The topic I have chosen for my thesis is Financial Performance Measurement for Three Cosmetics Producers: LOreal, Oriflame, and Farmec. The global beauty and care industry had sales of 426 billion USD. The European beauty and personal care industry represents one-third of the global beauty and personal care market (Euromonitor International, in "Colipa Annual Report 2010": 24), this fact making it very attractive for investors. According to Euromonitor International ("Latest Research: Beauty and Personal Care 2012 Now Live", 2012: 2), over 4000 companies operate in the European beauty and care industry. L'Oreal, Oriflame and Farmec are among those companies. L'Oreal and Farmec sell their products in shops, meanwhile Oriflame sells it directly to customers. L'Oreal is a French company, Oriflame is a Swedish one and Farmec is a Romanian one. Which one of these three companies would be the best investment? I will try to answer this question in the report with the aid of financial ratios calculated based on five consecutive yearly financial results.
Description of the problem
Given the large number of companies operating in the cosmetics industry, it is very difficult for investors to decide what company would give the highest return on investment. The report will try to help investors make the best choice. It will start with a brief presentation of the global beauty and personal care industry and the European cosmetics industry with the aim of emphasizing the advantages of investing in cosmetics producers. Then, the performance of the three companies - L'Oreal, Oriflame and Farmec - will be assessed and compared using ratios in order to show which one of them is the most profitable and the safest investment option for prospective investors. The financial statements of L'Oreal, Oriflame and Farmec- the basis on which the ratios are calculated - were elaborated and presented according to the same international standards, IFRS and IAS and, therefore, their figures can be easily compared. Being European companies, they all also respect the 4th and 7th European Directives. Last but not least, there will be detailed also other things indicated by financial ratios, besides a good or poor performance (such as, for example, the bankruptcy risk).
OBJECTIVE OF THE ASSIGNMENT
The objective of the assignment is to advise investors on the best beauty and personal care investment opportunity - L'Oreal, Oriflame or Farmec - based on the financial analysis of 2007, 2008, 2009, 2010 and 2011 yearly financial statements. L'Oreal was chosen for the analysis because it is "the first cosmetics group worldwide" (L'Oreal's "Annual Report 2011": 3), with which any company in the industry should compare (the perfect benchmark). Farmec is a Romanian beauty and care producer with a tradition of more than 120 years and the strongest Romanian player in the industry, exporting in more than 30 countries. Oriflame is a Swedish cosmetics producer ranked as the fifth direct sales company (according to Euromonitor International's "Passport: Oriflame Cosmetics SA in Beauty and Personal Care: World, 2011: 4) and I thought it would be interesting to compare the results of companies selling their products in shops with direct selling ones, in order to see what business model has the best financial performance.
CENTRAL RESEARCH QUESTION
The central research question of my thesis is: Which of the three cosmetics producers - L'Oreal, Oriflame or Farmec - would be the best investment opportunity based on the financial analysis?
SUBQUESTIONS
The subquestions related to the central research question are the following:
What do investors find important when selecting a company in which to invest?
What makes the beauty and personal care industry interesting for investors?
Based on what criteria will the investors be advised to select a certain investment opportunity?
How can performance, performance measurement and financial performance measurement be defined?
Why is financial performance measured?
What tools can be used to assess performance?
What are the most important ratios used for measuring the performance of the cosmetics companies?
Which of the three cosmetics producers has had the overall best performance based on financial analysis?
Which of the three cosmetics producers has had the best performance in each group of ratios?
For what other things, besides performance measurement, can the financial ratios be used?
PROCEDURES AND METHODS
In my thesis I will conduct qualitative research - literature research and desk research. The first subquestion will be answered using literature research - articles in the Saxion database and books in the library. For the second subquestion I will use desk research - industry reports and statistics of Colipa and Euromonitor International on the global cosmetics industry, respectively the European one (examples of industry reports used: Colipa's "Activity Report 2009" and "Activity Report 2010", Euromonitor International's "Global Beauty and Personal Care: State of the Industry 2010", "Beauty Beyond Crisis - The Year in Review and Growth Concepts for the Future" and "Beauty Beyond the Crisis - The Industry's Report"). The third subquestion will be answered using literature research - books from the library and articles found in the databases of Saxion. The fourth subquestion will be answered with the aid of Ilies, Turdean and Crisan's (2009) "Warehouse Performance Measurement - A Case Study" article, books and articles from the databases. The fifth subquestion will be answered using articles from the database (literature research). To answer the sixth subquestion, I will use literature research, articles and books from the Saxion database and Ilies, Turdean and Crisan's (2009) "Warehouse Performance Measurement - A Case Study" article. The seventh subquestion will be answered using the five books mentioned in "Literature", and other books and articles from the library on ratio analysis, so I will conduct literature research in order to answer this subquestion. The eighth and ninth questions will be answered using desk research, qualitative research consisting in the calculation of ratios based on the yearly financial statements of the three companies in the beauty and personal care industry, financial statements either found on the website of the companies, on the Romanian Ministry of Finance website or received from the companies. For the last question I will use a literature research - books from the library (the five books mentioned in Literature; Barry Elliott and Jamie Elliott's (2007) "Financial Accounting and Reporting 11th Edition and Geoffrey Holmes et al.'s (2008) "Interpreting Company Reports and Accounts. 10th Edition" and articles from the Saxion databases).
