Financial Management Theory and Practice, Essay Example

Financial Analysis

The financial statement analysis is a crucial element in the assessment and evaluation of the financial position of a certain company over a specified period of time. The financial ratios are the most commonly used tool for the evaluation. To understand the crucial application of the financial ratios, we shall focus on the performance of the Eerie company and compare the performance regarding the return on sales, return asset and return on equity and the explanation of how financial leverage explains the difference between the return on assets and return on equity.

Return on Sales (Profit Margin)

The ratio expresses the relationship between the net incomes to the sales revenue generated by the company in a given year. Looking into the use of performance indicators through the return of sales goes a long way in establishing the effectiveness of the company in subject. The comparison regarding the return on sales is indicated in the fourth round (2021), Eerie has a return on sales of 5.2% which is lower than that of Andrews (8.6%). In the fifth round (2022), Eerie has a return on sales of 10.5% which is above Andrew’s (7. 6%).In the sixth round (2023), Andrews’s profit margin is 4.8% whereas that of Eerie is 15.3%.

Table1

In 2021, Andrew had higher value of ROS than Eerie because he might have made more amount of net sales as compared to the cost incurred on sales, hence leading to larger amount of the gross profit (GP). However, in 2023 there is a change in market trend whereby Eerie derives 15.4% and Andrew 4.8%. Also, there is a noted decrease in Andrew’s return of sales throughout the three years, while there is an increase in those of Eerie throughout the period. One of the main factors that may have contributed to the change in return of sales is in an increase or decrease in prices. Andrew’s price point may have led to a decrease in its profit margining while that of Eerie may have led to its increase. Other impacting factors include the companies’ inventories, variable business costs, as well as fixed business costs of the two companies, in which Erie’s can have proved to be better that of Andrews.

The following is the comparison of profit margin of Eerie Company with its competitors

Table2

In table 2 above, the profit margin depends on the company’s gross profit and its net sales. For example, Eerie derived 5.55% ROS as compared to Andrew with 3.32%. The reason behind this might be due to Eerie having more net income and sales than Andrew. Also, as stated earlier, other determinant factors to put into consideration include variable business costs, price increase or decrease, inventory, variable business costs, and fixed business costs of the two companies. This shows that Eerie is performing well in the market than Andrew.

Graphical analysis

Return on Assets (ROA)

The return on assets also is a profitability ratio that provides the relationship between the net profit and total assets. The ratio is acquired through subtracting the expenses from total revenues, and then diving the figure by the cost of the assets. The company’s aggregate revenues encompass the money one gets from sales, while the expenses include variable costs and overheads such as payroll. The comparison regarding the return on asset is indicated in the fourth round (2021), where Eerie has a return on assets of 7.3% which is lower than that of Andrew’s (7.4%). In the fifth round (2022), Eerie has a return on assets of 6.0% which is lower than the Andrew’s (12.9%). In the sixth round (2023), Andrews’s profit margin is 3.7% whereas that of Eerie is 17.2%            Return on Assets.

Table3

In 2021, Andrew had more ROA (12.9%) than Eerie (7.3%), implying that Andrew derives more amount money from the value of assets invested. In 2023, Eerie derived an ROA that was 17.2% than Andrew’s (3.7%), which might be brought by Eerie acquiring a more competitive edge over Andrew.

The following is a comparison of ROA among the companies

Table4

From table 3, there is an indication of a different value of ROA for the competing companies’.

The value of ROA depends on the value or amount of assets invested by the companies. For example, Eerie (179,468) derived a 5.9% return on assets as compared to Andrew’s (137,776) which drives 2.4% ROA. However, a company like Digby invested the highest amount of assets and derived only 3.5% ROA, which may be because of introduction of disruptive innovation in the market hence increasing the level of competition.

