ACADEMY OF ECONOMIC STUDIES FACULTY OF BUSINESS ADMINISTRATIO N (ENGLISH TEACHING) GRADUATION THESIS COMPANY’S PERFORMANCE ANALYSIS CASE STUDY: NATIONAL SOCIETY OF LIGNITE OLTENIA ROMANIA Scientific Coordinator: Graduate: Prof.Univ.Dr. ANA-MARIA CIOBANU GABRIELA STOICHITOU BUCHAREST July, 2010
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8/8/2019 Stoichitoiu Gabriela Adela, graduation paper
Fundamental analysis or intrinsic value analysis uses financial and other economic
information to determine the firm’s value. The basic fundamentals used by specialists, are based on information which is available to everyone interested and which refers to
financial concepts like accounting earnings, dividends, growth factors or leverage ratios,
to derive the intrinsic value and compare it to the firm’s stock price (Lee, 1987).
This paper explains financial ratios are valuable ways to interpret the numbers found in
financial statements and that these ratios can provide a wealth of information to both
internal and external users. Ratio analysis is undertaken in the mining industry by
comparing the key financial ratios among three mining companies for a certain periods.
The paper aims to determine some financial strengths and weaknesses of the firm and to
suggest some changes to NSLO's future plans to improve the firm's financial
performance. The paper concludes that the financial ratio analysis shows that NSLO has
bad results in many areas and is experiencing financial difficulties.
For the comparable purpose, along with NSLO, were analyzed two other companies, one
of the largest U.S coal producer, Arch Coal Inc. and the UK Coal, Britain’s biggest coal producer. The research is limited to the entities presented in Balance Sheets and Income
Statements from 2007-2009 by NSLO, Arch Coal Inc. and UK Coal.
The reason I chose this topic for my thesis is that the financial analysis is essential in
determining a company’s strengths and weaknesses. Nowadays evaluating the financial
health of a company stands as a difficult and complex task which implies a professional
approach. It has to be reliable and objective and it should necessarily lead to appropriate
and efficient conclusions.
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This basic purpose of this chapter is to explain the theoretical framework which is used as
a tool to analyze the research (Analysis of financial statements, ratio analysis) for empirical finding. Prospective users of financial statements have little knowledge about
it; therefore conceptual component helps the readers to understand the purpose of
financial statement analysis
1.1 Financial Statement Analysis
Financial statements provide primary information of economic consequences of thefirm’s business activities. (Palepu, 2000) From economic factors transformed into
accounting numbers, financial statements report data of assets, liabilities, income and
cash flow that are useful to all users. (White, 1998) Despite the fact financial statements’
users are mostly investors that a firm seeks for its capital; the financial statements are
also used for other purposes from analysts inside to outside the firm including
governments that use the financial statements in social and economic policy-making.
(Penman, 2007)
One of the purposes of the analysis of financial statements is to aid the main investors
have a clear imagine of the firm’s activity and make better economic decisions. (White,
analysis is the method by which users extract information to answer their questions about
the firm.”
The four steps that compose fundamental analysis framework refer to: business strategyanalysis, accounting analysis, financial analysis and prospective analysis. (Palepu, 2000)
The main element of fundamental analysis is about creating and developing prediction of
future earnings, as they are one of the most important elements to a firm’s value.
(Penman, 2007)
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Bankers, investors, bondholders, and stockholders or the firm’s managers should possess
knowledge regarding financial statements analysis. A company’s strengths and
weaknesses imply having an objective financial assessment which leads to efficient
investment strategies. (Melicher, 2007)
The role of financial analysis
Financial analysis helps various parties, interested in a company’s activities, to obtain
financial information required to them. The main purpose of financial analysis is to
estimate current financial conditions and define actions necessary to conduct work on
improvement or preserving of these conditions. Financial analysis also summarizes a
firm’s business activities in the past, at present and in the near future. Its main function isto identify financial performance of a company, reveal weaknesses, potential sources of
problem occurrence in its further plans and to find out strengths on which the firm can
rely. Financial performance of a company, being one of the major business
characteristics, defines competitiveness, potential of the business, economic interests of
the company's management and reliability of present or future contractors. Therefore, the
secondary goal of analysis is to reveal financial condition of the company to external
users.
Main types of financial analysis
Financial analysis is about the selection, evaluation, and interpretation of financial data,
with the purpose of assisting in investment and financial decision-making. Internally,
financial analysis is used to assess issues such as employee performance, the efficiency of
operations, and credit policies. Externally, it implies evaluating the potential investments
and the credit-worthiness of borrowers, among other things. (Peterson, 2007)
In „ Finance d’entreprise analyse et gestion”, P. Vernimmen says:" The financial analysis
is more a tool than a theory, a method. Whether performed by internal departments or
external ones, its main objective is conducting a global assessment over the actual and
future situation of the enterprise.”
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Ratio analysis studies levels and changes of relative measurements of financial
performance. This method is the most commonly used in the world practices of financial
analysis because of its relative simplicity and availability of data sources. Ratio analysis
is a financial technique that involves dividing various financial statement numbers into
one another. (Melicher, 2007) It expresses a mathematical relation between two
quantities i.e. a ratio of 200 to 100 is expressed as 2:1, or simply 2. Even though the
calculation of a ratio is simple arithmetic operation its analysis is far more complex. A
ratio must refer to an economically important relation to be meaningful. Clues and
symptoms of underlying condition are provided by ratios. It identifies areas requiring
further investigation. It reveals important relations and bases of comparison in
uncovering conditions and trends difficult to detect by inspecting individual components
comprising the ratio. The interpretation of the right factors, which might influence future
ratios, proves the usefulness of ratio analysis.
