MBS546 Business Finance Journal of Business and Accounting
To evaluate the performance of a firm and its share’s value a financial analyst must be able to analyse the firm’s financial statements. When analysing these statements, the analyst must focus on cash flows of the firm because ultimately it is changes in the cash flows of the firm that determines its value. This is also a market consensus. Hence understanding how and why cash flows change is an indispensable component of security valuation.
The objectives of this assignment are:
1.To equip you with a good understanding of the financial statements of the firm;
2.To build up your analytical skills in the area of cash flows analysis;
3.To apply the methods of security valuation to value a real world company.
In addition to developing your knowledge of financial statements and security valuation, the assignment aims to develop the ability to work in groups: learning how to coordinate with and learn from peers as well as how to deal with any negative issues that may arise in the group process. As such, the assignment submission will include an evaluation of the group process. The group evaluation will not attract any marks; however the rest of the assignment will not be marked without a group evaluation. To assist in the smooth running of groups some guidelines are included with the assignment instructions. These are to be used as a guide only. Groups have their own personalities, so it is important to establish your group norms and plans in a way that best suits your group.
Assignment requirements:
1.Search for all available financial data* for Wesfarmers Ltd from the Australian Stock Exchange, the company’s and other finance websites (e.g. Yahoo Finance, Morning Star DatAnalysis and Bloomberg).
2.Give a brief description of Wesfarmers..
3.Explain the purpose of financial statement analysis.
4.Analyse the firm’s current operation using its financial statements (i.e. income statement, balance sheet and cash-flow statement). You should also take into account supply and demand factors (i.e. you need to look at the market conditions at both industry and economy levels).
5.Use an appropriate dividend valuation model to value Wesfarmer's shares (Hint: use the total dividend figures).
6.Draw graphs for Wesfarmers’s adjusted share price and return (you can use daily, monthly or quarterly return). Compare the company's share price and return with your analyses in questions (4) and (5) above.
7.Use the information and results from your analyses in questions 4-6 above; identify if there are areas of cash flow to which the firm needs to pay attention.
8.Suggest relevant investment and financing strategies to improve the firm’s cash flow position.
9.State and justify your recommendations in terms of shareholders’ wealth maximisation.
Note: (*) You should use data for the period 2005-2015 in your analysis. You need to obtain financial statements for Wesfarmers as well as all other relevant financial data and announcements. In particular, the details of the three main types of cash flows (operating, financing and investing) and all key financial ratios should be obtained. If you need to use a value for beta, then you should calculate it yourself, or verify (through your own calculations) the reasonableness of the value that you may have sourced elsewhere.
Answer:
1. Brief description of Wesfarmers:
Wesfarmers founded in 1914 has become one of the Australian conglomerates company, where its operations ranges from chemicals, retails, fertilisers, coal mining, industrial, and safety products. The company’s current revenues in 2016 were mainly at A$65.98 billion with its total profits at A$2.35 billion. Moreover, the company in 2016 has beaten the overall revenue of BHP Billiton and Woolworths, with a total staff of 205,000 ("ASX.Com.Au" 2017). The company has effectively improved its earnings by diversifying the operations, which helped in attaining higher revenue from investments. Moreover, the company’s overall total assets are at A$40.78 billion and Total Equity at A$22.95 billion ("Wesfarmers.Com.Au" 2017).
2. Explaining the purpose of financial statement analysis:
The main purpose of the overall financial statement analysis is to identify the financial viability of the overall company and understand its future growth. In addition, the investors mainly use the financial statement analysis to understand the financial capability of the company to continue its operations and provide relevant returns to its shareholders. Some researchers stated that mentioned that use of financial analysis mainly allows the investors to gauge into the benefits that might be provided from investment returns (“Zhu” 2014). On the other hand, other researchers criticise that financial statement analysis mainly conducted on previous results, where actual forecast cannot be conducted, which might help in identifying the risk from investment (“Shaverdi, Mohammad and Iman” 2014).
The use of financial analysis mainly allows investors to identify the risk from investment and make adequate investment decisions, which could mitigate the risk hindering their investment objectives. Therefore, the purpose of the financial statement analysis is to increase the overall understanding the current financial capability and strength of the company, which allows investors to make and take adequate investment decisions.
