This report is being drafted on the basis of analysis of the financial statements of Nestlé (hereinafter refer to as 'the company'). For the purpose obtaining an understanding, these financial statements were studied thoroughly and deeply analyzed. Since Nestlé's financial year starts from January 01 and ends on December 31, that's why, Financials for the year ending December 31, 2012, December 31, 2011 and December 30, 2010 were reviewed. The report will cover the following key areas;
A justification as to why the Published Financial Statement is structured in that way
Before answering this question, it is very important to know what financial statements are. The answer is quite simple that financial statements are a structured representation of financial information which is intended to communicate its users or stakeholders the future economic benefits owed to the entity from its assets as well as its financial and non-financial obligations. Financial statements include a balance sheet, an income statement, a cash flow statement, a statement of changes in equity and a summary of significant accounting policies adopted for their preparation along with explanatory notes that more extensively disclose the information presented in figures.
Now the above mentioned word structured shows that such financial information is presented in a systematic, organized and orderly manner for ease of understandability and consistency of presentation. But a question arises as why financial statements need to be structured that way. There is always a framework which is standardized for the purpose of ease of communication, for instance, English language is the International medium of communication. The same way in accounting world there are either GAAPs (Generally Accepted Accounting Principles) or International Accounting Standards pronounced by the International Accounting Standards Board (IAASB) widely recognized worldwide. Such pronouncements define the principles as to how financial statements are to be presented, how disclosures are to be made. They are meant to be the benchmark for ease of understanding and consistency of presentation so that the financial statements always give a true and fair view of the entity's economic resources and its liabilities. In addition, certain local laws and regulations also specifically prescribe the presentation, disclosures of the financial information presented in the financial statements.
The main stakeholders who would use the published information and for what purpose
The term stakeholders refer to those individuals and entities whose interest directly influence through the financial results of that enterprise or a company. They are called stakeholders because the organization is at their stake. They are the risk takers, they will be held accountable, if a company limited by shares is unable to meet its financial obligations. Now this is clear that they may be owners of the company. However, the list is not exhaustive and there are so many others whose interest is influenced. The major stakeholders are as follows;
Shareholders - Shareholders are the owners of the company subject to the amount they invested in the business of the company and are equally liable to that particular limit to meet the company's financial obligations. The interest of the shareholders is directly linked to the company's operations. Obviously, anybody wants to invest in a company which is profitable and high earnings per share from dividends can only be paid out of profits when the profit is maximized.
Lenders - Lenders mainly include banks, Government regulatory authorities that are interested in information that enable them to determine whether their loans, and the interest attaching to them will be paid when due.
Suppliers and other trade creditors - In business, the suppliers are also one of the significant stakeholders since they provide the company with the quality raw material/supplies and expect that they will be paid within the due authorized time
Employees - The success of any company is totally dependent on the workforce it carries. The employees, however, in turn want the payback in form of remuneration, bonuses, stock option scheme which can only be known through company's financial statements.
An explanation of where both long-term and short-term finance has been raised and used
There are two methods for financing the business of a company, that is, either through a bank loan base or an equity basis. The purpose of both is the availability of funds to finance the business. Since issuance of shares is not an easy task. The company has to comply with certain regulations of corporate laws that are prevailing within the jurisdiction of the boundaries of its operations. There is however, an authorized capital which is the maximum amount of capital that a company can issue to allocate to its shareholders under its memorandum of association or constitution whatsoever the case may be.
Now, as far as financing is concerned, short term refers to a finance facility obtained from financial institutions with a repayment time of not more than 1 year. Mark up payments is usually on a monthly basis. The bank however secures it by way of hypothecation or a charge on the company's present and future assets of the company and usually it acquires a 'pari pasu' (proportionate) charge subject to the amount lent or facility availed by the company. Short term finance is usually obtained when the company has been facing a liquidity crisis. There can be a disruption in the cash flow mechanism since it may be possible that there may be significant delays in recoveries from customers. However, in turn the company wants to pay off its suppliers as swiftly as possible to obtain better discounts. Since Nestlé is reasonably established company and has excellent liquidity ratios, there has been no short term financing. In contrast, long term finance as the term applies 'long' is for a longer period of time for the purpose of financing of long term project, for instance to finance a capital work in progress, a major expansion in the business operations etc. The long term financial debt comprises of bonds and commercial papers issued by Nestle Holdings Inc., USA, Nestle Purina PetCare Company USA and Nestle Finance International Ltd., Luxembourg. The effective rate of interest of such bonds ranges from 1.4% to 8.53 % on an annual basis. The Loan is specifically used for capital expenditure for financing of equipments and major restructuring.