PROJECT ORGANIZATION
As I work alone, I will be in charge of all the tasks:
Problem analysis
Research design
Data collection
Literature review
Financial statement search (L'Oreal, Oriflame & Farmec)
Global & European industry reports
Data processing and analysis
Selection of relevant company information
Translation of the yearly financial statements of Farmec
KPI (ratio) calculation for each company
Interpretation of ratios and comparison with the previous year ratios
Comparison of ratios of the three companies
Report writing
Table of contents
Introduction
Body
Conclusion
Appendices
Improving concept version
Report revision
Presentation & Defense
PPT presentation
Cue cards
PPT presentation and cue cards revision
TIME PLANNING
Activity
Sub-activities
Duration
PROBLEM ANALYSIS
COMPLETED
RESEARCH DESIGN
COMPLETED
DATA COLLECTION
Literature review
Company information
Industry reports
4 days (23.04.-26.04)
2 days (27.04.-28.04)
1 day (29.04.)
TOTAL: 7 DAYS (23.04.-29.04.)
DATA PROCESSING & ANALYSIS
Selection of relevant info l'Oreal + KPI calculation
Selection of relevant info Oriflame + KPI calculation
Selection of relevant info Farmec + translation of financial statements + KPI calculation
Interpretation of KPIs
Comparison of KPIs
1 day (30.04.)
1 day (01.05.)
2 days (02.05.-03.05)
1 day (04.05.)
1 day (05.05.)
TOTAL: 6 DAYS (30.04.-05.05.)
REPORT WRITING
Body
Introduction + abstract + conclusion + first page + table of contents
Appendices
Improving concept version
Report revision
29 days (07.05.-05.06.)
2 days (06.06.-07.06.)
1 days (08.06.)
17 days (08.06.-25.06.)
2 day (26.06.-27.06.)
TOTAL: 51 DAYS (07.05.-27.06.)
PPT PRESENTATION + CUE CARDS
PPT presentation
Cue cards
PPT presentation & cue cards revision
2 days (01.07.-02.07.)
1 day (03.07.)
1 day (04.07.)
TOTAL: 4 DAYS (01.07. -04.07.)
PRECONDITIONS
Time: 10 weeks (23.04.2012-28.06.2012) for report & 8 weeks for the presentation (01.07.2012-27.08.2012) for the Power Point presentation.
Laptop
Printer
Microsoft Office
I will use books in the library, so they won't cost me anything
Report/article downloading costs: 30 EUR
Electricity: 10 EUR
Telephone: 20 EUR
Paper: 4 EUR
Ink for the printer: 10 EUR
Cover for the final report: 5 EUR
Total costs: 79 EUR
LITERATURE
The first book I use in the thesis is entitled "Business Accounting and Finance. Second Edition" by Tony Davies & Tony Boczko (2005), ISBN: 9780077108090 and consists of three parts: "Financial Accounting", "Management Accounting and Business Finance". Chapter 5, "Business Performance Analysis" (pp. 147-193), relevant for my research, is included in the first part. The chapter starts with a presentation of the steps of the performance review process, then continues with financial ratio analysis and it ends by trying to decide whether cash flow or profit is the best financial performance measure.
According to the authors, "performance review is done for assisting investment decisions, in order to identify possible takeover targets and to evaluate the financial strength of customers and suppliers". The main purpose of the performance review process is to provide an understanding of the business and an interpretation of its financial results. Performance review starts with a SWOT analysis, which includes both an internal analysis of a company (Strengths and Weaknesses) and an analysis of the external environment of a firm (Opportunities and Threats).
