Financial Statement Analysis of a company can be performed through Accounting analysis, Finance Analysis and Credit Analysis and is utterly important as it helps to get a thorough and in depth understanding of the company’s operations and the market standing. The findings of the Financial Statement Analysis is used by different parties to serve their multiple intentions; investors for future investment decisions, creditors for the security of the payback of their dues, shareholders for the return on and the security of their funds.
LOLC Finance PLC is one of the major non-banking financial institutions in Sri Lanka, operating under the Mother Brand of LOLC Group. Being a member of Banking Finance and Insurance sector of the economy that involves in lending and borrowing business, the findings of the Financial Statement Analysis of LOLC Finance PLC are of higher importance to analyze and predict the direction and the standing of the company in the market.
In this report, the Financial Statement Analysis of LOLC Finance PLC has been performed to identify the Financial, Accounting and Credit standing of the company for three years from 2014 to 2016.
Lanka ORIX Finance PLC (LOFC) belongs to Lanka ORIX Leasing Company (LOLC) is one of the leading financial service provider in Sri Lanka. LOFC is one of the leading financial service providers in Sri Lanka which was formed in 1980 and as of date, the company has grown into one of the largest financial groups in the country with the acquisition of Commercial Leasing Company. LOLC’s portfolio is broadly categorized as financial services and non-financial services, encompassing leisure, plantations, agricultural inputs, renewable energy, construction, manufacturing & trading and other strategic investments.
LOFC is the largest subsidiary company of the LOLC group. LOFC is the license finance company that incorporated as a wholly owned subsidiary of LOLC which incorporated in year 2001. The LOLC acquired & owns 90% shares of LOFC.
Ratio analysis is a useful management tool which increases the understandability of financial statements. While analyzing financial statements profitability, financial, liquidity, gearing and investment/shareholder can be used. In ratio analysis are done comparison of ratios industry, past, sector and all firms.
In liquidity ratios seek to measure the company’s ability to meet customers’ withdrawal requests. When analyzing the current and quick ratios in past three years, due to the nature of the industry its absence of inventory resulted in similar kind of current ratio and quick ratio without significant fluctuations.
The gross profit margin is within a range of 40% – 55% whereas net profit margin lies in range of 10% – 15%.
|Gross Profit Margin||51%||54%||42%|
|Net Profit Margin||11%||14%||10%|
The Debt to Equity ratio of the company has increased from 2.02 in 2014 to 3.25 in 2016 as a result of excessive borrowings of the company over the years.
|Debt To Equity||3.25||2.71||2.02|
Cash flow analysis is focused to analysis sources of cash and uses of cash in the organization to identify to what are the real cash generating activities, less cash generating activities and where to allocate cash. The analysis begins with a starting balance and generates an ending balance after accounting for all cash receipts and paid expenses during the period.
Financing function of LOLC Finance PLC is managed and controlled by both at the Group level and the Company level. The Hierarchy of the financing can be depicted as follows;
The financing of the company for the past three years show that the company has mostly relied on the borrowings to finance the company. In 2014 the funding from borrowings amounted only to 67% of the total capital which subsequently has increased up to 73% in 2015 and further to 76% in 2016. Borrowings comprises of Interest bearing loans and the Deposits from customers. Company has moved more towards interest bearing borrowings from 2014 and the movement has increased by a whopping 97% at the end of the financial year of 2015/2016. There is a slight movement in the ‘Deposits from the customers’ used for funding.
Company’s equity comprises of Stated Capital and Reserves for which approximately there is a 25 – 75 formation.
The proportion of Stated Capital in the composition of equity has changed from 31% in 2014 to 25% in 2015 to 22% in 2016. The monetary value of the Stated Capital has remained unchanged over the three years but the value of reserves has increased and the percentage representation has changed accordingly. Most notably, the proportion of the retained earnings in the equity has increased over the years from 48% to 66% in 2016. The composition of the equity has not changed, only the percentage representation has changed.
The Debt to Equity Ratio of LOLC Finance PLC can be depicted as follows for the past three years.
In addition, the company’s financing activities, as per the Cash Flow statement, comprise of Interest bearing loans and borrowings and Debenture issues and therefore has incurred lease rental payments and finance costs. The inflows and outflows of money of the company can be summarized as follows;
The net proceeds from the interest bearing loans and borrowings shows a negative figure in 2014 only be to increased by 193% in 2015 by growing up to a positive figure. It has further been increased by 390% in 2016 as the company has, as stated earlier, heavily relied on loans and borrowings.
In the interim, the company has opted for a debenture issue in 2015 to finance its operations which also have amounted to the increase in the debt capital of the company and weaken the financial health to a certain amount by increasing the debt to equity ratio unfavourably.
