Airweave
financial analysis
Financial
analysis outline
- Introduction
- Capital Structure
- Financial Statement Background
- Trend Analysis
- Cross Sectional Analysis
- Financial Instrument risk information
- Conclusion
- Recommendation
- Bibliography
Introduction
This article is about the financial analysis of
Airweave. Airweave has been selling their core product, mattress pad since 2007. We examine the capital structure of Airweave
using Modigliani-Miller theory. We analyse the financial trend of
Airweave. We analyse and compare the financial statement of Airweave
with other companies in the industry group. The financial instrument
risk information will be discussed. Financial instruments are the
borrowings and equity that Airweave uses to manage its financing. A
conclusion will be made based on the analysis. Lastly, a few
recommendations that may be useful for Airweave to manage its
financial risks, will be discussed.
Capital Structure
We
can use financial theory to explain the optimal debt ratio.
The
Modigliani-Miller theorem with taxes, proposition one says that the
value of levered firm is equal to the value of the unlevered firm,
plus the tax multiplied by debt taken. Since debt borrowings are tax
deductible, there are advantages of taking up debt. Leverage adds
value to a levered company.
VL
= VU + T*D ----- 1.1
where
VL
is the value of levered company
VU
is the value of unlevered company
D is
the amount of debt taken
T is
tax rate
The
formula above says when we add debt to a company, the value of the
company increases.
The
Modigliani-Miller theorem with taxes, proposition two states that the
cost of equity rises with leverage.
rE
= r0 + D/E(r0-rd)(1-T) ----- 1.2
where
r0
is the cost of equity without leverage
T is
tax rate
rd
is the cost of debt
The
formula says when we use more debt to replace equity, the WACC drops
and there is an optimal capital structure.
For
the optimal capital structure, we can refer to the table below.
Firstly, we follow the Modigliani-Miller theory, and say that if the
company takes on debt beyond the optimal level, the company will have
greater default risk, so its cost of equity goes up, and its cost of
debt also goes up. From the table, we find out that the lowest
weighted average cost of capital (WACC) happens when D/E is equal to
one.
To
calculate WACC, we use the WACC formula as shown below:
WACC
= Re*E/(D+E) + Rd*(1-T)*D/(D+E) ----- 1.3
According
to the table below, the optimal D/E ratio for lowest WACC is when
debt is roughly equal to equity.
Table
1: Optimal D/E ratio for lowest WACC
D/(D+E)
|
Re
|
Rd
|
After-tax Cost of Debt
|
WACC
|
0
|
10.50%
|
8%
|
4.80%
|
10.50%
|
10%
|
11%
|
8.50%
|
5.10%
|
10.41%
|
20%
|
11.60%
|
9.00%
|
5.40%
|
10.36%
|
30%
|
12.30%
|
9.00%
|
5.40%
|
10.23%
|
40%
|
13.10%
|
9.50%
|
5.70%
|
10.14%
|
50%
|
14%
|
10.50%
|
6.30%
|
10.15%
|
60%
|
15%
|
12%
|
7.20%
|
10.32%
|
70%
|
16.10%
|
13.50%
|
8.10%
|
10.50%
|
In
2016, the Airweave ratio of total liabilities to total equity is
roughly one, which mean D/E is equal to one. So Airweave is close to
its optimal capital structure.
For
long term, and short term borrowing, the Japanese long term interest
rate is at historic low at the moment. There is a risk of interest
rate goes up in the next five years during to possible monetary
tightening policy of the Bank of Japan. Therefore, Airweave takes
advantage of the low interest rate situation by borrowing long term,
and locking in lower rates.
Financial Statement Background
From
the income statement below, the cost of goods sold is around 50% of its revenue in 2015, and
40% of its revenue in 2016, due to improving economies of scale. The selling and administrative expenses is slowly
increasing due to company expansion. For income tax expenses, the
corporate tax rate is about 40% in Japan from 2014 to 2016. Airweave pays 10% of its long term borrowing as the finance
cost. The depreciation expenses is calculated from the balance sheet.
