Financial Ratio Analysis Example

This assignment provides a detailed example of calculating various financial ratios, including liquidity ratios (quick ratio), profitability ratios (times interest earned), efficiency ratios (inventory turnover, receivables turnover, payables turnover, asset turnover), gearing ratios (debt to equity ratio, debt ratio), and investment performance ratios (earnings per share, price earnings ratio, dividend payout ratio, dividend yield ratio). The example uses two sets of data to illustrate the calculations and interpretations of these important financial metrics.

[Type the company name]
Ratio Analysis of Billabong International Limited
2015-2016
Windows User
[Pick the date]

Contents
Introduction...........................................................................................................................................1
Ratio Analysis........................................................................................................................................2
Profitability........................................................................................................................................2
Liquidity.............................................................................................................................................3
Efficiency...........................................................................................................................................4
Gearing..............................................................................................................................................5
Investment Performance...................................................................................................................5
Conclusion.............................................................................................................................................6
Recommendation..................................................................................................................................7
Appendix...............................................................................................................................................7
Executive Summary
Billabong International Limited is an Australian company engaged in the business of
distribution and retail of sports apparel, accessories and equipment. A financial ratio analysis
of the company for the financial years 2015 and 2016 has been conducted and the ratios have
been categorized into profitability, liquidity, efficiency, gearing and investment performance.
The ratio analysis show poor financial performance of the company with poor profitability,
low efficiency, high gearing and poor investment performance. The company has not paid
any dividend in the last two years. The main reason for poor performance being incurring
losses due to increased cost of sales with strengthening of the dollar, poor trade performance
by some brands, costs involved in closure of unprofitable businesses and other external
factors.
As a result of poor performance, it is not advisable to invest in the company stocks now.
However, the company is in the process of implementing a brand strengthening strategy
which is expected to yield positive EBIT in the coming years. Hence, depending on the future
results, one can invest in later years.
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Introduction
Billabong International Limited is an Australian company engaged in the business of
distribution, wholesale and retail of sports apparel, accessories, sports equipment, eyewear
and wetsuits. The sports for which the company majorly provides the accessories include
surf, skate and snow. The company operates through various brands which include Billabong,
RVCA, Element, Tigerlily, Von Zipper, Xcel, Palmers, Kustom and Honolua. The company
has presence in Asia Pacific, America, and Europe with major operations in Australia,
France, California and Hossegor (Bloomberg) The Company operates through its own
branded stores and specialized board sports retailers. It also sells online for each of its major
brands. It employs over 4000 people globally and has around 407 stores win more than 100
countries around the world (Billabong, Annual General Meeting and Annual Report, 2016)
Ratio Analysis
Financial ratios are used as tools to analyse the financial performance and position of a
business. They may be used to compare the performance of a company over the years or
comparison with another company. A ratio analysis has been performed for Billabong
International Limited for the financial years 2015 and 2016 and the results are presented as
under:
Ratios 2016 2015
Profitability
Gross profit margin 50.8% 53.1%
Net profit margin -2.1% 0.2%
Return on equity -9.1% 0.9%
Return on assets -3.2% 0.3%
Liquidity
Current ratio 2.3 2.2
Quick ratio 1.4 1.4
Times interest earned ratio -0.6 -0.4
Efficiency
Inventory turnover ratio 2.9 2.6
Receivables turnover ratio 6.4 6.4
Payables turnover ratio 3.2 2.7
Total assets turnover ratio 1.5 1.3
Gearing
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Debt to Equity ratio 1.1 0.9
Debt ratio 0.7 0.6
Investment performance
Earnings per share -0.12 0.01
Price earnings ratio -10.09 227.57
Dividend pay-out ratio 0 0
Dividend yield ratio 0 0
(Billabong, Annual General Meeting and Annual Report, 2015)
Profitability
The revenue of the company has increased by 4.5% in 2016 as compared to 2015. The
increase is due to the three major brands Billabong, Element and RVCA as a result of the
growth in social media engagement which led to higher sales. The company’s market share in
speciality retail channels increased in America and Australia. The revenue increase in
America was 6.5% and in Europe it was 8.4%. The year 2016 was also marked by increase in
operating costs as a result of currency movements. The company operates majority of its
business outside Australia, hence is exposed to currency risks. As a result, the cost of sales
increased due to currency movements in Asia Pacific and Europe. The gross margin fell by
3% even though the revenue has increased. Another reason for decreased margins was costs
incurred in clearing excess inventory in America for Sector 9 brand. The brand performed
poorly; hence it was sold off in June 2016.
