Assignment 3- Ratio Analysis and Capital Budgeting

Using Accounting for Decision making T1, 2016

ACCT11059

Martin Turner

Zac Beveridge

6th June 2016

ContentsStep 1- Ratio Analysis and Economic Profit...........................................................................................3

Profitability Ratios.............................................................................................................................3

Profit Margin.................................................................................................................................3

Return on Assets............................................................................................................................4

Efficiency (or Asset Management) Ratios..........................................................................................4

Total Asset Turnover Ratio (ATO)..................................................................................................5

Liquidity Ratio....................................................................................................................................5

Current Ratio.................................................................................................................................5

Financial Structure Ratios..................................................................................................................6

Equity/debt ratios..........................................................................................................................6

Equity Ratio...................................................................................................................................7

Market Ratios....................................................................................................................................7

Earnings per share.........................................................................................................................7

Dividends per Share.......................................................................................................................9

Price Earnings Ratio.......................................................................................................................9

Ratios Based on Reformulated Financial Statements......................................................................10

Economic Profit...............................................................................................................................12

Peer Forum..........................................................................................................................................13

Step 2- Investment Decision for Slater and Gordon Lawyers..............................................................14

Feedback.............................................................................................................................................16

Step 1- Ratio Analysis and Economic Profit

Profitability Ratios Profitability ratios are used to determine how profitable a firm is over a certain period of

time. ‘A profitability ratio is a measure of profitability, which is a way to measure a

company's performance. Profitability is simply the capacity to make a profit, and a profit is

what is left over from income earned after you have deducted all costs and expenses related

to earning the income’ (Study.com, 2016). This ratio demonstrates the efficiency of a

business and I believe it relates to the success of a business as to where it is heading in the

future.

Profit Margin‘Profit margins are expressed as a percentage and, in effect, measure how much out of

every dollar of sales a company actually keeps in earnings. A 20% profit margin, then, means

the company has a net income of $0.20 for each dollar of total revenue earned’

(Investopedia, 2016). Profit Margins are vital when taking into account the success of a

business, for a business to do well it first must have expenses. For example, freight

companies would have a large amount of revenue but also have a lot of expense s and this

must be taken into account when determining the success of a business.

Slater and Gordon Lawyers (Year) Profit Margin

2015 5.8%

2014 14.6%

2013 12%

2012 10.2%

Table 1-Slater and Gordon Lawyers’ Profit Margin

From analysis of Table 1, in 2013 and 2014 the company had worked out a way to improve

the profit per dollar of sales, through growth and goodwill. In 2015, the company had some

troubles due to traffic compensation and a rapid decline on the stock exchange and due to

this the profit margin for 2015 is significantly lower considering the company had increased

from 2012 to 2014. In saying this, some law firms worldwide have struggled over the past

year, ‘average profitability of firms has risen slightly to 9.5 per cent (from 9.4 per cent) while

growth forecast have dropped an average of 2 per cent, from an average of 11 per cent last

year to 9 per sent this year’ (Alpma, 2016).

Over the past four years the average profit margin for Slater and Gordon lawyers is 10.65

per cent so it is, on average, higher than the other internationally recognised law firms.

Return on Assets‘Return on assets (ROA) is an indicator of how profitable a company is relative to its total

assets. ROA gives an idea as to how efficient management is at using its assets to generate

earnings’ (Investopedia , 2016). ROA are vital when comparing a firm to other businesses

within the same industry as it provides very comparable data and gives a physical example

as to how the particular company is performing.

Slater and Gordon Lawyers (Year) Return on Assets (ROA)

2015 2.7%

2014 6.8%

2013 7.0%

2012 4.8%

Table 2- Return on Assets for Slater and Gordon Lawyers

As seen above, Slater and Gordon Lawyers had a strong ROA in 2013 and 2014 at around

6.9%; in 2012 the company was a lot smaller which caused the percentage to be lower. In

2015, the return on assets dropped because of the financial troubles associated with the

company. The ROA for law firms is relatively low compared to that of retail business due to

the assets being the service as opposed to goods. Slater and Gordon lawyers has an average

ROA of 5.32% over the last four years which is below the industry average of 6.2% and this is

due to the company’s poor performance in 2015.

Efficiency (or Asset Management) Ratios‘The efficiency ratio is a ratio that is typically used to analyse how well a company uses its

assets and liabilities internally’ (Investopedia, 2015). These ratios can determine turnover,

liabilities and general use of sales and assets.

