Introduction
The modern business environment is very competitive as many factors affect the performance of an organization. Technology has advanced with globalization taking the center stage in increasing the dynamism of the business environment. Therefore, in order to improve the performance of an organization, there is need to increase the competitive advantage that could be established in areas such as human resources, innovation and information technology among other factors. Firms are of great interest to many stakeholders including investors, owners, the state, suppliers and consumers. Basing on the performance of an organization, every stakeholder is interested in a specific section of the firm. While consumers are interested in the quality of products and services provided by the firm, investors are interested in the financial performance an organization especially in terms of its returns on invested capital. However, before investing, it is necessary for investors to determine the profitability of the firm and the ability of the investors to reap higher returns on their investments. This paper compares two companies in order to determine the ability of investors to invest in the companies. The comparisons made are in terms of the financial performance of the companies, which are indicated inform of financial ratios. The two companies are Woolworths Ltd and Wesfarmers Ltd.
Company Profiles
Woolworths Ltd
This organization operates in Australia within the retail industry as it sells various products at retail prices directly to consumers. The company operates in other countries too such as New Zealand and India. It currently has about 996 supermarket outlets that are located in different regions in Australia while operating under the company’s brand name, Woolworths. However, not all stores operate under the brand name as others operate under other brand names such as Foodtown and Countdown. The company operates other outlets of liquor that sell products under the brand name of BWS. Other products are petrol and BIG W general merchandises that are operated in Australia. In addition to sell of products in other industries, Woolworths operates 282 restaurants and hotels that include bars, accommodation and gaming among other services and products (Bloomberg Businessweek 2012, p. 1). The performance of the firm has been stable since its establishment in 1924. The firm is headquartered in Bella Vista in Australia although it operates in other multinational markets such as India and New Zealand.
Wesfarmers Ltd
This corporation was established in 1914, operates in Australia and is headquartered in Perth. Since its establishment, the company has been able to grow and diversify its operations. It operates in various industries including the competitive retail, mining processing and distribution industries. Consequently, Wesfarmers is involved in mining of coal, processing of gas together with its distribution, processing of other industrial chemicals such as fertilizes and provision of insurance. According to Bloomberg Businessweek (2012, p. 1), Wesfarmers has many outlets for its varied products sold out to individual consumers and organizations. For instance, the company has about 742 supermarkets that operate under the brand name Coles and BI-LO, liquor selling outlets amount to about 766 operating under different brand names of Vintage, Cellars and Liquorland. Other products offered by the firm include textiles products and outdoor living products. As noted by Bloomberg Businessweek (2012, p. 1), the firm targets country stores and outlets, Kmart stores and mining in which it operates open-cut mining enterprises. In spite of its humble beginning in Australia, the firm has diversified to operate in New Zealand apart from the domestic country of Australia. The internationalization of Wesfarmers ensures d that its financial performance improves as it was able to realize increased revenue.
Financial Analysis and Comparison
The financial analysis of these two companies involves the analysis of the financial records of the companies in form of ratios. The study conducts a two-year analysis of the profits of the companies, their efficiency and stability. Metrics such as ROI and ROA will be used to measure the performance of the organization.
Profitability Ratios
Every organization aims at maximizing its profitability hence minimizing all costs. The comparison of the profitability of Woolworths Ltd and Wesfarmers Ltd was through examination of the profitability ratios such as net profit margin, gross profit and return on assets among others of the two companies.
Gross Profit
Gross profit is the profit that an organization receives net of the cost incurred in the production of goods sold but before deduction of other expenses and tax. The gross profit is found through the deduction of the cost of sales from the total revenue. The gross profit realized by Woolworths Ltd as measured by the ratios for the financial period that ended in 2010 and 2011 was 25.73% and 25.78 respectively. On the contrary, the net profit realized by Wesfarmers for the same period was 30.99% and 30.965 respectively. Therefore, it is evident that Wesfarmers had a higher gross profit as compared to Woolworths Ltd.
Net profit Margin
This ratio indicates the net income of an organization after all deductions including taxes have been made. In this case, the net profit realized by the two firms would be measured using the net profit margin. The ratios for Woolworths Ltd for the 2010 and 2010 financial periods were 5.96% and 6.05% respectively. On the contrary, the net profit margins for Wesfarmers Ltd for a similar period were 5.67% and 6.115 respectively (Chava & Michael 2008, p. 2096). The ratios indicate that the two firms realized increased net incomes for the 2011 financial periods. However, Wesfarmers Ltd realized the highest increase of 0.35% thereby ending up having the highest net profit margin.
