Comparative Analysis of Financial Statements Between Two Companies free essay sample

The company with lower ratio, Reed Elsevier in our case, has higher debt burden. Even though it was much lower than competitor’s ratio, Reed Elsevier does not have difficulties generating the necessary cash to pay its interest obligations. The consistency of earnings is tremendously important in this case. If the interest coverage ratio would be below 1. 0, it would signal that the business is having difficulties generating cash to cover its obligations. Net Income from Continuing Operation After all of the expenses are deducted, the company is left with a figure called net income from continuing operations. This is a calculation of the profit from its continuing operations generated during the period. If we look at net income from continuing operations of Reed Elsevier, we can see increase by 302m due to increase in finance income, and disposal and other non-operating items. Net income from continuing operating of Thompson Corporation has also increased by 184m due to considerable decrease in net interest expense and other financing costs. Gross Profit Margin Gross profit margin will help us to understand company’s manufacturing and distribution efficiency during the production process. Gross Profit divided byTotal Revenue Reed Elsevier: 4,322 / 6,693 = 0. 6 Thomson Corporation: 2,021 / 7,296 = 0. 3 Reed Elsevier has a higher profit margin than Thomson and therefore appears to be more efficient. However, the information for Thomson is not as accurate as it should as the amount for Cost of Sales includes marketing and administrative expenses. Operating Margin Lets look at yet another indicator of management’s efficiency in these two companies and that’s is operating margin. Operating margin for the Thompson Corporation: 1,297 / 7,296 = 0. 7 Operating margin for Reed Elsevier: 1,296 / 6,693 = 0. 19 The operating margin of Reed Elsevier is a little bit higher, which means the company has lower fixed costs and a better gross margin. It gives company’s management more flexibility in determining prices and also provides an added measure of safety during tough economic times. Interest coverage ratio To better understand company’s short-term financial health, we can calculate interest coverage ratio for each of these corporations: Thompson Corporation has the following ratio: 1,263 / 167 = 7. 5 Reed Elsevier: 1,388 / 203= 6. The interest coverage ratio of Reed Elsevier is lower than that of Thompson’s. The company with lower ratio, Reed Elsevier in our case, has higher debt burden. Even though it was much lower than competitor’s ratio, Reed Elsevier does not have difficulties generating the necessary cash to pay its interest obligations. The consistency of earnings is tremendously important in this case. If the interest coverage ratio would be below 1. 0, it would signal that the business is having difficulties generating cash to cover its obligations. Net Income from Continuing Operation After all of the expenses are deducted, the company is left with a figure called net income from continuing operations. This is a calculation of the profit from its continuing operations generated during the period. If we look at net income from continuing operations of Reed Elsevier, we can see increase by 302m due to increase in finance income, and disposal and other non-operating items. Net income from continuing operating of Thompson Corporation has also increased by 184m due to considerable decrease in net interest expense and other financing costs. Net Income from Discontinued Operations? The amount shown on the income statement under discontinued operations is the profit made during the period from the businesses that will not be a part of the company in the future. The net profit for the year of Reed Elsevier is higher almost by 50% due to the profit made from discontinued operations. The net profit of the Thompson Corporation has also grown by almost 4 times, which is also due mostly to the earnings from discontinued operations. Net Profit Margin Now let’s see how much profit a company makes for every $ 1 it generates in revenue. Profit margins vary by industry, but all else being equal, the higher a company’s profit margin compared to its competitors, the better. Reed Elsevier: 1,713 / 6,693= 0. 26 Thompson: 1,096 / 7,296 = 0. 15 Return on Equity (ROE) One of the most important profitability metrics is return on equity. Return on equity reveals how much profit a company earned in comparison to the total amount of shareholder equity. It’s what the shareholders â€Å"own†. A business that has a high return on equity is more likely to be one that is capable of generating cash internally. For the most part, the higher a company’s return on equity compared to its industry, the better. Let’s calculate ROE for Thomson: the earnings for 2007 were 4,004, and the average shareholder equity for the period is 13,571, thus ROE= 4,004 / 13,571 = 0. 29 ROE for the Reed Elsevier: the earning for 2007 were 1,713. The total shareholder equity for the period is 4,032, therefore the ROE = 1,713 / 4,032 = 0. 