Total Asset Turnover Ratio (ATO) ‘Asset turnover ratio is the ratio of the value of a company's sales or revenues generated

relative to the value of its assets’ (Investopedia, 2016). The one thing about ATO is it can

demonstrate as to how efficient a business is becoming or how much that particular

company is struggling.

Slater and Gordon Lawyers (Year) Total Asset Turnover Ratio (ATO)

2015 0.46

2014 0.46

2013 0.58

2012 0.47

Table 3- ATO for Slater and Gordon Lawyers

As seen in table 3, the total asset turnover has remained fairly constant for the company

and thins is due to the skill set involved with law. The ATO is going to remain fairly

consistent because services will remain at a standard cost, whereas with a good the price

can change and this will cause the ATO to fluctuate over a period of time; when the business

grows (particularly in a place which sells goods) there will be higher total asset turnover

rate. Slater and Gordon has remained consistent with other international law firms as the

average ATO is around 0.5.

Liquidity Ratio ‘The Liquidity ratio is the ratio between the liquid assets and the liabilities of a bank or other

institution. They are a class of financial metrics used to determine a company's ability to

pay off its short-terms debts obligations’ (Investopedia, 2015).

Current Ratio‘The current ratio is a liquidity and efficiency ratio that measures a firm's ability to pay off its

short-term liabilities with its current assets. The current ratio is an important measure of

liquidity because short-term liabilities are due within the next year’ (MyAccountingCourse,

2016). The Current ratio can best determine the short term obligations of a business, when

a company has a ratio of 1.0 this means that it is liquid, this means one unit of asset for one

unit of liability. Anything below 1.0 means that the firm is partially liquid, whereas anything

above means the firm is performing very well.

Slater and Gordon Lawyers (Year) Current Ratio

2015 1.88

2014 2.15

2013 3.5

2012 3.62

Table 4- Current Ratio for Slater and Gordon Lawyers

Slater and Gordon Lawyers have a very high current ratio and this means that the business is

providing more assets per unit than liabilities on a short term basis. The company is

dropping because it is becoming more liquid as opposed to 2012 and this is linked to the fall

on the stock exchange. Most other international law firms are around 2.25 which

demonstrates that Slater and Gordon Lawyers is around the money.

Financial Structure RatiosFinancial structure ratios are the long term debt and equity of a business used by a company

to finance its operations.

Equity/debt ratios‘Debt/Equity Ratio is a debt ratio used to measure a company's financial leverage, calculated

by dividing a company's total liabilities by its stockholders' equity’ (Investopedia , 2015). If

the company has an equity/debt ratio of 1.0 it means that every asset funded by owners’

equity the same amount in debts are funded by debt owners. Generally speaking, if a

company has an equity/debt ratio of less than one than it hasn’t used a lot of money to fund

its assets whereas, if it’s above 1.0 the company is borrowing a lot of money for its assets.

Slater and Gordon Lawyers (Year) Equity/Debt Ratio

2015 1.13

2014 1.12

2013 0.71

2012 1.14

Table 5- Equity/Ratio of Slater and Gordon Lawyers

Slater and Gordon Lawyers have a relatively sound Equity/Debt Ratio at a median of 1.025

which means that almost every asset funded by the owners’ equity, the same amount of

debt(s) are funded by the debt owners over the past 4 years. The company has proved to be

quite strong in this aspect, particularly in 2013 with only a ratio of 0.71. In 2012, 2014 and

2015 to firm averaged 1.13 which is closer to the national average of law firms in Australia,

1.02.

Equity Ratio The equity ratio refers to the level of leverage (margin) used by a company and refers to the

total assets used by a company that are financed by stockholders, as opposed to creditors.

When a company has an equity ratio closer to 1 or 100% it means that most of the company

is funded by owners’ equity as opposed to borrowing money from creditors.

Slater and Gordon Lawyers (Year) Equity Ratio

2015 47%

2014 46%

2013 58%

2012 47%

Table 6- Equity Ratio of Slater and Gordon LawyersAs seen in table 6 Slater and Gordon Lawyers have remained fairly consistent with their

equity ratio. In 2013 the ratio was higher meaning that there was a higher percentage of

owners’ equity put into the business. This can be clearly seen when comparing table 5,

2013, to table 6, 2013, both of these prove that the business performed well in 2013 due to

the owners’ equity input.

