ratio analysis for nestle and f&n
TRANSCRIPT
Introduction
There are several methods in analyzing and interpreting the so called financial statement,
one of the well-known methods applied by many users of financial statement is ratio analysis.
Ratio is relation between two figures in the form of mathematical fraction and percentage. So,
we can say that ratio analysis is the analysis of financial statement by using the so called ratio
(finpipe, undated). There are 5 types of ratio analysis, Liquidity ratio, Leverage/Gearing ratio,
Profitability ratio, Efficiency ratio and the last is Market Value ratio. Finpipe(undated) define
liquidity ratio as measurement of the level of the company in fulfilling the short-term obligation
and surviving in the short-term. Gearing or leverage ratio measures the level of debt that used in
the company. Profitability ratio measures the level of the company in gaining the profit in the
range of time. Efficiency ratio measure the level of effectiveness in the operation of the
company. Last but not the least, market value ratio measures the level of relation between share
price, earnings and dividends. Beside the ratio analysis, there are other methods to analyze the
financial statement of the company. Some of the method like Horizontal analysis, Vertical
analysis, Common-size statements and Benchmarking can be applied either in analyzing the
company (Elliot&Elliot, 2001).
The analyses are needed for the user of the financial statement for further decision-
making. For instance, one of users of financial statement, Investor, uses the financial statement
by analyzing the liquidity, profitability and market value of the company for deciding whether
the company is worth to invest or choose another company. Managers use the financial statement
by analyzing the efficiency ratio to measure the level of effectiveness of the operations and
decide whether to maintain or improve the performance of the operation. Bank and suppliers use
the gearing and liquidity ratio to know whether the company is having high level of debt and the
risk that they can take over the level of liquidity of the company. Those financial analyses are
useless without an interpretation. So, all the analyses need to be interpreted to give clear picture
for the user (Bized, 2010).
In this chance, two companies listed in the Bursa Malaysia have been chosen for
investment. It was analyzed using the financial statement analysis. The purpose of the analysis is
to know the position of the company and suggest whether the company is worth to invest. Two
of the companies are Nestle Malaysia and Fraser and Neave (F&N). Both of these companies are
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popular among the consumer all around Malaysia. This report will give detailed performance of
these companies as successful companies in Malaysia based on the financial analysis technique.
Here are the brief description and history about those two companies.
Nestle is an International company which set up subsidiary in Malaysia. It began with the
Anglo-Swiss Condensed Milk Company in 1912 and was starting to develop until now. With the
vision, “Be the leading multinational company in food, nutrition and wellness” and several
missions like “Utilize well the local raw material”, “Take care well the Environment” and
“Produce HALAL food for Malaysian market”, Nestle operate in Malaysia until now employing
approximately 5000 employee. Nestle provides several range of product like Milo (Dairy
product), Nescafe, Purelife, and other range of product (Nestle, 2010).
Furthermore, Fraser and Neave (F&N) works in the consumer-related product, especially
soft drinks and dairies. F&N based in Singapore, founded by John Fraser and David Neave, it
formed a subsidiary in Malaysia in 1884. With a vision, “To become the leading total beverage
company in Malaysia and the region” and mission, “To be a world-class multinational enterprise
providing superior returns to our shareholders, excellent value for our customers and a rewarding
career for our employees”, F&N works in Malaysia successfully in providing range of product.
Several type of F&N product are Coca-Cola (under the license of Coca-Cola Company USA),
100Plus (isotonic drink), Magnolia (Dairy product), Sunkist, and the other range of product
(F&N, 2010).
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Ratio Analysis
Liquidity Ratio
Liquidity ratios measure the power of the company to fill up the short-term obligation. If
the company is failed to do so, it will drive to failure and bankruptcy. Soon after, the company
will end into liquidation to return all outstanding debt. The liquidation converts all the
company’s asset into liquid or cash to return to the creditors and shareholders in case of
bankruptcy (Horngren et al, 2007). There are 3 ratios in measuring the liquidity of the company,
Working Capital, Current Ratio and the last is Acid-test Ratio.
i. Working Capital
Working capital measures the ability of a company to cover up the short-term debt with
its current assets. It only measures brief position of company’s liquidity. The ideal result for
working capital is positive (+) figure. The positive figure means that the company can cope up
with the current liability over their liquid assets. Other than positive figure means the company
unable to repay their short-term debt and highly risk in bankruptcy (Kennon, 2010). The formula
for working capital is shown below:
WorkingCapital=Cur rent Asset−Current Liability
From the working capital, Nestlé had a negative figure for RM -148,575. It means that
Nestlé had a very low liquidity. Nestlé is risky in bankruptcy and liquidation, because with the
current assets of the company cannot cover up the short-term debt. This will happen if Nestlé’s
present project is unsuccessful. Nestlé must lower their short-term debt in order to put the
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-200000 -100000 0 100000 200000 300000 400000 500000 600000 700000
621172
-148575
Working Capital
Nestle F&N
Nestlé F&N
Acid-test Ratio881,882−1,030,457=¿ -
148,5751,391,372−770,200=¿ 621,172
company in a safety position. At least, Nestlé must lower their current liability for the number of
RM 148,575 and maintain the working capital on positive figure to makes sure that Nestlé
always on the safe position. On the other hand, F&N has a very good position in working capital.
The company was liquid enough to cover up the current debt with the current assets. F&N is on a
safety position in the 2008. F&N should maintain the liquidity position like that.
For the comparison on the graph, the position of liquidity of these two companies has a
significant difference. F&N has a very good liquidity compared than Nestlé. Nestlé must set
another strategy in order to have a better liquidity.
However, with working capital alone, the user of the financial statement cannot easily
decide the company’s liquidity. There are two other liquidity ratios that can be used for further
decision-making. The current ratio and acid-test ratio can measure the company’s liquidity in
detail.
