Executive summary

The aim of this paper is to analyze the financial ratios of the given companies i.e. Harvey Norman Holding Ltd and JB Hi-Fi Ltd., in order to make an informed investment decision based upon the interpretation of the ratios implying the profitability, efficiency and stability of the companies and based upon that making a judgment regarding the potential returns one may expect from investing in the company that provides better opportunity and why and how may one come to such conclusion. The interpretation of the ratios along with comparative analysis of the companies is provided along with the limitations and the recommendation in respective regard.

Table of Contents

Introduction...................................................................................................................................1

Analysis of the Financial Ratios......................................................................................................2

Profitability.................................................................................................................................2

Efficiency....................................................................................................................................4

Financial Stability....................................................................................................................... 4

Analytical Reasoning..................................................................................................................7

Limitations..................................................................................................................................... 8

Conclusion and Recommendations................................................................................................9

Appendix......................................................................................................................................11

Introduction

This report comprises analysis of two companies HNV and JB Hi Fi. HNV was formed in NSW as

Caviton Ltd on 02nd Feb 1987 and became Harvey Norman Holdings Ltd (HNV) on 20th May 1987.

HNV is Australia’s one of major electrical franchisor and its most important activities consists in

retail business dealing furniture, home furnishing and wide range of electrical goods computers,

3D TV, sound systems, communication and electrical consumer products and had 264 retail

complexes at different geographical location under different brands name (HNH, 2010).

Whereas, Mr. John Barbuto (JB) founded JB Hi-Fi in 1974 as a discount retailer of Hi-Fi

equipment and recorded music through a single store in Melbourne. In 1983, the business was

sold, and there were 10 stores formed in 2000. JB Hi Fi stores offer the world top brands of

consumer electronics, electrical products and range of specialist Hi-Fi products. JB Hi Fi has

already expanded 141 stores, 131 stores located in Australia and 10 stores in New Zealand (JB

Hi-Fi, 2010). The analysis aims to provide the information to any investing body about the

financial stability, profitability and efficiency of both businesses.

1

Analysis of the Financial Ratios

The importance of the analysis of the financial ratio can be understood by the fact that they

provide with quantitative information to facilitate the evaluation of the operations of

companies and their stance in the sector or industry from investor's point of view as well and

manager's point of view (Gallizo & Salvador, 2002). They are taken as a measure of any

company's health and ,thus, works as an effective measure to judge the performance of the

company, its strengths, its weaknesses and the risks that it faces in the sector. However there

limitations apply to this analysis and the solutions would not always be easily available for every

financial diagnosis of any company (NACVA, 2005).

Keeping this in mind to conduct the financial analysis of Harvey Norman Holdings Ltd. and JB Hi-

Fi Ltd., we consider the following perspectives of the companies' financial operations in order

to evaluate the companies' investment potential. Our approach is to conduct the financial

analysis on the companies comparatively and then based on our evaluation decide upon our

investment relation with the company that is relatively more profitable for this investment. And

for that we evaluate the following factors financially:-

Profitability

Efficiency

Stability

Profitability

Profitability Ratios, based on revenues, assess a company's ability to generate income. A high

value for most of these ratios imply that a company is doing well furthermore, these ratios are

comparable with competitors' in order to evaluate one as better in profitability than other i.e. a

company with higher ratio will surely be doing better than a company with relatively lower

values for these ratios. Some of this ratio used to measure the profitability of companies under

our consideration, are discussed below:-

Gross Profit Margin: It's the percentage of sales revenue left after paying for the direct

costs. Harvey Norman had a GPM of about 27.98% at the year ended June 2010 while back in

2

2009 it was 27.58%, which shows a growth in 2010 relative to the previous year's GPM. JB Hi-Fi

had GPM of 21.75% in 2010 as compared to 21.64% in 2009. Both the Gross profit margin and

the size of the growth in 2010 as compared to previous year shows that Harvey Norman

performed better in this ratio as compared to JB Hi-Fi.

