Introduction

There are several methods in analyzing and interpreting the so called financial statement,

one of the well-known methods applied by many users of financial statement is ratio analysis.

Ratio is relation between two figures in the form of mathematical fraction and percentage. So,

we can say that ratio analysis is the analysis of financial statement by using the so called ratio

(finpipe, undated). There are 5 types of ratio analysis, Liquidity ratio, Leverage/Gearing ratio,

Profitability ratio, Efficiency ratio and the last is Market Value ratio. Finpipe(undated) define

liquidity ratio as measurement of the level of the company in fulfilling the short-term obligation

and surviving in the short-term. Gearing or leverage ratio measures the level of debt that used in

the company. Profitability ratio measures the level of the company in gaining the profit in the

range of time. Efficiency ratio measure the level of effectiveness in the operation of the

company. Last but not the least, market value ratio measures the level of relation between share

price, earnings and dividends. Beside the ratio analysis, there are other methods to analyze the

financial statement of the company. Some of the method like Horizontal analysis, Vertical

analysis, Common-size statements and Benchmarking can be applied either in analyzing the

company (Elliot&Elliot, 2001).

The analyses are needed for the user of the financial statement for further decision-

making. For instance, one of users of financial statement, Investor, uses the financial statement

by analyzing the liquidity, profitability and market value of the company for deciding whether

the company is worth to invest or choose another company. Managers use the financial statement

by analyzing the efficiency ratio to measure the level of effectiveness of the operations and

decide whether to maintain or improve the performance of the operation. Bank and suppliers use

the gearing and liquidity ratio to know whether the company is having high level of debt and the

risk that they can take over the level of liquidity of the company. Those financial analyses are

useless without an interpretation. So, all the analyses need to be interpreted to give clear picture

for the user (Bized, 2010).

In this chance, two companies listed in the Bursa Malaysia have been chosen for

investment. It was analyzed using the financial statement analysis. The purpose of the analysis is

to know the position of the company and suggest whether the company is worth to invest. Two

of the companies are Nestle Malaysia and Fraser and Neave (F&N). Both of these companies are

Page | 1

popular among the consumer all around Malaysia. This report will give detailed performance of

these companies as successful companies in Malaysia based on the financial analysis technique.

Here are the brief description and history about those two companies.

Nestle is an International company which set up subsidiary in Malaysia. It began with the

Anglo-Swiss Condensed Milk Company in 1912 and was starting to develop until now. With the

vision, “Be the leading multinational company in food, nutrition and wellness” and several

missions like “Utilize well the local raw material”, “Take care well the Environment” and

“Produce HALAL food for Malaysian market”, Nestle operate in Malaysia until now employing

approximately 5000 employee. Nestle provides several range of product like Milo (Dairy

product), Nescafe, Purelife, and other range of product (Nestle, 2010).

Furthermore, Fraser and Neave (F&N) works in the consumer-related product, especially

soft drinks and dairies. F&N based in Singapore, founded by John Fraser and David Neave, it

formed a subsidiary in Malaysia in 1884. With a vision, “To become the leading total beverage

company in Malaysia and the region” and mission, “To be a world-class multinational enterprise

providing superior returns to our shareholders, excellent value for our customers and a rewarding

career for our employees”, F&N works in Malaysia successfully in providing range of product.

Several type of F&N product are Coca-Cola (under the license of Coca-Cola Company USA),

100Plus (isotonic drink), Magnolia (Dairy product), Sunkist, and the other range of product

(F&N, 2010).

Page | 2

Ratio Analysis

Liquidity Ratio

Liquidity ratios measure the power of the company to fill up the short-term obligation. If

the company is failed to do so, it will drive to failure and bankruptcy. Soon after, the company

will end into liquidation to return all outstanding debt. The liquidation converts all the

company’s asset into liquid or cash to return to the creditors and shareholders in case of

bankruptcy (Horngren et al, 2007). There are 3 ratios in measuring the liquidity of the company,

Working Capital, Current Ratio and the last is Acid-test Ratio.

i. Working Capital

Working capital measures the ability of a company to cover up the short-term debt with

its current assets. It only measures brief position of company’s liquidity. The ideal result for

working capital is positive (+) figure. The positive figure means that the company can cope up

with the current liability over their liquid assets. Other than positive figure means the company

unable to repay their short-term debt and highly risk in bankruptcy (Kennon, 2010). The formula

for working capital is shown below:

WorkingCapital=Cur rent Asset−Current Liability

From the working capital, Nestlé had a negative figure for RM -148,575. It means that

Nestlé had a very low liquidity. Nestlé is risky in bankruptcy and liquidation, because with the

current assets of the company cannot cover up the short-term debt. This will happen if Nestlé’s

present project is unsuccessful. Nestlé must lower their short-term debt in order to put the

Page | 3

-200000 -100000 0 100000 200000 300000 400000 500000 600000 700000

621172

-148575

Working Capital

Nestle F&N

Nestlé F&N

Acid-test Ratio881,882−1,030,457=¿ -

148,5751,391,372−770,200=¿ 621,172

company in a safety position. At least, Nestlé must lower their current liability for the number of

RM 148,575 and maintain the working capital on positive figure to makes sure that Nestlé

always on the safe position. On the other hand, F&N has a very good position in working capital.

The company was liquid enough to cover up the current debt with the current assets. F&N is on a

safety position in the 2008. F&N should maintain the liquidity position like that.

For the comparison on the graph, the position of liquidity of these two companies has a

significant difference. F&N has a very good liquidity compared than Nestlé. Nestlé must set

another strategy in order to have a better liquidity.

However, with working capital alone, the user of the financial statement cannot easily

decide the company’s liquidity. There are two other liquidity ratios that can be used for further

decision-making. The current ratio and acid-test ratio can measure the company’s liquidity in

detail.

