Profitability and efficiency analysis of Poh Kong Jewellers

By | April 19, 2014

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1. Introduction of Poh Kong Jewellers 2
2. Comprehensive profitability and efficiency 3
2.1 ROCE (Return On Capital Employed) 3
3. Profitability 4
3.1 NPM (Net Profit Margin) 4
3.2 CR (Cost Ratio) 4
3.3 OER (Operating Expense Ratio) 5
4. Efficiency 5
4.1 AT (Asset Turnover) 5
4.2 ITR (Inventory Turnover Ratio) 6
4.3 SHP (Stock Holding Period) 6
4.4 (RT) Receivable Turnover 7
4.5 DSO (Days Sales Outstanding) 7
4.6 PT(Payable Turnover) 8
4.7 DPO (Days Payable Outstanding) 8
5. Short term liquidity 8
5.1 CR(Current Ratio) 8
6. Long term solvency 9
6.1 GR (Gearing Ratio) 9
6.2 IC (Interest Cover) 9
7. EPS(Earning Per Share) 10
Appendix 1 Consolidated balance sheet 14
Appendix 1 Consolidated balance sheet (Continued) 15
Appendix 2 Consolidated income statement 16

1. Introduction of Poh Kong Jewellers

Poh Kong Jewellers established in 1976. This company is specialized in selling and manufacture jewellery. It started trading from an area of 55 square feet with total stock worth RM200, 000. The first branch started in 1982 in SS2, with occupying a floor space area of 1,500 square feet with 20 staff force. In 1990 Poh Kong started to grow bigger and bigger nationwide with 70 branches around the country. It is the largest retailer chain group in Malaysia. It offers different choices of gold ornaments, especially fine jewelleries. Its products are divided into two main categories, viz gold and gemset jewelleries. The Group also represents exclusive designer jewellery brands, such as Brumani, Luca Carati, SunDay, Rodney Rayner, Lapplesite Collection, Alessandro Fanfani and Angel Diamond of Belgium. Let’s check the financial highlights of the company.

Figure 1.0 Total revenue and profit before tax from 2005 to 2009
(source: Poh Kong Jewellers Financial Report 2009)
As illustrated in the figure above, for the last five consecutive financial years the revenue of Poh Kong Jewellers keeps raising in a steady way. Though in 2009 there is a little drop in the before tax profit from RM 39,956,000 to RM 38,558,000, but by taking into the consideration of the weakening demand in the jewelry industry due to the bad macroeconomic environment, the relatively stable performance of high revenue and profit should be considered as a sign of good financial performance as the company is expanding the business in a moderate pace with more prudent approach in major capital expenditure (Chairman Statement). What’s more the company 6.93 sen per share has been paid for the 2009 financial years compared with 6.99 sen per share in 2008. Below examination would be done to check the health of the financial performance more comprehensively using the financial ratio analysis.

2. Comprehensive profitability and efficiency

2.1 ROCE (Return On Capital Employed)

Return On Capital Employed= EBIT/ Capital Employed *100%
= (EBIT/(Total Asset – Current Liabilities))*100%
ROCE 2009= (38558535/(490109272- 139963192))*100%= 11.01%
ROCE 2008= (39955540/(501319591- 139730009))*100%= 11.05%

Return on Capital Employed or return on invested capital, is the predominant method to examine a company’s past performances (Grant 2005,p52). By comparing the profit before tax and interests with capital employed, investors could see the overall profitability and efficiency of the company to turn investments into profits. The ROCE in 2009 is 11.01% with a slight drop from that of 2008 indicating that investment would be experiencing a less return but in a long term’s perspective, such little could be ignored.

3. Profitability

3.1 NPM (Net Profit Margin)
Net Profit Margin=(EBIT/Total Revenue)*100%
NPM 2009= (38558535/ 541635833) *100%=7.12%
NPM 2008= (39955540/ 509354368) *100%=7.84%

Net profit margin, or profit margin is calculated by dividing net income by sales (Brigham & Houston 2009,p95), rather than judge the company’s financial performance by the total revenue the NPM ratio remove the expense to check with the company’s ability to generate profit in term of net profit. The decreases in this ratio from 7.84%(2009) to 7.12%(2008) complied with the fact that the revenue in 2009 was even more than that of 2008 indicates that the company was not doing a good job in controlling the cost. As the income statement shows, the company had increased amounts in the cost of sales, selling and distribution expenses and administration expenses and these expenses had offset the profit and caused a drop in NPM in 2009.

3.2 CR (Cost Ratio)

Cost Ratio=(Cost of Good Sold/ Revenue)*100%
CR 2009= 376817809/ 541635833= 69.57%
CR 2008= 353558743/ 509354368= 69.41%

Though the cost of sale had increased by 6.58% the closed cost ratios in 2008 and 2009 demonstrates that the sale revenue increased accordingly and the increase of sale was the fundamental reason of the growth of the cost of good sold. So the cost ratio actually suggested that the raised cost was normal and did not influence the profitability of the company.

