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Stakeholders: Financial Analysis

The Financial Analysis of Digital China Limited

From Financial Year 2002-03 to 2006-07

Listed on Hong Kong Stock Exchange

 

 

This report has been prepared on the basis of the five most recent income statements and balance sheets of Digital China Limited covering the Financial Years 2002-03 to 2006-07. Financial Analysis used in the report is based on the calculations shown in the appendix attached.

 

 

Stakeholder effecting from the Financial Analysis are as follows:

Ordinary (equity) share holder are the providers of the risk capital of a company and usually their goal will be to maximize the wealth which they have as a result of the ownership of the shares in the company. They naturally interested in knowing how profitable and how durable the business is. This in turn means their interest in knowing the extent of net worth, liabilities to third parties and distribution of these resources into fixed and current assets. Additionally they are also interested in the amount of revenue and profit which the aforesaid resources generate.

 

Long term creditors which will often be banks have the objective of receiving payments of interest and capital on the loan by the due date for the repayments. Where the loan is secured on assets of the company the creditor will be able to appoint a receiver to dispose of the company’s assets if the company defaults on the repayments. To avoid the possibility that this may result in a loss to the lender if the assets are not sufficient to cover the loan, the lender will wish to minimize the risk of default and will not wish to lend more than is prudent.

 

Employees will usually want to maximize their rewards paid to them in salaries and benefits, according to the particular skills and the rewards available in alternative employment. Most employees will also want continuity of employment.

 

Government has objectives which can be formulated in political terms. Government agencies impinge on the firm’s activities in different ways including through taxation of the firm’s profits, the provision of grants, health and safety legislation, training initiatives and so on. Government policies will often be related to macroeconomics objectives such as sustained economic growth and high levels of employment.

 

Trade creditors have supplied goods or services to the firm. Trade creditors will generally be profit maximizing firms themselves and have the objective of being paid the full amount due by the date agreed. On the other hand they usually wish to ensure that they continue their trading relationship with the firm and may sometimes be prepared to accept later payment to avoid jeopardizing that relationship.

 

Management has, like other employees (and managers who are not directors will normally be employees), the objective of maximizing their own rewards. It is the duty of the directors and the managers to whom they delegate responsibilities to manage the company for the benefit of shareholders. The objective of reward maximization might conflict with the exercise of this duty.

 

Present and prospective investors: With the advent of money markets, especially the stock exchange, a class of potential investors has come into being, operating in many cases from their homes. These investors however have to have an access to financial statements of relevant business entities. Either these investors themselves become conversant with the discipline of financial analysis or obtain this knowhow from appropriate outside sources. A substantial part of day to day activity on stock exchange is due to these present and prospective private investors.

 

The actions of stakeholder groups in pursuit of their various goals can exert influence on strategy. The greater the power of the stakeholder, the greater his influence will be.

 

 

Company’s Current Financial Position:

 

Performance:

Revenue have increased consistently by 18%, 14%, 8%, 29% and 28% in Financial year 2002-03, 2003-04, 2004-05, 2005-06 respectively from previous year’s revenue and it increased 103% in 2006-07 as compared to Financial year 2002-03. So it shows increasing trend from last five years which is the good sign for the investor. There could be also cause of increase in revenue is to increase in sale prices of companies merchandise which could adversely affect the financial position of the company but on the other hands company is maintaining its gross profit margin at same point at where it was at five years before so its gross profit increases as the revenue of the company increases.

 

In contrast, the gross profit margin has remained relative static over the last five year’s period, although it has risen by approximately 1% in the financial year 2006-07 as compared to financial year 2003-04. Once dropped in the year 2003-04 it slightly improving very slightly in 2004-05 to 2006-07. This marks a rise in direct expenses but they are also well controlled because of increase in revenue gradually from last five years and gross profit rates are the relatively consistent which shows good sign of maintaining gross profit even with increase in revenue which also requires a to increase in fixed cost of the company and it also show that the company is maintaining its economies of scales from last five years.

 

On the other side of financial statement Return on Investment Capital (ROIC) is not consistent. In the year 2003-04 it decrease by ten percent but after that it maintains its percentage more than 8% per annum which is quite a reasonable rate on ROIC.

