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Financial Comparison Between Two Companies, Case Study Example

Pages: 6

Words: 1718

Case Study

Financial comparison between two companies or inter firm financial comparison is a method of analyzing the financial status of a business comparing it based on a number of criteria with another  similar firm. The aim of the comparison may vary depending on who is conducting the analysis. For example, the management may want to compare their firm’s performance with other firms in order to establish their weaknesses and therefore improve on them or establish a competitor’s weakness and therefore capitalize on it. An investor on the other hand may want to compare two firms in order for him to invest in the best company that will offer him good return for his investment.

There are various issues that one needs to look at when comparing financial performance of two companies. Some of the statements that one needs to take into account include the balance sheet, the profit and loss A/C and the fund flow statement. However the above three statements might not make any since in their low form since the companies being compared may be of different sizes. Furthermore the fact that a large company makes a huge profit does not mean that it has performed better than a smaller company in the same industry but with a smaller amount of profit. Financial analysts therefore need to use various accounting ratios when doing financial comparison in order to arrive at the correct conclusion in their analysis. The ratios include income ratios, profitability ratios, liquidity ratios, working capital, bankruptcy, coverage and leverage ratios among others (Eric, 1999).

This paper tries to compare the financial performance of two multinational vehicle manufacturing companies’ namely Universal motor manufacturers and Global Automobiles Company for the financial year 2008. I will also give my recommendations on what the companies should do to improve on their financial performance based on my analysis. Universal motor manufacturers are based in the United States of America while Global automobiles are based in the United Kingdom. Both the companies manufacture all types of vehicles. My analysis will be based on their financial results as outlined below.

The other information available forth above companies is that universal motor manufacturers limited has 1000 shareholders who own a total of 10 million shares in the company. Global Automobiles Company on the other hand has 700 shareholders who own a total of 5 million shares in the company. During the year 2006, universal motor manufacturers limited sold a total of 60000 units while global automobiles sold a total of 70000 units.

From the information above the following ratios can be deduced.

Income ratios

Turnover of total operating assets

Turnover of total operating assets ratio=total sales/total operating assets

For universal motor manufacturers limited, the ratio =176558/36877=4.8

For global automobiles company the ratio would be=177260/32899=5.4.

Net sales to tangible net worth

Net sales to tangible net worth=net sales/tangible net worth.

For universal motor manufacturers limited the ratio =176558/12117=14.5

For global automobiles limited the ratio would be=177260/13566=13

Gross margin on net sales-this is gross margin /net sales

Universal motor manufacturers-gross margin on net sales ratio=49749/176558=0.28

Global automobiles limited-gross margin on net sales ratio=33410/177260=0.19

Operating income to net sales ratio-this is operating income/net sales

Universal motor manufacturers limited-operating income on net sales ratio=16697/176558=0.09

Global automobiles company-operating income on net sales ratio=9108/1777260=0.05

Profitability ratios

The ratios seek to establish the overall effectiveness of management as far as returns generated on sales and investments are concerned. One such ratio is gross profit on net sales ratio which is gross profit/net sales. For universal motor company limited the ratio is 49749/176558 or0.28 while that of global automobiles limited is 33410/177260 or0.19.

Net profit on net sales ratio. This is the ratio between earnings after tax and net sales. Universal motor company had a net profit ratio of 5929/176558 or 0.03 while global automobiles had a ratio of 750/177260 or 0.004.

Liquidity ratios –these ratios help in determining the company’s liquidity position and therefore the ability to settle its obligations. One such ratio is the current ratio which is the ratio between the current assets and current liabilities i.e. current assets/current liabilities. For the year 2006 universal motors company had a current ratio of 36877/57362 or 0.64 while global automobiles limited had a current ratio of 32899/54434 or 0.60.

Current debt to net worth ratio-this ratio compares the relationship between the invested capital and borrowed fund. The amount of debt should not exceed the owners’ equity. The ratio is calculated by dividing current liabilities with tangible net worth of a firm. In this case, universal motor company had a current debt to net worth ratio of 12117/57362 or 0.21 while global automobiles had a ratio of 0.24.