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ii. Current Ratio
Current ratio is the measurement of the company to fulfill the short-term obligation. On
the other words, current ratio can simply define as the power of the company to repay their debt
over the following year. It represents the day-to-day operations, like buying the raw material,
paying the short-term loan by creditors, etc. The ratios can be calculated by dividing the current
asset with current liability. The ideal number for this ratio is in the range of one to two
(Horngren et al, 2007). But, according to Kennon (2010), the current ratio of 1.5 is quite good for
industrial company. The equation can be express as follows:
Current ratio= Current AssetsCurrent Liability
By looking at the current ratio of Nestlé for 0.86, Nestlé has borderline liquidity. It means
that each ringgit of the current debt, Nestlé only has RM 0.86 for returning the debt. Since the
ratio is below 1, Nestlé is highly risk in bankruptcy, because they will not be able to meet their
short-term obligations. The current ratio of F&N is quite good enough. From the financial
statement of F&N we can calculated the current ratio for 1.81. F&N can cover up all short-term
obligations with the current assets that F&N has.
For comparison, there is difference for 0.95 in current ratio of both of the companies. Just
like the previous working capital, F&N has better liquidity than Nestlé.
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2008
0 0.2 0.4 0.6 0.8 1 1.2 1.4 1.6 1.8 2
1.81
0.860000000000001
Current Ratio
Nestle F&N
Nestlé F&N
Current Ratio881,882
1,030,457=¿
0.8558
1,391,372770,200
=¿
1.8065
iii. Acid-test (Quick) Ratio
The acid-test ratio is the ratio measuring the ability of the company to convert most of the
current asset into cash to repay the current liability in a very short time, considering days and
months. It named as acid-test because its measures the firm for a very short period, since acid is
very fast affecting the victim. In the acid-test ratio, the formula is nearly the same with current
ratio, but it excludes the stocks in the current asset. This is because stock is not easy converted
into cash. Result in the range of 0.9 to 1.00 is acceptable for the acid-test ratio (Kennon, 2010)).
The acid-test ratio formula can be shown as follows:
Acid−test ratio=Current Asset−StocksCurrent Liability
Acid-test ratio also gives the same result for the both companies. Nestlé has a portion of
50-50 on their current asset with the stock which made the position of Nestlé is worsen. Nestlé
will not be able to pay even half of the current debt. Nestlé is in a very dangerous situation. If
Nestlé did not do anything to the current liability, Nestlé will be easily come into bankruptcy.
F&N has a very strong position of liquidity, even for the acid-test ratio it has 1.24. It has
no significant change in the current ratio with the acid-test ratio. It means that F&N hold
reasonable amount of stock in the warehouse.
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2008
0 0.2 0.4 0.6 0.8 1 1.2 1.4
1.24
0.41
Acid-test Ratio
Nestle F&N
Nestlé F&N
Acid-test Ratio-200000 -100000 0 100000 200000 300000 400000 500000 600000 700000
621172
-148575
Working Capital
Nestle F&N
0.4099
1,391,372−437,860770,200
=¿
1.2380
In conclusion, F&N has a very strong liquidity position in 2008 rather than Nestlé which
has low liquidity in the following year. F&N has higher value on working capital, current ratio
and acid-test ratio than Nestlé. For overall liquidity ratios, F&N has better position than Nestlé.
Gearing Ratio
The measurement of gearing ratio is about the level of debt financing that the company
used in the capital. Companies must utilize well the debt financing as it gives so many
advantages, like tax deductible for the company and supplement the shareholders as well in
financing the company (Investopedia, 2010). Tax deductible by the debt means as the interest of
the debt are paid before the tax payment, the income decrease and the tax charge will be lower in
the end (Richards, 2010). However, if the company is too much in using the debt, the company is
risky in bankruptcy since it has less equity and assets than the level of liability. Gearing ratio
consist of four ratios, they are Debt ratio, Long-term debt ratio, Interest Coverage, and Debt to
Equity ratio.
i. Debt Ratio
Debt ratio is the form of relation between debt and asset. Since asset usually use by the
company as collateral in borrowings with the bank, debt ratio is used generally by banks to
measures the risk that they took in lending the money to the company. Usually, the higher the
debt ratio, the bank asks for the higher return as the higher the risk that the banks take.
Shareholders use the same way of think in the analysis of the debt ratio. There is no ideal number
of debt ratio, but usually a good debt ratio is under 50% for well long-run sustainability (Ward,
2010). However, the decision based on debt ratio is different for each investor. According to
Investopedia (2010), the ratio under 100% means that the company is financed by equity, and
vice versa. The debt ratio equation explained as follows:
Debt Ratio= Total DebtTotal Asset
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Nestlé F&N
Debt Ratio1,144,6461,660,401
=¿
68.94%
1,196,9332,514,089
=¿
47.61%
Nestlé had a quite high debt
ratio of 68.94% for the year 2008.The high level of debt indicates high risk that the investor will
take. Therefore, the investors will ask for higher return/dividend for each share invested in
Nestlé. On the other hand, F&N has debt ratio for 47.61%, which is lower than 50%. It indicates
that F&N has quite good position on debt ratio. The risk of F&N eventually lower and the return
that F&N should pay will be lower than Nestlé.
Both of companies have debt ratio lower than 100%, so both of it are still using the equity
in financing the companies. Investors might find lower risk in the investment in the company
since the company still in low-leverage firm.