3. Analysing Wesfarmers financial statements i.e. income statement, balance sheet, and cash-flow statement, while looking into the supply and demand factor:
The following horizontal analysis of income statement, balance sheet, and cash flow statement could mainly be identified from 2005 to 2015. The analysis could mainly help in identifying the financial condition of Wesfarmers, which could depict its operational capability.
Mainly helps in depicting the horizontal analysis of income statement, where the increment in the financial condition of the company c
ould be identified. The overall financial revenue and total expenses of the operations mainly increased from 2005, where the revenue increases drastically in 2015, as compared to 2005. The relative increment in total expenses increment is relatively higher than the revenue growth attained by the company over the period of 10 years. This only indicates the growth prospects of Wesfarmers over the period of 10 years, where demands for company’s products have gradually increased over the time. The net profit of the company mainly declined in 2014 in comparison to 2005 earnings, which indicates the loss of income incurred during the year. Some researchers mentioned that use of financial statement analysis mainly help in identifying the income that is been generated by the company over the period (“Roberts et al.,” 2015). Therefore, the total expenses have grown more than the overall revenue generated by the company.
Mainly indicates the overall financial condition of Wesfarmers, where the total assets and total liabilities drastically increased over the tenure of 10 years. The overall net assets of the company have drastically increased over the period of 10 years, where in comparison from 2005 the net assets increased by 800% in 2015. This only indicates that Wesfarmers have effectively accumulated the required assets to support its activities. However, from 2013 both total assets, liabilities and net assets of Wesfarmers have declined to indicate a low performance of the company. Furthermore, it could also be evaluated that total asset of the company was much higher than the total liabilities, which helped in supporting its future endeavours. Other researchers argued that balance sheet valuation does not help in identifying the future prospects of the company, which could be attained for increasing dividend payouts (“Rae, John and David” 2015).
The overall figure mainly helps in depicting the overall cash flow statement, where cash inflow and outflow of Wesfarmers could effectively be identified. In addition, the overall net change in cash has mainly declined drastically in 2015 in comparison to 2005, which indicate the rising cash out low conducted by the company. Moreover, the net cash provided by operating activities has mainly increased by 406% in 2015, as compared to 2005. Furthermore, the overall net cash used for investing activities has mainly increased adequately over the period of time. However, the net change in cash has drastically declined by -6457% in 2015 in comparison to 2005. This only indicates that adequate adjustment needs to be conducted on the cash flow condition of Wesfarmers in future years (“Abid” 2013).
The profitability ratio of Wesfarmers could be identified from 2005 to 2015. The gross profit of the company has gradually declined from 2006 to 2015, which indicates the high cost incurred to continue its operations. The net profit of Wesfarmers also declined from 2005 to 2015, where it had a 7.56% net income in 2005 to 3.91% in 2015. This decline in overall net profit indicates the rising administrative and financial cost incurred by the company to support its operations. The difference in the overall net profit margin and gross profit margin drastically increased over the period of 10 years, which directly depict the rising expenses incurred by the company to support and continue with its operations (“Heikal, Muammar and Ainatul” 2014).
The evaluation of liquidity ratio in figure 5 could eventually help in identifying the current financial capability of Wesfarmers. The overall liquidity condition of the company as mainly declined from 2009 where both current and quick ratio started to demise. Currently, in 2015, the current ratio is mainly at 0.93 while the quick ratio is at 0.37 which indicates the low financial capability of Wesfarmers. The company financial capability can be measured by a quick ratio, which depicts the low capability to support its short-term obligations. Therefore, it could be understood that if Wesfarmers Financially liquidity condition is not improved then it might Increase the chances of forcing the company to become insolvent (“Dokas, Dimitris and Anastasios” 2014).
Which indicates the overall financial strength of Wesfarmers. The overall depreciate the company is relatively higher in 2015, as compared to 2005, Which only depicts its overall incompetency to improve its financial position. Furthermore, the debt to equity ratio of Wesfarmers has gradually declined from 0.38 in 2005 to 0.18 in 2015, which that the company is using more of equity and reducing the overall financing costs. This is an indication of improved financing capability, which reduces the chances of attaining insolvency. However, the rising debt ratio indicates that the company is acquiring more debt each year (“Benfratello, Alfredo and Luca” 2015).
