Rio Tinto Plc Ratio Analysis 2019-2018

On the analysis of the ratios of the company Rio Tinto Plc for the years 2019 and 2018, the following observations have been drawn. On the analysis of the Return on capital employed and the Return on equity it has been observed that the earnings of the entity have declined in the year 2019 as compared to 2018. Therefore, declining trends have been observed in both the ratios affecting the profitability, which cannot be stated to be efficient from the point of view of investors and highlight the issues in the environment of the business. On the analysis of the liquidity position of the company as supported by the current ratio it has been observed that the current ratio has marginally  declined in year 2019 at 1.56 times from 1.9 times in 2018. However such a decline cannot be stated to have much affected the working capital. On the analysis of the efficiency of assets as supported by the debtor ratio and the creditor ratio it has been observed that the debtor ratio has declined from 21 days in year 2018 to 18 days in year 2019 which is a positive sign. This means the entity is able to realise cash from the debtors a little early from the previous trends. On the contrary the creditor ratio has increased from 57 days in year 2018 to 67 days in year 2019, indicating that the company is addressing the creditor claims a little late. Thus, it can be stated that the attempts are made to improve the cash flows needed in day to day business operations. On the analysis of the capital structure ratio as supported by the debt equity ratio it has been observed that the financial risk in the operations of the business has increased because the debt equity ratio has increased from 94 % in 2018 to 105% in 2019. This may have negative impact on the interest of the investors and may be a point of concern for them. However the interest coverage ratio has improved in the year 2019 which indicates that the entity has sufficient amount of earnings before interest and tax to address the interest claims on long term liabilities. The impact of the financial performance is that the overall PE Ratio has declined from 6.09 times in year 2018 to 3.70 times in year 2018 indicating that the investor declined the market value of the entity because their expectations were not met. Therefore it can be stated on the basis of the ratio analysis that the financial position of the company Rio Tinto has declined slightly in the year 2019. 

The ratio analysis is regarded as one of the most efficient and primary techniques of analysis of financial statements, which sheds light on various aspects of operations of a business, and thereby aids the stakeholders to make informed judgements. The following are presented the merits and limitations of ratio analysis.

The primary benefit of the ratio analysis is the ease of performance of the technique, and the ease of understanding of the results. Therefore while it is easy for the management to perform the analysis in less time consuming manner, it is easy for the stakeholders as well to understand the result and draw conclusions about the efficiency of business operations. In addition the benefit is that it sheds light on different aspects of business such that are liquidity, profitability, capital structure, market performance, and efficiency of assets. Yet another benefit of the ratio analysis is in form of allowance of comparison of the current performance with the previous trends (Williams and Dobelman 2017). Apart from this the ratio analysis helps in comparison of the performance of a business with similar competitors in the same industry. Further it can be stated that the ratio analysis helps in future decision making, strategic planning, and business reporting. However the technique has certain limitations as well which are provided hereunder. The primary limitation of the ratio analysis is that the efficiency of the results is dependent on the data provided by the management of a business which is subjected to window dressing (Robinson et. al, 2015). Therefore even if the analysis is performed efficiently, the results could be misleading owing to the data used. In addition the limitation of ratio analysis is that the information used is historic and is not current. Further the limitation lies in the fact that the ratio analysis fails to take into account the external factors such as inflation, economic recession and others. Apart from this the limitation of ratio analysis is that it fails to take into account the measurement of the human element of a business or the qualitative aspects. 

Observations

The financial management is rightly regarded as the science and art of management of the money of a business so that its long term and short term objectives can be attained. The following are listed the key aspects of the role of financial managers of business enterprises.

The primary role of finance manager is to enhance the value of the firm as well as the wealth of the shareholders for the latter have invested their money in the business with an objective of increment of their wealth. Therefore the business decisions must be taken in a manner that leads to enhancement of profits of the business as a whole. In addition, the role of finance manager involves the decision of investments. This calls for analysis of various investment opportunities and applying appraisal techniques such as capital budgeting, share valuation and others before deciding on an efficient investment opportunity depending on the objectives of business and interests of stakeholders. In addition, the role of the finance manager involves to ensure the liquidity in the business and sufficiency of cash flows day-to-day operational needs. Thus, the cash collections and disbursements must be monitored on timely basis. In addition, the finance manager must coordinate with the other departmental managers for the overall strategic planning and reporting; that involves activities like budgeting, variance analysis, analysis of financial data and others. Thus, it can be rightly stated that the role of finance managers is complicated and challenging.

