Corporate Finance

Explain analysis of financial performance.
 

Introduction:

The given assignment is about an Australian company, ABC Learning Limited, a childcare service provider that achieved a dramatic growth the mid 2000s but it was liquidated voluntarily in the year 2008 and taken over by “GoodStart Childcare in 2009” . The company is operating in New Zealand, U.S. and U.K. apart from Australia where ABC limited had occupied 25% of the total domestic market. The following study representing the analysis of financial performance of ABC Limited in the period 2000 as well as the non-financial strategic issues the company was facing. The financial analysis on the performance of the company is to be done by evaluating important financial and profitability significant ratios, capital structure and debt structure in connection to the failure of the company.

Discussion:

1. Analysis of financial performance

Financial performance of any company is a subjective measure through which it can be determined about the maximum utility of its assets in order to generate revenue and maintain growth and stability (Dittmar and Duchin 2016). This section of the study is comprised of evaluation of financial data of ABC limited for the years ended June 2005, June 2006 and June 2007 by considering key ratios- Profitability and financial that includes cash flow ratios, earnings ratios, asset management ratios, debt-borrowing ratios.

From the given data it can be observed that the net profit margin of the company in the year 2005 was 14.61%, 13.22% in the year 2006 and 8.73% in the year 2007. This percentage shows decline in revenue generation of ABC approximately by 1.5 % from the year 2005 to 2006 but in the year 2007 the net profit declined with a high percentage of around 5.5%. Secondly, Earning before Interest and Taxes (EBIT) margin also showing huge decline in the year 2007 compared to the financial year 2006 and 2005. The EBIT margin in the year 2007 dropped to 16.74% from 22.98% in the year 2006 and 24.98% in the year 2005. Thirdly, another important factor for the analysis of financial performance is return on equity, return on assets and return on invested capital. According to the data of ABC limited provided for the three years 2005, 2006 and 2007 in appendix, the following results have been observed:

Ratios	2005	2006	2007
Return on Equity	3.99%	4.30%	7.53%
Return on Assets	3.28%	4.08%	5.11%
Return on Invested Capital	5.55%	5.92%	6.32%

The above table shows the increase in the return on equity, assets and invested capital over the three years, which was a positive sign even though the company was experiencing decline in the net profit margin and earnings margin. Return on equity indicates how much a company is providing profit to its investors and equity share holders whereas return on asset indicates the utilization capacity of the company from its underlying and owned assets. Further, return on invested capital indicates the income generating capacity from the capital invested by the company (Charlo, Moya and Muñoz 2015). From the above table it can be observed that ABC Learning Limited had incurred increased rate of return over the years unlike gross and net profit margin. This implies that the efficiency of ABC in generating return for its operations as well as for satisfying the investors were quite good.

On the other hand, the financial ratios used to analyze the performance of ABC Limited are current ratios, quick ratios, cash ratios, return on sales ratios apart from the profitability ratios mentioned above. These ratios can be determined as per the data provided in the appendix. Current ratio is determined by considering the current assets and current liabilities of ABC Learning Limited that is working capital ratio. In the given data working capital and revenue ratios given for the year 2005, 2006 and 2007 are -1.59%, 0.07% and -8.54% respectively. These results imply that ABC limited was not utilizing its working capital efficiently for generating its revenue. In the year 2007, the ratio declined with a huge difference and resulted to -8.5% while it was 0.07% in the year 2006.

It can be said that ABC Learning Limited was declining in its performance and efficiency in respect to utilization of its assets and cash funds for generating revenues and profit that eventually affected its growth and sustainability in the later years.

From the above analysis from the part (a) it is observed that ABC Learning Limited incurred negative profit margin in the later years of the its business i.e. in the years 2005, 2006 and 2007 that indicates that the company was incurring losses or less profits on its operation of business. The decline in the revenue generation was more in the year 2007 in compared to the years 2005 and 2006. Further, it has also been observed that ABC Limited incurred negative working capital to revenues in the years 2005, 2006 and 2007 that interprets the less efficiency in the performance and utilization of its current assets and current liabilities. Working capital indicates the availability of short-term funds so that a company can meet its short-term obligations and contingencies in order to run the business smoothly (Ortas, Gallego‐Alvarez and Álvarez Etxeberria 2015).