Therefore, seeing the overall financial position and Rising revenue obtained by Wesfarmers the overall supply and demand condition on the company is identified. The overall service provided by the company increased over the period of time for accommodating the rising demands of consumers. This incorporation of rising demand of consumers by Wesfarmers could be identified from the increasing revenue stream of the company. The company's operations adequately increased from 2005 to 2015, as its total revenue was raised from 8,190 million to 62,447 million in 2015, which depicts a total increment of 762% in revenue. Hence, it could be said that the Wesfarmers has effectively supported the overall demand of consumers by providing the adequate supply and increasing its production capacity (“Michelon, Giacomo and Kamalesh” 2013).
Using the dividend discount model to value Wesfarmers Shares:
|
Particulars |
Value |
|
Current growth rate |
11.22% |
|
Current Dividend |
2 |
|
Risk-free rate |
2.40% |
|
Average (^AORD) |
0.040805 |
|
Covar |
0.000111594 |
|
std (FTSE) |
0.0111 |
|
beta |
90.56% |
|
cost of equity |
3.922% |
|
DI |
2.22444 |
|
Actual Stock Price |
79.11 |
|
Current Price |
40.61 |
Table 1: Depicting the dividend discount model of Wesfarmers
(Source: As created by the author)
The overall table mainly helps in identifying the dividend discount model, which is been used to identify the actual stock price according to the returns and dividends provided by Wesfarmers. Furthermore, the overall dividend discount model depicts the share price value which could be attained by the company in near future according to its paid dividends. The actual stock price that could be attained by the company is 79.11, where is its current stock prices at 40.61. This only indicates that there is more growth that could be obtained from the investment in Wesfarmers, which could increase return on investment. Some researchers mentioned that dividend discount model many allows investors to gauge into the returns that might be provided from an investment opportunity (“Lazzati and Amilcar” 2015). On the other hand, other researchers criticise that dividend discount model does not provide adequate value which could be attained by the company, as a change in the related news could also depreciate or appreciate the overall share value (“Agosto, Alessandra and Enrico” 2016).
The current growth rate in the above table is mainly derived from the average increment in evidence that was provided by Wesfarmers from 2010 to 2015. Determination of the growth rate mainly helps in identifying the increment in the dividend that will be provided in near future. Other researchers argued that there are many derivations of determining the growth rate, which could change the overall value of derived from the dividend discount model (“Irons” 2014). Furthermore, the average returns provided from the market is analysed to determine the returns and cost of equity of Wesfarmers. This determination of the cost of equity mainly helps in identifying the overall actual stock price of Wesfarmers, Which could be used as an adequate benchmark for making investment decisions. Some researchers mentioned that the use of dividend discount model mainly allows investors to identify the risk involved in investments, which could be mitigated by taking adequate investment decisions (“Norman et al.,” 2013).
Comparing company’s current share price with other analysis conducted on the performance of Wesfarmers:
Mainly helps in depicting the share price of Wesfarmers from 2005 to 2015, which gradually increased with the increment of its profits. The overall financial condition of the company during 2005 was relatively weak then in comparison 2015, where its share price is currently traded at 40. Moreover, the Growth in share price mainly increased from 2009, after the end of the financial crisis, which declined the overall performance of the company and reduced its net income. The performance of the company according to the share price relative is increased when it was providing higher dividends and obtaining higher net income each year. This mainly boosted the returns that might be provided from investments in Wesfarmers, which increased the demand among investors and inflated the prices. During 2015 view all share price of the company declined due to the reduction profits that was obtained from operations. This only indicates that the share price of the company adequately depicts the overall financial position of Wesfarmers and demand of the investors (“Boppart” 2014).
From the evaluation of figure 8, returns provided by Wesfarmers from 2005 to 2015 could be identified. Aggregate returns could be identified from the figure which was provided by Wesfarmers until the 2008 crisis where returns were provided more than 10% and less than 12%. This overall volatility in returns indicates that the financial position and condition of Wesfarmers was not adequate, which rapidly increase the risk of investment. This reduction in returns indicated the overall financial incapability of the company to support its future growth, which was anticipated by the investors. Hence, the returns provided by Wesfarmers mainly indicate the overall profits, which could be reduced from investment due to increased volatility (“Zheng and Yongbin” 2014).
Identifying the areas of cash flow that needs to be analysed by Wesfarmers:
The relevant areas that need to be analysed by Wesfarmers for improving the overall cash flow and increasing its ability to attain more profits are depicted as follows.