Items
|
Yearly/2016
|
Yearly/2015
|
Yearly/2014
|
(31/12/2016)
|
(31/12/2015)
|
(31/12/2014)
|
|
million
yen
|
million
yen
|
million
yen
|
|
| Income Statement | |||
| TOTAL REVENUES |
14000
|
12000
|
9500
|
| COST OF GOODS SOLD |
5500
|
6000
|
4500
|
| SELLING AND ADMINISTRATIVE EXPENSES |
2200
|
1610
|
1250
|
| DEPRECIATION EXPENSES |
200
|
200
|
200
|
| OTHER EXPENSES |
90
|
90
|
90
|
| TOTAL EXPENSES |
7990
|
7900
|
6040
|
| PROFIT (LOSS) BEFORE FINANCE COSTS AND INCOME TAX EXPENSES |
6010
|
4100
|
3460
|
| FINANCE COSTS |
323
|
233
|
114
|
| INCOME TAX EXPENSES |
2275
|
1547
|
1338
|
| NET PROFIT (LOSS) |
3412
|
2320
|
2008
|
| Other Comprehensive Income Statement | |||
| NET PROFIT (LOSS) |
3412
|
2320
|
2008
|
| EXCHANGE DIFFERENCES ON TRANSLATING FOREIGN OPERATIONS |
192
|
76
|
-38
|
| TOTAL OTHER COMPREHENSIVE INCOME |
3604
|
2396
|
1970
|
| DIVIDENDS |
200
|
200
|
200
|
From
the balance sheet below, the cash and cash equivalent number in
2015 and 2016 are calculated from cash flow statement. The property, plant and equipment, it is increasing because of
Airweave company expansion. Similarly, the long term borrowings are
increasing because Airweave borrows capital for expansion.
We
can see that the ordinary shares and paid up capital are constant.
The retained earnings keeps increasing from 2014 to 2016 because of
strong financial performance of Airweave. As a result, the total
equity of the company increase by 44% from 2014 to 2015, and 47% from
2015 to 2016.
Items
|
Yearly/2016
|
Yearly/2015
|
Yearly/2014
|
(31/12/2016)
|
(31/12/2015)
|
(31/12/2014)
|
|
million
yen
|
million
yen
|
million
yen
|
|
| CASH AND CASH EQUIVALENTS |
4327
|
3924
|
2110
|
| ACCOUNTS RECEIVABLE |
3942
|
3117
|
2783
|
| INVENTORIES |
3433
|
4389
|
3468
|
| PREPAID EXPENSES |
458
|
453
|
367
|
| SHORT TERM INVESTMENTS |
434
|
636
|
424
|
| OTHER CURRENT ASSETS |
624
|
765
|
536
|
| TOTAL CURRENT ASSETS |
13218
|
13284
|
9688
|
| INVESTMENT PROPERTIES |
1921
|
1821
|
1221
|
| PROPERTY, PLANT AND EQUIPMENTS |
6023
|
3951
|
1832
|
| Less: Accumulated Depreciation |
600
|
400
|
200
|
| INTANGIBLE ASSETS |
167
|
167
|
167
|
| Less: Accumulated Amortization |
29
|
23
|
17
|
| DEFERRED TAX ASSETS |
428
|
453
|
367
|
| OTHER NON-CURRENT ASSETS |
87
|
52
|
13
|
| TOTAL NON-CURRENT ASSETS |
9255
|
6867
|
3817
|
| TOTAL ASSETS |
22473
|
20151
|
13505
|
| BANK OVERDRAFTS |
300
|
200
|
100
|
| ACCOUNTS PAYABLE |
1121
|
2122
|
1343
|
| CURRENT PORTION OF LONG-TERM LIABILITIES |
230
|
230
|
230
|
| ACCRUED EXPENSE |
1522
|
2122
|
1733
|
| OTHER CURRENT LIABILITIES |
553
|
213
|
121
|
| TOTAL CURRENT LIABILITIES |
3726
|
4887
|
3527
|
| LONG-TERM BORROWINGS FROM FINANCIAL INSTITUTIONS |
3233
|
2333
|
1135
|
| LIABILITIES FOR EMPLOYEE RETIREMENT BENEFITS |
524
|
477
|
165
|
| OTHER NON-CURRENT LIABILITIES |
746
|
453
|
233
|
| TOTAL NON-CURRENT LIABILITIES |
8229
|
8150
|
5060
|
| TOTAL LIABILITIES |
11955
|
13037
|
8587
|
| ORDINARY SHARES |
4499
|
4499
|
4499
|
| ISSUED AND FULLY PAID-UP SHARE CAPITAL |
240
|
240
|
240
|
| RETAINED EARNINGS |
5460
|
2248
|
128
|
| CURRENCY TRANSLATION CHANGES |
319
|
127
|
51
|
| TOTAL EQUITY |
10518
|
7114
|
4918
|
From the cash flow
statement below, for the cash from operating activities, the net
profits numbers are calculated from income statement. The changes in
account receivable, inventories, prepaid expenses, short term
investments, other current assets, account payable, accrued expenses,
other current liabilities, non current liabilities are from balance
sheet.