Page | 4

ii. Current Ratio

Current ratio is the measurement of the company to fulfill the short-term obligation. On

the other words, current ratio can simply define as the power of the company to repay their debt

over the following year. It represents the day-to-day operations, like buying the raw material,

paying the short-term loan by creditors, etc. The ratios can be calculated by dividing the current

asset with current liability. The ideal number for this ratio is in the range of one to two

(Horngren et al, 2007). But, according to Kennon (2010), the current ratio of 1.5 is quite good for

industrial company. The equation can be express as follows:

Current ratio= Current AssetsCurrent Liability

By looking at the current ratio of Nestlé for 0.86, Nestlé has borderline liquidity. It means

that each ringgit of the current debt, Nestlé only has RM 0.86 for returning the debt. Since the

ratio is below 1, Nestlé is highly risk in bankruptcy, because they will not be able to meet their

short-term obligations. The current ratio of F&N is quite good enough. From the financial

statement of F&N we can calculated the current ratio for 1.81. F&N can cover up all short-term

obligations with the current assets that F&N has.

For comparison, there is difference for 0.95 in current ratio of both of the companies. Just

like the previous working capital, F&N has better liquidity than Nestlé.

Page | 5

2008

0 0.2 0.4 0.6 0.8 1 1.2 1.4 1.6 1.8 2

1.81

0.860000000000001

Current Ratio

Nestle F&N

Nestlé F&N

Current Ratio881,882

1,030,457=¿

0.8558

1,391,372770,200

=¿

1.8065

iii. Acid-test (Quick) Ratio

The acid-test ratio is the ratio measuring the ability of the company to convert most of the

current asset into cash to repay the current liability in a very short time, considering days and

months. It named as acid-test because its measures the firm for a very short period, since acid is

very fast affecting the victim. In the acid-test ratio, the formula is nearly the same with current

ratio, but it excludes the stocks in the current asset. This is because stock is not easy converted

into cash. Result in the range of 0.9 to 1.00 is acceptable for the acid-test ratio (Kennon, 2010)).

The acid-test ratio formula can be shown as follows:

Acid−test ratio=Current Asset−StocksCurrent Liability

Acid-test ratio also gives the same result for the both companies. Nestlé has a portion of

50-50 on their current asset with the stock which made the position of Nestlé is worsen. Nestlé

will not be able to pay even half of the current debt. Nestlé is in a very dangerous situation. If

Nestlé did not do anything to the current liability, Nestlé will be easily come into bankruptcy.

F&N has a very strong position of liquidity, even for the acid-test ratio it has 1.24. It has

no significant change in the current ratio with the acid-test ratio. It means that F&N hold

reasonable amount of stock in the warehouse.

Page | 6

2008

0 0.2 0.4 0.6 0.8 1 1.2 1.4

1.24

0.41

Acid-test Ratio

Nestle F&N

Nestlé F&N

Acid-test Ratio-200000 -100000 0 100000 200000 300000 400000 500000 600000 700000

621172

-148575

Working Capital

Nestle F&N

0.4099

1,391,372−437,860770,200

=¿

1.2380

In conclusion, F&N has a very strong liquidity position in 2008 rather than Nestlé which

has low liquidity in the following year. F&N has higher value on working capital, current ratio

and acid-test ratio than Nestlé. For overall liquidity ratios, F&N has better position than Nestlé.

Gearing Ratio

The measurement of gearing ratio is about the level of debt financing that the company

used in the capital. Companies must utilize well the debt financing as it gives so many

advantages, like tax deductible for the company and supplement the shareholders as well in

financing the company (Investopedia, 2010). Tax deductible by the debt means as the interest of

the debt are paid before the tax payment, the income decrease and the tax charge will be lower in

the end (Richards, 2010). However, if the company is too much in using the debt, the company is

risky in bankruptcy since it has less equity and assets than the level of liability. Gearing ratio

consist of four ratios, they are Debt ratio, Long-term debt ratio, Interest Coverage, and Debt to

Equity ratio.

i. Debt Ratio

Debt ratio is the form of relation between debt and asset. Since asset usually use by the

company as collateral in borrowings with the bank, debt ratio is used generally by banks to

measures the risk that they took in lending the money to the company. Usually, the higher the

debt ratio, the bank asks for the higher return as the higher the risk that the banks take.

Shareholders use the same way of think in the analysis of the debt ratio. There is no ideal number

of debt ratio, but usually a good debt ratio is under 50% for well long-run sustainability (Ward,

2010). However, the decision based on debt ratio is different for each investor. According to

Investopedia (2010), the ratio under 100% means that the company is financed by equity, and

vice versa. The debt ratio equation explained as follows:

Debt Ratio= Total DebtTotal Asset

Page | 7

Nestlé F&N

Debt Ratio1,144,6461,660,401

=¿

68.94%

1,196,9332,514,089

=¿

47.61%

Nestlé had a quite high debt

ratio of 68.94% for the year 2008.The high level of debt indicates high risk that the investor will

take. Therefore, the investors will ask for higher return/dividend for each share invested in

Nestlé. On the other hand, F&N has debt ratio for 47.61%, which is lower than 50%. It indicates

that F&N has quite good position on debt ratio. The risk of F&N eventually lower and the return

that F&N should pay will be lower than Nestlé.

Both of companies have debt ratio lower than 100%, so both of it are still using the equity

in financing the companies. Investors might find lower risk in the investment in the company

since the company still in low-leverage firm.

