Financial Managment – First Investments, Inc.: Analysis of Financial Statements
Team 4: Nathalie Strookman, Dieter Wolfram, Demis Busropan
The 1994 Basic Industries annual report shows a decline in the return on owners’ equity. This has got the portfolio people worried. An analysis has to be made of the way the company has achieved its return on equity over the last 10 years. The focus should especially be on the 1993-1994 period and the quality of the returns on equity of 1985 and 1994 should be compared, as well as other key financial ratios. By doing these financial analysis we hope to find out why the return on shareholders’ equity is varying in ...view middle of the document...
In addition, if a firm borrows money, a greater part of the profits is absorbed by interest which is reflected in a lower debt burden ratio.
When looking at the graphs presented in the results section, we can compare the different ratios with the return on equity. We see a fluctuation over the years with the lowest return on equity in 1988, which was 14.87%. If we compare the course of the operating profit margin with the return on equity we can see many similarities. In 1988 the profit margin was also the lowest (5.10%) over the years. This lower profit margin leads to a lower amount of money per sales and thus decreases your return on equity. So in time, every year the profit margin increases the ROE increases and vice versa. A comparable relationship can be drawn between asset turnover and return on equity, where we also see that an increase in turnover generates more sales per unit of asset which leads to a higher ROE and vice versa. The product of the profit margin and asset turnover make the return on assets. Comparing the graph of the ROE and ROA we can clearly see the effect of ROA on ROE. Every time the return on assets increases, the return on equity also increases.
Over the years we see a steady increase in leverage ratio which means that the company makes use of more debt to finance its operations. Furthermore, a decrease in debt burden can be found because of the interest the company has to pay to its creditors which in turn leads to absorption of part of the profits. The increase in leverage ratio does not necessarily have a negative effect on the ROE, as explained above, however the return on assets is decreasing whereas more interest is being paid. If the interest rate becomes higher than the return on assets it influences ROE negatively. This is because the interest has to be paid first before the shareholders can receive their dividend. Because of the increasing interest the profit margin is also decreasing which influences the ROE even more.
Comparing 1985 with 1994
Leverage ratio: assets/equity
This ratio compared the value of the company’s assets to that of the equity; it describes the debt equity mix. An increase in leverage ratio could be explained by a either a decrease in equity or an increase in assets. Equity is composed of total assets minus liabilities. The leverage ratio has mainly increased when comparing 1994 to 1985 because the liabilities have increased to a larger extend than the equity.
Asset turnover= sales/ average total assets
The increase in sales that the company has seen over the past years was complemented by an increase in average total assets resulting in a barely changing asset turnover. Asset turnover describes the efficiency of the company, it can therefore be stated that this has not changed significantly between 1985 and 1994.
Debt burden = net income/ (net income + interest)
This means that an increase in paid interest will lead to a decrease in debt burden. It...