Next ratio is the Net profit margin ratio. This ratio measures how much net income or profit is generated as a percentage of revenue. Our target company net profit margin hovers around 6% over the last 5years and further weakened further to 3% in the current year. This then speaks to the issue of the target company profitability and the management of its cost. The selling and distribution expenses which represents about 77% of the operating selling expenses while revenue grew by mere 35%, the direct cost had grown by 41% and the operating expenses grew by 4%. We reckon this could be as a result of cost miscalculation or even increase in government taxes and the currency devaluation on imported goods which occurred in the year under review. There might be need to engage management further on reason for the difference in cost and revenue profile.
Meanwhile, for the benchmark company, the ratio shows a reasonable and consistent profitability as an average of 14% over the last 5years. Though, profit dropped by 3% to 11% in the current year, its net profit is quite stronger than that of the target company. One of the considerations for the benchmark company in our opinion might be to the fact that it has a diversified product portfolio and the fact that most of the raw materials are sourced locally unlike our target company that usually got significant portion of its raw materials from overseas. This was clearly shown in the account by a significant amount of about N75billion relating to prepayment for imported items which we suspected was a stock of raw materials.
The gross profit margin is a profitability measure that looks at a company’s gross profit as compared to its revenue or sales. The gross profit margin over the last five (5) years had shown consistent average margin at 20%. This may be low compared to that of the benchmark company which had a consistent gross profit margin at an average of 42%. The direct cost for the target company is 20% higher compared to that of the benchmark company. The implication is that the profit margin may not be adequate to cover the operating expenses and finance cost effectively. The implication of this is that any marginal increase in the cost profile or any attempt by the management to increase the sales and distribution expenses for more sales drive could negatively impact the net gross margin. This may, therefore, worsen the rate of return to equity holders and invariably the investors.
Current ratio is a liquidity ratio that measures a company’s ability to pay short term obligations or those due within one year. It informs the investors and analysts how a company can maximise the current assets on its balance sheet to satisfy its current debt and other payables. A current ratio that is in line with the industry average or slightly higher is generally considered acceptable. The target company current ratio was at an average of 96%. The implication of this is that for every N100 owed to suppliers or owed under current liability, the company can comfortably pay N96 if all current assets are realized as at the balance sheet date. The current ratio of the target company shows a better position than the benchmark, but in the current year, there was an exceptional event that resulted in the payment of N75billion for the imported item. We also noticed that there is a high inventory being carried by the target company and our conclusion was that there may be some slow-moving stock which might have invariably tied down the capital.
The acid-test ratio, commonly known as the quick ratio, uses a firm’s balance sheet data as an indicator of whether it has sufficient short-term assets to cover its short-term liabilities. For the target company, the average acid test ratio is around N65 which means that if the target company is unable to realize its inventory immediately, the company can conveniently pay N65 out of every N100 owed as current liability. This is a good sign for the target company as it is able to manage well its working capital and credit cycle reasonably. In comparison to the benchmark however, the average current and acid test ratio over the last five years is 49% which is lower compared to that of the target company.
Our final recommendation to the management was as follows:
- Friesland can go ahead to increase the share capital in order to dilute the gearing ratio.
- The management should look for a creative way of managing their direct cost as well as operating cost in order to increase profitability.
- They need to expand their product line so they can grow revenue to match cost.
- Management should source raw material locally through backward integration.
- Renegotiate term of trade with suppliers.
Our final recommendation to the potential investors is that they should go ahead and invest for the following reasons:
- The company has been around for the last 50years.
- They have not had any losses in the last 10 years.
- They have paid dividend consistently over the last 10year even in COVID year.
- Their share price on the stock exchange is stronger compared to their peers.
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Basic Accounting principles