Page | 8

2008

0.00% 10.00% 20.00% 30.00% 40.00% 50.00% 60.00% 70.00% 80.00%

47.61%

68.94%

Debt Ratio

Nestle F&N

ii. Long Term Debt Ratio

Long-term debt ratio is nearly the same with the debt ratio, but it just measures the

number of long-term debt financing in the company. This ratio usually used by the

debenture/bondholders in investing the company with the long-term debt. There is no ideal

number in the long-term debt ratio. However, the company must utilize well the long-term debt

ratio to increase the tax deductible from paying off the interest to the bondholders (Richards,

2010). The long-term debt ratio formula can be described below:

LongTermDebt Ratio=LongTermDebtTotal Asset

The analysis of long term debt ratio describes that Nestlé did not utilize well the long

term debt. Only 6.88% of the debt in each single ringgit of asset and it was considered too low

for the manufacturing company like Nestlé. Nestlé must utilize well the long-term debt in order

to maximize the debt financing and to deduct the tax as well. F&N utilize better the long-term

debt than Nestlé done. F&N has 16.97% of long-term debt in each ringgit of assets. So, we can

say that F&N utilize the long-term debt better than Nestlé.

Page | 9

2008

0.00% 2.00% 4.00% 6.00% 8.00% 10.00% 12.00% 14.00% 16.00% 18.00%

16.97%

6.88%

Long Term Debt Ratio

Nestle F&N

Nestlé F&N

Long Term Debt Ratio114,189

1,660,401=¿

6.88%

426,7332,514,089

=¿

16.97%

iii. Interest Coverage

Two above ratios only measures the debt over the asset from the so called Balance Sheet,

but both of them stress on the power of the company in paying the interest of the debt. So,

interest coverage is used for further decision-making, especially for the banks and bondholders.

Interest coverage computed in order to know the level of the profit before paying the interest in

paying the debt’s interest (Kennon, 2010). In the other words, the interest coverage measures

how well the company can manage the payment of the interest over their operating profit. The

higher interest coverage, the better for the bondholder since the company makes sure the

payment of the interest and shareholders will get higher dividends. The Interest Coverage can be

computed using the formula below:

Interest Coverage=Profit before InterestInterest

From the interest coverage, both of the company has good interest coverage. It means that

Nestlé has power to pay off 20 times of interest over their operating profit and F&N has power to

pay off 15 times of interest over their operating profit. So, both of this company can manage well

the payment of long-term debt like debenture, bond, etc. Thus, the dividends generated by F&N

will be smaller than Nestlé since the interest coverage is lower.

iv. Debt to Equity Ratio

Page | 10

2008

0 5 10 15 20 25

15.12

20.24

Interest Coverage

Nestle F&N

Nestlé F&N

Interest Coverage464,53022,952

=¿20.24256,65016,978

=¿

15.12

Debt to equity ratio measures the proportion between the total debt financing and the

equity financing in the company. The debt to equity ratio also indicates the earnings that the

shareholders receive after the profit deducted with the interest of debts. The higher the ratio, it

means that the company is using more in the debt financing rather than in equity financing.

Therefore, the earnings that received by the shareholders are lesser in the end (Kennon, 2010). In

the worst case of high debt to equity ratio, the company will not be able to pay the interest of the

debt and lead the company to bankruptcy. The debt to equity ratio formula shown below:

Debt ¿ Equity Ratio= Total DebtTotal Equity

Nestlé F&N

Debt to Equity Ratio1,144,646515,755

=¿221.94%1,196,9331,317,156

=¿ 90.87%

From the debt to equity ratio, Nestlé has very high ratio for 221.94% compared than F&N

that only 90.87%. It means that Nestlé has higher debt financing rather than equity financing.

The return of dividend for Nestlé’s shareholder will be lower, since the operating profit is

deducted to pay off the interest. Nestlé is highly risk of bankruptcy, if it is unable in paying off

the large number of debt interest. Besides, F&N has more equity financing rather than debt

financing, which means F&N spread higher dividends to the shareholder. F&N has a good

proportion of debt with the equity.

From all the gearing and liquidity ratios above, a conclusion can be taken. Nestlé has too

much short-term debt in the daily operations. Nestlé should try to reduce the short-term loan and

Page | 11

2008

0.00% 50.00% 100.00% 150.00% 200.00% 250.00%

90.87%

221.94%

Debt to Equity Ratio

Nestle F&N

change over to the long-term debt, since the long term debt was not utilized well in the following

year. Nestlé should lower their debt in order to reduce the debt to equity ratio, because Nestlé

was on highly-leverage position and considered too risky to invest in. But, for the following year

2008, investors still can calm since Nestlé can manage well the payment of the interest over the

profits. Besides that, F&N has a strong position in the gearing as it has low debt ratio, utilize

well the long-term debt, high interest coverage and low debt to equity ratio. For the overall

gearing ratio, F&N has better position than Nestlé.

Page | 12

Profitability Ratio

Profitability ratio measures the level of profitability of the company. As the main purpose

of the business is to earn profit, the company must have a high profitability in order to attract

shareholders to invest in the company. Profitability shows the combination of the liquidity,

leverage and efficiency of the company. So, profitability is the overall measure of the effective

use of the all resources in the company. As profitability is one of the most important criteria in

decision-making, profitability ratio hold significant role in helping the user of the financial

statement (Peaveler, 2010). There are several ratios in determining the profitability, Gross Profit

Margin, Operating Profit Margin, Net Profit Margin, ROCE, ROE, ROA, and the last is Earnings

per Share.

i. Gross Profit Margin

Gross Profit Margin is the ratio to measure not only the financial performance of the

company, but also the efficiency of the production process in the manufacturing as well. Gross

profit margin shows the level of gross profit generated over 1 ringgit of sales (Peaveler, 2010).

The gross profit margin formula can be described as follows:

Gross Profit Margin=Gross ProfitNet Sales

As from the computation above, the gross profit for Nestlé and F&N are 31.05% and

25.03% respectively. Gross profit margin of both companies indicates that both of the companies

manage well in their operation in year 2008. Nestlé can manage their cost of goods sold for RM

Page | 13

2008

0.00% 5.00% 10.00% 15.00% 20.00% 25.00% 30.00% 35.00%

25.03%

31.05%

Gross Profit Margin

Nestle F&N

Nestlé F&N

Gross Profit Margin1,203,7503,877,068

=¿

31.05%

898,9253,591,204

=¿

25.03%

0.69 for each Ringgit of sales and earn RM 0.31. Thus, F&N can retain RM 0.25 for each RM1

of sales with RM 0.75 of cost of goods sold. From the comparison above, Nestlé has better

performance and efficiency in producing the products as Nestlé has lower cost for 0.06 over

sales than F&N.

