FNA1002 Group Project B29 FINAL[1]

FNA1002

FINANCIAL ACCOUNTING

GROUP PROJECT

TUTOR

Ms Tan Wee Szu

B29 GROUP 1

PHAM TUAN MINH (U056702N)

TAN WEI PING REGINA (U025461X)

LIU DAN (U059739R)

LIU RIJING (U037462W)

DEPARTMENT OF FINANCE & ACCOUNTING

SCHOOL OF BUSINESS

NATIONAL UNIVERSITY OF SINGAPORE

SEMESTER 2

SESSION 2005/2006

FNA1002 – Financial Accounting Project B29 - Group 1

Question 1

What is the nature of business of the company?

Stamford Tyres Corporation Ltd. (will also be subsequently referred to as ‘Stamford’ in

this project) does manufacturing and also provides services. The manufacturing segment

of Stamford consists of the manufacturing of Stamford Sport Wheels (which is one of the

company’s proprietary brands) light alloy wheels and tyres outsource contract

manufacturing using Stamford’s brands. The service segment consists of retain chain

operations, international distribution network, and fleet and mining tyre management

services.1

What are the company’s main types of revenues and expenses?

The company’s main revenue is from their tyres and wheels business. It is divided into

wholesale and distribution, retail and fleet and servicing of motor vehicles. The revenue

from the wholesale and distribution of tyres and wheels amount to S$157,191,000. While

S$34,022,000 is from retail and fleet, S$80,000 is from servicing of motor vehicles2.

Revenue coming from the Singapore segment contributes 58.2% of total revenue, 28.8%

from South Asia and 13.0% from North Asia3.

Stamford’s main types of expense are the cost of raw materials and goods sold

(S$138,811,000) and salaries and employees benefits (S$15,473,000)4.

Question 2

What is meant by the term “revenue recognition”?

Revenue recognition is defined as recognizing revenue after realization. In cash basis

accounting, revenues are recognized when cash is received. However, in accrual basis

1 Pg 1, Letter to Shareholders2 Pg 51, Note 33 Pg 76, Note 354 Pg 39, Consolidated Profit and Loss Account

1


accounting, revenues are recognized when they are (1) realized or (2) realizable and

earned no matter when cash is received.

When does the company recognize revenue?

Based on the revenue recognition policies by Stamford Tyres Corporation Limited5:

The revenue from services provided is documented when the services have been

rendered. As for the revenue from the rental of tyres, it is recorded based on the usage of

tyres by customers.

For the purchases made from the financial year, volume rebates from the suppliers is

subtracted if the goods are unsold on the date in the balance sheet. Otherwise, it is

credited against cost of goods sold in the profit and loss account in the case where the

goods were sold on the balance sheet date.

Advertising and promotion rebates given by suppliers are recognized under 2 different

categories. In the first, those that are determined according to the amount of purchases

made during the financial year will be credited against marketing and promotion

expenses in the profit and loss account. In the second category, those that are reimbursed

at the suppliers’ discretion will be credited when these are received against marketing and

promotion expenses in the profit and loss account.

During the financial year in which the Company and/or the Group’s prerogative to accept

payment have been established, dividend income is recognized gross in the profit and loss

statement

Time proportion basis is used to record interest income on the basis of the principle

outstanding and at the applicable rates.

Explain concisely if the methods adopted are appropriate?

5 Pg 44, Note 2(c)

2


Stamford records revenue on the accrual basis which means revenue is recorded right

after the services have been performed or the goods have been delivered. Stamford also

takes into account the amount of any volume rebates, advertising and promotion rebates

from the suppliers. Therefore, the amount recorded is the cash value of the service

transferred to the customer.

The revenue recognition is appropriate because revenue is recognized to the extent that it

is probable that the economic benefits will flow to the Group and the revenue can be

reliably measured. The method used is appropriate since it obey the revenue principle;

revenues are recognized when they are realized or realizable and earned.

Question 3

What percentage of total assets does the company hold as accounts receivable at the

end of the financial year? How does this compare to the previous year?

