Impact Of Liquidity Ratio On Profitability - MyAssignmenthelp.com

Question: Discuss about the Impact Of Liquidity Ratio On Profitability. Answer: Introduction Telstra Corporation Limited is a leading telecommunications and technology company operating in Australia. The company builds telecommunication networks and provide product and services like mobile, internet access, pay television and many other. It provides 17.4 million mobile services, 6.8 million fixed voice services and 3.5 million retail fixed broadband services. The vision and mission of the company is to connect more and more people and to provide them more opportunities. For this, the company build simple and easy to use technology and content solutions, making it the largest national mobile network of Australia ("Telstra", 2018). Telstra was previously originated with the Australia Post as a government department but now it is fully privatized. The CEO of the company is now focusing to make the company more consumer focused by undergoing a change program. In August 2011, Telstra announces to expand its customer services to social media having 24/7 coverage. By the end of November 2012, the company enjoys the increase in its live chats and the growth rate of this service has also increased to a great extent ("Telstra", 2018). As of 2016, the company owns about 360 retail stores and more than 300 stores are equipped with low energy Bluetooth beacons. After the privatization, the shares of Telstra has risen to $5 per share in December 2013 to $6 per share in December 2014. The company is listed on Australian Stock Exchange (ASX) and traded as ASX: TLS. The company is looking forward to extend its growth in the international markets under the new CEO Andy Penn ("Telstra - Investors", 2018). Income statement The income statement also known as statement of performance, is prepared to measure the amount of profit created by the company. It also provides users with an idea about the profitability of a concern (Buckland Davis, 2016). Profit and loss is basically the difference between the total income and total expense. If the difference is positive, it is profit and if it is negative, there is a loss. A financial profit shows an increase in the owners equity and a loss shows a decrease in the same. Income means earning benefits through reduction in liabilities or inflow of assets (Hussey, 2011). Figure 1: Total net income or loss for the year ending 2013-2017 The summary of income statement (Appendix 1.1) shows the data of Telstra Corporation for the financial year starting from 2013 to 2017. During the first two years, it can be seen that the profit has increased by $684 million. In financial year 2015, the trend reversed and profit started decreased by $263 and continues to decline by approx. 17% in FY 2016 and 2017, as compare to the percentage change in FY 2014. The maximum profit earned was in FY 2014, $4,549 (Figure 1). Figure 2: Sales revenue, COGS and Gross margin comparison Ideally, to run a healthy business, the % increase in the sales should be greater than than the % increase in expenses including cost of sales (Charifzadeh Taschner, 2017). Taking the data from the horizontal analysis of income statement (Appendix 1.2) and keeping 2013 as base year, it can be seen that there has been an increase in the sales from -1.50% to 1.34% in year 2014-2015 followed by a rise in COGS from 1.20% to 7.04%, as a result of which, gross profit has declined $18,975 in FY2015 as compare to that of $19.084 in 2013. The same trend continues in the subsequent years and profit tends to declines. The vertical analysis (Appendix 1.3), shows that the gross profit margin as a percentage of sales was almost constant from the year 2013-2016. Later it decreases to 57.71% in 2017. COGS keeps on increasing from 25.17% in 2013 to 42.29% in 2017. An increase in administrartive cost as a percentage of sales revenue is reported during the period whereas other operating expenese reduces during 2013-2017, with lowest of 7.07% in 2017. A fluctuating trend has been noticed in the net income of the company. The income as a % of sales increases to 18.11% in 2014 and then tends to decraese in following years. in 2017, net icome was 14.95% of sales revenue. Figure 3: selected factors as a percentage of sales Balance sheet The sheet of balances is also known as statement of financial position. It represents the financial position of the company in the market for a given period of time. It shows all the assets and liabilities owned by the organization (Woolf Hindson, 2011). Analysing Telstras balance sheet for FY 2013-2017, it can be said that the total assets has increased over the period but a decrease is also there in FY 2017 $42,133 as compare to the previous