Market Ratios A market ratio is an equation that relates the stock price of a particular company to a

financial indictor on the company’s financial statement.

Earnings per share‘Earnings per share (EPS) is the portion of a company's profit allocated to each outstanding

share of common stock. Earnings per share serves as an indicator of a company's

profitability’ (Investopedia , 2016). EPS is vital to a business, it can determine the net profit

after tax based on the share of a business. Slater and Gordon lawyers hit their peak

performance on the stock exchange in 2014, after a steady increase from 2012. The

company then hit a rapid decline at the back end of 2015 and early 2016, as seen in figure 1.

The company is slowly on the increase due to the road compensation starting become more

feasible; because of this, the company’s EPS will begin to increase again.

Figure 1- Stock Market Performance of Slater and Gordon Lawyers

Slater and Gordon Lawyers (Year) Earnings per share (EPS)

2015 0.09

2014 13.87

2013 0.58

2012 0.75

Table 6- EPS of Slater and Gordon Lawyers

As seen in figure 1 and table 2014 proved to be the best performance on the stock market

and the best EPS and this is where the company was maximising profits, until the there was

a mishap in the road compensation which caused a rapid decline on the stock exchange and

hence an all-time low for company with earnings per share at 0.09.

Dividends per ShareDividends per share is pretty straight forward, as the name suggests it shows how much

dividends were paid per share. This is vital information for an investor, as with EPS this can

help outside investors determine the amount of dividends receive with every share

purchase. With Slater and Gordon Lawyers over the past year there has been a relatively

low dividends paid per share, but as the company continues to sort out its problems it will

increase.

Slater and Gordon Lawyers (Year) Dividends per Share (DPS)

2015 0.02

2014 3.13

2013 0.15

2012 0.26

Table 7- Dividends per Share of Slater and Gordon Lawyers

As seen above the dividends per share of Slater and Gordon have fluctuated quite a lot over

the past 4 years. The company help steady over 2012 and 2013, then in 2014, when the

owners’ equity into the company increased so did DPS which allowed to firm to sky rocket

on the stock market. Unfortunately for Slater and Gordon Lawyers when the plummeted on

the stock exchange at the backend of 2015, so did everything else, goodwill, EPS and DPS

but the company is slowly on the rise again after its downfall.

Price Earnings Ratio‘The price-earnings ratio (P/E Ratio) is the ratio for valuing a company that measures its

current share price relative to its per-share earnings’ (Investopedia , 2016). A company can

expect to increase it’s PER as it grows but in some cases it will fluctuate do to the change on

the stock exchange.

Slater and Gordon Lawyers (Year) Price Earnings Ratio (PER)

2015 2.65

2014 4.9

2013 5.52

2012 5.78

Table 8- Price Earnings Ratio of Slater and Gordon Lawyers

As seen above, in 2012 the company was a stronghold on the stock exchange as it had a

decent ratio of 5.78, from this the company decreased due to change in the dollar and stock

market interruptions. The law industry has a relatively low PER and this is due to the low

total asset turnover. Slater and Gordon Lawyers has a relatively low PER compared to other

law firms and this is due to its inconsistency on the stock exchange.

Ratios Based on Reformulated Financial Statements

The ratios based on reformulated financial statement contains: return on equity (ROE),

return on net operating assets (RNOA), net borrowing cost (NBC), profit margin (PM), asset

turnover (ATO) and economic profit. ROE is the amount of net income received as a

percentage of the shareholders equity, it defines how profitable a company is based on the

shareholders’ investment. RNOA is a financial performance based on a particular business

and its net assets such as land and vehicles. NBC involves the interest rate that a firm is

paying on its finances, hence the name suggests. PM refers to the amount of profit a

company makes per dollar of sales. ATO is the value of a company’s sales generated by the

businesses assets.

