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Reg # 17743
FINAL ASSIGNMENT
Question: Use any Organizations financial statements and find out Business & Financial Risk of the organization. Also explain the risk appetite of the organization and what recommendation would you offer regarding investing in this organization. For this assignment I have selected Indus Motor Company Limited (Pakistan) Balance Sheet, Income Statement & Cash Flows for 5 years starting from 2007 to 2011. 1.Business Risk: It reflects the overall uncertainty of an organization ability of earn base on sales and cost related to its manufacturing. It is generally measured by the variability of the firms operating income over time. It is in turn measured by calculating standard deviation of the operating income.
Business Risk Ye ar 201 1 201 0 200 9 200 8 200 7 Prob. (P) 0.2 0.2 0.2 0.2 0.2 70 5,246,1 15 2,072,5 53 3,544,4 71 4,252,1 66 Mean EBIT (X) 4,088,5 (P.X) 817,7 14 1,049,22 3 414,5 11 708,8 94 850,4 33 3,840,77 5 (XMean)^2 6140236202 5 1.97498E+1 2 3.12661E+1 2 8779606041 6 1.69243E+1 1 Variance 1041156.1 4 0.27 ((XMean)^2).P 12280472405 3.94996E+11 6.25322E+11 17559212083 33848510976 1.08401E+12
Explanation: The above solution explains the variability present within the operating income of Indus Motors both EBIT & EBT have same coefficient variance showing the central variation of 0.27 within the income and sales of Indus Motors. Due to large size of standard deviation more attention is paid to coefficient of variance as per requirement. The Business Risk of Indus Motor Company LTD is 0.27 which shows risk present in the operating income of the organization. Furthermore, sales volatility is checked in order to get further insight. Sales volatility: Since sales are the determinant of operating income variability this evaluation will further help in explaining the risk involved in investing in Indus Motors Company LTD.
Ye Prob. Sales Volatility (Rupees in 000) Sales (X) (P.X) (X((X-
(P) 0.2 0.2 0.2 0.2 0.2 61,702,6 77 60,093,1 39 37,864,6 04 41,423,8 43 39,061,2 26 Mean 12,340,5 35 12,018,6 28 7,572,9 21 8,284,7 69 7,812,2 45 48,029,0 98
Explanation: As per calculation we can see the overall coefficient of variance is 0.22 which means the overall variability is only limited to 0.22 but in operating income (EBIT & EBT) it is up to 0.27 which means operating income has greater variability then sales. Degree of Operating Leverage: The variability of an organization operating income is also depended on its mixture of cost involved in its operation. Thus reflecting the basic relationship between operating profit and sales show operating leverage.
Operating Leverage Year EBIT Sales OL 2011 96% 158% 0.61 2010 123% 154% 0.80 2009 49% 97% 0.50 2008 83% 106% 0.79 2007 100% 100% 1.00 Degree of Operating Leverage
74%
This evaluation shows operating incomes are more volatile as compared to sales due to which this high operating leverage value of 74% is obtained. 2.Financial Risk: This risk shows additional uncertainty of returns to investors due to use of fixed assets and financial obligation securities by the organization. This financial uncertainty is in addition to the organization business risk.
Debt to Equity Ratio: In this ratio the overall debt to equity is calculated as per year wise. Indus Motors has a good debt to equity ratio never going over 6%.
Debt to Equity Ratio (Rupees in '000) Ye Long Term D-E ar Debt Total Equity Ratio 201 454,0 14,119,6 1 12 48 3% 201 325,7 12,587,6 0 97 15 3% 200 503,7 10,296,9 9 00 73 5% 200 532,1 9,436,3 8 38 40 6% 200 210,1 8,043,9 7 49 75 3%
Total Debt to Total Capital Ratio: As per debt to capital ratio Indus Motor Company LTD has a mixed standing in while most of time its debt to capital ratio at minimum has never gone under 46% in last 4 years. In past 5 years it has increased at an increasing trend impacting the overall viability of investment.
Total Debt to Total Capital Ratio (Rupees in '000) Ye ar Total Debt Total Equity % 201 1 12,714,970 14,119,648 90% 201 116 0 14,550,663 12,587,615 % 200 101 9 10,388,550 10,296,973 % 200 8 4,311,769 9,436,340 46% 200 7 7,621,075 8,043,975 95%
Interest Coverage Ratio: As per interest payments in Income statement the overall Indus Motor Company LTD standing is very good as it is able to pay all its interest based liability with easy thru out 5 years of evaluation.
Interest Coverage (Rupees in '000) Ye ar 201 1 201 0 200 9 200 8 200 EBIT 4,088, 5,246, 2,072, 3,544, 4,252, Interest 77, 115 3, 576 26, 540 2, 760 22, Times 53 67 78 84 1,2 1,4
166
685
187
Cash Flow Coverage: As per cash flow only in year 2008 was the cash flow was in negative while in remaining 4 years it was positive. But in year 2011 it has reduced extremely from previous year high which means a lot of volatility in the cash flow.
