Financial Analysis Of Oil And Gas Development Company Finance Essay - Free Essay Example

CHAPTER 1 INTRODUCTION Oxford brookes university provided an opportunity for an ACCA student to obtain a degree of BSC(hons) of applied accounting by passing the Oxford university research and analysis project.This is not only an opportunity to obtain a OBU degree but a chance to extend and improve my skill and as well as the practical application of my knowledge acquired during the CAT and ACCA. There are twenty topic given by the Oxford university.I have chosen the topic number eight The business and financial performance of an organisation over a three year period.The company I have chosen is OGDCL(oil and gas development company limited) and the year under consideration is 2008-2010. INTRODUCTION OF THE COMPANY OGDCL is the largest oil and gas company in Pakistan.it has a monoply and stands with a government support.Being the national oil and gas company OGDCL holds the flagship of the countrys exploration and production sector.it will be worth noting that the company is a market leader in Pakistan,in terms of reserves,production and acreage.The company contributes 21% of Pakistans total natural gas production and 54%of its oil production.There are 75 OGDCL fields in Pakistan of which 45 fields are owned and operated while 30 fields are Non-operated.the company is also registered in London Stock Exchange in addition to countrys own major stock exchanges.The company is all set to ride the wave of EP activity.The company is with the vision of becoming the leading producer and supplier of oil and gas in the international market by using all the possible options including strategic treaty.Being the most stable company,sales revenue and profits of the company currently enhanced by 9% and 6.5% to Rs 142.572 billion and Rs 59.177 billion respectively. COMPANY HISTORY The government of pakistan established Oil and Gas Development Corporation(OGDCL)under an ordinance dated 20th september 1961 as a statutory corporation to undertake exploration and development of oil and gas resources.The company was converted into a public limited company in 1997 and renamed as Oil and Gas Development Company Limited(OGDCL). MOTIVATION TO CHOOSE THIS TOPIC My academic knowledge and prior understanding during my study of ACCA,regarding accounting and finance,is the key factor of motivation for me to choose the topic of financial statement and business analysis of the organization.Financial reporting,performance management and control and financial information management are the subjects which I have studied and which truly relate to the financial statement and business analysis.This project offers me to apply this knowledge and skills in a real business scenario. Reasons to choose the company I have selected this organizaton (OGDCL)for analysis because it is the largest and the most stable organization so far in the country.As it is also listed in the London stock exchange so,it seems more appropriate to choose this company for analysis because ACCA is also a qualification which has bais in UK so it will provide me the opportunity to analyze its financial position and financial performance in international context.Moreover,the monoply of the company in the field of Petroleum and Gas exploration and production enhanced my motivation to pursue the analysis project of the organization. RESEARCH AIM AND OBJECTIVE 1 the primary objective of my report is to evaluate the financial performance of the company in context of overall business performance of OGDCL for the year 2008-2010 2 the research aim to provide the impartial and objective opinion on the financial as well as the business performance of the company. RESEARCH QUESTION 1 what actually is the business strategy of the OGDCL 2 what is the existing and preceding two financial position of the company 3 what factors affecting the financial and business performance of OGDCL during the period 2009 to 2010. 4 what are the implication of OGDCL future growth OVERALL RESEARCH FRAMEWORK AND TOOLS USED TO ANSWER THE RESEARCH QUESTION EVALUATION OF FINANCIAL PERFORMANCE In order to evaluate the financial performance of OGDCL the following tools are used in the report Ratio analysis Horizontal analysis Vertical analysis BUSSINESS EVALUATION The business strategy and growth prospect of the OGDCL is evaluated by the following two tools 1 porters model 2 swot model FINANCIAL ANALYSIS To evaluate the financial condition and performance of the company the financial analyst need a yardstick.The yardstick frequently ratio analysis. The limitation of accounting ratio is that it is based on accounting reality and ignores the economic realities. PROFITABILITY RATIO GROSS PROFIT MARGIN NET PROFIT MARGIN CAPITAL EMPLOYED RETURN ON EQUITY LIQUIDITY RATIO CURRENT RATIO QUICK RATIO EFFICIENCY RATIO DEBTORS TURNOVER DEBTORS IN DAYS CREDITORS DAYS NET ASSET TURNOVER INVESTMENT RATIO EARNING /SHARE INTEREST COVER DIVIDEND/SHARE PROFITABILITY RATIO GROSS PROFIT MARGIN A measure calculated by dividing gross profit by net sales.Gross profit is indication of firm ability to turn a dollar of sales into profit after the cost of good sold. Gross profit margin= gross profit/net sales 2008 2009 2010 Current Variance Current Variance Current variance 70% + 0.39 69.92% 70.57 +0.65 The above trend show that company maintain the gross profit ratio almost 70% during the three years.Although there is increase in sales 25% in year 2008,39% in year 2009 and 9% increase but the mcrcalo has been