 

Return on equity is also showing same trend as the return on investment capital, that is in 2003-04 it decrease by 11% percent but after that it maintains its percentage more than 10% per annum which is pretty a sound rate on ROE. In the year 2005-06 the return on equity had increased up to 14% and after that there is the decline in this ratio so it shows that such return can increase up to such percentage or more than that so there is the margin in return on equity as compared to last year.  

 

Debt and liquidity:

External borrowings to equity ratio, is quite consistent from last five years except in the year of 2003-04 due to decrease of earnings of the company. In that year it seems that the company’s position is deteriorate due to some reasons or the others so that’s why the company took more borrowings to recover that deterioration. After that year such debt to equity ratio is at decreasing trend which shows that company is retaining its current years’ profit and investing it into the business rather than to give more dividends to its shareholders. It also shows that the company paying off the long term bank borrowings and not rescheduling it. Due to increasing rates of interest in international markets it is a good thing for the company. Unless its interest costs would have been is at its increasing trends which could munch the shareholders profits gradually.

 

While reviewing Digital China Limited’s liquidity the situations has also consistent over the periods of five years current ratios of the company is as follows for the from 2002-03 to 2006-07:

 

06/07

05/06

04/05

03/04

02/03

 

  Current ratio

1.44

1.25

1.4

1.68

1.6

                 

It shows decreasing trend in first four years after that in fifth year an increase in current ratio. So there is no consistency but it shows the good position of the company. But first we should check that whether there is so much stock accumulation or whether the stocks are valued at high rates than actual, for this we should look at the quick assets ratio of the company which is as follows:

  Quick ratio

1.05

0.86

0.98

1.16

1.14

It is also higher than one in three years in from year 2002-03, 2003-04 and 2006-07 and in other two years this ratio is close to one which shows that it has too much cash and bank balances, short term deposit, trade receivables and other receivables which can easily cover the current liabilities so in short term company’s liquidity position is very strong. In long run it can invest or boost up its business by capital investments and by taking long term loans from financial institutions because it has so much margin in short term assets.

 

It can increase its dividend policy by paying off more dividends. Except in the year in which the company faced deterioration it paid on consistent basis approximately 8% dividends. Through which it should have a consistent share prices in the stock exchange or rather at increasing trend also.

 

The efficiency ratios, receivables ratio and inventory turnover, give a useful indication of how the company is managing its current assets.

 

Company’s debtor turnover ratios are between 8 to 10 times but it will clear that whether it is good or bad we have to check debtors collection period and creditor payment period of the company.

 

As can be seen from the appendix that the debtors collection period is from 40 to 50 days in that particular five years and creditors payment period is also from 40 to 50 days which shows that the company’s management policy is really very good. The company give credit to its customer for such number of days as it receive credit from its suppliers in other words whenever it receive from its customer it pays off its suppliers’ or creditors’ debts. So it has really very consistent policy about its receipts and payments of short term finance management. It can be make better by improving debtor turnover ratio and creditor turnover ratio.

 

Looking at inventory turnover, this has decrease gradually from 32 days to 26 days in last five years. There is the indication of lower stocking and high turnover of stocks which is really very appreciable to the company, it also indicates that company has no slow moving stocks or obsolete stocks.

 

Strategic issues and their likely financial implications

 

As discussed above company’s revenue is at increasing trend and revenue growth rate is from 18% to 28% in last five years if this growth rate maintains company will come into China’s big revenue generation companies in Information Technology.

 

The company in next coming year should maintain its debtor turnover ratio and creditor payment ratio or it should improve its debtors’ turnover to improve its finance management strategies. By doing this the company can avoid its finance cost of short term borrowings or credits and other banks overdrafts.

 

Inventory turnover is getting improved with the passage of time the reason behind this is coming of new technology and doing proper strategies of job order castings as there are no extra inventories in the company’s store rooms which could not sale in the open markets. With the emergence of technology company has to improve such ratio in further better ways.