Apart from the above-mentioned negative ratios, it is observed that ABC Learning Limited had earned positive return on equity, return on assets and return on the capital invested by the company that indicates the earnings of company as a percentage of the total worth of interest of investors and owners. Whereas return on assets indicates, the total earning of the company as a percentage of total assets employed and return on invested capital is the percentage measurement of the profit or income earned by the company out of the value of capital invested (Lins, Servaes and Tamayo 2015). From the data of the financial years 2005, 2006 and 2007 it was noticed that ABC limited was earning returns in a positive and increasing trend that represents the utilization of the assets and capital employment to the fullest.

Moreover, the current ratio of the company in the year 2005, 2006 and 2007 is 1.57, 1.81 and 0.27 respectively while quick ratio is 1.5, 1.77 and 0.27 respectively. This result indicates that the company’s ability to meet its current obligations in the year 2005 and 2006 is according to the industrial standards that are more than one but it is not best, as the ratios are less than two. Whereas in the year 2007 the both current ratio and quick ratio are less than one that indicates the danger state of the ABC limited’s ability to pay off its current liabilities.

In context to the above stated indications on the financial performance of ABC limited it can be commented that the company should utile its assets and short- term and current funds so that the current obligations could be met. Apart from this, it is also suggested that ABC could lower its cost of providing service without compromising on the quality so that the net profit margin could be increased.

According to the information available, ABC Learning Centres Limited was found to liquidate voluntarily in the year 2008 and sold to GoodStart Childcare in the year 2009, the capital structure as per the latest financial year ended on 30^th June 2007 is available. The capital employment of the company at the time of its liquidation comprised of Issued capital, reserves and retained earnings. The issued capital of ABC limited was around $1,744.5 million, reserves stood at $2.8 million and retained earnings amounted to $ (17.2) million. On the other hand, the capital structure of the company in the previous financial year 30^th June 2006 was $1,635.0 million, reserves stood at $0.5 million and retained earnings amounted to $4.1 million.

It was observed that the company-incurred huge loss in earnings in the year 2007 compared to that in the year 2006. Whereas, the reserves in the financial year 2006 was $0.5 million and that in 2007 it was $2.8 million. This data indicates that in the financial 2006, ABC had not transferred its earnings to reserves while in the year 2007 retained earnings showed negative balance but quite high balance in the reserves. Hence, it can be said that the company either transferred its earnings to its reserved fund and accordingly, represented negative balance on the other hand, the company if actually earned loss and carried forward its reserve fund balance from the previous financial year that seems impossible because the reserve balance in previous year 2006 was only $0.5 million.

It has also been noticed that the there has been changes in the issued equity capital of the company in 2007. During the financial year 2006- 2007, the company had issued “share based payment options” due to that the equity capital of ABC limited had increased in the financial year 2007 before its liquidation. The strategies of the shareholders in this context were that the investors were positive about the return from the company and therefore, they invested further in the year 2006- 2007. The company also declared and paid dividend to the shareholders out of its retained earnings that are another reason shareholders were keen to invest in the shares of ABC Limited that were more in the financial year 2007 than in the years 2006 and 2005.

Debt structure of ABC Learning Centre limited consisted of long-term debts and short-term debts that increased in each of the financial years of the company. In the financial year 2004-2005 the company’s, long term debt $195.66 million that increased to $234.88 million in the year 2005-2006 and $ 610.40 million in the year 2006-2007. On the hand, short-term debt amounted to $4.45 million in the year 2005 that increased to $8.06 million in the year 2006 and $ 1,149.70 million in the year 2007.