A financial ratio is meaningful only when it is compared with some standard, a norm,
such as an industry trend, ratio trend, or a planned management objective. This is called
benchmarking and it can be used as a measure. According to David Vance, benchmarking
“involves analyzing the financial statements of the best companies in an industry andusing their financial ratios as a basis for evaluation of a company’s performance”.
(Vance, 2003)
In order to see the profitability and growth of a firm through a certain period of time there
are used three basic categories of ratio analysis:
Trend or time-series analysis- uses ratios to evaluate a firm’s performance over
time;
Cross-section analysis- uses ratios to compare different companies at the same
point in time; it usually concerns two or more companies in similar lines of
business.
Industry-comparative analysis- is used to compare a firm’s ratios against average
ratios for other companies in the same industry. (Melicher, 2007)
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Certainly, the most informative approach to ratio analysis combines both cross-sectional
and trend analyses.
The ratio analysis method is based on a correct interpretation of calculated values.
However, it has some limitations. Because there are so many tools for doing performance
assessment, we must remember that different techniques address measurement in very
specific and often narrowly ways. One can be tempted to “run all the numbers,”
particularly given the speed and ease of computer spreadsheets. Yet normally, only a few
selected relationships will yield information the analyst really needs for useful insights
and decision support. By definition, a ratio can relate any magnitude to any other—the
choices are limited only by the imagination. To be useful, both the meaning and the
limitations of the ratio chosen have to be understood. The problem is to choose a proper ratio that suits best to a goal of analysis. The proper application of a ratio depends on
correct economical and financial meaning of that ratio. To be useful, both the meaning
and limitations of a chosen ratio have to be understood.(Helfert, 2001)
Meaningful ratio analysis must conform to the following elements:
1) the viewpoint of the analysis taken;
2) the objectives of the analysis;
3) the potential standards of comparison.
Any particular ratio or measure is useful only in relation to the viewpoint taken and the
specific objectives of the analysis. When there is such a match, the measure can become a
standard for comparison. (Helfert, 2001)
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The acid test ratio, also denominated quick ratio, is a more convincing element,
calculated on the base of only a part of the current assets-cash, marketable securities, and
accounts receivable, afterwards in connection with the current liabilities. (Helfert, 2001):
Formula:
Acid Test = Cash + Marketable Securities + Receivables / Current Liabilities
Quick assets are those current assets that are quickly convertible into cash. Inventories
are the least liquid current assets. Many financial analysts believe it is important to
determine a firm’s ability to pay off current liabilities without relying on the sale of inventories. (Ross, 2005) A high liquid ratio indicates that the firm is liquid and has the
ability to meet its current or liquid liabilities in time and on the other hand a low liquidity
ratio represents that the liquidity position of the firm is not good. The general convention
considers the 1:1 ratio as appropriate.
However, this 1:1 ratio cannot be imperatively the main reason of a satisfying liquidity
level of the company, unless the debtors are met, therefore cash is necessary to cover the
current obligations. On the other hand, the low level of liquidity ratio doesn’t lead to an
inappropriate liquidity position, the inventories not being entirely non-liquid, this being
considered as a drawback of the ratio. Therefore, a company with a high liquidity ratio
may not reach an appropriate liquidity position if their debts are not being paid in time. In
contrary, a firm with a low liquidity ratio can reach a satisfying liquidity position if the
inventories are rapidly converted to sales. This ratio is also used by lenders in measuring
the liquidity of a firm to see weather it’s able or not to pay the debts.
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These ratios express the proportion in which the assets influence the sales. This kind of
ratios is also known as activity or utilization ratios, each of them relating the financialterms from the income statement with those from the balance sheet. (Melicher, 2007)
The purpose of efficiency ratios is to determine the effectiveness and efficiency of the
controlling process of the assets which have to lead to sales and profit. In addition, they
express the efficiency of the receivable collection process. The company’s health and
efficiency are directly determined by high values of these ratios.
These ratios are used by the company’s manager in order to measure the efficiency of the
firm in using the assets in order to generate sales, the speed with which they collect their
receivables and to see if the inventories have a good management.
Total Asset Turnover Ratio
This ratio indicates how efficiently the firm is utilizing its assets to produce revenues or
sales. It is a measure of the dollars of sales generated by $1 of the firm’s assets. The totalasset turnover ratio is determined by dividing total operating revenues for the accounting
period by total assets.
Formula: Asset Turnover = Sales / Total Assets
This ratio is intended to indicate how effectively a firm is using all of its assets. If the
asset turnover ratio is high, the firm is presumably using its assets effectively in
generating sales. If the ratio is low, the firm is not using its assets to their capacity and
must either increase sales or dispose of some of the assets. One problem in interpreting
this ratio is that it is maximized by using older assets because their accounting value is
lower than newer assets. (Ross, 2005)
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The inventory turnover expresses how many times per year the inventories have been
transformed into sales as well as the efficiency of the management of inventories. The
ratio of inventory turnover is calculated by dividing the cost of goods sold by inventory
Formula: Inventory Turnover = Cost of Goods Sold / Inventory
An important objective is to transform the inventories into sales as rapidly as possible.