The company incurred losses in 2016. This is majorly on account of income tax expense of
$7.8 million in 2016. In 2015 there was an income tax benefit of $12.2 million. Hence there
were profits in 2015 but in 2016 apart from the increased cost of operations on account of
current movements, income tax expense accounted for majority of the loss. Also the interest
expense increased due to strengthening of the US dollar as the company’s debt is US dollar
denominated. There were losses in 2015 before tax due to currency movements and sale of
Surf Stitch and Swell in 2015 (Harbaugh, 2016)
The return on equity decreased in 2016 as a result of losses incurred in the year. The total
equity has decreased in 2016 due to an increase in retained losses. However the increase in
losses are more than decrease in equity and hence the return on equity is negative.
The return on assets has also become negative in 2016 due to losses incurred. The total assets
have also decreased by 7.4%. This is majorly on account of decrease in current assets as the
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inventory has reduced and the cash balance has reduced significantly. The cash balance has
reduced due to cash utilized in purchase of a property in America and also costs incurred in
selling off Sector 9 in America.
Liquidity
Liquidity ratio measure the ability of the company to meet its short term obligations with its
current assets. The liquidity of a company can be measured by using ratios like current ratio,
quick ratio and interest coverage ratio.
The current ratio of the company is almost the same in both the years above 2. The current
assets comprise of cash and cash equivalents, receivables, inventories, current tax receivables
and others and the current liabilities comprise of payables, borrowings, current tax liabilities
and provisions. Both current assets and current liabilities have reduced in 2016. The current
assets have reduced on account of a decrease in cash and cash equivalents and inventory. The
cash balance has decreased due to repayment of borrowings worth $16 million. Also the
company has purchased a property in Australia. The cost of sales and finance costs have
increased as a result of strengthening of dollar. The inventory has reduced due reduction in
surplus inventory for the Sector 9 store in America. The payables have reduced leading to a
decrease in current liabilities. Also the deferred payment amounting to $20 million has been
eliminated.
The quick ratio is the same in both the years. This is because both the current assets and
current liabilities have reduced and the change in inventory is not significant enough to
change the ratio. The quick ratio is more than 1 which means the company has enough
immediate liquid assets to pay for its current obligations.
The times interest earned ratio is negative for both the years and has decreased further in
2016. The company has a negative EBIT in both the years. Year 2015 was also challenging
for the company due to currency movements leading to an increase in cost of goods
purchased. Though the loss before interest and tax has reduced in 2016 due to increased
revenue, however, the negative earnings make the company unable to pay for its interest
expenses. The interest expense has increased in 2016 as the company has undertaken
additional borrowings in 2016 and also the value of interest expense has increased due to
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strengthening of the U.S. dollar against the Australian dollar as most of the debt is dollar
denominated.
Efficiency
The efficiency ratios measure the ability of the company to utilize its short term and fixed
assets to generate sales. It also measures the working capital management of the company
and takes a look at its operations efficiency.
The inventory turnover ratio is low at approx. 3. Though the ratio has improved in 2016,
however the inventory is very slow moving and only rotated three times in 2016. This also
can be related to the nature of the industry the company operates in. It is a retail and
wholesale company and hence has to maintain large stocks of items for sale. The increase in
the ratio in 2016 as a result of a decrease in inventory and increase in cost of goods sold. The
inventory reduced owing to reduction of surplus inventory in Sector 9, America.
The receivables turnover has remained the same in both the years. The receivables have
increased to some extent in 2016 and so has the revenue. The turnover is at approx. 6 which
mean the company can turnover its receivables six times into cash during the year.
The payables turnover ratio has increased in 2016 from 2.7 to 3.2. This is due to an increase
in revenue and decrease in payables. The payables have reduced as a result of the company’s
supplier consolidation strategy. This has improved the ratio. This means the company is
paying its suppliers faster as it is now concentrating only on limited suppliers.
The total assets turnover ratio has increased from 1.3 to 1.5 due to an increase in revenue and
a decline in total assets. The fall in total assets is majorly on account of a decline in cash. The
fixed assets have more or less remained the same.