Graphical analysis between Earie and Andrews

Return on Equity

The return on equity also is a profitability ratio that provides the relationship between the net profit and total equity. The comparison regarding the return on equity indicates the fourth round (2021), Eerie has a return on equity of 12.5% which is lower than that of Andrews (15.7%). In the fifth round (2022), Eerie has a return on sales of 19.5% which is lower than the Andrews (12.0%). In the sixth round (2023), Andrews’s profit margin is 8.4% whereas that of Eerie is 26.5%.The following is the comparison of Erie’s company return on equity with its competitors.

Table5

In 2021, Eerie had higher value of RAO than Andrew because it might have borrowed a lot of money and, therefore, has more amount of liabilities and proportionately less equity invested in the firm. Whether this is negative or positive, it solely depends on whether Eerie is using its borrowed amount of assets well. Due to some companies needing more assets than others in their regular operations, such can be the fact behind Andrew’s ROA being lower than that of Eerie.

The DuPont analysis incorporates the return on assets, the financial leverage and asset turn over. The financial leverage evaluates the amount of the firm’s asset which is financed by the shareholders through comparing the total assets with the shareholders’ equity. It also shows the level debt of financing used to acquire and maintain the company operations. It implies that the financial leverage separates the assets and those that are financed through equity and debt capital. In the DuPont model, assuming we have to determine the equity multiplier, the equity multiplier takes the component of total assets and equity. Equity multiplier = total assets/Total Equity. The higher the total assets, the more the chances of the company becoming highly levered and also, conversely, the lower leverage the company has. The fact that Andrew’s ROA has been decreasing can be an indication of the company becoming more capital-intensive. On the other hand , an increase in Eerie’s ROA may be due to the fact that the company may not have necessarily  been in need of much equipment and machinery in their operations. Companies offering services as opposed to products need to generally expect a higher percentage in their return of sales.

Stock Price

Stock is a group of shares traded in the stock exchange market.

A share is a unity of capital to a particular limited liability company. It is the main source of capital of the company, hence companies mostly generate capital through buying and selling shares in the stock exchange market.

Different stocks have various stock prices in the market. For instance, Eerie has a stock price of 57.69 which is lower than Andrew’s 59.64 in the fourth round (2021), whereas in the fifth round (2022), the Erie stock price is 85.02, the highest stock price in the market, and that of Andrews has $59.20. Additionally, in 2023, Erie has the stock price of $126.6 whereas Andrews has $53.51. the lesson that Andrews needs to learn from Eerie is that the stock market should be looked into as a reflection if the happenings in the real world. Andrews may have released poor earning and its stock price tanks, or its shares may have risen in the event the firm becomes an acquisition target.

Dividends

A dividend is an amount paid to the shareholders at a particular period of time generated from the investments of share in a given company.

Andrews’s dividend is $5.37 in the fourth round (2021) whereas Eerie pays no dividend in that year. Additionally, in 2022 no dividend payment was made this year. However, in 2023 Andrew has $0.59 whereas Eerie has $3.00, which shows that instability in the stock exchange market should solved by companies performing well so that they can be listed in order to attract more investor. Ultimately, the company’s worth will be coming from what it can pay in dividends. The justification of Andrew having a value for money solely lies on its ability to pay dividends either now or at some point in the future. It will not matter if one owns an enterprise outright or if the business is owned partially through a purchase of shares.

Earnings per share

Andrew also has an EPS of $4.58 and $4.78 for the Eerie. Andrew Company has an EPS of $4.02 whereas Eerie has $9.28 in 2022. In 2023 Eerie has an EPS of $15.5 whereas Andrews has $3.02. Such shows that in 2022 more investors are likely to buy more shares from Andrew as compared to Eerie, due to the law of demand and supply in the stock exchange market. In 2023 more investors are more likely to buy shares from Andrew also than in Eerie.

While the EPS may indeed impact the market price of Andrew’s stock, the relationship may rarely be inverse. The EPS of the company is solely determined through dividing the earnings by a number of considered shares. The consideration of the EPS ensures a few things in the investment world operate in a vacuum. In order for the market price of its stocks to rise, the company needs to have a strong market per share.

References

Brigham, E. F. (2014). Financial management theory and practice. Atlantic Publishers & Distri.