Efficient firms achieve this task, saving capital otherwise needed to store raw materials or
finished goods. In order to have an efficient inventory management, it is important to
reach an appropriate amount of inventories needed to avoid lack of products, but in the
same time not dealing with huge amounts of them, which would imply extra financing. This kind of ratio also expresses the level of profitability of a company. Thus, high value
of ratio leads to higher profit, while low ratio determines low profit. A drawback would
be the fact that not always the high ratio necessarily leads to high profits, the cause being
low investment rate in inventories.
1.3.3 Financial leverage ratios
When a company borrows money, it agrees to make a series of fixed payments in the
future. Because their shareholders get only what is left after the debt holders have been
paid, the debt is said to create financial leverage. In extreme cases, if crisis times come, a
company may be unable to pay its debts. (Brealey, 2001) Financial leverage enables a
company to have an asset base larger than its equity. A company can finance its assets
with equity or with debt. Usual practice is expanding the equity through borrowings andthe creation of other liabilities like accounts payable, accrued liabilities, and deferred
taxes. Financial leverage increases the company’s ROE as long as the cost of the
liabilities is less than the return from investing these funds. “While a company’s
shareholders can potentially benefit from financial leverage, it can also increase their
risk”. (Palepu, 2000)
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Contrasting with equity, liabilities have predefined payment terms, and the company may
face risk of financial distress if it fails to meet these obligations. There are some ratios to
evaluate the degree of risk coming from a financial leverage. (Palepu, 2000)
There are two types of financial leverage ratios:
• Component percentages
• Coverage ratios.
Component percentages compare the debt of a company with its total capital (liabilities
plus equity) or with its equity capital. Coverage ratios have the ability to satisfy fixed
financial obligations, such as interest, principal repayment, or lease payments. (Fabozzi,
2003)
Financial leverage ratios are used by lenders which fund the needs of a business and theyhave to look for a margin of safety in the assets held by the company. These ratios test
the relative debt exposure in order to weight the position of lenders versus owners.
Total Debt to Assets Ratio
It expresses how much the level of total debts of a company was used to finance its total
assets. It also gives information regarding solvency and ability to meet new financing
opportunities. This ratio determines the proportion of “other people’s money” in
connection with the assets of the company. (Helfert, 2001) The debt ratio is calculated by
dividing total debt by total assets.
Formula: Debt Ratio = Total Liabilities / Total Assets
The higher the ratio, the greater the risk for the lender. This is not necessarily a true test
of the ability of the business to cover its debts, however. The asset amounts recorded on
the balance sheet are generally not indicative of current economic values, or even
liquidation values. Nor does the ratio give any clues as to likely earnings and cash flow
fluctuations that might affect current interest and principal payments. (Helfert, 2001)
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The interest coverage ratio indicates how many times interest is covered by the profits
available to pay interest charges. A high interest coverage ratio means that the firm is
able to cover its interest expenses from the earnings before interest and taxes and alsoassures the lenders a regular interest income. A low ratio can cause some problems to the
financial manager in raising funds from debt sources.
1.3.4 Profitability ratios
Generally, profits are the difference between revenues and costs. Profitability is thought
to be the most difficult quality of a firm to conceptualize and to measure. (Ross,
Westerfield, Jaffe, 2005)
The purpose of profitability ratios is to evaluate the ability of the company to make profit
and cover its expenses in a specific period of time. In addition these ratios determine also
the efficiency of transactions, pricing strategies and asset or shareholders profitability.
(Van Horne, 2005)
Assessing the efficiency and the profitability of the operations is a main concern for the
managers of a company, thus the three profit margins as well as return on assets are
computed and analyzed from their point of view.
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Financial ratios have certain limitations in their use and are not meant to be applied as
definitive answers. They are usually used to provide additional details in the
determination of the results of financial and managerial decisions. They can provide cluesto the company’s performance or financial situation. However, on their own, they cannot
explain whether performance is good or bad. As for the external financial analysis, ratios
also play a role of basic indicators, showing just an overview of studying business entity.
Ratios have to be interpreted carefully.
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This chapter describes the methodology using for the study. The chapter organizes as
research philosophy, research approach, research method, and data collection.
The research question is: Based on the ratio analysis, does National Society of Lignite
Oltenia perform better financial results than other companies from the mining industry?
2.1 Research Approach
Research is a systematic method of finding solutions to problems. It is
essentially an investigation, a recording and an analysis of evidence for
the purpose of gaining knowledge. Theoretically speaking, it must be said that
there are two forms of research approach: deductive approach and inductive approach.
The deductive approach descends from the theoretical matters and concepts through
observations in order to obtain results which do or do not align with the hypotheses On
the other hand the inductive approach (or bottom up approach) begins from the particular
situation and observations with the aim of developing and setting new theories. Thedeductive approach is based on scientific principles and quantitative information,
explaining the relationship between variable data. The inductive approach is based on the
matter of human relating within the interpretation of the research context. It is also
qualitative data based.
