Financial Ratio Analysis

Question: Discuss the ratios and other calculations in the context of the companys profitability, efficiency, liquidity, gearing (leverage) and investment performance. Answer: Profitability Ratios Two of the most important measures of Billabongs profitability are return on assets and return on equity. Return on Assets Return on Assets (ROA) of Billabong will measure how effectively the company's assets are being used for generating its net profits. This useful measure provides Billabongs comparison with respect to its competitive performance. Formula This ratio is calculated by dividing net income by average total assets. Return on Equity Return on Equity (ROE) of Billabong will measure the net return per dollar which the common shareholders invested in the firm, (Baker Riddick, 2013). Formula This ratio is calculated by dividing net income by shareholder's equity. It should be noted that the profitability ratios are derived from the Billabongs income statement. Hence, these measures demonstrate the companys periodic performance, covering the period as reported in its income statement, (Taylor, 2013). Asset Utilization Ratios These ratios will provide the managements measure of control as the ratios provide guidance for critical factors concerned with the use of the Billabong's assets, inventory and collection of accounts receivable in the companys day-to-day operations, (Greuning, Scott Terblanche, 2011). Total Asset Turnover (TAT) The TAT demonstrates that Billabong has been using its assets productively over the year. Even though there is no substantial change in the value between 2014 and 2015 in the value of this ratio, such a situation also signifies that the management had an effective control over asset turnover, (Greuning, Scott Terblanche, 2011). Formula This ratio is calculated by dividing net sales by average total assets. Fixed Asset Turnover (FAT) Billabong has been making good use of its fixed assets, including its plant and equipment and has demonstrated that these are more aptly utilised for direct production along with the current assets, which include cash and accounts receivable, hence many analysts would be encouraged for recommending the company because of the companys this measure of effectiveness, (Keown et al, 2012). Formula This ratio is calculated by dividing net sales by average total fixed assets. Inventory Turnover Cost of goods sold (COGS) is derived from the companys income statement and it indicates those expenses which are attributed to production of the goods and which are sold during the specified period and inventory is a shown as a current asset on the balance sheet. The purpose of this measure is to see how often Billabong is utilising its inventory to further its sales during the specified period, (Keown et al, 2012). Formula This ratio is calculated by dividing the cost of goods sold for a specific period by the average inventory for the same period. Days Sales Outstanding (DSO) This is one critical ratio, also termed as Accounts Receivable Turnover ratio, which the management of Billabong must monitor on a regular basis. This ratio also reflects the average collection period of the company for its debts. A smaller DSO means that the management of Billabong has a tight control over its markets and is efficient in managing the funds of the shareholders, (Yona, 2011). Formula Accounts receivable turnover is calculated by dividing the net credit sales for a specific period by the average accounts receivable for that period. Leverage Ratios Leverage ratios provide measure of Billabong's use of debt financing. This is the reason why analysts use these extensively to arrive at decisions for recommending new credit or extension of an existing credit arrangement. Since the use of debt financing can increase the risk factor of the company, managements and creditors should monitor the additional risk constantly in connection with borrowing of money by the company and also take note of the increased opportunities which the fresh capital shall provide, (Yona, 2011). Total Debt Ratio The above discussion is important as any company has only two ways of financing the acquisition of an asset either through borrowed funds or by utilising funds generated from internal operations or by selling stock in the market. Billabongs debt ratio of 65% means that, for every dollar of assets which Billabong has, 65 cents are financed with debt finance, (Mudra, 2014). Formula This ratio is calculated by dividing total liabilities by total assets. Long-term Debt Ratio On the same basis as above, some creditors may also focus on Billabong's use of long-term debts. This can be determined as it incorporates a small variation in the total debt ratio, by incorporating long-term liabilities in the numerator. Debt-to-Equity Ratio The debt-to-equity ratio of 185% for Billabong means that for each dollar of itsequity, the company has 1.85 dollars of debt financing. The debt to equity ratio is a balance sheet ratio as all the elements are shown in the balance sheet, (Mudra, 2014). Formula This ratio is calculated by dividing total liabilities by total equity. Two other leverage ratios of Billabong are significant for the company's creditors and these are the times-interest-earned and the fixed-charge coverage ratios. These two ratios help the analysts in measuring the company's ability to meet its on-going commitments in servicing the debts which it had borrowed previously, (Taylor, 2013). Times Interest Earned The times-interest-earned (TIE) ratio in the case of Billabong has shown a decline from 5.62 in 2014 to 4.10 in 2015. But it is still a healthy indicator that the companys operating profits during the recent period also exceeded the total interest expenses by 410 percent. From the analysts point of view, the higher this ratio goes, the more will be Billabong considered to be strong financially, (Taylor, 2013). Formula This ratio is calculated by dividing income before interest and income taxes by the interest expense. Fixed Charge Coverage On the same basis as the time interest earned ratio, this fixed charge coverage ratio, which is also termed as the debt service coverage ratio, takes into account all the regular periodic obligations of the company for a given period. Formula This ratio starts with the times earned interest ratio and adds in applicable fixed costs. Liquidity Ratios The liquidity ratios are those measures which indicate the company's ability in repaying its short-term debt obligations. Current liabilities represent only those obligations which are required to be settled in one year or less, (Greuning, Scott Terblanche, 2011). Current Ratio This ratio compares the current assets held by Billabong in comparison to its current liabilities. Formula This ratio is calculated by dividing current assets by current liabilities. Quick ratio Analysts believe that the economic definition of liquidity for a company is its ability to turn an asset into cash at or near the fair market value of the asset. Since inventory cannot be easily sold, it is not considered to be able to meet any short-term obligations. By excluding inventories, this ratio gives a more stringent liquidity measure of the company as compared to the current ratio, (Greuning, Scott Terblanche, 2011). Formula This ratio is calculated by adding cash, cash equivalents, short-term investments, and current receivables together then dividing them by current liabilities. Market Value Ratios Investors and managements are interested in the market ratios, which can be used in valuing Billabong's common stock. Price/Earnings Ratio This ratio, which is universally known as the PE Ratio, has been the most widely-quoted statistical ratio which concerns a company's common stock, (Yona, 2011). Formula This ratio is calculated by dividing the market value price per share by theearnings per share. Market-to-book Ratio This ratio is another related measure, often used along with the PE Ratio, for stock valuation purposes by analysts. Most of the investors would like to compare Billabongs current price of the common stock with the companys book value of stock. Such a measure is termed as the price/book ratio. In case the ratio is greater than one and this is what happens to be the case for majority of stocks, then the analysts assume that the companys stock is trading at a premium as compared to its book value, (Baker Riddick, 2013). List Of References Baker, H.K. and Riddick, L.A. (2013) International Finance: A Survey. Oxford: OUP USA. Greuning, H., Scott, D. and Terblanche, S. (2011) International Financial Reporting Standards: A Practical Guide. Washington DC: World Bank Publications. Keown, A.J., Martin, J.D., Petty, J.W. and Scott, D.F. (2012) Financial Management: Principles and Applications (10th ed). New Delhi: Pearson Education India. Mudra, J. (2014) International Financial Management (12th ed). Stamford, CT: Cengage Learning. Taylor, M.P. (2013) Purchasing Power Parity and Real Exchange Rates. Oxon: Routledge Yona, L. (2011) International Finance for Developing Countries. Keynes: AuthorHouse.