The above debt structure shows the huge increment in the debt funding of the company in the year 2007 compared to the previous years. It can be said that the company adopted this increased strategy in debt funding so that ABC Learning centre limited can leverage its capital structure. Further, it is also noticed that in order to operate its business and service and due to low amount of reserve fund balance the company adopted to borrow short term and long term funds that also helps to lower the cost of capital of the company. However, this strategy by a company is not advisable as the obligation to meet the short-term liability is not sufficient as the company’s current ratio in the financial year 2007 is below 1 that means the efficiency of ABC to meet its obligation is not sufficient and eventually company had to decide to liquidate its business.

In the above section of the solution, it was noted down that ABC Learning Centre Limited had borrowed funds in the financial years 2006, 2007 but in the year 2007 the company had borrowed huge amount of funds whereas earnings of the company resulted into negative balance. Moreover, the current ratio and quick ratio of the company was 0.27 that is quite less than the standard requirement in the industry while financial leverage in the year 2007 was 213.88%. On analyzing these data, it can be said that there was no consistency in the financial position, capital structure and working capital in the performance of the company. Additionally, profitability ratios that is net profit margin, earnings before interest and taxes margin, earnings before interest taxes and depreciation margin also discloses results in declining percentage in the year 2007 compared to that in the years 2005 and 2006. Further, percentage of working capital to revenue and working capital turnover also discloses negative balance.

On evaluation of the above stated data, it is clear that ABC Learning Centre Limited faced financial and revenue generation in the years of 2000s. The financial performance of the company in the year 2007 seemed to be very poor that indicates one of the reasons of liquidate the business. Apart from that, the company also increased its financial leverage with a high increase in percentage. According to the management systems of an enterprise, it is a good financial strategy to leverage its capital funds but to certain limit whereas the selected company ABC Learning centre in this case adopted in high financial leverage strategy that is a negative management and business operating strategy. 

In order to manage the capital structure better, the finance team and management of ABC Learning Centre Limited are required to take certain steps to change the policy of funding their capital structure (Allen, Carletti and Marquez 2015). In the first place, the management is required to lower its debt funding values in the year 2007 so that the obligation to pay back the debts is reduced. Secondly, if the company wants to increase the capital component the management can do so by issue of ordinary securities that will lower its cost of capital employed. Additionally, ABC limited can also issue debentures at a standard interest rate instead of borrowed funds at high rate of interest. Thirdly, the company should maintain its retained earnings with positive balance that can be done by transferring lower balance to the reserve funds.

2. Analysis of strategic issues

Apart from the financial strategies that faced by the ABC limited, there were non- financial strategic issues faced by the company in terms of social and political terms. In this context, it was observed that the ABC Learning Centre Limited failed to comply with internal control norms and internal risks that were associated with the valuations in connection with the operation of its business and services (Elsas and Florysiak 2015). Further, in relation to compliance of corporate laws and regulations as well as certain political norms can hamper the continuity of the operation of its business. It is very important for any company to follow the non-financial strategic issues apart from the financial issues so that the company can maintain its growth and sustainability in the market industry (Bernaoui, Issolah and Hassoun 2015).

These issues can be quality of the service providing by the company, marketing strategy, compliance of the rules and principles for its employees etc (Sundaresan, Wang and Yang 2015). In case of ABC limited, child learning and care service provider the most important factor is the employee or man power therefore, the focus of the company should be on the fulfillment of basic requirements in regard to the compensation packages, proper work infrastructure, etc so that employees get motivation to work with the organization. Another issue that can be addressed is the focus on satisfying the needs of the clients and society that is providing them with better quality of service and benefits (Schepens 2016). As ABC limited was engaged in learning and care service provider hence it should focused on providing developmental issues, education awareness among the society, compliance of rules and regulations and duties as part of citizen of the society.

According to the corporate laws and regulations, statutory reporting is the submission of financial statements that is mandatory for the use of shareholders and investors and government officials that has to be prepared in accordance with the “International Financial Reporting Standards or “Generally Accepted Accounting Principles”. In case of failure of submission of the statutory report, there are certain penalties and compensations levied on the management of the company that varies from countries to countries (Paroutis, Franco and Papadopoulos 2015).

