Analysis of Financial Statement

Analysis of Financial Statement

Ratio analysis

Financial statements provide stakeholders with an opportunity to ‘tell the story’ regarding a businesses’ operation (Vandyck 2006). From the financial information provided, it is possible to understand a business’ history such as its strengths and weaknesses (Tracy 2012). However, this requires one to possess effective financial accounting skills. One of the most important skills entails ratio analysis, which entails numerical indicators on how two components of the financial statement correlate (Ahmed 1998). Financial ratios are a source of critical insight, which can be utilised for purposes of performance evaluation, budgeting and making budgeting decisions (Atrill, McLaney & Harvey 2014). Financial ratios provide critical knowledge that investors can use in gauging the performance of a company (Bowhill 2008). There are different categories of financial ratios that investors can use in making investment decisions. The major categories include profitability, liquidity, efficiency, gearing and investment potential ratios (Davies 1999).

The telecommunication industry is one of the most attractive industries that investors should consider investing in. It is estimated that the industry generates approximately US$15 trillion annually. Vodafone Group PLC and BT Group PLC are amongst the largest telecommunication firms that investors should consider investing in, for example by purchasing the companies’ stocks. Using different types of ratios, it is possible for investors to make an informed choice on the company to invest in between BT Group and Vodafone Group as evaluated herein.

Profitability ratios

This category of ratios indicates a firm’s efficiency in utilising its resources (Lee). The rate of return on capital employed [ROCE] or return on investment is one of the profitability ratios that assess a firm’s profitability (Petterson & Fabozzi 1999). Between 2014 and 2015, Vodafone’s ROCE increased from -4% to 2% , which represents a growth by a margin of 6% while that of BT Group’s increased from 12.6% to 12.8%, which represents a marginal growth by 0.2%. Thukaram (2011) asserts that the ideal ROCE should be above 15%. Thus, Vodafone has a high level of productivity compared to BT Group, which indicates that it has a higher productivity. The rate of return on equity [ROE] depicts the proportion of a firm’s profit available to equity shareholders in relation to the amount of capital invested. BT Group rate of ROE in 2014 and 2015 was -340.9% and 264.2% respectively, which represents a substantial growth. On the other hand, Vodafone’s rate of ROE for the two years amounted to 9% and 83% respectively. Therefore, BT Group experienced a high rate of ROE growth compared to Vodafone, which means that BT Group was more effective in utilising the capital invested to generate profit.

With reference to operating profit margin, Vodafone Group rate increased from -10% in 2014 to 5% in 2015, which represents a growth by 15% margin. Conversely, the operating profit margin of BT Group increased from 17.2% to 19.4%, which represents a growth by 2.2%. Thus, Vodafone was more effective in managing operating costs and expenses in generating profit between 2014 and 2015 compared to BT Group.

With reference to gross profit margin, Vodafone’s rate remained unchanged at 27% during the two years under consideration while BT Group did not report any gross profit margin, which is in line with the company’s policy not to declare gross profit.

Liquidity ratio

These ratios depict a firm’s short-term financial position (Finkler & Ward 1999). The current ratio and quick ratio are some of the major liquidity ratios used to evaluate a businesses’ short-term financial position. An analysis of BT Group and Vodafone Group shows that the two companies had significant variations with regard to their current ration during the period under consideration.  Vodafone’s current ratio for 2014 and 2015 was 0.99 and 0.69 respectively. This shows that Vodafone’s current ratio declined significantly by 0.3 points between 2014 and 2015. On the other hand, the current ratio for BT Group during the same period amounted to 0.74 and 0.97 respectively, which also indicates a marginal improvement by 0.23 points. The current ratio for the two companies is within the ideal current ratio of 1:1. On the basis of the current ratio, both Vodafone and BT Group have adequate working capital. However, that of Vodafone Group during its 2014/2015 financial year was relatively weaker compared to that of BT Group. Therefore, BT Group has a stronger liquidity position.

With reference to quick ratio, Vodafone’s quick ratio for 2014 and 2015 financial years was 0.97 and 0.67 respectively while that of BT Group was 0.73 and 0.96 respectively. This shows that Vodafone had a weaker liquidity performance during the two years compared to BT Group whose quick ratio grew by a margin of 0.23 points while that of Vodafone declined by 0.3 points. Despite the fact that the quick ratios for the two companies is within the acceptable level of 1:1 (Harris & Hazzard 2009) BT Group has stronger performance.

Efficiency in use of assets

The efficiency of the two companies can be analysed on the basis of inventory turnover ratio (Leach 2010). The table below shows the inventory turnover of BT Group and Vodafone Company respectively between 2014 and 2015.

Table 1

Table 1 above shows that BT Group has a relatively high rate of inventory turnover compared to Vodafone Group, which indicates that Vodafone is less efficient in making sales compared to BT Group (Shim & Siegel 2001). With reference to debt collection, BT Group debt collection period increased from 27 to 30 days while that of Vodafone declined from 35 to 34 days. Despite the slight improvement at Vodafone, BT Group is more efficient in collecting debt compared to Vodafone.

Table 2; comparison of debt collection days

The two companies further differ significantly with reference to the period taken to pay creditors as illustrated by table 3 below.

Table 3: Comparison of the companies’ payables days

The table shows that Vodafone experienced an improvement in the duration taken to pay creditors from 62 to 60 days while that of BT Group declined from 66 to 71 days.  Therefore, Vodafone is more efficient in paying its creditors compared to BT Group.

Solvency/ gearing ratio

This ratio is used to determine a firm’s capacity to meet its long-term debt obligations (Wagner 2003). According to table 4 below, BT Group experienced a 7% improvement in its capital gearing ratio while that of Vodafone Group declined from 26% to 28%. This shows that BT’s dependence on credit capital to finance its operations declined in 2015 compared to 2014. Therefore, the firm depended on equity capital as opposed to credit finance as opposed to Vodafone which experienced an increase in its dependence of debt finance (Gibson 2009).

Table 4

With reference to interest cover ratio or times interest earned, BT has a high interest coverage ratio compared to Vodafone as illustrated by table 5 below. According to table 5, Vodafone experienced a significant growth in the rate of its interest coverage between 2014 and 2015 compared to BT Group.  This shows that BT Group has a relatively high level of profit that improves its effectiveness in covering interest expense (Atrill, McLaney & Harvey 2014).

Table 5: interest coverage rate

Investment potential

The attractiveness of a company can be evaluated by determining its dividend yield ratio, which assesses a company’s ability to offer investors dividends as earnings. Between 2014 and 2015, Vodafone’s dividend earnings ratio declined from 68% to 5% while that of BT Group remained constant at 2.9%. This indicates that BT Group is more effective in generating dividend earnings. On the basis of the analysis conducted, investing in BT Group is more viable compared to investing in Vodafone Group.

References

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Gibson, C 2009, Financial reporting and analysis; using financial accounting information, Cengage, Mason, OH.

Harris, P & Hazzard, P 2009, Managerial accounting in the hospitality industry, Nelson Thornes, London.

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Vandyck, C 2006, Financial ratio analysis; a handy guidebook, Trafford Publishing, London.

Wagner, M 2003, How does it pay to be green, Tectum-Verlag, Marbug.