Page | 14

ii. Operating Profit Margin

Operating profit margin indicates the level of efficiency of the sales from the

manufacturing of the product, administrative of the office, until distributed to the customer.

Since the operating profit is computed from the sales deduct with both production and non-

production expenses, operating profit margin can be treated as the profit after paying the variable

costs (Peaveler, 2010). Companies with healthy operating profit may cover their fixed cost, for

example the interest on debt. Operating profit margin can be calculated with the formula as

follows:

Operating Profit Margin=Operating ProfitNet Sales

Operating profit margin of

Nestlé above 10% indicates that the operation of Nestlé in all sectors, including production,

administrative, marketing, selling and delivery expenses, are quite efficient. For every single

ringgit of sales, Nestlé can retain 11.98% from it before paying off the interest and tax. Besides

that, F&N has the margin below the average, for 7.15% only. It indicates that F&N was not

efficient enough in the operation, although F&N gain quite good figure for the gross profit

margin. F&N should manage the operation well, like the administrative, marketing, and selling

and delivery cost, in order to cut off cost on that expenses. The difference for 4.24% between the

margins of two companies can describe well that F&N spend too much on the operation.

iii. Net Profit Margin

Page | 15

2008

0.00% 2.00% 4.00% 6.00% 8.00% 10.00% 12.00%

7.15%

11.39%

Operating Profit Margin

Nestle F&N

Nestlé F&N

Net Profit Margin464,530

3,877,068=¿

11.98%

256,6503,591,204

=¿

7.15%

Net profit margin is the ratio that can be used in comparing the performance over the

company in the same industry. As the higher of net profit margin indicates that the company is at

a good and better performance than other companies in the same industries. Same as Gross profit

margin, Net profit margin shows the net profit generated from each ringgit of sales (Peaveler,

2010). The formula for net profit margin is as follows:

Net Profit Margin= Net IncomeNet Sales

Net profit margin indicates

that Nestlé has good performance for the year 2008. 8.79% of net profit margin can be defined as

the net profit of RM0.08 can be retained from every RM1 of sales after paying off all expenses,

including interest and tax. Thus, F&N has average borderline net profit margin of 5%. This

indicates F&N has quite good performance in the following year. But, for comparison of both of

the companies, Nestlé has better performance in the following year as it has higher net profit

margin.

Page | 16

2008

0.00% 1.00% 2.00% 3.00% 4.00% 5.00% 6.00% 7.00% 8.00% 9.00% 10.00%

5.00%

8.79%

Net Profit Margin

Nestle F&N

Nestlé F&N

Net Profit Margin340,887

3,877,068=¿

8.79%

179,7313,591,204

=¿

5.00%

iv. Return on Assets

Return on Assets included in the so called return ratios. ROA measure the earnings

generated from each of asset used in the company. It indicates the level of efficiency of the usage

of the assets in the operation. Usually ROA use in measuring the manufacturing companies since

manufacturing companies hold a lot of assets. The higher the level of ROA, the better is the

company. The reason is the company can generate the money efficiently from lesser amount of

assets (Peaveler, 2010). The formula of ROA shown below:

Returnof Asset= Net Income before Interest∧TaxTotal Asset

ROA of Nestlé, 20.53% describe that Nestlé utilize the asset very good in generating the

earnings. Even with low number of Asset, Nestlé can retain their earnings for RM0.20 for each

RM1 of asset. F&N only can utilize their asset for 7.15%, which means that RM0.07 return from

RM1 of asset. From the ROA, Nestlé is efficient in utilizing their asset to generate their revenue.

Therefore, Nestlé is more profitable than F&N.

Page | 17

2008

0.00% 5.00% 10.00% 15.00% 20.00% 25.00%

7.15%

20.53%

ROA

Nestle F&N

Nestlé F&N

ROA340,887

1,660,401=¿

20.53%

179,7312,514,089

=¿

7.15%

v. Return of Equity

Same as Return on Assets, Return on Equity, usually called as ROE also included in the

return ratios. ROE is a ratio that tells us the level of the efficiency of the company in using the

shareholders fund invested to generate revenue in the business. Each percentage in ROE

indicates the earnings of each ringgit invested in the company. As the most important ratio to the

investors, return on equity measures the earnings that the investor will get in the future. So, ROE

is one of consideration for investors in the decision-making (Peaveler, 2010). Company must

have at least 10% of the ROE to attract the investors up. The ROE equation can be expressed as

follows:

Returnof Equity= Net IncomeShareholder Equity

Nestlé has

a very high ROE for 66.09% for return on each ringgit of equity. It is high since Nestlé has

highly risk on the liquidity and gearing, especially on the short-term debt. This number of ROE

is very high and will attract the risk-taker investors in investing in Nestlé. F&N has quite good

ROE of 13.65% for the following year, as it has a good position on both liquidity and gearing.

The risk-averse can take the following shares to invest in.

Page | 18

2008

0.00% 10.00% 20.00% 30.00% 40.00% 50.00% 60.00% 70.00%

13.65%

66.09%

ROE

Nestle F&N

Nestlé F&N

ROE340,887515,755

=¿

66.09%

179,7311,317,156

=¿

13.65%

vi. Return on Capital Employed

Other than ROA and ROE, another return ratio is Return on Capital Employed, usually

called as ROCE. it is a ratio that tells us the level of the efficiency of the company in using the

shareholders fund invested and bondholder (long-term loan) fund to generate revenue in the

business. Each percentage in ROCE indicates the earnings of each ringgit invested both by

equity and long-term debt in the company (Peaveler, 2010). ROCE values usually lower than

ROE as the earnings spreads to both equity and debt. The ROCE equation can be expressed as

follows:

ROCE=Net Profit before Interest∧after taxLongTerm Loan+Equity

The ROCE of Nestlé measures that each RM1 invested in Nestlé will generate RM0.63 in

return. This number is very good for Nestlé, as Nestlé utilize well the financing both from debts

and shares. F&N’s ROCE shows that F&N only generate RM0.11 in the following year over

RM1 in debt and equity. From ROCE, Nestlé indicates significant high level of profitability than

F&N.

