Section C - Financial Analysis (50 MARKS)
Part A: Analyzing the Companies using Financial Statements
Construct and present each company's common sized income statements and common sized balance sheets for the past three years.
Calculate the gross profit margin, operating profit margin (EBIT margin) and net profit margin for the three-year period. Calculate year over year percentage change in these profit measures. What is the trend for your companies? Does it suggest that the companies are in a fast growth or slow growth pattern?
Calculate their Revenue, Gross Profit (or Operating Profit) and Net profit growth during this three-year period. What is the three year compound annual growth rate for each company? Compare and contrast the two companies and discuss how this will impact your investment decision. Remember to discuss and analyze your results - don't just say the companies are in good/bad conditions. (6 MARKS)
Part B: Analyzing the Companies using Financial Ratios
Calculate and compare financial ratios for each company in the categories as follows:
- Liquidity
- Leverage/Coverage
- Activity
- Profitability
- Market Ratios. This is the most important section. Once you have analyzed the first four sets of ratios, you should have a sense of which company is in a better operating position. Now you must determine whether the company is 'cheap' or 'expensive' based on the market ratios.
Present the ratio analysis in tables - so the reader is able to easily understand your analysis that will follow.
For example: Liquidity Ratios:
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Company A
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Company B
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Current ratio
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2.3x
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4.5x
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Quick ratio
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1.7x
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3.6x
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Etc.
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Etc.
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Analysis of Liquidity Ratios: Company B's main liquidity ratios are much higher than those of company A's because reason 1, reason 2, reason 3...Do not just repeat the numbers in the Analysis section! You must determine the reasons for the differences.
The most relevant ratios to be used in your analysis depend on your understanding of your companies. For example inventory would be a key ratio in the retail sector; it would be of little value in an analysis of the movie theatre business. Thus, the ratios you use should be the ones that are most relevant in helping you understand and assess your companies.
You will need to present your analysis on five different categories of ratios separately.