The thesis is composed of two major parts: theoretical part and the empirical part .The
theoretical section contains descriptive approaches of the various important concepts such
as financial statement analysis, ratio analysis. This part aids setting the foundation and
acts as a point of reference of the empirical study in the last part of the paper.
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Moreover, besides the descriptive approach it will be used explanatory approach, which
helps in creating a general image on the cause and effect relationship among different
features of the financial statements and their consequences.
2.2 Research Method
Depending upon the objective of the research there are two methods between one can
chose for his analysis and those are qualitative and quantitative methods. A difference in
categorizing qualitative and quantitative methods is data. It can be simply stated that
qualitative data contains words while quantitative data contains numbers. Besides data
collection another difference is assumption of the research.
Qualitative methods are usually more flexible. Their objective is to ease the relationship between the researcher and the study subject, as a measure of increasing the spontaneity
and efficiency. In addition, with qualitative methods, the relationship between the
researcher and the participant is often less formal. Participants are allowed to respond
more detailed than in the case of quantitative methods.
Qualitative research contains three elements, according to Strauss and Corbin. The first
one is data, obtained through methods like interviews, observation, and close studies of
documents. The second element refers to procedures performed by the researcher in order
to possess the required data. The third one represents a final report which concludes the
results and findings of the study, as well as its consequences and implications.
Quantitative research refers to counting and measuring of events as well as statistical
analysis of data gathered. This method brings objectivity and reliability to the research.
The researcher is mainly external to the actual research, and results are expected to be
replicable no matter who conducts the research.
Quantitative methods are usually appropriate for carrying evaluations comparing
outcomes with baseline data. This is an excellent way of testing a hypothesis. The
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benefits of using quantitative approach refer to quantifiable and reliable data, usually
applicable to some larger population.
Concerning this study it must be said that the quantitative method suits best because there
are analyzed financial statements from different points of view, such as investors,
lenders, managers and owner. In addition to quantitative method, qualitative method is
complementary being characterized by reciprocal dependence. (Yin, 2006) According to
Yin (1989), the particular strength of a case study is its capability to face different types
of evidence.
2.3 Data Collection
Data collection is an important feature which is part of all research studies. As a result of this process, researcher gathers the needed material on which his research will base on.
(Ibert, 2001)
The main sorts of data collection methods are primary and secondary. The primary
sources represent discussing with employees, collecting data using questionnaire.
Secondary data stands as finished products having been already treated statistically some
way or another.
In conducting this research mainly secondary data collection method were used. The
secondary data source comprises balance sheets and income statements of the studied
companies. Secondary data forms the basis for both the theoretical and empirical part of
the study. It is true that “secondary data is data that was developed for some purpose
other than helping to solve the problem in hand.” (Fay, 1997) There is no doubt that
primary data is important for creating new data and that the secondary data might be
distorted from its value instead of primary data.
The data of chosen company is mainly collected from annual reports between 2007 and
2009. Among different tools and techniques various authors used as performance
measure, financial ratios found to be quite commonly used in the literature. The
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National Society of Lignite Oltenia placed first in the hierarchy of firms operating in
mining area.
The digging for the material is performed with sterile plants with flows between 2500
haldare, ¬ 12 500 m3 / h discharge arm length is between 60 and 170 meters. Excavation
is performed in continuous flow rotor excavators range SRs1300, SRs1400, SRs2000,
working the steps with heights of 25-30m.
Transport excavated material is carried by conveyor belt with a width of 1000-2250 mm,
maximum speed of 6.15 m / s and carrying capacity reaches 12,500 m3 / h. Low oil and
gas reserves available to Romania and the ongoing trend of price increase of these natural
resources worldwide are very strong grounds for solid impetus for recovery in the production of electricity and heat. The process of extraction of lignite mining technology
includes the following: selective excavation, transport, deposit and deposit tailings dumps
lignite deposit.
BENEFICIARIES:
S.c. C.E. ROVINARI S.A.
S.c. C.E. TURCENI S.A.
S.c. C.E. Craiova S.A.
S.c. Oradea ELECTROCENTRALE S.A.
S.c. C.E.T. ARAD S.A.
S.c. Colterm S.A.
R.A.A.N. TERM ROMAG HALÂNGA S.A.
S.c. C.E.T. GOVORA S.A.
The main objectives of S.N.L. Oltenia are:
- Concentration of manufacturing activity in the mining perimeters potential economic
efficiency by reducing and reshaping business activity underground quarries;
- Continuance of rehabilitation, refurbishment and modernization and computerization of
dispatching assimilation components of the business;
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- Technical and technological restructuring in reducing the number of machines in
operation and increase their operating ratios;
- Adapting the organizational structure with fewer hierarchical levels and organization in
accordance with specific mines extraction technology (underground and career) and
resize work under this principle;
- Labor productivity growth to support salary increases and improved living standards for
employees;
-Continuing development and upgrading computer systems;
- Capital raising, given that the company is subject to the privatization process;
- Extended consultation with the local community to achieve environmental measures;
- Promoting community incentives offered morphological reconstruction and landscaping
of land affected by mining so that they become carriers of resources for the future;- Community development activities that use the assets made available to the mining
facilities will close.
Short presentation of Arch Coal Inc.