Page | 19

2008

0.00% 10.00% 20.00% 30.00% 40.00% 50.00% 60.00% 70.00%

11.49%

63.48%

ROCE

Nestle F&N

Nestlé F&N

ROCE340,887+22,952

114,189+515,755−56,801=¿

63.48%

179,731+16,978426,733+1,317,156−32,077

=¿

11.49%

vii. Earnings per Share (EPS)

The earnings per share is the fundamental value of the company to the investors. The EPS

itself can be a single of significant variable in positioning the share price in the market

(Investopedia, 2010).

EPS straightly states that the level of profitability of Nestlé is higher than F&N

significantly. Nestlé has earnings for 145 cents or RM1.45 and F&N for 64.8 cents for each share

holds by the shareholder.

Profitability ratios above prove that Nestlé is more profitable than F&N. Nestlé is

successful in developing the source of finance, both from debt and shares. Since Nestlé is

stressing more on debt financing, the net profit shared to the shareholders is high due to the high

risk that the shareholders take and low number of shares on the market. Although F&N

profitability is lower than Nestlé, it does not mean F&N is not profitable. With the strong

condition of liquidity and low gearing, F&N generates profitable amount of money in the year

2008. Shareholders get the reasonable amount of earnings for the low risk that they take. Thus,

F&N can try to increase their efficiency on the operation in order to increase their profitability,

for example, decrease cost on administrative expense, selling and delivery cost, etc.

Page | 20

2008

0 20 40 60 80 100 120 140 160

64.8

145

EPS

Nestle F&N

EPS (cents) Nestlé F&N

2008 145 46.8

Efficiency Ratio

Efficiency ratio measures the effectiveness of the usage of the assets, inventory and

warehouse in generating the income of the company. The higher the efficiency means that the

company utilizes the resources well in generating the earnings. This ratio usually used by the

manager of the company to see the productivity and performance in the production. The

managers can decide whether the present state is good enough to maintain or need to be

improved (BizWiz, undated). There are five ratios in determining the efficiency in the company,

fixed asset turnover, total asset turnover, day sales outstanding, stock turnover and the last is the

account payable to sales.

i. Fixed Asset Turnover

Fixed asset turnover indicates the level of efficiency of the company in generating

earnings from the cost of fixed asset. Fixed assets including property, plant and equipment which

usually highly cost must be utilized well in order to cover up the sunk cost. We can say as pay

back for the investment of the fixed asset. As the high number of the ratio indicates the revenue

gathered in each ringgit of the cost of fixed asset invested in the company. Manufacturing

company usually highly invest in the fixed asset. Therefore, it should maintain the high level of

efficiency to utilize the assets well (DNB, undated). The fixed asset turnover equation can be

written as follows:

¿ Asset Turnover= Sales¿ Asset

Page | 21

Nestlé F&N

Fixed Asset Turnover3,877,068778,519

=¿

4.98

3,591,2041,122,717

=¿

3.20

Nestlé has better fixed asset

turnover for 4.98 than F&N with

3.2. Nestlé can generate revenue 4.89 times and F&N can generate revenue 3.2 times from the

value of fixed asset. It means that Nestlé fixed asset are used and managed properly to produce

the goods. From the figure, F&N has higher number of fixed asset, but it generates even less

sales than F&N. F&N should try to increase the efficiency of the fixed asset by applying new

strategy or improving the present performance. If there is unused or scrap fixed asset, F&N can

salvage it for increasing this ratio.

Page | 22

2008

0 1 2 3 4 5 6

3.2

4.98

Fixed Asset Turnover

Nestle F&N

ii. Total Asset Turnover

A bit difference between fixed asset turnover with total asset turnover is the total sales

turnover includes the calculation of both non-current and current asset in the measurement of

efficiency. By knowing the efficiency of whole assets in the company, the managers can

eventually know the total utilization of the assets of the company (Answers, 2010). From the

ratio, the manager would maintain and increase the department performance, especially the

production department. The total asset turnover formula is as follows:

Total Asset Turnover= SalesTotal Asset

Just like the fixed asset turnover, the total asset turnover shows the same level of

efficiency of Nestlé and F&N. Nestlé with 2.33 and F&N with 1.43 shows the efficiency of

Nestlé is better than F&N. The total asset turnover also shows that Nestlé holds more current

asset than current asset and F&N holds nearly same proportion of current and non-current assets.

Page | 23

2008

0 0.5 1 1.5 2 2.5

1.43

2.33

Total Asset Turnover

Nestle F&N

Nestlé F&N

Total Asset Turnover3,877,0681,660,401

=¿

2.33

3,591,2042,514,089

=¿

1.43

iii. Day Sales Outstanding

The days sales outstanding analyzed the number of days that the debtor could pay the

short-term loan to the company. The lower of the DSO means the debtors are paying the debt in

the short period of time. On the other words, the DSO measures the level of company’s

efficiency in managing the debtor payment. If the company has a low DSO, the company can

easily receive the cash from customer and eventually use the cash generated for the other

investment or project (Investopedia, 2010). The DSO formula can be shown below:

Day SalesOutstanding=Total ReceivableNet Sales

x daysanalyzed

Nestlé can manage well their debtor in terms of return of receivable to the company. In

only three days, Nestlé can retain back their receivables. Nestlé has high efficiency on DSO, so

that Nestlé can use the lump sum of receivable for another project or investment. F&N has quite

good DSO, in average of 62 days the debtor pay back their debt to F&N. However, F&N still has

lower efficiency in managing the debtors.

