Financial Statement Analysis

This refers to the process of analyzing the financial statements of a company for the purpose of decision-making. The external stakeholders can use the information to understand the overall health of an organization and evaluate the business value and financial performance. The financial statements of a company record important financial data on all business activities, hence making it possible to evaluate the company based on the current, past, and projected performances. The rationale for financial statement analysis entails the need to reassure confidence among the investors and be used to evaluate the performance of a company using various metrics such as liquidity and profitability (Linares-Mustarós, Coenders & Vives-Mestres, 2018).

The Financial Statements under Consideration

The major financial statements here include the balance sheet, the income statement, and the cash flow statements. The balance sheet provides information on what the company is worth from a book value perspective. It gives a more comprehensive picture of the company's liabilities, assets, and the shareholder's equity on a given date. It paints a picture of a company's long-term assets and how efficiently a company can manage its receivables in the short term. The income statement provides details on the revenue earned by a company and the expenses involved in its operating activities. It shows the direct, indirect, and capital expenses that are incurred by a company. The income statement helps the analysts to look at the operating efficiency. Finally, the cash flow statement provides a view of a company's overall liquidity by showing cash transaction activities. It takes into consideration the cash inflows and outflows over the course of an accounting period, with the summation of the total cash available. Ideally, cash flow statements are supposed to be broken into three parts: operating, financing, and investing

(Lev, Li & Sougiannis, 2010). The cash flow statement is supposed to capture the net increase and decrease in total cash in each of the three areas.

Measuring Company Performance

Company performance is measured by taking into consideration both numerical and financial factors. Apart from the numerical factors such as the profit margin, other indicters allow one to evaluate a company's performance on purely financial terms. Solvency and liquidity ratios evaluate a company's performance in line with ensuring that it can continue its operations. Ratios can be compared to those of other companies in order to evaluate performance. Other factors that can be considered when measuring a company's performance include cash flow, working capital, cost base, and borrowing.

Profitability of a Company

Various ratios can be used to measure the profitability of a company. The ratios here include return on equity (ROE), return on capital (ROC), and return on assets (ROA). ROE determines the company's growth rate of earnings as it measures the profitability of the equity investment exhibited by a company. ROC shows the earning for every dollar of the capital invested in a company in the long term. ROA shows the income earned for every dollar earned by a company (DeFusco et al., 2015).

Financial Liquidity

Liquidity refers to the ability to convert assets into cash cheaply and quickly. The internal analysis of the liquidity entails using the multiple accounting periods, which are reported using the same accounting methods. A higher liquidity ratio involves using multiple accounting periods, which are reported using the same accounting methods. The ratios here include the current ratio, cash ratio, and quick ratio. The current ratio measures a company's ability to pay off its current liabilities with its current assets, such as accounts receivable, cash, and inventories. The quick ratio measures a company's ability to meet the short-term obligations with its most liquid assets and therefore excludes inventories from the current assets (DeFusco et al., 2015).

Asset Utilization

This is measured by a ratio called asset turnover, which shows how efficient a company can use assets in line with the generated sales for each dollar of assets. Higher turnover ratios give a more positive impression to the investors as it shows a good ability to generate sales using the assets.

Financial Leverage

Financial leverage is normally determined by checking on the proportion of assets to equity. Unfavorable leverage happens when a company is not in a position to earn more than the funds cost. This makes it costly for the company to borrow funds and depicts its own profitability or losses levels.

Identification of Issues

The paper considers a comparative analysis of the performance of two firms and investment decisions. This is achieved by conducting a five-year trend analysis to understand each company's consistency and profitability, hence offering advice to the client on the investment decision. The financial data under consideration range from 2016 to 2020. The two companies under consideration are Bapcor limited and Baby Bunting Group Limited, which operate in the same industry. As a financial analyst, there is a need to unveil the firm in which the client should invest, based on the financial information analysis and the ratios mentioned above.

Financial Analysis of Bapcor Limited and Baby Bunting Group Limited.

Financial leverage basically refers to the use of debts to acquire additional assets. Here, a figure of 0.5 or less is appropriate. This means that no more than half of a company's assets are supposed to be financed by debt. However, investors are sometimes obliged to tolerate high leverage ratios, which may not be healthy. A leverage ratio that is more than 1 indicates a financial weakness. Both companies in the above charts are highly leveraged. For most of the financial years, Bapcor Limited had had higher financial leverages than Baby Bunting Group, except for 2020, when Baby Bunting recorded financial leverage of 2.77. This shows that Bapcor has done better than Baby Bunting as far as the financial leverage is concerned.

