Financial analysis of the Parma PDO ham firms
di Giuseppe Bonazzi (University of Parma), Mattia Iotti
(University of Parma) e Vlassios Salatas (University of Piraeus, Greece)
Luglio 2010
Intervento tenuto presso 7th AFE (Applied Financial Economics) Congress, Samos Island,
Greece, July 1-3, 2010 e pubblicato su "Conference proceedings" of the 7th
International Conference on Applied Financial Economics, Samos Island, Greece,
July 1-3, 2010, published by National and Kapodistrian University of Athens, Greece,
sponsored by Oxford University Press, UK.
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1. Introduction
Parma PDO Ham sector characterizes the socio-economic system of the province of
Parma, in Italy. In the sector are involved many agri-business firm that process and
mature fresh leg of pork to produce one of the typical Italian cold cuts, as Parma
PDO Ham. These firms are often characterized by high capital intensity, due to the
cycle of maturation of meat and because of investments in property, plant and
equipment that are needed for production. It is therefore to consider if the firms
were able to support the financial cycle of business management, through the
generation of positive cash flows. In particular, it is interesting to evaluate the
ability of firms in the sector to support the cycle of working capital and to serve
debt. To assess these aspects, the paper analyzes a sample of 20 firms in the sector,
using annual account data. The annual accounts have been reclassified and are applied
indexes and ratios to asses profitability and sustainability of the business cycle.
2. Parma PDO Ham sector
The Parma ham PDO sector includes agri-business firms that operate in the processing
chain of pork meat with the aim to produce matured Parma PDO Ham; Parma Ham is a
product subject to the guidelines of designations of origin of the UE and it is
produced in the province of Parma, in Italy. Annual production, in the period
2006/2008, shows an increase
(Figure 1)
production for processed hams, and for hams matured and marked with the PDO Prosciutto
di Parma. The annual production for the year 2008 is 10,023,281 processed hams and
is 9,770,842 for hams matured and marked.
In the sector, from 2006 to 2008,
prices
of hams have fallen and the average annual wholesale price of ham (weight over 9.0 kg)
fell from euro 5.48/kg to euro 5.01/kg while the average annual wholesale price of ham
(weight less than 9.0 kg) fell from euro 4.97/kg to 4.50 euro/kg.
The crisis in the price of ham, with an average decrease of market price of 8.92%
during the years of analysis, has contributed to various firm crisis situations.
Between 2006 and 2008, over 183 firms active in the sector, three were declared
failures, while five firms were placed in liquidation. In particular, corporate
crises were caused by industrial decline, with negative operating income, and
situations of high debt, with borrowing costs higher than operating income. In this
way it is often given a situation of negative net income in firms, with reduction of
equity. In some cases the reduction of corporate equity was likely to cause business
failure.
3. Methodology
3.1) Annual accounts analysis
The profitability analysis of firm management uses as a first indicator of
convenience, the analysis of the firm's annual accounts (Ferrero, Dezzani, Pisoni,
& Puddu, 2005). The analysis of annual accounts consider the data issued in patterns
required by law (Andrei & Fellegara, 2006); these schemes, issued by the European
Union, are in accordance with the Fourth EU directive, which aims to make the firm's
date comparable for firms operating in Europe (Andrei & Fellegara, 2006). This
approach to the annual accounts considers the legal requirement that the annual
accounts is the main document for business information and, therefore, it is necessary
for the protection of third parties. The annual accounts scheme is therefore aimed,
in particular, to inform and protect of and economic subject with whom the firm has
economic relations. It is therefore useful to analyze the data using the annual
accounts reclassification schemes (Iotti, 2009); these schemes differently aggregate
data of annual accounts to increase the level of information that it could be possible
to provide, by evidence of additional capital and profit margins than as this in the
annual accounts (Ceccacci, Camanzi, & Rigato, 2008). The reclassification of income
statement proposed in the paper uses the value-added scheme, where profit and loss
are analyzed by value-added reclassification (Iotti & Bonazzi, 2005); we have:
| [1] |
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S ± DI - Ce = VA - Cw = |
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= EBITDA - (D+A) = |
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= EBIT ± I ± V ± E ± T = P |
In [1] S is sales, I is the stock (inventories), Ce are external costs,
VA is value added, Cw is labour cost, EBITDA is earnings before interest,
tax, depreciation and amortization, D is Depreciation, A is Amortization, EBIT is
earnings before interest and tax, I is interest, V is revaluations and devaluations,
E is extraordinary gain and loss, T is taxes, P
is profit. The reclassification of the balance sheet (Ceccacci, Camanzi & Rigato, 2008)
substance is conducted on the basis of the scheme to liquidity:
[2] TA = aWCt + FA = aWCc + aWCi + aWCar
In [2] TA is total asset, aWCt is total
investment in working capital (asset), aWCc
is working capital (cash), aWCi is
working capital (inventories), aWCar
is working capital (accounts receivable), FA is fixed asset. The reclassification of
balance sheet liabilities is conducted according to the origin of sources of capital:
[3] TS = E + D = E + bWCt + DFs + DFl
In [3] TS is total liabilities and equity, E is equity, D is total liabilities,
bWCt is working capital total
liabilities, DFs is short-term financial debt (maturity within 12 months),
DFl is medium-long term financial debt (maturity over 12 months). The
difference between total investment in working capital (aWCt)
and working capital total liabilities (bWCt)
is net working capital (NWC). To deep annual account analysis it could be possible to
use financial ratios; these indexes are the ratio between net income and sales
(P / S), the Roe, as ratio between net income and
Equity (P / E), the Roa, as ratio between EBIT
and total asset (EBIT / TA), the Ros, as ratio between EBIT and sales (EBIT / S) and
the turnover, as ratio between sales and total asset (S / TA), (see Iotti, 2009).