ROA
ROA measure the income that an organization realizes on its assets. As an efficiency ratio, ROA indicates effectiveness of the management of Elder Ltd and Goodman Fielder Ltd in managing the company assets to generate revenue. The ratio provides the earnings generated from the capital that was invested by the firm. The ROA of Woolworths for the 2010 and 2011 financial period was 16.67% and 15.53% respectively as compared to that of Wesfarmers Ltd that had a ROA of 7.31% and 7.92% for the similar period respectively. It is clear that Woolworths has a high return on assets and its investors are happy for this (DeAngeleo & Douglas 1992, p. 299).
ROE
Funding of activities of the organization usually involves the owner’s equity and shareholder’s equity. This ratio indicates the level of income generated on the shareholder’s funding. Thus, it reveals the profit realized by an organization from the investment made by the company’s shareholders. The ROE of the two firms for the 2010 and 2011 periods were 26.07% and 27.28% respectively while that for Wesfarmers Ltd were 6.34% and 7.59% respectively. The outcomes indicate that Woolworths Corporation generates higher income on owner’s equity as compared to Wesfarmers’ Corporation.
Efficiency Ratios Comparison
Inventory Turnover
This ratio indicates the period taken to convert the company’s inventory into revenue. The inventory turnover for the two financial periods 2010 and 2011 for Woolworths was 33 days and 34 days respectively as compared to that of Wesfarmers Corporation that was 49 days and 50 days respectively for a similar period. It is clear that Woolworths has a better inventory turnover compared Wesfarmers and is therefore able to collected its debts in time (Altman 1968, p. 594).
Asset Turnover
Assets turnover as a ratio provides a relationship that exists between the assets of an organization and the revenue realized by the organization. The ratio indicates the sales generated from each dollar of assets. The asset turnover of Woolworths for the 2010 and 2011 financial periods were 2.8 and 2.57 respectively thereby indicating a reduction. On the contrary, Wesfarmers Ltd had an asset turnover of 1.27 and 1.3, which is lower than that of Woolworths Ltd. This implies that Woolworths is in a better position of sales generated as compared to Wesfarmers Ltd.
Debtors’ Turnover
This ratio indicates the amounts of funds received from the debtors of the firm. The ratio indicates the how fast an organization is able to collect debts. From the financial performance of the two firms, Woolworths Ltd had a debtors’ turnover of 1.5 days and 2 days for the 2010 and 2011 financial periods respectively. On the contrary, Wesfarmers Ltd had a debtors’ turnover of 10 days and 11 days for similar periods respectively. It is evident that Woolworths Corporation is the best firm as it has a low debtor’s turnover as compared to Wesfarmers Corporation (Camelia & Laura 2008, p. 9).
Creditor’s Turnover
The ratio indicates the speed at which an organization is able to pay of its creditors and debts. The creditors’ turnover for Woolworths was 40 days for the 2010 and 2011 financial periods while that of Wesfarmers Corporation was 49 and 50 days respectively for a similar period. Therefore, Woolworths Corporation had the best creditor’s turnover as compared to Wesfarmers, thereby becoming the best option for investors (Giroud & Holger 2010, p. 319).
Liquidity ratios
Current ratio measures the ability of the two firms to meet their short-term obligations as they fall due. Three ratios were used to measure the ability of Elder Ltd and Goodman Fielder Ltd to meet their short-term obligations as discussed below.
Current Ratio
The current ratio indicates the speed at which an organization can meet its obligations in the short term. A higher current ratio is usually preferred to a lower ratio because a higher ratio indicates a higher capability of the firm to meet its short-term obligations using its current assets. The current ratios of Woolworths Ltd for the 2010 and 2011 financial periods were 0.73 and 0.8 respectively. On the contrary, the current ratio for Wesfarmers Ltd was 1.23 and 1.17 respectively for similar periods. It is clear that Woolworths Corporation is liquid compared to Wesfarmers and therefore able to meet its obligations as they fall due in the short run.