Net Profit Margin: This ratio shows the percentage of revenue generated by the

company that is translated into profits. Harvey Norman had NPM of about 31.24% at the year

ended June 2010 while back in 2009 it was 26.58%, which shows a growth in 2010 relative to

the previous year's NPM. JB Hi-Fi had NPM of 6.46% in 2010 as compared to 6.16% in 2009. Not

unlike Gross Profit margin, both the size and the percentage figure and the size of the growth in

2010 as compared to previous year shows that Harvey Norman performed better in this ratio as

compared to JB Hi-Fi.

Return on Equity: This ratio measures the return on the equity of the company that is

contribution of shareholders in the company. Harvey Norman had ROE of about 11.03% at the

year ended June 2010 while back in 2009 it was 10.65%, which shows a growth in 2010 relative

to the previous year's ROE. However, JB Hi-Fi had ROE of 40.45% in 2010 as compared to

41.19% in 2009, which actually fell in 2010. In 2010 as compared to previous year, Harvey

Norman performed better in this ratio compared to its previous year performance. Although, JB

Hi-Fi performed better in this ratio in both years than Harvey Norman, but it performance

declined in 2010 as compared to 2009 performance.

Return on Assets: This ratio indicated how well the assets are being managed by the

company by measuring the return on the total assets of the company. Harvey Norman had ROA

of about 11.34% at the year ended June 2010 while back in 2009 it was 10.47%, which shows a

growth in 2010 relative to the previous year's ROA However, JB Hi-Fi had ROA of 24.71% in

2010 as compared to 21.69% in 2009, which increased in 2010. In 2010 as compared to

previous year, Harvey Norman performed better in this ratio but only as compared to its

previous year performance. JB Hi-Fi not only performed better in this ratio in both years than

Harvey Norman but also its performance improved in 2010 as compared to 2009 performance.

3

Efficiency

Efficiency ratios tend to maximize the asset utilization efficiency. In other words it is the

measure of company's effectiveness in maximizing its use of resources. The higher the value for

these ratios the better the company is supposed to be performing in terms of efficiency. Two of

the main efficiency measures are as follows:-

Asset Turnover: This ratio measures the efficiency of a company in generating sales

from its assets. Harvey Norman had an Asset T.O. ratio of about 0.36 times at the year ended

June 2010 while back in 2009 it was 0.39 time which shows a decline in 2010 relative to the

previous year's performance. However, JB Hi-Fi had Asst T.O. of 3.82 times in 2010 as compared

to 3.51 times in 2009, which increased in 2010. In 2010 as compared to previous year, Harvey

Norman did not perform better in this ratio as compared to its previous year performance. JB

Hi-Fi not only performed better in this ratio in both years than Harvey Norman but also its

performance improved in 2010 as compared to 2009 performance.

Inventory Turnover: This ratio shows the time a company takes to sell and replaces its

inventory within a given period or the number of days it takes to replace its inventory. Harvey

Norman had an Inventory T.O. ratio of about 98 days at the year ended June 2010 while back in

2009 it was 91 days which shows a growth in 2010 relative to the previous year's performance.

However, JB Hi-Fi had Inv. T.O. of 57 days in 2010 as compared to 65 days in 2009, which

apparently fell in 2010. In 2010 as compared to previous year, Harvey Norman performed

better in this ratio as compared to its previous year performance as well as compared to JB Hi-

Fi, while JB Hi-Fi showed a fall in this ratio from 2009 to 2010. A high value for this ratios shows

strong sales but it may also imply that the buying is ineffective and the cost is just too high. On

the other hand a low turnover implies low sales but it may also be caused by excess in

inventory.

Financial Stability

To evaluate the stability of the company, two types of ratio analysis are discusses. Liquidity

ratios, which determine the company's ability to pay of its obligations in the short run, and

4

Leverage ratios, which determines the methods of financing of a company to meet its

obligation mostly n the long run. A higher value of liquidity ratio provides margin of safety and a

cushion against bankruptcy for the company. some of th important ratios are discussed below.