Page | 24

2008

0 10 20 30 40 50 60 70

62

3

Days Sales Outstanding (in days)

Nestle F&N

Nestlé F&N

Days Sales Outstanding (days)23,814

3,877,068x365=¿

2.24≈3

617,3933,591,204

x 365=¿

61.89≈62

iv. Account Payable to Sales

The opposite of days sales outstanding is account payable to sales. This ratio measures

the level of unpaid short-period liability over the number of sales. It also indicates the efficiency

of the payment of the liability to the creditors, so that the interest of the debt is controllable and

kept to be low as much as possible. The short-term debt also gives advantages to the company as

the company can purchase other materials rather than pay off the one material using cash. The

higher the ratio indicates that the company is using the supplier as financing (CreditGuru, 1999).

The account payable to sales can be calculated using the equation below:

Account Payable¿ Sales= Account PayableNet Sales

From the account payable to sales shows that 23.32% of Nestlé’s and 18.27% of F&N’s

sales are funded by the suppliers. Both of this company is good in utilizing the short-term debt

funding from suppliers for their overall sales. But as the low liquidity of Nestlé, the short-term

debt should be decreased.

Page | 25

2008

0.00% 5.00% 10.00% 15.00% 20.00% 25.00%

18.27%

23.32%

Account Payable to Sales

Nestle F&N

Nestlé F&N

Account Payable to Sales904,368

3,877,068=¿

23.32%

656,1703,591,204

=¿

18.27%

v. Stock Turnover

The level of stock turnover is measuring the stocks of the year that have been sold and

generated into the cash. It can be used to know the efficiency of the production and distribution

of the products. Usually the stocks remains in the warehouse are the outstanding amount of

stocks that have not been distributed and sold to the customer. The lower number of stock

turnover means that the stocks were efficiently distributed to the customer and converted into

cash. However, the company should maintain the reasonable number of stocks in order to fulfill

the extra demand of the product. Based on research by Horngren (2007), for food and beverages,

the ideal stock ratio is about 8 times or approximately 47 days. The formula of the stock turnover

can be described below:

StockTurnover= Net SalesClosing Stock

Average stockholding period is just the same as stock turnover, but this ratio is expressed

in the number of days. It indicates the average days of stocks stays in the warehouse after the

production. The formula of average stockholding period is as follows:

Average Stockholding Period=Closing StockNet Sales

xdays analyzed

Page | 26

2008

8.05 8.10 8.15 8.20 8.25 8.30 8.35 8.40 8.45 8.50

8.20

8.44

Stock Turnover

Nestle F&N

Nestlé F&N

Stock Turnover3,877,068459,489

=¿8.443,591,204437,860

=¿ 8.20

From both ratios, both of these companies were maintaining well their stocks till the

distribution. There is no significant difference in the stock turnover as well as the period. Both of

these companies also keep the reasonable amount of stock to fulfill the extra demand from

customer. Therefore, both of this company has same efficiency in the stock management.

Nestlé has more efficient in all aspect of the efficiency ratio, this is the one of key of

success in Nestlé’s high profitability. By maximizing the utility of resources, Nestlé can achieve

the satisfactory position in the year 2008. F&N has quite good efficiency in the production, but

still, F&N must try to increase the efficiency in using the assets.

From all above four ratios, conclusion can be taken, Nestlé has an outstanding level of

profitability with high level of efficiency in the production. The efficiency is the key of success

in achieving the profitability, especially in using the assets and short-term debt. But, Nestlé must

make sure that they must put their liquidity position above the average. Nestlé also highly

leveraged, which indicates that the company is in highly risk in bankruptcy. However, if Nestlé

can maintain well the efficiency in using the short-term debt, the high level of gearing is not a

threat for Nestlé. On the other hand, F&N has strong position of liquidity and low level of

gearing. Thus, F&N must increase the performance in efficiency in order to increase the

profitability of the company.

Further Analysis

Page | 27

2008

43.4 43.6 43.8 44 44.2 44.4 44.6 44.8 45 45.2

45

44

Average Stockholding Period

Nestle F&N

Nestlé F&N

Average Stockholding Period459,489

3,877,068x365=¿

43.25≈44

437,8603,591,204

x 365=¿

44.50≈45

Ratio analysis alone cannot determine the decision-making of the investors, since the

ratio analysis only analyzes the performance in single year. Ratio also has many limitations that

will be explained in the next section on Limitation of Ratio Analysis. Because of that, the users

cannot see the real performance and development of the company. To gain clearer view of a

company’s performance, it is necessary to analyze the financial statement more than two or

three-year period. There are other analyses such as multivariate analysis, horizontal analysis, and

vertical analysis (Elliot&Elliot, 2001). Those analyses can be used in order to support the ratio

analysis, or even give an argument to the ratio analysis. There is no such a best analysis to the

financial statements. The result of this analysis will only suggest the investor whether to choose

to invest in those companies, but decision made only based on the type of investor itself. In this

report, trend analysis is used to analyze thoroughly after the ratio analysis does. Trend analysis

applied in this report since both of these companies have nearly the same size of company and

within the same industry.

