Financial Statement Analysis of the Blackmore Company Finance Essay

A firms earning capability and financial position can be predicted, compared and evaluated with the help of analysis of information available in the major financial statements i.e., balance sheet and income sheet. Balance sheet indicates the firms' financial condition or the state of affairs of the business where as Income sheet reflects earning capacity and financial strength of a firm. To practically implement the knowledge gained so far about these financial statements, and to perform the analysis on a realistic data; the following study has been conducted on the firm Blackmore. Blackmore, being a leading supplier of different products which includes equipment, plastic trays to the horticulture industry; had faced great loses despite of increasing plant capacity and undergoing new market campaigns. This study tries to analyze the financial statements of Blackmore and comment on the changes that could be taken for surviving and establishing itself as a profitable business.

Contents

Introduction

Company's financial information is foundation of financial planning & analysis which is needed to predict, compare and evaluate a firms' earning ability. This financial information is provided in the company's financial statements or accounting reports i.e., balance sheet, income sheet and cash flow statement. Balance sheet and Income sheet are amongst the most significant financial statements, used to determine the financial condition and financial strength of a firm. Balance sheet provides information about assets, liabilities and owners' equity for a business firm as on a specific date. It reflects the financial position of the firm at the close of the firm's accounting period. Income sheet presents summary of revenues, expenses and net income of a firm. It acts a measure of firm's profitability. Financial health of the firm can be judged by proper financial analysis. Financial analysis needs careful relation establishment between different financial statements like balance sheet and the income statements. Relative analysis of items of cash flow statement, income statement & balance sheet gives clear view of financial health of organization.

Blackmore is a leading supplier company of different items like equipments. It had recently increased plant capacity and had undertaken a new market campaign to go national. Despite of these efforts, it had faced great losses in the year 2008 and is concerned about its survival. Faisal, Blackmore's chairman, who is planning to bring back the firm into sound financial position, has appointed Hazza as his assistant. Examining the monthly data and comparing it with the annual data, Hazza found that the lags between spending money and deriving benefits were longer than that of Blackmore's managers had anticipated. Thus, they could see a hope for the company if it could survive in the short run. This study proceeds further, to help Hazza by analyzing the balance and income sheets of the firm and commenting on further proceedings.

Project Discussion

As mentioned above, financial health can be predicted accurately by good financial analysis. There are various tools for performing financial analysis. These include: Ratio Analysis, Time Series Analysis, Cross sectional Analysis, Industry Analysis and Performa Analysis. Now, with the help of relevant tools; let us proceed further towards our study about financial health of Blackmore Company. (Blackman, 1995)

From the balance sheet of the Blackmore Company, the following details can be summarized:

Blackmore's sources of funds include equity as well as debts. The capital employed in the years 2007, 2008 and estimated 2009 values are as follows:

CE 2007: $1,952,352 + 400,000

= $2,352,352

CE 2008: $492,592 + 723,432

= $1,216,024

CE 2009 estimated: $663,768 + 323,432

= $987,200

It is clear from the above that in the year 2008, the firm has gone for larger debt source compared to 2007, and unable to generate the profits, has faced great loses. Estimating a lesser amount in the debt source seems to be a good sign for stabilizing the financial position of the firm.

It is very much necessary for any organization to meet its obligation at earliest. An organization should have enough resources to meet its short term obligation because this plays an important role in success of any organization. Firm's ability to meet its short term obligation can be measured by Liquidity ratios. The most common measures of liquidity are Current Ratio and Quick Ratio. All these ratio measures liquidity of a company but quick ratio use more strict liquidity measure.

Current Ratio:

CR= Current Assets/ Current Liabilities.

It is a measure of the firm's short term solvency.

Quick Ratio:

QR= Current Assets- Inventories/ Current Liabilities.

Inventories are considered to be less liquid and require some time for realizing into cash.

The following table 1 displays the liquidity ratios of Blackmore firm in the years 2007, 2008 and the estimated values for 2009.