counter by the cost of goods sold with almost same percentage. GRAPH AND INDUSTRY AVERAGE NET PROFIT MARGIN Net income divided by net sales,a measure of management ability to carry a dollar of sales down to the bottom line for the stock holder,it also measures how well a company control its cost Net profit margin = net income/net sales 2008 2009 2010 Current 40 Deviation -6 Current 43 Deviation +3 Current 42 Deviation -1 Net profit margin In the year 2008,the company show the deviation of 6% in net profit margin,the downfall is mainly due to the tax litigation,the provision for the taxation of the company is 33 billion which is 118% more then the year 2007 There is a increase in 2009 by 3% this is due to increase in sale revenue by 4% and decrease in royalty as well as taxation expense by 12% and 25%. Although in year 2010 the sale have been by 9% but this increase is counter down by taxation,royalty and as well as the operation expenses.This is main cause of decrease in profit margin by 1%. GRAPH AND GROSS SECTION RETURN ON EQUITY INTEREST COVERAGE RATIO Interest coverage ratio is the ratio of earnings before interest and tax to the amount of interest charge for the period Interest coverage ratio give an insight into the ability of the company to service its debt 2008 2009 2010 Current Deviation Current deviation Current Deviation Interest coverage= PBIT/INTEREST EARNING PER SHARE Earnings per share represent the amount of profit earn by each ordinary share In a simple word it means the amount of profit available for the average shareholder EPS = PROFIT AFTER TAX/ACTUAL NUMBER OF SHARES 2008 2009 2010 Current 11.54 Deviation +.93 Current 12.91 Deviation +1.37 Current 13.76 Deviation +.85 The above trend shows the steady growth in the EPS.The reason for the growth is very obvious from the entitys financial statement that there is steady growth profit.The reason for growth has already been discussed in in the profitability ratio. The important point should be considered here that there is no change in equity ÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¦ÃƒÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¦ÃƒÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¦. GRAPH DIVIDEND /SHARE The amount of dividend received by the ordinary share is called dividend per share 2008 2009 2010 Current 9.50 Deviation +.50 Current 8.25 Deviation -1.25 Current 5.50 Deviation -2.75 The OGDCL have a decreasing trend since 2008,when you consider the following figure,this will obviously make it clear why the company has such decreasing trend,even though there is steady growth in profit. Dividend payout ratio 2008 2009 2010 92% 64% 40% The company has a policy to retain profit. ASSETS TURNOVER RATIO This ratio measures the managements efficiency in generating revenue from the net assets at disposal. If this ratio gives the higher result, the more the management is efficient in generating the revenue from their net assets. Net Asset turnover Year(XXXX) Percentage (%) 2008 87 2009 79 2010 70 Reasons for Decline Assets OGDCL Asset Turnover ratio decreases from the last three years, this is due to significant increase in value of its fixed assets, as from the financial results the increase in fixed assets is shown as in table below: Particulars 2008 2009 2010 Fixed Asset(Rs in Billion) 67.71 87.69 103.18 Current Assets(Rs in billion) 79.82 85.46 120.43 As shown in the table the highlighted figures tells us that the fixed assets are increasing 30% from 08 to 09 and 18% from 09 to 10 and therefore significantly increasing from 2008 to 2010 which will cause decrease in the asset turnover, Also we have seen that the value of current assets in the year 2010 will have an significant increase, as 41% increase from 09 to 10 , this will also affect the asset turnover. This company is not using its assets efficiently. Management efficiency is going to decline. Sales We will discuss also the value of sales which will also affect this ratio, but for this company the value of sales is not significantly affect this ratio as the sales revenue does not have any significant change in the last three years as shown in the table: Particulars 2008 2009 2010 Net Sales(Rs in Billion) 125.91 130.83 142.57 From the figures in the table showing that there is insignificant change in the value of sales in the year 2008 2009 due to this asset turnover will not effect because of these results. But in year 2010 the value of sales increases 9% which should affect the asset turnover but unfortunately in this year the value of fixed assets and current assets are increased too much that the effect of the sales is cancelled. Remedies for Good Asset turnover: The company should increase the value of its sales as much so that the increase in asset will not disturb the turnover. Alternatively, the company should dispose of some of its non useful assets and utilize fewer assets efficiently. CURRENT RATIO The current ratio measures the adequacy of current assets to meet the current liabilities as they fall due. Current Ratio Particulars 2008 2009 2010 Current ratio(times) 3.72 4.01 3.46 Reasons for Change As we know that these values of current ratios are extracted from the figures of current assets and current liabilities of the last three years, so we will discuss the change in the value of current assets and liabilities which will cause these ratios to change. Table shows the value of current assets and Current liabilities from the last three years. Particulars 2008 2009 2010 Current Asset(Rs in Billion) 79.82 85.46 120.43 