Three Financial Ratio Analysis

Published Date: 02 Nov 2017

088942

Guang REN

19/04/2012

Executive summary

The intention of this report is to calculate the results of an analysis conducted on JB Hi-Fi. This report will assess JBH relative to profitability, asset efficiency, liquidity, gearing and investment. The trends and the causes of the trends will be discussed and some industry comparisons as well. And will give brief suggestion of improvement. Annual reports from the past three years and analysts published views were used as the basis for the final recommendation.

Table of contents

Overview of the company and its operations

JB Hi Fi was established in 1974 by Mr. John Barbuto (JB), trading from a single store in East Keilor, Victoria. He had one simple philosophy: to deliver a specialist range of Hi-Fi and recorded music at Australia's lowest prices.

JBH is a discount retailer, specialising in a variety of consumer personal electronics, with a customer base that slants towards the young. JB Hi-Fi Limited engages in the retail of home consumer products in Australia and New Zealand. The company primarily offers audiovisual equipment, computing equipment, whitegoods, kitchen appliances, and other related equipment. As of June 30, 2012, it had 168 stores, including 155 in Australia and 13 in New Zealand.

Research shows that JB Hi-Fi has mainly profited of struggling competition within Australia, while the consumer electronics market is showing steady growth. Customer demand is driven by new products and new technologies and government programs are opportunities for the future. The success of JB Hi-Fi can be explained by its ‘lean and mean’ organization, which is very much focused on the knowledge of margins and customer demands. 

Analysis of the company

Comments relating to Profitability

Gross profit margin

　

　2010

2011

2012

(Gross profit / sales) x 100

%

21.75

22.03

21.10

Net profit margin

　

　

　

　

(Net profit before interest and tax / sales) x 100

%

6.46

5.57

5.18

Return on total assets

　

　

　

　

(NPBIT / Average total assets) x 100

%

25.66

22.25

20.53

Profitability ratios measure a company’s ability to produce earnings relative to sales, assets and equity. These ratios assess the ability of a company to generate earnings, profits and cash flows relative to some metric, often the amount of money invested. They emphasize how effectively the profitability of a company is being managed (Matarneh, F. G, 2009).

Gross profit margin ratio relates the gross profit of the business to the sales generated during the same period.

The gross profit margin in 2010 is 21.75% then it increased to 22.03% in 2011 and dropped into 21.10% in 2012. According to the chairman’s report, the major movement in gross margin was caused by a combination of the challenging trading environment, higher and more aggressive levels of discounting by the market rivals as they chased the market shares and raised shrinkage levels.

Moreover, the labour cost is also a main reason for the reduction of the profit as the combined fair work award increases over the past three years of over 10% in Australia.

Net profit margin ratio relates the net profit for the period to the sales during that period, which is also normally expressed as a percentage.

The net profit margin is 2.45% for the retail sector, whilst JB operates at 5.18 %( 2012), 5.57% (2011) and 6.46% (2010), which indicates a reasonably higher net profit margin. This may indicate that JB Hi-Fi carries a higher margin of safety and less risk, compared to the average retail sector net profit, as a decline in profits would leave less of a strain on JB Hi-Fi. Having a higher net profit margin than the sector average leaves JB in a good position to be a strong performer within the industry.

The decline in net profit margin is linked to the decline in the gross profit margin ratio. The decrease in NPR over the past three years considering of the return has been derived during the recovery of global financial crisis. This indicates that the business model of JB is great affected by the depression of the economic domestically.

Return on total assets (ROA) compares the net profit generated by the business with the assets owned by the business.

Here the retail average is 7.77% whilst JB is almost triple at 20.53% (2012), 22.25% (2011) and 25.66% (2010). This shows that JB is superior to its industry average and its assets are highly successful in generating revenue. It shows that JB Hi-Fi management is successful in utilising assets correctly and gives them an advantage over the competition within the retail industry.

