Financial Ratio Analysis and Interpretation

In order to make an investment choice, often the financial performance and stability are compared. In this backdrop, the objective of this report is to draw a comparison of the financial performance of two companies i.e. Retail Food Group (RFG) and Freedom Foods Group Limited (FFGL) considering FY2017 annual report. The key tools used for financial analysis are trend analysis and ratio analysis. However, the shortcomings of relying only on financial performance have also been indicated in reference to focus on the social and environmental performance of the two companies.

Financial ratio analysis and interpretation

The objective of the given task is to carry out a comparison of the ratio analysis of the two companies based on the financial statements highlighted in FY2017 annual report.

1. a) Profitability Comparison

With regards to profitability returns and ratios, RFG is the superior choice as compared to FFGL. This is because for each of the five profit ratios RFG has a superior value. One of the key reasons for the same is on account of franchisee fee contributing a significant chunk of the revenue for RFG. Considering that this is fee based income, the underlying cost for the same is quite less and hence a boost to the profit margins is provided (RFG, 2017).

On the other hand, FFGL does not have any significant franchise based fee and hence the profits earned on account of the food products that are manufactured and marketing. It is noteworthy that the above is only one of the reasons since RFG has a higher gross margin when compared to FFGL which may be the result of difference in product mix since the former is in QSR and fast foods segment while the latter is in health and wellness products (EEGL, 2017).

1. b) Asset Efficiency Comparison

With regards to asset efficiency, RFG is the superior choice as compared to FFGL. This is captured in all the ratios except one i.e. asset turnover. The asset turnover is higher for FFGL since for RFG the business model is more asset intensive since there is requirement of company owned stores. Also, for RFG, the franchise fee related income is not included in the revenue which also subdues the same. With regards to inventory turnover and debtors turnover, a higher ratio is exhibited by RFG which indicates the ability of the company to turn inventory into sale faster and also recover the business receivables (Parrino and Kidwell, 2014).

Profitability Ratios

This also may be attributed to the nature of business of RFG since inventory is readily converted into sales and also the franchisees do not need to stock inventory. This is unlike the case in FFGL where the cash cycle is longer because of the longer time to convert inventory into sales and higher credit period to sales partners (Damodarsn, 2015).

1. c) Liquidity Comparison

With regards to liquidity ratios, RFG is the superior choice as compared to FFGL. This is because for each of the three liquidity ratios RFG has a superior value. Liquidity ratios tend to act as indicators of the short term liquidity and potential cash crunch in the near term (Brealey, Myers and Allen, 2014).  For FFGL, it is apparent that the liquidity ratios are quite unhealthy. This is apparent from the fact that current ratio is only 0.56 which represents that only 56% of the current liabilities are covered by corresponding current assets. For RFG, the corresponding ratio is 1.48.

If the quick ratio is considered, then the situation for FFGL is even more dismal as the ratio drops to 0.30 which indicates high presence of inventory in the current assets. The corresponding value for RFG is 1.17. The cash ratio is even dismal for FFGL at 0.02 which presents that cash on the books as on June 30, 2017 is just 2% of the outstanding current liabilities. Going forward, it may be possible that FFGL may face some liquidity crisis (Damodaran, 2015).

1. d) Capital Structure Comparison

With regards to capital structure, the results are mixed with some of the ratios being superior for RFG while the other superior for FFGL. With regards to interest coverage and debt coverage ratio, the superior value tends to exist for RFG considering the fact that EBIT and operating cash flows are significantly higher for RFG aided by the income from the franchisees. However, with regards to other ratios such as debt equity ratio, debt ratio and equity ratio, FFGL has superior performance in comparison with RFG.

This to an extent may be related to more asset intensive model of RFG owing to ownership of certain company stores which is not the case for FFGL. However, the capital structure ratios do not indicate any issues going forward for RFG as the ratios are quite healthy. FFGL needs to improve the profits so as to better serve the debt related obligations (Parrino and Kidwell, 2014).

Superior Investment Bet

Asset Efficiency Ratios

The above financial analysis was conducted with the objective of identifying the better company for investment on the basis of financial performance and stability. The key takeaway from the ratio interpretation and comparison is that RFG has the upper hand in majority of the key financial ratios. Further, even in certain ratios that FFGL does have superiority, the lower numbers for RFG does not pose any concern from an investment perspective.

Further, considering the inferior liquidity ratios of FFGL as on June 30, 2017, there does arise valid concerns related to short term liquidity crunch which may be faced by the company because of facing issues regarding serving short term liabilities. Also, owing to the issues regarding lower profits being generated in FY2017, FFGL also has potential issues going forward in relation with servicing the debt owing to low interest coverage and debt coverage ratios (Damodaran, 2015).

On the other hand, RFG offers a very stable bet which tends to have superior profitability margins along with comfort with regards to liquidity and solvency. As a result, based on the financial statements, there does not seem that any short term or long term concerns are posed for RFG. Also, the asset efficiency ratios tends to be superior for RFG owing to which there is a shorter cash cycle and hence the working capital usage would be lower, leading to higher profitability (Brealey, Myers and Allen, 2014).

Limitations of financial ratio analysis and non-financial information of an entity  

The above decision to invest in RFG is based solely on the financial statement analysis which has certain shortcomings. One of the shortcomings is that the past performance may not be a reliable indicator of future performance of the company and hence it would not be wise to extrapolate the past performance into the future.

Also, in the given case, the analysis has been conducted for only one year and based on that the conclusion is being derived (Damodaran, 2015). The year FY2017 was particularly bad for FFGL and hence relying on comparison of just one year is clearly not correct. Additionally, it is imperative to consider the difference in business models of the two companies even if they belong to the same sector as the ratio differences at time is attributed to this aspect which gets if focus is solely on financial performance (Parrino and Kidwell, 2014).

Further, it is imperative to consider the social and environmental aspects of the activities. In this regards, the underlying product offering does matter. RFG focuses on products which to an extent are related to the burgeoning social menace of obesity and can lead to lowering of health outcomes in the long run. In contrast, the focus of FFGL is on wellness and health products which are aimed at improving the health of the people and thereby have a positive externality associated with the same. Also, consideration also needs to be given on the underlying carbon footprint of the business activities of the two companies

Conclusion

Based on the above, it can be concluded that based on financial performance for FY2017, RFG appears to the superior option from investment perspective and stability. However, a key shortcoming is that the future performance of the respective companies might not be the same as past performance. Also, the above analysis tends to ignore the social and environment aspects related to the two companies which is pivotal. In this regards, the social impact of RFG products is inferior in comparison to that of FFGL which is significant. Similarly, the environmental performance also needs to be considered.

Reference List

Brealey, R. A., Myers, S. C. and Allen, F. (2014) Principles of corporate finance, 6^th ed. New York: McGraw-Hill Publications

Damodaran, A. (2015). Applied corporate finance: A user’s manual 3^rd ed. New York: Wiley, John & Sons.

FFGL (2017) Annual Report FY2017,

Parrino, R. and Kidwell, D. (2014) Fundamentals of Corporate Finance, 3^rd ed. London: Wiley Publications

RFG (2017) Annual Report FY2.