Financial Reporting and Analysis System †Free Samples to Students

Question: Discuss about the Financial Reporting and Analysis System. Answer: Introduction The analysis and interpretation of financial position of a business entity is essential for the end-users such as investors and creditors for taking accurate investment decisions. As such, the report discusses and analyses the findings obtained from financial analysis of two ASX listed companies operating in the same sector in Australia. The companies selected for the purpose are ERM Energy and Pacific Energy Limited. The reports present the findings interpreted from the horizontal, vertical and ratio analysis of both the companies. It also provides recommendations to the investors regarding their potential investment decision based on their financial performances. The limitations of the investment decisions based on the financial statements analysis is also discussed in the report. The investment decision recommend is also supported from the CSR performance of both the companies. Financial ratio analysis and interpretation The financial ratio analysis is an important tool in analysing and examining the financial performance of both the companies. The analysis will help the end-users in making decisions relating to their investment in either of two companies (Stickney et al., 2009). The results interpreted from the financial ratio analysis of both the companies can be discussed as follows: The profitability ratio helps in evaluating the earnings realised by a company as compared to the expenses incurred during a specific period of time (Weygandt, Kieso and Kimmel, 2010). The profitability position of both the companies is analysed through the calculation of the following ratios: Return on Equity: The return on equity ratio measures the efficiency of a company in generating earnings in comparison to the investment incurred. The return on equity ratio of Pacific Energy Limited is 11.9% and of ERM Power Limited is 9% and therefore it can be said that ROE of Pacific Energy is better than ERM Energy. Return on Assets: The ratio measures the profit or loss realised by a company from its overall assets. The return on assets of Pacific Energy Limited is 8.58% which is far better than that of ERM Energy of 3.31%. Profit Margin: The profit margin ratio depicts the profit realised by a company in comparison to the sales revenue. The profit margin of Pacific Energy is 31.37% as compared to ERM Energy of 1.3%. Cash Flow to Sales Ratio: The ratio measures the net cash flow realised by a company in comparison to the sales revenue. The ratio of Pacific Energy Limited is 68.63% as compared to ERM Energy of 4.34% (Morning Star, 2017). The asset efficiency ratio indicates the efficiency of a company in using its asset base in generating revenue. It can be measured through the calculation of the following ratios: Asset Turnover ratio: The asset turnover ratio provides an analysis of sales revenue realised by a company through its overall asset base. The asset turnover ratio of ERM Energy is 2.55 % that is better in comparison to Pacific Energy Limited of 0.27%. Days Debtors: The ratio measures the average number of days taken by the debtors in repaying the amount taken by them. It can be said that debtor days of Pacific Energy is 46.52 and is better than that of ERM Energy of 36.25. Times Debtors Turnover: The ratio helps in measuring the effectiveness of a company in collecting its outstanding debts. It can be said from this ratio analysis of both the companies that times debtor turnover of Pacific Energy is 7.85 and is better than ERM Energy of 10.07. The liquidity ratio measures the ability of a company to meet its debt obligations. The liquidity position of both the companies is compared through the following formulas: Current Ratio: The ratio compared the current assets of a company in comparison to the current liabilities. The current ratio of Pacific Energy is 1.17 and that of ERM Energy is 1.68. Quick Ratio: The quick ratio measures the current assets of a company that can be converted quickly into cash in comparison to its current liabilities. The quick ratio of ERM Energy is 1.63 that is far better than hat of Pacific Energy of 1.08 Cash Flow Ratio: The ratio depicts the net cash flow realised by a company from its operating activities in comparison to the current liabilities. The cash flow ratio of ERM Energy of 28.41 is far better than that of Pacific energy of 2.92. Capital Structure Ratios The capital structure ratio of a company provides analysis of its debt and equity structure (Ernst and Hcker, 2012). It is assessed for the both the companies through the calculation of the following ratios: Debt to equity ratio: The ratio depicts the total liabilities of a company in comparison to its total equity. The debt to equity ratio of ERM Energy is 162.77% as compared to that of Pacific energy of 42.34%. Debt Ratio: The ratio provides an analysis of total liabilities of a company in comparison to the total assets. The debt ratio of ERM Energy is 61.94% that is better in comparison to Pacific Energy of 29%. Equity Ratio: The ratio depicts the total equity of a company in comparison to the overall asset base. The equity ratio of Pacific Energy is 70.62% as compared to ERM Energy of 38.06%. Interest Coverage Ratio: The ratio depicts the EBIT realised by a company in comparison to overall financing costs. The interest coverage ratio of Pacific Energy is 11.5% as compared to ERM Energy of 2.84%. Debt Coverage Ratio: It measures the non-current liabilities of company in comparison to the overall cash flow realised from the operational