Profitability
Return on total assets of the firm declined by three points which reflected weaker project performance where investments are dedicated. However, as the results of competitors and industry average are coinciding with the firm, it is apparent that business environment for the specific sector is generally disagreeable. Despite this, return on equity of the firm increased by four points which means common stockholders are awarded with higher returns. Such situation happened not in connection with the decreased in net return in investments but from the reduction of shareholder’s equity in 2006. As a result, number of common stockholders that will share the earnings is lowered providing bigger returns to the remaining holders. In contrast, its competitor afforded three times holder returns compared to the firm’s performance. In effect, the decline in the firms profit after interest and taxes in 2006 was also a significant factor.
On the other hand, the decline in net profit margin of the firm by two points is the same as competitor and industry that underpin the disagreeable environment. It also showed that earnings have less effect on the stockholder return rather narrowing holder base. Decrease in net profit margin indicated decrease in sales and subsequent increase in the cost of goods sold, selling and administrative expenses and interest expenses. Such additional costs for 2006 are not prevented despite lowering other expenses and using tax relief. Minimal difference of loss of net profit margin and gross profit margin is shown because the regular operations where the firm incurred substantial costs. In fact, PAIT’s adverse effect due to increased interest expense in 2006 was cancelled by decrease in tax expense. Increased in interest expense can be avoided by the firm if it did not borrow quite intensely in 2006.
Earnings per share (EPS) have declined by .13 which showed the implication of lower net and gross profit margins. However, even if the firm reduced its issuance of shares and implemented buybacks to diminish outstanding holders did not push the EPS upwards. Compared to its competitors, the firm lagged EPS performance. Further, in connection with lower EPS, the firm offered a higher dividend return to its holders to compensate the loss in capital gains. This is reflected in eleven-point increased in dividend pay-out ratio. The idea is that the firm’s inability to increase earnings in 2006 required dividends to have a higher share in those earnings to adjust the lower earnings with the previous or customary dividend targets attributable to holders.
Liquidity
Current ratio showed decline in the firm’s ability to meet its current financial liabilities. It is decreased by eight points in 2006 compared to higher ratios performed by the competitors and the whole industry. Lower current ratio was adversely affected by decreased in cash receipts and lower sales in 2006 which was not cancelled by reduced cash payments in 2006. The firm may be experiencing contraction of the market or the competition became more intense. The former reason is evidenced by higher inventory level in 2006 while the latter is evidenced by higher selling expenses and investments long-term assets possibly to increase innovation. Due to smaller turnover, the available cash and propensity to pre-paid future expenses have also declined. The firm is currently on the risk of being in default when obligations fall due.
The evidence above that high inventory level is an indication of lower sales is clearly shown in the four-point decline in quick ratio. The firm became more reliant on its inventory to pay its current obligations. This is a helpful tactic if the products/ services of the firm are fairly liquid or its creditor have interest on them. However, in the case that they are bank, the firm is in the risk of disabling its ability to loan or use its banking relationship. Such situation is quite indicated in the decline of the firm’s short-term loans in 2006. Further, a high quick ratio and a high level of inventories are counter-beneficial for the firm to pay its short-term obligations. This is because if inventories will not be sold a relatively high quick ratio is useless and the firm does not re-position it to avoid default. In this category, competitors and the industry also showed outstanding results.
Efficiency
The increase of efficient receivable collection by six points can aid the firm to ease its problem in short-term obligations. Accounts receivable turnover of the firm, however, was still higher than its normal 30-day credit term. Also, compared to competitor and industry performance, its collection efficiency is lagging. As a result, the increase in its accounts receivable for 2006 is on the risk of not maximizing its value when need if the firm does not improve further its current improvement in collection. In addition, inventory turnover has increased by one and a third of points which disputed the finding earlier that high inventory levels is an indication of its products being less saleable. It is merely a signal that the company is increasing its capacity perhaps to consider rare seasonal demand from the market. Nevertheless, the contribution of its inventory to sales is highly efficient compared to its competitor and almost in line with the industry.
