Financial statements helps an organisation to measure its performance in the market. Analysis of financial statements is an efficient way to assess the position of the company in all aspects of the business. Ratio analysis is used to analyse and compare the data of the company with its past performance. It also gives useful information about the liquidity, solvency and efficiency of the company. These analysis form an important part in decision making and strategies for the future. The report includes the analysis of Vodafone company and its performance in the last two financial years. Vodafone is a British multinational telecom company with its networks across 50 countries.
It is the second largest telecommunication company with its headquarters in London, UK. Along with this, the benefits and limitations of ratios for Vodafone has also been included in the report.
1. Main activities and markets of Vodafone
Vodafone is a global company and it has variety of products in its portfolio. It is a world famous telecommunication company has products like fixed lines, mobiles, internet services, digital television, money transfers and mHealth services. The turnover and the customer base has been growing at a good pace in the recent past. It has 7 billion mobile phone and 1 billion land line customers around the world. It also offers communication solutions like cloud computing, unified collaborations and communications to various companies. Furthermore, mobile payment, mobile emails, broadband, managed services and machine to machine services are provided by the company. The profits and revenues has been constantly rising and it is a good sign for the future of the company.
2. Basic principles, roles and purpose of financial statements
The purpose of financial statements is to provide information about the performance of the company to its stakeholders and management to facilitate their decision making process. The stakeholders who rely on these statements are customers, suppliers, investors, employees, management, lenders and government. All the credit decisions, investment decisions, taxation decisions and union bargaining decisions are taken on the basis of these statements. The financial statements include Balance sheet, profit and loss statements and cash flow statements. So the statements not only show whether the business is profitable or not it also helps the stakeholders to find the solvency, liquidity and efficiency of the business. It is also mandatory for the the companies to prepare annual statements which should depict true picture of the company.
3. Analysis of financial performance of Vodafone
Ratio analysis is a tool which is used by management to assess the financial statements of a company. It gives useful details about the performance and position of the company. Ratios can be helpful in finding out the profitability, solvency and liquidity position of the company. The shareholders require such information to see whether their investment is profitable. Similarly other stakeholders need these information for their decision making.
The major categories of ratios are:
It calculates the short term payment capacity of the firm. So it used to measure the short term solvency of Vodafone. Lack of liquidity is harmful for any organisation. It could result in loss of creditor's confidence, bad image and legal actions against the company. High liquidity would means that the firm has idle funds which should have been invested somewhere else. So it is important to have a proper balance between them. The ratios which are used to calculate liquidity are current ratio, quick ratio and absolute liquid ratio.
These ratios calculate the profitability and efficiency of the company. The major ratio to calculate profitability are gross profit ratio, net profit ratio and operating ratio. This helps the management to see the performance of the company. Profitability means capacity to generate profits which is left after deducting all costs and expenses from it.
Turnover ratios calculates the efficiency of the company towards managing their resources. High turnover ratio means that the organisation is using their assets in an effective manner. The different turnover ratios are inventory turnover ratio, debtor turnover ratio, creditor turnover ratio and assets turnover ratio.
The liquidity ratio short term solvency of the firm while solvency measures the long term solvency. Positive solvency ratio gives assurance to the lenders and creditors that the firm will pay their debts on time. It is very useful in calculating the long term payment capacity of the company. Not on payment of debts but also instalment or interest payment capacity of the firm can also be calculated from it. The ratio which are used to calculate it are debt equity ratio, debt to capital ratio, proprietary ratio, interest coverage ratio and fixed asset to net worth ratio.
4. Analysis of Vodafone's ratios for 2015 and 2014
Current Ratio: The current ratio of Vodafone is 0.69 in 2015 and 0.99 in 2014. This shows that the company has lack of funds to pay off their liabilities. This indicates liquidity issues in the company. Vodafone has to ensure that it has sufficient funds to pay their expenses, bills and salaries. They have to collect their receivables on time and manage their cash in a proper way to avoid this situation. The current ratio in 2014 was 0.99 but it dropped to 0.69 which means that they can have serious cash crunch situation in the future. It is necessary to take action before any problem arise.
