Concept of Financial Statements
Financial statement refers to a formal financial record of a company including aspects like balance sheet, income statement, equity statement, cash flow statement and more. According to Lewellen and Lewellen (2016), financial statement can be applied to provide data regarding financial position changes and performances of an organization in order to make economic decisions. This implies that financial statement is relevant to measure financial position of a company that deeply relies on company assets, income and liabilities.
Trading and profit and loss account are applied in financial analysis to show income that has been generated from sales and also direct costs of those sales. This includes stock balance as observed at the beginning and at the end of year. According to Weber (2018), balance sheet is used to report a list of organizational liabilities, assets and owner's equity as observed in a given period of time. Cash flows help in providing a sum of money that has been transferred into or from the company. Statement of changes in equity is utilized to explain the shifts in share capital of a company. Finally, fund flow statement helps in disclosing analytical information regarding different funding sources to understand the changing transactions.
Background of Company
Wolseley has a proud and rich history which was founded in 1887 by Frederick York Wolseley in UK. Wolseley is the world largest distributor of heating products and plumbing and is also the supplier of building materials and is also the leading supplier in the world. Wolseley is the subsidiary of Ferguson plc and they have expertise professionals in field of construction (wolseley.co.uk, 2018).
Wolseley is the market leader with good reputations in the construction business. Company undergoes large-scale investment is in procuring software for supply chain and in information technology. It also invests on its employees to give proper training to its employees to develop, efficiency and skills of its employees and also rewards them with awards and pensions.
Similarly, Admiral Organization is one of the top three insurance providers of car in UK launched in 1990 by Henry Engelhardt. Company operates in a number of popular brands such as Admiral insurance, diamond insurance, gladiator for especially commercially vehicles (admiralorganization.co.uk, 2018). They are the fast-growing and profitable financial services corporation with almost operations in eight countries. They have almost 6 organization customers throughout the world and continuously launching new products and brands in UK and also overseas.
Cost behavior and forecasting
According to Lewellen and Lewellen (2016, p. 1135), cost behavior provides an understanding how operating cost changes to a change in the level of organizational activities. Wolseley operating cost in 2015 was 3172 million dollars and in 2016 it was 3312 million dollars and in 2017 it was 3184 million dollars which refer that the company variable cost increases in the year 2016 and 2017 compared to 2015 variable cost keeping fixed same. This implies that in 2016 and in 2017 the company profit has been increased as compared to 2015. [Refer to Appendix 1, 2]
In comparison, the total operating cost of Admiral in the year 2015 was 548 million dollars and in 2016 was 648.8 million dollars. In 2017 it recorded a staggering 753.5 million dollars. This means that the variable cost of the company in the year 2016 and 2017 has been increased keeping the fixed cost constant. This means that in the year 2016 and 2017 the company has earned more profit as compared to 2015. [Refer to appendix 4, 5]. In comparison among the two companies, Wolseley has earned more profit than Admiral Group in all the three years.
Ratio analysis and market reactions
Ratio analysis is the quick analysis of the firm financial position such as its liquidity, solvency, profitability and its efficiency
Analysis of company performance
The noncurrent assets of Wolseley in the year 2015 was 2559 million dollars which were increased to 2920 million dollars and its current assets in the year 2015 was 4772 million dollars which imply that company has a low proportions of noncurrent assets to current assets. It is an indicator of high liquidity, and no amount of investment will be required in noncurrent assets in the upcoming years. In the year 2016 Wolseley noncurrent assets were 2920 million dollars and current was 5175 million dollars which means the proportion of current assets is high as compared to noncurrent assets. It is an indicator of high liquidity and the company is not required to invest any amount in noncurrent assets in the upcoming year. In 2017 the noncurrent assets of Wolseley were 2378 organization dollar and the current assets were 5827 million dollars which also implies that the company has high liquidity and there is no risk which is associated with noncurrent assets.