Cash flow from financing activities:
The overall cash flow from financing activities has relatively increased over the period of 10 years, which has affected the net change in cash and free cash flow of Wesfarmers. These overall financing activities of the company could be checked for reducing the whole cash outflow and retaining cash to sustain business activities. The majority of Cash outflows are mainly conducted by the purchase of treasury stock and cash dividend. Therefore, adequate measures need to be taken by Wesfarmers to control its rising financing cost.
Cash Flow from Investing Activities:
Moreover, other cash outflows that need to be considered by Wesfarmers is from the net cash used for investing activities. The company has been readily investing in plant, property and equipment for increasing the overall operational capability. Therefore, adequate measures need to be conducted for reducing the investments in fixed assets, as it might block the essential capital to continue with its operations. Hence, control over the net cash investing activities could be conducted by Wesfarmers for controlling its cash outflow.
Raw Materials:
Lastly, the major cash outflow that is conducted by Wesfarmers is from the raw material purchases that are conducted to support its business. The overall expenses on raw materials have not declined since 2008, where with every increment in revenue, raw material expenses also increased proportionately. Therefore, adequate measures need to be conducted by Wesfarmers for reducing the expenses in raw materials, which might help in controlling the cash outflows and increasing the net profit. Thus, Wesfarmers needs to develop an adequate plan, which might help in reducing the excess expenses conducted in the raw material purchase.
Producing relevant investment and financing strategies that could improve Wesfarmers cash flow:
There are a relevant investment and financing strategies that could be adopted by Wesfarmers to increase the cash inflow and reduce cash outflow. The overall strategy certificate as follows, which could help Wesfarmers improve its financial condition.
Reduction in Administrative expenses:
The overall expenses that are conducted by Wesfarmers on administration could be reduced for effectively declining the cash outflow conducted by the company. This could eventually help in minimising the expenses and improving is for all that profits. Furthermore, the financing cost could also be reduced by Wesfarmers effectively for contracting the overall cash outflow. Therefore, controlling the administrative expenses and reducing non-significant cost could eventually help Wesfarmers decline its overall cash outflow.
Adoption of advanced machinery for reducing costs:
The second option that could be used by Wesfarmers is involvement of advanced machinery, which could help in reducing the costs that are included and its operations. Furthermore, the strategy would eventually help Wesfarmers in reducing overall expenses, while increasing its supply capability, which could help in supporting the increasing demands of the consumer. Therefore, the overall increment in operations could eventually help Wesfarmers attain higher revenue and reduce the overall expenses incurred from operations.
Adoption of Zero-based budgeting strategy:
The third financing activities that could be used by Wesfarmers are the adoption of Zero Based Budgeting strategy. This strategy could eventually help Wesfarmers in improving the overall income by reducing or controlling overall expenses conducted on operations. The use of zero-based budgeting could eventually help Wesfarmers in identifying the activities that contribute to the revenue generation stream, whereas it rejects all the activities that do not contribute to the revenue stream. This major could eventually help the company in controlling as cash outflow and improving overall net profits.
Justifying the overall recommendations in term of shareholders wealth maximisation:
The overall recommendations, which is mainly be provided to Wesfarmers is relatively supported by shareholders wealth maximisation, as it might help in increasing the overall net profits and raise its dividend payment. This overall improvement in the financial condition of Wesfarmers could eventually help shareholders to attain higher return from the investment. In addition, the overall recommendation is focused on increasing or enhancing the performance and financial condition of Wesfarmers. This overall focus being concentrated only in improving the performance by reducing expenses of Wesfarmers could eventually increase the return that might be provided by the company. Therefore, it could be understood that recommendations are focused on increasing financial performance of Wesfarmers, which in turn supports the overall shareholder's wealth maximisation.
Shareholder wealth maximisation is mainly conducted by managers to increase the overall stock price value of its organisation by implementing relevant measures, which could maximise the wealth of their firm. These measures could effectively increase the firm wealth, which might help in boosting the stock prices and net worth of individuals who owns the stocks. Therefore it could be stated that the recommendations provided for West, could effectively increase shareholders wealth and support its future and endeavours.
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"Wesfarmers.Com.Au". 2017. Wesfarmers.Com.Au. Accessed June 20 2017. https://www.wesfarmers.com.au/.
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