42 *** Cash flow statement As another major component of the financial statement, cash flow statement reflects the cash and cash equivalent flows of an entity. Here we observe the two companies’ cash flow statement in detail. On Reed Elsevier, the cash flow is shown as below, which indicates the cash sources and uses from operating activities, investing activities, and financing activities. Cash Flow Statement – Reed Elsevier (Euro) By 31 December 2007, total net cash generated from operating activities amounted to 1,213m, after deducting tax and interest payments. However, the net cash from operating activities dropped by 93m against fiscal year 2006. We also see a positive status of cash flow as there was huge cash inflows of 2,674m from discontinued operations, resulting from selling off a major business segment of higher education (Harcourt Education). This facilitates the company’s focus on professional research field and also supports the company for further acquisition and development. With this additional source of cash, we have seen tremendous growth in the increase of cash and cash equivalents to 3,355m at the end of 2007. ### On Thomson Corporation: In the same Accounting period, total cash generated from operating activities in 2007 decreased by 309m, while at the same time, Thomson also made decisions on disposal of specific business units (law), thus generated huge amount of cash flows by 7,151m. In a similar scenario like Reed Elsevier, Thomson obtained tremendous amount of cash flow from disposal of business units, and we have good reasons to speculate the company will have big moves on acquisition or on investing. (Actual result: in 2008, Thomson acquired Reuters and strengthened its position in information industry. ) Cash Flow Statement – Thomson (US Dollars) Cash flow is a crucial financial indicator to show a company’s profitability and solvency. Lack of cash can be a big obstacle for the growth, but oversized cash flow can also be a burden if the company does not use it properly. *** Balance sheet Balance Sheet Reed Elsevier (Euro) Balance Sheet – Thomson (U. S dollars) The main purpose of balance sheet is to determine if a company is financially strong and economically efficient. Balance sheet tells us how much money the company has, how much it owes, and what is left for the stockholders. When looking at a company’s current assets, we need to pay special attention to the inventory. Inventory consists of merchandise that a company owns but has not sold. However, it can be sold in the near future, and can be turned into cash. But we also know that when inventory piles up, it faces two major risks. The first is the risks of obsolesce and another one is the risk of spoilage. Spoilage occurs when a product goes bad, this is a serious concern for companies that make or sell perishable goods. Since the companies in questions are providers of scientific, technical and medical information and solutions, it can not face the risk of spoilage however can be subjected to obsolesce, it actually loses value as time passes. Information provided by these companies needs to be constantly updated to keep up with technological advances. Thus, the faster a company sells its inventory, the smaller the risk of value loss. When we look at company’s balance sheet and make an informed decision about how much the inventory worth, we should base this decision on how fast the inventory is turned. We should divide current years cost of goods sold by average inventory for the period. Read Elsevier: 2371: ((368+943)/2) = 3. 6 It means Read Elsevier sells its entire inventory 3. 6 times a year. We do not know if it is a good indicator unless we compare it with the result for company’s competitor. Thompson Corporation has not inventory declared on its balance sheet. Reeds Elsevier clears its inventory 6. 3 times per year 365:6. = 101 days Working Capital Why do we need to know about working capital of a company? Because it reveals more about the financial condition of a business than almost any other calculation do. It tells us what would be left if a company raised all of its short-term resources, and used them to pay off its short term liabilities. The more working capital, the less financial str ain a company experiences. If company has enough working capital, we can clearly see if it has resources necessary to expand internally, or it has to turn to a bank for loan. Current assets – current liabilities= working capital Reed Elsevier: 5,570-5,260=310 Thomson: 9,678-3,239 = 6,439 Thomson’s working capital is much higher than the one of Reed Elsevier’s. Poor capital leads to financial pressure on a company borrowing and late payments to creditor. Current ratio Current ratio is another indicator of a company’s financial strength. It calculates how many dollars in assets are likely to be converted to cash within one year in order to pay debts that come due during the same year. Total current assets / total current liabilities = current ratio Reed Elsevier: 5,570 / 5,260 =1. 06 Thomson: 9,678 / 3,239 =2. 9 For most companies, 1. 5 is an acceptable current ratio. As the number approaches or falls below 1 (which means the company has a negative working capital), you will need to take a close look at the business and make sure there are no liquidity issues. Thomson has higher current ratio which reiterates its financial strength. *** Final thought All our calculations and observations i ndicate that both companies have no risk of bankruptcy. Reed Elsevier has acceptable current ratio, and Thomson’s current ratio is quite strong. Both companies have enough working capital. Even though both companies do not have financial issues, Thompson’s financial position appears to be stronger based on calculated ratios. Another interest trend we spotted is that both companies are working to repositioning, by disposing less profitable or strategically poor performing business units. With huge amount of cash at hand, both companies are looking for acquisitions to strengthen their competitiveness in respective fields. We should have enough reason to see future acquisitions or restructuring happening at the companies. Appendix Major Financial ratios Note: Due to the unavailability of some necessary data like share price at certain time, number of common shares at certain time, and tax rate, etc. , the ratios of P/E ratio, ROA are not available. ) 4Net income1713. 00 ROE (Return on shareholders euqity)0. 42 Net income4004. 00ROE (Return on shareholders euqity)0. 29 Shareholders equity4032. 00 Shareholders equity13571. 00 The shareholders equity in Reed is 4032 pound and the shareholders equity of Thomson is 13571 USD. If only compare these two numvers, it is obvious that Thomson shareholders investment is higher than Reeds.