Gearing
Gearing ratio measures a company’s long term stability. The capital structure of a company
comprises of debt and equity.
Debt to equity ratio shows the share of debt and equity in a company’s financing. The ratio
has increased in 2016 as the company has increased its debt whereas the total equity has
declined due to retained losses. The net debt has increased from $185.2 million in 2016 as
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compared to $113.5 million in 2015. The additional debt was taken to pay for the deferred
consideration of RVCA which was acquired in 2014 (Bradstreet, 2015), to finance the capital
expenditures undertaken by the company and the increase in finance charges. The company is
undergoing a structural change since 2013 where it is focusing on the three major brands and
selling off the unprofitable ones. Hence, capital expenditures are taking place. The group has
more debt than equity in 2016. This makes it a little risky.
Debt ratio is the ratio of total liabilities to the total assets. The company has more assets than
liabilities as the ratio is below 1. The total liabilities have decreased in 2016 due to a decrease
in the payables owing to supplier’s consolidation strategy and the total assets have also
decreased due to a decrease in the cash balance. The company is in a position to pay for its
total liabilities from its total assets.
Investment Performance
These ratios are specific to the market performance of the company in terms of its share
price. It shows how the share prices have moved and measures the returns of the
shareholders.
The earnings per share have become negative in 2016 due to losses incurred. There is no
change in the number of outstanding shares.
The price earnings ratio is the prospect of the market for the company in relation to its
earnings. A higher ratio means the market is positive about the company and the shares are
trading at higher than the earnings. Billabong has a negative ratio in 2016 again due to
negative earnings. The share price has gone down from $2.88 to $1.21 (Yahoo)as a result of
negative performance.
The dividend pay-out ratio and the dividend yield are both at 0 because the company has not
paid out any dividends in the two years. This show the shareholders have not received any
returns from the company in last two years and hence the negative market sentiments about
the company.
Conclusion
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The company’s profitability is poor as it has incurred losses before tax in both the years as a
result of increased cost of sales due to tough economic and business environments. Also the
selling and administration expenses have increased along with an increase in the finance costs
resulting in loss for the company before tax. Also the company is under the process of brand
strengthening where it is selling off the unprofitable ones and strengthening the profitable
ones. It aims to focus on the three main brands which are Billabong, Element and RVCA. It
has sold off Surf Stitch and Swell in 2015 and Sector 9 in 2016. This restructuring cost have
added to the total costs and hence made the company unprofitable. The liquidity of the
company is good as both the current ratio and quick ratio are more than 1. The current assets
are more than the current liabilities and hence the liquidity is good. The trade payables have
reduced as a result of selling off of the unprofitable brands like Sector 9 which has reduced
the excessive purchasing of raw materials. Also Sector 9 sale has enabled the company to get
rid of surplus inventory. The asset management efficiency of the company is poor as all the
turnover ratios have low values. The inventory is slow moving with turnover of 3, the
receivables turnover is only at 6 and payables turnover is at 3. This shows lot of company
funds are stuck in working capital. The company is highly geared with more debt than equity.
The company is undergoing a structural change and the funds required for the restructuring is
being financed through debt as the company is low on cash balance also. Thus, the riskiness
of the company is increasing. The debt ratio is at 70% which means most of the assets of the
company are financed through debt. The investment performance ratios also show poor
performance as the earnings per share and price earnings ratio are negative and the dividend
pay-out ratio is 0 as the company has not declared any dividends over the last two years. The
shareholders are not getting proper returns on their shareholding.
Recommendation
On the basis of the above ratio analysis, we do not recommend to invest in the shares of
Billabong International Limited as the company has poor profitability, inefficient asset
management, instable business as it is highly geared and thus exposed to risks and also poor
market performance with no dividends at all for the shareholders. The company has been
incurring losses for continuous two years. The company has many brands and most of the
brands are performing poorly. As a result the company has undertaken a restructuring activity
under which it is selling off the non performing brands and focussing on three major brands
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which are Billabong, Element and RVCA. The company is faced with challenges which are
outside its control like foreign currency exposure and channels disruption. Such challenges
have slowed down the effect of the brand strengthening strategy the company is working on.