Performance measurement has two main purposes: to assess managerial performance and to evaluate economic performance. It can be done by using ratios, also called "key performance indicators". The most often used ratios to measure performance are grouped, according the authors, into 5 categories: profitability, efficiency, liquidity, investment and financial structure. Profitability ratios are related to the objective of "profit maximization of company wealth". The main profitability ratios are: return on sales, gross margin, operating profit, profit before tax, net profit, return on investment, return on equity and capital turnover. Efficiency ratios express "how effectively business transactions are being converted into cash" (p. 162). The most important efficiency ratios are: debtor days, creditor days, stock days, stock weeks, operating cycle (in percentage and days), asset turnover and defensive interval. The efficiency of a company can be assessed using the vertical analysis of its profit and loss account/income statement. Liquidity ratios reflect the ability of a firm to meet its short-term obligations. Current ratio and "acid test" (quick ratio) are the most often used liquidity ratios. The "current ratio" measures the overall liquidity of a business and the acid test (quick ratio) indicates the ability of a firm to pay its short-term debts. The liquidity of a company can also be measured with the aid of defensive interval, cash ROCE and cash interest cover ratios. The most important investment ratios are: earnings per share, dividend per share, dividend cover, dividend yield, price/earnings ratio, capital expenditure to sales and capital expenditure to gross fixed assets. Financial ratios are related to the connection between debt and equity capital, also called gearing, and they measure the long-term solvency of the company. The most commonly financial ratios used are: gearing and debt/equity ratio (leverage). Dividend cover and interest cover are also used sometimes. An important aspect regarding ratios analyses is the fact that they are calculated on past performance and may, therefore, not show the current performance of a business, but the past one. When interpreting the ratios, there must to be taken into account also not easily quantifiable factors, such as: customer satisfaction and delivery performance. Furthermore, there can sometimes appear inconsistencies in some of the performance measures. As a result, it is extremely important to compare current performance and past performance of the same company, with the budget established earlier and with the performance of companies in the same industry or market.
In the last part of the chapter, the advantages and disadvantages of cash and profit performance measure are listed. The authors conclude that there isn't a panacea for evaluating financial performance, both methods having both advantages and disadvantages.
The second book used in my research is "Financial Accounting. Tools for Business Decision Making. Fifth Edition. International Student Version" by Paul D. Kimmel, Jerry J. Weygandt & Donald E. Kieso, John Wiley & Sons, Inc., 2010, ISBN: 9780470413357. It consists of 13 chapters. Chapter 2, "A Further Look at Financial Statements" (pp. 46-98 - important for us until pp. 64), presents the ratios that can be used for evaluating liquidity and solvency of companies. It also includes a brief presentation of the characteristics of useful information and constraints in accounting.
The chapter begins with a feature story on the way in which internet has changed the investment world. The financial statements introduced in the first chapter of the book are reviewed in chapter 2 and it is shown how they can be evaluated. Firstly, the classified balance sheet and its elements are defined and explained. Then ratio analysis used for financial performance measurement is defined and described. Company performance is assessed using intracompany comparisons covering at least two years for the same company, industry-average comparisons, based on average ratios for particular industries, and intercompany comparisons based on comparisons with a competitor in the same industry. Profitability ratios, measuring how successful a company is in a certain time interval, are calculated using the income statement. An example of profitability ratio is earnings per share, which assesses the net income earned on each share of common stock. Liquidity and solvency of a company are measured using the classified balance sheet. Liquidity, a company's ability to pay short-term obligations/ debts, is assessed by calculating the working capital and the current ratio. Working capital is the difference between currents assets and current liabilities. Current ratio is calculated by dividing current assets by current liabilities. Solvency, "the ability of a company to survive in the long-run", is assessed by using the debt to total assets ratio, calculated by dividing total liabilities by total assets.
The chapter continues with a presentation of the financial reporting concepts. First of all, the main standard-setting bodies are mentioned. Second of all, the characteristics of useful information are briefly explained. Accounting information is relevant if it influences a business decision. Reliability of information means that it can be trusted. In order to be reliable, accounting information must be easy to check, a true representation of the facts and "neutral". Comparability is the "result of different companies using the same accounting principles". Consistency results if the same accounting principles and methods are used every year by the company. Third of all, there are described key assumptions and principles used by the Financial Accounting Standard Board (FASB) to develop accounting standards.
Chapter 2 of the book ends with a description of two main constraints in accounting: materiality and conservatism. Materiality refers to a financial statement element's impact on the overall financial condition and operations of a company. There are material and immaterial financial statement items. Conservatism means that, when preparing financial statements, a company should use an accounting method that is less likely to overstate assets or income. The chapter also includes a summary of the study objectives and a glossary.