Current Ratio: The ratio measures the company's ability to pay its short term obligations

and is a liquidity ratio. Harvey Norman had a Current ratio of about 1.62 at the year ended June

2010 while back in 2009 it was 1.11 which shows a growth in 2010 relative to the previous

year's performance. However, JB Hi-Fi had current ratio of 1.25 in 2010 as compared to 1.31 in

2009, which apparently fell in 2010. In 2010 as compared to previous year, Harvey Norman

performed better in this ratio as compared to its previous year performance as well as

compared to JB Hi-Fi, while JB Hi-Fi showed a fall in this ratio from 2009 to 2010. A current ratio

under 1 indicates signs of bankruptcy.

Quick Ratio: The ratio measures the company's ability to pay its short term obligations

but with its most liquid assets and is a liquidity ratio. Harvey Norman had a quick ratio of about

1.43 at the year ended June 2010 while back in 2009 it was 0.99 which shows a growth in 2010

relative to the previous year's performance. However, JB Hi-Fi had quick ratio of 0.33 in 2010 as

compared to 0.31 in 2009, which also grew in 2010. In 2010 as compared to previous year,

Harvey Norman performed better in this ratio as compared to its previous year performance as

well as compared to JB Hi-Fi, while JB Hi-Fi also performed better in this ratio from 2009 to

2010.

Debt to Equity Ratio: For every dollar of common equity finances, this ratio tells the

proprtion the firm uses of long-term debt. Debt to Equity Ratio is a measure of a company's

financial leverage. Harvey Norman had an Debt to Equity ratio of about 0.717 at the year ended

June 2010 while back in 2009 it was 0.775 which shows a decline in 2010 relative to the

previous year's performance. However, JB Hi-Fi had Debt to equity ratio of 1.43 .in 2010 as

compared to 1.88 in 2009, which also fell in 2010. In 2010 as compared to previous year,

Harvey Norman did not perform better in this ratio as compared to its previous year

performance as well as compared to JB Hi-Fi, while JB Hi-Fi also did performed better in this

ratio from 2009 to 2010.

5

Debt to Asset Ratio: This ratio tells the Proportion of assets of the company that are

financed by the creditors Harvey Norman had an debt to asset ratio of about 41.7% at the year

ended June 2010 while back in 2009 it was 43.67% which shows a decline in 2010 relative to the

previous year's performance. However, JB Hi-Fi had Debt to asset ratio of 58.9% in 2010 as

compared to 65.3% in 2009, which also declined in 2010. In 2010 as compared to previous year,

Harvey Norman did not perform better in this ratio as compared to its previous year

performance as well as compared to JB Hi-Fi, while JB Hi-Fi also did not perform better in this

ratio from 2009 to 2010.

Interest Coverage Ratio: This ratio determines the feasibility of a company to pay

interest on outstanding debt. Harvey Norman had TIE ratio of about 12.48 times the year

ended June 2010 while back in 2009 it was 11.03 times which shows a growth in 2010 relative

to the previous year's performance. However, JB Hi-Fi had TIE ratio of 25.38 times in 2010 as

compared to 17.86 times in 2009, which also grew in 2010. In 2010 as compared to previous

year, Harvey Norman performed better in this ratio as compared to its previous year

performance but not as compared to JB Hi-Fi, which also performed better in this ratio from

2009 to 2010.

6

Analytical Reasoning

We see that except for the stability ratios that are in favor for investment in JB Hi-Fi

because the risk of default seems low, profitability and efficiency remain with Harvey Norman

with potential for greater returns. the reason for such outcome can be seen in the events both

the companies have been facing. According to Bloomberg Shares of Harvey Norman rose on the

third day on the speculation of the new store opening, which implied greater sales and growth.

However, stocks were falling before this and the revenues declined as the selling prices

were repressed to lure customers in during a season of low sales and high cost of borrowing.