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2008
0.00% 10.00% 20.00% 30.00% 40.00% 50.00% 60.00% 70.00% 80.00%
47.61%
68.94%
Debt Ratio
Nestle F&N
ii. Long Term Debt Ratio
Long-term debt ratio is nearly the same with the debt ratio, but it just measures the
number of long-term debt financing in the company. This ratio usually used by the
debenture/bondholders in investing the company with the long-term debt. There is no ideal
number in the long-term debt ratio. However, the company must utilize well the long-term debt
ratio to increase the tax deductible from paying off the interest to the bondholders (Richards,
2010). The long-term debt ratio formula can be described below:
LongTermDebt Ratio=LongTermDebtTotal Asset
The analysis of long term debt ratio describes that Nestlé did not utilize well the long
term debt. Only 6.88% of the debt in each single ringgit of asset and it was considered too low
for the manufacturing company like Nestlé. Nestlé must utilize well the long-term debt in order
to maximize the debt financing and to deduct the tax as well. F&N utilize better the long-term
debt than Nestlé done. F&N has 16.97% of long-term debt in each ringgit of assets. So, we can
say that F&N utilize the long-term debt better than Nestlé.
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2008
0.00% 2.00% 4.00% 6.00% 8.00% 10.00% 12.00% 14.00% 16.00% 18.00%
16.97%
6.88%
Long Term Debt Ratio
Nestle F&N
Nestlé F&N
Long Term Debt Ratio114,189
1,660,401=¿
6.88%
426,7332,514,089
=¿
16.97%
iii. Interest Coverage
Two above ratios only measures the debt over the asset from the so called Balance Sheet,
but both of them stress on the power of the company in paying the interest of the debt. So,
interest coverage is used for further decision-making, especially for the banks and bondholders.
Interest coverage computed in order to know the level of the profit before paying the interest in
paying the debt’s interest (Kennon, 2010). In the other words, the interest coverage measures
how well the company can manage the payment of the interest over their operating profit. The
higher interest coverage, the better for the bondholder since the company makes sure the
payment of the interest and shareholders will get higher dividends. The Interest Coverage can be
computed using the formula below:
Interest Coverage=Profit before InterestInterest
From the interest coverage, both of the company has good interest coverage. It means that
Nestlé has power to pay off 20 times of interest over their operating profit and F&N has power to
pay off 15 times of interest over their operating profit. So, both of this company can manage well
the payment of long-term debt like debenture, bond, etc. Thus, the dividends generated by F&N
will be smaller than Nestlé since the interest coverage is lower.
iv. Debt to Equity Ratio
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2008
0 5 10 15 20 25
15.12
20.24
Interest Coverage
Nestle F&N
Nestlé F&N
Interest Coverage464,53022,952
=¿20.24256,65016,978
=¿
15.12
Debt to equity ratio measures the proportion between the total debt financing and the
equity financing in the company. The debt to equity ratio also indicates the earnings that the
shareholders receive after the profit deducted with the interest of debts. The higher the ratio, it
means that the company is using more in the debt financing rather than in equity financing.
Therefore, the earnings that received by the shareholders are lesser in the end (Kennon, 2010). In
the worst case of high debt to equity ratio, the company will not be able to pay the interest of the
debt and lead the company to bankruptcy. The debt to equity ratio formula shown below:
Debt ¿ Equity Ratio= Total DebtTotal Equity
Nestlé F&N
Debt to Equity Ratio1,144,646515,755
=¿221.94%1,196,9331,317,156
=¿ 90.87%
From the debt to equity ratio, Nestlé has very high ratio for 221.94% compared than F&N
that only 90.87%. It means that Nestlé has higher debt financing rather than equity financing.
The return of dividend for Nestlé’s shareholder will be lower, since the operating profit is
deducted to pay off the interest. Nestlé is highly risk of bankruptcy, if it is unable in paying off
the large number of debt interest. Besides, F&N has more equity financing rather than debt
financing, which means F&N spread higher dividends to the shareholder. F&N has a good
proportion of debt with the equity.
From all the gearing and liquidity ratios above, a conclusion can be taken. Nestlé has too
much short-term debt in the daily operations. Nestlé should try to reduce the short-term loan and
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2008
0.00% 50.00% 100.00% 150.00% 200.00% 250.00%
90.87%
221.94%
Debt to Equity Ratio
Nestle F&N
change over to the long-term debt, since the long term debt was not utilized well in the following
year. Nestlé should lower their debt in order to reduce the debt to equity ratio, because Nestlé
was on highly-leverage position and considered too risky to invest in. But, for the following year
2008, investors still can calm since Nestlé can manage well the payment of the interest over the
profits. Besides that, F&N has a strong position in the gearing as it has low debt ratio, utilize
well the long-term debt, high interest coverage and low debt to equity ratio. For the overall
gearing ratio, F&N has better position than Nestlé.
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Profitability Ratio
Profitability ratio measures the level of profitability of the company. As the main purpose
of the business is to earn profit, the company must have a high profitability in order to attract
shareholders to invest in the company. Profitability shows the combination of the liquidity,
leverage and efficiency of the company. So, profitability is the overall measure of the effective
use of the all resources in the company. As profitability is one of the most important criteria in
decision-making, profitability ratio hold significant role in helping the user of the financial
statement (Peaveler, 2010). There are several ratios in determining the profitability, Gross Profit
Margin, Operating Profit Margin, Net Profit Margin, ROCE, ROE, ROA, and the last is Earnings
per Share.
i. Gross Profit Margin
Gross Profit Margin is the ratio to measure not only the financial performance of the
company, but also the efficiency of the production process in the manufacturing as well. Gross
profit margin shows the level of gross profit generated over 1 ringgit of sales (Peaveler, 2010).
The gross profit margin formula can be described as follows:
Gross Profit Margin=Gross ProfitNet Sales
As from the computation above, the gross profit for Nestlé and F&N are 31.05% and
25.03% respectively. Gross profit margin of both companies indicates that both of the companies
manage well in their operation in year 2008. Nestlé can manage their cost of goods sold for RM
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2008
0.00% 5.00% 10.00% 15.00% 20.00% 25.00% 30.00% 35.00%
25.03%
31.05%
Gross Profit Margin
Nestle F&N
Nestlé F&N
Gross Profit Margin1,203,7503,877,068
=¿
31.05%
898,9253,591,204
=¿
25.03%
0.69 for each Ringgit of sales and earn RM 0.31. Thus, F&N can retain RM 0.25 for each RM1
of sales with RM 0.75 of cost of goods sold. From the comparison above, Nestlé has better
performance and efficiency in producing the products as Nestlé has lower cost for 0.06 over
sales than F&N.