The net present value is regarded as one of the crucial capital budgeting techniques that involves the computation of the present values of all the estimated cash flows involved in a project at a pre decided discount rate. If the results are positive it means that the present value of the cash inflows are more than the present value of the cash outflow, and it is suitable to accept the proposal on the basis of quantitative analysis. As per the NPV computation it has been observed that the NPV of the project proposal is positive £ 1120. Thus, the Council can accept the proposal to build an additional swimming pool at the discount rate of 12%.

The payback period refers to the period in which the initial expenditure of a proposal would be recovered by the cash inflows to be earned in the later years. A proposal is accepted if the payback period is shorter than the life of the proposal. On the computation of the payback period, it has been assessed that the payback is 3 years which means the initial investment of £ 90000 shall be recovered by the earnings within the period of 3 years. Therefore the proposal can be suitably accepted by the management.  However this technique has a limitation that it does not considers the time value of money.

To: Brenty County Council

Regarding: Project to build a swimming pool in the local area

It is imperative to conduct an investment appraisal of the project proposals to assess the different quantitative aspects involved in a proposal. The significance of conduct of investment appraisal is that there is a huge amount involved and that such decisions are generally irreversible. There are several techniques available for the conduct of investment appraisal such as NPV, IRR, ARR and others.

Merits of Ratio Analysis

The techniques of net present value (NPV) and payback period have been utilised to assess the financial viability of the project of constructing additional swimming pool in the local areas of the council. Accordingly it has been observed that at the estimated cash flows and the given cost of capital of 12% the NPV is positive and the payback period is shorter than the length of the overall project proposal, standing at 3 years. Therefore it is recommended to the management of the Council that the said proposal can be accepted considering the other qualitative aspects. 

Yours Sincerely.

Since overall cost of proposed scenario is lower than the original scenario, it can be stated that the offering of 2.7% discount will improve the profitability of the business.

There are different sources of finance available for a business to opt, which leads to impact on the financial risk as well as the overall business risk, including the cost of finance. The benefits and drawbacks of different sources of finance have been provided hereunder.

The primary benefit of the ordinary shares is from the point of view of business is in form of less risk because there is no legal obligation on the payment of dividends  on consistent basis and the same is dependent on the discretion of the management. Therefore the dividends are paid only when the long term and short term objectives of the business entity allow for the same. As a result the other benefit is in the form of maintenance of cash flows of the business unlike in the other sources of finance. The yet another benefit is in the form of enhancement of credit availability because of overall less risk in the capital structure. However there are certain drawbacks of ordinary shares that are in form of dilution of control and resulting possibilities of conflict of interest. Therefore the more number of ordinary shareholders, the more are the chances of difficulty in reaching the business decisions. In addition, it has a high cost of finance, and if the risk perception of shareholders is not addressed, the market capitalisation may be affected with the reduced share prices.

The primary benefit of preference shares is in form of no legal obligation of consistent payments of interest unlike in bonds, and therefore the same allows for maintenance of profitability as well as liquidity of the business. In addition the same improves the borrowing capacity as inclusion of it leads to the improvement of the debt to equity ratio. In addition, the benefit lies in the fact that it does not leads to charge on the assets of the company. However it has its own share of drawbacks which have been elaborated as follows. The primary drawback of preference share is that they get preference in the claims over the ordinary shareholders, and may not be desirous to the existing ordinary shareholders of the business entity. Since the preference dividend is not subjected to the tax, it is a costly source of finance as well.

The yet another source of finance is in form of redeemable bonds. The primary benefit of redeemable bond is that it is comparatively cheaper source of finance. This is because the interest payments are subjected to tax and therefore the overall cost of debt is low and the overall weighted cost of finance of the entity also reduces due to the leverage effect of inclusion of debt in the capital structure. In addition, it has less risk from the point of view of investors, and therefore the same is available at efficient rates. Apart from above, there is no dilution of control of business in this source of finance. The primary drawback of the redeemable bond is in the form of increased financial risk for the entity because the consistent coupon payments are required to be paid by the business. This results in issues of profitability as well as liquidity. In addition it affects the creditworthiness of the business because if the debt equity ratio is already high in the business, the interest of new redeemable bonds could be very high. Further the drawback lies in the collateral requirements in certain cases as well as stringent contract covenants.

References

Bodie, Z., Kane, A. and Marcus, A. J. (2015) Portfolio management.UK: McGraw Hill/Learning Solutions.

Reilly, F. K. and Brown, K. C. (2011) Investment analysis and portfolio management.UK: Cengage Learning.

Robinson, T. R., Henry, E., Pirie, W. L., and Broihahn, M. A. (2015) International financial statement analysis. UK: John Wiley & Sons.

Williams, E. E., and Dobelman, J. A. (2017) Financial statement analysis. World Scientific Book Chapters, pp. 109-169.