St. Louis-based Arch Coal is one of the largest U.S. coal producers. In total, it contribute
about 16% of America’s coal supply from its 11 mining complexes in Wyoming, Utah,
Colorado, West Virginia, Kentucky, and Virginia. With 126 million tons of coal sales in
2009, it provided U.S. utilities with the fuel for roughly 8% of the nation’s electricity.
The company controls a vast domestic reserve base summing 4.7 billion tones. Of that
total, 88% is low in sulfur and nearly 83% meets the most stringent requirements of the
Clean Air Act without the application of expensive scrubbing technology.
Short presentation of UK Coal
UK COAL is Britain's biggest producer of coal, supplying around 6% of the country'senergy needs for electricity generation. The Group has four deep mines located in Central
and Northern England with substantial reserves and employs 3,100 people. It had five
active surface mines producing around 1.7 million tones of coal a year in 2008. Total
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surface mining coal reserves, including projects being worked and in planning, are in
excess of 90 million tones.
With substantial land and property interests, UK COAL develops and regenerates brown
field sites, manages business parks on former mine sites and manages a substantial
agricultural portfolio of land and buildings.
3.2 Empirical results
This part of the thesis contains ratios calculated and presented as described above. All
ratios were arranged in tables to make them easier to understand. One summary table,
including the three companies was created for this purpose.
As it was mentioned earlier, ratios itself do not provide enough information withoutcorrect explanation. Therefore, ratio evaluation is the subject of next paragraphs.
Table 1 Financial ratios of the companies.
NSLO Arch Coal Inc. UK Coal2007 2008 2009 2007 2008 2009 2007 2008 2009
Liquidity Ratios
Current ratio 2.75 1.83 1.46 .94 1.07 1.09 .85 .87 1.63Quick ratio 2.008 1.37 1.13 .62 .78 .71 .67 .66 1.26 Efficiency Ratios
Short term liquidity gained much importance for creditors and investors because“liquidity is a matter of degree, a lack of liquidity may mean that the enterprise in unable
to avail itself of favorable discounts and is unable to take advantages of profitable
business opportunities as they arise” (Bernstein, 1999)
Short term liquidity is of great importance while conducting analysis due to the fact that
until a firm is able to pay its short term debts, it has the prospects of continuing as a going
concern.
Table 2 Liquidity ratios results.
NSLO Arch Coal Inc. UK Coal2007 2008 2009 2007 2008 2009 2007 2008 2009
Formula: CR = current assets / current liabilities
The result of the above table presents some important clues of analyzing short term
liquidity over the previous three years of NSLO. The current ratio of NSLO in first year,
according to the rule of thumb, is relatively high, 2.75 but after that, current ratio
decreased every year, reaching its lowest level in 2009, being equal to 1.46. The rule of
thumb of current ratio is 2:1 (or 200 percent), meaning that anything below that norm is
bad while the higher above that figure the current ratio is, the better. (Bernstein, 1999)
High current ratio in 2007 implies a great liquidity meaning that the company is able to pay off its short-term debts as it comes due. The balance sheet from 2007 shows an
increase in both inventories and accounts receivables, with a percentage of 53,5, 33.3
respectively. Meanwhile, the increase in current liabilities is almost insignificant.
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In 2008 and 2009 was a rapid decrease in the current ratio due to increase rate of growth
in current liabilities from year 2007 to 2009 continually, meaning 78% in year 2008 as
compared to previous year leading to the conclusion that the company faces serious
difficulties in paying its bills and 25% in 2009 as compared to 2008 where there can be
observed an improvement comparing to the last year. The decrease of the current ratio in
2009 was also influenced by the decrease in inventories with 12%1. The values of the
ratio for 2008 and 2009 were 1.83, 1.46 respectively. This means that in case of a force-
majeure, current assets were still able to cover all obligations immediately and even leave
around 50 percent of the current assets.
As compared to the other companies, NSLO has a greater level of liquidity being able to
cover up its current liabilities on the basis of its current assets meanwhile the other twocompanies, experienced major issues with liquidity of its assets during the analyzed
period. For instance, in the case of Arch Coal Inc., the year 2007 proves that the company
has the level of liquidity too low to cover up its current liabilities, even though the
currents assets increased, the current liabilities increased with a greater percentage. On
the contrary, in the following two years, 2008 and 2009, a slight increase in the current
ratio can be noticed which leads to the ability of the company to cover up the liabilities,
above mentioned, with a left over of 1% of the current assets. In 2008, the increase of the
ratio was due to a higher growth in all current assets than the growth in current liabilities.
In 2009, the current liabilities decreased, meaning that the company’s difficulties in
paying its bills are diminishing. The current assets decreased, too but with a smaller
percentage. The reason for this decrease was that the company’s cash and receivables
decreased more than the increase in inventory and other current assets. The increase in
the inventory and decrease in cash and receivables is not a very good sign for the
company, signaling bad management practices
In UK Coal case, the current assets proved insufficient to sustain current liabilities both
in 2007 and 2008, the current ratio reaching values of 0.85 in 2007 and 0.87 in 2008.
Surprisingly in 2009 the company managed to cover its liabilities on the basis of its
1 Even though the decrease in inventories lead to a smaller current ratio, this is a good sign for thecompany, meaning that they manage better their inventories.