Page | 14
ii. Operating Profit Margin
Operating profit margin indicates the level of efficiency of the sales from the
manufacturing of the product, administrative of the office, until distributed to the customer.
Since the operating profit is computed from the sales deduct with both production and non-
production expenses, operating profit margin can be treated as the profit after paying the variable
costs (Peaveler, 2010). Companies with healthy operating profit may cover their fixed cost, for
example the interest on debt. Operating profit margin can be calculated with the formula as
follows:
Operating Profit Margin=Operating ProfitNet Sales
Operating profit margin of
Nestlé above 10% indicates that the operation of Nestlé in all sectors, including production,
administrative, marketing, selling and delivery expenses, are quite efficient. For every single
ringgit of sales, Nestlé can retain 11.98% from it before paying off the interest and tax. Besides
that, F&N has the margin below the average, for 7.15% only. It indicates that F&N was not
efficient enough in the operation, although F&N gain quite good figure for the gross profit
margin. F&N should manage the operation well, like the administrative, marketing, and selling
and delivery cost, in order to cut off cost on that expenses. The difference for 4.24% between the
margins of two companies can describe well that F&N spend too much on the operation.
iii. Net Profit Margin
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2008
0.00% 2.00% 4.00% 6.00% 8.00% 10.00% 12.00%
7.15%
11.39%
Operating Profit Margin
Nestle F&N
Nestlé F&N
Net Profit Margin464,530
3,877,068=¿
11.98%
256,6503,591,204
=¿
7.15%
Net profit margin is the ratio that can be used in comparing the performance over the
company in the same industry. As the higher of net profit margin indicates that the company is at
a good and better performance than other companies in the same industries. Same as Gross profit
margin, Net profit margin shows the net profit generated from each ringgit of sales (Peaveler,
2010). The formula for net profit margin is as follows:
Net Profit Margin= Net IncomeNet Sales
Net profit margin indicates
that Nestlé has good performance for the year 2008. 8.79% of net profit margin can be defined as
the net profit of RM0.08 can be retained from every RM1 of sales after paying off all expenses,
including interest and tax. Thus, F&N has average borderline net profit margin of 5%. This
indicates F&N has quite good performance in the following year. But, for comparison of both of
the companies, Nestlé has better performance in the following year as it has higher net profit
margin.
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2008
0.00% 1.00% 2.00% 3.00% 4.00% 5.00% 6.00% 7.00% 8.00% 9.00% 10.00%
5.00%
8.79%
Net Profit Margin
Nestle F&N
Nestlé F&N
Net Profit Margin340,887
3,877,068=¿
8.79%
179,7313,591,204
=¿
5.00%
iv. Return on Assets
Return on Assets included in the so called return ratios. ROA measure the earnings
generated from each of asset used in the company. It indicates the level of efficiency of the usage
of the assets in the operation. Usually ROA use in measuring the manufacturing companies since
manufacturing companies hold a lot of assets. The higher the level of ROA, the better is the
company. The reason is the company can generate the money efficiently from lesser amount of
assets (Peaveler, 2010). The formula of ROA shown below:
Returnof Asset= Net Income before Interest∧TaxTotal Asset
ROA of Nestlé, 20.53% describe that Nestlé utilize the asset very good in generating the
earnings. Even with low number of Asset, Nestlé can retain their earnings for RM0.20 for each
RM1 of asset. F&N only can utilize their asset for 7.15%, which means that RM0.07 return from
RM1 of asset. From the ROA, Nestlé is efficient in utilizing their asset to generate their revenue.
Therefore, Nestlé is more profitable than F&N.
Page | 17
2008
0.00% 5.00% 10.00% 15.00% 20.00% 25.00%
7.15%
20.53%
ROA
Nestle F&N
Nestlé F&N
ROA340,887
1,660,401=¿
20.53%
179,7312,514,089
=¿
7.15%
v. Return of Equity
Same as Return on Assets, Return on Equity, usually called as ROE also included in the
return ratios. ROE is a ratio that tells us the level of the efficiency of the company in using the
shareholders fund invested to generate revenue in the business. Each percentage in ROE
indicates the earnings of each ringgit invested in the company. As the most important ratio to the
investors, return on equity measures the earnings that the investor will get in the future. So, ROE
is one of consideration for investors in the decision-making (Peaveler, 2010). Company must
have at least 10% of the ROE to attract the investors up. The ROE equation can be expressed as
follows:
Returnof Equity= Net IncomeShareholder Equity
Nestlé has
a very high ROE for 66.09% for return on each ringgit of equity. It is high since Nestlé has
highly risk on the liquidity and gearing, especially on the short-term debt. This number of ROE
is very high and will attract the risk-taker investors in investing in Nestlé. F&N has quite good
ROE of 13.65% for the following year, as it has a good position on both liquidity and gearing.
The risk-averse can take the following shares to invest in.
Page | 18
2008
0.00% 10.00% 20.00% 30.00% 40.00% 50.00% 60.00% 70.00%
13.65%
66.09%
ROE
Nestle F&N
Nestlé F&N
ROE340,887515,755
=¿
66.09%
179,7311,317,156
=¿
13.65%
vi. Return on Capital Employed
Other than ROA and ROE, another return ratio is Return on Capital Employed, usually
called as ROCE. it is a ratio that tells us the level of the efficiency of the company in using the
shareholders fund invested and bondholder (long-term loan) fund to generate revenue in the
business. Each percentage in ROCE indicates the earnings of each ringgit invested both by
equity and long-term debt in the company (Peaveler, 2010). ROCE values usually lower than
ROE as the earnings spreads to both equity and debt. The ROCE equation can be expressed as
follows:
ROCE=Net Profit before Interest∧after taxLongTerm Loan+Equity
The ROCE of Nestlé measures that each RM1 invested in Nestlé will generate RM0.63 in
return. This number is very good for Nestlé, as Nestlé utilize well the financing both from debts
and shares. F&N’s ROCE shows that F&N only generate RM0.11 in the following year over
RM1 in debt and equity. From ROCE, Nestlé indicates significant high level of profitability than
F&N.