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Calculations of the key financial ratios, including cash flow analysis, and a comment on the findings
Cash Flow Analysis and Ratio Analysis of Nestle'
2012
2011
2010
Cash flow from operating activities ( in millions)
$ 18,861
$ 9,763
$ 13,608
The percentage of cash flow from operations By taking 2010 as base year
139%
72%
169%
The percentage of cash flow from operations By taking the previous year as the base year
193%
72%
200%
Cash flow from financing activities outflow ( in millions)
(57)
(2,358)
(25,808)
The percentage of cash flow from financing By taking 2010 as base year
2%
9%
-320%
Liquidity Ratios
Current Ratio
0.91
0.95
1.29
Quick Ratio
0.67
0.72
1
Inventory to Net Working Capital
(2.57)
(4.85)
0.90
Cash Ratio
0.24
0.23
0.54
Profitability Ratios
Net Profit Margin (%)
10%
8%
28%
Gross Profit Margin (%)
47%
47%
58%
Return on Investment (%)
7%
6%
28%
Earnings per share ($)
2.92
2.06
10.16
Activity Ratios
Inventory Turnover Ratio
10.10
9.04
13.85
Days of Inventory (days)
69
77
63
Net Working Capital Turnover
(26)
(44)
12
Asset Turnover
0.73
0.73
0.98
Fixed Asset Turnover
3
3
5
Average Collection Period Days
39
42
30
Accounts Payable Period
50
56
45
Debt to Asset Ratio (%)
22%
20%
18%
Debt to Equity Ratio (%)
44%
38%
32%
Leverage Ratios
Price/Earnings Ratio ($)
2
3
5
Dividend Payout Ratio (%)
1%
1%
2%
Dividend Yield on Common Stock (%)
1%
1%
3%
Amount of working capital (in millions)
$ (3,548)
$ (1,908)
$ 3,765
Commentary on above analysis
The above ratios are analyzed on the basis of the financial statements for the year ended December 2010, 2011 and 2012. The company showed a significant decrease in the cash flow generated from its operating activities which is also indicative of the fact that there has been a significant decline in net profit margin from 28% to 8 % in 2011. This is due to certain reasons that the overall revenue has been decreased. It's mainly due to increase in inflation all over the world resulting in the increase costs of production. That's why the company cannot afford to sell its products at low price. Since prices go higher, the demand has been decreased as the customers switch off to other substitutes like Aqua Fina launched by Pepsi Cola International Inc,.
The current ratio was stable and closes ideal position in the year 2010 showing 1.29 greater than 1 showed that the company is self sufficient to meet its financial debt obligations. In other words, there is zero percent liquidity risk. However, it has been deteriorating due to decrease in sales revenue in subsequent years. Moreover, it has also affected the quick ratio.
The inventory turnover showed that how effective a company is to replenish its stock and so the days in inventory management have also been increased from 63-77. There is a decrease in the year 2011 due to lesser sales; however in the year 2012 we can see the company is going to stabilize its inventory turnover ratio.
The net working capital turnover has gone too negative in the year 2011 because of lesser revenues and increased costs. Moreover, it can also be due to the increase in the average collection period in terms of days since it indicates that there happens to be a time lag in the recoveries from customers.
The debt to asset ratio has been relatively stable; however there is a slight increase in subsequent years. However, the debt to equity ratio has been increasing consistently at 6% per year which is due to changes in equity and the overall profitability of the company.
The leverage ratios have been slightly affected by the profitability; the price earnings ratio indicates that how much investor is willing to pay for every single amount of currency unit which showed a slight fluctuation.
An explanation of the different methods that could be used for appraising capital projects and the strengths of each
For the purpose of the appraisal of capital projects, there are several methods that are being implied analytically of which the main theme behind this is to have an efficient spending of funds such that the benefits that will accrue to the company will be long lasting. Different methods are normally used;
Net present value method. In this method, the estimated revenue and cost are being discounted by the amount of funds that are to be invested in any venture. When the value is positive and substantial, is showing that the project is profitable and should be pursued further, however if it comes negative then it must be rejected.
Discount rate. The discount rate is used to convert estimated costs and benefits to calculate present value to replicate preference of time. It is also sometimes called Test Discount Rate and currently a benchmark is set at 4%. However as soon as the circumstances change it should be reviewed and updated accordingly.
Internal Rate of Return (IRR). It is the rate of discount that when it is being applied to net revenue that is to be generated from a project then it must be equal to the present value of investment. However, the best possible option is when the IRR is greater than any hurdle discount rate. The hurdle discount rate is same as Test discount rate. The project achieves breakeven when both rates of returns become equal.
The benefit / cost ratio is as the term applies that the benefit which is to be discounted or net revenues that are to be generated from a project should be discounted and divided by the amount of initial investment. If the ratio is greater than or equal to 1, the project should be accepted, else rejected. The key strength of this method is its simplicity.
An indication of the weaknesses of published financial information
Generally speaking, there can be weaknesses in the published financial information; however some of them are as follows;
Financial information is prepared, presented and disclosed on the premise that users or major stakeholders have reasonable knowledge of business and economic activities and willingness to study the information presented therein but this is not the case always. As sometimes for instance users cannot interpret this information because of complex and technical accounting terms used in the financial statements for example, temporary differences in the deferred tax calculation. Furthermore, financial information is prepared, presented and audited to levels of materiality. Users may not know what materiality is.
Financial statements may not disclose off-balance sheet transactions since the financial statements are prepared from the records that have been maintained by the management, that are general and subsidiary ledgers and other supporting documentation and worksheets.
Financial statements are always audited on a test basis as auditors use sampling techniques to the population under scrutiny and they also state this fact in the auditor's report that they are giving a reasonable assurance and it may be possible that some material misstatements may go undetected.
So, keeping in view, there can be a major loophole if financial statements contain a material misstatement that may have gone unnoticed by auditors.