The table of percentage of total assets held as account receivable:

Title/Year 2005 2004

Total assets (S$ ‘000)6 199,470 182,117

Total Account Receivable (S$ ‘000)7 68,748 60,067

Percentage of total asset hold as

account receivable (%)34.5% 33.0%

The percentage has raised 1.5% compare to the previous year (2004)

How would you evaluate the appropriateness of the company’s bad debt policy?

Stamford accounts for its bad debt using the Allowance for uncollectible account

method8. This method accounts for the losses of bad debt on the basis of estimates.

Stamford records the estimated amount in the Allowance for Doubtful Trade Receivables

6 Pg 40, Balance Sheets7 Pg 59, Note 16 & 178 Pg 47, Note 2(m)

3


and Allowance for Doubtful Receivables. These are the contra accounts for Trade

Receivable and Other Receivables.

This method is appropriate because it neither overestimates the total assets nor

underestimates the expense. Thus, it provides a clearer view of Stamford’s financial

position. It is also consistent with accrual accounting and matching principle.

In 2005, Stamford records S$5,329,000 for total Allowance for doubtful receivable,

which is about 8% of total receivable9.

Question 4

What are the types of inventories carried by the company?

Stamford holds four types of inventories (1) inventories for sale, (2) inventories held for

rental, (3) raw materials and (4) work-in-progress – aluminum alloy wheels10.

In general, why must companies use cost flow assumptions to cost their inventories?

What cost flow assumption does the company use to cost its inventories?

In general, the price of a good is not constant. For instance, it can be affected by

inflations, influences from the market, etc. Therefore, it is difficult to record for

inventories without any cost flow assumption of product sold.

The company uses weighted-average-cost method to record its inventories.

Is the assumption appropriate?

This assumption is appropriate. Last-in, first-out method is not allowed to used in

Singapore thus, Stamford cannot use this method. Moreover, Stamford does not deal with

unique or expensive inventories such as antique of jewelry and its sales volume is high so

the specific unit cost should not be used. Since types of tires sold are based on market

demand so it will be appropriate to assume that later purchases of a certain vehicle’s tires

9 Pg 59, Note 16 & 1710 Pg 59, Note 15

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may be sold first than earlier purchases of a different vehicle’s tires and vice versa.

Therefore, it is appropriate to use the weighted average cost method, which assumes that

the inventories sold are a mixture of earlier and recent purchases.

In addition, the cost includes all direct expenditure and production overheads based on

normal level of activities. In addition, as compared to first-in, first-out (FIFO) cost

method, the weighted-average cost method incurs lower income taxes as it reports lower

profits when inventory unit costs are increasing.

Compute the total historical cost of the company’s inventories as the latest balance

date?

Historical Cost = Inventories for sale + allowance for obsolescence11

= S$62,338,000 + S$6,278,000

= S$68,616,000

Question 5

How does the company depreciate its property, plant and equipment (fixed assets)?

Does this policy look reasonable? In answering the latter question, explain concisely

the tradeoffs management makes in choosing a depreciation policy, and how an

investor can assess the reasonableness of the depreciation policies of a company.

Stamford uses the straight-line method to calculate the depreciation of property, plant and

equipment (P, P & E).12

Depreciation rate (per annum):

Leasehold land and building 1.7% to 5.0%

Leasehold improvement 10%

Motor Vehicle 20%

Plant and equipment 5% to 10%

Computer Software and Hardware 331/3 %

11 Pg 59, Note 1512 Pg 42, Note 2 (d)

5


There is no depreciation for free hold land and construction-in-progress.

During the financial year, the whole year’s depreciation is charged in the year of

acquisition and no depreciation is charged for the year of disposal. Fully depreciated

assets which are still in use are retained in the financial statements.

Stamford reviews the useful life of property, plant and equipment annually to ensure that

the method used and period of depreciation are consistent with the fluctuations of

economic benefits. Based on the above information, Stamford has changed the period for

office furniture and equipment from 10 years to 8 years and leasehold building from 64

years to 50 years. Those changes have incurred an additional S$294,000 depreciation

charge for the financial year.

