Accounting Ratio Analysis And Comparison Of Companies Finance Essay

1) Question 1

Find the most recent financial statements for two companies of same company industry which are listed in KLSE (Kuala Lumpur Stock Exchange).Evaluate the financial position and performance for each of these two companies using accounting ratio analysis. You are required

to compute and compare the accounting ratio between these two companies, and conclude the results of your finding. The limitations or problems of using accounting ratios for performance analysis should be included in your conclusion.

entify and discuss three different ways for transferring capital or fund from saves to borrowers in the financial market.

Table of content Page

Questions 1

Introduction for question 1 3 – 7

Calculation for Gamuda and WCT Berhad 8 – 14

The ratio comparison between two companies 15 – 16

Conclusion 17

Question 2 18 – 24

Bibliography 25

Appendix 26

2) Question 1

Introduction

Accounting ratios are the ratios that expressed and counted based on the financial statement of a company. Besides that, accounting ratios are also useful indicators of a firm’s performance and financial situation. Most of the ratios can be calculated from the information that is provided by the financial statements. Each type of accounting ratio provides an important data about a firm’s ability to repay its debts, its financial standing, and the potential for profit and how valuable stocks or investments in the company are. On top of that, accounting ratio also can be used to analyze the calculation and comparison of ratios which are derived from the information in a company’s financial statements. Accounting ratios are a valuable and easy to interpret the numbers that is found in statements. When computing financial relationships, a good indication of the company’s financial strengths and weaknesses becomes clear. Accounting ratio analysis the ratios into categories which tell us about different facets of a company’s finances and operations. The following types of accounting ratios that is used,

Liquidity ratios

Asset turnover ratios

Financial leverage ratios

Profitability ratios

Dividend policy ratios

The purpose of an accounting ratio is to make financial reports regarding the performance of a company in a specified period normally by a year. These financial reports are later made available to the tax authorities, investors and creditors of the firm. Accounting ratios are calculated and grouped into five different categories for measuring the five different aspects of the business performance. There are five aspects of business measured by an accounting ratio.

Profitability of company

Liquidity of company

Asset management of company

Debts management and gearing of company

Market value of investment to ordinary shareholders and common stockholders

The formula for accounting ratio that are used to measure each aspect or area of business by accounting ratios are

Profitability of company

Gross profit markup (%) = Gross profit ÷ Cost of goods sold – 100

Gross profit margin (%) = gross profit ÷ net sales value – 100

Operating profit margin (%) = operating profit before interest and before taxation ÷ net sales valuex100

Profit margin on sales (%) = net income available to common stockholders ÷ Net sales value -100

Basic earning power (BEP) = operating profit before interest and before taxation ÷ total assets – 100

Return on total assets (ROA) = net income available to common stockholders ÷ total assets – 100

Return on common equity (ROE) = net income available to common stockholders ÷ common equityx100

Liquidity of company

Current ratio/working capital ratio = current assets ÷ current liabilities

Liquid ratio/quick ratio/acid-test ratio = liquid assets ÷ current liabilities

Asset management of company

Inventory turnover or stock turnover = cost of sales÷ average stock value OR cost of sales÷ closing stock value

Total assets turnover = net sales ÷ total assets

Debtor ratio = debtor ÷ credit sales

Days sales outstanding (DSO) = debtor ÷ credit sales – 365 days

Debts management and capital gearing of company

Debts ratio = total debts ÷ total assets

Debts equity ratio = total debts ÷ common equity

Times interest earned = profit before interest and before taxation ÷ interest charges

Market value of investment to ordinary shareholders/common stockholders

Earnings per share = net income available to common stockholders ÷ number of ordinary shares in issue

Price/earnings ratio = market price per ordinary share ÷ earnings per share

Earnings yield = gross earnings per share ÷ market price per ordinary share – 100

Market price/book value ratio = market price per ordinary share ÷ net book value per ordinary share

Besides that, there are three methods to compare accounting ratios for business performance measurement which are inter-temporal comparison between two periods, inter-firms comparison between two companies and comparison with industry averages. The two companies that are selected for business performance measurement are Gamuda Berhad and WCT Corporation Berhad. Gamuda Berhad is a Malaysia-based investment holding company which is the most famous in civil engineering construction. The industry of this company also operates in three business segment which involves engineering and construction, construction of highways and bridges, airfield facilities, railway, water treatment plants, dams and general and trading services. WCT Berhad is a Malaysia-based company which provides the provision of engineering services. The Company operates in three segments: civil engineering and construction, civil engineering works specializing in earthworks, infrastructure works, and property development. The information for these two companies which are required for business performance is measurement by accounting ratios in income statements and balance sheets of the two companies.