For the cash from
investing activities, the changes in investment properties, property
plant and equipments are calculated from balance sheet. For the cash from
financing activities, the changes in long term borrowings and
retirement benefits are calculated from balance sheet.
Items
|
Yearly/2016
|
Yearly/2015
|
Yearly/2014
|
(31/12/2016)
|
(31/12/2015)
|
(31/12/2014)
|
|
million
yen
|
million
yen
|
million
yen
|
|
| NET PROFIT |
3412
|
2320
|
2008
|
| DEPRECIATION |
-200
|
-200
|
-200
|
| AMORTISATION |
-6
|
-6
|
-6
|
| CHANGES IN ACCOUNT RECEIVABLE |
-825
|
-334
|
-321
|
| CHANGES IN INVENTORIES |
956
|
-921
|
-345
|
| CHANGES IN PREPAID EXPENSES |
-5
|
-86
|
-50
|
| CHANGES IN SHORT TERM INVESTMENTS |
202
|
-212
|
45
|
| CHANGES IN OTHER CURRENT ASSETS |
141
|
-229
|
-100
|
| CHANGES IN ACCOUNT PAYABLE |
-1001
|
779
|
343
|
| CHANGES IN ACCRUED EXPENSES |
-600
|
389
|
212
|
| CHANGES IN OTHER CURRENT LIABILITIES |
340
|
92
|
46
|
| CHANGES IN OTHER NON-CURRENT LIABILITIES |
293
|
220
|
101
|
| NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES |
2707
|
1812
|
1733
|
| CHANGES IN INVESTMENT PROPERTIES |
-100
|
-600
|
-100
|
| CHANGES IN PROPERTY, PLANT AND EQUIPMENTS |
-2072
|
-2119
|
-212
|
| CHANGES IN INTANGIBLE ASSETS |
0
|
0
|
0
|
| NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES |
-2172
|
-2719
|
-312
|
| CHANGES IN LONG-TERM BORROWINGS FROM FINANCIAL INSTITUTIONS |
900
|
1198
|
500
|
| CHANGES IN LIABILITIES FOR EMPLOYEE RETIREMENT BENEFITS |
47
|
312
|
93
|
| DIVIDEND PAID |
-200
|
-200
|
-200
|
| NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES |
747
|
1310
|
393
|
| NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENT |
1282
|
403
|
1814
|
| CASH AND CASH EQUIVALENTS, BEGINNING BALANCE |
4327
|
3924
|
2110
|
| CASH AND CASH EQUIVALENTS, ENDING BALANCE |
5609
|
4327
|
3924
|
Trend Analysis
We
analyse the Airweave financial data from year 2014 to year 2016.
The
company has about the same liabilities and equities in 2016 due to
increased borrowings from the bank for company expansion. The Account Receivables is slowly increasing, and Property Plant and
Equipments (PP&E) increases significantly over the three years
due to increase in fixed assets investment.