The policy of estimating the depreciation is appropriate. Usually, managers consider the

tradeoffs in choosing a depreciation method out of 3 main types: Straight line, units-of-

production, and double-declining-balance method. Straight line method divides the

depreciation costs by its useful life in years; this makes the calculation easier and more

convenient, however, this method may not accurately reflect the economic benefits

obtained from the assets in a particular financial period, and hence depreciation expenses

may not match revenue earned. Therefore, when operating revenue is high, this method

will give a good net profit, but when operating revenue is not good, the net profit reported

will be low. The units-of-production method compute the depreciation based each unit of

output produced by the assets. By using this method, the manager can have a better

estimation of depreciation and the asset’s remaining useful life. The double-declining-

balance method is used mainly to reduce the income tax as it accelerates depreciation and

lower the net profit.

An investor can look at the annual report of the company to get the information about the

method used to compute the depreciation of property, plant and equipment. Furthermore,

the investor can also find annual depreciation rates of property, plant and equipment and

compare with the usual rate of depreciation of these assets. Investors should also compare

previous financial period’s operating revenue and depreciation expenses with current

period, if for instance, there is a big jump in operating revenue but depreciation expense

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does not match, or vice versa, then the policy may not be reasonable. Thereby, he or she

can make an evaluation of the reasonableness of the depreciation policies of Stamford.

Did the company dispose of any property, plant and equipment during the latest

financial year? Was there any gain or loss on such disposals? What would be the

journal entry to record such disposals? (Where applicable, use one of the disposals

made by the company to illustrate how the gain/loss should be recorded.)

Stamford did record a gain of S$193,000 on disposal of property, plant and equipment for

the year ended 30 April 2005.13

Journal entry for this disposal14:

30 April 2005 Accumulated Depreciation ……………………. $662,000

Cash…………………………………………….. $416,000

Gain on Disposal of plant and equipment ……………$193,000

Plant and equipment…………………………………..$885,000

To record gain on disposal of plant and equipment

Question 6

Does the company have any intangible assets? What are these? What are the

accounting policies regarding amortization or impairment of these intangible assets?

Yes, Stamford Tyres Corporation Limited has intangible assets15, which are (1) computer

software (2) goodwill (3) preliminary, pre-operating expenses and (4) research and

development costs

For computer software, they are stated at cost less accumulated amortization and any

impairment loss. Commencing from the date the software is available for used, the cost is

amortized on a straight line basis over a period of 3 years.

13 Pg 52, Note 514 Pg 55, Note 915 Pg 46, Note 2(j)

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Goodwill is regarded as the excess of the fair value of the consideration given over the

fair value of the identifiable net assets of the subsidiary, joint venture and associated

companies when acquired.

Positive goodwill is amortized through the consolidated profit and loss account on a

straight line basis over its useful economic life up to a maximum of 20 years, determined

on individual basis. Goodwill which is assessed as having no continuing economic value

is written off to the consolidated profit and loss account.

Preliminary, pre-operating expenses and research and development costs are

expensed as incurred, except for development costs which are expected to generate future

economic benefits. Such development expenses are capitalized and amortized through

profit and loss account on a straight line basis over a period of 5 years upon

commencement of operations.

Question 7

Besides the stated liabilities on the balance sheet, state and (if possible) quantify other

possible future obligations that the company has as at the latest balance date. What is

the importance of such information to investors? (Note: If the company reports more

than three other possible future obligations, pick any three to explain.)

The possible future obligation is Guarantees issued for bank facilities granted to

subsidiary companies16.

This information is important because it provides a better look on the company’s

prospects when the obligation occurs. The future obligation will involve cash outflows in

the future which can result in lower cash equivalents. Investors may do a wrong

investment on the company if the obligation were not stated on the annual report.

Question 8

16 Pg 72, Note 32

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What are the transactions that are reported in the company’s statement of changes in

equity? In your own words, explain as completely as possible the nature of each of

these transaction(s). (Note: If there are more than three transactions reported, pick any

three to explain.)

The transactions reported in the Company’s statement of equity changes are the (1)

issuance of ordinary shares, (2) cash dividend payout and the (3) transfer from capital

reserves.

The issuance of shares is to finance or expand the operations and the investments of the

Company by issuing to investors shares that represent the market value of the business,

which in turn receive cash or equivalent asset from investors and transfer to its paid-up

Capital. Cash dividend payments are made from the revenue reserves account, which is

the retained profits of the business, and this transaction can be carried out even when the

company incurred a loss in the financial period only if retained profits balance is positive.

