1 Introduction
Specialty Fashion Group Ltd holds a leading position in the women's apparel retailing in Australia. It manages 6 brands aimed at offering women of all ages and sizes contemporary fashion at competitive prices. During 2010, the group closed 10 underperforming stores and refurbished 52 stores. This strategy is expected to be continued in 2011. By the signing of the agreement with Limited Brands, the group will be the exclusive La Senza licensee in Australia and New Zealand until August 2020. The expansion of brand portfolio is believed to be a key drive of growth in the future.
Noni B Ltd is one of Australia's leading fashion retailers with two fashion labels focused on becoming the fashion store of choice for the 40+ women. The improvement of every detail- e.g. ensuring the quality of garments; strengthening the relationship with customers; tightening the inventory control and providing personal in-store services is believed to be the drive of growth.
Financial ratios are indicators of the broad state of a business. The level and historical trends of these ratios can be used to make inferences about a company's financial condition, its operations and attractiveness as an investment (Financial Pipeline 2009). Therefore, informed decisions can be made on the basis of this analysis. Ratio is also a useful tool for management. Certain ratios must be maintained as specified in some debt covenants and manager is responsible for calculating and monitoring those ratios (Atrill, McLaney & Harvey 2006).
2 Body of report
2.1 Profitability
Every company is most concerned with profit. Profitability ratio measures the overall efficiency of a company (Biz/ed 1996-2010).
Margin ratios
Margin ratios represent a company's ability to transform sales dollars into profits at various stages of business (Peirson & Ramsay 2003).
2.1.1 Gross Profit Margin
Gross profit margin=Gross profit/ Net sales= (Sales-COGS)/Net sales
GPM for Noni B has increased from 57.48% to 59.69% while it has slightly decreased from 57.52% to 57.03% for Specialty Fashion Group. The difference between the two companies is not significant. It may indicate that the inventory control in Noni B has improved over the two years period as every sales dollar could generate more profit now (as a result of lower COGS or higher price). However, it is unlikely to conclude that Noni B has better inventory or pricing policy in place than SFG as the differences in the company size; strategy and related sales volume.
2.1.2 Net Profit Margin
Net profit margin = Profit before interest and tax / Net sales
This figure that measures profitability after considering all the expenses has increased for both companies. It has increased by 153% for Noni B, which implies the success of Noni B's policy of focusing on margin rather than sales volume. Tighter inventory control has enabled Noni B to avoid the more aggressive discounting and improved operation throughout the business has brought lower costs. The modest increase in profitability for SFG is driven by its sophisticated marketing strategy, increased store optimization, well controlled costs and direct sourcing strategy. This ratio for SFG is 60% greater than Noni B, which might suggest the overall efficiency of the business.
Returns ratios
Returns ratios measure the overall efficiency of a company in generating returns for its shareholders (Peirson & Ramsay 2003).
2.1.3 Return on asset
Return on assets=Net profit/ Total assets
The increment of return on asset ratio for both companies is about 7%. These ratios have shown that both companies are managing their assets efficiently and using them effectively to generate profit. However, Noni B has improved its efficiency more significantly (the figure for 2009-10 is 136% higher than 2008-09) during the relevant period compared with SFG (with only 34% higher). The profit earned by SFG is 30% relative to the company's level of investment in assets while Noni B's profit is only 13%. Thus, these figures show that Noni B is under rapid growth even though the assets base is relatively small and SFG is at a mature stage and generates profit steadily from assets invested.
2.1.4 Return on equity
Return on equity=Net profit/ owner's equity
The movements of this ratio for the two companies are at opposite direction. This ratio is perhaps the most important to investors as it shows how the company is doing its job using the investors' money. Even SFG has decreased from 73% to 50% and Noni B has continued its growth trend, the return on equity for SFG is still 233% greater than it for Noni B. It further confirms the conclusion that Noni B is a fast growing company and SFG is profitable and stable. The dropping of ROE for SFG is probably due to the financial crisis and government's less aggressive fiscal policy, leading to a sever swing in consumer confidence. More detailed discussion will be given later.
2.2 Efficiency
2.2.1 Asset turnover (Times)
Asset turnover=Net sales/ Total assets
This ratio measures a company's productive use of fixed asset (Biz/ed 1996-2010). Noni B' amount of sales generated from every dollar's worth of assets has decreased by 0.07 times and SFG has increased this figure slightly. It may indicate that SFG is more efficient at using its assets in producing revenue. It may also simply imply the difference in pricing policy. Noni B with higher gross profit margin (60%) tends to have lower asset turnover (2.61) and SFG with lower gross profit margin (57%) tends to have higher asset turnover (3.88).