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assets, with a high ratio value of 1.65. The large increase of the ratio in 2009 was due to
the fact that the company’s liabilities decreased, which is a good sign for the company
and also due to the increase of receivables which lead to the increase of the current assets.
Quick Ratio (Acid Test Ratio) (ATR)
Formula: ATR = (current assets – inventories) / current liabilities
In general, a ratio of 1.0 indicates a reasonably liquid position in that an immediate
liquidation of marketable securities at their current values and the collection of all
accounts receivables, plus cash on hand, would be adequate to cover the firm’s current
liabilities. NSLO acid-test ratio from 2007 to 2009 (2, 1.37 and 1.13 respectively) had
been seen rapidly decreasing position. However, the company has a very good liquid
position. The sharp decrease in from 2007 to 2008 was due to the fact that inventories
went up, same thing happened to the current liabilities. As stated above, the companyfaces difficulties in paying its bills. The positive part is that their current liabilities growth
rate decreased every year.
As compared to the NSLO, neither Arch Coal Inc, nor UK Coal, managed to reach
normal value of this ratio, except UK Coal in 2009 when reached a value of 1.26.
3.2.2 Efficiency ratios
Table 3 Efficiency ratios results.
NSLO Arch Coal Inc. UK Coal2007 2008 2009 2007 2008 2009 2007 2008 2009
Total assets turnover 1.27 1.19 .90 .70 .78 .58 .50 .68 .62Average collection period
The NSLO had value of this ratio exceeding "1" in 2007 and 2008. This means that total
assets of these companies completed more than one full business cycle and created
amount of sales listed in their income statements during that year.
Total assets turnover indicate lower performance in year 2009 for NSLO as compared to last
two years. The total assets turnover in year 2007 and 2008 was 1.27, 1.19 respectively while
in year 2009, this ratio had been 0.9. This means that NSLO in 2007, require 0.78 RON of
investment in assets in order to produce 1 RON in revenues. For 2008, NSLO generated 1
RON of sales for 0.83 RON of assets. In 2009, NSLO needed 1.1 RON of assets in order to
generate 1 RON in revenues. Generally, the more efficiently assets are used, the higher a
firm’s profits. The NSLO”s level of profit reveals that the assets are not very efficiently used.
The yearly decrease in the ratio indicates that total assets increased more rapidly than sales in
2008, comparing to the previous year and in 2009 the sales decreased while total assets
increased which lead to a higher decrease in ratio than in 2008. In percentage terms, total
assets increased 13% compared to 1,4% for sales in 2008 and in 2009, sales decreased with
20% compared to previous year and total assets increased with 1,5%. The increase in total
assets, in 2008 was due to the increase in current assets but also in fixed assets, determined
by the purchasing of new equipments, while in 2009, was only because of the increase in
fixed assets, which means investments in equipment. Even though, in 2009 this investmentlead to a low asset turnover ratio, on the long run will bring benefits to the company.
For Arch Coal Inc, low values of the ratio are explained by the increase in total assets,
yearly, caused by the continuous improvement and investments made by the company,
which will lead to higher values in the future. As far as UK Coal is concerned, the
increase of the ratio in 2008 was the result of the increase in sales and the decrease in
total assets, which was caused by the reduction of the amount invested in the
improvements of the fixed assets. In 2009, the ratio decreased, the main cause being the
large decrease in sales. Compared to them, NSLO is using more efficiently its assets.
Average Collection Period (ACP)
Formula: ACP = (account receivables / sales) x 365
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The Average collection period ratio measures average number of days that company’s
customers needed in order to pay their bills, indicating effectiveness of credit and
collection policies of the businesses. The average collection period should not be
exceeding 30 days.
NSLO’s average collection period rose sharply from 2007 to 2009. NSLO has a very high
average collection period which may indicate that the firm has too lax a credit policy and
may be in danger of experiencing a larger number of credit accounts that cannot be
collected as it later on occurred. In 2007, the company’s customers paid their bills in 91
days and in 2008 the period extended with 21 more days, having the average collection
period equal to 112 days, while in 2009 the ratio increased with 33 days, reaching a
period of 145 days needed for having their bills paid. This means that their customers had
difficulties in paying their bills or they were abusing their credit privileges. Still, themain factor affecting the payment is the financial blockage in the economy.
Arch Coal Inc was the only company closest to the normal period of having their bills
paid, with an average of 34 days. In what concerns UK Coal, the company has a higher
period of getting their bills paid, compared to NSLO, this being a bad thing for the
company.
Inventory Turnover (IT)
Formula: IT = cost of good sold / inventories
Inventory turnover is used for estimation of how fast a company's stock is sold and
replaced over the period. Inventory management also requires a delicate balance between
having too low an inventory turnover, which increases the likelihood of holding obsolete
inventory, and too high an inventory turnover, which could lead to stock-outs and lost
sales.
NSLO’s annual inventory turnover decreased slightly from 10.2 in 2007 to 9.6 in 2008 so
that in 2009 reached the value of 9.2. These values are not very satisfactory for the
company. It can be observed that the amount of inventories is increasing in 2008, which
means a bad inventory management which leads to low inventory turnover ratio. Even
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The debt ratio shows share of company’s assets that is financed at the expense of loan
proceeds, irrespective of their sources. Some financial experts commend keeping this
indicator at the lowest level.