To quantify the ability to support the debt, according to economic approach, it will
be used the interest cover ratio (ICR) as a ratio between EBIT and interest (EBIT / I).
To express the impact of financial charges it will be used the relationship between
interest and sales (I / S). It then used the leverage (L), as the ratio between equity
and total assets (TA / E) and the debt equity ratio (DER), as the ratio between debt
and equity (D / E) to express the level of debt.
3.2) Cash flow analysis
The income statement of the firm is prepared using principle of accrual
(Andrei & Fellegara, 2006) that is to express the time of value creation. The income
statement is independent from the generation of cash flows generated by operations.
It is therefore useful to analyze firm data using financial statements, that is the
document useful to analyze the source of cash flows (Shireves & Wachowicz, 2000).
To quantify cash flows it could be possible to use the indirect approach to issue
financial statements (Brealey, Myers, & Sandri, 2003) for calculating unlevered free
cash flow:
| [4] |
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EBIT+ D + A ± T = CF + D±NWC = |
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= OCF + D±FA = UFCF - DS = FCFE |
In [4] CF is cash flow, OCF is operating cash flow, UFCF is unlevered free cash flow,
FCFE is free cash flow to equity. CF correct EBIT with costs that do not cause an
outflow of money (D + A) and the impact of taxes (T); OCF quantifies the absorption
of net working capital (NWC) deriving from the management of the company and, in the
case of firms of Parma ham, it has particular importance for the impact of stock as
investments, because of the hams maturation period; UFCF is determined as the sum
between OCF and absorption of capital resulting from investment in fixed assets (FA);
UFCF has importance because it is the cash flow available to serve debt (DS, as debt
service, defined as DS = K + I, where K is the repaying in capital and I is cost of
debt, as interest). FCFE is free cash flow to equity, defined as to sum of cash
available to pay dividend to shareholders. First of all, if UFCF > 0 the firm is able
to create source of finance; is important to quantify the capacity to cover debt
service using a specific ratio. In order to quantify the capacity of the financial
cycle of the firm to cover debt service, it is possible to use debt service cover
ratio (DSCR), as ratio between UFCF and DS (UFCF / DS as to say UFCF / (K + I)). If
DSCR is > 1 the firm is able to cover debt service. It could be useful to consider
that only in the case in which FCFE > 0 it could be possible to pay dividend to
shareholders, even if P > 0.
4. Data analysis
4.1) Annual account analysis
The methodology used in the paper involves the analysis of the annual accounts
(year 2008) of a sample 30 firms in the sector of Parma PDO Ham, analyzing balance
sheet and income statement (for the analysis of financial statements has also been
used 2007 annual account). The annual account used for the analysis are available at
the local Chamber of Commerce; in fact, the economic and capital data in the annual
account of limited liability firms (public and private firms limited by shares) must
be deposited at the end of the year as a document of the external reporting. The
analysis of income, for the 2008 annual account, shows that the 20 firms in the
sample have S that varies from a minimum to 1.654 million euro to a maximum of 77.973
million euro, the average turnover is 19.093 million euro. The sample of firms is
divided into two sub groups; in the first, composed by 10 firms, sales below 10
million euro per year (group A), while the second 10 firms, sales over 10 million
euro per year (group B). In the sample, 13 firms generate profits (P > 0)
and 7 generate loss (P < 0); there are no cases
of balance (P = 0). The average ratio between
profit (net income) and sales (P / S) in the
sample is -0.88% with a minimum of -17.46% and a maximum value of 4.42%; the average
Roe of the sample is equal to -1.21%, with a minimum value of -27.09% and a maximum
value of 9.83%. The survey shows a negative net profitability in firms in the sample.
