Report on Redding Co. or Neaves Co. as an investment choice for potential investors

This report analyzes the financial ratios of Redding Co. and Neaves Co. to help potential investors make an informed decision. It discusses the significance of ratios pertaining to profitability, efficiency, liquidity, gearing, and investors. The report also evaluates the limitations of financial ratios and suggests the need for non-financial measures of performance. Additionally, it explains the usefulness of agency theory in the context of listed companies.

Running Head: Report on Redding Co. or Neaves Co. as an investment choice for potential investors
Report on Redding Co. or Neaves Co. as an investment choice for potential investors
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Report on Redding Co. or Neaves Co. as an investment choice for potential investors
Section 1: Corporate performance analysis through financial ratios:
(a) Ratios pertaining to profitability: The significance of ratios pertaining to profitability
comes from the ability of these ratios to give an idea of how the absolute amounts of the
profits made by a business stack up vis-à-vis other amounts such as capital employed in the
business or sales effected by the business or the like. Often, the amount of profit alone may
look attractive but only when this amount is related with or linked to another number (such as
capital employed, sales, etc) does the real picture emerge in terms of whether these profits are
sufficient/justifiable or not. While profit is an absolute concept, profitability is a relative
concept.
Here, a comparison of the two companies is presented based on the following two ratios (for
computation of the ratio, please refer Appendix 1).
Net profit margin:
Significance in being considered for analysis and what this ratio measures:
This ratio is significant given that it measures a company’s profit which remains after the
company has met its operating costs.
Comparison between the companies and explanation for the same:
The net profit margins for Redding Co. and for Neaves Co. are respectively 41.02% and
47.90%.
Neaves Co. did a comparatively better job at managing its operating costs so that the
company ends up with a better net profit margin as compared to Redding Co. This is worth
appreciating given that this company is newer and has grown through acquisitions; the
company seems to have done well in ensuring proper control over operating costs.
Return on capital employed:
Significance in being considered for analysis and what this ratio measures:
This ratio is significant in that it reflects the percentage of profits before interest and taxes
that a company's capital employed is able to fetch to the company. Profits before interest are
considered here since this profit figure is of relevance to those expecting interest payments
from the company (debt capital providers) and those expecting dividends from the company
(shareholders).
Comparison between the companies and explanation for the same:
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Report on Redding Co. or Neaves Co. as an investment choice for potential investors
The returns on capital employed for Redding Co. and for Neaves Co. are respectively 27.59%
and 47.41%.
In terms of return on capital employed, Neaves Co. seems to have done way better than
Redding Co. and a part of the reason is Neaves Co.’s management of its operating expenses
besides being able to make better use of capital.
(b) Ratios pertaining to efficiency: The significance of ratios pertaining to efficiency lies in
the fact that each company is accountable to its owners for efficiently managing the company
assets in the pursuit of attaining the ultimate goal of maximization of wealth for the company
owners. Ratios pertaining to efficiency throw light on whether or not the company has
optimally managed its assets, be they current assets or other assets. Thus, how good the
company has been at managing its short-term assets (such as debtors, inventory, etc) and its
long-lived assets is what gets measured through these ratios. Any failure in the optimum
management of these assets will imply inefficiencies which can be a drag on the company’s
profits as well as profitability.
Here, a comparison of the two companies is presented based on the following two ratios (for
computation of the ratio, please refer Appendix 1).
Stock turnover ratio:
Significance in being considered for analysis and what this ratio measures:
This ratio indicates how good or otherwise is the company in terms of turning over its
inventory and converting it into cash. This helps to understand whether or not the company's
inventory is marketable enough to assure adequate liquidity for the company.
Comparison between the companies and explanation for the same:
The stock turnover ratios for Redding Co. and for Neaves Co. are respectively 5.20 times and
8.02 times.
Neaves Co. has a higher stock turnover ratio when compared with Redding Co. This indicates
that Neaves Co. has been much more successful at being able to sell its products and convert
the inventory into cash.
Debtors’ turnover ratio:
Significance in being considered for analysis and what this ratio measures:
This ratio indicates how quickly or otherwise is the company able to convert its debtors into
cash. This helps to understand whether or not the company's collection efforts are
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Report on Redding Co. or Neaves Co. as an investment choice for potential investors
commensurate with the quality of its receivables so that the company is able to ensure the
liquidity of its receivables.