The third book relevant for my research, Aidan Berry & Robin Jarvis's , "Accounting in a Business Context - Fourth Edition", Thomson Learning, 2006, , ISBN: 9781844802517, consists of 21 chapters grouped in two parts: "Financial Accounting" and "Management Accounting". Chapter 12, called "Financial Statement Analysis" (pp. 245-286) is included in the first part and focuses on the way in which information in financial statements helps evaluate the performance of companies. It begins with a presentation of accounting information needs of different groups of users: investors, preference shareholders, lenders, employees, auditors, management and, in the end, it mentions the common needs of all these stakeholders: the need of information regarding the past and future profitability of a business", the requirement for information about the financial risk and return on investment in the business.
Chapter 12 continues with a brief presentation of the directly relevant factors to any analysis of business performance: the size of the business, the riskiness of the business, the economic, social and political environment, the industry trends and effects of changes in technology. According to the authors, predictions about the future of a business can be made using external sources of the business - government statistics, trade journals, financial press, databases and specialist agencies - and internal sources of the business - the annual report and accounts.
Furthermore, the main financial statements are briefly presented and explained: the income statement, the cash flow statement, the balance sheet, notes to the accounts and the accounting policies statement. Then the common needs of the users of accounting information are described: profitability, liquidity and financial risk. The next important part of the chapter is an explanation of the main techniques of analysis: vertical (trend analysis) and horizontal. Trend analysis can be done by using two methods: index number trends and percentage changes.
Another important topic of chapter 12 is ratio analysis. According to the authors, it is very easy to calculate the ratios, but it's very difficult to interpret them. The ratios are divided into four categories: profitability, efficiency, financial risk and returns to investors. Profitability ratios are important because the shareholders can only get a return on investment if the business is profitable. They are calculated using information from the income statement. The most important profitability ratios are: gross profit margin and net profit margin. Profitability relative to capital investment ratios are the following: "return on capital employed" and return on equity. Efficiency ratios measure the way in which business assets are used to generate profit. There are two main categories of efficiency ratios: inventory turnover and receivables and payables turnover. Inventory turnover measure the number of times the inventory is turned over each year" (p. 273) and can be calculated in days or times. Receivables and payables turnover ratios measure how quickly the money from customers is collected and how fast the company is paying its suppliers. It is important to calculate efficiency ratios for a few years, in order to identify trends. Financial risk is measured with ratios such as the gearing, debt-equity, full gearing, current ratio and quick ratio. Earnings per share, dividend cover and interest cover are examples of return to investors' ratios. These ratios also have to be compared over time and with other businesses.
The chapter ends by showing the key limitations of financial analysis. The encountered problems while doing financial analysis are grouped into: information problems, comparison problems - inter-temporal and comparison problems - inter-firm.
The fourth book used is William L. Megginson, Scott B. Smart & Brian M. Lucey's "Introduction to Corporate Finance, Cengage Learning EMEA, 2008, ISBN: 9781844805624. It has five parts: "The Basic Tools of Finance", "Valuation, Risk and Return", "Capital Budgeting", "Capital Structure and Dividend Policy" and, last but not least, "Additional Topics in Corporate Finance". The chapter which is relevant for my research is included in Part 1. Chapter 2, entitled "Financial Statement and Cash Flow Analysis" (pp. 30-65) starts with a presentation of the financial statements: balance sheet, income statement, statement of cash flows and notes to financial statements, then it focuses on cash flow analysis and financial performance analysis using ratios (the authors classify the ratios into: liquidity, activity, debt, profitability and market ratios) and it ends with a conclusion. The chapter also provides some self-study problems and a mini case.
The financial statements provide outsiders with an image of a firm's financial performance and position. "The balance sheet is a <<snapshot>> view of a company's financial position at a specific point in time, the financial year-end". The income statement includes the net income, also called "bottom line", which is, according to the authors, the most important accounting number for corporate managers and external financial analysts. The statement of cash flows is a summary of a company's cash flows over the year. The notes to financial statements give detailed information on the relevant accounts in the statements, on the accounting policies, calculations and transactions underlying entries in the financial statements. The cash flow analysis helps estimate the value of a firm. The inflows and outflows of a company' cash are divided into: operating flows, investment flows and financing flows.