The average Roa of the sample is equal to 3.32% with a minimum value of -0.06% and a
maximum value of 6.70%, the level of Roa shows a low operating profitability level of
the sample firms. The average Ros in the sample is equal to 6.22% with a minimum
value of -0.10% and a maximum value of 12.86%; Ros shows that the operating
profitability of sales is very low. The average turnover of the sample is equal to
0.638, with a minimum value of 0.166 and a maximum value of 1.150; the sample firms
are characterized by high capital intensity (turnover < 1). Average ICR in the sample
amounted to 137.91% with a minimum of -1.62% and a maximum of 248.51%. It could be
possible to note a relationship between ICR and Roe: in the sample, the relationship
between ICR (independent variable) and Roe (dependent variable) has R2
equal to 0.659 (y = 0.093x - 0.141), and expresses the explanatory power of ICR in
obtaining profit. Is therefore important for analyzed firms, to be able to cover the
cost of debt (I) with operating profit (EBIT). The I / S is equal to 5.21%, and shows
a high level of incidence of the cost of debt on sales. The analysis of the balance
sheet shows the average TA 23.073 million euro, euro 2.861 million minimum TA and
135.289 maximum TA; and as average, aWCt / TA
is 65.26% and FA / TA is 34.74%; aWCi / TA
is 42.40%; is therefore issued the importance of inventories in
total assets.
Others working capital asset, as (aWCc +
aWCar) / TA, are 22.86%. The source of
capital analysis shows in the sample an average L that is 3.615 and a DER that is
2.615 (standard deviation is 1.60). The sample firms use debt to finance their
investments so that D = 2.615E. It is to note that there is a relation between L and
Roe (that is y = -0.028x - 0.089 with R2 = 0.281) and between DER and Roe
(that is y = -0.028x - 0.061 with R2 = 0.281).
4.2) Annual account analysis (group A and
group B)
In the group A of the sample, 7 firms generate profits (P > 0)
and in group B, 6 firms generate profit. The average ratio between profit and sales
(P / S) in the group A of the sample is -1.56%
and is -0.21% in group B; average Roe in group A is -1.62% and is -0.80% in group B.
Average Roa in group A is -3.51% and is -3.12% in group B. Average Ros in group A is 8.
13% and is 4.31% in group B. Average turnover in group A is 0,438 and is 0,839 in
group B. Average ICR in group A is 141.08% and is 134.73% in group B. The I / S
average ratio in group A is 6.56% and is 3.87% in group B. The analysis of financial
ratios shows that the smaller firms (group A) are characterized by higher incidence of
financial burden (I / S); A group firms have higher return on sales (Ros), but because
of lower capital turnover (turnover) generate lower net profitability (Roe) and
operating profitability (Roa). The analysis of the balance sheet shows the average TA
that is 9.781 million euro (group A) and 47.597 million euro (group B), as average,
aWCt / TA is 59.69% (group A) and
70.83% (group B); FA / TA is 40.31% (group A) and 29.17% (group B); aWCi / TA
is 40.77% (group A) and 44.04% (group B); others working capital asset, as
(aWCc + aWCar) / TA
are 18.92% (group A) and 26.79% (group B). It could be possible to note a decreasing
in FA investment in increasing of average firm size, with an increasing importance
of working capital (aWCt). The source
of capital analysis in the sample shows an average L that is 3.825 (group A) and
3.438 (group B) and a DER that is 2.825 (group A) and 2.438 (group B). The level of
indebtedness of smaller firms (group A) is slightly higher than larger firms (group B).