Current Liabilities(Rs in Billion) 21.44 21.29 34.84 From the figures of 2008 2009 we have seen that value of current liability was not changing but only there is a change in the value of current assets which will cause the increase in current ratio in 2009. But in 2010 the current ratio declines which is due to greater increase in the value of current liabilities increases 67% while less increase in the current assets 41% which will results in lower current ratio. If the value of current assets increases much more than current liabilities than current ratio will increase, but this do not happen in this year. ACID TEST RATIO This is a part of current ratio and is found by comparing liquid resources i.e., cash and bank balance, readily saleable securities and book debt with current liabilities. A decline in this ratio indicates overtrading which, if serious , may land the company in difficulties. A good current ratio accompanied by a low quick ratio will indicate a disproportionately high investment in stocks. Acid test Ratio Quick ratio of OGDCL of the last three years is as follow in table: Particulars 2008 2009 2010 Quick ratio(times) 2.94 3.25 3.03 As shown in the table, the trend in the quick ratio is same as in the current ratio. So we should study the change in value of stock here. Stock levels in the last three years are as follows: Particulars 2008 2009 2010 Stock In trade(Rs in 000) 151,782 108,301 172,084 These results show that stock in trade decrease in the year 2009 which will result increase in the quick ratio in this year. As in the table stock in trade decreases 29% from 08 to 09 and suddenly 59% increase in the stock in trade from 09 to 10. DEBTORS TURNOVER RATIO Debtors turnover ratio establishes the relationship between credit sales and accounts receivable. A high debtors turnover ratio will mean that debts are being collected efficiently. It is reliable measure of the time of cash flow from credit sales. A low debtor turnover ratio will tell us that management is performing inefficiently. Debtors turnover = Debtors turnover ratio of OGDCL of the last three years is shown in the table as follow: Particulars 2008 2009 2010 Debtors turnover ratio(times) 3.66 2.70 2.05 From the figures we have seen that from the last three years the debtors turnover ratio is going to decline. This will show that debts are not being collected efficiently. Hence it indicates a poor credit control. Reason for Decline There are several reasons for the declining debtors turnover ratio, for example we should discuss here the value of credit sales and account receivable (trade debts) figures The value of trade debts from the last three years are as follow: Particulars 2008 2009 2010 Trade Debts(Rs in 000) 40,705,299 56,140,092 82,992,291 From the figures we have seen that the value of debts from 2008 to 2010 is about 51% increase which is a huge increase in the value of debts this increase effect on the debtor turnover ratio to decline. The OGDCL,s management allowed his debts to increase which is showing their weak efficiency in their management. DEBTORS COLLECTION PERIOD It shows the number of days sale that remain uncollected on the average. On comparison with the official credit period, it would whether the debts are collected in time or not. Debtors collection period x 365 Debtors collection period of OGDCL from the last three years are as follow: Particulars 2008 2009 2010 Debtors Collection Period(Days) 100 135 178 From the debtors collection period there is 78% increase in days of which the debt is to be collected from the year 2008 to 2010, which is a huge increase and it shows us that debt of the company is collected in longer days in 2010 as compared to 2008. It will indicate the poor credit control of the company. Reason for Increase The reason for the great increase in the debtors collection period is due to the significant increase in the value of Trade debts which is 51% increase from 2008 to 2010. The figures are shown in the previous debtors turnover ratio. BUSINESS ANALYSIS Business analysis is the set of tasks and techniques used to work as a liaison among stakeholders in order to understand the structure, policies and operations of an organization, and to recommend solutions that enable the organization to achieve its goals. It involves understanding how organizations function to accomplish their purposes and defining the capabilities an organization to provide products and services to external stake holders. It includes the definition of organizational goals, how those goals connect to specific objective, determining the courses of action that an organization has to undertake to achieve those goals and objectives, and defining how the various organizational units and stake holders within and outside of that organization interact. Need to perform of a business analysis: Business analysis is performed to understand the current state of a company (OGDC) or to serve as a basis for the later identification of its business needs. It also defines and validate solutions that meet OGDCs business needs, goals and objectives. Techniques applied for business analysis: There are various business techniques used to carry out the analysis. The major ones used are: SWOT analysis: This is an effective business tool in carrying out a companys internal and external analysis. Companys internal analysis can be carried out looking at the Strengths and Weaknesses whereas external analysis requires looking at the Opportunities and Threats. OGDCLs Strengths, Weaknesses, Opportunities