2009E

2008

2007

Current Ratio

2.34

1.17

2.33

Quick Ratio

0.84

0.39

0.85

Table 1: Blackmore Company Liquidity Ratios

Ratios in the above table indicates that the year 2008 has shown quite low figures compared to 2007, and the estimation by the experts for 2009 shows a hope for the good performance of the firm. In the year 2008, current and quick ratio being low, and as seen above debt source being larger; they faced great loses. Hazza can proceed with the estimated source, and try achieving the anticipated figures as per the estimated values regarding liquidity.

A firm should have strong both short and long term financial position. Short term financial position is identified by liquidity ratio while financial leverage ratios are used to identify and calculate long term financial position of any organization. Financial Leverage Ratios are calculated as shown in the table 2. The Financial Leverage Ratios include Long term Debt Ratio, Debt - Equity Ratio and Equity ratios. These ratios are calculated based on the below mentioned formulae:

Long term Debt Ratio= Total Long term Debt/ Capital employed

Where Capital employed is the total capital kept in the business from various sources which include debt as well as equity sources of funds.

Debt- Equity Ratio= Total debt/ Net worth

Where Net worth is equivalent total equity and from the given information, total debt is considered as the total long term debt since no other sources were mentioned in the balance sheet of the firm.

Equity ratio = Total Equity or Net Worth/ Capital Employed.

Interest Coverage= EBITDA/ Interest

Where EBITDA is the operating income or the earnings obtained after deducting operating, selling and administrative expenses only.

2009E

2008

2007

Long term Debt Ratio

0.17

0.59

0.33

Debt- Equity Ratio

0.21

1.47

0.49

Equity Ratio

0.83

0.41

0.67

Interest coverage

4.78

-0.11

8.71

Table 2: Blackmore Company Leverage Ratios

Observing the debt equity ratio, the estimated figure is quite satisfactory to maintain a good financial health. In the year 2008, the value of 1.47 of debt- equity ratio indicates that creditors have got a greater claim than owners, which implies a certain amount would be at a risk to be paid to the creditors and company in case of not reaching the estimated profits would have to face great loses as in this case. Interest Coverage ratio which helps in testing the firms' debt servicing capacity; obviously because of loss in earnings would be less and negative for the year 2008 where as the firm is sound in the year 2007 with the ratio equals to 4.71 and well performing for the estimated value for the year 2009.

The above discussed ratios are static in nature, and might not indicate the firm's ability to meet interest obligations. Interest Coverage ratio, which is computed by dividing earnings before interest and tax by interest charges, determines the firms' debt servicing capacity.

Blackmore Company's interest coverage ratio is as follows: 4.35, -0.96 and 7.03 for the years 2007, 2008 and 2009E. From the income sheet it can be seen that EBIT is negative for the year 2008 due to which the ratio also turned to be negative implying that minimum interest expense could also be not earned by the firm in that year. The 2007 figure is quite appreciable that it has earned 4.35 times the required expense and the estimated figure for 2009 also is sufficient to maintain sound financial position. So, Hezza should take care to reach the estimated EBIT for the year 2009.

Since most of the above ratios and their analysis says that the firm has to run efficiently to reach out the estimated figures for the year 2009 to have a profitable business; we now try to calculate firm's ability to use its assets efficiently which will tell about firm's management's ability of best resource utilization. These can be calculated with the help of Activity or turn over ratios. The following table 3 displays the firms' activity ratios which are calculated as explained below:

Current Assets turnover Ratio= Sales/ Current assets. (Financial Ratios )

The other turnover ratios can be similarly calculated replacing the denominator with the corresponding value. These ratios as explained above would help in evaluating the efficiency of the firm in the application of funds.