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Quick Ratio: The quick ratio in 2014 was 0.81 and in 2015 it dropped to 0.59. This also shows liquidity situation in the company. Vodafone has less marketable securities and more money is invested in inventory. A company should have 1:1 ratio but it less in case of Vodafone. The quick ratio has also good down from the previous year. This is an alarming situation as some actions are required against it.
Absolute Liquid Ratio: The absolute liquid ratios are also very low. Vodafone has lack of marketable securities which can be easily converted into cash. Marketable or liquid assets are important because at the time of cash requirements these assets can be sold to pay off the debts.
The liquidity position of Vodafone is not satisfactory. It indicates that in future they will be facing liquidity issues. It would be beneficial for them to collect their receivables on time and invest more in liquid assets.
Gross Profit: Gross profit calculates the total profit earned by the company without including the indirect cost like selling, distribution, administration and labour costs. The gross profit has gone down from 27.13 % to 26.87 % despite the increase in sales in 2015. The gross profit earned by Vodafone is quite good but it should have been growing as the time progresses. The efficiency has gone down for the company.
Net Profit: Vodafone's net profits have also decreased from 15.49% to 14.01 % despite the rise in sales in the year 2015. Net profits includes all operating and indirect costs. By comparing the data of the two financial years it can be seen that Vodafone has not done well in 2015.
Operating Ratios: It takes into consideration all operating costs of the company. It has gone down form 37.80 to 22.21 which is a good sign. It show that Vodafone has reduced its expenses and are using their resources efficiently.
The overall profitability ratios suggests that Vodafone has not done well in 2015. Their gross and net profits have decreased while their operating costs have reduced. It is important for them to reduce their indirect costs and improve the efficiency of the business. All the unnecessary expenses have to be cut down by them.
Inventory Turnover Ratio: It measures the number of days to sell inventory. It was 63.36 in 2014 and it increased to 64.07 in 2015. It evaluate a firm' efficiency in managing its sales. The rise in turnover in a good sign as it means that Vodafone is selling more than the last year.
Debtors Turnover Ratio: It calculate the effectiveness of the company in collecting its debts. The ratio was 10.60 in 2014 and it increased to 11.50 in 2015. It shows that the debts are collected more quickly then the last year. In 2014 it took Vodafone 34 days to collect their debts which was reduced to 31 days in 2015. It shows that the collection process of Vodafone is efficient and they have quality customers whop pay their dues on time. The policy should not be too conservative and too tight because it will drive away the customers.
Creditors Turnover Ratio: It calculates the repayment period of credit to suppliers. It has increased from 1.8 to 2.07 in 2015. This shows that the company has been paying off its debts quickly. Vodafone has to make sure that they use the credit period properly as they have liquidity problem in the company.
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Working Capital: It is the difference between current assets and current liabilities. It measures company's efficiency as well as the short term solvency. It should be positive but in the case of Vodafone it is negative. It has increased to 9050 which is not a good sign because it means that the current liabilities are more than the current assets. The short term funds are not adequate enough to pay off the debts. The similar problem could be seen in liquidity ratios as well.
Turnover ratios of Vodafone has shown that they have been efficient in their operations. But the only problem with the company is that there working capital is negative. It indicates that they have less funds to pay off their debts.
Capital Gearing ratios
Debt Equity Ratio: It compare the owner's funds and funds from lenders. The ratio for Vodafone has increased from 0.30 to 0.34 in 2015. This shows that the company has more debts than the equity. Too much leverage increases the risk and the lenders may feel vulnerable. Lenders prefer the equity to be more than the debts. But the ratio is still below 1 which is good for the company. It has increased by 0.04 which may not affect the business or the lenders. But it is important for the company to ensure that it remains below the value of equity.
Proprietary Ratio: The proprietary ratio for Vodafone was 0.72 which dropped to 0.69 in 2015. It is inverse of debt equity ratio as it is not very widely used. A high ratio means tat the company has ample of funds in equity while low shows insufficient funds in equity.
