Wesfarmers Financial Analysis

Wesfarmers is a highly reputable entity listed on the Australian Stock Exchange, with approximately 200,000 staff and 500,000 shareholders (Knight, 2014). The entity that started as a small Western Australian farmer co-operative has now diversified into sectors such as retail, resources and insurance and now earn revenue of over $50 billion per annum. This report will examine the performance of Wesfarmers over the 2011 to 2013 financial periods. The areas of profitability, efficiency, solvency and liquidity have been assessed and would be of great interest to all of their stakeholders, who trades in a highly competitive business environment.

Financial Analysis (Profitability and Efficiency)
Return on Equity
One of the major areas of interest to all stakeholders of Wesfarmers is its recent profitability, defined as ‘the ability to retain profit compared to a base such as sales, total assets or owner’s equity’ (Simmons and Hardy, 2013). The return on equity measures the amount of profit that has been retained compared to the amounts invested by ordinary shareholders. In $million

2011
2012
2013
Net profit after tax
01,922
02,126
02,261
Shareholder’s Equity
25,329
25,627
26,022
Return on Equity
7.7%
8.4%
8.9%
Table 1.1 Return on Equity calculations, 2011 to 2013

The results above indicate that the return on equity has gradually increased over the course of the period. This can be explained by an increase in net profit after tax. Whilst shareholder’s equity also increased in each consecutive period, profit has increased by a higher proportion. The 2013 annual report also indicates that some of the group’s leading stores recorded strong revenue growth over the three-year period. Coles, for example, increased their revenue from $32.07 billion in 2011 to $35.78 billion in 2013.

However, stores such as Target reported deterioration in earnings of $124 million from 2011 to 2013, which has been attributed to strong competition, reduced prices and high levels of inventory (Wesfarmers Annual Report, 2013). It should be noted that the return on equity of Woolworths, the main competitor to Wesfarmers in the Australian retail environment, is much higher over the same three year period. In 2013, for example, Woolworths reported a return on equity of 27.37% (Woolworths Annual Report, 2013). This difference can be explained by Woolworths having a much lower equity base of $9.02 billion. Return on Assets

ROA is a key profitability Ratio, which measures amount of profit that is made by a company per dollar of its asset. It reflects Wesfarmers ability to make profits before leverage rather by using leverage. Return on asset predominantly shows how company effectively manages its asset to generate profits, which can be of less interest to the shareholders than some other ratios like ROE. This ratio is calculated using Return by dividing a company’s net income after tax by its total assets, and is displayed as a percentage. In $million

2011
2012
2013
NPAT (Net Income Less Tax)
01,922
02,126
02,261
Total Asset
42,312
40,814
39,236
Return on Asset
4.5%
5.2%
5.8%
Table 1.2 Return on Asset calculations, 2011 to 2013

The increase in ROA over the period of three years depicts how well the Wesfarmers has utilized its assets in generating profits. Managers tend to use ROA to determine the performance to get most out of the company’s assets. Whereas the investors primarily use the Return on investment ratio to monitor how well the company is utilizing their investment.

2.3Gross Profit Margin

The gross profit margin is defined as a budgetary metric used to evaluate a company’s monetary wellbeing or efficiency by uncovering the proportion of money left over from incomes in the wake of representing the expense of merchandise sold (Bussiness.qld, 2014). The Gross profit margin is a useful source for paying additional expenses and future savings. In $million

2011
2012
2013
EBIT
03,232
03,549
03,658
Sales
52,891
55,897
57,897
Gross profit margin
6.1%
6.3%
6.3%
Table 1.2 Gross Profit Margin calculations, 2011 to 2013
The Gross Profit Margin remained stable over this period, which tells us that Wesfarmers has been efficient in the production and distribution of its products. From a management perspective, Wesfarmers should be able to remain profitable as long as the overhead costs are controlled.