3.3 OER (Operating Expense Ratio)

Operating Expense Ratio= (Operating Expenses/Total Revenue)*100%
OER 2009= ((59963719+59607470+10260433)/ 541635833)*100%=23.97%
OER 2008= ((54531144+52407350+10167468)/ 509354368)*100%=22.99%

Operating expense ratio is the ratio of operating expenses to the gross income (Friedman, Harris & Diskin 2009, p61).Operating expenses refer to the necessary expenses to keep the daily operation such as administrative expenses and payrolls.The growth of administrative expenses from 52.4 million to 59.6 million has majorly contributed to the increases of the operating expense ratio of 0.98%. This trend has indicated a slight decline of the company’s management efficiency.

4. Efficiency

Rather than focusing in using the company’s assets to generate profits, efficiency ratios measure the frequency of the company in term of replacing the inventory for example (Hunt 2009, p32). The efficiency ratio is very critical to Poh Kong Jewellers since the company need to maintain and improve its efficiency ratio in order offset the influence and lost caused by the weakening demand due to the bad economic conditions.

4.1 AT (Asset Turnover)

Asset Turnover= Total Revenue/ Capital Employed)
= Total Revenue/ (Total Asset – Current Liabilities)
AT 2009= 541635833/ (490109272- 139963192)= 1.55 times
AT 2008= 509354368/ (501319591- 139730009)= 1.41 times

Asset turnover ratio measures the efficiency of an individual business in generating sales with its assets (Weygandt, Kimmel & Kieso 2009). In other words, it calculates how many dollars could be generated by investing one dollar in assets. A company with a higher asset turnover ratio is more productive than the one with a lower asset turnover ratio. The asset turnover has increased from 1.41 times in 2008 to 1.55 times which proves a better use of the company’s asset in creating more sale.

4.2 ITR (Inventory Turnover Ratio)

Inventory Turnover Ratio= Sale Revenue/ Average Inventory

ITR 2009= 541635833/ 356726857 = 1.52 Times
ITR 2008= 509354368 / 391286395 = 1.30 Times

Inventory turnover calculates a company’s cost of good sold in a year against the average inventory balance as the formula above shows. It demonstrates the efficiency of a company in using its inventory (Hunt 2009, p33). Like the asset turnover ratio, the inventory turnover witness an improvement from 1.30 times to a higher digit of 1.52 time. The improvement in the inventory turnover shows a more prudent inventory management of the company to reduce the risks of holding large stocks in hand for a long period of time.

4.3 SHP (Stock Holding Period)

Stock Holding Period= (Average Stock/ Cost of Good Sold)*365 days
=((Beginning Inventory+Ending Inventory)/(2*COGS))*365 days

SHP 2009= ((391286395+ 356726857)/(2*376817809))*365 days = 362.28 days
SHP 2008= ((391286395+ 324370613)/(2*353558743))*365 days= 369.41 days

Stock holding period transform inventory turnover ratio (ITR) into exact number of days on a annual basis indicating that how long the company would hold the inventory on hand before it’s sold (Hunt 2009, p33). With a better performance in the inventory turnover ratio, the decreases in the stock holding period from 369.41 days to 362.28 days is reasonable and in another way demonstrates the improved stock management efficiency.

4.4 (RT) Receivable Turnover

Receivable Turnover= Sale Revenue/Average Receivable
=Revenue/((Opening Receivable+ Closing Receivable)/2)
RT 2009= 541635833/((1216978+1538022)/2)=393.20 Times
RT 2008= 509354368/((1538022+1887523)/2)=297.39 Times

Like the inventory turnover, by dividing the total revenue by average receivable the receivable turnover measures the efficiency of a company in managing its receivable account. With the fast raise of RT by 95.81 times from 297.39 in 2008, it is evident that the company is performing well in managing the receivable account.

4.5 DSO (Days Sales Outstanding)

Days Sales Outstanding = (Average Receivable/Sale Revenue)*365 days
DSO 2009=(((1216978+1538022)/2)/541635833)*365 =0.93 days
DSO 2008=(((1538022+1887523)/2)/509354368)*365 =1.23 days

The days sales outstanding calculates how many days of sale that is equivalent to the receivables in financial year. The days sales outstanding drop from 1.23 days to 0.93 days, but both digits have shown that receivable account does not play an important role in influencing the company’s overall efficiency and profitability.

4.6 PT(Payable Turnover)

Payable Turnover= Cost of Good Sold/Average Payable
PT 2009=376817809/((16180487+23363050)/2)= 19.06 Times
PT 2008=353558743/((23363050+22714510)/2)= 15.35 Times

Payable Turnover measures a company’s payable cycle by dividing the cost of good sold against the average payable in a certain period of time(Hunt 2009, p34). The PT has increased by 3.71 times suggesting that the company speed up the circle in 2009 which is good news to investors.