Moving on to the analysis of financial performance using ratio analysis, the ratio analysis is firstly defined as the "calculation and interpretation of financial ratios to assess a firm's performance and status" (pp.43). Financial ratios are calculated taking into account the needs of the users of financial information. The ratios calculated for a business are compared with the ones of the previous years of the same business in order to identify trends and with those of "benchmark" firms in the same industry or industry average obtained from a trade association or a third party provider. Liquidity ratios measure the ability of a firm to fulfill its short-term obligations. Current ratio is the most popular liquidity ratio. The quick (acid-test) ratio is also used by some firms. Activity ratios measure how fast the firm transforms various accounts into cash or sales. The most important activity ratios used are: inventory turnover, average age of inventory, average collection period, average payment period, fixed asset turnover and total asset turnover. Debt ratios assess the extent to which a firm uses money from creditors rather than shareholders to finance its operations. There are two main types of debt ratios - one focuses on balance sheet measures of outstanding debt relative to other sources of financing and the other type is centered on income statement and measures "a firm's ability to generate enough cash flow to make scheduled interest and principal payments". Both types of ratios are used by investors and credit rating agencies to assess a company's creditworthiness. The most popular debt ratios are: debt ratio, assets-to-equity ratio (also called equity multiplier), debt-to-equity ratio and times interest earned ratio. Profitability ratios are the most popular category or ratios. The most widely used profitability ratios are: gross profit margin, operating profit margin, net profit margin, return on total assets and return on equity. Market ratios measure "a firm's market value as measured by its current share price and relate it to certain accounting values". There are two popular market ratios - one that is centered on earnings and another one that takes into account the book value. The price/earnings ratio is used to assess a company's long-term growth potential. The market/book ratio measures a firm's future performance by relating its market value per share to its book value per share.
The last book relevant for my research is Eddie McLaney's "Business Finance. Theory and Practice. Eight Edition", Pearson Education Ltd., 2008, ISBN: 9780273717683 (pp. 41-76). It consists of 16 chapters grouped in four parts: "The Business Finance Environment", "Investment Decisions", "Financing Decisions" and "Integrated Decisions". Chapter 3, called "Financial (Accounting) Statements and Their Interpretation" is included in part 1.
The chapter starts with an introduction, then it briefly presents the financial statements, it defines the most important accounting terms and conventions, and shows what the most important problems of accounting information when making decisions are. Furthermore, it defines creative accounting and presents the most famous and controversial cases when creative accounting was used. Ratio analysis is the next part of the chapter. The ratios are grouped into five categories: profitability ratios, activity ratios, liquidity ratios, capital gearing ratios, and investors' ratios. Limitations of accounting ratios are explained and it is shown how ratios can predict financial collapse. The chapter ends with a summary of what was previously discussed in the chapter.
The introduction enumerates, defines and briefly presents the financial statements which companies are obliged to publish: the income statement (profit and loss account), the balance sheet (position statement) and the cash flow statement. The most important accounting terms and convention are then defined: asset, money, historic cost, stable monetary unit, realization, matching, accruals, prudence and going concern conventions. The problems with using accounting information for decision making are then explained: matching costs against revenues and the understatement of an amount of wealth that is invested in the business. Furthermore, there are presented the main reasons for using creative accounting: getting around restrictions, avoiding government action, hiding poor management decisions etc.
According to the authors, ratio analysis helps summarize complex accounting information into a small number of key indicators: profitability, activity, liquidity and capital gearing. Profitability ratios measure the effectiveness of a business to generate profit. The most important key indicators used to measure profitability are: return on capital employed (return on net assets) ratio, return on ordinary shareholders' funds (return on equity) ratio, gross profit margin and operating profit margin ratio. Activity ratios measure the effectiveness of a business in using its assets. The most important activity ratios are: sales revenue to capital employed (net asset turnover) ratio, inventories turnover period ratio, settlement period for trade receivables (days trade receivables) ratio and settlement period for trade payables (days trade payables) ratio. Liquidity ratios, used to measure how well the working capital of a business is managed, includes the current ratio, the acid test (quick assets) ratio and the no credit period ratio. Capital gearing ratios focus on the relative sizes of the funds provided by shareholders and by long-term lenders. Two capital gearing ratios are often used: gearing ratio and interest cover ratio. Investors' ratios show how shareholders view a business. Earnings per share ratio, price/earnings ratio, dividend yield and dividend cover are the most important investors' ratios. Ratio analysis is not a very exact science and, therefore, the ratios should be interpreted cautiously. Ratio analysis rather raises questions than answers.
Accounting ratios are also used for judging a company's ability to survive and prosper. Taffler has created the Z-score model which helps decide whether a company is likely to get bankrupt. A positive Z-score indicates that a company is financially healthy meanwhile a negative Z-score implies a relatively high risk of failure.
DECLARATION OF APPROVAL
Name: Ana-Maria Turdean
Title: Plan of Approach - Financial Performance Measurement for Three Cosmetics Producers: L'Oreal, Oriflame & Farmec
Position: Saxion University of Applied Sciences
Date: 30.05.2012
City: Deventer
Signature, Signature of Graduation Mentor,
________________________ _________________________