four years. Total liabilities and total equities both have increased throughout the period. Liabilities from $ 25,916 to $ 27,592 and equities from $12,611 to $14,541 (Figure 4, Appendix 1.4) Figure 4: Total Assets, liabilities, and equities comparison In FY 2014, current assets were 26.52% of total assets and by the end of 2017, they made up 18.66% of total assets. On the other hand, in FY 2015, non-current assets were 82.77% of total assets which reduces to 81.34% in FY 2017 (Figure 5 a, Apeendix 1.6). The reason for this large percentage is the incresase in the proportion of assets used for property, plant and equipment and also the increased goodwill (Figure 5 b) Figure 5: Selected Factors as % of Total Assets (a) Figure 5: Selected Factors as % of Total Assets (b) The reason for the increase in total liabilities over the period is the rise in current liabilities including deferred revenues, short trem borrowings and other current liabilities. Total equities has also increased in proportion to total assets. In FY 2013, equities were $12,611 (32.73%), which gradually increased to $14,541 (34.51%) in FY 2017. Constant increase in retained earnings and less fluctuation in value of common stock is the reason for increased equities (Figure 6). Figure 6: Change in Total Liabilities and Equities (%) Cash Flow Statement It is the statement which shows total cash inflows and total cash outflows of the company. It gives an idea about the companys cash movements for a particular time period (Vogel, 2014). Apart from examining the profit and loss statement and balance sheet of Talestra Ltd., it is also necessary to examine and evaluate its cash flow satement, just to know about the cash position of the company and the problems related to it, if any. Cash Flow from Operating Activities It is the net flow of cash from companys operations. Telstras operating cash flow had fluctuated to great extent. In FY 2014, it was $8,613 which was more than $8,359 of 2013. After that it continues to fall in subsequent years and reported at $7,775 in FY 2017. Cash Flow from Investing Activities Investing activities shows negative cash flow over the period of five years. Large variations can be seen as in 2014, net cash used was $1,130 and it boost up to $5,692 in FY 2015. Then, again it reduces in 2016 and increases in 2017 at $4,279. The reasons for these variations are increase in the investments in plant and property and purchase of intangibles throughout the year. The sale proceeds of intangibles and investment are compartive less. Net cash inflow/outflow The result of companys cashflow activities comprises the net cash inflow and outflow. In FY 2014, it has increased from negative -$1,466 to positive $3,048. However, the trend changes in 2015 and net cash become negative -$4,131. It again became positive in 2016 and then in 2017, it became negative -$2,614. The fluctuations in the cashflow activities are the result for these variations. Financial Ratio Analysis Profitability ratios Return on assets (ROA) It is a ratio which gives an idea about how efficiently, a company is using its assets to make revenue. It is calculated by dividing net income with companys total assets (Barman Sengupta, 2017). Referring to (Appendix 1.9, Figure 7), it can be seen that ROA of Telstra has been compared to ROA of Queste communications Ltd. Telstras ROA has dropped from 10.98% to 10.60% during FY 2014-2015. It again increases to 13.81% in year 2016 and then reduces to 9.11% in year 2017. This fluctuation and reduction in FY 2017, shows that the company is not able to produce more revenue from its assets as it is less efficient in managing them. On the other hand, ROA of Queste remain negative throughout the period. In FY 2014, it was -7.27% and in 2017 is was -20.67%. Figure 7: ROA Return on Equity The ROE of Telstra was almost same fo year 2014 and 2016, whereas it was highest in 2017 at 25.72% (figure 8). In comparision to this, Questes ROE was negative in all the years. in FY 2014 and 2016, it was almost same and in 2017 it was -21.97%, highest among all (Appendix 1.9). Figure8: ROE Efficiency ratios These ratios indicate how effectively and efficiently company manages its assets and liabilities. They are used to measure companys short term performance (Jordan, 2014). A comparison of all the efficiency ratios between Telstra and Queste is done in Appendix 1.10. Asset turnover ratio (figure 9) of Telstra remains constant at 0.17% for the time period 2014-2016 and in 2017 it increases to 0.26%. It is said that, higher the ratio, the more a company make sales with use of its assets. That is why, I high asset turnover ratio is preferred, depending upon the type of industries (Jenter Lewellen, 2015). Increase in the ratio in 