Ratio with formula

(Profitability of company)

Calculation for 1st company

(Gamuda Berhad)

Calculation for 2nd company

(WCT Berhad)

Gross Profit Markup(%)=

Gross profit=2455143000-1580125000-363348000-8595000-19973000-19260000-40866000

=RM422976000

Cost of goods sold =1580125000+363348000+8595000+19973000+19260000+40866000

=RM2032167000

=20.81%

Gross profit

=RM354659000

Cost of goods sold

=RM4311943000

=8.23%

Gross Profit Margin(%)=

Net sales value=2455143000-0

=2455143000

Gross profit=2455143000-1580125000-363348000-8595000-19973000-19260000-40866000

=422976000

=17.23%

Gross profit

=RM354659000

Net sales value

=sales – return inwards

=4666602000-0

=RM4666602000

=7.60%

Operating Profit Margin On Sales(%)=

Net sales value=2455143000-0

=2455143000

Operating profit before interest and taxation

=259852000

=10.58%

Operating profit before interest and taxation

=RM244145000

Net sales value

=sales – return inwards

=4666602000-0

=RM4666602000

=5.23%

Profit Margin On Sales(%)=

Net income available to common stockholders

=280693000

Net sales value

=2455143000-0

=2455143000

=11.43%

Net income available to common stockholders

=RM147098000

Net sales value

=sales – return inwards

=4666602000-0

=RM4666602000

=3.15%

Basic Earning Power=

Operating profit before interest and taxation

=RM259852000

Total assets

=total non-current assets + total current assets

=2347737000+4203173000

=RM6550910000

=3.97%

Operating profit before interest and taxation

=RM244145000

Total assets

=total non-current assets + total current assets

=RM1925297000+RM2553187000

=RM4478484000

=5.45%

Return On Total Assets=

Net income available to common stockholders

=RM280693000

Total assets

=total non-current assets + total current assets

=2347737000+4203173000

=RM6550910000

=4.28%

Net income available to common stockholders

=RM147098000

Total assets

=total non-current assets + total current assets

=RM1925297000+RM2553187000

=RM4478484000

=3.28%

Return On Common Equity=

Net income available to common stockholders

=RM280693000

Common equity

=Ordinary share capital + Reserves

=2025888000+1231637000

=RM3257525000

=8.62%

Net income available to common stockholders

=RM147098000

Common equity

=Ordinary share capital + Reserves + Share premium

=388856000+369256000+492134000

=RM1250246000

=11.77%

Ratio with formula

(Liquidity of company)

Calculation for 1st company

(Gamuda Berhad)

Calculation for 2nd company

(WCT Berhad)

Current Ratio=

Current assets

=RM4203173000

Current liabilities

=RM1930241000

=2.18:1

Current assets

=RM2553187000

Current liabilities

=RM1807550000

=1.41:1

Acid-test ratio=

Liquid assets

=Current assets – Inventories

=4203173000-79738000

=RM4123435000

Current liabilities

=RM1930241000

=2.14:1

Liquid assets

=Current assets- Inventories

=2553187000-113709000

=RM2439478000

Current liabilities

=RM1807550000

=1.35:1

Ratio with formula

(Asset Management of Company)

Calculation for 1st company

(Gamuda Berhad)

Calculation for 2nd company

(WCT Berhad)

Inventory Turnover=

Cost of goods sold=1580125000+363348000+8595000+19973000+19260000+40866000

=RM2032167000

Closing inventories or stock

=RM79738000

=25.49 times

Cost of goods sold

=RM4311943000

Closing inventories or stock

=RM113709000

=37.92 times

Total Assets Turnover=

Net sales value

=sales – return inwards

=2455143000-0

=RM2455143000

Total assets

=total non-current assets + total current assets

=2347737000+4203173000

=RM6550910000

=0.37 times

Net sales value

=sales – return inwards

=4666602000-0

=RM4666602000

Total assets

=total non-current assets + total current assets

=RM1925297000+RM2553187000

=RM4478484000

=1.04 times

Debtor Ratio=

Debtor or receivables

=RM1607772000

Credit sales

=RM2455143000

=0.65:1

Debtor or receivables

=1206971000+265684000

=RM1472655000

Credit sales

=RM4666602000

=0.32:1

Day Sales Outstanding=

Debtor or receivables

=RM1607772000

Credit sales

=RM2455143000

=237.25 days OR

=0.65-365days=237.25 days

Debtor or receivables

=1206971000+265684000

=RM1472655000

Credit sales=RM4666602000

=116.8 days or

=0.32-365days=116.8 days

Ratio with formula

(Debts Managements of company)