Acid Test Ratio (quick ratio)
The Acid Test ratio is almost similar to the current ratio. However, it does not include the inventory of the firm in its calculation although they both serve a similar purpose. The quick ratio for Woolworths Ltd was 0.21 and 0.32 for the 2010 and 2011 financial periods respectively. However, the quick ratio for Wesfarmers was 0.64 and 0.59. Given that a smaller quick ratio is more preferable, Woolworths is the most preferred company for investors.
Debt Asset Ratio
The ratio is significant in financial management as it determines the level of activities in the firm financed through debt. The ratios for Woolworths for the 2010 and 2011 financial periods were 57.71% and 62.81% respectively. On the contrary, the debt to asset ratio for Wesfarmers was 37.06% and 37.94% for similar financial periods. Therefore, it is clear that Woolworths Ltd finances most of its activities using debt as compared to Wesfarmers Corporation.
Debt to Equity Ratio
The ratios measures the leverage of an organization and it is significant in financial management of the assets of an organization as it indicates the proportion of an organization’s equity used to finance the company’s operations (Amihud 2002, p. 33). The debt to equity ratio of Woolworths Ltd for the 2010 and 2011 financial periods were 136.485 and 168.86% respectively. On the contrary, the debts to equity ratio of Wesfarmers Corporation for the two financial periods were 58.89% and 61.14% respectively. Therefore, it is evident that Woolworths uses a small section of its equity to finance its activities as compared to Wesfarmers Ltd.
Limitations and Recommendations
Financial measures have been for a long time been used as the basic performance measures of business enterprises. However, financial measures like profit margins, mark-ups, and earnings per share have been criticized for not incorporating non-financial elements like customer and employee satisfaction, production efficiency in its evaluation of company performance. The balanced scorecard is widely used to link a company’s actions to its strategic goals in strategic planning. As such, the balanced scorecard is used to “improve both the organization’s internal and external communication and monitor its strategic performance” (Kaplan &Norton 2002, p. 56). As a bottom line, the balanced scorecard goes beyond the traditional financial measures to incorporate strategic non-financial measures in evaluating a company performance. The balanced scorecard has four diverse viewpoint from which an institute must be assessed, i.e. financial or monetary, client; in-house business; and education & development viewpoints.
Financial Perspective
The balanced scorecard emphasizes that managers should always aim at providing adequate and accurate financial data. Proper financial data will help the management evaluate how the company has been able to generate value over a certain period. Several financial measures that Woolworths Ltd can use to evaluate its performance exist. Firstly, the company can evaluate how much Return on Investment (ROI) it has been able to earn. ROI is a percentage of what the company has earned as profit on the invested funds. The company will be deemed to have performed well if it earns ROI higher than the cost of capital. Secondly, the company can use Return on Equity (ROE). ROE is a percentage measure of how much profit has been earned on the funds contributed by common shareholders. The company will have performed better if the ROE is greater than the cost of obtaining the equity funds. Finally, the company can use Economic Value Added (EVA). The EVA is the difference between profit after but before interest and the capital charges of invested capital, i.e. EVA = PBIT (1-T) – WACC* CE. The EVA should always be a positive for a company to be considered as having a better financial performance (Kaplan & Norton 2002, p. 102).
Customer Perspective
This perspective holds that companies should focus on customer satisfaction. Better-satisfied customer means a much larger customer following which increases revenue hence higher financial performance. Woolworths can use measure such as Customer Satisfaction, Customer Retention, and Market Share to evaluate this perspective. Higher customer satisfaction, retention and a large market share will highlight better performance.
Internal Business Process Perspective
Internal business process ensures that products produced and services by the company are of high quality. The management should make sure that the company is managed efficiently and effectively and that its output meets customer needs. The company should use measures such as Process Improvement, which assesses how well the company is run; Suppliers Retention, which evaluates the confidence of suppliers in the company’s processes and Customer Product Approval, which examines the quality of products the firm, produces (Merton 1985, p. 120).
Learning and Growth Perspective
Focuses on the ability of people in the organization to learn and grow for managing and sustaining change and improvement. It emphasizes training and building. The various performance measures the company can use to assess this perspective are employee satisfaction, employee retention and employee productivity.
Conclusion
This paper has compared the financial performance of two Australian companies, Woolworths Ltd and Wesfarmers Ltd using financial ratios. The outcomes of financial ratio analysis indicate that Woolworths Ltd is the better firm for investors to invest in. This is because the firm has a better position in terms of liquidity to manage its short-term liquidity, performs better than Wesfarmers Ltd in terms of profitability and is more efficient.
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