Analyse the evolution of the working capital and capital employed

Discuss about the Corporate Finance for Companies and Business.

Introduction

Companies and business entities apply several methods to measure their performance in the market. One of the methods commonly used by corporations is the financial analysis where several techniques are used to examine the company’s past and present performance and project its future trend. Financial analyses help firms to identify their strengths and weaknesses in the industry. They then focus on either maximizing the internal strengths by taking advantage of the external opportunities or minimizing the internal weaknesses through mitigating the external threats.  Car Aïb Ltd is one of such companies.

Car Aïb Ltd specializes in supplying automotive components in the industry. The company has developed an excellent reputation and brand by proving quality products and reputable services. Car Aib Ltd has created business objectives which emphasize on customer-oriented services. However, the organization is currently facing fierce competition in the industry arising from market saturation. This paper focuses on evaluating the company’s comparative financial performance during the 2014 and 2015 fiscal years. Some of the financial performance indicators to be analysed are; a) evolution of the working capital and capital employed; b) the cash-flow statement; c) the financial leverage and the Return On Equity; and d) the financial leverage and the Return On Equity. Finally, a brief comment, conclusion, and recommendation will be provided based on the results obtained from the financial analysis.

Note: the company’s comparative balance sheet and income statement for the financial years 2014 and 2015 were provided and had been used in the respective financial performance indicator.

Analyse the evolution of the working capital and capital employed

the working capital

Brief analysis

Working capital technique is used by companies and business entities to evaluate their ability operational liquidity. It shows that ability of the business to meet its short-term financial obligations (Blocher, et al., 2009, p. 198). A firm should have a positive working capital to fund sufficiently its short-term debts nearing maturity, finance its operational expenses and continue with its daily operations. A negative working capital means that the firm cannot meet its daily operations, fund its upcoming expenses or operate sufficiently (Horngren & Sundem, 2013, p. 45).

Car Aïb Ltd had a negative working capital both in 2014 and 2015. Its working capital reduced further from negative (- 1904) in 2014 to negative (-3566) in 2015. Conversely, the working capital(days of sales ) which shows the number of days it takes the customers to clear their credit sales by the company increased further from negative(12) in 2014 to negative (22) in 2015 (Gleim, 2001, p. 61).

Build the cash-flow statement

The reduced working capital was attributed to the increased amount of inventories from 5,800 in 2014 to 6,913 in 2015 and increased amount of credit sales i.e. payables from 8,845 in 2014 to 10,600 in 2015. A number of other liabilities also rose from 4839 in 2014 to 6170 in 2015.  In 2014, it took customers 24 days to clear their debts. However, the number increased to 39 in 2015.  It is important to note that the receivables account rose from 6,080 in 2014 to 6,291 in 2015 ( Cheffi & Beldi, 2012, p. 94).

With a more negative working capital and working capital in days on sales, Car Aïb Ltd is not in the position to meet its short-term financial and operational obligations.

The capital employed

Brief Analysis

Capital employed refers to the total amount of capital invested in acquiring revenue. The Car Aïb Ltd.’s capital employed decreased by $ 161 from $ 18818 in 2014 to 18979 in 2015. Fixed assets increased from 20,722 in 2014 to 22,545 in 2015. The reduction experienced in the operating capital was contributed by significant reduction of the working capital as stated above (Ittelson, 2009, p. 54).

Conversely, net debts investments increased significantly by $289 from $4100 in 2014 to $4389 in 2015 while Equity investments decreased from 14,717 in 2015 to 14,590 in 2015. The information shows that the company’s shareholders demanded to be paid more dividends leaving the company with less amount to invest (Tracy, 2012, p. 89).

To enhance its growth regarding operational performance, and increased revenues, the management should increase the capital employed by reducing the amount of bonus and dividends payable to shareholders as well as look for other methods of funding its projects besides debts. For instance, the company should authorize the sale of more common shares to the public through Initial Public Offering (IPO) ( Hoyle, et al., 2012, p. 187).

Build the cash-flow statement

The Car Aïb Ltd cash flow statement for the year 2015 is calculated as shown below;

Brief Analysis

The company had a free cash flow of 651 after investment expenses had been deducted. The free cash flow was also affected by the adverse change in working capital and positive changes in the fixed asset depreciation (Ross, 2010, p. 145). Part of the free cash flow was used to pay dividends to the shareholders (940) and paying part of the company debt capital (1374) However; it should be noted that the company did not increase its equity/ capital investment from the income. The change in cash and cash equivalents increased by 963 at the end of 2015 ( Kieso , et al., 2011, p. 46).