Page | 19
2008
0.00% 10.00% 20.00% 30.00% 40.00% 50.00% 60.00% 70.00%
11.49%
63.48%
ROCE
Nestle F&N
Nestlé F&N
ROCE340,887+22,952
114,189+515,755−56,801=¿
63.48%
179,731+16,978426,733+1,317,156−32,077
=¿
11.49%
vii. Earnings per Share (EPS)
The earnings per share is the fundamental value of the company to the investors. The EPS
itself can be a single of significant variable in positioning the share price in the market
(Investopedia, 2010).
EPS straightly states that the level of profitability of Nestlé is higher than F&N
significantly. Nestlé has earnings for 145 cents or RM1.45 and F&N for 64.8 cents for each share
holds by the shareholder.
Profitability ratios above prove that Nestlé is more profitable than F&N. Nestlé is
successful in developing the source of finance, both from debt and shares. Since Nestlé is
stressing more on debt financing, the net profit shared to the shareholders is high due to the high
risk that the shareholders take and low number of shares on the market. Although F&N
profitability is lower than Nestlé, it does not mean F&N is not profitable. With the strong
condition of liquidity and low gearing, F&N generates profitable amount of money in the year
2008. Shareholders get the reasonable amount of earnings for the low risk that they take. Thus,
F&N can try to increase their efficiency on the operation in order to increase their profitability,
for example, decrease cost on administrative expense, selling and delivery cost, etc.
Page | 20
2008
0 20 40 60 80 100 120 140 160
64.8
145
EPS
Nestle F&N
EPS (cents) Nestlé F&N
2008 145 46.8
Efficiency Ratio
Efficiency ratio measures the effectiveness of the usage of the assets, inventory and
warehouse in generating the income of the company. The higher the efficiency means that the
company utilizes the resources well in generating the earnings. This ratio usually used by the
manager of the company to see the productivity and performance in the production. The
managers can decide whether the present state is good enough to maintain or need to be
improved (BizWiz, undated). There are five ratios in determining the efficiency in the company,
fixed asset turnover, total asset turnover, day sales outstanding, stock turnover and the last is the
account payable to sales.
i. Fixed Asset Turnover
Fixed asset turnover indicates the level of efficiency of the company in generating
earnings from the cost of fixed asset. Fixed assets including property, plant and equipment which
usually highly cost must be utilized well in order to cover up the sunk cost. We can say as pay
back for the investment of the fixed asset. As the high number of the ratio indicates the revenue
gathered in each ringgit of the cost of fixed asset invested in the company. Manufacturing
company usually highly invest in the fixed asset. Therefore, it should maintain the high level of
efficiency to utilize the assets well (DNB, undated). The fixed asset turnover equation can be
written as follows:
¿ Asset Turnover= Sales¿ Asset
Page | 21
Nestlé F&N
Fixed Asset Turnover3,877,068778,519
=¿
4.98
3,591,2041,122,717
=¿
3.20
Nestlé has better fixed asset
turnover for 4.98 than F&N with
3.2. Nestlé can generate revenue 4.89 times and F&N can generate revenue 3.2 times from the
value of fixed asset. It means that Nestlé fixed asset are used and managed properly to produce
the goods. From the figure, F&N has higher number of fixed asset, but it generates even less
sales than F&N. F&N should try to increase the efficiency of the fixed asset by applying new
strategy or improving the present performance. If there is unused or scrap fixed asset, F&N can
salvage it for increasing this ratio.
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2008
0 1 2 3 4 5 6
3.2
4.98
Fixed Asset Turnover
Nestle F&N
ii. Total Asset Turnover
A bit difference between fixed asset turnover with total asset turnover is the total sales
turnover includes the calculation of both non-current and current asset in the measurement of
efficiency. By knowing the efficiency of whole assets in the company, the managers can
eventually know the total utilization of the assets of the company (Answers, 2010). From the
ratio, the manager would maintain and increase the department performance, especially the
production department. The total asset turnover formula is as follows:
Total Asset Turnover= SalesTotal Asset
Just like the fixed asset turnover, the total asset turnover shows the same level of
efficiency of Nestlé and F&N. Nestlé with 2.33 and F&N with 1.43 shows the efficiency of
Nestlé is better than F&N. The total asset turnover also shows that Nestlé holds more current
asset than current asset and F&N holds nearly same proportion of current and non-current assets.
Page | 23
2008
0 0.5 1 1.5 2 2.5
1.43
2.33
Total Asset Turnover
Nestle F&N
Nestlé F&N
Total Asset Turnover3,877,0681,660,401
=¿
2.33
3,591,2042,514,089
=¿
1.43
iii. Day Sales Outstanding
The days sales outstanding analyzed the number of days that the debtor could pay the
short-term loan to the company. The lower of the DSO means the debtors are paying the debt in
the short period of time. On the other words, the DSO measures the level of company’s
efficiency in managing the debtor payment. If the company has a low DSO, the company can
easily receive the cash from customer and eventually use the cash generated for the other
investment or project (Investopedia, 2010). The DSO formula can be shown below:
Day SalesOutstanding=Total ReceivableNet Sales
x daysanalyzed
Nestlé can manage well their debtor in terms of return of receivable to the company. In
only three days, Nestlé can retain back their receivables. Nestlé has high efficiency on DSO, so
that Nestlé can use the lump sum of receivable for another project or investment. F&N has quite
good DSO, in average of 62 days the debtor pay back their debt to F&N. However, F&N still has
lower efficiency in managing the debtors.