In case of selected company, ABC Learning Centre Limited one of the reasons for its liquidation could be failure in submission of its statutory reports. In the financial year 2007- 2008 the company did not prepare its annual reports and hence could not file its statutory reports due to which there was no information and results of performance of company available to the shareholders, creditors, governments and other personnel of the company (Watts and Ormsby 2015). In order to get the proper information about the company’s performance for the purpose of investments or recovering of borrowed funds and taxes financial statement plays an important role.

Moreover, the finance providers to the company in terms of long- term and short- term debts, it is important to evaluate the company’s revenue generation, utilization of the assets. In addition, availability of working capital to meet the short-term obligations and payment of interests on loan etc should be evaluated so that the finance provider can analyze the recoverable value and chances (Hinterhuber and Krauthammer 2015). In case of ABC limited as the company failed to provide the statutory reports, the finance providers were not able to relate the company’s efficiency in repaying back the borrowed fund. ABC faced these important issues in the financial years 2000s that resulted the management to take a step to liquidate the company on voluntary decision in 2008 and sold to another learning company of Australia in December 2009.

There are generally, four types of business model are manufacturing, Distributing, Retailing and Franchising. However, in case of service sector, manufacturing business model cannot be preferred but other three types can be considered. In order to get more success in business, the management of the company ABC limited could have opted franchising busing model. In this business model, the owner can sell the franchisee to other company or individual and the right to use and operate the business on behalf of the main company (Graham, Leary and Roberts 2015). Further, the franchisee should be transferred to the company or individual who is efficient in operating business and marketing strategy so that it can earn more profits and fulfill the compliance of reporting and other governmental requirements.

On the other hand, the capital structure of the company is also required to be changed by issuing ordinary shares or debentures either on face value or at premium as well as the debt funding should be reduced so that the obligation to repay off the debt burden could be reduced. Apart from that, working capital of the company should also be maintained so that the current ratio can be increased. Moreover, in relation to political and governmental issues, ABC limited can apply for the governmental assistance as its core business is learning and care to children but for this assistance, the company should comply with the requirements of filing returns, payment of tax liabilities and other requirements on time.

In order to enter into the childcare industry an entrepreneur might require facing certain barriers that can be structural barrier, strategic barrier or financial barrier (Hipp, Bernhardt and Allmendinger 2015). Structural barrier refers to the format of conducting the foster business in terms of different departments like care takers department, financing department, materials suppliers, place of business management etc (Patrick, Stephens and Weinstein 2016). It is very important for a business to plan and structure its operations well so that the business can sustain in the long run. Secondly, strategic barrier is another barrier that is faced in child care market. Strategic barrier is related to the types of childcare service to be provided, infrastructure facility, fulfillment of basic needs in context to prove education and other skills (White 2016). Thirdly, financial management could also be the important barrier to be taken care of by the service providers so that their cost of service could be lower without affecting the quality and revenue generation could be higher so that a decent amount of profit can be plough back to the business (Pilarz, Claessens and Gelatt 2016).

As per the discussion it can be concluded that the above mentioned barriers are primary barriers that every marketer should analyze before entering into the child care market, therefore considered to be high. This is because this industry is related to the care, protection and education of children that is quite sensitive and hence the business owners should pay heed to these important factors.

3. Executive Summary and Conclusions:

The conclusion of ABC Learning Centers Limited in relation to the financial performance can be made that the company in the years of 2000, were declining. The company was generating losses and negative returns as well as low maintenance of funds that affected its sustainability. Apart from that, the company faced strategic issues in relation to the compliance of statutory regulations, corporation laws and principles that resulted in negative impact to its stakeholders. On considering these issues, it was recommended that the company could restructure its capital employment by issuing ordinary shares or debentures instead of borrowing long term debts at high interest rates. The company could also restructure its financial position by asking its creditors to waive of certain amount of amounts outstanding.