Nevertheless, the recent figures indicate that Harvey Norman had made his grip firmer through

elite competition and advanced consumer offers. 7 out of 10 analysts remain positive on the

stock position for Harvey Norman supporting the facts (Fenner, 2005).

On the other hand embarrassment has been the fate for JB Ho-Fi brought on by Clive

Anthony failure in turning the sale figure tracks upwards. The returns have been utterly

disappointing, while rebranding, restructuring and closing of non-operational stores has been

have been actively under consideration recently. The sales have fallen, and performance has

remained substandard (Stockdill, 2011).In spite of negative figures the retailers remain hopeful

for a positive future. Considerations for closing some and changing the format of the stores

somewhat seem to keep some potential for the company, however on a smaller scale (AAP,

2011).

According to Harvey, lack of a good business model leads to business failure. He also regrets not

buying JB Hi-Fi at $ 140 million when he had the chance seeing how the online business has

elevated its cost to $ 2 billion now. The article suggest though that what seems to be the

greatest weakness of HNV is its greatest strength, his continuing leadership. where Harvey is a

quite a hand on operation as the article quotes, it would be difficult to replace him. His advice

for business model remained that w" while in the black" put retail pricing as the focus of your

attention in business (Black, 2010).

7

Limitations

The emphasis that we put on the financial ratios for the purpose of decision making does not in

any way imply that they predict definite failure or success of the company (Beaver, 2010).The

main concern is the interpretation of these ratios and the discernment regarding to how the

movement in these ratios take effect and what is the actual perpetrator in the event. These

ratios or the financial data do not just provide solution rather that should base solely upon the

decision makers judgment. However, what these ratios do is that they keep the ability to

predict the circumstances upon which the policy makers and investors can base their decision.

Nevertheless, nothing can be predicated with absolute certainty and mangers are well

equipped to window dress their information with information that is ambiguously deceiving.

Also there appears to be no consensus for many indicators about what should be accepted as

"good performance" as a hard and fast rule (Flex Monitoring Team, 2005).

8

Conclusion and Recommendations

It is evident that the ability of the ratios to predict is uncertain and there are different

perspectives to ratio interpretation while a certain figure may imply both positive and negative

prospect to the company. The ratios suggest that in terms of profitability and efficiency which

imply both greater return to invested money and maximum utilization in an effective manner,

Harvey Norman seems to be the appropriate investment opportunity. However since there are

greater returns the risk is bound to be greater as well. With respect to the ratios indicating

liquidity and stability of the company financially both in the short run and the long run, the

better option appears to be JB Hi-FI since it is much better cushioned against liquidity risks.

Even though Harvey Norman in this case seems to be a better investing option, besides the

conventional recommendations and conclusion, a wise act would be to make judgment upon

experience and proper research regarding the credential of the company and the sector in

order to familiarize with the window dressing and the market dressing. Investing solely upon

the basis of the interpretation of these comparative ratios is not enough without market

knowledge and first hand exposure to the sector in operation. Further analytical ratios and

graphs for Harvey Norman for decision making analysis samples are provided in the appendix to

help support the investment decision.

9

References

AAP. (2011, April 4). JB Hi Fi: Still Room for more Stores.

Beaver, W. H. (2010). Financial Ratios As Predictors of Failure. Journal of Accounting Research .

Black, A. (2010, October). In Store For Success .

Fenner, R. (2005, September 7). Harvey Norman Shares Rise a Third Day After Analyst Upgrade.

Flex Monitoring Team. (2005). Financial Indicators for Critical Access Hospitals. The Flex Monitoring Team.

Gallizo, J. L., & Salvador, M. (2002). Understanding the Behavior of Financial Ratios:The Adjustment Process. Journal of Economics and Business .

HNH. (2010). Annual Report . HArvey Normans Holdings Limited.

JB Hi-Fi. (2010). Annual Report. JB Hi-Fi.