During the analyzed period, NSLO had good values of this ratio (less than 35-38 %)
increasing annually. This increase was due to the continuous increase of total liabilities,meaning higher interest cost and penalties. In year 2007, the debt ratio of NSLO was
20%. This can be quite costly. Since the interest expenses are deductible for income tax
purposes, the government in effect pays a portion of the debt-financing costs. In year
2008, the NSLO is financed 32% with debt, both long-term and short-term and in 2009
debt-ratio was 38%.
NSLO has the lowest debt-to-assets ratio compared to the Arch Coal Inc. which has a
constant debt ratio of 56% and UK Coal which has an increasing debt ratio in the first
two years, starting from 33% in 2007 and reaching a ratio of 45% in 2008. This might be
due to the fact that NSLO doesn’t rely on debt financing as an investment method. Only
in 2009 the UK Coal company registered a debt ratio smaller than NSLO, because of a
large decrease in total liabilities. Even though they have greater ratios than NSLO, this
does not mean that they do not have debt ratios at a satisfactory level.
Debt to Equity Ratio (DER)
Formula: DER = total liabilities / owner’s equity
The debt to equity ratio shows the company’s dependence on external financing.
Higher value of this ratio means higher risk of insolvency. Importance of this ratio also
reflects potential threat of deficiency of money resources. During the analyzed period,
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The times interest-covered ratio is a measure for estimation a company's abilities to meet
its debt obligations and indicates how many times their interest charges can be covered
on pre-tax basis. Banks prefer to lend to firms whose earnings are far in excess of interest
payments.
Taking a look at the NSLO’s values for this ratio, it is obvious that the company is not
able to cover their interest expenses with their earnings before interest and taxes since
they have registered in 2008 and 2009 only losses. As far as is concerned the year 2007,
there were no interest expenses to cover. Beginning with 2007 the company’s debts
increased every year, as well as the interest leading to a decrease in the interest coverage
ratio. Obviously, this is not the only reason for the decrease in interest coverage ratio.
The high costs of goods and the decrease in the sales lead to a negative EBIT. Even
though UK Coal registered losses in the same years as NSLO, the negative ratios are far smaller then those of NSLO. With an interest coverage ratio of 3.16, 7.17, 1.26 in 2007,
2008, 2009 respectively, Arch Coal Inc. was the only one able to cover its obligations
each year on earnings before interest and taxes basis.
Based on the above leverage ratios, the Arch Coal Inc proved to be the most eligible for a
loan, from lenders’ viewpoint. Its debt ratio recorded constant good values for the whole
analyzed period, as for the interest coverage period, was the only one able to cover its
obligations.
3.2.4 Profitability ratios
Profitability indicators allow giving performance evaluation of a company’s management
by study of how well they use corporate assets. An overall managerial performance is
defined by parity of profit, identified in various ways, with assets used for earning this
profit.
Table 5 Profitability ratios results.
NSLO Arch Coal Inc. UK Coal2007 2008 2009 2007 2008 2009 2007 2008 2009
Gross profitmargin
1.8% (2.2%)
(7.4%) 21.7%
27% 20% 3% 0.7% (24%)
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Gross profit margin shows how much money is left in revenues after accounting for the
cost of goods sold. During the analyzed period, NSLO’ gross profit margin had a
decreasing tendency, same as the other two companies. NSLO was profitable only in year
2007, with a low gross profit margin of 1.8%. Compared to the other two companies, in
the same year, NSLO was the least profitable, Arch Coal Inc. having a margin of 21.7%
and UK Coal with a lower margin and closer to the NSLO’s, equal to 3%. In the next two
years, NSLO was unprofitable, with margins of negative 2.2%, 7.4% respectively,
indicating the absence of any profit for company, while the other two companies
remained profitable except UK Coal, which registered a negative margin at the end of the
analyzed period.
Negative gross profit for NSLO was due to the increased cost of sales compared to their
sales. In 2008, even though the sales increased with 1.4%, the cost of sales had a higher
growth rate equal to 5.6%, leading to a negative gross profit. Even if the cost decreased
from 2008 to 2009, the sales decreased too, and with a higher percentage, having as
consequence a larger decrease in the ratio compared to the previous year.
The Arch Coal Inc’s gross profit margin has very good values. Still, the sharp decrease of the margin in 2009 is not a good sign for the health of the company. This was caused by
the large decrease of the gross profit with 36.2% due to the decrease in the sales with
13.7%. As far as UK Coal is concerned, the gross profit margin is continuously
decreasing, in 2009 reaching negative value. This negative value of the margin was due
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to the inefficient use of assets which lead to an increase in the cost of goods sold even
when the sales are going down.
Operating Profit Margin (OPM)
Formula: OPM = operating profit / sales
Operating profit margin is associated with proportion of the company's revenues that is
left after paying for variable production costs such as wages, raw materials and so on.
This ratio is a rough measure of the operating leverage a company can achieve in the
conduct of the operational part of its business. It indicates how much EBIT is generated
per dollar of sales.