Table
2: Airweave overall cash flow analysis
Cash
flow analysis Unit:Million yen
Item
|
2016
|
2015
|
2014
|
Net Cash flow
from operating activities
|
2,207
|
1,812
|
1,733
|
Net Cash flow
from investing activities
|
(2,172)
|
(2,719)
|
(312)
|
Net Cash flow
from financing activities
|
747
|
1,310
|
393
|
Net change in
cash
|
1,282
|
403
|
1,814
|
Table
3: Airweave cash flow analysis showing sources and uses of cash
2016
|
2015
|
2014
|
|
Revenue
|
14,000
|
12,000
|
9,500
|
Net Income
|
3,412
|
2,320
|
2,008
|
Account Receivable
|
(825)
|
(334)
|
(321)
|
Inventories
|
956
|
(921)
|
(345)
|
Account Payable
|
(1,001)
|
779
|
1,343
|
Accrued Expenses
|
(600)
|
389
|
212
|
Capital
Expenditures
|
(2,072)
|
(2,119)
|
(212)
|
Common Dividends
|
(200)
|
(200)
|
(200)
|
Long Term
Borrowings
|
900
|
1198
|
500
|
For
cash flow from operations, the major source of cash are net income,
and increase in Account Payables for year 2014 ad 2015. The major use
of cash are Inventories for year 2014 and 2015, Account Receivables
from year 2014 to 2016. The Account Payable is a source of cash in
2014 and 2015, and a use of cash in 2016. The Accrued Expenses is a
source of cash in 2014 and 2015, and a use of cash in 2016. The cash
flow from operations is a positive number and increases from 2014 to
2016.
For
cash flow from investing, the major use of cash is purchase of PP&E
or capital expenditures. It was used in new shops and capacity
expansion. The cash flow from investing is a negative number and
highest negative value in 2015.
For
cash flow from financing, in 2014 and 2015 and 2016, the major source
of cash was an increase in long term borrowings. In all three years,
the major use of financing cash flow is the dividends paid. The cash
flow from financing is a positive number and has highest positive
value in 2015.
In
the overall, the net change in cash is positive from 2014 to 2016.
DuPont
Analysis
DuPont
analysis is useful to measure the financial performance of a company.
This analysis method was started by the DuPont Corporation in 1920s.
It measures return on assets (ROA) and return on equity (ROE). ROE is
the net income as a percentage of total shareholder equity. ROA is
the net income as a percentage of total assets. According to DuPont
analysis, ROA is broken down into two parts, and ROE is broken down
into three parts. The details are shown below.
ROA
= NI/Sales * Sales/total Assets
ROE
= NI/Sales * Sales/total Assets * Total Assets/Total SH Equity
DuPont
Analysis is useful to determine what is driving the company’s
financial performance. Profit Margin shows the operation efficient.
Asset Turnover shows the asset usage efficiency. The financial
leverage shows the degree of leverage of the company.
Table
4: NI/Sales (Profit Margin)
2016
|
2015
|
2014
|
0.2437
|
0.1933
|
0.2114
|
Table
5: Sales/total Assets (Asset Turnover)
2016
|
2015
|
2014
|
0.6229
|
0.5955
|
0.7034
|
Now,
we have Profit margin and Asset turnover. We multiply them and obtain
the ROA number.
Table
6: ROA calculation
Item
|
2016
|
2015
|
2014
|
ROA
|
0.2437*0.6229
=0.1518
|
0.1933*0.5955
=0.1151
|
0.2144*0.7034
=0.1508
|
The
Net profit margin is declining from 2014 to 2015, and increases from
2015 to 2016.
The
Asset Turnover declines from 2014 to 2015, then increases from 2015
to 2016.
In
the overall, ROA declines from 2014 to 2015, and increase from 2015
to 2016. It is a good indicator of company performance.
Table
7: Total Assets/Total SH Equity (Financial Leverage)
2016
|
2015
|
2014
|
2.1367
|
2.8325
|
2.7460
|
Now,
we multiply Profit margin, Asset Turnover and financial leverage, we
obtain the ROE number.
Table
8: ROE calculation
Item
|
2016
|
2015
|
2014
|
ROE
|
0.2437*0.6229*2.137
=0.3244
|
0.1933*0.5955*2.833
=0.3261
|
0.2144*0.7034*2.746
=0.4141
|
The
Net profit margin is declining from 2014 to 2015, and increases from
2015 to 2016.