and Threats have been looked at in this analysis which are as follows: Strengths OGDCL is the largest oil and gas company in Pakistan. It has a monopoly and a great confidence in the Oil and Gas market due to Govt of Pakistans support. It is also listed on an International Stock Exchange. OGDC has Dynamic Strong Financial Position due to the experience of four decades. It holds nearby fifty blocks/ concession which are the enormous combination among other oil and gas companies in Pakistan. Paramount business locations which are found after long process. Best quality process and procedures. Experienced and technical workforce. Innovation of wells through expert Geologists. Confidence of the customers. The company is being expanded to other countries of the world like Yemen, Sudan, Iraq and Nigeria. Weaknesses Unsatisfied workforce: Recently there was a labour strike at OGDCL which affected lot of its business. Lack of marketing expertise. Undifferentiated products or services in relation to the competitors. Lack of coordination of operations. Government Influence. For employees there is a slow promotion process which reduces the performance. Lack of check and balance. Opportunities Moving into new market segments that offer improved profits. A developing market such as the Internet. Mergers, joint ventures or strategic alliances. A market vacated by an ineffective competitor. Large workshops for training and development. Support of the Ministry of Petroleum and Natural Resources. Better Competitive Position. Threats Fear of Privatization. Price wars with competitors. A competitor has a new, innovative product or service turns to tuff competition through globalization which brings the strong companies in Pakistan. Competitors have superior access to channels of distribution. POTERS FIVE FORCES MODEL ANALYSIS This model describes the OGDC in relation to its economic environment. The competitive position of an OGDC depends on five competitive forces. Together these forces determine the overall profit potential of the company. Although, looking at an individual firm , its ability to earn higher profit margins will be determined by weather or not it can manage the five forces more effectively than competitors. All five forces together provide a good overview of the company and can help to estimate OGDCLs further profit potential. The five forces are discussed one by one: Industrial Rivalry This describes the intensity of competition of a company between other companies. In case of Oil and Gas Development Company Limited the major competing companies are National Refinery Limited (NRL), Pak-Arab refinery limited (PARCO) and Pakistan Refinery Limited (PRL). They are competing with OGDCL on the basis of their products and pricing making it heard for any new rivals to enter. The rivalry is intense because the OGDC is equally sized enough among these companies. Therefore, the switching cost of OGDC is relatively low as the fixed cost is huge enough which encourage the competitors to fill unused capacity by price cutting. The switching cost in oil and gas industry is relatively low. Threat of Potential Substitute Threat of substitute exist in OGDC because the products demand is affected by the price change of a substitute product e.g. LNG substituting CNG. The price elasticity of oil and gas products like Petrol and CNG is affected by the substitute products because more substitutes are becoming available and the demand become more elastic since customers have more alternatives such as CNG, LPG, and LSD etc. Because of the availability of close substitute of oil and gas product the company may raise prices. While the threat of substitutes typically impacts OGDC through price competition, there are other concerns in accessing the threats of substitute like the substitutability of liquid oxygenated products and bio-fuels versus gas, oil and diesel. The Bargaining Power of The Buyers The major buyers of OGDCs products are Attock Petroleum Limited (APL), Pakistan State Oil Company LTD, Shell Pakistan LTD, Caltex Oil Pakistan LTD and Total Parco Pakistan LTD. The bargaining power of the buyers is weaker because they have the threat of forward integration by the producers like Saudi Arabian Oil Company (SAUDI ARAMCO), British Petroleum (BPP), etc who can take over their own distribution or retailing. Significant buyer switching cost which means buyer cannot easily switch to another product. Buyers are fragmented which means the buyers have no particular influence on product and producer supply critical portions of buyers input. The Bargaining Power of The Suppliers In opposition to OGDC the major suppliers of crude oil and natural gas are Saudi Arabian Oil Company (SAUDI ARAMCO), E.N.I Pakistan LTD, B.H.P Petroleum, Pakistan Petroleum Limited, Orient Petroleum International Private Limited (O.P.I (PVT) LTD), O.M.V Pakistan, and British Petroleum. Therefore, the suppliers are powerful they have an influence on producing industry such as selling raw material at a higher price to capture some of the industry profits. They can integrate forward. They have the information of their buyer. Threats of New Entrants Barriers to enter in Oil and Gas industry are arising from many sources. In case of OGDCLs which is Government holding company, barriers are taxes, freight margin, Petroleum Development Levy, patents and proprietarily knowledge. Note: Sources which were fruitful in analyzing the above described analysis are: www.brecorder.com www.accountancyforum.com www.google.com www.scribd.com