Calculation for 1st company

(Gamuda Berhad)

Calculation for 2nd company

(WCT Berhad)

Debts Ratio=

Total debts

=total non-current liabilities + current liabilities

=1312946000+1930241000

=RM3243187000

Total assets

=total non-current assets + total current assets

=2347737000+4203173000

=RM6550910000

=0.50:1

Total debts

=total non-current liabilities +current liabilities

=1183958000+1807550000

=RM2991508000

Total assets

=total non-current assets + total current assets

=1925297000+2553187000

=RM4478484000

=0.67:1

Debts Equity Ratio=

Total debts

=total non-current liabilities + current liabilities

=1312946000+1930241000

=RM3243187000

Common equity

=Ordinary share capital + Reserves

=2025888000+1231637000

=RM3257525000

=1:1

Total debts

=total non-current liabilities +current liabilities

=1183958000+1807550000

=RM2991508000

Common equity

=Ordinary share capital + Reserves + Share premium

=388856000+369256000+492134000

=RM1250246000

=2.39:1

Times Interest Earned Or Interest Cover=

Operating profit before interest and taxation

=RM259852000

Interest charge or cost

=RM43813000

=5.93 times

Operating profit before interest and taxation

=RM244145000

Interest charge or cost

=RM50308000

=4.85 times

Ratio with formula

(Market Value of Investment to Stockholders of Company)

Calculation for 1st company

(Gamuda Berhad)

Calculation for 2nd company

(WCT Berhad)

Earnings Per Share=

Net income available to common stockholders

=RM280693000

Number of ordinary shares issue or ordinary share capital

=2025888000 shares

=RM 0.14

Net income available to common stockholders

=RM147098000

Number of ordinary shares issue or ordinary share capital=388856÷RM0.50=777712 shares

=RM0.19

Price Earnings Ratio=

Market price per ordinary share=RM3.20

Earnings per share=RM0.14

=22.86 times

Market per ordinary share=RM2.60

Earnings per share=RM0.19

=13.68 times

Earnings Yield=

Gross earnings per share

=100÷75 – Rm0.14

=0.187

Market price per ordinary share=RM3.20

=5.83%

Gross earnings per share

=100÷75-RM0.19

=0.253

Market price per ordinary share=RM2.60

=9.74%

Market Price Per Book Value=

Market price per ordinary share=RM3.20

Net book value per ordinary share

=Common equity / ordinary share in issue

= Common equity

=Ordinary share capital + Reserves

=2025888000+1231637000

=RM3257525000

Number of ordinary shares issue or ordinary share capital

=2025888000 shares

==Rm1.61

=

=1.99:1

Market price per ordinary share=RM2.60

Net book value per ordinary share

=common equity / ordinary share in issue

Common equity

=Ordinary share capital + Reserves + Share premium

=388856000+369256000+492134000

=RM1250246000

Number of ordinary shares issue or ordinary share capital

=388856÷RM0.50=777712 shares

==RM1.61

=

=1.61:1

Profitability of company:

Gross profit markup, Gross profit margin, Operating profit margin, Basic earning power, and return on total asset of Gamuda Berhad is higher than the second company that is WCT Berhad. This indicates that the company was effective in controlling the expenditures. Besides that, for Basic earning power and Return on common equity, the first company is lower than the second company. This is because the ineffective use of assets and capital employed in business activities are at higher costs to reduce the production volume and sales volume.

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Liquidity of company

The current ratio and the Acid test ratio for the companies Gamuda Berhad is higher than the second company WCT Berhad because the has the Gamuda Berhad highest amount of current assets and also highest amount of liquid assets that can be used to finance its current liabilities so that the company has highest liquidity to finance its short-term liabilities and also got chances to face short-term liabilities financial problem.

Asset Management of company

The inventory turnover for the Gamuda Berhad is much lower than the WCT Berhad because Gamuda has a slow stock turnover in the business which kept in store was very slowly taken out for resale, resulting large amount of stock accumulated to tie up money, which were having poor inventory management. For total assets turnover, the first company is low than the WCT because the Gamuda has a lowest sales from the assets indicating that company was inefficiently using the assets in business. On top of that, debtor ratio and day sales outstanding of the first company is higher than the WCT because the company got longer credit time to collect money slowly from debtors so that the balance is collected to tie up money and thus, having poor management on debtor collection.

