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Writing on topic 8, i am at operating cycle right now and i am so confused with certain things.
When calculating receivable days, we take average receivables for the period divided by sales into 365.Now in FY 2011 my R.days were 7.5 and in FY 2010 they were 9.2 days.
However in FY 2011 debtors increased substantially over the year (more than increase in sales) and at the same time cash balance decreased which indicates that company might be having lenient credit policy, however if receivable days are decreasing then it means that its stricter policy?I literally dont understand this contradiction, it would go away if i use closing receivables instead of average receivables when calculating days..
What i noticed is that although closing debtors increased over the period by 50%, they decreased on average (compared to average of FY 2010) by 6.7%.How do i explain this? Please help
@captmario The important things to remember with ratios are that it is the overall trends that matter and also there may be a ‘knock-on effects’ elsewhere e.g. if the cash balance has decreased because receivables have grown how is the company funding itself? You have to stand back and try to see the bigger picture rather than fixating on one particular year. (You must not try to change the formula just because you don’t like the result!) Also how is the comparator faring?
The first part of this document may give you a few ideas (it is a very technical paper so don’t try to understand it all) but it covers financially distressed firms – if your company has increasing receivables and decreasing payables and decreasing cash it could be descending into what the authors term ‘financially distressed’ status. (Also look at overtrading as there may possibly be an element of that)
Don’t just let yourself get frustrated and stuck on any particular element in your analysis – move on, look at others and come back to it at a later date and it may become clearer when you have a better understanding of the company’s operations.
Well the trends are pretty much normal and company is performing quite well, only issue is in FY 2011. in following FY 2012, receivables again reduced to FY 2010 point so apparently it suggest that this is part of normal routine.
However what goes over my head is that basically if debtors increased by 50% during the year while sales only increased by 15%. Why would Debtor days decrease?
Now it is just because i am using average debtors instead of closing debtors
Let me put it this way to make myself clear since i personally believe i am not able to clarify the situation properly 😀
closing debtors in 2009 = 500k
closing debtors in 2010 = 300k
closing debtors in 2011 = 450k
closing debtors in 2012 = 300k
closing debtors in 2013 = 270kaverage debtors for 2010 = 400k
average debtors for 2011 = 375k
average debtors for 2012 = 375k and so onnow issue in 2011 is that although closing debtors increased by 150k, average debtors still decreased by 25k (because 2009 figure caused average debtors of 2010 to be pretty high ) furthermore cash decreased during the year, since these figures are pretty immaterial i would just say company was having lenient policy, however debtors day decreased which would indicate otherwise.
Otherwise company is doing pretty good but i am quite unsure on how to explain the reduction in debtors days only in FY 2011, any suggestions?@captmario I don’t think you need to dwell on this unduly as the overall trend is downward (2013 closing debtors is nearly half the 2009 figure) provided the sales are showing an upward trend. It may have been that in order to get the best sales and profit figures for 2011 year end that a lot of sales were invoiced just before year end (and if you think about it – as every credit has to have a debit, this is going to impact on the closing debtors figure). Provided the debtor situation is being managed and controlled there is not much you can comment on. General good liquidity and evidence that long-term loans are not being used to finance everyday operations are probably more important when discussing liquidity.
It is probably easier to find more external evidence for Profitability and investor ratios to support your evaluation if doing T8 so ensure these are well covered. I think markers generally seem to accept that with debtors, creditors and inventory the information for a really detailed analysis is not normally publicly available so just make comparisons with the competitor. Don’t speculate too much on what could have gone on unless you have the evidence to support it, stick to facts and concentrate on the researching the other areas well
@captmario
Don’t get engrossed with irrelevance…% movement may be one of them in this case
Company A sales growth- 2m To 5m will give you 150% increase while
Company B sales growth -20m To 25m gives you 25% increase.
Would you because Company A had a whopping 150% growth conclude it performed better than company B?Compute the simple TR days which is TR/sales *365….don’t even bother about average TR.
Do the trend analysis over the period and evaluate by explaining why
Compare n evaluate with those of the comparator comparator company
The marker is looking at the quality of your evaluation and not these stuffs you are currently engrossed in.
Hope this helpsWhat my mentor suggested me is to do three year analysis where i can compare each year with its previous year and explain the changes.
Competitor analysis will be done in a separate section right after own business analysis is completed.
It’s kind of difficult to explain the trend if you are only comparing each year separately.@captmario Well it’s up to you whether you follow your mentor’s advice or mine. The year by year approach in my opinion is not a good idea as you become fixated on calculating numbers and differences rather than recognising the important trends and the real underlying issues.
Ask yourself this – does the management start out at the first day of the new financial year with new policies? do the business factors in the PESTLE all stop at the end of the financial year? Of course not! That’s exactly why you are finding it difficult to actually EXPLAIN everything. Believe me Brov your mentor is not helping you here – ask him what his student pass rate is and how many of his students have ever actually got above a C. The real issue is trends – so I suggest that you read my article on Evaluation on our home page before you continue….
@captmario
Consider this step approach for your analysis n evaluation
1. You do your trend (or 3 yr analysis) …
a. ) stating what your ratio analysis says and whether or not the trend is good or bad following the 3 yr trend ratio analysis
B. ) explaining possible reasons for the results obviously backing it up with findings from the business environment as revealed by your PEST, five forces analysis or press release etc. No conjuring here!…this is where the quality of the our evaluation lies.
2. Then come your comparator analysis. To me, it wont be effective if you open a fresh sub section and name it “comparator analysis”. Immediately after you conclude your statement for 1b above, you quickly compare the comparator co ratio results vis a vis that of the focus co (eg for GPM) and AGAIN state whether the focus co performance is good or not.
You should take the above steps for your eg GPM, opm, npm, gearing ratios etc@captmario pretty good advice from @marquez they only thing I want to clarify is the bit about opening a new section for the comparator. Based on the marker feedback I have read – you should show comparative figures for the both companies on the same graph, then discuss each trend first for your main company and then compare it with the comparator say for GP margin and then move on to NP or whatever and again graph, discuss main company, compare with comparator. Maybe that is what @marquez is saying too but just want to make it clear that you should not split your RAP into graphs just about the main company and explanations on all the trends dealing with profit, liquidity, inevestors etc and then start a new section where in effect you are looking at the comparator in isolation.
You have to do the two in tandem – and remember to pass E & A it is explanations, explanations and more explanations that will get you a pass and just saying that something has increased or reduced or that one company has performed better than the other without researching the reasons and tying it to the PEST etc is sure to end up with an F for E & A…
Ok what i am doing is, i am basically showing three year analysis of each ratio as my mentor suggested (not applicable to porter/PEST/swot as it’s based on trends and happenings). after this is done i am going to undertake competitor analysis in which ill firstly explain trend of both my company and competitor’s and then compare them.
So your suggestion that we have to analyse trend will somehow be included in the analysis, maybe not where its supposed to be but do you think that will be fine and fulfill the trend analysis requirement?
I agree that my mentor may not be the very best option but i am too far in to back out right now, i am on job so i can’t just switch it out and start from beginning as i probably won’t be able to finish by the deadline then.
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