Asset turnover had decreased by two points which undermined the efficiencies in employing inventories. It can be affected by the increase in investing activities of the firm which substantially rise from 2005 levels. Increase in investments for plants, equipments and even trademarks (i.e. intangibles) resulted to lower asset turnover as the initially lower sales have to be distributed to a large number of assets. To support issues of sub-optimal collection, the firm had performed well in extending the accounts payable turnover by twenty one points. Unlike its competitors and the industry, the firm can use its available current funds to finance other operations than pay it automatically to creditors. This is also exemplified by substantial decreased in repayment of loans and increased in accounts payable in 2006. Such situation has positive implication to the firm if the extension was derived using bargaining and not merely as the cause of being in default position.
Financial Stability
The debt/ asset ratio of the firm increased by two points which means that its assets are currently financed through increased debt. Compared to the industry, it is more leveraged and in greater risks when creditors start to ask for repayment. The decreasing repayment of loans can be a signal that the firm has difficulties in paying its debt and can be evidence that it could enter the danger zone. However, with reference to higher leverage of competitors, the firm is relatively in comfortable position because much of its assets are financed by equity. The position of the competitor finalized the finding that it intended to reduce its holders substantially. For its part, the firm deviates to the same thinking and balance its weakness in paying short-term obligations with its relatively bigger support from stockholders.
Times interest earned or the coverage ratio have decreased by one and a ninth points. A decrease in firm’s ability to pay interest obligations from its long-term loans is caused by lower sales and high expenses mentioned earlier. In effect, the continued increased of its mortgage loan in 2006 is an aggravation of the lower coverage ratio much the same adverse effect of lower repayment loans. Due to this, if the interest expense continued to rise, the firm can face increasing risk of not able to pay interest charges. The problem of increasing long-term loans, however, is much apparent to competitors and the industry. With all of these financial ratios, the eight and an eight points decreased in price-earnings could be the most adverse outcome. The debt/ ratio showed that most of the assets are financed through equity. If the market perception of the firm turned to be slow-growing and more risky, the promising direction of the firm of reducing its long-term debt cannot be met. Due to this, the former positive status of the firm with the market, is reversed and therefore on the risk of loosing potential investors in favor of the competitors.
Potential Add-On Information, Limitations and Recommendations
One data that should be available is the two-year performance of the industry and the competitors to determine if the direction/ change of performance being indicated by the firm are the same with other companies. This will further concretize conclusions and minimize certain assumptions that are reflected by using “assuming”, “possibly” and “could”. Another important data is the historical collection performance of the firm which can verify the validity of its sales as part of current-assets. All of the sales of the firm are quoted as credit which can undermine its fair performance in receivable turnover. By using the historical performance, the expected collection can be estimated/ forecasted and bring to the fore the “rationalized” sales of the firm subject for analysis. The limitation of the financial ratio analysis is also limited to this shortcoming on available data.
Finally, the decision of whether potential investors should invest in the firm and buy shares is relative. When it comes to profitability, the firm is at par with the industry and competitors. While competitors have exemplified higher return in equity, it is not echoed in the dividend payment where the firm excelled. On the contrary, the firm is at risk of being in default for non-payment of short-term obligations which can continuously affect the security of equity returns being allocated to holders. However, the firm is efficient and also showed that its products are more saleable than the near competitor and its recent investments in long-term assets are just waiting to be felt. Lastly, its leverage is relatively lower than the near competitor and its market outlook is seemingly waiting for the big announcement/ result. Therefore, the firm is advisable for equity investment if the potential stockholder prefers higher returns from a high risk venture.
Possible Actions to Solve Certain Problems
Value Adding Analysis
The process involves the identification of separate organizational activities like selling, production and employee recruitment and the assessment of their value added for the firm. Value added results to additional money the firm receives from its products and services by managing linkages between organizational activities that can create competitive advantage. The bottom line is to situate the primary (logistics) and secondary (procurement) activities in which it can cut cost, produce more or improve quality. For example, the firm decided to transfer its logistics in the hands of a shipping company to cut costs in maintenance and repair expenses or forms linkage between its available technologies like software to train its human resources.