Comparison between the companies and explanation for the same:
The debtors’ turnover ratios for Redding Co. and for Neaves Co. are respectively 3.90 times
and 7.72 times.
Neaves Co. has a better debtors' turnover ratio signaling that its collection efforts are much
more successful than those of Redding Co. In fact, less satisfactory collections performance
of Redding Co. has forced the company into overdrawing from its bank accounts, as is
evident from the company’s statement of financial position.
(c) Ratios pertaining to liquidity: The significance of ratios pertaining to liquidity lies in the
fact that businesses always need to have sufficient amounts of cash or assets that can be
converted into cash if there were a need to meet short-term obligations. Thus, these ratios
measure a company’s ability to maintain the requisite levels of liquidity to pay bills in the
short term. Failure to maintain the required liquidity will compel a business to resort to short-
term borrowings which would have costs attached to the borrowed amounts. These costs
would unnecessarily go on to hurt the company’s profits and profitability.
Here, a comparison of the two companies is presented based on the following two ratios (for
computation of the ratio, please refer Appendix 1).
Current ratio:
Significance in being considered for analysis and what this ratio measures:
This ratio measures the company's ability to pay off its current or short-term obligations by
resorting to its short-term or current assets. This ratio, thus, shows the number of times a
company's current assets are able to cover its current liabilities.
Comparison between the companies and explanation for the same:
The current ratios for Redding Co. and for Neaves Co. are respectively 2.17 and 1.29.
The current ratio of Neaves Co. is lower than that of Redding Co. since Neaves Co. seems to
have been depending much more on utilizing its current liabilities and delaying payments to
the extent possible.
Quick ratio:
Significance in being considered for analysis and what this ratio measures:
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Report on Redding Co. or Neaves Co. as an investment choice for potential investors
This ratio, just as current ratio does, measures the company’s ability to pay of its current or
short-term liabilities but differs from the current ratio as the quick ratio only allows current
assets other than inventory and prepaid expenses to be considered in determining the
company’s ability to meet its short-term liabilities.
Comparison between the companies and explanation for the same:
The quick ratios for Redding Co. and for Neaves Co. are respectively 1.67 and 1.07.
While there was a larger difference between the two companies’ current ratios, there is not
that large a difference between the two companies’ quick ratios. This is attributable to the fact
that for Neaves Co. inventory is just about 17% of its current assets while for Redding Co.
inventory is close to 23% of its current assets. This observation is in line with the fact that
Redding Co.’s inventory turnover ratio was lower than that of Neaves Co.
(d) Ratios pertaining to gearing: Ratios pertaining to gearing gain significance for the fact
that they may help one set of capital providers (holders of ordinary shares) get an idea of
what they can expect from the company once it has fulfilled its obligations towards the other
set of capital providers (those who have either lent funds to the company or hold its
preference shares). Those who have lent funds to the company are effectively its creditors
and have a preferential treatment in getting paid the interest amounts over the shareholders of
the company. A company always has to first meet its obligations in servicing its interest
payments and only then would it be able to pay dividends. Again, for payment of dividends,
the preference shareholders get a preferential treatment and then comes the turn of ordinary
shareholders. Thus, ordinary shareholders are risk takers and while they assume risk (that
they may or may not get paid any dividends), they do have a reasonable expectation that the
company will be able to pay them some dividends. This is why, the more debt a company
assumes, the more concerned the company’s ordinary shareholders would be about their own
investment in the company and about receiving some returns for what they have invested in
the company.
Here, a comparison of the two companies is presented based on the following two ratios (for
computation of the ratio, please refer Appendix 1).
Debt-to-equity ratio:
Significance in being considered for analysis and what this ratio measures:
This ratio indicates how much long-term debt the company has assumed relative to the capital
invested by the shareholders. Ideally, a shareholder would like to see a company assume less
of debt in its capital structure.
Comparison between the companies and explanation for the same:
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Report on Redding Co. or Neaves Co. as an investment choice for potential investors
The debt-to-equity ratios for Redding Co. and for Neaves Co. are respectively 1.40 and 0.83.
While Redding Co. seems to have taken more long-term debt for every dollar of equity,
Neaves Co. has assumed relatively lesser long-term debt for every dollar of equity. Neaves
Co. seems to be having enough cash to finance its operations while this is not the case with
Redding Co.
Interest cover ratio:
Significance in being considered for analysis and what this ratio measures:
This ratio measures how many times a company’s fixed obligations towards interest payment
is covered by its profits before such interest charges. The higher this ratio, the greater is the
ability of the company to service its interest obligations and the more likely the company
would be to be in a position wherein it would be able to provide returns to ordinary
shareholders by way of dividends.