The transfer from capital reserves due to exercise of Warrant 200717 is a transaction

where by warrants owners are allowed to purchase ordinary shares at exercise price of

$0.10 and the net proceeds will be transferred from capital reserve to share premium

reserve.

Question 9

Refer to the balance sheet. Are there any investments in other companies or entities

made by the company? How are they accounted for?

Yes, Stamford Tyres Corporation has investments in other companies and entities in the

form of (1) subsidiary companies, (2) joint venture company and (3) associated

companies

Investments in subsidiary companies are recorded at cost less provision for diminution

in value in the financial statements. The purchase method of accounting is applied in the

acquisitions of subsidiary companies. 17 Pg 69, Note 28

9


Joint ventures are considered as entities having interest on a long-term basis by the

Company and are also partly managed by the Group having one or several parties under a

contractual agreement.

The Group’s interest in the joint venture company is documented in the consolidated

balance sheet and profit and loss account using the proportionate consolidation method.

The Group’s share of the joint venture company’s assets, liabilities, income and expenses

are joined on a line by line basis with items that are the same in the consolidated financial

statements. Investments in Joint Venture Company are stated at cost less provision for

diminution in value on the Company’s financial statements

An associated company is regarded as a company, not being a subsidiary company, in

which the Group has a long-term interest of not less than 20% of the equity and in whose

financial and operating policy decisions the Group exercises significant influence.

The Group’s share of the post-acquisition reserves of associated companies is included in

the investments in the consolidated balance sheet. When the Group’s share of post-

acquisition losses surpasses the amount of the respective investment, the investment is

reported at nil value and recognition of losses is ceased except to the extent of the

Group’s commitment.

In the event where the audited financial statements of these associated companies does

not match those of the Group’s, the share of profits is obtained from the last audited

financial statements available and unaudited management financial statements to the end

of the accounting period. Investments in associated companies are stated at cost less

provision for any diminution in value.

Question 10

Is there a “minority interests” item on the balance sheet and, if so, what does this refer

to? Is there a “goodwill” item on the balance and, if so, how did this arise?

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Yes, there is a “minority interests” item on the balance sheet. Minority interests refers to

the event whereby the parent company i.e. Stamford Tyres Corporation Limited,

purchases less than 100% of the shares of her subsidiary companies. In this case here,

minority interests on the consolidated balance sheet indicate the percentage of the

subsidiaries’ equities which are not held by Stamford Tyres Corporation Limited. The

minority interests can be thought of as an adjustment .This is because during the

preparation of the consolidated balance sheet, Stamford Tyres Corporation is assumed to

have whole ownership of her subsidiaries.

There is not a “goodwill” item on the balance sheet. Goodwill arose when Stamford

Tyres Corporation Limited paid more than the market value of her subsidiaries’ net assets

in order to acquire the subsidiary companies. At the beginning of the financial year, there

is an amount of $61,000 of goodwill in the Intangible Assets account. However, it is fully

amortized during the year and at the end of the year and it account becomes zero at the

end of the year18.

Q uestion 11

Did the cash and cash equivalents are the company increase or decrease? What are the

causes of this decrease?

The cash and cash equivalents of the year 2004 is $18,699,000 and of the year 2005 is

$8,776,000. The cash and cash equivalents of the company decreased by $9,923,000

during the latest financial year.

This decrease is mainly caused by financing activities. Compared with 2004, the cash

flows from financing activities have decreased sharply by $17,511,000. The proceeds

from trust receipts in 2004 are $20,050,000, while in 2005, it becomes minus $7,179,000,

plus that the proceeds from issue of shares have decreased by $4,452,000. Also due to the

18 Pg 58, Note 13

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$2,059,000 used in operating activities, cash and cash equivalents decrease during the

latest financial year19.

Is this positive or negative for the company? Explain.

It is more or less good that the company has settled a significant amount of obligations

and cash flow from investing activities is negative which imply that the company is

growing.