4.7 DPO (Days Payable Outstanding)

Days Payable Outstanding=(Average Creditors/Cost of Good Sold)*365 days
DPO 2009= (((16180487+23363050)/2)/376817809)*365= 19.15 days
DPO 2008= (((23363050+22714510)/2)/353558743)*365= 23.78 days

Accordingly the days payable outstanding witnesses a drop from 23.78 days in 2008 to 19.15days, meaning that the company spent less 4.63 days in outstanding payable.

5. Short term liquidity

5.1 CR(Current Ratio)

Current Ratio=Current Assets/ Current Liabilities
CR 2009=401142738/139963192= 2.87
CR 2008=422714423/139730009= 3.03

Current ratio is a test of a company’s short-term solvency (Tracy 2008, p287), it divide the current assets by the current liabilities to check the ability of the company to pay the short term debts that are due in the near future. The current liabilities account does not change significantly from 2008 to 2009 but the shrink of the current assets has caused a drop in the current ratio from 3.03 times to 2.87 times indicating that the company is less capable to cover the current liability than in 2008.

6. Long term solvency

6.1 GR (Gearing Ratio)

Gearing Ratio= (Long-term Borrowing/Capital Employed)*100%
GR 2009= 45252479/(490109272-139963192)*100%=12.92%
GR 2008= 76366669/(501319591-139730009)*100%=21.12%

Gearing ratio, that calculate the percentage long-term borrowing in the total long term financing, is an important indicator of finance risks for a company(Davies 1999, p67). With a more prudent finance, the company had reduced the long term borrowing account from RM 76.37 million in 2008 to only RM45,25 million in 2009 leading to a significant drop in the gearing ratio by 8.2% which suggests a low finance risk and could attract more investment in the future.

6.2 IC (Interest Cover)

Interest Cover=EBIT/Interest Expenses

IC 2009=38558535/ 10260433=3.78 Times
IC 2008= 39955540/10167468=3.93 Times

Interest cover could also reflect the long term solvency of a company. Though there is mild decline of IC in 2009 as the calculation above shows, but the IC of these two years are much more than 1.5 times below which questions should be asked (Davies 1999, p67).

7. EPS(Earning Per Share)

EPS 2009= 6.93 sen
EPS 2008= 6.99 sen

Earnings per share could be defined as the net income divided by the number of shares(Singhvi & Bodhanwala 2006, p313). A decreased earnings per share in 2009 of 6.93 sen from 6.99 sen will make the company less attractive to the investors. The drop in the earning per share actually reflects the fact that the company has less net income in the 2009 financial year.

1. Usefulness of ratio analysis

Ratio analysis is a meaningful techniques to analyzed the financial statement of a company. Firstly, by comparing to the past years’ ratios, investors could identify the trend of the financial situation of a company to see whether the company is performing in a progressing trend or a deteriorating trend (Mowen, Hnsen & Heitger 2009, p693). Secondly, financial ratios analysis as an evaluation method based on financial statements (Brigham & Daves 2007,p250) can help investors to make comparisons between several firms or with industrial average to examine the advantages or disadvantages of a firm compared with other competitors in the industry in term of profitability, efficiency, liquidity and solvency. But please notice that ratio analysis alone could not provide sufficient information to investors in the decision making process as other source of data and analysis are also necessary.


Reference

Brigham, E. F. & Houston, J. F. 2009, Fundamentals of Financial Management, 12 edition, Mason: South-Western Cengage Learning

Brigham, E. F. & Daves, P. R. 2007, Intermediate Financial Management, 9 editon, London: Thomson Learning. Inc

Davies, D. B. 1999, Managing financial information, London: Chartered Institute of Personnel and Development House, p67

Friedman, J. P., Harris, J, C. & Diskin, B. D. 2009, Barron’s real estate handbook, 7 Edition, Barron’s Educational Series, Inc, p61

Grant, R. M.,2005, Contemporary Strategy Analysis, Fifth Edition, Victoria: Blackwell Publishing, p52

Hunt, P. A. 2009, Structuring mergers & acquisitions: a guide to creating shareholder value, Austin: Aspen Publishers, p33

Mowen, M. M, Hnsen, D. R. & Heitger, D. L. 2009, Cornerstones of Managerial Accounting, 3 edition, Mason: South-Western Cengage Learning

Poh Kong Jewellers Annual Report 2009, Financial Highlights, accessed on 4th Nov 2010, [online] available: http://www.pohkong.com.my/info/investor.html

Singhvi, N. M. & Bodhanwala, R. J. 2006, Management Accounting, New Delhi: Pretice- Hall of India Private Limited:, p313

Tracy, J. A. 2008, Accounting For Dummies: A reference for the rest of us! 4 edition, Indiana: Wiley Publishin. Inc

Weygandt,J. J, Kimmel,P. D. & Kieso, D. 2009, Accounting Principles, 9 edition, New York: John Wiley & Sons, Inc

Appendix 1 Consolidated balance sheet


Appendix 1 Consolidated balance sheet (Continued)

Appendix 2 Consolidated income statement