According to Weber (2018, p.486), total liabilities of a company can be divided into three parts such as long terms, short-term and other liabilities. Wolseley total liabilities in 2015, 2016, and in 2017 was 4875, 5250, 6067 million dollars respectively. This implies that the current liabilities were increased in the year 2016 and 2017. This is definitely not a good sign for the company because its credit payment has been increased. Its outstanding liabilities, bank loans, provisions, deferred tax liabilities, other payables also increased as compared to 2015. This is the amount which company has to pay. The profit after tax of Wolseley in the year 2015, 2016, 2017, was 321, 496, 888 million dollars which imply that the company is utilizing its assets properly, and the company is also utilizing its financial resources properly without wasting its resources to earn high profits. [Refer to appendix 1, 2]
In comparison with the Wolseley organization, Admiral organization total noncurrent assets in the year 2015, 2016, 2017 was 3400, 3749.3, 4526.4 million dollars and its total current assets in the year 2015, 2016, 2017 was 4202.4, 4860.8, 589.1 which implies that in all the three years admiral organization has a high proportion of current assets to noncurrent assets which means the company has a high liquidity and there is no risk associated with noncurrent assets. Admiral organization net profit after tax in the year 2015, 2016, 2017 was 291.8, 214.1, 331.6 million dollars which implies that the company net profit after tax was increased in the year 2016 as compared to 2015 by 77.7 million dollars that means in the year 2016 company does not utilize its assets properly and also its total liabilities get increased in all the three years. [Refer to appendix 4,5]. However, from the above analysis, Wolseley has larger proportion of noncurrent assets than Admiral group of companies.
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Analysis of income statement
In words of Barberis (2015, p.1), income statement depicts the expenses, net income, revenue generated by the company over a particular period. The gross profit margin of Wolseley in the years 2015, 2016, 2017 was 27.96%, 28.27%, 28.95% respectively. The net profit margin Wolseley for the year 2015, 2016, and 2017 was 1.60%, 4.50%, 5.14% as follows. Similarly, revenue growth in 2015, 2016, and 2017 as compared to previous year growth was 8.65%, 8.23%, and 5.50%. The gross profit margin and net profit margin has increased constantly in all the three years while the revenue has been decreased in all the three years as compared to their previous years. [Refer to appendix 1, 2]. The company is not performing as per its expectation.
In comparison, the gross profit margin of Admiral Organization in the year 2015, 2016, and 2017 was 74.97%, 61.19%, 69.25%. The net profit margin of Admiral Organization in the year 2015, 2016, and 2017 was 32.15%, 23.71%, 7.93%. Revenue growth in the year 2015, 2016, 2017 as compared to their previous year are 2.28%, 12.37%, and 11.024%. The gross profit margin, net profit margin has been declined as compared to their previous year but the revenue has shown a high growth rate in the year 2016 as compared to 2015 and in the year 2017 it has declined by 1.346%. [Refer to appendix 4, 5]. In this analysis however, Admiral Group has higher gross profit margin than Wolseley in all the three years.
Use of management accounting in decision making
According to Aazam and Huh (2015, p.687), management accounting identifies, analyze, measure, interpret and communicate information for the success of organizational goals. Wolseley can improve its financial decision by applying management accounting so that the company can take important decision to improve the financial position of the company and will also ascertain the managers of Wolseley to formulate the policies of the business. In comparison, Admiral Organization uses management accounting as an important decision-making tool for the company and slots to control and monitor the performance of the policies implemented. In words of KUEHN et al. (2017, p.2131) managerial accounting gives detailed segment reports of the company and is also flexible in comparison to financial accounting.