Moreover, it is true that every business enterprise have to face certain basic barriers in the industry before and after entering the market that needs to evaluated and addressed properly in order to grow and sustain in the market. Child care industry is an industry that faces most difficulties before entering into the market as it involves faith of the children and parents at the same time. Childcare market is one of the sensitive industry because it’s a service provider to the young and minor children who mostly experience ignorance, abuse and negligence at their home and hence the parents opt for foster care services for the child’s care, protection and development. Hence, Childcare business and service providers should properly plan their business and accordingly execute the same. 

Reference List:

Allen, F., Carletti, E. and Marquez, R., 2015. Deposits and bank capital structure. Journal of financial economics, 118(3), pp.601-619.

Bernaoui, R., Issolah, R. and Hassoun, M., 2015. Strategic Issues of a Value-added Information System for Higher Education in Algeria.Perspectives of Innovations, Economics and Business, 15(1), pp.57-66.

Charlo, M.J., Moya, I. and Muñoz, A.M., 2015. Sustainable development and corporate financial performance: a study based on the FTSE4Good IBEX index. Business Strategy and the Environment, 24(4), pp.277-288.

Dittmar, A. and Duchin, R., 2016. Looking in the Rearview Mirror: The Effect of Managers' Professional Experience on Corporate Financial Policy. Review of Financial Studies, 29(3), pp.565-602.

Elsas, R. and Florysiak, D., 2015. Dynamic capital structure adjustment and the impact of fractional dependent variables. Journal of Financial and Quantitative Analysis, 50(05), pp.1105-1133.

Graham, J.R., Leary, M.T. and Roberts, M.R., 2015. A century of capital structure: The leveraging of corporate America. Journal of Financial Economics, 118(3), pp.658-683.

Hinterhuber, H.H. and Krauthammer, E., 2015. Leadership-Verantwortung: Kernprodukte/Kerndienstleistungen und Strategic Issues. In Leadership—mehr als Management (pp. 59-71). Gabler Verlag.

Hipp, L., Bernhardt, J. and Allmendinger, J., 2015. Institutions and the prevalence of nonstandard employment. Socio-Economic Review, 13(2), pp.351-377.

Lins, K.V., Servaes, H. and Tamayo, A., 2015. Social Capital, Trust, and Firm Performance: The Value of Corporate Social Responsibility during the Financial Crisis. European Corporate Governance Institute (ECGI)-Finance Working Paper, (446).

Ortas, E., Gallego‐Alvarez, I. and Álvarez Etxeberria, I., 2015. Financial factors influencing the quality of corporate social responsibility and environmental management disclosure: A quantile regression approach.Corporate Social Responsibility and Environmental Management, 22(6), pp.362-380.

Paroutis, S., Franco, L.A. and Papadopoulos, T., 2015. Visual interactions with strategy tools: producing strategic knowledge in workshops. British Journal of Management, 26(S1), pp.S48-S66.

Patrick, C., Stephens, H. and Weinstein, A., 2016. Where are all the self-employed women? Push and pull factors influencing female labor market decisions. Small Business Economics, 46(3), pp.365-390.

Pilarz, A.R., Claessens, A. and Gelatt, J., 2016. Patterns of child care subsidy use and stability of subsidized care arrangements: Evidence from Illinois and New York. Children and Youth Services Review, 65, pp.231-243.

Schepens, G., 2016. Taxes and bank capital structure. Journal of Financial Economics, 120(3), pp.585-600.

Sundaresan, S., Wang, N. and Yang, J., 2015. Dynamic investment, capital structure, and debt overhang. Review of Corporate Finance Studies, 4(1), pp.1-42.

Watts, L.R. and Ormsby, J.G., 2015. The effect of operational and strategic planning on small firm performance. Journal of Small Business Strategy,1(2), pp.27-35.

White, L.A., 2016. The United States in Comparative Perspective: Maternity and Parental Leave and Child Care Benefits Trends in Liberal Welfare States. Yale Journal of Law & Feminism, 21(1), p.8.