For NSLO, the operational profit margin in decreasing annually, from 1.3% in 2007 tonegative values in 2008 and 2009, negative 2.1% and negative 7.4% respectively. It
illustrates that in 2007, 1 RON of sales generates 0.013 RON of operating profits. For
2008 and 2009, the company is not profitable, and this may be due to the increase of the
costs and the inefficient use of materials. Company's management has not been very
successful in generating income from the operation of the business, getting worse year by
year leading to serious consequences regarding the health of the firm.
The highest value of the margin was recorded by UK Coal, approximately 25% in 2007,
but drastically decreased to negative values in the following years due to the fact that the
operating expenses exceeded operating revenues and the difference between them
continued to increase. The Arch Coal Inc is the only one which remains profitable for the
entire analyzed period, but with a high decrease of the margin registered in 2009. These
results most likely can be connected with high variable production costs.
Net Profit Margin (NPM)
Formula: NPM = net profit / sales
The net profit margin ratio tells how much profit the studied company made for every 1
RON they generated in revenue. As is expected, NSLO’s net profit margin values are
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very low. 2007 was the only year in which the net profit margin is positive, generating
0.014 RON net profits for 1 RON of sales.
Compared to UK Coal whose ratios decreased drastically, NSLO faces a less aggressive
decrease in the net profit margin. As far as Arch Coal Inc. is concerned, their ratios
fluctuate, but with positive values for the analyzed period.
Return On Assets (ROA)
Formula: ROA = profit / total assets
Return on assets is the most important profitability indicator in the thesis. It shows how
effectively has been used each monetary unit involved in the business cycle i.e. how acompany’s assets were allocated for earning its profit.. The ROA ratio is logically
connected with net profit margin and assets turnover.
In 2007, NSLO had maximum ROA equal to 1.8%. However, this is extremely low figure
for company (taking into account decreasing trend of this indicator), which shows that
only 1.8 % of the company's profit were generated from the capital invested. The NSLO's
ROA decreased from 1.8 % to negative 2.9% during the analyzed period. Main cause for
that were financial losses of the company. In 2008 and 2009, NSLO lost 0.029, 0.067
RON respectively, for each 1 RON invested in total assets.
Compared to Arch Coal Inc., NSLO is less profitable, Arch Coal Inc. recording positive
values for ROA during analyzed period. UK Coal is less profitable than NSLO, values of
the ratio in 2007 and 2008 being slightly less than NSLO’s. In the last year had an
aggressive decrease, reaching a negative value of 24%.
Return On Equity (ROE)
Formula : ROE = profit / owner’s equity
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Return on equity defines effectiveness of using a company’s own capital. It shows how
much money per one RON of shareholder’s equity was earned during the analyzed
period. Being the comparative indicator, there is no normal value for this ratio.
NSLO registered a decreasing trend of the ratio, reaching negative values in the last two
years. In 2007, the company earned 0.022 RON per 1 RON of shareholder’s equity. In
2008 and 2009 reached the negative values of 4.2%, 10.8% respectively due to a high
decrease in the profit from 2007 to 2008, when the company began to record losses which
increased in the following year. Again, UK Coal had sharply decreased from 2007 to
2009, reaching high negative values in the last year. Arch Coal Inc. profitability results
were close to critical, with its ROE equal to 5%, 9% and 0.9 % in 2007, 2008 and in 2009
respectively. There is one observation that can be made. For a properly functioningcompany, relation of non-negative ROE to positive ROA will be always higher than 1.
This condition was achieved by NSLO only in 2007, the ratio between them being equal
to 1.22.
3.2.5 The DuPont Analysis
Return on equity is a strong measure of how well the management of a company creates
value for its shareholders. The number can be misleading, however, as it is vulnerable to
measures that increase its value while also making the stock more risky. Without a way
of breaking down the components of ROE investors could be duped into believing a
company is a good investment when it's not.
ROE = profit margin x asset turnover x equity multiplier
= (net income / sales) x (sales / total assets) x (total assets / equity)
National Society of Lignite Oltenia
2007: ROE (0.022) = 0.014 x 1.25 x 1.25
2008: ROE (-0.042) = (-0.025) x 1.13 x 1.47
2009: ROE (-0.108) = (-0.075) x 0.89 x 1.61
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ROE is broken down into net profit margin (how much profit the company gets out of itsrevenues), asset turnover (how effectively the company makes use of its assets), and
equity multiplier (a measure of how much the company is leveraged).
Between 2007 and 2009, the main reason for the decrease in NSLO’s return on equity
was a high decrease in the net profit margin, reaching negative values and a decrease in
asset efficiency, although the equity multiplier increased every year. The lowering of the
ROE is due to the fact that NSLO has higher costs than sales that decrease its profit
margin, the increase in the total assets, due to the acquisitions, and the decrease in sales is
also a factor which leads to the decrease of ROE. Another reason for ROE’s reduction
might be the fact that creditors perceive the company as riskier and charge it higher
interest.
In case of Arch Coal Inc., the values of ROE fluctuate from year to year. From 2007 to
2008, ROE increased with 33.33% due to the increase of profit margin and asset
turnover, which means that the company’s profitability and efficiency is increasing. In
2009, ROE’s value recorded a sharp decrease of 90% due to a drastic decrease of the
profit margin. Also it was influenced by the decrease in asset turnover and a slight
decrease in equity multiplier. Compared to NSLO, Arch Coal Inc. had only positive
values of ROE, meaning that the latter one is more profitable even if it does not use its
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