Analyse the operating performance (ROCE)

Analyse the operating performance (ROCE)

Brief Analysis

The company’s ROCE before tax decreased from 9.23% in 2014 to 12.5% in 2015. The change shows the company ineffectiveness in controlling its growth. The company’s operating margin decreased from 4.02% to 2.97% before and 2.7% in 2014 to 1.93% in 2015 after tax (Kelly & Barrow , 2016, p. 121).  The deterioration of the company’s operating performance was majorly contributed by the decreased of capital employed in investments. However, the company made efficient use of its operating capital as shown in the Capital Employed turnover. The ratio progressed slightly from 3.1 in 2014 to 3.11 in 2015 (Byrne, 2012, p. 46).

Assess the financial leverage and the Return On Equity

Brief Analysis:

Just like the reduction of the ROCE after tax, the Return on Equity dropped from 8.72% in 2014 to 5.7% in 2015. The effective cost of debt increased from 459 in 2014 to 503 in 2015. Poor ROE returns resulted from the rising cost of debt and negative financial leverages. For the gearing percentage, it can be revealed that the company reduced its dependency on debt to fund its investment and operational; activities. In 2014, gearing stood at 30.08% but decreased to 27.9% in 2015. The ROE and financial Leverage analysis shows that the company is performing poorly as far as its investments are concerned (Kaplan, 2012, p. 287).

Assess solvency and liquidity

Brief Analysis

The company has no issue with solvency. The gearing percentage (i.e. the extent of which debt versus equity funds the company’s operations) decreased from 30% in 2014 to 27.9% in 2015. Likewise, in 2015, 15.2% of the operating cash flow came from net debts. Therefore, the creditors should be a bit worried (Michael, 2012, p. 18). The liquidity ratios are very low, and the company is not in the position to meet its daily financial obligations. The current ratio, which shows the ability of an organization to fund its day-to-day operation using current liability decreased from 1.01 in 2014 to 0.94 in 2015. Likewise, the quick ratio, which is obtained by dividing current assets minus inventories by current liabilities reduced from 0.64 in 2014 to 0.58 in 2015 (Michael & Pizzica, 2015, p.122). However cash ratio, which is the amount of cash and cash equivalents an organization has against current liabilities, remained constant between the two periods.

brief summary with your comments and recommendations on the financial situation and performance of the company

Assess the financial leverage and the Return On Equity

The Car Aïb Ltd is not competitive in the market based on the financial analysis conducted above. The company has failed to control its operations efficiently and is also faced with liquidity issues. The number of days it takes the customers to clear their credit sales by the company increased during the 2015 financial period (Proctor, 2012, p. 97). Therefore, during the days of the sales period, the company is not in a position to meet its short-term financial obligation. The management should introduce policies aimed at reducing the number of days the customers are possible to stay with the company’s debts. For example by introducing discounts and bonuses on cash sales, many customers will strive to go cash purchases to have the discounts stated (Simons, 2013, p. 154). Likewise, introducing a policy where credit customers are offered discounted for clearing their debts within ten days following the sales would increase cash collections.

Second, the company has an ineffective internal control system. This has been revealed by increase on the number of stocks in the company’s warehouse at the end of 2015. Likewise. The number of liabilities also increased. It would be expected that with the number of increased ordering of stock, the company’s cash and cash equivalents would have increased significantly ( Horngren , et al., 2011, p. 67). There is a possibility of growing number of dead stock. The company should introduce an effective internal control system to reduce the stock being held in the warehouse. For example, the management should offer discounts on large purchases. Second, the company should use the ABC stock ordering method.

The shareholders demanded to be paid dividends even with the poor organizational performance, therefore, escalating the level of financial risk facing the company. Payment of dividends limited the company’s ability for further growth or investment. The gearing percentage shows that the company’ depends on mostly on debts to fund its operations (Vaughn, 2007, p. 150). Low level of equity capital can only mean that the shareholders have lost their trust on the management to maximize the value of their funds. Things are likely to worsen when the bank and other financial institutions cannot give the company loans to run its activities. With the current financial trend, the organization is heading to insolvency (Gibson, 2008, p. 211).

The liquidity ratio also shows that the firm is facing adverse short-term liquidity problems. First, from the current ratio it has been revealed that the company lacks enough current assets to meet its daily obligations. In 2015, the company only had 0.94 in current assets to pay for my dollar owed to the creditors (Tracy, 2012, p. 108). Second, the quick ratio was even whose with only o.58 dollars to pay for a single dollar owed to the creditors.  With the current situation, the company is not in a position to expand its market share, invest more capital, meet both its short-term and long-term financial obligations and compete in the market (Guenther, 2004, p. 303).

Conclusion

Car Aïb Ltd is in a financial crisis, and there is a lot to be done to save the company from insolvency. The management should strive to gain shareholder’s trust and influence them to invest more money in the company.

References List

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