Descriptions of traditional approaches of analyzing methods- [corporate financial statements –ratios
According to Petruzzo (2015, p. 2213), traditional approaches to analyzing financial statements analyze the financial data by applying traditional tools such as intra firm comparison, inter-firm comparison percentage, accounting ratios. It also includes vertical comparison and horizontal comparison of financial statements of the firm. According to Sujan (2017, p. 2404), vertical analysis compare the same line of items in the financial statements of the company The vertical analysis of total current assets Wolseley financial statements for the year 2015, 2016, 2017 are;
2015 Total current assets in 2015 were 4722 million dollars, Inventory: 35.74% (1688/ 4722*100 organization dollar) Trade receivables: 35.74% (1646/4722*100 million dollars) Other receivables: 5.69% (269/4722*100 million dollars) Current tax receivables: .084% (4/4722*100 million dollars) Cash and cash equivalents: 23.40% (1105/4722*100 million dollars)
2016 Total current assets in 2016 were 5175 million dollars, Inventory: 38.97% (2017/5175*100 million dollars) Trade receivables: 36.59% (1894/5175*100 million dollars) Other receivables: 6.04% (313/5175*100 million dollars) Current tax receivables: Nil Cash and cash equivalents: .019% (940/5175*100 million dollars)
2017 Total current assets in 2017 were 5827 million dollars, Inventory: 31.16 (1816/5827*100 million dollars) Trade receivables: 30.39% (1771/5827*100 million dollars) Other receivables: 5.525% (322/5827*100 million dollars) Current tax receivables: .137% (2/5827*100 million dollars) Cash and cash equivalents: 32.79% (1911/5827*100 million dollars) [Refer to appendix 1, 2, 3]
As compared to Wolseley, vertical analysis of Admiral Organization of current assets for the year 2015, 2016, 2017 are
2015 Total current was 802.4 million dollars, Trade and other receivables: 66.94% (537.1/802.4*100 million dollars) Cash and cash equivalents: 33.06% (265.3/802.4*100 million dollars)
2016 Total current was 1111.5 million dollars, Trade and other receivables: 70.62% (784.9/1111.5*100 million dollars) Cash and cash equivalents: 29.38% (326.6/1111.5*100 million dollars)
2017 Total current was 5859.1 million dollars, Trade and other receivables: 17.16% (1005.9/5859.1*100 million dollars) Cash and cash equivalents: 55.47% (326.8/589.1*100 million dollars) [Refer to appendix 4, 5, 6]
Critical assessment of methods of analyzing
Both the company can adapt the technique to analyze the financial statement so that they can present to the stakeholders of the company on the annual meeting of the company. According to Xu (2014, p. 59), the tools or techniques are fund flow analysis, cash flow analysis, ratio analysis, comparative statement, statement in changes of working capital, cost volume profit analysis method.
Identifying performance indicators (financial risk and operating risk)
According to Sujan (2017, p. 2404) Financial indicators measures and track the progress of the company performance in essential area of the financial statements. The operating cash flow of Wolseley in the year 2015, 2016, 2017 are 684,787 and 752 which implies that in 2016 the operating cash flow sufficient cash for the business and in 2017 the operating cash flow was reduced by 35 million dollars as compared to 2016 which means that the company has not generated sufficient cash for the year 2017 to expand the business. The current ratio for Wolseley for the year 2015, 2016 and 2017 was; Current ratio = current assets/current liabilities
2015 Current ratio = 4722/3431*100 = 137.62% 2016
Current ratio = 5175/3537*100 = 146.31% 2017
Current ratio = 5827/4086*100 = 142.60% The company's current ratio was 146.31% in the year 2016 which means that the company has 1.46 times the current assets to meet its current liabilities. In the year 2017, the company's current ratio was 142.60% which means that the company has 1.426 times the current assets to meets its current liabilities. [Refer to appendix 1, 2, and 3]
As compared to Wolseley, the current ratio for Admiral Organization for the year 2015, 2016, 2017 are:
2015 Current ratio = 802.4/1050.6*100 = 76.37%
2016 Current ratio = 1111.5/1305.6*100 = 85.13%
2017 Current ratio = 1332.7/1665.4*100 = 80.02%
The current ratio of all the year for Admiral Organization below 100% which means that the current assets is not sufficient to meet its current liabilities. [Refer to appendix 4, 5, 6]
Introduction to financial market
According to Xu et al. (2014, p. 59), financial market is a place where both the sellers and buyers participate for trading of bonds, equity, derivatives, and currencies. Financial markets are of two types’ capital market and money markets. Wolseley Company has both equity and bank loan in their capital structure in all the three years which means that Wolseley Company is not an all-equity company. It keeps bank borrowing and also equity share capital in its capital structure to run the business. So, Wolseley Company has to pay both the equity shareholders and bank lenders as dividend and interest from their earning.