2.2.2 Inventory turnover (Days)
Inventory turnover=COGS/ Average inventory
The inventory turnover for SFG is almost 2 times fast than Noni B. Sourcing directly from Asian suppliers not only could help SFG increase gross margin, it could also avoid cash being tied in inventories. The integration of planning, buying, design and sourcing and sophisticated marketing strategy allow SFG to achieve the inventory turnover ratio to only 68 days. On the other hand, low turn may indicate overstocking for Noni B. As fashion is a highly-fluctuated industry, inventory may become obsolete quickly and further lead to inaccurate sales forecast.
2.2.3 Debtors turnover (Days)
Debtors turnover=365/ (Net credit sales/Average receivables)
Debtors' turnover measures the number of days r accounts receivable can be turned into cash (Birt 2008). The lower the ratio, the more liquidate the company. The figure shows that Noni B can liquidate its accounts receivable fairly fast.
2.2.4 Creditors turnover (Days)
Creditors turnover= 365/ (COGS/ Average payables)
Creditors' turnover measures the number of days the company needs to pay its debt (Birt 2008). SFG pays its debts 3 times faster than Noni B does and it is significantly lower than its trading term of 45 days. This has shown a strong cash position, as confirmed in the chairman's report that the operating cash flow rose to $49.6 million for the year. It took Noni B 11 weeks to pay its trade debts and almost 18 weeks to turn its inventory; these figures might indicate a cash shortage during economic downturn.
2.3 Financial stability
Short-term
2.3.1 Current ratio
Current ratio= Current assets/ Current liabilities
As Noni B has reduced its level of current assets modestly in relation to current liabilities, SFG has prudently managed its balance sheet by paying off its debt to $5.3 million from $25.8 million, increased its current ratio from 0.57 to 0.84. However, it is still lower than the general rule of thumb (2 to 1). This ratio is more satisfactory for Noni B as 1.26 means that it has $1.26 of current asset to pay for every $1 of current liability.
2.3.2 Quick ratio
Quick ratio= (Cash and its equivalent + Short-term investments + Trade receivables)/ Current liabilities
Quick ratio is a more conservative measure of short-term liquidity because only cash and accounts receivable are taken into account (Carlon 2009). The total current liabilities of SFG were probably settled by cash, therefore quick ratio dropped by 0.22. On the contrary, Noni B has an increased amount of total current liability than 2009, but its year end cash position has been improved. Thus its quick ratio moved in a positive direction. Both companies' ratios are lower than the general rule of thumb (1:1), which might suggest that the company may not be able to pay its debt in a crunch situation. This problem is especially severe for borrowers of SFG.
Long-term
2.3.3 Debt asset ratio (total debt)
Debt assets ratio= Total debts/ Total assets
This ratio measures the leverage of assets-what you owe to what you own (Hoggett, Edwards & Medlin 2006). Both ratios are below 1, which means that for both companies the majority of assets are financed via equity. Debt asset ratio for SFG has decreased by more than 20% with the change in total assets negligible, and the decrement in total debts is consistent with chairman's announcement. Again as the two businesses are different in scale, these two figures are not immediately comparative.
2.3.4 Debt equity ratio (total debt)
Debt equity ratio= Total debts/ Total equity
This ratio is a common benchmark used to measure the leverage within a company (Hoggett, Edwards & Medlin 2006). Given a fixed level of total assets, the less the debt, the higher the net worth. As SFG has reduced its debts by $20 million and set aside a great amount of reserves, the debt equity ratio has increased by 251%. Yet it is still quite highly-leveraged. According to this ratio, Noni B appears to apply a more cautious strategy and maintains a moderate level of debt related to equity. It is inappropriate to give a judgment about which company is better.
2.3.5 Times interest earned
Times interest earned=Profit before taxes and interest / Interest expense
Both companies have shown a strong cash-flow to cover their interest expenses. Noni B has earned a profit that is 8 times of the interest it has to pay. Even it has dropped by 2.7 times (probably due to the six consecutive interest rate increases), it is sufficient to be a going concern. For SFG, attention needs to be paid, this ratio has increased by 18.5 times- borrowing costs have decreased significantly (likely because debts had been paid off). However, SFG has financed an $8 million loan from bank during the year; this ratio is expected to drop in the future.