Comparison between the companies and explanation for the same:
The interest cover ratios for Redding Co. and for Neaves Co. are respectively 4.21 times and
17.34 times.
Neaves Co. has a very comfortable interest cover ratio and this means that it is much better
placed to consider giving out dividends to its shareholders after having serviced its interest
charges.
(e) Ratios pertaining to investors: Ratios pertaining to investors are clearly significant in
any case where a potential investor is evaluating a company for its suitability or otherwise as
an investment choice. These ratios measure the success or otherwise of a company in terms of
providing adequate and acceptable returns against the capital of the ordinary shareholders
which is at stake with the company. If a company appears to be weak in terms of ratios which
specifically pertain to investors, no potential investor would want to invest in the company.
Here, a comparison of the two companies is presented based on the following two ratios (for
computation of the ratio, please refer Appendix 1).
Return on equity:
Significance in being considered for analysis and what this ratio measures:
This ratio measures the post-tax earnings as a percentage of the capital of ordinary
shareholders at stake with the company. Post-tax earnings are relevant in computing this ratio
since only these earnings are actually available with the company to pay out as dividends to
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Report on Redding Co. or Neaves Co. as an investment choice for potential investors
ordinary shareholders, if the company were to so decide about paying their dividends. The
higher this ratio, the more impressive will the company be to a potential investor.
Comparison between the companies and explanation for the same:
The return on equity ratios for Redding Co. and for Neaves Co. are respectively 40.50% and
78.96%.
Given the obvious better management of operating costs and assets, Neaves Co. has been able
to ensure a much better return on equity to its ordinary shareholders.
Earnings per share:
Significance in being considered for analysis and what this ratio measures:
This ratio indicates the post-tax earnings that are available for every ordinary share that is
outstanding. The higher this ratio, the more earning each ordinary share of the company is
getting to the investor.
Comparison between the companies and explanation for the same:
The earnings per share for Redding Co. and for Neaves Co. are respectively $2.45 and $2.92.
Neaves Co. has outperformed Redding Co. in terms of fetching the ordinary shareholders
more post-tax earnings for every share held by them.
Evaluation of financial ratios as a tool for assessing performance and further suggestions:
Financial ratios, while helpful in assessing and comparing business performance, do suffer
from their inherent limitations. However, they can be made more meaningful through further
information in addition to the financial information already made available in this instance.
Thus, it is suggested that notes to the annual accounts be made available so that a deeper
analysis can be done to understand the ratios better. Besides, non-financial measures of
performance also must be consulted to better judge a company’s performance.
Section 2: Agency in the context of listed companies and its usefulness in helping the
companies in question attain their objectives:
Agency theory depends on the contractual relationship of an agent with its principal. Agency
theory, thus, states that a company’s owner is the principal who relies on the company’s
agent (the directors and the managers) to operate the company on behalf of the company
owner (principal). In case of listed companies, it is the company’s shareholders who become
the company’s owners. No matter how small their shareholding, these shareholders
individually own a part of the company and collectively own the whole company. Being in
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Report on Redding Co. or Neaves Co. as an investment choice for potential investors
the position of an agent, a director or a manager has a considerable extent of freedom to
exercise while pursuing the objectives laid down by the company’s owner (the principal). The
prime objective, from a financial management perspective, is that the wealth of the
shareholders must get maximized through the operating of the company. Besides, there may
be many other objectives that the companies in question would be desirous of getting
achieved. Since owners of a listed company (i.e. the shareholders) are scattered everywhere,
it is the agents (the directors and managers) who are best placed to take optimal business
decisions and ensure that the objectives of the companies are attained. Thus, the concept of
agency is helpful to listed companies in the attainment of their objectives (so long as the
agents do not misuse the authority given to them).
Section 3: Assessment of how Redding Co. will be impacted if it raises additional loans
to fund the refurbishment:
Redding Co. is already running a bank overdraft which is a short-term liability that it will
eventually need to meet. Besides not-so-impressive asset management, its long-term debt
position has also strained its capacity to service interest charges in a way that will allow it to
consider giving out dividends to the real risk takers – the ordinary shareholders. If Redding
Co. funds its expenditure by resorting to additional loans, the company’s debt-to-equity ratio
will worsen and its interest cover will worsen as well. Both the ordinary shareholders as well
as the new lenders will view the company as being a much riskier bet and will likely demand
greater returns for providing capital to the company. The already existing loan and the fact
that the bank account remains overdrawn will only put into question the company’s ability to
pay off its short-term and long-term obligations. If the company’s ability to settle its creditors
itself is questionable, there is no reason why any potential investor would want to invest in
this company.