Value adding analysis aids the company to evaluate inefficient and unlinked activities it performs. From the evaluation, it can take necessary remedial steps to create value added linkages. As it cut back costs of production, it has greater control with the price of the product or service that leads not only to price stability but also flexibility. As it lowers its price, it creates additional value to the organizational activities reflected in the increase of revenues, demand and customer base. From strategic analysis of activities that can be improved and ultimately can reduce cost, the company is rewarded with savings.
However, not all value added factors are embedded within the company. The failure of the firm to look outside the organization’s resources and technologies, it can be left behind by its competitors who dig into the advantages of information technology, strategic alliances and economies of scale. With this limitation, the value adding capability of organizational activities can be offset by external factors. It can no longer obtain competitive advantage since other firms not only exploited the value adding activities within the organization but also the value-added opportunities found in the external environment.
Open Systems Analysis or Thermodynamics
To answer the limitation of the value adding analysis completely, this model emphasizes the external environment in which a firm belongs implicitly both at industry level and general environment. No specific and obvious process to aid in strategic analysis was illustrated. But it claims absolute assertion. It argues that closed systems, one that disregards the environment, will face deterioration. Because of this, it should maintain relationship within the environment for its self-existence and as well as the whole system. Thus, mutualism serves as the condition that balances and sustains harmony, if not continuum, in the whole system.
In applying to corporate world, the unpreparedness of the firm about political, economic and social forces can result to macroeconomic deficiencies of its strategies. This is the effect of lack of knowledge and reactive tendencies of firms. When the firms within an industry are exhausted with strategies limited within its own resources and capabilities, environmental scanning can provide it with competitive advantage like possible corporate tax exemption, economic recovery, transportation infrastructures, superior quality over competitor’s products and anti-discriminatory features of certain services. If the firm is patient enough to review the outside world, it can exploit resources, issues and spill-over effects of the environment.
Although, long-term success and additional source of competitive advantage is attached to the use of the model, it can be tedious and impractical exercise especially when the firm is small- to medium- scale. For some large firms, the model can only be useful when the firm is really large may be at the multinational level. In addition, some critics attacked the model because of its strict externally-related view. It overlooked the capability of the internal environment to stimulate the external environment. Or companies may view different markets and therefore some factors in the environment are irrelevant to be confined in analysis.
In continuation, the model put concentrated emphasis in belief that the whole is greater than its parts. Such stand is partly the result of its inception from the principle of Thermodynamics or the relationship of heat to mechanical and electrical work. Because of this, the reality in business environment is bypass by the exclusivity and generalization.
Complex Adaptive Systems
The shortcomings and absolutism of the internal (value adding) and external analysis (thermodynamics) are resolved by the development of a system that highly believes in complexity, change and unpredictability. Unlike the open systems approach, it cannot exist in a state of equilibrium and requires the organization to cope with the external environment. Another, there is a weak cause and effect relationship between organizations and its environment. It means that small changes can cause huge changes while large changes may have little effect.
On the other hand, the value adding capabilities of internal activities is limited by the environmental characteristics. When a government policy does not allow a local firm to do business with foreign logistics company, suppliers raise their whole sale price due to high tariffs or competition, not only for customers, but also healthy business partners. Such examples can freeze if not diminish the value produced by a certain activity.
The characteristic of the model is highly confined with the ability of firms to predict a certain phenomenon within the industry or environment that can affect its operations, possibly its key activities. Consequently, they can develop contingency plans to respond and protect its competitive advantage and stay profitable. The dynamic nature of primary and supporting activities of the firm added by the effects of external factors enable their managers to develop systems such as forecasting to discern patterns to increase predictability of a given situation. Does it lead to a trend that follows specific past experiences?
From the analysis, a firm can formulate strategic plans to gain and maintain competitive advantage. The model keeps the firms aware of internal and external developments and disruptions. This transforms the inside-outside-the-box approach of the first two models into a more proactive one. Because of this, it can be inferred that the analysis of bought the internal and external aspects of the firm is a sufficient method towards sound decision-making. Although the model imposes a more complex and integrative approach to strategic analysis, the quality of the output is parallel to the complicated procedure--- flexible and versatile strategy.
Credit:ivythesis.typepad.com
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