Comparing financial performance of PM Pty Ltd with Bega Cheese

Question

Task: You need to write a comparative financial report for the management. Comment critically on the five-year performance trends for PM’s liquidity, profitability, efficiency, and financial leverage using the relevant ratios provided. Using the DuPont Method, provide a critical analysis of PM’s Return on Equity (ROE) performance during 2017-2021 relative to the competitor. Discuss the ethical implications. Evaluate the pros and cons of listing the company and becoming public. Based on your analysis and discussion above (in Questions 1 through 4), make specific recommendations to the Board of as to whether PM Pty Ltd would continue the same trajectory and whether listing the company would be beneficial. Suggest other alternative growth options for the company as well. Identify and discuss the limitations of your analysis.

Answer

1. Introduction

Financial management comprises of planning, controlling, and proper utilization of funds in a manner that helps in the maximization of the financial goals (Carlon 2019). The aim of the assignment is to conduct a study on the performance of PureMilk (PM) Pty Ltd based in Australia through a comparison with Bega Cheese a pioneer in the dairy industry. The report is prepared on the evaluation of the performance with the help of ratio analysis followed by the critical analysis of PM’s ROE in the past five years. Simultaneously, the idea of floating the company to raise capital is discussed in the report. The pros and cons of the company’s listing are evaluated in the report. Based on the overall analysis, a recommendation is drafted and an alternative growth option is defined. Listing the company would prove to be beneficial as then the company PM Pty Ltd could then use the additional financial might to strong enter the market and expand. Rolling out a loyalty program can bring further benefits to the company at large in the long run.

2. Comparative ratio Analysis

Introspection into the ROE of the company (PM Pty Ltd) can be ascertained that a drop has been witnessed in 2022 whereby the ratio fell from 4.92% to 1.86% 2022. The company suffered a declining trend in the ROE which was noticed in the form of 6.92%, 5.39%, and 0.16% in 2018, 2019, and 2020 respectively. The drop in the level of 2020 was due to Covid. Similarly, a drop was witnessed in 2020 however; the company bounced back to the original and showcased upward movement whereby ROE increased from 2.61% in 2021 to 5.70% in 2022. From the computation, it is observed that the performance of Bega Cheese is above PM and hence generates more returns.

Coming to the liquidity part, it is seen that PM Pty Ltd has sufficient current assets to meet its obligations. The current ratio for PM Pty has been above 1:1 in the past five years meaning that the company has control over the liquidity. Similarly, Bega Cheese has maintained its current ratio which reflects that the company has sufficient current assets for meeting its obligations.

PM Pty has posted better profitability numbers however if compared with Bega Cheese it can be noted that Bega Cheese has better profitability numbers. Bega Cheese has posted an NPM of 2.4% while PM has posted 1.09%.

Similarly, Bega Cheese has been able to post a better ratio when it comes to the proper utilization of assets. Bega Cheese has posted an ATO of 1.2 times in 2022 as compared to PM’s ratio of 0.95.

The result indicates that for every $1 of the assets, Bega has generated $1.2 in revenue as compared to PM’s $0.95. Coming to the financial leverage part, it can be commented that Bega has outperformed the PM Pty ratio in 2022. As per the ratio, the financial leverage of PM is 1.8 while that of Bega has 1.98 which means for every $1 of debt Bega has $1.98 of assets while PM has $1.8 of assets.

As per the analysis, the major strength of PM Pty Ltd consists of liquidity and solvency. From the ratio, it is evident that the company has 1.78:1 as current assets while debt gearing is 0.44. This means the company has formidable strength in liquidity whereby it has more than $1 of current assets concerning $1 of current liabilities. Conversely, it has a debt ratio of 0.44 which means the debt component of the company is below 50% and hence manageable with the liquidity it has. This is well justified and better for the company's prospects.

However, PM Pty has weaknesses in ROE and ATO. The ROE and ATO stand at 1.86% and 0.95 times respectively. The ROE has plunged sharply in 2022 indicating a weakness in the utilization of the equity while 0.95 times ATO indicates for every $1 of the assets; the company has generated $0.95 in revenue.