Conclusion:
Even though Redding Co. is older than Neaves Co., the latter seems to be a better investment
than the former. One reason could be that Neaves Co. has much better agents in place (i.e.
leading specialists) when compared to the agents (directors from related circles who may not
necessarily be leading specialists) which Redding Co. has put in place. Thus, while Redding
Co. needs to learn a lesson or two in managing its operating costs and assets, Neaves Co.
seems to be an attractive choice available to potential buyers of its ordinary shares.
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Report on Redding Co. or Neaves Co. as an investment choice for potential investors
References:
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Report on Redding Co. or Neaves Co. as an investment choice for potential investors
 Edwards, C. (2003). Fundamentals of Corporate Finance. Available at:
http://highered.mheducation.com/sites/dl/free/0070898669/65177/Chapter17.ppt.
[Accessed: 03 September 2018]
 Freeman, R.E. and Reed, D.L. (1983). Stockholders and Stakeholders: A New
Perspective on Corporate Governance. California Management Review. Available at:
http://journals.sagepub.com/doi/10.2307/41165018 [Accessed: 03 September 2018].
 Tirole, J. (2006). The Theory of Corporate Finance. Princeton University Press. New
Jersey.
 Quiry, P., Dallocchio, M., Fur, Y. L., & Salvi, A. (2009). Corporate Finance: Theory
and Practice. John Wiley & Sons Ltd. United Kingdom.
 Kim, K. A. (2011). Global Corporate Finance: A Focused Approach. World Scientific
Publishing Co. Pte. Ltd. Singapore.
 Peterson, P. & Fabozzi, F. (1999). Analysis of Financial Statements. John Wiley &
Sons. New Jersey.
 Bragg, S. (2012). Business Ratios and Formulas: A Comprehensive Guide. John
Wiley & Sons. New Jersey.
 Baker, H. K. & Powell, G. E. (2005). Understanding Financial Management: A
Practical Guide. Blackwell Publishing. United Kingdom.
 Clayman, M. R., Fridson, M. S., & Troughton, G. H. (2012). Corporate Finance: A
Practical Approach. John Wiley & Sons. New Jersey.
 Vance, D. E. (2003). Financial Analysis and Decision Making. Tata McGraw-Hill.
USA
 Clauss, F. J. (2010). Corporate Financial Analysis with Microsoft Excel. Tata
McGraw-Hill. USA.
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Report on Redding Co. or Neaves Co. as an investment choice for potential investors
Appendix 1: Calculation of ratios:
Ratios pertaining to profitability
Net profit margin: The formula to compute this ratio is provided below along with the
workings of the ratio for the two companies.
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Report on Redding Co. or Neaves Co. as an investment choice for potential investors
Return on capital employed: The formula to compute this ratio is provided below along
with the workings of the ratio for the two companies.
Ratios pertaining to efficiency
Stock turnover ratio: The formula to compute this ratio is provided below along with the
workings of the ratio for the two companies.
Debtors turnover ratio: The formula to compute this ratio is provided below along with the
workings of the ratio for the two companies.
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Report on Redding Co. or Neaves Co. as an investment choice for potential investors
Ratios pertaining to liquidity
Current ratio: The formula to compute this ratio is provided below along with the workings
of the ratio for the two companies.
Quick ratio: The formula to compute this ratio is provided below along with the workings of
the ratio for the two companies.
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Report on Redding Co. or Neaves Co. as an investment choice for potential investors
Ratios pertaining to gearing
Debt-to-equity ratio: The formula to compute this ratio is provided below along with the
workings of the ratio for the two companies.
Interest cover ratio: The formula to compute this ratio is provided below along with the
workings of the ratio for the two companies.
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Report on Redding Co. or Neaves Co. as an investment choice for potential investors
Ratios pertaining to investors
Return on equity: The formula to compute this ratio is provided below along with the
workings of the ratio for the two companies.
Earnings per share: The formula to compute this ratio is provided below along with the
workings of the ratio for the two companies.
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Report on Redding Co. or Neaves Co. as an investment choice for potential investors
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