NACVA. (2005). ANALYSIS OF THE STATEMENT OF CASH FLOW AND FINANCIAL RATIO ANALYSIS. In CASH FLOWS AND FINANCIAL RATIO ANALYSIS: Fundamentals, Techniques & Theory (pp. 44-58). National Association of Certified Valuation Analysts.

Stockdill, R. (2011, March 29). JB Hi Fi may Axe Electrical Chains.

Trigueiros, D. (1994). Incorporatin Complementary Ratios in the Analysis of Financial Statements. Elsevier Science Ltd .

10

Appendix

Table 1.1

JB Hi Fi Ltd (Consolidated) for years ended 30 June

Harvey Norman Holdings Ltd. (Consolidated) for years ended 30 June

KEY RATIOS 2009 2010 2009 2010 Gross Profit Margin

21.64% 21.75% 27.58% 27.98%

Net Profit Margin

6.16% 6.46% 26.58% 31.24%

Return on Equity 41.19% 40.45% 10.65% 11.03% Asset Turnover 3.51 times 3.82 times 0.39 times 0.36 times Return on Assets 21.69% 24.71% 10.47% 11.34% Inventory Turnover

65 days 57 days 91 days 98 days

Debtors Turnover

1.8 days 1.34 days 261 days 282 days

Creditors Turnover

49 days 44 days 250 days 248 days

Current Ratio 1.31 1.25 1.11 1.62

Quick Ratio

0.31 0.33 0.99 1.43

Debt Asset Ratio 65.3% 58.9% 43.67% 41.7% Debt Equity Ratio

1.88 1.43 0.775 0.717

Times Interest Earned

17.86 times 25.38 times 11.03 times 12.48 times

11

Table 1.2

Growth Ratios Sales Growth -6.7%Income Growth 11.0%Asset Growth 1.3%Activity Ratios Receivable Turnover 1.2Inventory Turnover 3.7Profit Ratios Profit Margin 28.7%Return on Assets 10.5%Return on Equity 18.3%Dividend Payout Ratio 58.0%Price Earnings Ratio 0.0Liquidity Ratios Current Ratio 1.62Quick Ratio 1.29Solvency Ratios Debt to Total Assets 0.42Times Interest Earned (Accrual) 16.90Times Interest Earned (Cash) 12.54

12

Table 1.3

RATIO ANALYSIS

Income Statement Common Size Data Gross Profit/Sales 28.0% 21.8%Income from Continuing Operations/Sales 0.0% 4.3%Balance Sheet Common-Size Data Current Assets/Total Assets 42.0% 63.6%Current Liabilities/Total Assets 26.0% 50.8%Liabilities/Total Assets 41.8% 58.9%Equity/Total Assets 58.2% 41.1%Profit Ratios Profit Margin 0.0% 4.3%Return on Assets 0.0% 17.2%Return on Equity 0.0% 45.4%Dividend Payout Ratio 35.7% 56.5%Liquidity Ratios Current Ratio 1.62 1.25Quick Ratio 1.29 0.32Solvency Ratios Liabilities/Total Assets 0.42 0.59Times Interest Earned (Accrual) 5.41 25.38Operational Ratios Receivable Turnover 1.2 44.1Inventory Turnover 3.7 6.5

13

Figure 1.1

2009 2010

$0

$500,000

$1,000,000

$1,500,000

REVENUE TREND

Figure 1.2

2009 2010

$0

$50,000

$100,000

$150,000

$200,000

$250,000

$300,000

$350,000

$400,000

NET INCOME TREND

14

Figure 1.3

2009 2010

$0

$50,000

$100,000

$150,000

$200,000

$250,000

$300,000

$350,000

$400,000

$450,000

$500,000

INCOME TO CASH FLOW COMPARISON

Income - Con-tinuing Opera-tions

Cash Flow from Opera-tions

Figure 1.4

2009 2010$0

$500,000

$1,000,000

$1,500,000

$2,000,000

$2,500,000

$3,000,000

$3,500,000

$4,000,000

ASSET CHANGES

Total Assets

15