As compared to Wolseley, Admiral Organization is an all-equity company as it has been analyzed from its capital structures which mean that Admiral Organization does not want debentures or any kind of debt in its capital structures. Admiral organization is an insurance company of motor car so it does not like to leverage in its capital structure and has to pay only to its equity shareholders.
Pricing model
The role of capital assets pricing model is to describe the relationship between expected return and systematic risk for assets, especially stocks. Wolseley capital structure in all the three years consist of 25% bank loans and 75% equity which means the company has been financed by most of the equity. The company does not rely much on long-term borrowings still they are taking the advantage of tax benefits as debenture or bank loans do not attract tax. However, Admiral Organization takes 100% equity in its capital structure and is not relying upon bank loans or debentures in its capital structures.
Economic value added
Economic value added measure the economic profits of a company based on residual income of the company. Economic value added is the value addition of what shareholders expect from a company. Economic value is an indicator of how profitable the company business is in relation to performance of the business.
Importance of cash flow analysis technique
The significance of this relies on the fact that this helps in attaining cash outflows and inflows. In order to be more specific, this helps in showing the areas where cash entities have been generated and where they have been spent. Direct method of cash flow analysis is highly important as it is capable of revealing payments and cash receipts related to operations of a company (Barberis et al. 2015). On the other hand, indirect method of cash flow analysis is relevant because this makes it easier to assemble the information that is required for this analysis.
Comparison and contrast of contemporary and traditional methods of financial analysis
Both the traditional and contemporary methods of financial analysis are highly applicable for financial analysis of a company. In this regard, it can be said that traditional approach has some amount of faults for which the modern methods had been developed later (Liu et al. 2015). In order to be more specific, it can be mentioned that preparation of contemporary financial analysis methods is simpler and less time consuming than the traditional methods. Moreover, contemporary methods are more useful in analyzing specifications of financial statements such as liquidity position.
Recommendations
It is to be recommended to both the company to use more of debenture in its capital structures as the gearing increases the equity cost. Gearing can help the company to offset the effect of debt so that the weighted average cost of capital remains the same. Both companies should use debenture to take the tax advantage on interest by the government and debenture is also cheap source to use in the capital structure. To maintain the gearing ratio both the company should use both debenture and equity in its capital structure. Wolseley revenue growth margin has declined in all the three years so; Wolseley should use different methods or technique in its strategy to increase the revenue so that the company would be able to meet all its possible obligations. It is to be recommended to Admiral Organization to utilize the current assets in an effective manner. It can help the company to meet its short-term obligations such as payment to creditors, suppliers, and meeting all its other outstanding liabilities.
Conclusion
From the above analysis of both the company financial statements it has been derived that both the company focus only on issuing equity capital and does not like to gear in its capital structure. Both the company invest huge amount in financing activities which gives them high amount of cash inflow from the business. Both the company keeps high amount of cash in hand which is not good for the companies rather they should invest in shares or securities or purchase new assets for the business or invest in modifying products. Keeping idle cash is not good for the company as it will not result in any increase or decrease in profits. Wolseley Company pays dividend every year and Admiral Organization do not declare dividend in all the three years. Wolseley Company should not declare the dividend every year rather it should retain it to invest in the business.