2009E

2008

2007

Current Assets turnover

2.63

3.13

3.05

Net Current Assets turnover

4.58

21.84

5.34

Fixed Assets turnover

8.61

6.42

9.95

Total assets turnover

2.01

2.10

2.34

Net Assets turnover

2.99

4.96

3.48

Table 3: Blackmore Company's Turnover Ratios

The above values in the table imply that a sale of Rs. 2. 63 can be generated from the capital employed of Rs. 1 on current assets in the year 2009E. In other words to generate a sale of Rs. 1 in the year 2009, the firm needs to invest Rs. 0.38 investment in current assets and Rs. 0.12 in fixed assets. But these ratios alone cannot reflect the efficiency of the firm, since it depends on the liabilities as well. For example, in the year 2008, though it is seen that the turn over ratios of all the assets except for fixed assets are high; still it is said that the firm faced great loses. This is because the firm has invested remaining percentage through debts and hence has faced great loss irrespective of the high turnover ratios. Having a optimal ratio of debt to equity in the year 2009, the efficiency of the firm is satisfactory and should be maintained as per the estimation.

Further the firms' earning power can be determined with the help of profitability ratios. DuPont Analysis helps in evaluating this. These profitability ratios can be determined with respect to sales or investment. The following table 4 shows the Blackmore Company's analysis of earning power.

Gross Margin = Gross Profit/ Sales

Where gross profit equals to sales reduced by the selling and administrative expenses.

ROE/ Return on Equity = Profit after Tax/ Net Worth

Where profit after tax is EBIT reduced by the interest expense and tax deduction.

2009E

2008

2007

Net Assets turnover

2.99

4.96

3.48

Gross Margin

0.16

0.08

0.17

Operating Leverage

0.42

-0.26

0.34

Return on Net Assets

0.21

-0.11

0.19

Return on Equity

0.13

-0.33

0.13

Table 4: Blackmore Company's Analysis of Earning Power

Looking at the Gross Profit margin, we can see that cost of goods and sold has increased in the year 2008 which has given a significant impact in reducing the gross profit. Further the operating and administrative expenses have also increased and thus landed up with negative EBIT. The operating and administrative expenses occurred in the year 2008, could not generate profits to maintain financial position. But looking at the estimated figures, the profits are seen in the next year and were sufficient and satisfactory as discussed above with the help of various ratios. Thus as well found by Hazza, it is that the lags between spending money and deriving benefits were longer than Blackmore's managers had anticipated, could be the major problem as discussed above. So the management has to concentrate more on the current asset turnover and concentrate its investment accordingly to see the benefits and bring sound financial position back in the firm. Since the estimated values generate good profit and as found above, those figures would be leading to an efficient firm. Thus, they have to concentrate on achieving these figures. As well estimated, debt source can be reduced and large amount can be invested on current assets, to derive benefits and run the firm successfully. (Helfert, 2002)

Conclusion:

Thus, from the above study and analysis of various ratios it is clear that the firm is growing compared to year 2008. The reasons behind the loses faced in the year 2008 could be that it has financed high amount through debt, decreased the amount of retained earnings and utilized these amount into increasing the plant capacity and in marketing campaigns. These don't give an immediate impact, thus added up to the expenses without having any immediate positive profits. This could not be anticipated by the firm, which led to great loses in the year 2008. The benefits could have started affecting the market which led to good estimation of sales without any extra expenses leading to profits. Thus, in future the firm should take care while investing in such expenses keeping in mind the estimation of earnings that would be made in that particular year and anticipating the lags between the investments made & benefits that would be obtained. Since as discussed above, overall the firms' financial position would be sound and healthy if it achieves the estimated targets for the year 2009, it should be trying to achieve the same while taking care of above mentioned points. Hazza should concentrate more on achieving the estimated values for the future and should be more careful while investing in such marketing campaigns looking into the impact period. Overall, by the end of the year 2009, Blackmore would be able to sound and healthy financially.

Recommendations:

This study would have been more effective, if the cash flow statement and the cost of goods sheet were provided. Also since the company is broad in its products, it would have been more effective if the nature of marketing campaign undertaken is also mentioned to assess its impact on the customers. Overall, the given data is sufficient to analyze the firms' financial position and to comment on the issues required.

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