The capital gearing ratio of Vodafone reveals that the company has been doing well in maintaining its solvency. The equity is more than debts which reduces the leverage and makes the business less risky. Though the solvency ratio has increased towards the debt side but still it is well below the danger level. Vodafone has long term solvency and they don't have to worry about it.
5. Benefits and limitations of different ratios
Current Ratio: It is most commonly used ratios which is used by banks and financial institutions before sanctioning a loan. The advantages of current ratio is that it is easy to calculate and understand. It show the liquidity position and the operating cycle of the company. The efficiency of management can be seen from this ratio. But it is not sufficient alone when deciding the liquidity position of the company. Furthermore, inclusion of inventory leads to overestimation of liquid assets. It is because assets cannot be easily converted into cash.
Quick Ratio: It is an improved version of current ratio as it ignores inventory in its calculation. Its advantages are that it only considers liquid assets in its calculation. The inventory can be seasonal and high in dying industry as such acid test removes this limitation. But still it ignore time value and considers accounts receivables as a liquid asset. Similar to current ratio it cannot be used alone.
Absolute Liquid Ratio: It only considers the marketable securities in its calculation which is its major benefit. But it also ignores the time of cash flows and needs other ratios before taking any decisions.
Gross Profit Ratio: It help in calculating the financial health of an organisation. It is very useful tool to compare the performance of the company with the industry. A high margin means the company is doing while low indicated loss in sales. But the disadvantage of gross profit is that it only considers direct cost in its calculation and other costs are ignored.
Net Profit Ratio: It includes all the costs associated with the business which gross profit ignores. As such it gives more relevant results. But it is difficult for the company to compare the ratios with other companies because the costs are different.
Operating Cost Ratio: It helps in measuring the efficiency of the firm as well as in finding out the operating cost of the business. But it ignores the other costs which are also important in decision making.
Inventory Turnover Ratio: It helps an organisation to study the number of days a product takes to sell. This becomes foundation of the minimum and maximum stock that has to be maintained in the warehouse. But it considers all the items on the average basis which may not be true.
Debtor Turnover Ratio: The credit polices are made considering the debtor turnover ratio. It shows whether the company is collecting its receivables on time or not. But plays an important role deciding the liquidity position of the company.
Creditor Turnover Ratio: It accommodates a company to maintain its liquidity position in the market. But gives the management information about the payment period to the creditors. But it takes average of all the credit availed which may give wrong indication to individual creditor.
Working Capital: It gives essential detail to the company regarding the working capital. Positive indicates that company while negative indicates that Vodafone has to make changes in it.
Debt Equity Ratio: It helps an organisation to study the leverage position and risk that it possess. Too much leverage can be bad for the business as such it helps in maintaining it. The disadvantage of it is that it ignores the cost of issuing the equity and other sources of finance.
Proprietary Ratio: The Proprietary ratio is similar to debt equity ratio and it also accommodates in finding out the leverage of the company. But it also ignores the cost and implications of other sources of finance.
6. Analysis necessary for short and long term financial decisions
Short term financial planning involves decisions for a shorter period of time like 12 months. So all the decisions regarding working capital, buying raw materials, manufacturing, selling and collecting cash are important in short-term financial decisions. It helps in finding out the availability of cash to pay bills, inventory management and the policies regarding the credits. So it involves short term liquidity and solvency decisions. Long term planning is much more complex than this. The management has to consider short and long term objective of the business before making decisions. It involves projecting revenues, sales, budgets, maintaining solvency and liquidity in the long run of the business. Lot of changes in policies and strategies have to be done in order to ensure growth and survival of the business. The profitability, solvency and liquidity ratio are used to make decisions regarding the future of the company.
It can be concluded from the above that financial statements and information play an important for the organisation as well as its stakeholders. These information can be used to take decisions about the future if the company. Vodafone has been growing at a good pace and the same is reflected in their statements. But a thorough analysis show that they have lot of problems maintaining the liquidity position of the company. Analysis of financial statements also gives useful details about the solvency and efficiency of various business operations. As such financial decisions have to be taken considering all such factors. This will not only fulfil the short term objectives of the company but they will also accomplish their long term goals.
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