The gearing ratio depicts the extent to which a company is funded by debt versus the extent to which it is funded by equity. Although an appropriate gearing ratio can be determined by the individual companies relative to the industry players, 50% is considered to be at greater financial risk. 25% to 50% can be optimal or normal for the walk established companies. 25% gearing ratio can be considered low risk by both the investors and the lenders. For the years 2016 and 2020, Bapcor recorded an acceptable gross gearing, i.e., within the optimal range. The other years portrayed some financial weaknesses. Baby Bunting Group did exceptionally when it comes to gross gearing, except for 2020. It also had a negative net gearing, which depicts a very healthy state of net cash. However, the performance of 2020 was worrying.

Inventory turnover is the measure of the number of times inventory is sold or used in a given period, such as a year. A good inventory turnover is supposed to be between 5 and 10. Low inventory turnover means low sales, too much inventory or overstocking and poor liquidity associated with the inventory (Dahmash, 2015). For the five consecutive years, the Baby Bunting group has had a higher inventory turnover than Bapcor Limited. An asset turnover measures the efficiency of a company's use of its assets in generating sales revenue. A higher asset turnover is generally favorable. For the five consecutive years, Baby Bunting Group has recorded a higher asset turnover, hence better asset utilization that Bapcor consistently performed dismally, recording an asset turnover of below 1. Days receivable is also significantly low for Baby Bunting Group, which is a good indication because it means customers are not taking very long to pay their bills, and therefore they could be more satisfied with their goods. On the other hand, Bapcor has performed poorly by having more days receivable.

The current ratio measures whether a firm has enough resources that can help it meet its financial obligation. It compared the current assets to the current liabilities of the company (Reilly & Brown, 2011). Both companies have good current ratios because the ratios are above 1. This implies that the companies have never struggled to pay the current liabilities at any given time. The current ratio for Bapcor has been fluctuating since 2016, whereby the company recorded the highest current ratio in the year 2017. It has been able to maintain the current ratio within a stable range.

On the other hand, the current ratio for Baby Bunting Group has not been encouraging towards 2019 and 2020. In fact, in the year 2020, the company's current liabilities were also equal to the current liabilities, which should be a red flag for the investors. An investor who is keen on this liquidity ratio will have to take more time to observe the trend before committing funds to the Baby Bunting Group limited.

The quick ratio also indicates a company's capacity to pay its current liabilities without needing to sell its inventory or get additional funding. The higher the ratio, the better the financial health of a company. Bapcor Limited has had a better quick ratio for the five consecutive years. The quick ratio for the Baby Bunting Group has been very low. For both companies, the quick ratios have not been healthy because they have been less than 1.

Profitability

The return on equity measures the profitability of the companies in relation to equity. A ROE of between 15% and 20% is generally considered good. The Baby Bunting group exhibited a higher ROE for the last two years, implying that the company is increasing its profit generation without needing as much capital. The ROE for Bapcor significantly declined during 2020.

The return on assets (ROA) shows the percentage of how profitable the assets of a company are when it comes to generating revenue. ROAs that are above 5% are generally considered to be good. For the 5 financial years, the two companies were able to record good

ROAs. When two companies are compared, the Baby Bunting group was able to record a higher ROA for the 5 financial years. This shows that Baby Bunting Group’s assets use its assets in a more profitable way to generate revenue.

The tables above represent the cash flows from investing, financing, and operating activities. The highlighted figures represent negative cash flows. Cash flow from the operating activities depicts the amount of money generated from the company's key operations activities. It shows the company's financial strength in terms of operating ability and the ability to venture into new areas without going an external debt. Both companies exhibited positive net cash flows for five years. Bapcor Limited had exhibited growing cash flows for the five years, except for 2019, when the cash flows went slightly down. The net operating cash flows for Baby Bunting have also been strong and growing consistently. However, the net operating cash flows for Bapcor are more robust. The net investing cash flows for the companies are negative. Investing activities refer to the purchase and sale of long-term assets and other business investments. The companies performed dismally, with each company recording one year of positive cash flows. Cash flows from the financing activities show the net flows of cash used to fund the company. Financing activities include transactions involving debt, equity, and dividends. Bapcor limited also exhibited stronger financing cash flows, with a negative cash flow in only one year, 2018.

Most of the financing cash flows for Baby Bunting were negative. Both companies had a strong end of period cash flows, although Bapcor recorded more positive end of period figures.

Conclusion and Recommendation

From the above analysis, both companies exhibit some strengths and weaknesses. Bapcor Limited has had higher financial leverages as compared to the Baby Bunting Group. Baby Bunting Group did exceptionally when it comes to gross gearing. Again, Baby Bunting Group has been able to record a higher asset turnover, hence better asset utilization. For most of the liquidity ratios, Bapcor performed better than the Baby Bunting group. The Baby Bunting group also did better when it comes to most of the profitability ratios. When it comes to the cash flow statements, Bapcor limited outweighed the Baby Bunting Group for investing activities, financing activities, and operating activities. As such, an investor will be encouraged to invest in Bapcor Company because of the numerous strengths it has exhibited across the board. The company is in a more viable position and has better prospects for the future.