Earnings per share

The two companies though being in similar business did not perform in the same manner. The sole purposes for investing in a company would be to earn dividends or at least get a capital gain. Hence a company whose earnings per share is higher would be better in the eyes of the shareholder as compared to that whose earning per share is less. For the year 2006, universal motor company had an earning per share of 592.9 while global automobiles had an earning per share of 150 (Leopold & John, 2000).

According to the financial analysis above, both companies are performing well. However their profitability is not the same especially when the profitability is compared with the annual revenue. However in the overall performance, universal motor company seem to be doing better even though its annual revenue is lower than that of global automobiles limited however both companies have areas which they could take advantage of in order to improve their financial performance. Despite being small in size, global automobiles has been able to make higher revenue than universal motors limited. However its efficiency or its ability to turn the large revenue into profits is questionable bearing in mind that the company made a very small profit compared with the amount of sales made. Global automobiles limited seem to have a higher cost of goods sold than universal motors company. Consequently, this is reflected in its level off gross profit. Similarly, Global automobiles limited seem to have very many expenses which affect its profitability as compared to universal motors company (Daniel, 1997).

What the companies should do in order to improve their financial performance:

Global automobiles limited

The company seems to be doing well as far as making sales is concerned. This means that more effort should now be focused on cost cutting measures so that the high sales can lead to high profits in turn. The cost cutting measures should be employed both at acquiring goods for sale and also on other expenses that are incurred by the company. The company could employ some of the following measures in order to cut costs.

Reducing the cost of production

The company should come up with ways of reducing the cost of production without compromising on the quality of the vehicles it produces. For instance the company can make use of locally available raw materials instead of importing the materials. Similarly the company could reduce the number of workers involved directly with production provided this does not have a negative effect on the quality of vehicles produced. The company could also talk with employees to accept wage cuts though this might be difficult especially in this era of trade unions.

Reducing the amount of general expenses

The company should come up with ways of reducing the general expenses as they form a very big part of expenses and have a negative effect on the company’s profitability. The company should reduce its advertising budget and concentrate more on quality .The Company should also study its costs structures and come up with the costs to be cut. However any reduction in expenses should not have a negative effect on its profitability.

Cutting the cost on interest expense         

As can be seen from the statements debts form a very big part of the company’s liability. Consequently, the amount of interest paid is also very big. The company should come up with ways of reducing the amount of interest paid by converting some of the debt into shares or clearing some of the debt.

Acquiring new capital

Given that the company is able to make a lot of sales, it should acquire more capital which should be used in research. This research will help the company cut down on production costs, improve on the quality of units produced and open new markets for its products in a bid to boost sales and consequently the profits.

Universal motor company

The company did not make more sales as compared to global automobiles limited and therefore, it has a higher efficiency. It should capitalize on its efficiency in order to improve its financial stability. The company could employ some of the following measures in order to improve its financial position.

Market research and advertisement

The company should to take advantage of the fact that it seems to be more efficient as compared to global automobiles limited to improve on its sales and consequently its profitability. The company should invest more on market research and advertisement with a view to open up new markets, increase in the number of units sold and thereby boost its financial position by improving on its profitability. Research should also be geared towards improving the quality of units produced. This wills in turn impact positively on customer confidence. The customers will responds by increasing their purchases .this will increase the company’s profitability level and hence its financial position will improve. By improving on the quality, the company could also increase the price per unit of each vehicle it offers to the market thereby increasing the profit margin (Peter & Eddie, 1997).

Reduction of interest expense

Similar to global automobiles limited the company also seems to be using a very big amount of money in paying out interest for the debt it owes. The company should therefore look for ways of minimizing interest expense and thereby improve on its level of profit. This should be done by either clearing the debts or converting some of it into capital.

In conclusion both companies need to cut on their production costs and cut on their interest expense in order to improve on their profitability and therefore improve their financial position.

References

Peter, A. & Eddie, M. (1997). Accounting and Finance for Non-Specialists. London: Prentice Hall.

Leopold, B. & John, W. (2000). Analysis of Financial Statements.  New York: McGraw-Hill.

Daniel, L. (1997). Advanced Accounting. New York: McGraw-Hill College Publishing.

Eric, P. (1999). Analyzing Financial Statements. Michigan: Lebahar-Friedman.

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