Page | 24
2008
0 10 20 30 40 50 60 70
62
3
Days Sales Outstanding (in days)
Nestle F&N
Nestlé F&N
Days Sales Outstanding (days)23,814
3,877,068x365=¿
2.24≈3
617,3933,591,204
x 365=¿
61.89≈62
iv. Account Payable to Sales
The opposite of days sales outstanding is account payable to sales. This ratio measures
the level of unpaid short-period liability over the number of sales. It also indicates the efficiency
of the payment of the liability to the creditors, so that the interest of the debt is controllable and
kept to be low as much as possible. The short-term debt also gives advantages to the company as
the company can purchase other materials rather than pay off the one material using cash. The
higher the ratio indicates that the company is using the supplier as financing (CreditGuru, 1999).
The account payable to sales can be calculated using the equation below:
Account Payable¿ Sales= Account PayableNet Sales
From the account payable to sales shows that 23.32% of Nestlé’s and 18.27% of F&N’s
sales are funded by the suppliers. Both of this company is good in utilizing the short-term debt
funding from suppliers for their overall sales. But as the low liquidity of Nestlé, the short-term
debt should be decreased.
Page | 25
2008
0.00% 5.00% 10.00% 15.00% 20.00% 25.00%
18.27%
23.32%
Account Payable to Sales
Nestle F&N
Nestlé F&N
Account Payable to Sales904,368
3,877,068=¿
23.32%
656,1703,591,204
=¿
18.27%
v. Stock Turnover
The level of stock turnover is measuring the stocks of the year that have been sold and
generated into the cash. It can be used to know the efficiency of the production and distribution
of the products. Usually the stocks remains in the warehouse are the outstanding amount of
stocks that have not been distributed and sold to the customer. The lower number of stock
turnover means that the stocks were efficiently distributed to the customer and converted into
cash. However, the company should maintain the reasonable number of stocks in order to fulfill
the extra demand of the product. Based on research by Horngren (2007), for food and beverages,
the ideal stock ratio is about 8 times or approximately 47 days. The formula of the stock turnover
can be described below:
StockTurnover= Net SalesClosing Stock
Average stockholding period is just the same as stock turnover, but this ratio is expressed
in the number of days. It indicates the average days of stocks stays in the warehouse after the
production. The formula of average stockholding period is as follows:
Average Stockholding Period=Closing StockNet Sales
xdays analyzed
Page | 26
2008
8.05 8.10 8.15 8.20 8.25 8.30 8.35 8.40 8.45 8.50
8.20
8.44
Stock Turnover
Nestle F&N
Nestlé F&N
Stock Turnover3,877,068459,489
=¿8.443,591,204437,860
=¿ 8.20
From both ratios, both of these companies were maintaining well their stocks till the
distribution. There is no significant difference in the stock turnover as well as the period. Both of
these companies also keep the reasonable amount of stock to fulfill the extra demand from
customer. Therefore, both of this company has same efficiency in the stock management.
Nestlé has more efficient in all aspect of the efficiency ratio, this is the one of key of
success in Nestlé’s high profitability. By maximizing the utility of resources, Nestlé can achieve
the satisfactory position in the year 2008. F&N has quite good efficiency in the production, but
still, F&N must try to increase the efficiency in using the assets.
From all above four ratios, conclusion can be taken, Nestlé has an outstanding level of
profitability with high level of efficiency in the production. The efficiency is the key of success
in achieving the profitability, especially in using the assets and short-term debt. But, Nestlé must
make sure that they must put their liquidity position above the average. Nestlé also highly
leveraged, which indicates that the company is in highly risk in bankruptcy. However, if Nestlé
can maintain well the efficiency in using the short-term debt, the high level of gearing is not a
threat for Nestlé. On the other hand, F&N has strong position of liquidity and low level of
gearing. Thus, F&N must increase the performance in efficiency in order to increase the
profitability of the company.
Further Analysis
Page | 27
2008
43.4 43.6 43.8 44 44.2 44.4 44.6 44.8 45 45.2
45
44
Average Stockholding Period
Nestle F&N
Nestlé F&N
Average Stockholding Period459,489
3,877,068x365=¿
43.25≈44
437,8603,591,204
x 365=¿
44.50≈45
Ratio analysis alone cannot determine the decision-making of the investors, since the
ratio analysis only analyzes the performance in single year. Ratio also has many limitations that
will be explained in the next section on Limitation of Ratio Analysis. Because of that, the users
cannot see the real performance and development of the company. To gain clearer view of a
company’s performance, it is necessary to analyze the financial statement more than two or
three-year period. There are other analyses such as multivariate analysis, horizontal analysis, and
vertical analysis (Elliot&Elliot, 2001). Those analyses can be used in order to support the ratio
analysis, or even give an argument to the ratio analysis. There is no such a best analysis to the
financial statements. The result of this analysis will only suggest the investor whether to choose
to invest in those companies, but decision made only based on the type of investor itself. In this
report, trend analysis is used to analyze thoroughly after the ratio analysis does. Trend analysis
applied in this report since both of these companies have nearly the same size of company and
within the same industry.