The
Asset Turnover declines from 2014 to 2015, then increases from 2015
to 2016.
The
equity multiplier increases from 2014 to 2015, then decline in 2016.
In
the overall, ROE declines from 2014 to 2016. The decline in 2016 is
due to less financial leverage. ROE decline is an indicator that the
company is using more equity to generate net income. The more equity
comes from increased retained earnings. This is a good sign.
The
conclusion of DuPont analysis : Airweave profitability performance is
improving from 2014 to 2016. For every Japanese yen that the
investors put into AIrweave assets, the return that investors get out
of it, is increasing.
Cross Sectional Analysis
Cross
sectional analysis is a comparison of company financial performance
against industry peers, within the industry group. The purpose is to
find out the financial performance of Airweave relative to its
industry peers. Airweave is a mattress and mattress pad company. It
is not possible to find listed Japanese company that manufactures
mattress or mattress pad in the Tokyo Stock Exchange or other stock
exchange in Japan. We use Japanese hospital bed manufacturer,
Paramount Bed, Dutch mattress and bedroom furniture company, Beter
Bed and American bed and mattress company, Sleep Number, as the
industry peers. Only one of these companies is located in Japan. The
other two companies are not located in Japan but they are mattress
company. So we use them for comparison.
Firstly, we will see
the fiscal year end of the companies. Their fiscal year end is shown
in table below.
Table
9: Fiscal year end of companies
Airweave
|
Paramount Bed
|
Sleep Number
|
Beter Bed
|
31 December
|
31 March
|
31 December
|
31 December
|
Next,
we find out and compare the financial ratios of the four companies in
year 2016. For the easy understanding of the readers, we explain the
financial ratios used in the analysis.
Firstly, there is
the Liquidity ratio. It is a measure of the company’s ability to
pay debt obligations.
Current
ratio = Current Assets / Current Liabilities
Quick
ratio = (Cash and equivalents + Marketable securities + Accounts
receivable) / Current Liabilities
Current ratio
measures the company’s ability to pay short term and long term
debt. Quick ratio is an indicator of company’s short term
liquidity.
Secondly,
there is Asset Management ratio. It measures company’s ability to
use assets to generate sales.
Inventory Turnover = Sales / Average Inventory
Asset Turnover = Sales / Total Assets
Fixed Asset Turnover = Sales / Fixed Assets
Inventory
Turnover measures the company’s management of its inventory. Asset
Turnover measures the company’s management of its assets. Fixed
Asset Turnover measures the company’s management of its fixed
assets
Thirdly,
there is Debt Management ratio. It measures the company’s resources
coming from debt or from equity. It measures the company’s
financial leverage.
Debt ratio = Total Debt / Total Assets
Debt/Equity ratio = Total Debt / Total Assets
Debt
ratio measures the level of debt of a company. Debt/Equity ratio
measures the degree of leverage of a company. It shows how much debt
the company use to finance its assets relative to the amount in
equity.
Fourthly,
there is Profitability ratio. It measures the business profit
compared to its expenses and cost.
Gross Margin = Gross Profit / Revenue
Operating Margin = Operating Profit / Revenue
Net Margin = Net Profit / Revenue
ROA = Net Profit / Total Assets
ROE = Net Profit / Total Equity
The
gross margin measures the profitability before operating factors is
considered. The operating margin measures the profitability after
operating efficiency is considered. The net margin measures the
profitability after tax and interest payments are calculated. The ROA
and ROE are described in details in DuPont analysis section.
Lastly,
there is receivable turnover and payable turnover.
receivable
turnover = sales/account receivable
payable turnover = sales/account payable
High
numbers in receivable turnover means fast cash recovery, fast cash
collection time.
Low
numbers in payable turnover means company pays suppliers slowly.