The company believes to have positive EBIDTA with the implementation of the strategy
provided the external environment remains stable.
Thus, on the basis of the current performance, we do not recommend investing in the shares
of Billabong but the future outlook of the company may be good if the implementation of the
strategy is successful and the external environment is also supportive of the changes being
made by the company (Mickleboro, 2016) Hence, in future depending on the company’s
financial performance one may think of investing but as of now, it is not a good investment.
Bibliography
Billabong. (2015). Annual General Meeting and Annual Report. Australia: Billabong International
Limited.
Billabong. (2016). Annual General Meeting and Annual Report. Australia: Billabong International
Limited.
Bloomberg. (n.d.). Company Overview of Billabong International Limited. Retrieved September 15,
2017, from Bloomberg:
https://www.bloomberg.com/research/stocks/private/snapshot.asp?privcapId=1061739
Bradstreet, K. (2015, February 25). Billabong Returns To Profitability In Half-Year Report. Retrieved
September 13, 2017, from Transworld Business: http://www.grindtv.com/transworld-
business/news/billabong-returns-profitability-half-year-report/
Harbaugh, J. (2016, August 30). The Future Isn't Here Yet: Billabong Results for the Year. Retrieved
September 15, 2017, from Jeff Harbaugh & Associates: http://www.jeffharbaugh.com/the-
future-isnt-here-yet-billabongs-results-for-the-year/
Mickleboro, J. (2016, November 22). Why Billabong International Limited shares have skyrocketed
today. Retrieved September 16, 2017, from The Motley Fool:
https://www.fool.com.au/2016/11/22/why-billabong-international-limited-shares-have-
skyrocketed-today/
Yahoo, F. (n.d.). Billabong International Limited (BBG.AX): Historical Data. Retrieved September 14,
2017, from Yahoo Finance: https://au.finance.yahoo.com/quote/BBG.AX/history?
period1=1433097000&period2=1467225000&interval=1d&filter=history&frequency=1d
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Appendix
Ratio Formula 2016 (figures in
$million)
2015 (figures in
$million)
Profitability
Gross profit margin Gross profit /
revenue
561.1 / 1103.5
= 50.8%
560.8 / 1056.1
= 53.1%
Net profit margin Net profit / revenue -23.7 / 1103.5
= -2.1%
= 2.5 / 1056.1
= 0.3%
Return on equity Net income / equity -23.7 / 259.2
= -9.15
2.5 / 281.5
= 0.9%
Return on assets Net income/ total
assets
-23.7 / 744.2
= -3.2%
2.5 / 803.9
= 0.3%
Liquidity
Current ratio Current assets /
current liabilities
464.4 / 197.9
= 2.3
523.7 / 236.7
= 2.2
Quick ratio (Current assets –
inventory) / current
liabilities
(464.4 – 185.5) /
197.9
= 1.4
(523.7 – 187.1) /
236.7
= 1.4
Times interest earned
ratio
EBIT / interest
expense
-26.4 / 42.3
= -0.6
-14.1 / 34.2
= -0.4
Efficiency
Inventory turnover COGS / inventory 542.4 / 185.5
= 2.9
495.3 / 187.1
= 2.6
Receivables turnover Revenue /
receivables
1103.5 / 171.6
= 6.4
1056.1 / 164.5
= 6.4
Payables turnover Revenue / payables 1103.5 / 169.9
= 3.2
1056.1 / 184.1
= 2.7
Asset turnover Revenue / total assets 1103.5 / 744.2
= 1.5
1056.1 / 803.9
= 1.3
Gearing
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Debt to equity ratio Total debt / equity 274.3 / 259.2
= 1.1
266.8 / 281.5
= 0.9
Debt ratio Total liab. / total
assets
484.9 / 744.2
= 0.7
522.3 / 803.9
= 0.6
Investment performance
Earnings per share Net income /
weighted average
shares outstanding
-23.7 / 197.7
= -0.12
2.5 / 197.7
= 0.01
Price earnings ratio Share price / EPS 1.21 / -0.12
= -10.09
2.88 / 0.01
= 227.57
Dividend pay-out
ratio
Dividends paid / net
income
0 / -23.7
= 0
0 / 2.5
= 0
Dividend yield ratio Dividend per share /
share price
0 / 1.21
= 0
0 / 2.88
= 0
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