Debts Management

The debts ratio for the Gamuda is less than the second company because the Gamuda got lower debts burden with smaller amount of debts and also bearing low interest cost to the available profit. Therefore, times interest earned for the Gamunda is much higher than the WCT because it has a bearing high interest charges to the available profit.

Market value of investment to stockholders

Earnings per share and earnings yield for the Gamuda is less than the WCT which indicates that the company has less growth in business profit , resulting lower net income available to each unit share , being less attractive and lower value to the common stockholders. Due to lower earnings per share, stockholders have to use more times of profit earning, more times of net cash inflow and a longer period to recover back their share investment. Besides, the price earnings ratio for the Gamuda is higher than the WCT. Market price per book value for the Gamuda is higher than the WCT that shows the company share price has inequitably risen up above its real asset value or book value for not being realistic to the stockholders.

Conclusion

As a conclusion, I will like to choose WCT Berhad because this company has a better performance in the business and here are some goods points of this company. On top of that, the WCT berhad company also have the highest Basic earning power and Return on common equity which is meant to increase the production volume and sales volume at lower costs as well as to increase the profit earning. Other than that, WCT berhad also has the is highest Inventory turnover which indicates a fast stock turnover where the goods purchased kept in store are fast taken out for resale so that the stock is not accumulated and money is not tied up with stock. Thus, the WCT berhad company did not face any short-term liabilities, and they are stable. The different firms using different financial policies which are also the comparison problems in inter firm.

Question 2

Definition

Financial markets are an organization for the people who are shortcoming of money and want to borrow money. Besides that, each financial market has different ways of financial methods in terms of its maturity and the asset backing it. Different financial markets have different ways of serving customers and operate different types the country. Financial markets dissent from physical asset markets because it is called tangible asset markets or real asset markets to deal with the tangible and physical manufacture such as machinery, computer and other physical assets.

Physical asset market and financial market can also work as the future or spot market. Future market defines as the deals being sold for on the future delivery at some future date such as a year into the future whereas the spot market is define as the deals is being bought on the spot delivery within a few days. There are many types of various in financial market for an example such as money markets, capital markets, mortgage markets, consumer credit markets, primary markets, secondary markets, initial public offering (IPO) market and last but not least private market. 

Money markets:

Money market is a market dealing with short-term financial methods. Money market methods are include bankers acceptance, commercial paper, federal funds, treasury bills, and highly liquid debt securities which funds are loaned or borrowed for a short periods of less than one year. Money market is a segment of the financial market in which financial instruments with high liquidity and very short maturities are traded. The money market is used by participants as a means for borrowing and lending in the short term, from several days to just under a year. Money markets do not have a fixed physical location. A money market fund is also called a mutual fund that empower in money market securities.

Capital markets:

Financial market that works as a conduit for demand and supply of primarily long term debt and equity capital. It channels the money provided by savers and depository institutions banks, credit unions, and insurance companies to the borrowers and investors through a variety of financial instruments called securities. It transports the money that is provided by depository institution and savers to invest or borrow through choices of financial methods called securities. Capital market also runs as an interchange for trading existing that request on capital in the form of shares or stock.

Mortgage markets:

A market for loans to people and organizations buying property a market for mortgages those has been bought by financial institutions and are then traded as asset backed securities. This arrangement will sum up the transaction in commercial mortgage, multi-family residential mortgage, home mortgage and farm mortgage. The holders of mortgage including the lenders that both originate the investment and change them as assets, such as thrift institution, commercial banks and insurance companies as well as those institutions that gets the loans in the secondary market. 

Consumer credit markets:

Consumer credit market is about a borrower uses any line of credit or loan to purchase goods services at the retail level. The cost of credit is the additional amount, over and above the amount borrowed, that the borrower has to pay. It includes interest, arrangement fees and any other charges. Consistently, consumer credit finances can be use at any asset that it will minimize quickly and it is not use for investment purpose. Loans for education, vacation or cars are also examples of consumer credit. However, consumer credit does not include loans that are for real estate.

Primary markets:

Primary market consists of the first buyers and issuer of the issues. Investors who buy shares in a new security issue meant they are buying from the primary market. Besides that, investors who purchase bonds and stocks in the primary market normally are not refundable commissions because the fees for selling the issue are built into its price and collected by the issue.

Secondary markets:

This market in which the existing and already purchases a security or other financial assets are able to trade among the investors after they have been issued by the institutions or corporation. Secondary markets is a market which investor buys a security from another investor rather than the issuer, the consequences to the original issue in the primary market is also called as aftermarket. 