Table
10: Cross sectional analysis
Item
|
Airweave
|
Paramount
|
Sleep
Number
|
Beter
Bed
|
Average
|
Liquidity
ratio
|
|||||
Current Ratio (x)
|
3.55
|
3.51
|
0.61
|
1.50
|
2.29
|
Quick Ratio (x)
|
2.34
|
2.98
|
0.14
|
0.54
|
1.50
|
Asset
Management Ratio
|
|||||
Inventory
Turnover (x)
|
4.08
|
10.19
|
17.48
|
6.63
|
9.59
|
Asset Turnover
(x)
|
0.62
|
0.59
|
2.87
|
2.86
|
1.74
|
Fixed Assets
Turnover (x)
|
2.32
|
2.46
|
6.29
|
8.74
|
4.95
|
Debt
Management Ratio
|
|||||
Debt Ratio(x)
|
0.53
|
0.33
|
0.65
|
0.46
|
0.49
|
Debt/Equity
ratio(x)
|
1.14
|
0.48
|
1.85
|
0.87
|
1.08
|
Profitability
Ratio
|
|||||
Gross Margin %
|
60.71
|
42.64
|
61.78
|
57.76
|
55.72
|
Operating Margin
%
|
42.93
|
13.04
|
5.85
|
6.34
|
17.04
|
Net Profit Margin
%
|
24.37
|
8.62
|
3.92
|
4.63
|
10.38
|
ROA %
|
15.18
|
5.06
|
11.25
|
13.24
|
11.18
|
ROE %
|
32.44
|
7.49
|
32.07
|
24.73
|
24.18
|
Receivable
and Payable Turnover Ratio
|
|||||
Receivables
Turnover(x)
|
3.55
|
3.01
|
66.55
|
31.59
|
26.17
|
Payable Turnover
(x)
|
12.49
|
5.69
|
12.44
|
12.88
|
10.87
|
As
can be seen from the table above, we compare the liquidity ratio,
asset management ratio, debt management ratio and profitability
ratio, and receivable payable turnover ratio.
For
easy understanding, the above table is plotted in the graphs below.
Figure
1: Liquidity ratio
Figure
2: Asset Management ratio
Figure
3: Debt Management ratio
Figure
4: Profitability ratio
Firstly,
the liquidity ratio, Airweave current ratio is above industry
average, and the quick ratio is above industry average too. For the
liquidity ratio, the higher the number, the better it is. So Airweave
is in good position in terms of liquidity ratio.
Secondly,
the asset management ratio, Airweave’s Inventory Turnover, Asset
Turnover and Fixed Assets Turnover are below industry average. For
the asset management ratio, the higher the number, the better it is.
The implication is that Airweave is not generating high enough sales
from the existing assets and inventories. Airweave is using more
assets to generate sales, compared to its industry average. There is
room for improvement in asset management for Airweave. Airweave could
improve its asset management strategy.
Thirdly,
the debt management ratio, Airweave debt ratio and debt/equity ratio
are slightly higher than industry average. Airweave is using more
borrowings compared to its industry average. However, Airweave is a
young and growth company. It is using leverage to grow its business
and generate sales. Its debt/equity ratio is close to one, which is
the optimal case for capital structure. Therefore, it is acceptable
for a company such as Airweave to borrow up to 50% of its assets
because it uses the borrowings to maximise the value of the company.
Fourthly,
profitability ratio, the Airweave numbers beat the industry average
in every cases. For the profitability ratio, the higher the number,
the better it is. It shows that Airweave is well managed, with little
operating and administration overhead. It could be because Airweave
is a small and tightly run company. Airweave has less overhead and it
can achieve a high profitability ratio.
Lastly,
the receivable and payable turnover ratio is discussed. The
receivable ratio measures the efficiency of company collecting credit
sales from customers. The ratio is the higher the number, the better
it is. Airweave has the lowest receivable turnover ratio. The payable
turnover ratio is the ratio that measures the efficiency of company
paying credit sales to suppliers. The ratio is the lower the number,
the better it is. Airweave has the highest payable turnover ratio.
Airweave is collecting receivables too slow and paying payables too
fast.
Furthermore,
for further understanding of company performance, we calculate the
net operating cycle. Net operating cycle shows how many days it takes
to create inventory, sell inventory, and collect money from
customers. The lower the number, the better is the company
performance.
