsible for this low return. In case of ACICO, all three components have been showing steady improvement and so are the values of ROE overtime. Therefore the position of the firm with respect to financial leverage, operating efficiency and asset utility has improved overtime. In case of Gulf , it is again the profit margin that is responsible for the change ROE in overtime despite a steady improvement in financial leverage and asset utility.
Conclusion
Therefore the operating efficiency is moderate and fluctuating and this is influencing the value of ROE. More or less we find that the operating efficiency is responsible for the fluctuations of returns in case of ACICO unlike Gulf, which shows steady progress. Therefore, improvements and innovations are sought on the technological side for ACICO in order to catch up with the competitors. While Gulf shows its versatility and ability to reach consumers at all levels, they has won the edge due to its geographical and brands coverage. An environment friendly technology and research and development oriented towards environmental sustainability would be a profitable area to invest for ACICO and thus catch up with the challenges faced by the industry today.
References
Altman (1993)E I corporate financial distress and bankruptcy, 2nd edition new York John welling and sons.
Beaver W. H (1989) Financial reporting: Accounting revolution, Englewood cleves, prentice hall.
Bernstein L (1993);financial statement analysis, 5th edition, Homewood, Irwin.
Berk and DeMarzo (2006); Corporate finance; Addison Wesle.
Collier, P. (2006); Accounting for managers: interpreting accounting information for decision making, Wiley.
Dyson, J. R., Accounting for Non- Accounting Students (2004), Pearson Education Ltd.
Glautier M W E & Underdown D (1977) accounting theory and practice pitman.
Groppelli, Angelico A.and Ehsan Nikbakht, Finance, 4th ed. Barron’s Educational Series, Inc., 2000.
Herald Tribune (2008); Ford takes over Romanian plant. The Associated Press.
Holmes, G, Sugden A, Gee Paul (2008) Interpreting Company Reports and Accounts.
Shannan, P. (2008). Retail Store Closures Symptomatic of Ailing Economy. American Free Press, August 2008, B.3.
Sterling, Robert R, (1970);Theory of the measurement of enterprise income. Lawrence, KS: university press of Kansas.
Weygandt, J. Kieso D. and P. Kimmel (2005) Accounting principles, Wiley.
White G I Sondhi E C & Fried D (1999): The analysis and use of financial statements Wiley.
Appendix
Financial statements of 2004, 2005 and 2006 for ACICO and Gulf cement company.