4.3) Cash flow analysis
In order to quantify the source of cash, it could be useful to analyze the creation
cash flow. The date show a situation in which average CF is 1.303 million of euro
(CF / TA 4,83%), no negative CF, average OCF is 0.181 million of euro (OCF / TA 1,77%),
7 case of negative OCF on 20 firms, and average UFCF is -1.772 million of euro
(UFCF / TA -7,86%), 12 case of negative UFCF on 20 firms, average FCFE is -3.147
million of euro (FCFE / TA -11,71%), 16 case of negative FCFE on 20 firms. The
analysis shows that the sample firms have difficulty to generate positive cash flow to
serve debt (UFCF) and to distribute dividends to the shareholders (FCFE). In
particular, the working capital cash flow affect significantly the absorption of
liquidity (0 cases of CF negative and 7 cases of OCF negative). For the analysis of
the creation of cash flow is interesting to note that the methodology that approximates
the level of cash through the creation of EBIT analysis is incorrect in the case
analyzed. Indeed, the data show a linear relationship between EBIT and CF (R2
is 0.738, with y = 1.483x +16,561) but there is, practically, no relation between
EBIT and OCF (R2 is 0.115, con y = -1.765x +20,006) and between EBIT and
UFCF (R2 is 0.065, con y = 1.695x -47,132). The analysis then shows how the
dynamics of capital and investment are essential to explain the generation of cash flow
in the analyzed sample of firm. Thus, a positive EBIT is illustrative of the
generation of CF, but it is not illustrative of the generation of OCF and UFCF,
therefore, the economic approach and the financial approach gives different results in
the sample. Indeed, it is insufficient to analyze EBIT to have information about the
capacity to generate cash flow; then, it could be useful to use cash flow statement
in order to analyze directly the generation of cash. It is interesting to note that
P is not a determinant of cash flow generation;
in fact, there is not a significant relationship between P
and UFCF (R2 0.048), between P and FCFE
(R2 0.021). The
DSCR
assumes, in analyzed, firms an average value of -5.37 and this shows, as mentioned
above for calculating UFCF, the debt service is unsustainable, on average, in
analyzed firms. Indeed, in 4 cases out of 20 DSCR > 1, while in 4 cases out of 20
0 < DSCR < 1.
4.4) Cash flow analysis (group A and group B)
It is useful to quantify the generation of cash flow even in groups of firms. The
date show a situation in which average CF is 0.424 million of euro (CF / TA 4.37%);
in group A, average CF is 2.183 million of euro (CF / TA 5.30%) in group B, average
OCF is 0.295 million of euro (OCF / TA 1.81%) in group A average OCF is 0.067 million
of euro (OCF / TA 1.72%) in group B. Interesting is to note that UFCF analysis shows
that in group A average UFCF is -1.426 million of euro (UFCF / TA -13.60%) and, in
group B, average UFCF is -2.081 million of euro (UFCF / TA -2.12%); FCFE analysis
shows that FCFE is -1.890 million of euro in group A (FCFE / TA -17.51%) and average
UFCF is -4.404 million of euro in group B (FCFE / TA -5.91%). It is note that the
generation of cash flows (FCFE and UFCF) for debt service and to distribute dividends
to the shareholders in smaller firms (group A) is less than in larger firms (group B).
DSCR assumes, in the analyzed firms, an average value that is and - 8.81, with 1 in
10 cases a DSCR > 1 and 2 in 10 cases 0 < DSCR < 1, in smaller firms (group A); the
DSCR average value of -1.91 with 3 in 10 cases is DSCR > 1 and 2 in 10 cases 0 < DSCR < 1,
in larger firms (group B). DSCR analysis shows that firms in group A are in a serious
financial risk for unsustainable debt service in 9 out of 10 analyzed cases.
5. Summary
The Parma PDO Ham sector has been affected by a decline in market prices during the
years 2006/2008, this reduction in market prices caused a lower profitability level
(Roe, Roa, Ros); as shown in sample of firms analyzed, a low level of capital
turnover (turnover) is one of the cause of reducing profitability, especially for
smaller firms (group A); moreover, relevant for all firms analyzed is the impact of
financial charges. In general, the analysis revealed a difficulty in generating cash
flow (CF, OCF, UFCF, FCFE), particularly in smaller firms (group A). The DSCR analysis
shows the difficulty to sustain business cycle (4 cases out of 20 DSCR > 1). The
analysis thus emphasizes the need to integrate economic analysis (financial ratios)
with financial analysis (cash flow statement analysis) to ensure not only convenience
but also the sustainability analysis of the management cycle of the enterprise sector
of Parma PDO Ham.
6. Acknowledgements
This work was supported by the data availability of annual accounts of firms in the
sector of Prosciutto di Parma PDO Ham, made available through the Consorzio Fidi
database of the Emilia Romagna Region; the authors are also grateful for the
availability of analisiaziendale.it in the
provision of IT and methodology support that has facilitated the development of
research data, with special thanks to the administrator of the company,
Paolo Camanzi. The responsibility remain in charge to the authors. The work, although the result of
a joint reflection, was prepared as follows: Giuseppe Bonazzi wrote paragraphs 1, 3.2,
4.3, 5; Mattia Iotti wrote paragraphs 3.1, 4.1, 4.4; Vlassios Salatas wrote
paragraphs 2, 4.2.
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Nota: il contenuto del documento deve essere interpretato in relazione al periodo
in cui è stato redatto.
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