2017, shows that the company became more efficient in sense of utilizing its assets to create revenue. Inventory turnover ratio indicates the number of times, the inventory is sold or replaced during a given period of time. The Telstras ITR has fallen over the period of five years. In FY 2013, it was 16.38% which reduces to 15.11% in FY 2017. This requires the company to increase the volume of inventories in order to extend its business (figure 9). Debtor turnover ratio also known as receivable turnover ratio, directly influences the liability of the company. Usually, a high DTR is better because it indicates that the company is very much effective in its debtor collection. A low DTR shows ineffectiveness in collection (Penman, et.al. 2017). Telstras DTR has increased throughout the period from 0.96 to 1.07, which means the company is collecting its receivables timely and effectively. On the other hand, Questes DTR is comparatively low that is 0.54 in 2014 and 0.65 in 2017. Creditor turnover ratio of Telstra remains almost same in year 2014-2016 and it increases to 8.27% in year 2017. Questes CTR is negative during the five years, -0.05 in 2014 to -0.12 in 2017. Liquidity ratios The ratios represents the liquidity of the company. It is very necessary for the company to have enough liquid resources to meet its short term obligations (Tracy, 2012). A comparison of liquidity ratios between two companies is shown in Appendix 1.11. Figure 10 (a): Liquidity ratios The current ratio represents comparision of businesss current assets with current laibilities. Ideal current ratio is 2:1. A high ratio indicates more liquidity in the business and vice-versa (Periasamy, 2009).The CR of Telstra is highest at 1.20 in 2014 and lowest at 0.86 in 2017. Although the CR of 2017 and 2015 is same (figure 10 a). In contrast, Questes CR is highest at 11.78 in 2013 and lowest at 1.63 in 2017. It has constantly reduced during the period. In terms of this, Queste is more liquid than Telstra (figure 10 b). The quick ratio means excluding inventory and prepaid expenses and the ideal is 1.1 (Saleem Rehman, 2011). Telstra QR was 1.12 in 2014 which declined to 0.70 in 2017, whereas QR of Queste was 11.35 in 2013 and for subsequent years it was same as the current ratio because of absence of inventory value. Capital structure ratio Capital structure or gearing ratio (Appendix 1.12) helps the company in determining the level of risk and long term solvency. If the portion of debt is too high then there will be a risk for business, to become insolvent (Levi Segal, 2015). The summary of capital structure ratios is given in Appendix 1.12. Debt to equity ratio, Debt ratio and Equity ratios shows the extent to which company has raised funds through outsiders. It is an important factor to be considered while assessing the risk. Analysis shows that D/E ratio of Telstra has reduced from 2.06% to 1.90% over the period. The debt ratio stands at 0.67% in 2013 to 0.65% in 2017. Equity ratio has also increased from 0.33% to 0.35% D/E ratio of Queste has almost remain same during the years except in 2017, where it was 0.10%. Debt ratio has risen from 0.4% to 0.9% and equity ratio has decreased during the period from 0.96% to 0.91%. The portion of debt is more in Queste as compare to Telstra. Conclusion The report concludes that the financial analysis of Telstra Corporation Ltd. for years 2013-2017, represents significant changes in the performance and position of the company. Sales has grown over the period as it was highest $25,912 in 2017 with the increased COGS of $10,958 in same year, resulting in decreasing gross profit margin. Total assets and liabilities both have increased during this period which results in declining net profit. The companys cash flow statement has also shown negative cash flows in year 2013, 2015 and 2017, indicating the state of companys liquidity and solvency. Ratio analysis is been used to measure the overall performance of Telstra comparing to Queste Communications Ltd. Profitability, efficiency, liquidity and capital structure ratios are used to investigate about the companys financial performance. Overall it is concluded that, Telstra is performing pretty well as compare to Queste and is more efficient and effective in terms of earning profits. References About Us. (2018).Queste.com.au. Retrieved 13 January 2018, from https://www.queste.com.au/about-us Barman, A.N. Sengupta, P.P., (2017). DETERMINANTS OF PROFITABILITY IN INDIAN TELECOM INDUSTRY USING FINANCIAL RATIO ANALYSIS.International Journal of Research in Management Social Science, p.25. Buckland, R., Davis, E. W. (Eds.). (2016).Finance for growing enterprises. Routledge. Charifzadeh, M., Taschner, A. 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