Trend Analysis
Trend analysis is one of the forms of horizontal analysis. Trend analysis used to analyze
the trend or movement of performance in the period of time. Trend analysis usually analyses
over 5 to 10 years period (Horngren et al, 2007). In this report, the trend analysis will be
conducted for the 5 years period, 2004 to 2008. This trend analysis will analyze five criteria that
important for the shareholders, there are revenue, cash flow from operating activity, dividend
payout and cash flow for investing activities. There are two forms of trend analysis that can be
used, percentage changes and index number (Elliot&Elliot, 2001). Percentage changes give the
exact changes in each variable for each one year period. Percentage changes use the formula
shown below:
Percentagechanges=Present year variable−Last year variableLast year variable
x100 %
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Thus, index number gives the exact percentage of the variable over the base variable. It is
calculated by dividing each year variable by the base year. This analysis uses the index number
method for the trend analysis. In the first place, it is necessary to choose the base year, which is
2004 in this analysis. The formula of index number is as follows:
Percentagechanges=Present year variableLast year variable
x100 %
Page | 29
Trend Analysis each Company
Trend Analysis of Nestlé in 5 years
2008 2007 2006 2005 2004RM’000 RM’000 RM’000 RM’000 RM’000
Revenue 3,877,068 3,416,028 3,275,541 3,127,441 2,901,183
in % 134% 118% 113% 108% 100%Cash flow from Operating Activity
555,972 290,657 358,057 266,956 376,543
in % 148% 77% 95% 71% 100%
Dividend payout ratio (no.) 0.8 1.1 1.1 1.3 1.2
in % 67% 92% 92% 108% 100%
Cash flow in Investing Activity
185,696 100,721 76,294 72,152 52,668
in% 353% 191% 145% 137% 100%
Trend Analysis of F&N in 5 years
2008 2007 2006 2005 2004RM’000 RM’000 RM’000 RM’000 RM’000
Revenue 3,591,200 2,865,100 1,943,600 1,935,100 1,728,100
in % 208% 166% 112% 112% 100%Cash flow from Operating Activity
325,457 71,480 289,674 90,783 177,038
in % 184% 40% 164% 51% 100%
Dividend payout ratio (no.) 1.2 1.3 1.2 1.2 1.3
in % 92% 100% 92% 92% 100%
Cash flow in Investing Activity
222,943 374,580 115,699 61,759 116,722
in% 191% 321% 99% 53% 100%
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Graph can be plotted from each of the variable that used in the trend analysis. Graph
believed to supplement users in analyzing using the trend analysis. Graph and its interpretation is
as follows:
2008 2007 2006 2005 2004
134%118% 113% 108% 100%
208%
166%
112% 112%100%
RevenueNestle F&N
Revenue trends index show that Nestlé has a gradual increase in 5 years. Revenue of
Nestlé increases for average of 8% every year. F&N revenue increases gradually in year 2005
and 2006. Then, in 2007 and 2008 F&N’s revenue increase significantly to 166% and 208%.
This indicates that F&N’s took over of Nestlé’s dairy (Thailand) company in 2006 was
successful (Patton, 2006). Take over for RM 310million increase the revenue for 54% in 2007
and 42% in 2008. Trend analysis indicates that in the next year there will be significant increase
for F&N’s revenue. However, Nestlé has invested for the development of Nestlé’s manufacturing
and technology facility in 2007. One of the developments is the air-dried noodle for the so called
Maggi noodle. Since the turnover of Maggi noodle 1.3 million per day, it was believed that the
technology will boost the revenue in the future (Nestlé, 2007).
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Operating activities trend indicates that, both of these companies are having fluctuation in
the cash inflow from the operating activity. Nestle has fluctuative cash flow from 2005 to 2008
and increase significantly in 2008 for 148%. Thus, F&N has significant declining in the cash
flow, especially in 2005 and 2007, drop for 51% and 40% respectively. Moreover, F&N also has
significant increase in 2006 and 2008 for 164% and 184% respectively. The fluctuation
happened to both companies can be treated as market effects to the company. But, F&N has
better performance in year 2006 and 2008 as it perform well after the grave performance, even
the grave performance of F&N worse than Nestle. In 2009, there will highly probable that both
of companies will enter the grave performance and enter good performance in 2010.
2008 2007 2006 2005 2004
67%
92% 92%
108%100%
92%100%
92% 92%100%
Dividend PayoutNestle F&N
Page | 32
2008 2007 2006 2005 2004
148%
77%
95%
71%
100%
184%
40%
164%
51%
100%
Cashflow from Operating ActivityNestle F&N
Dividend payout measures the amount that company give to the shareholder compared
with the earnings that they get per share. Outstanding amount of earnings that taken by the
company is called retained earnings. Usually, retained earnings use for investing a project or
other development for a better performance in the future. Trend analysis of dividend payout
indicates that Nestlé give almost same dividends payout to shareholders in 2004 to 2007. But in
2008, Nestlé retained 23% more than the base year to develop a new factory in Shah Alam. The
factory produces non-dairy creamer ‘Coffeemate’, Coffee and cereals. Coffeemate is the best
product in the market, occupy 88% of share market. Nestlé has invested for the total of
RM100million in renovating and developing their factories since year 2007 (Nestlé, 2008). The
trend forecasted that Nestlé’s dividend payout will increase as the development of the company.
Nevertheless, F&N gave stable dividend payout to shareholder and this indicates that dividend
for next year will be not very much different.
2008 2007 2006 2005 2004
353%
191%
145% 137%
100%
191%
321%
99%
53%
100%
Cashflow in Investing ActivityNestle F&N
As from the trend of dividend payout, the analysis scope to the investing activity of both
of companies. Nestlé’s investing activity increased year by year, but in 2008 there is significant
increase for almost 150%, due to the investment of factory in Shah Alam. F&N on the other
hand, has a significant cash outflow for the year 2007 for the take over and acquisition of Nestlé
Dairy Thailand. These investing activities of both companies believed to be successful in the
upcoming years.
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Conclusion
As ratio analysis indicates that Nestle is having better profitability and efficiency, but
with low level of liquidity and highly-leveraged. F&N has good position on both liquidity and
gearing, but with lower profitability and efficiency than Nestle. Trend analysis may supplement
or reject the result of ratio analysis. Trend analysis shows that Nestle is on stabile position in
revenues. From the operating cash flow of Nestle, it can manage to perform well, even in bad
economy situation in 2005 and 2007. This indicates that Nestle is stabile and strong. Even
though Nestle is strong enough, it must use the long-term debt for investment, so that
shareholders did not get burden from those activity. In this case, trend analysis reject the result
from ratio analysis as Nestle was very strong and stabilized, even with low liquidity and high
leverage.