Trend Analysis

Trend analysis is one of the forms of horizontal analysis. Trend analysis used to analyze

the trend or movement of performance in the period of time. Trend analysis usually analyses

over 5 to 10 years period (Horngren et al, 2007). In this report, the trend analysis will be

conducted for the 5 years period, 2004 to 2008. This trend analysis will analyze five criteria that

important for the shareholders, there are revenue, cash flow from operating activity, dividend

payout and cash flow for investing activities. There are two forms of trend analysis that can be

used, percentage changes and index number (Elliot&Elliot, 2001). Percentage changes give the

exact changes in each variable for each one year period. Percentage changes use the formula

shown below:

Percentagechanges=Present year variable−Last year variableLast year variable

x100 %

Page | 28

Thus, index number gives the exact percentage of the variable over the base variable. It is

calculated by dividing each year variable by the base year. This analysis uses the index number

method for the trend analysis. In the first place, it is necessary to choose the base year, which is

2004 in this analysis. The formula of index number is as follows:

Percentagechanges=Present year variableLast year variable

x100 %

Page | 29

Trend Analysis each Company

Trend Analysis of Nestlé in 5 years

 

2008 2007 2006 2005 2004RM’000 RM’000 RM’000 RM’000 RM’000

Revenue 3,877,068 3,416,028 3,275,541 3,127,441 2,901,183

in % 134% 118% 113% 108% 100%Cash flow from Operating Activity

555,972 290,657 358,057 266,956 376,543

in % 148% 77% 95% 71% 100%

Dividend payout ratio (no.) 0.8 1.1 1.1 1.3 1.2

in % 67% 92% 92% 108% 100%

Cash flow in Investing Activity

185,696 100,721 76,294 72,152 52,668

in% 353% 191% 145% 137% 100%

 

Trend Analysis of F&N in 5 years  

 

2008 2007 2006 2005 2004RM’000 RM’000 RM’000 RM’000 RM’000

Revenue 3,591,200 2,865,100 1,943,600 1,935,100 1,728,100

in % 208% 166% 112% 112% 100%Cash flow from Operating Activity

325,457 71,480 289,674 90,783 177,038

in % 184% 40% 164% 51% 100%

Dividend payout ratio (no.) 1.2 1.3 1.2 1.2 1.3

in % 92% 100% 92% 92% 100%

Cash flow in Investing Activity

222,943 374,580 115,699 61,759 116,722

in% 191% 321% 99% 53% 100%

Page | 30

Graph can be plotted from each of the variable that used in the trend analysis. Graph

believed to supplement users in analyzing using the trend analysis. Graph and its interpretation is

as follows:

2008 2007 2006 2005 2004

134%118% 113% 108% 100%

208%

166%

112% 112%100%

RevenueNestle F&N

Revenue trends index show that Nestlé has a gradual increase in 5 years. Revenue of

Nestlé increases for average of 8% every year. F&N revenue increases gradually in year 2005

and 2006. Then, in 2007 and 2008 F&N’s revenue increase significantly to 166% and 208%.

This indicates that F&N’s took over of Nestlé’s dairy (Thailand) company in 2006 was

successful (Patton, 2006). Take over for RM 310million increase the revenue for 54% in 2007

and 42% in 2008. Trend analysis indicates that in the next year there will be significant increase

for F&N’s revenue. However, Nestlé has invested for the development of Nestlé’s manufacturing

and technology facility in 2007. One of the developments is the air-dried noodle for the so called

Maggi noodle. Since the turnover of Maggi noodle 1.3 million per day, it was believed that the

technology will boost the revenue in the future (Nestlé, 2007).

Page | 31

Operating activities trend indicates that, both of these companies are having fluctuation in

the cash inflow from the operating activity. Nestle has fluctuative cash flow from 2005 to 2008

and increase significantly in 2008 for 148%. Thus, F&N has significant declining in the cash

flow, especially in 2005 and 2007, drop for 51% and 40% respectively. Moreover, F&N also has

significant increase in 2006 and 2008 for 164% and 184% respectively. The fluctuation

happened to both companies can be treated as market effects to the company. But, F&N has

better performance in year 2006 and 2008 as it perform well after the grave performance, even

the grave performance of F&N worse than Nestle. In 2009, there will highly probable that both

of companies will enter the grave performance and enter good performance in 2010.

2008 2007 2006 2005 2004

67%

92% 92%

108%100%

92%100%

92% 92%100%

Dividend PayoutNestle F&N

Page | 32

2008 2007 2006 2005 2004

148%

77%

95%

71%

100%

184%

40%

164%

51%

100%

Cashflow from Operating ActivityNestle F&N

Dividend payout measures the amount that company give to the shareholder compared

with the earnings that they get per share. Outstanding amount of earnings that taken by the

company is called retained earnings. Usually, retained earnings use for investing a project or

other development for a better performance in the future. Trend analysis of dividend payout

indicates that Nestlé give almost same dividends payout to shareholders in 2004 to 2007. But in

2008, Nestlé retained 23% more than the base year to develop a new factory in Shah Alam. The

factory produces non-dairy creamer ‘Coffeemate’, Coffee and cereals. Coffeemate is the best

product in the market, occupy 88% of share market. Nestlé has invested for the total of

RM100million in renovating and developing their factories since year 2007 (Nestlé, 2008). The

trend forecasted that Nestlé’s dividend payout will increase as the development of the company.

Nevertheless, F&N gave stable dividend payout to shareholder and this indicates that dividend

for next year will be not very much different.

2008 2007 2006 2005 2004

353%

191%

145% 137%

100%

191%

321%

99%

53%

100%

Cashflow in Investing ActivityNestle F&N

As from the trend of dividend payout, the analysis scope to the investing activity of both

of companies. Nestlé’s investing activity increased year by year, but in 2008 there is significant

increase for almost 150%, due to the investment of factory in Shah Alam. F&N on the other

hand, has a significant cash outflow for the year 2007 for the take over and acquisition of Nestlé

Dairy Thailand. These investing activities of both companies believed to be successful in the

upcoming years.

Page | 33

Conclusion

As ratio analysis indicates that Nestle is having better profitability and efficiency, but

with low level of liquidity and highly-leveraged. F&N has good position on both liquidity and

gearing, but with lower profitability and efficiency than Nestle. Trend analysis may supplement

or reject the result of ratio analysis. Trend analysis shows that Nestle is on stabile position in

revenues. From the operating cash flow of Nestle, it can manage to perform well, even in bad

economy situation in 2005 and 2007. This indicates that Nestle is stabile and strong. Even

though Nestle is strong enough, it must use the long-term debt for investment, so that

shareholders did not get burden from those activity. In this case, trend analysis reject the result

from ratio analysis as Nestle was very strong and stabilized, even with low liquidity and high

leverage.