Cash Flow Coverage (Rupees in '000) Ye Cash Flow ar (Op.) Interest Times 201 701, 77, 1 831 115 9 201 7,424,2 3, 2,0 0 79 576 76 200 6,536,5 26, 9 29 540 246 200 (811,0 2, (2 8 77) 760 94) 200 2,823,7 22, 7 27 685 124
Degree of Financial Leverage: As per financial leverage in all years the Indus Motor Company LTD has enjoyed positive standing meaning its overall financial aspect are maintained in order to give an overall positive outlook.
Degree of Financial Leverage (Rupees in '000) Ye ar EBIT EBT DFL 201 4,088, 4,011, 1 1 570 455 .02 201 5,246, 5,242, 1 0 115 539 .00 200 2,072, 2,046, 1 9 553 013 .01 200 3,544, 3,541, 1 8 471 711 .00 200 4,252, 4,229, 1 7 166 481 .01
3.Indus Motor Company Investment Ratios: Following are investment ratio for year 2007 to year 2011. Return on Asset: As we can see only in year 2007 the return on asset was 18% after which the return is decreasing almost dropping blow 10% in year 2009 but bouncing back in 2010 and again decreasing to 10%. This entire scenario shows that Indus Motor Company is unable to efficiently use its assets for steady returns.
Return on Asset (Rupees in '000)
Return on Equity: Compared with ROA, ROE has better returns never going below 13% which means almost at par with numerous investments available in the market. The best year was 2007 with 34%. While decreasing in year 2009 to 13%. While bouncing back in 2010 to 27% then again decreasing to 19% in year 2011. All these volatility shows the overall prospect of affecting return both in short and long run.
Return on Equity (Rupees in '000) Ye ar 201 1 201 0 200 9 200 8 200 7 Net Income 2,743,384 3,443,403 1,385,102 2,290,845 2,745,701 Equity 14,119,648 12,587,615 10,296,973 9,436,340 8,043,975 Tot al 19% 27% 13% 24% 34%
Return on Investment: As per data ROI has decreased from 53% in 2007 to 29% in year 2011. Thus reflecting overall impact of various actions taken by Indus Motor Company LTD. ROI shows that overall returns are good but they are not consistent and fluctuate a lot based on various reason within financial management of the organization.
Return on Investment (Rupees in '000) Yea RO r EBIT Total Equity I 201 29 1 4,088,570 14,119,648 % 201 42 0 5,246,115 12,587,615 % 200 20 9 2,072,553 10,296,973 % 200 38 8 3,544,471 9,436,340 % 200 4,252,166 8,043,975 53
4. Risk Appetite Analysis: As per the above evaluation of business risk and financial risk combined with investment ratio. Indus Motor Company has positive and negative aspect. As per long term liabilities it prefer not to overextend itself while overextending itself in short term liability. It cash flow are not steady with unusual level of volatility showing it does take risk while doing its operation activities. It overall business risk is at 0.27 which is considerably good. But on the other others cash flows and ROA and ROE are not consistent. Its overall degree of operating leverage is at 74% which is acceptable and its degree financial leverage are over 1 but not exceeding 1.05 in any year. They are lacking efficiency in the long run. In some cases is it a very risk adverse organization not taking chance in long run but in short runs it has shows very aggressive actions in cash flow. 5. RECOMMENDATION: As per my limited knowledge and experience I would like to recommend certain actions that can be help in addressing some of risk related issues. Think about improving sales figure in order to reduce volatility attached with sales figures and reduce overall business risk in both long and short runs. Its overall operating leverage is overall 50% in all 5 years which is at good point and must be maintained in order to get maximum potential. Increase the overall debt to equity ratio by increasing long term debt over 10% at minimum this would reduce pressure on operating cash flow and reduce volatility. Indus Motors current liabilities are very high compared with non-current it must think about reducing them in order to reduce pressure on profitability and operating cash flow. It interest coverage ratio is quiet good but fluctuation are present limiting the overall potential to reap benefit from this positive attribute. So it must be clear-fully evaluated in order to the necessary point of efficiency. Due to changing sales and current liabilities the operating cash flow is affected thus impacting greatly in operating activities in order to reduce this volatility Indus Motors must look toward reducing this either by maintaining a minimum level or looking toward other options.
Indus Motors financial leverage is equal its EPS and EBIT but due to fluctuation in operating cash flow it must look into improving it in order to protect itself from increasing it financial risk. ROA & ROE both have positive outlook but are showing volatility which affect the prospect of consistent returns thus Indus Motor must look into way of improving these ratios for long and short run.