 

Return on capital employed and return on investment capital is also in improving trends and with the passage of time it is going better so the company can increase its production lines and company can also increase its business geographically in all over the world with the extra financing. It can take finance by issuing more equity capital and other interest bearing instrument such as preference share or debentures by giving higher interest rates to the investor, which will benefit to the company as this interest cost lower than the interest cost charged by the banks or other financial institutions. Company can also borrow long term loans from financial institutions for the enhancement of the business in long run. With this financing the company can do business in all over the world as well as it can also take over other small scale established business in China. It can also increase business by related diversification by such long term financing.

 

By paying higher dividends to its equity shareholders company can gain higher share value in the stock exchange. By issuing such higher valued shares in market as further Issue Company can gain extra premium on such shares and can enhance its business in well and organized manners.

 

Conclusion:

After the review of the five year financial statements for Digital China Limited we can conclude that the company is still in its developing stage or at growth stage and there is no chance to reach the company on maturity or decline in the business of Information Technology until unless there is some unexpected activity happen. So that is why Digital China Limited has to grow in the competitive market in the world.

 

 

 

 

APPENDIX

 

Following is the abstracts form the financial statements and some financial ratios from last five years:

 

HK$ million

FY06/07

FY05/06

FY04/05

FY03/04

FY02/03

Income Statement

 

 

 

 

 

Revenue

25,418

19,865

15,457

14,277

12,511

  Revenue growth rate

27.96%

28.52%

8.26%

14.12%

18.91%

Gross Profit

1,849

1,405

1,184

940

1,001

  Gross margin (%)

7.27%

7.07%

7.66%

6.58%

8.00%

Other income and gains

220

123

48

-

-

Profit from operating activities

415

375

222*

61*

226

  Operating margin

1.63%

1.89%

1.43%

0.43%

1.81%

Net profit

208

252

186*

20*

179*

  Net margin

0.82%

1.27%

1.20%

0.14%

1.43%

 

 

 

 

 

 

Balance Sheet

 

 

 

 

 

Fixed assets

351

434

495

394

324

Other non-current assets

311

377

143

81

62

Inventories

1,684

1,567

1,284

1,101

1,021

Trade and bills receivables

2,852

2,585

2,104

1,614

1,512

Prepayments, deposits and
other receivables

957

567

408

327

334

Cash and bank balances

717

298

453

521

667

Non-current assets classified
as held for sale

13

0

0

0

0

Total assets

6,885

5,827

4,887

4,038

3,920

 

 

 

 

 

 

Trade and bills payables

2,667

2,055

1,661

1,200

1,424

Other current liabilities

1,007

760

561

454

335

External borrowings

1,238

1,206

1,076

1,009

761

Total liabilities

4,912

4,021

3,298*

2,663*

2,520*

 

 

 

 

 

 

Share capital

87

87

86

86

86

Other reserves

1,104

1,041

1,003*

967*

943*

Retained earnings

698

572

417*

312*

301*

Proposed final dividend

72

87

73

-

63

Minority interests

12

19

10

11

7

Net Assets

1,973

1,787

1,579

1,365

1,393

 

 

 

 

 

 

Cash Flow Statement

 

 

 

 

 

CF from operating activities

571

130

127

(145)

258

CF from investing activities

26

(239)

(221)

(152)

(311)

CF from financing activities

(193)

(54)

26

151

250

 

 

 

 

 

 

Key Ratios

 

 

 

 

 

Return (%)

 

 

 

 

 

  ROA

3.03

4.32

3.81

0.51

4.57

  ROE

10.63

14.10

11.80

1.49

12.85

  ROIC

8.26

9.28

8.42

1.09

11.98

Gearing (%)

 

 

 

 

 

  Net Gearings

26.5

50.84

39.45

35.74

6.74

  External borrowings/Equity

63.08

67.50

68.17

73.91

54.63

  Liabilities/Equity

250.43

225.06

208.98

195.03

180.88

Liquidity (x)

 

 

 

 

 

  Current ratio

1.44

1.25

1.40

1.68

1.60

  Quick ratio

1.05

0.86

0.98

1.16

1.14

Payment period of Debtors

41.0

47.5

49.7

41.3

44.1

Collection period of creditors

41.3

40.6

42.5

32.8

45.2

Debtor turnover

8.9

7.7

7.3

8.8

8.3

Creditor turnover

8.8

9.0

8.6

11.1

8.1

Inventory turnover

26.1

31.0

32.8

30.1

32.4

 

 

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