Table 1.3 Comparison of Three years EBIT, Wesfarmers, 2011-2013. The above representation of EBIT should have satisfied the board that Wesfarmers profits are stable and have a steady growth. However we can also notice a gradual decrease in Target’s profit earnings, raising concerns of uncontrolled overhead cost. (Wesfarmers Annual Report, 2013)

2. 4Solvency

The solvency of an entity can be evaluated by the Debt-to-Assets ratio, which measures the proportion of assets, which are financed by debt. To differentiate from equity, excessive debt can lead to liquidity issues if a firm fails to meet its debt obligations. The financial risk of an entity with a debt ratio of 50% is considered as highly leveraged (Money-Zine, 2014). In $ Million

2011
2012
2013
Total liabilities
15,485
16,685
17,133
Total assets
40,814
42,312
43,155
Debt to Asset ratio
37.94%
39.43%
39.70%
Table 1.4 Debt-to-Asset Ratio calculations, 2011 to 2013
The changes in the Debt to Assets ratio shown above illustrate that Wesfarmers have funded a slightly higher proportion of assets via debt over the three year period. Whilst this may have created a higher solvency risk, the Return on Equity results show that the asset purchases have resulted in improved profitability. Given the 2013 result, we would not consider the entity to be highly leveraged.

2.5Liquidity

Short- term solvency is an area which can measure Wesfarmers ability to meet its short term debt. Generally the higher the liquidity ratios are, the higher the chances of Wesfarmers to meet its current liabilities. A Liquidity ratio higher than 1:1 indicates that the company is likely to have good financial health (Simmons and Hardy, 2012). There are multiple ratios used to examine liquidity such as the Current, Acid-Test and the cash ratio. $ million

2011
2012
2013
Total current liabilities
08,722
10,747
09,572
Total current assets
10,218
10,911
10,586
Inventories
04,987
05,006
05,047
Cash and Cash Equivalents
00,897
01,127
01,333
Current ratio
1.17:1
1.02:1
1.11:1
Acid-Test ratio (Quick ratio)
0.60:1
0.55:1
0.58:1
Cash ratio
0.10:1
0.10:1
0.14:1
Table 1.5 Current Ratio, Acid-Test ratio and Cash ratio calculations, 2011 to 2013 Even though the current ratio analyses the overall financial performance of Wesfarmers liquidity, the acid-test ratio provided an alternate view as it excludes inventories. It is evident from their balance sheet that Wesfarmers have a high amount of their current assets tied up in stock (47.6% in 2013). Given that the acid- test ratio was below 1:1, it is imperative that the group sell inventory on a continuous, rapid basis so that their short-term obligations can be paid on time.

Conclusion

The above results illustrate that Wesfarmers recorded gradual improvements in profitability and efficiency over the 2011 to 2013 financial periods. This provides satisfactory returns to the board of directors and the stakeholders, which further creates an invitation to potential investors for future growth. Consequently, Wesfarmers are advised to seek opportunities for potential growth into international emerging markets. However, there are liquidity concerns that need to be constantly monitored so that the group remains financially stable and can generate higher shareholder returns in the medium to long term.

References:

Bazley, M, & Hancock, Contemporary accounting, 8th edn, Cengage Learning, South Melbourne, Chapter 12. Business and Industry Portal, 2014, Gross Profit, retrieved 20 September 2014, http://www.business.qld.gov.au/business/running/making-and-managing-money/making-your-business-more-profitable/calculating-profit-margins Evangeline Marzec, eHow contributer. ‘What Does It Mean When a Return on Asset Ratio Decreases? ‘ http://www.ehow.com/info_8699026_mean-return-asset-ratio-decreases.html Investing, Live Quotes, retrieved 20 September2014, http://www.investing.com/equities/wesfarmers-limited-ratios Knight, E., 2014. ‘Goyder weighs next move as pressure mounts for a deal’, The Age, retrieved September 20 2014, Business Day pp 8-9. Money-Zine, 2014, Debt or leverage ratios, retrieved 15 August 2014, http://www.money-zine.com/investing/investing/debt-or-leverage-ratios. Simmons, A., Hardy, R. (2013), VCE Accounting: Units 3 and 4 – 2nd edition, Cambridge. Wesfarmers 2014, Annual report, retrieved 12 September 2014,
http://www.wesresources.com.au/sites/default/files/publications/2013%20Annual%20Report.pdf Wesfarmers Annual Report, 2014, http://www.wesfarmers.com.au/investors/shareholder-information/five-year-financial-history.html Wesfarmers, 2013, Annual report, retrieved 15 August 2014, http://www.wesfarmers.com.au/. Woolworths Limited, 2013, 2013 Financial report to shareholders, retrieved September 20 2014, http://www.woolworthslimited.com.au/annualreport/2013/downloads/WoolworthsLimited_AnnualReport_2013_FinancialReportToShareholders.pdf