3. DuPont Method

Refer Screenshot below and the excel sheet for the Ratios and side by side comparison of Bega Cheese and PM Pty and the DuPont analysis below.

Excel sheet containing data and calculation of Ratios and DuPont for Bega cheese and PM Pty Ltd

SO firstly if we look at PM Pty Ltd, we see that its return on equity (ROE) has decreased from 4.92% in 2021 to 1.86% in 2022. Also, there was a decreasing trend in the initial years as well with ROE decreasing from 6.92% in 2018 to 5.39% in 2019 to 0.16% in 2020. While the 2020 decrease was probably due to COVID, the decrease from 2018 to 2019 seems unhealthy.

If we compare this on the other hand to Bega Cheese Ltd, we see that while they also faced a decrease in 2020, again due to COVID; their recovery from that has been fantastic and there is a strong upward slope in the ROE curve with ROE increasing from 2.61% in 2021 to 5.70 % in 2022. Also, in terms of absolute comparison in 2022 ROE figures, Bega is well ahead of PM with ROE being 5.7% while that of PM being 1.86% (Yahoo finance 2022). This means that for $100 of equity that both business use, Bega is able to generate $5.7 on it while PM generates just $1.86 on it. If we look closer at the components that we used for DuPont analysis, we see that the Profit margins of Bega are consistently better than PM with 2022 profit margins standing at 2.4% for Bega and that of PM being 1.09%.

If we look at the Assets Turnover Ratio, we will see that Bega is able to better utilize its assets to generate revenues as Bega’s Assets Turnover Ratio for 2022 stands at 1.2 while PM’s is 0.95. This means that for every $1 of asset that these companies hold, Bega generates $1.2 of revenue against it while PM generates just $0.95. Again with Financial Leverage, Bega outperforms PM with 1.98 for Bega and 1.8 for PM in 2022. This means that for every $1 of debt that the companies have, Bega has $1.98 of assets and PM has only $1.8 of assets .

Thus it is seen that using DuPont analysis, the different drivers of Return on Equity indicate that Bega Cheese Ltd is better performing than PM Pty Ltd.

4. Ethical implications

Accounting policies are basics of any organization’s accounting health portrayal. Transparency in accounting policies helps stakeholders develop confidence in the organization (Atril 2014). Ethics is always a part of accounting practices. A change in accounting policies should be done only on two conditions:

i. If it helps in better presentation of books of accounts

ii. If it is required by an IFRS or any applicable accounting concept (Chambers et al 2018).

In the given case, the company PM Pty Ltd. had faced many problems during Covid. 2020 was a bad year as far as businesses were concerned and 2021 could not resume to normal. Since business was highly impacted due to covid, the management of PM Pty. Ltd. decided to make a few changes in the accounting policies to keep up with the low scale of business operations during and post Covid. The existing accounting policy of the company was to expense out any expenditure more than $5000. Expense more than $5000 was only capitalized. However, after a shift in scale of operations post Covid, the management decided to change the amount from $5000 to $1000. It is logical since it shall help in better presentation of business. The ethical implications are as under:

i. If the change in accounting policy is transparently and honestly communicated to the stakeholders as well as investors, there will not be any ethical question on the change of accounting policies (Chambers et al 2018)

ii. Proper assignment of duties and responsibilities for change in essential

iii. Every employee and stakeholder should be informed about his or her role in the change process and only then should the change be undertaken (Chambers et al 2018)

iv. Every employee connected with the implementation of change should also be given a say on his or her view about the change.

In this way, the ethical implications can be overcome.

5. Pros and cons of listing the company and becoming public

Listing a company essentially means going out to people to get some money as a loan – short term as well as long term in order to accumulate capital to conduct business on a larger scale and more smoothly and distributing the risk and rewards of the business to public at large.

Benefits of being listed:

1. The company once listed gets to distribute its losses and risks across a wider section of people and thus helps in diversification of risks (Peirson et al 2015).

2. Increase in scale of operations is achievable once the shares have been listed.

3. A private limited company is closely knit. Whereas a public limited company is, out in the public and has full visibility (Peirson et al 2015).