Initial public offering (IPO) market:

IPO is the first sale of stock to a company. Furthermore, the most common reason is by offering securities or shares to the public for the first time. The most difficult part of an IPO is to find out the proper price to initially proffer the new stock. If the price is too high, the buyers will not be interested but if it’s too low, the company will sacrifice a lot of money that might have been made if others are higher.

Private market:

Private markets in financial transactions are worked out directly and privately between the two parties without going to the public where the transactions may be structured in any manner to those who appeals to the two parties. The three different ways for transferring capital or fund from savers to borrowers in the financial market are direct transfer from savers to borrowers, indirect transfer from savers to borrowers through investment banking house and indirect transfer from savers to borrowers through a financial intermediary.

Direct transfer from savers to borrowers:

Direct transfer takes place when an organization issues and sells its stock or shares immediately to the savers without passing through any other financial institution so that the organization as borrower immediately delivers its securities to the saver who in turn gives money to the organization. By this, the fund or capital is immediately transferred from savers to the organization or borrower.

Issue corporation’s securities to

Business Corporation —————————————-ƒ  Savers

(Borrower)  ƒŸ————————————— (Money Lender)

          Receive capital of fund from

Indirect transfer from savers to borrowers through investment banking house:

This takes place when investment underwrites the issuance of a cooperation’s securities and where the contributors bank serves as a middleman to facilitate the issuance by buying the securities of the organization and then resell the same securities of the organization to the savers so that the money paid by the savers for buying of organization’s securities are passed by the investment bank and will be received by the organization which acts as borrower.

Issue Corporation’s Resell corporations

Securities to Securities to

Business ———————–ƒ  Investment€  ————————-ƒ € Savers (Money

CorporationƒŸ———————— Banking House ƒŸ———————— Lender)

Receive fund from Receive fund from

Indirect transfer from savers to borrowers through a financial intermediary:

This takes place when a financial intermediary also know as a bank or a mutual fund that is obtain fund that are from the savers and by issuing its own certificate or securities of deposit to the savers. Then, the financial intermediary uses the fund that is collected from the savers to buy and to hold the securities of other company as contributors. In this case, the fund or the capital is transferred from the saver to financial intermediary when the saver has pay the money to the financial intermediary in interchange for receiving a certificate if securities or deposit issued by the financial intermediary. Therefore, the financial intermediaries will incredibly increase the efficiency of money and capital markets. This is shown in the following diagram:

                      Issue corporation’s securities to Issue intermediary’s own securities to

Business Corporation ——————-ƒ € Financial intermediary ————————–ƒ Savers

(Borrow) ƒŸ——————–                                 ƒŸ————————– (Money Lender)

       Receive fund from                                           Receive fund from

Investment banking house:

The investment banking house runs by buying all the new security issue from a company or organization at one price and selling the issue with a smaller unit to the investing public at a inadequate high price to cover the expenses of sale and earn a profit. The company or corporation that distributes and underwrites the new issue of business organization’s securities to assist the organization to collect fund for financing. 

Financial intermediaries:

Since the financial intermediaries are usually very large and they have gain economies of scale in analyzing the creditworthiness of those borrowers potential in collecting and processing loans. There are many type or various in financial intermediaries and those are commercial banks, savings and loan associations, mutual savings fund, credit unions, pension funds, life insurance companies and mutual funds.

Commercial banks:

Commercial banks are totally different from investment banks because commercial banks, they lend out money to the borrowers whereas the investment banks, they assist business company to raise fund or capital from the savers.

Savings and loan associations:

Savings and loan associations served residential and commercial mortgage borrowers where they likes to collect money or funds from those small savers and lend out this money to his house buyers or any other types of borrowers.

Mutual savings fund:

Mutual savings fund and savings and loan associations are almost the same process because they also accept savings from individual savers and lend out the money on a long-term basis to his house buyers and consumers. 

Credit unions:

This is a cooperative association which members are supposed to have something in common, so that the association collects funds from members and then lend to other members who need money to finance their house mortgage, house improvement and auto purchases.

Pension funds:

This is a retirement plans that given by the organization or government agencies for their employee  and administered primarily from the life insurance companies or the trust departments of commercial banks.

Life insurance companies:

Life insurance companies collect funds in the term of annual premiums and then invest back in to real estate, bonds, mortgages and shares, after that they will make their payments to the beneficiaries of the insured parties.

Mutual funds:

Mutual funds will collect savings from those savers and then use the savings to buy shares, short-term debt and long-term bonds method