Net
operating cycle = No. of Days of Inventory + No. of Days of
Receivables - No. of Days of Payables
Table
11: Net operating cycle comparison of the four companies in year 2016
Airweave
|
Paramount
|
Sleep Number
|
Beter Bed
|
|
No. of Days of
Inventory
|
89.46
|
35.82
|
20.88
|
55.05
|
No. of Days of
Receivables
|
102.82
|
121.26
|
5.48
|
11.55
|
No. of Days of
Payables
|
29.22
|
64.15
|
29.34
|
28.34
|
Net Operating
Cycle
|
163.06
|
92.93
|
-2.98
|
38.26
|
Airweave
has the highest Net operating cycle. So it is below the performance
of industry peers.
Next,
we look at the cash flow of the four companies in year 2016. We will
attempt to get a clearer picture of the financial health of the
companies from the cash flow analysis.
For
USD, we use exchange rate of JPY/USD of 115.
For
Euro, we use exchange rate of JPY/EUR of 121.
Table
12: Cash flow comparison of the four companies in year 2016
Unit:Million yen
Item
|
Airweave
|
Paramount
|
Sleep Number
|
Beter Bed
|
Net Cash flow
from operating activities
|
2707
|
9657
|
17439
|
4119
|
Net Cash flow
from investing activities
|
(2172)
|
(2038)
|
(4907)
|
(2391)
|
Net Cash flow
from financing activities
|
747
|
(5493)
|
(13610)
|
(2178)
|
Net change in
cash
|
1282
|
2126
|
(1078)
|
(450)
|
From
the table above, we can see that Airweave operating cash flow sizes
are smaller than other other three companies. This is expected as
Airweave is a smaller company in terms of operation size, and sales.
It can be seen that Airweave has a strong positive net change in cash
given its smaller net cash flow from operations. Its has an investing
cash flow which is almost equal to the cash flow from operations. It
is also getting a positive financing cash flows.
Breakeven Point Analysis
The
analysis is to find out the minimum number of units required to
overcome the variable cost and fixed cost of the company’s
operation. A graph illustrating the break even analysis is shown
below.
Figure
5: Breakeven analysis
Source:
http://www.12manage.com/methods_break-even_point.html
In
2016, the sales is 14000 million yen. The Airweave mattress pad
selling price ranges from 50000 yen to 250000 yen. Taking the middle
figure of 150000 yen, 14000 million is divided by 150000, the result
is 93333 unit sales. Airweave cost of goods sold is 5500 million yen.
The 5500 million is divided by by 93333 unit, the result is 58928
yen. This number is the variable cost per unit sold. For the fixed
cost, it can be found by adding up the selling and administrative
expenses, depreciation expenses, and other expenses. The result is
2490 million yen which is the fixed cost.
To
show the calculation:
14000 million / 150000 = 93333 unit (sales)
5500 million / 93333 = 58928 yen (variable cost)
To
break even, we can use a formula to calculate. Assuming unit is the
number of units to breakeven:
150000 * unit = 2490 million + 58928 * unit
Unit = 27341
Therefore,
we can see that 27341 units are needed for the company to break even.
The company is selling 93333 units in 2016. It has exceeded the break
even point.
Financial instrument risk information
Financial
instrument risk is the risk of using the financial instrument in a
company’s operation. In Airweave case, it uses long term
borrowings, and equity from green tea company to fund its investment.
Airweave has roughly one to one of debt to equity ratio in 2016. From
the capital structure, Airweave financial instrument (debt, equity)
is subject to market risk, such as interest rate risk, currency risk,
price risk.
To
measure the market risk, we can use Value at risk (VaR) method. Value
at risk measures the probability that financial instrument of a firm
will lose a certain amount in a given period of time. For example, we
can say: with 95% confidence, we expect the investment will not lose
$10 million yen over a year.
There
are three methods to calculate VaR. There are historical method,
variance covariance method, and Monte Carlo method.
The
VaR formula is: VaR = Rp
- Z *
σp
Z
is the value of test statistics, it can be of 95% or 99% confidence
level.
95%:
1.65
99%:
2.33
For
the Airweave debt borrowing, Airweave takes up fixed rate borrowings
at low interest rates, so there is very little market risk.
For
the Airweave equity, it is subject to currency risk. Airweave equity
valuation will decline when its domestic currency appreciates.