activities. The ratio of Pacific Energy is 131.43% as compared to ERM Energy of 2.88% (ERM: Annual Report, 2016). It can be said from the analysis of financial position of both the companies that investors should invest in Pacific Energy Limited as compared to ERM Energy. The Pacific Energy has better capital structure and also is providing larger profits as compared to ERM Energy. The Pacific Energy though doe snot possesses good liquidity position in comparison to ERM Energy but its asset efficiency and cash flows is better than that of ERM. The main shortcomings of investment decision based on financial statement analysis area s follows: It is mainly based on ratio analysis that is has several limitations It has not incorporated the use of non-financial information such as social and environmental performance for decision-making The investment decisions are based on expected cash flows and thus doe not provide accurate financial information (Palepu et al., 2007). Thus, as such investors should also rely on information obtained from other source such as non-financial information for their investment decisions. As such, the comparison of CSR (Corporate Sustainability Report) of both the companies will help in making better investment decisions. The energy companies operating in Australia are presently emphasizing to a large extent on improving their social and environmental performance to achieve sustainable growth and development. It can be analyzed from the sustainability report of ERM Energy that the company is taking active steps in promoting the social and environmental development. The company has actively contributing in carrying of the vents such as UN Sustainable Development Summit and UN Climate Change Conference in Paris. In addition to this, the company has also implemented effective strategies for minimizing the carbon emissions and overcoming the depletion of natural resources in order to promote its sustainable growth. The compan y is actively working with global clients to support the sustainable growth of local communities globally. The company has also developed ERM foundation in order to align its strategic objectives as per the GRIs G4 Sustainability Reporting Guidelines (ERM publishes its 2016 Sustainability Report, 2016). On the other hand, Pacific Energy is also placing emphasis on improving its sustainability performance through adopting strategies for reducing the greenhouse gas emissions in development of its energy products. The company has placed achieving improved environmental performance and energy efficiency as its major strategic goals for promoting the social and environmental development. The company is also attributed to be a recognized leader in developing clean burn technology. Therefore, it can be said although both the companies are implementing strategies for improving the sustainable performance but ERM is performing better on the basis of sustainability perspectives. The Pacific Energy Limited has not disclosed its CSR reports and therefore investors re recommend investing in ERM as it has provided larger information reading its social and environmental performance (Pacific Energy, 2017). Limitations of financial ratio analysis and non-financial information of an entity The financial ratio analysis through supports the decision-making process of investors by providing an insight into the present and future financial condition of a business entity has also some limitations. The ratio analysis helps the investors in comparing the financial position of different business entities but sometimes the results obtained from its use is not accurate due to some limitations of the method. The major limitation of ratio analysis is that some results obtained from the method are based on historical data and some on current financial data (Gibson, 2010). For example, the income statements report some financial elements on the current costs while in balance sheet some information is stated on historical cost. As such, the ratio analysis can provide unusual financial results. Also, the use of only non-financial information in decision-making has a major problem that it does not depict the future performance of an entity in absence of accounting estimations and predi ctions (Weil, Schipper and Francis, 2013). Conclusion It can be inferred from the overall report that end-users should integrate the use of both financial and non-financial information in making investment decisions. References Annual Report. 2016. ERM Limited. ERM publishes its 2016 Sustainability Report. 2016. [Online]. Available at: https://www.erm.com/en/news-events/news/erm-publishes-its-sustainability-report-2016/ [Accessed on: 7 October, 2017]. Ernst, D. and Hcker, J. 2012. Applied International Corporate Finance. Vahlen. Gibson, C. 2010. Financial Reporting and Analysis: Using Financial Accounting Information. Cengage Learning. Morning Star. 2017. Pacific Energy Ltd PEA. [Online]. Available at: https://financials.morningstar.com/balance-sheet/bs.html?t=PEAregion=ausculture=en-US [Accessed on: 7 October, 2017]. Pacific Energy. 2017. Green Energy. [Online]. Available at: https://pacificenergy.net/green-energy [Accessed on: 7 October, 2017]. Palepu, K. et al. 2007. Business Analysis and Valuation: Text and Cases. Cengage Learning EMEA. Stickney, C.P. et al. 2009. Financial Accounting: An Introduction to Concepts, Methods and Uses. Cengage Learning. Weil, R., Schipper, K. and Francis, J. 2013. Financial Accounting: An Introduction to Concepts, Methods and Uses. Cengage Learning. Weygandt, J., Kieso, D.E. and Kimmel, P.D. 2010. Financial Accounting: IFRS. John Wiley Sons.