However, there are also a negative signs for the company. Cash and cash equivalents

decrease sharply during the last financial year, and it has a trend to decrease in the

following years, because instead of generating cash from operation activities, the

company actually used up $2,059,000 in 2004. It implies four things:

Firstly, the cash flow from operating activities is negative and decreased during the latest

financial year, which means managers did not manage cash well.

Secondly, the decrease in cash and cash equivalents means the company does not have

strong ability to pay dividends to share holders and interest and principal to creditors in

the future.

Thirdly, from the cash flow statement we can predict future cash flows. The decrease of

cash and cash equivalents implies that the cash flow of next year may not be good either.

Fourthly, we can see that the quantity of earnings is not good, because most of its cash

comes from borrowing.

Question 12

19Pg 40, Consolidated Statement of Cash Flow

12


Who are the company’s external auditors? What sort of audit opinion did the company

receive in its latest financial year? In your own words, what does the opinion mean to

external users?

Stamford’s external auditor is Ernst & Young, Certificated Public Accountants20.

The auditors’ opinion was that Stamford had prepared the consolidated financial

statements of the Group and the balance sheet of the Company appropriately in

conformity to the provisions of the Singapore Companies Act, Cap. 50 and Singapore

Financial Reporting Standards. This reflects a reasonable view of the financial position of

both group and company as at 30 April 2005.

To external users, the opinion shows that Stamford’s financial statements are acceptable

and dependable. Therefore, it makes investors can be sure that the statements were not

modified to hide bad trends or show unreal statistics. External users can rely on these

statements to assess the current and future prospect of Stamford, and thus, making the

right decision in investing.

Question 13

The Council on Corporate Disclosure and Governance (CCDG) has issued a Guide on

the operating and financial review. In your own words, explain why an OFR can be

useful to an investor. Does the company provide information recommended by the

OFR guide?

The OFR provides analysis on the operating, investing and financing activities of

Companies and their financial positions. Companies are advised to disclose their

business’s nature and main types of operations in the OFR. They should also provide

information on their business objectives and strategies to achieve them. In addition,

companies should also provide analysis on the company’s operating environment,

discontinued and continuing operations, market conditions for its products and any

exceptional item, which affects performance. Through this analysis, investors can decide

whether the company’s operations are stable, sustainable in the long run, and profitable.20 Pg 38, Auditors’ Report

13


Secondly, investments should be analyzed for their risks and their realizable benefits

should be disclosed in the OFR, other than that, their losses and gains have to be

disclosed and discussed. Having these investments information, investors then can decide

whether the investments are sound and will enhance the financial position and

profitability of the company.

Thirdly, Companies are advised to discuss how they finance their operations and

investments that is, their debt and equity financing and what are the interest rates and

dividends payouts, their debt and equity positions. Knowing this information, investors

can decide on which investing way will have more financial benefits to them.

Besides that, companies are advised to discuss their capital structure, which include what

currencies their cash, cash equivalents and debts are measured, when their debts are due

and the amounts and the financial instruments associated. Companies are also advised to

discuss their liquidity and cash flows, special businesses and business-associated events,

not affecting balance sheet, such as contingent liabilities, main sources of revenue, and

their assets impairments. Therefore, investors can decide on the survivability of a

company and whether it is at risk of bankruptcy and whether the rate of assets usage is

compatible with revenue earned.

Lastly, companies are advised to produce notes to financial statements and discuss the

accounting policies and estimates used so as to help investors understand its financial

report and to decide whether it is in a sound position.

Stamford has provided information on its business initiatives and operations, operating

environment and products markets21. It also has information showing the trends on

financial performance indicators and positions over the years22. Its main sources of

revenues and tyres contract manufacturing investment are also discussed23. Lastly,

Stamford has provided information on its accounting policies and estimates such as assets

21 Pg 1-2, 10-12,22 Pg 4 – 5, Board of Directors23 Pg 14, 16 and 18

14


impairments, debts incurred, cash flows, capital structure, special businesses, contingent

liabilities and investments through its financial statements notes24.

Question 14

Refer to the Corporate Governance Statement (or equivalent) in the company’s annual

report. In your own words, explain why this statement can be useful to an investor.