Although the trend is going well, the strong competition in the electronic retail market has levied heavy pressure on price under economic downturns. The company is not suggested to drive sales by offering lower prices as it may not sustain when rivals start a price war. It is recommended to focus on minimizing its CODB and by maintaining good relationships with suppliers and landlords to maximize the profits.

Comments relating to Efficiency

Average inventory turnover period

　

2010　

2011

2012

(Average inventory held / Cost of sales) x 365

days

56.30

45.74

48.73

Average settlement period for debtors

　

　

　

　

(Average trade debtors / Credit sales) x 365

days

37.65

36.45

40.98

Asset turnover period

　

　

　

　

(Average total assets employed / sales) x 365

days

91.94

91.36

92.09

These ratios may be used to measure the efficiency with which particular resources have been used within the business. They are also referred to as activity ratios.

Average inventory turnover period measures the average period inventory was held, it is normally expressed in terms of days.

In the case of JB HIFI, the inventories turnover period for the year 2010 is 56.30 days. This means on average the inventories held are being turned over every 56.3 days. So, an electricity good bought by the business on a particular day would, on average, have been sold about eight weeks later. A business will normally prefer a short inventories turnover period to a long one, because holding inventories has a cost. In 2011 and 2012, however, the inventory turnover period is decreased to 45.74 day and 48.73 days respectively. This means the company had considered about the demands, supply shortages, likelihood of price rises, etc. of the inventories and improved the inventory management (Shanab, S.A, 2008).

Average settlement period for accounts receivable (debtors) calculates how long, on average, credit customers take to pay amounts owed, which is normally expressed in terms of days.

In 2012, the settlement period increased by 4.5% with compared to 2011. The extension of the date is no healthy for the company. Changing product lines can be regarded as one of the reason. JB HiFi used to sell car accessories and stereos. Several years ago, JB HiFi was the only business who selling high end stereo systems. Then it not only moved into CDs, DVDs and associated products before being listed, but also provides a range of subsidiary products like strings, tuners and keyboard.

Asset turnover period examines how effectively the assets of the business are being employed in generating sales revenue, which is normally expressed in terms of days

Not a huge difference among the past three years.

It is not only a threat for the discount retailers including JB but also a great challenge as it may immensely improve the efficiency. As JBH runs the JB Hi-Fi Online as an additional sales channel of the company with 13.29% of the total site visits in 2010, it can be expected JB could take advantage of this challenge.

Comments relating to Liquidity

Current ratio

　

2010　

2011　

2012　

Current assets / current liabilities

proportion

1.25

1.45

1.22

Cash flow from operations

　

　

　

　

Operating cashflows / current liabilities

times

0.42

0.32

0.49

Current ratio compares the business’s liquid assets with short-term liabilities (current liabilities). It can be expressed in terms of the number of times the current assets will cover the current liabilities. The calculation can be list as:

The average ratio in this industry is 2.76 which indicate that for every dollar owed, companies will have $2.76 presented in assets to change into cash in a short period. As the JB Hi Fi data estimated, it is attractive to note that current ratios of the last three year period are considerably below the industry average. Nevertheless, it is not concerning as JB still have a ratio above 1, hence it would still be able to satisfy their current responsibilities. The company got a highest ratio in 2011 while it decreases to 1.22 on 2012 which is preferable. Research shows that JB Hifi is aware of its debt. In the Q3 and Q4 of 2012, the debt has reduced from about $200m to only $44m. It is likely to be gone within the next two quarters with such impressive cash flows. The current debt/equity ratio of JB is just 21 percent.

Cash flows from operations ratio compare the operating cash flows with the current liabilities of the business, which is expressed in terms of the number of times the operating cash flows will cover the current liabilities.

Although JB experienced a reduction of 30% in its cash flows in the 2010-2011 periods, it has been quick to rectify it with substantial growth in 2012 up 90%. The higher the ratio is, and the better the liquidity of the business. However, it stills less than 1 time, which indicates the operating cash flows for the year are not quite sufficient to cover the current liabilities at the end of financial year.

The company is suggested to improve its liquidity by changing their products lines. The digital downloading of music and movies presents a threat to the industry. JB uses a large part of its space for selling music and DVDs which may have a much lower growth rate in the coming years.