To
show an example of the application of VaR formula: If return of
equity is set at 10%, the standard deviation of return is 10%, at 95%
confidence level, the VaR is:
VaR = 0.10 - 1.65*0.10 = -0.065
In
2016, the total shareholder equity capital is 10518 million yen. We
multiply 0.065 by 10518 million, the result is 683 million. In this
example, the minimum equity capital at risk, or losses, would be 683
million, at 95% confidence level.
Conclusion
Airweave
is a growth company. Its total revenue is growing. Its retained
earnings is increasing in the three year period from 2014 to 2016.
Its net cash flows are positive in the three year period from 2014 to
2016. It has a strong balance sheet, such as strong current ratio,
quick ratio, reasonable D/E ratio, and high ROE and ROA and high
profit margin. All these numbers show that it is in good financial
position.
The
negative with Airweave is the asset management ratio. Airweave’s
asset management ratio is below its peers. Airweave should improve on
asset management, in the way that it should use less assets to
generate sales. With expected revenue growth in the coming years,
Airweave is expected to continue with its strong financial position.
Furthermore,
Airweave has the worst net operating cycle. Airweave should improve
on this aspect. Airweave can shorten the number of days in inventory,
number of days in receivables.
After
three years, when Airweave is listed on the Tokyo Stock Exchange,
their financial statements will be available for public viewing. It
will help to validate our assumptions in the financial statements.
Recommendation
Airweave
is preparing to be listed on Tokyo Stock Exchange before the Tokyo
Olympics in year 2020. Airweave is aggressively expanding overseas so
it is subject to more currency risk. On a sales revenue of 14000
million, if 30% are from overseas, 4200 million is at risk of
exchange rate changes.
To
reduce finance risk of Airweave, we propose the following strategies
as written below. The strategies make use of derivatives, such as as
FX futures, FX forward, FX swap, and swaption. The details of the
derivatives are described in the points below.
- Use FX futures contract or FX forward contract to hedge the earnings coming from outside Japan, managing the currency risk. FX future is a publicly traded future contract, it is standardised and free of counterparty risk. Counterparty in this case is the exchange. FX forward is a privately negotiated contract between one company and one financial institution. It can be customised and subject to counterparty risk. Both FX future and FX forward are used to lock in the exchange rate in the future.
- It can also use FX swap to manage the currency risk. FX swap is a privately negotiated contract between one company and one financial institution, to exchange one currency for another currency.
For
item one and two, we can further analyze. Firstly, we see the
domestic currency return is made up of:
Rdc
= (1+Rfc)(1+Rfx)-1
Where
Rfx
= Return of foreign exchange rate
Rfc
= Return of foreign currency
And
the variance of return σdc2
= σFc2
+ σFX2
+
2 σFcσFx
COV(FC, FX)
We
can hedge foreign currency return, be it USD or SGD or HKD, and
convert them to yen.
For
example, we can see from table 12 below about how to make hedging
decision.
Table
12: Hedging foreign currency
Current spot rate
|
six month forward rate
|
six month forecast spot
rate
|
|
JPY/USD
|
113.4
|
116.4
|
112.6
|
Airweave
is long the USD against JPY, and JPY/USD is selling at a forward
premium. Moreover, Airweave expects USD to depreciate against the
JPY. This is a case of hedging the USD exposure.
To
find the optimal the minimum variance hedge ratio, (the optimal
hedging ratio) we can use the formula:
Hedge
ratio = correlation(FC, FX)*σFc/σFX
For
example, if the hedge ratio is 2.3, for a USD 1 million exposure,
Airweave will need short a JPY/USD forward contract of USD 2.3
million.
- Manage the interest rate risk, Airweave borrows in fixed interest rate. If interest rate goes down, Airweave will suffer a loss. Airweave can buy a swaption on pay floating, receive fixed swap, Airweave can exercise it if necessary. Swaption is an option to enter into an swap.
- Implement an action plan to accelerate collecting account receivables from customers, so that it can increase its receivables turnover.
- Implement an action plan to delay paying payables to suppliers, so that it can reduce its payable turnover.
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