The purpose of the Corporate Governance Report is to institute and ensure an ethical and

lawful environment within the company. In the Report, the matters concerning how the

company is managed are stated adequately. Such issues with regards to how the Board

conducts its affairs, the hierarchy in the company, the people in the Board, the distinction

of the roles of the President and the Chairman, the selection and performance of the

Board, accessibility of information, remuneration matters, audit cum accountability and

communication with shareholders are included. By disclosing such information, it allows

the investors to have an insight view of how the organization is managed. This

knowledge will assist the investors in assessing if the company is organized in such a

manner that it is safe to make an investment. In addition, the details allow the investors to

know who are the people running the company and who they want to elect for in the next

election at the Annual General Meeting.

Besides these, the Corporate Governance Report also states the risks that arise from the

business operations i.e. the common business risk, inventory and credit risk and product

liability claims. This disclosure informs and updates the investors on the risks the

company runs into and the measures taken to minimize or prevent them. Such

information will assure the investors that their investments are secure and also to consider

if the company is worth investing in.

The Report also assures the investors that there will be timely disclosure of the

company’s information to update them on the businesses and operations as well as

24 Pg 43-87, Financial Statements Notes

15


general meetings to address the queries or displeasures of the investors. Such interactions

will boost the investors’ confidence in the company because this gives the investors’ a

deeper feeling of ownership of the company. The rights of the shareholders to participate

in voting and the internal code on dealings with securities further enhance trust in the

Company

With this information provided by the Corporate Governance Report, investors will also

be able to evaluate the credibility of the company’s financial statements and the

transparency in which it reveals information about its operations, and whether there are

enough checks and balances to prevent any abuse of power by any directors or by the

management.

By considering all these matters, investors can then decide whether a company has good

governance in terms of its performance and also accountability.

Question 15

Compare the performance of the company for the latest two years. If you are a

shareholder, will you be happy? Support your answer with appropriate ratio and

percentage analysis. Show computations of the ratios and percentages.

Stamford financial analysis:

Ability to pay debt and current liability:

Year/Ratio 2005 2004

Total current assets ($ ’000) 144,918 133,557

Total current liabilities ($ ’000) 86,522 85,326

Current ratio 1.67 1.57

Total liabilities ($ ’000) 131,018 118,588

Total assets ($ ’000) 199,470 182,117

Debt ratio 0.66 0.65

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Current ratio shows the company’s ability to pay current liability with current assets,

i.e. the ability to pay the current debt of the company. The ratio has increase from 1.57 to

1.67, which is an acceptable ratio for most company.

Debt ratio shows the proportion of Stamford’s liabilities that have to be financed by

assets. It increased from 0.65 to 0.66 (a relatively low-risk position), meaning that

Stamford has keep the obligations stable (with an insignificant change in the ratio).

Current ratio and debt ratio imply that Stamford has a relatively strong financial position

and is unlikely to go bankrupt in the next few years.

Ability to sell inventory and collect receivable:


Cost of goods sold ($ ’000) 138,811 138,805

Average inventory25(62,338 + 52,657) / 2

= 57,498

(52,657 + 40,43226) / 2

= 46,544

Inventory turnover 2.41 2.98

One day’s sales ($’000)27 524.8 520.6

Average Account Receivable ($ ‘000)(68,748 + 60,067) / 2

= 64,408

(60,067 + 51,29328) / 2

= 55,680

Days’ sales in receivable 122.7 106.9

Inventory turnover indicates the salebility of inventory; it shows how many times the

company sells its average inventory in a year. Stamford’s slightly decrease by 0.57, from

2.98 to 2.41. It is a reasonable value for inventory turnover.

Days’ sale in receivable shows how many days it takes for Stamford to collect the

average level of receivable. Days’ sale in receivable has increased from 106.9 to 122.7.

The increase shows a bad sign in collecting cash and could lead to cash shortage.