F&N gives picture of good performance year by year in the revenue. It also uses long-
term debt to invest in order to minimize shareholder’s burden as well as maintain the dividend
payment. However, F&N was not strong enough to stay in the bad economic situation like
Nestle. This can be seen from the trend analysis on the operating activities, F&N entered the
grave performance in year 2007. The grave performance also supplemented by the new growing
investment, the takeover of Nestle, made F&N enter even worse position in 2007. The growing
investment will enter the mature stage soon, so the performance of F&N will not increase
significantly in the upcoming years. Trend analysis gives different picture of F&N’s performance
from the ratio analysis. Although with good position of liquidity and gearing, F&N still easily
affected with economic situation and enter the grave performance.
From all analysis above, Nestle has better and stronger position in the market than F&N.
Nestle has been a stabilized multi-national company since long time ago. Therefore, Investors
might consider investing in Nestle with the consideration of new investment and strong position
in the market.
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Limitation of Ratio Analysis
Ratio analysis is the one of best methods in analyzing performance of company. It can
analyze most of data from financial statements to clearer picture, so that the data from financial
statement become meaningful. For example, in spite the user see the liability that the company
take, gearing ratio can be used to see whether the company is utilizing the debt well or it is
taking too much debt for financing. Users of financial statement can focus on the area that they
would see for their further decision-making. However, there is nothing perfect in the world, ratio
analysis also has limitation and problem in the implementation. Here are some common
limitations that people argue in the practice of ratio analysis.
Firstly, accounting technique has been one of limitation for practice of ratio analysis.
Usually, different company has different method to apply into their financial statement
(accountingformanagement, 2009). For example, Nestle and F&N in this report use different
accounting policies on calculating their cost of inventories. Nestle is using first-in-first-out
method, thus F&N is using weighted average basis. Another limitation of ratio in accounting
sector is creative accounting. Since the development of creative accounting, accountants are
adjusting the accounts to form a better performance of the company. Creative accounting is the
attempt of legal manipulation in creating financial reports. It was created in order to create high
or low figure of profit for special reason. Other than profit, asset and liabilities also one of
variables that can be manipulated using several techniques like leasing, off-balance sheet
financing, and so on (Moneyterms, 2009). Creative accounting usually is used by listed
companies, because listed companies publish financial statements for public in order to attract
shareholders to invest in their company.
Secondly, information itself can cause problem either in the ratio analysis. One reason
that people argue on the ratio analysis is outdated historical cost. Since the financial statements
are made based on the historical cost, the information in it might be outdated and do not relevant
with current situation (CBDD, 2003). Other than that, the interpretation from financial
statements might not be accurate, since companies are publishing summarized information and
many of them are using group or consolidated financial statements (accountingformanagement,
2009). Summarized financial statement only gives not detail data, moreover consolidated
financial statements usually aggregates assets and minimized its liabilities (Elliot&Elliot, 2001).
Page | 35
Financial statements also not single item which give performance of the company. There
are other information like qualitative reports like number of employees and factory, future plans
and strategy, and so on (Elliot&Elliot, 2001). The most appropriate example is Nestlé’s and
F&N’s project in development in the year 2007 and 2008. Nestlé’s project like factory in Shah
Alam and F&N’s acquisition and takeover of Nestle dairies Thailand, those were not stated in the
financial report. Then, the interpretation of ratios is different each person who analyze it. This
made problem to choose whether this company is good or bad, because everybody has their own
opinion in the interpretation (accountingformanagement, 2009).
Thirdly, comparison over the performance between companies is impossible in long-run.
This happened because of the changing of many outside factors like inflation, technology,
seasonal trading, accounting policy and standards. Inflation may bring the ratio analysis
inappropriate, since all price are increasing and revenue are increasing either. Users of the
analysis might thought that the increasing of revenue because of good performance. Technology
also takes part in the problem of ratio analysis (CBDD, 2003). This means that ratio analysis
cannot measure companies which using different or change their technology. For example, users
cannot measure machine-based company with labour-based company, for example food
company which is machine-based with restaurant which is labour-based. Seasonal trading has
been one common problem to ratio analysis, if companies have different financial closing
accounts. For example, paper companies with different closing account dates. One of them is
closing their account before ‘back to school’ season, and another close the account after that
season. The revenue of two companies is incomparable, since they have different closing
account. Since International Accounting Standard Founded, there are so many accounting
policies and standards which shifting to other policy and standards. While the changing of those
policies as well as standards gives higher chances to directors for making manipulation and bias
to the current situation of the company (accountingformanagement, 2009).
Finally, financial ratio cannot measure company with different size and different
industry. Ratio analysis cannot give accurate data to comparison in different industry, because
financial, risk, capital structure and size of company may be in different proportion each
industry. Manufacturing company might have high number of asset and financed by
shareholders, although financing companies do not have much in assets and use debt financing.
Page | 36
The risk of business also gives limitation to ratio analysis (CBDD, 2003). Airline companies
which usually highly-leveraged cannot be compared with other companies with average level of
gearing. Other than above, government’s help also give contribution in the limitation of ratio
analysis. For example, tax-redemption for multi-national companies, especially in Malaysia,
gives lower tax charge to multi-national companies in order to attract foreign companies (lowtax,
2010).
These limitations might argued by people, usually people who prefer in finance rather
than accounting. Finance people usually use forecasted data in analyzing the company. They
believe that forecasted data will be more relevant and reliable, rather than historical data.
Although ratio analysis has a lot of limitations, many people are still using the analysis.
Professionals and economic researchers are developing other method in analyzing stock market.
The upcoming method of analysis believed to be more relevant to recent situation.
Page | 37