The lease rental payments have increased by 190% in 2015 in comparison to the previous year and once again by 106% in 2016 as a result of the excessive leasing facility taking policy of the company. Company has faced a decrease of finance costs by 57% in 2014 but has again got it increased by 268% in the following year of 2016 as a result of the heavy loans and borrowings in the subsequent years.
As per all the above information, the Debt to Equity ratio of the company has increased from 2.02 in 2014 to 3.25 in 2016 as a result of excessive borrowings of the company over the years. Hence, the company is not in a very healthy position as at the end of the year 2016 the debt funding has amounted to three times of equity funding.
Analyzing Operating Activities
The principal activities of the company comprise of leasing, hire purchase, margin trading, loans, property development, mobilization of public deposits and Islamic financing.
Operating activities of the company are included in the statement of profit or loss and other comprehensive income. Since the company is a finance company, unlike a typical manufacturing company, the terms interest income, interest expense and net interest income are used instead of revenue/Sales, Cost of sales and gross profit.
The company’s interest income comprises of interest on leases, interest on hire purchases, interest on loans, factoring income, interest on margin trading, income from operating lease and hire and interest on overdue rentals and others.
The primary interest income source for the company is interest on loans and for the year ended 31st March 2016, contribution from loans to the interest income is 57% approximately out of the total interest income. Interest income from leases has been the second highest contribution to the interest income.
The company’s interest expense comprises of interest on fixed deposits, interest on savings deposits, profit distributed to IBU deposit holders, interest on foreign currency deposits, interest on re-red refinancing, finance lease interest and interest on short term loan & bank overdraft. The composition of the interest expense for the most recent financial year is depicted in Figure 8.
The main interest expense source for the company is interest on fixed deposits and as per the most recent financial statements, it has been 64% out of the total interest expense. Interest on short term loan and bank overdraft has been the second largest contribution to the interest expense.
Following table illustrates the interest income, interest expense, net interest income and the margin the company has kept across the past five years.
|Interest income (LKR ’000)||13,137,597||10,871,227||10,515,811|
|Interest expense (LKR ’000)||(6,499,475)||(4,978,312)||(6,125,280)|
|Net interest income (LKR ’000)||6,638,122||5,892,915||4,390,531|
The company has been able to maintain its margin slightly above 50% during 2016 and 2015. When analyzing the growth rate in interest income for the past two years, there has been a drastic drop in preceding years, the income increase in 2015 is only 3% but it has further increased in 2016 up to 21%.
When analyzing the operating activities of the company, it is relatively important to identify the underlying components of net other operating income. As can be seen in the below table, from the year 2013 to 2015 net other operating income has been increased gradually. Between 2015 and 2016 the rate of change in net other operating income is less. Therefore, careful consideration should be given to the components of net other operating income in the analyzing point of view.
|Net other operating income||2016||2015||2014|
The expenses that are not related to interest expense of the company are categorized into five components. Those are direct expenses excluding interest cost, allowance for impairment and write offs, personnel expenses, depreciation and general and administration expenses.
General and administration expenses are the largest aggregated expense category among others. As per the common size financial statements of the company, it has been amounted 15% on average during past three years. Allowance for impairment and write offs is the second largest expense category in the non-interest expenses. Since the company is engaged in the business of financial intermediary, it is utter important to adjust financial statements to reflect the fair value of the lending portfolios. Therefore, recoverability of the loans and advances needs to be adjusted for impairment.
Personnel expenses represent 8% of interest expense on average as per the common size financial statements. Though the amount of expense has gradually increased, the rate of increment is kind of a fluctuating nature. It has been 23%, 31%, 25%, 17% and 52% for the years 2016-2012. Depreciation expense is the lowest category of expense which has amounted Rs. 32,717,251 in 2016. Though it is the lowest category of income, its rate of increment is the largest among others. For instance, between 2015 and 2016, the rate of increment is 169%, 218% between 2014 and 2015. The net profit of the company after tax has been as follows for the past three years.
|Profit for the year||1,426,993,242||1,483,582,221||1,000,299,308|
|Net profit margin||11%||14%||10%|
Except in 2013, the company has achieved at least 10% net profit margin in past years. Although this is a healthy net profit margin for the company, special attention must be given for the items contain in net other operating income and expenses which might represent special items, which in turn distort the analysis of operating activities of the company.
Following figure shows the trend of net income and the net cash flows from operating activities over the past years except iv 2016. In most of the times net cash flow is higher than the net income. This difference occurs due to the assumptions in accrual basis and cash basis accounting.