Profitability:

25 Pg 40, Balance Sheets26 Stamford Tyres Annual Report 2004, Pg 16, Balance Sheets27 See Question 328 Stamford Tyres Annual Report 2004, Pg 16, Balance Sheets

17



Net profit ($ ‘000) 8,607 11,544

Interest expense ($ ‘000) 0 0

Average total assets ($ ‘000)(199,470 + 182,117) /

2 = 190,794

(182,117 + 145,38629) /

2 = 163,752

Return on assets (%) 4.51 7.05

Net profit ($ ’000) 8,608 11,544

Net sales ($ ’000) 191,581 190,005

Rate of return on net sales 4.49 6.08

Net profit ($ ’000) 8,607 11,544

Preference dividend ($ ’000) 0 0

Average ordinary shareholders’ equity

($ ’000)

(68,452 + 63,529) / 2

= 65,991

(63,529 + 49,444) / 2 =

56,487

Return on equity (%) 13.0 20.4

Return of assets (ROA) measures a company’s success in using its assets to earn profit

for the two groups who finance the business: creditors and shareholders. 4.51% is a not

very good rate of return on total assets since the industry average ROA is about 7.80%.

Furthermore, Stamford has shown a bad sign in operating its assets as ROA reduced

slightly from 7.05% to 4.51%.

Return of equity (ROE) a measure of the amount of profit earned for every dollar

invested by the ordinary shareholders; it can indicate how successful the company is.

20.4% in 2004 and 13.0% in 2005 is a good ROE. Stamford’s return on equity is higher

than its return on assets which shows that its operating income exceeds the interest from

borrowing. However, a decrease from 20.4% to 13.0% is a considerable dropping off. As

a result, the amount of profit for every dollar invested has decreased. This is unfavorable

for shareholders.

The earnings per ordinary share (EPS) give the amount of net profit per share of

Stamford’s issued ordinary shares. This EPS dropped from 6.2 to 4.2 cents due to a

29 Stamford Tyres Annual Report 2004, Pg 16, Balance Sheets

18


decreased net profit and an increased in the number of issued ordinary shares which

means each share is now linked with a lower proportion of net profit, suggesting concerns

about the value of shares.

Share analyzing:


Earnings per ordinary share (cents/share)30 4.2 6.2

Dividend per ordinary share (cents/share) 2.031 2.0

Market price per ordinary share (cents/share)32 15.0 15.1

Dividend yield (%) 13.3 13.2

Market price per ordinary share (cents/share) 15.0 15.1

Earnings per share (cents/share) 4.2 6.2

Price/earnings ratio 3.6 2.4

Dividend yield measures the part of a share’s market value that is returned as dividend in

a particular year. Stamford’s dividend yield in 2005 seems to be equal to 2004’s. It means

that the amount of return as dividends is unchanged for the year.

Price/earnings ratio (P/E) is an important ratio in deciding the status of the shares, i.e. to

buy, hold or sell shares; it indicates the market price for every dollar earned. Stamford’s

P/E has increased from 2.4 to 3.6, meaning that shares are sold at 3.6 times the earnings.

This increasing ratio indicates a high probability of market share price to fall.

Although Stamford is considered to have a good financial position and/or seems not to

face with probable financial problems, the dropping off of return of assets, return of

equity, earning per share indicates declined returns to shares. The increased in P/E also

suggest that the market price of Stamford’s share will fall soon. This may even lead to an

unexpected release of ordinary shares and thus, making the price to fall dramatically. As

shareholders, we will obviously be not happy with such a pessimistic condition.

30 Pg 39, Consolidated Profit and Loss Account31 Pg 70, Note 2932 Market price = (Share Capital + Share premium) / Total number of Share

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Question 16

If you are a potential investor, would you use your own money to buy shares of the

company? Why?

From the above ratios and data used for analysis, we can see that Stamford’s financial

position can be considered ‘healthy’ and ‘strong’ although there are some bad signs

appear on Cash Flow and days’ sale on receivable. Stamford seems not easy to go

bankrupt in next few years as it has high current ratio and very low debt ratio.

However, as potential investors, we will consider the trends of these ratios and the returns

of share/equity. As we have computed and discussed in Question 15, Stamford shows

some bad symptoms on the returns to shareholders (such as decrease in return on equity,

return on total assets and EPS) and an increase in P/E from 2004 to 2005. As those

problems appear, we will not invest in Stamford’s share at the moment, based on the

2005’s statistics. However, we will keep lookout for and further analyze its business in

the next year as Stamford has such a good financial position which can help it change

those not good signals.

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Documents

FNA1002 Group Project B29 FINAL[1]