4. With more people investing in the business, that through a stock exchange, increases liquidity position of the company. These benefits cannot be overlooked when PM Pty Ltd will go out for listing.

There are cons too for listing a dairy company such as PM Pty Ltd. they are as under:

1. The lead-time of activities and decision making in a dairy company is very less since the shelf life of products is very less. However, with a listed company set up. Decision-making becomes a lengthy process due to multiple compliances and processes which become mandatory to be followed due to a listed company kind of set up. This results in business losses (Zainudin & Hashim 2016).

2. With lesser people and lesser involvement of officials and boards, the risk is also less for a private limited company, which increases as it goes listed.

3. Lesser compliances and complications also entail lesser costs. A listed company has to go through multiple costs of compliances and processes.

4. There are multiple tax benefits, which are enjoyed by a private company in comparison to a listed company, which shall be foregone once the company is listed (Zainudin & Hashim 2016).

6. Recommendations

PM Pty Ltd has two options before it as of now- 1. To go listed, 2. To continue as private limited with change in accounting policies Now as per analysis, Bega Cheese limited has been performing better financially, in the recent years. Hence, it is evident that PM Pty Ltd cannot continue its operations in current scenarios in order to survive in competitive market.

From critical analysis of Answers 1-3 above, wee see that listing the company would be a more beneficial move. This would bring in additional capital for the company has will allow greater resources to be used to

• Settle debts

• Fund growth and expansion

• Improve the Human resource quality and quantity

It can be clearly seen at Question 1 that Bega cheese is currently ahead of PM Pty Ltd is almost all financial ratios. Listing the company would prove to be beneficial as then the company PM Pty Ltd could then use the additional financial might to strong enter the market and expand. This would allow PM Pty Ltd to disrupt the operations of Bega and force them to try something different which can be a useful strategy. Also, this would allow PM to acquire a large customer base first which in turn would force Bega to reduce prices thereby reducing their margins.

Also, PM Pty Ltd can roll out loyalty programmes for customers (by giving them loyalty points, cashbacks, discount coupons, etc.) so that they remain associated with the company for a longer period of time and don’t switch over to a competitor. This would prove vital going forward as this immunes PM against Bega trying to poach customers from us later on.

Hence, by looking at answers 1-4, we see that PM Ptd Ltd though currently lagging behind Bega cheese, has the opportunity to improve. Our suggestion on the improvement measures would be to

• list the company

• and roll out customer loyalty schemes.

We feel this would allow the company to compete better with its competitors like Bega.

The limitations of the analysis it that specific ratios have been computed and the result is based on that. Depending only on specific ratios can turn out to be misleading because there are plenty of ratios. In some ratio the company might overtake Bega Cheese. Moreover, ratios depend on past data and there might be a different future hence depending on ratios can be misleading at times.

References

Atril, P 2014, Financial Ratios, In: Financial Management for Decision Makers, (7th Edition). Pearson Education Limited

Bega Cheese. (2020). Bega Cheese 2020 annual report & accounts. Retrieved from: https://www.begacheese.com.au/wp-content/uploads/2020/08/Bega-Cheese-Ltd-Annual-Report-2020-redopt.pdf

Carlon, S 2019, Financial accounting: reporting, analysis and decision making, Milton, QLD John Wiley and Sons Australia, Ltd

Chambers, I., Jeremy Russell?Smith, Costanza, R., Cribb, J., Kerins, S., George, M., Sangha, K 2018, ‘Australia's north, Australia's future: A vision and strategies for sustainable economic, ecological and social prosperity in northern Australia’, Asia & the Pacific Policy Studies, vol. 5, no. 3, pp. 615-640.

Peirson, G, Brown, R., Easton, S, Howard, P. & Pinder, S 2015, Finance, North Ryde: McGraw-Hill Australia.

Yahoo finance 2022, Bega Cheese Ltd Statistics, viewed 26 December 2022,

Zainudin, E. F., & Hashim, H. A 2016, ‘Detecting fraudulent financial reporting using financial ratio’, Journal of Financial Reporting and Accounting, vol.14, no. 2, pp. 266-278. doi:http://dx.doi.org/10.1108/JFRA-05-2015-0053

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