F&N gives picture of good performance year by year in the revenue. It also uses long-

term debt to invest in order to minimize shareholder’s burden as well as maintain the dividend

payment. However, F&N was not strong enough to stay in the bad economic situation like

Nestle. This can be seen from the trend analysis on the operating activities, F&N entered the

grave performance in year 2007. The grave performance also supplemented by the new growing

investment, the takeover of Nestle, made F&N enter even worse position in 2007. The growing

investment will enter the mature stage soon, so the performance of F&N will not increase

significantly in the upcoming years. Trend analysis gives different picture of F&N’s performance

from the ratio analysis. Although with good position of liquidity and gearing, F&N still easily

affected with economic situation and enter the grave performance.

From all analysis above, Nestle has better and stronger position in the market than F&N.

Nestle has been a stabilized multi-national company since long time ago. Therefore, Investors

might consider investing in Nestle with the consideration of new investment and strong position

in the market.

Page | 34

Limitation of Ratio Analysis

Ratio analysis is the one of best methods in analyzing performance of company. It can

analyze most of data from financial statements to clearer picture, so that the data from financial

statement become meaningful. For example, in spite the user see the liability that the company

take, gearing ratio can be used to see whether the company is utilizing the debt well or it is

taking too much debt for financing. Users of financial statement can focus on the area that they

would see for their further decision-making. However, there is nothing perfect in the world, ratio

analysis also has limitation and problem in the implementation. Here are some common

limitations that people argue in the practice of ratio analysis.

Firstly, accounting technique has been one of limitation for practice of ratio analysis.

Usually, different company has different method to apply into their financial statement

(accountingformanagement, 2009). For example, Nestle and F&N in this report use different

accounting policies on calculating their cost of inventories. Nestle is using first-in-first-out

method, thus F&N is using weighted average basis. Another limitation of ratio in accounting

sector is creative accounting. Since the development of creative accounting, accountants are

adjusting the accounts to form a better performance of the company. Creative accounting is the

attempt of legal manipulation in creating financial reports. It was created in order to create high

or low figure of profit for special reason. Other than profit, asset and liabilities also one of

variables that can be manipulated using several techniques like leasing, off-balance sheet

financing, and so on (Moneyterms, 2009). Creative accounting usually is used by listed

companies, because listed companies publish financial statements for public in order to attract

shareholders to invest in their company.

Secondly, information itself can cause problem either in the ratio analysis. One reason

that people argue on the ratio analysis is outdated historical cost. Since the financial statements

are made based on the historical cost, the information in it might be outdated and do not relevant

with current situation (CBDD, 2003). Other than that, the interpretation from financial

statements might not be accurate, since companies are publishing summarized information and

many of them are using group or consolidated financial statements (accountingformanagement,

2009). Summarized financial statement only gives not detail data, moreover consolidated

financial statements usually aggregates assets and minimized its liabilities (Elliot&Elliot, 2001).

Page | 35

Financial statements also not single item which give performance of the company. There

are other information like qualitative reports like number of employees and factory, future plans

and strategy, and so on (Elliot&Elliot, 2001). The most appropriate example is Nestlé’s and

F&N’s project in development in the year 2007 and 2008. Nestlé’s project like factory in Shah

Alam and F&N’s acquisition and takeover of Nestle dairies Thailand, those were not stated in the

financial report. Then, the interpretation of ratios is different each person who analyze it. This

made problem to choose whether this company is good or bad, because everybody has their own

opinion in the interpretation (accountingformanagement, 2009).

Thirdly, comparison over the performance between companies is impossible in long-run.

This happened because of the changing of many outside factors like inflation, technology,

seasonal trading, accounting policy and standards. Inflation may bring the ratio analysis

inappropriate, since all price are increasing and revenue are increasing either. Users of the

analysis might thought that the increasing of revenue because of good performance. Technology

also takes part in the problem of ratio analysis (CBDD, 2003). This means that ratio analysis

cannot measure companies which using different or change their technology. For example, users

cannot measure machine-based company with labour-based company, for example food

company which is machine-based with restaurant which is labour-based. Seasonal trading has

been one common problem to ratio analysis, if companies have different financial closing

accounts. For example, paper companies with different closing account dates. One of them is

closing their account before ‘back to school’ season, and another close the account after that

season. The revenue of two companies is incomparable, since they have different closing

account. Since International Accounting Standard Founded, there are so many accounting

policies and standards which shifting to other policy and standards. While the changing of those

policies as well as standards gives higher chances to directors for making manipulation and bias

to the current situation of the company (accountingformanagement, 2009).

Finally, financial ratio cannot measure company with different size and different

industry. Ratio analysis cannot give accurate data to comparison in different industry, because

financial, risk, capital structure and size of company may be in different proportion each

industry. Manufacturing company might have high number of asset and financed by

shareholders, although financing companies do not have much in assets and use debt financing.

Page | 36

The risk of business also gives limitation to ratio analysis (CBDD, 2003). Airline companies

which usually highly-leveraged cannot be compared with other companies with average level of

gearing. Other than above, government’s help also give contribution in the limitation of ratio

analysis. For example, tax-redemption for multi-national companies, especially in Malaysia,

gives lower tax charge to multi-national companies in order to attract foreign companies (lowtax,

2010).

These limitations might argued by people, usually people who prefer in finance rather

than accounting. Finance people usually use forecasted data in analyzing the company. They

believe that forecasted data will be more relevant and reliable, rather than historical data.

Although ratio analysis has a lot of limitations, many people are still using the analysis.

Professionals and economic researchers are developing other method in analyzing stock market.

The upcoming method of analysis believed to be more relevant to recent situation.

Page | 37