Comments relating to Gearing

Gearing

　

2010　

　2011

　2012

Long term liabilities / (share capital + reserves + retained profits + LTL)

%

16.48

76.69

74.32

Interest cover

　

　

　

　

NPBIT / interest expense

times

25.41

26.30

11.87

Gearing is a measure of financial leverage, demonstrating the degree to which a firm's activities are funded by owner's funds versus creditor's funds.

Gearing ratio measures the contribution of long-term lenders to the long-term capital structure of the business, which is expressed in terms of a percentage.

In 2010, JB HIFI has a very low gearing ratio which is one-third of the following two years. The long term liabilities in that year were only 57887 compared to 268888 in 2011 and 187167 in 2012. The main reason for this trend might be the recovery of financial crisis from 2010. The confidence of both venders and buyers were strengthened.

Interest cover ratio (times interest earned) measures the amount of profit available to cover interest expense of the business. Interest cover ratio can be calculated as: (Profit before interest and taxation)/ (Interest expense). It has declined dramatically from around 26 in both 2010 and 2011 to one where operating covered interest only 11.87 times in 2012. This was mainly caused by the huge increase in borrowings in 2012.

Although the interest cover ratio is in a healthy status, but the dramatically declined trend is dangerous for the company and would also bring risks to the shareholders. The New Zealand market has been challenging for JBH with a loss of $1.9m recognized at the end of FY12. JBH New Zealand is still in its infancy, which requires more spending on marketing before it can achieve economies of scale and generate positive profits. It is not expected the business to contribute much in the coming years.

Comments relating to Investment

Dividends per share

　

2010　

2011　

2012　

Dividends announced during period / number of shares on issue

cents / share

0.62

0.90

0.78

Earnings per share

　

　

　

　

Earnings available to ordinary shareholders / number of ordinary shares

cents / share

1.10

1.11

1.06

Dividends per share relate the dividends announced to the number of shares on issue of the business during a period, it is not a measure of total return of the business. In 2011, the dividends per share reach the peak while the average of the past three years is still higher than the medium of this industry which is 0.54 per share. Its shows, that the JB Hi-Fi has adopted the policy to increase its dividend for shareholders, as the lower growth expectation from investors. This made the company more attractive for investors who looking for regular cash flow.

JBH’s capacity to deliver growth presents an attractive offering for an investor displaying exceptional results over the 2010 to 2011, however, the trend changed in the next FY2012.

Conclusions and recommendations

In summary, JB Hi-fi’s profitability is quite good which of ROA ration is almost triple the industry average. It shows that JB Hi-Fi management is highly successful in generating revenue and utilising assets correctly. It is suggested that JB should not extend its finance liabilities from the creditors to finance its further investment as the currently level is already high.

The data in asset efficient reflects a positive improving result. JBH’s asset efficiency ratios indicate that they are efficient in selling as well as collecting money from sales. JBH’s capacity to generate income from inventory is positive allowing the company to pay its debtors promptly. 

JB Hi-Fi’s liquidity to repay short-term debts is positive. JB have the capacity to meet all short-term obligations with inventory held without over investing in working capital. JBH’s ability to efficiently cycle inventory supports their system. 

For the gearing ratio, JB Hi Fi did well on the first year of the period which has a low liability. However, during the FY2012, it has a dramatically increase of interest expense which cause the low interest cover ratio which may touch the profits of the shareholders.

The investment went well during FY2011 period, but fell on the next period by almost 15%. As the same numbers on share, the dividends announced decreased.

Based on the financial analysis, it is believed that JB Hi-Fi will keep performing in the areas of business activity, profitability and paying an attractive dividend. However, some issues should be considered. The main issue for JB HiFi is that many of its products are moving from a physical product such as a DVD, to a digital product, available online. After reaching a peak in 2009/10, DVD sales and rentals (including Bu-Ray) have been steadily falling. Games can now be downloaded, rather than having to buy a physical DVD in a shop. And there is only 26% of sales are in software.