The Economic Profit/Loss shows how much money the firm has made over and above its expenses and its cost of capital (the opportunity cost). This figure needs to be positive, a profit. It uses the weighted average cost of capital (WACC), which is the percentage of the opportunity cost to the firm. It represents the rate of return on investment (ROI) that could have been made on another existing investment option. This is exceptionally important for a firm. For GSL, with a WACC of 10%, the results are terrible. They have not made an economic profit for any of the four years, but rather have made large economic losses. This suggests that GSL is an extremely bad investment option for shareholders.
How do your firm’s ratios differ to the ratios of firms of other students?
Steven Minehan’s firm of Dynamic Holdings Limited has excellent profitability ratios, poor efficiency ratios, good liquidity ratios, is more equity funded compared to debt, and has great earnings and dividends paid on shares. The firm has mixed ratios based on reformulated financial statements. Return on Equity (ROE), Return on Net Operating Assets (RNOA), Net Borrowing Cost (NBC) and Profit Margin (PM) are all pretty good. However, for all four years the efficiency ratio of Asset Turnover (ATO) is very bad and there are large economic losses.
Scott Anderson’s firm of Credit Corp Group Ltd has great profitability ratios, poor efficiency ratios, excellent liquidity ratios, is more debt funded compared to equity, has great earnings and dividends paid on shares and has excellent ratios based on reformulated financial statements (except for Asset Turnover – ATO). His firm is excellent. It is making excellent returns and has large economic profits for all years.
Kimsoth Ryan’s firm of FirstGroup PLC has modest profitability ratios, good efficiency ratios, average liquidity ratios, is heavily debt funded compared to equity, has modest earnings and dividends paid on shares and has great ratios based on reformulated financial statements (a pleasant surprise to finish). Her firm is the only one I have seen with a good efficiency ratio of Asset Turnover (ATO), being greater than 1.
My firm of Greatcell Solar Limited has poor ratios everywhere compared with the firms of these other students. Although, my firm has an improving Asset Turnover rate and still has a good Current Ratio. So, as bad as things are, it’s not over yet.
What do your firm’s ratios tell you about how well your firm is performing?
The ratios of my firm tell me that the firm is performing very poorly. They are making no money, but are rather losing money in a big way.
What new questions the ratios might raise in your mind about your firm?
No new questions were raised in my mind about GSL.
However, I could see, from the comparison with the firms of other students, that the economic profit relies on the RNOA being greater than WACC. If RNOA is not greater than WACC than there will certainly be an economic loss. The reason for this is that you will be multiplying by a negative figure. This was the main reason for the economic losses that I saw. Therefore, RNOA is indeed a key driver of economic profit.
(RNOA – WACC) x Net Operating Assets (NOA) = Economic Profit/(Loss)
Economic Profit Discussion:
My firm has large economic losses for all four years. I believe the key thing driving this is the large losses seen in the operating income after tax (CI) figures. The net operating assets are clearly not generating enough revenue. Therefore, there are large negative RNOA figures. As a result of this, there is a negative figure, in economic loss, for each year. The economic loss figures are roughly the same for all four years. Perhaps the most recent economic loss is lower than the other losses, but this is only because the net operating assets are a bit smaller because of the increased operating liability of ‘trade and other payables’. Perhaps the firm is also falling behind in paying its bills.
In comparison with the firms of other students (Steven Minehan, Scott Anderson and Kimsoth Ryan), I can see varying results.
Steven Minehan’s firm of Dynamic Holdings Limited has large economic losses for all four years, despite having good RNOA and PM, and big, healthy and positive NOA. However, his firm has really bad ATO, worst than my firm. This probably means that his firm is not efficient in making sales transactions, despite making excellent returns when the firm does make sales transactions. His firm simply needs to make more sales. Perhaps his firm isn’t as good as I initially thought it was.
Scott Anderson’s firm of Credit Corp Group Ltd has excellent economic profits for all four years. His firm has RNOA above 10% and positive NOA, and therefore can expect an economic profit as a certainty. The firm also has a PM above 20%, which is excellent. However, the firm also has an average ATO. Therefore, to continue the great results, the firm is going to have to make more sales transactions in the future. In other words, be more efficient with those operating assets.
Kimsoth Ryan’s firm of FirstGroup PLC has modest economic profits for the last three years. Despite not having PM above 10% for any given year, and only having RNOA above 10% for 2015 and 2017, the firm has excellent ATO rates for all four years, being well above 1.5. This means that the efficiency of the firm is the key difference. The excellent efficiency combined with the modest profitability has meant that economic profit is being made. However, the economic profits are small. It is as though the firm is really just breaking even for all four years. This is not too bad. Nevertheless, as an investor, one would want good economic profit all of the time.
I cannot see how my firm is similar to these firms at all. Simply because my firm has bad profitability and efficiency. A recipe for disaster. It makes big losses and has poor ATO rates. Therefore, the economic losses are big also.
What insights have you gained by ‘breaking into bits’ your firm’s financial statements? What insights have you not gained?
I have learnt more about the key drivers of economic profit: If RNOA is bigger than WACC and NOA is positive then there will be an economic profit as a certainty. The elements of good efficiency and good profitability make for the best RNOA. If one element is average and the other element excellent, there may be an economic profit or a break-even-ish figure.