Net Cash Flow Analysis
|Net Cash Flows||2016||2015||2014|
Return on Invested Capital and Profitability is a measure of a company’s success in using financing to generate profits. Return on Invested Capital and Profitability analysis plays vital role in measuring performance of a company and it is probably the most widely recognized measure of company performance. Importance of this analysis can be categorized under main three dimensions as follows,
- As a measurement of managerial effectiveness
- As a measurement of profitability
- As a measurement of planning and controlling
In analyzing return on invested capital and profitability of LOFC, we focused on two different measures stated in below,
1. Return on Net Operating Assets (RNOA)
2. Return on Equity (ROE)
Accordingly, return on net operating assets and return on stockholder’s equity of the company for the past three years (2014 – 2016) can be analyzed as follows.
As per the above trend analysis, it is observable that there is a similar trend in both Return on net operating assets and Return on equity for the past three years. From 2014 to 2016, there was a decreasing trend of each of measure.
Analyzing credit risk is one of most important part of a company where it shows what can be expected and anticipated from a company. Credit risk can be divided into Short term liquidity analysis and Long term solvency analysis.
It concerns the availability of the company resources to meet short term cash requirements. Current ratio and Acid test ratio has been used to analyze the company liquidity risk.
As per the ratio analysis (based on the calculations) even though the current ratio of the company has increased from year 2014 to 2015 it shows a drop in year 2016. Quick ratio has also taken the same pattern as current ratio. When comparing with the expansion of current assets over last three years, current liabilities show a considerable increase than current assets. This can be seen as the main reason for the decline in current and quick ratios in year 2016. Trade and other payables and other non- financial liabilities has largely influenced for this increase in current liabilities. However, it can be said that the company is maintaining a positive liquidity position mainly by looking at the current and quick ratios.
According to the asset composition analysis, LOLC Finance PLC had maintained inventory only in the year of 2014 and the inventory figures are not available in 2015 and 2016 since the company has transferred these stocks and the leasing portfolio to LOLC Micro Credit Limited after year 2014. However, not maintaining an inventory in the routine business cycle is common feature in finance companies. Hence, there is no any huge variance between the current ratio and the quick ratio. The company has been able to maintain a greater amount of liquid assets in their asset portfolio.
Company’s rental receivable on leased assets, hire purchase, loan and advances has been increased over the past three years. Since the company portfolio has been improved significantly over past three years the interest income has increased slightly than the portfolio growth.
Debtor’s outstanding period has been becoming higher over the past two years and it indicates the negative signs of the company’s credit policy. Company’s success in managing current liabilities has been varied over the years.
Solvency refers to the ability of a company to meet its long-term financial obligations. Analysis of solvency involves several key elements including capital structure analysis. The capital structure refers to the sources of financing available for a company.
The borrowings of the company have been rising over the recent years. At the same time creditors outstanding period has been increasing over the years. The lenders may have offered more flexible credit terms to the company.
In accordance with the computations on capital structure it can be seen that company is maintaining a higher total debt to equity ratio over past three years of 2014, 2015 and 2016 amounting to 2.02, 2.71 and 3.25 times respectively.
It seems to be they have given less protection to their equity holders by increasing the debt proportion. The total debt to equity capital ratio also has different increasing percentages over the past three years since they had been more into debt capital.
However they should be mindful when investing funds collected from long term sources. It is necessary to have a proper trade off when collect & invest funds between long term and short term sources in order to reap maximum benefits to the entity.
Referring to the above analysis and the current condition of the company, the following recommendations can be given to the management.
- Reduce debt
More than half of the company funding have come from the debt sources to the company which indicates that the company is paying higher interests for the debt funding. If the company can reduce its debts, if it can maintain the debt to equity ratio nearby 50:50, it would be beneficial for the company.
- Reduce excessive operating leases
Company’s operating lease expenses have increased by massive 268% in 2016 in comparison to 2015 and this is not a healthy indication. Therefore, it is healthier for the company to focus on reducing unnecessary operating leases.
- Increase factoring income
Factoring has become quite popular among companies and being a finance company, LOLC Finance can benefit from this. It is better if company opts for factoring with recourse.
Lanka Orix Finance PLC is operating in a market that is driven fierce competition and innovativeness. Furthermore, finance industry has been heavily affected by government interventions and regulatory enforcements.
In conclusion, it can be said that Lanka Orix Finance PLC is performing well in terms of the industry standards set by other players in the finance industry. This is evident from the workings and the analysis of the ratios in the first section of the report. Especially Lanka Orix Finance PLC is having higher revenue compared to other non- banking institutions in the market and company has been showing better growth rate over the past years.
Hence, investing in Lanka Orix Finance PLC is beneficial as an investor.
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