2015 2014 2013 2012

Return on Equity 10% 0.02% 0.03% 0.04%

Return on Net

Operating Assets

6.9% 0.17% 0.5% 0.61%

Net Borrowing

Cost

-0.29% 0.66% -3.68% -1.89%

Profit Margin 30.60% 0.26% 0.70% 1.01%

Asset Turnover 0.23 0.67 0.73 0.61

Table 9- Ratios Based on Reformulated Financial Statements- Slater and Gordon Lawyers

As seen above, Slater and Gordon Lawyers has had a whirlwind couple of years, from

growing and building to falling in recent years. The ROE of the company has remained pretty

steady until 2015 when the percentage increased and this suggests that the management is

utilising its equity base and hence resulting in better return to the investors. The RNOA of

the business has decreased from 2012 to 2014 but then increased again in 2015, the higher

the percentage of RNOA the better the profit performance is by the company. The NBC has

of Slater and Gordon Lawyers has been in the negative and positive over the past 4 years. In

2014 the company has provided it’s only NBC which is when owners’ equity was at its

highest and in the 2012, 2013 and 2015 the company has had high interest on borrowings

due to its financial state. The profit margin slowly decreased from 2012 to 2014 and then

skyrocketed in 2015, this means that the company is earning $0.30 on every dollar of the

total revenue which is very large considering the size of the business and compared to

previous years. The asset turnover has remained fairly consistent over the past four years

although it dropped in 2015 due the finical demise of the company.

Overall, Slater and Gordon Lawyers has remained a very dominant business across the

board which can be seen in all the tables provided. In 2015, the company, although boasting

massive amounts of revenue, has struggled behind the scenes and hence has causes

management a lot of trouble. The company is slowly starting to build up its reputation again

and gain a position on the stock market as it had in 2014.

Economic ProfitEconomic profit is basically the costs a firm pays and the revenue the company receives

from the original costs.

Slater and Gordon Lawyers (Year) Economic Profit

2015 -66,866

2014 -53,681.7

2013 -38,219.6

2012 -13,760.4

Table 10- Economic Profit of Slater and Gordon Lawyers?????????????????????

Peer Forum

Step 2- Investment Decision for Slater and Gordon LawyersInvestment decision(s) relating to Slater and Gordon Lawyers can prove quite challenging as

the company is quite large and it covers almost every aspect of the law industry. The

company already dominates a very large area of Australia as seen in Figure 2. I believe the

company should invest in a sponsorship of Car Company and aim to increase its success in

road compensation, employ more people that specialise in this area and provide. The main

downfall of Slater and Gordon in the road compensation department was the accounting,

schoolboy errors which resulted in a poor cash flow summary which caused investors to

become confused and withdraw stocks. I believe these can drive the company to further

success because this area has caused the company the most grief. Below is table showing

the possible future earnings if the investment opportunities were to go ahead.

Road Compensation

(Accounting)

Car Sponsorship (Toyota)

Original cost: $300,000 $200,000

Estimated life: 5 years- N/A 5 years

Residual value: $420,000 $280,000

Interest Rate: 5% 5%

Future Cash Flow Estimate:

Year 1 $22,000 $15,000

Year 2 $33,000 $30,000

Year 3 $48,000 $70,000

Year 4 $92,000 $85,000

Year 5 $124,000 $115,000

Payback Period 4 years 7 months 3 years 1.7 months

N.P.V $34,805.57 $62,000.45

I.R.R 1.79% 12.97%

Table 11- Investment Strategy for Slater and Gordon Lawyers

The first option considered is Road compensation (accountants) due to the demise in the

company’s worth due to this. Is provided decent cash flow with a short payback period and

this is due to the size of the company. The net present value is relatively sound at

$34,805.57 which is the difference between cash inflows and outflows over the 5 year

period. It has a low internal rate of return over the 5 years because of the magnitude of cash

flow compared to cost, although it will increase over time.

Secondly, a car company sponsorship in order to promote the company in the road

compensation side of the law industry. This proves to be a strong option as it is very good

cash flow over the short period, the NPV is very high at $62,000.45 and the IRR percentage

is also very high a 12.97%. The most beneficial thing about this option is the payback period

of 3 years 1.7 months and this is very worthwhile for a company trying to rebuild a

reputation.

In conclusion, option two proves to be the most beneficial option for Slater and Gordon

simply due to the rate at which it can provide for the business, as well as the magnitude of

cash flow which can help to promote positive messages towards investors which in the

company’s main goal.

Figure 2- Slater and Gordon Australia

FeedbackFeedback From:

Feedback To:

My Comments

Step 1

Calculation of ratios, Ratios – commentary

(blog) Calculate economic profit Commentary –

drivers of economic profit (blog)

Step 2

Develop capital investment decision for your

firm Calculation of payback period, NPV & IRR

Recommendation & discussion

Step 3

N/A

Overall ASS#3