3 Additional information
The past financial year had been very challenging for clothing retailing industry due to the financial crisis and a series of government fiscal and monetary policies. In June 2009, government made stimulus payments. The additional cash injections, together with the low interest rate, had pulled domestic demand from recession. Consumers had more confidence in the market as well as more disposable income. However, since October 2009, the Reserve Bank had adjusted interest rate upwards six times in a row. Consumer confidence was dragged to a historically low level and the international financial market was also gloomy during the same period.
Both companies stated in their annual reports that they benefited from the stimulus packages in the first half year and carried out aggressive discounting to attract reluctant customers in the second half year. SFG and Noni B are trading under this tough situation, challenging but still hold a strong market position.
4 Limitations
Financial ratio analysis is valuable to managers only if the data under comparison are comparative (Peirson & Ramsay 2003). As procedures normally adopted, ratios are compared with company's historical figure as well as industry data in this report. However, the appropriateness of comparison is subject to many factors, such as scale of business, company's visions and strategies, accounting policy used, largely depreciated fixed assets, seasonal fluctuations, fraudulent reporting and miscalculation etc.
More specifically, It is inappropriate to conclude that Noni B performed better then SFG simply because of higher gross profit ratio. In fact, SFG earned a much larger amount of profit as its size of business is greater. Low Times Interest Earned does not necessarily suggest insufficient cash flow; Noni B may be just less leveraged than SFG.
5 Recommendations
According to profitability, efficiency and financial stability discussed above, Special Fashion Group Ltd appears to be a preferable choice for investors. It is the largest women's apparel retail group in Australia and has generated a very high return on equity to investors. It has differentiated itself by its S.H.I.R.T culture; sophisticated marketing strategies-especially the valuable customer database which can reach over 85% of the target market and direct sourcing from Asian factories. The effectiveness and efficiency of these strategies can be proven by the turnover ratios. SFG is a company that is mature and financially stable. It has sufficient operating cash inflows to pay for its interest expenses and has recently reduced its debt to an even more prudent level. The addition of La Senza would bring youth market to the group, which will benefit investors in the long term.
On the other hand, Noni B is growing at full speed and has a huge potential to grow further. This is particularly shown by margins ratios and returns ratios that almost doubled previous year's figure. However, it is highly recommended that Noni B could tighten its inventory control and speed up cash flows to improve inventory and/or creditor turnover. It may develop more brands and widen its market to include more young customers.
6 Conclusions
This report has evaluated the financial ratios of the two leading fashion retailers of Australia over the two years period of 2008-2010 from three broad perspectives. The analysis shows that Special Fashion Group Ltd is more attractive to investors as its stability in generating profits and higher efficiency in asset and debt management. Noni B Ltd also demonstrates a strong growth potential in the long term and the management adopts a very prudent strategy in managing resources. Its low level of debt would positively affect equity holders' wealth. Each company has its own strength and weakness, and the analysis is not complete because of the limitations discussed in part 5. As a whole, financial ratio analysis is an objective and useful instrument for decision-making and manager's performance assessment.
7 List of References
Atrill, P., McLaney, E. & Harvey, D. 2006, Accounting: An Introduction, 3rd ed., Prentice Hall, Sydney.
Birt, J., et al, 2008, Accounting: Business reporting for Decision Making, 2nd ed., Wiley, Brisbane.
Biz/ed (1996-2010), Ratio Analysis 1: Profitability, <http://www.bized.co.uk/compfact/ratios/profit1.htm>
Biz/ed (1996-2010), Total Asset Turnover, <http://www.bized.co.uk/compfact/ratios/asset3.htm>
Carlon, S., et al, 2009, Accounting Building Business Skills, 3rd ed., Wiley, Brisbane.
Financial Pipeline (2009), Financial Ratio Analysis, <http://www.finpipe.com/equity/finratan.htm>
Hoggett, J., Edwards, L. & Medlin, J., 2006, Accounting in Australia, 6th ed, Wiley, Brisbane.
Noni B Ltd Annual Report 2010, viewed 27th Dec 2010, available at <http://www.nonib.com.au/assets/pdf/Noni-B-Annual-Report-2010.pdf>
Peirson, G. & Ramsay, A. 2003, Accounting: An Introduction, 3rd ed, Prentice Hall, FrenchsForest, NSW.
Special Fashion Group Ltd Annual Repot 2010, viewed 27th Dec 2010, available at <http://media.corporate-ir.net/media_files/irol/15/154279/ar_2010_sfg.pdf>.
8 Appendices
1. The percentage of change over 2008-2010
| % of change of ratios | Noni B Ltd | Specialty Fashion Group Ltd | % of higher over lower (2010) |
| Net profit margin | | | |
| Return on asset | | | |
| Return on equity | | | |
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