Top Down Analysis And Bottom Up Analysis Essay

Question:

Discuss about the Top Down Analysis And Bottom Up Analysis.

Answer:

Introduction

The top down analysis and bottom up analysis is carried out for two companies operating in mining industry of Australia namely Rio-Tinto and BHP Billiton. The top down analysis helps in understanding the impact of changes in the economic factors on the current economic growth of Australia that also affects the industry performance. Besides this, the bottom up analysis helps in understanding the financial situation of the companies selected for the analysis (Robinson, et al., 2015). Mining industry is considered as the primary industry which contributes significantly towards the economy of Australia. The mining industry deals in the exploration, processing and extraction of the resources such as gold, lead, iron ore, bauxite, copper and zinc. Rio Tinto is a company that deals in mining and metals and was established in the year 1962 (Rio Tinto, 2016).

It mainly deals in mining, exploration and processing of mineral resources such as aluminum, iron ore, energy and minerals and copper and diamonds. The different segments of the company are located in 10 countries including Australia. The main aim of the business is to deliver superior value to its shareholders. The company emphasizes on integrity, excellence, safety, respect and teamwork (Rio Tinto, 2016).

BHP Billiton was established in the year 1885 with its headquarters in Australia. The company deals in exploration and mining of different minerals and oil and gas products such as metallurgical coal, iron ore, uranium, and copper. The company has dual listed company structure with two parent companies namely BHP Billiton Plc and BHP Billiton Ltd and operates as a single economic entity. Besides this, the company has provided employment to approximately 65000 employees (BHP Billiton, 2016).

Top-down Analysis: Fundamental Analysis

Fundamental analysis is the most common method used by the experts to estimate the intrinsic value of the firm. it analyses the basic financial information of the company such as sales, profits, dividend payout, interest assets, dividend coverage, market share and evaluation of promoter record which in turn facilitates in valuing equity shares on value based methods in three phases namely company analysis, economic analysis and industry analysis (Bouchard and Chassagneux, 2016).

Economic Analysis

Economic analysis is an approach that results in the determination of the optimum use of limited resources by making comparisons of the available alternatives to achieve specific objective under given assumptions and constraints. It takes into consideration the opportunity cost of resources employed in order to measure the private and social costs in monetary terms related to a project or economy. The mining sector has contributed 8.5% to the total GDP of Australia by providing employment to approximately 2% of the workforce in the year 2013 (The Conversation, 2015). Downstream processing is considered as mining output instead it is considered as production or manufacturing. Besides this, the mining sector pays approximately $12.7 billion as taxes that include $170 million as carbon tax in the year 2013. The major source of income for mining industry in Australia composed of 50% of Australia’s total export earnings (The Conversation, 2015).

Majority of the export earnings of the mining industry is dominated by iron ore and coal. In the year 2013-2014, the exports from iron ore is $74.67 billion. There are approximately 1300 mining firms in Australia out of which, the production is dominated by large firms such as Rio Tinto and BHP Billiton. Besides this, the mining industry has contributed approximately 10% to the total output. Besides this, the GDP per capita income of Australia is $51320 billion in the year 2015. The current exchange rate of Aus$ is 0.73 in the year 2015 which affects the buying behavior of other countries customers to buy Australian products at low exchange rate. This helps in creating competitiveness of the Australian businesses beneficial for economy of Australia (Stanley, 2017).

Industry Analysis

In the year 2016, there is a decline in the enthusiasm of investors for Australian mining with the growing sector for China. The companies in the mining industry is investing in the innovation and research and development activities in the year 2017 for the purpose of pursuing development in the sector. There are different companies such as BHP Billiton and Rio Tinto to implement autonomous hauling systems for the purpose of increasing the efficiency by making optimum utilization of the available resources with minimum wastage and minimizing the occurrence of errors. There is an occurrence of the decline in the prices of iron ore since 2011 which results in a decline in the prices of the commodities which has a negative effect on the profits of miners and prices of the shares (Latimer, 2016).

In the year 2015-16, the mining industry has provided employment to almost 163000 employees. There is a decline in the employment rate by 8.4%. Besides this, the sales from mining industry are $188943 million in 2015-2016. There is a decline in the growth rate in sales income by 11.4%. There is also a decline in the gross income to $60760 million with a decline of 17.5%. There is a decline in the prices of the commodity despite of which there is an occurrence of tremendous transitions in the production phase. Despite of the slow demand of mining, there is a growth in the construction sector. Besides this, there is an occurrence of rapid changes taking place in the technologies used by the mining industry such as autonomous hauling system which results in improving the overall performance and efficiency of the whole industry (Office of the Chief Economist, 2016).

Company Analysis

It is required to analyze the financial performance and productivity of the companies as it help investors to take decisions regarding the investments to be made in the companies which results in accelerating the growth of the companies. This also helps in gaining competitive advantage over other players in the market. The company is analyzed from the perspective of management or operations carried out by the companies along with its financial performance. It is essential for the companies to disclose the information related to different procedures and processes adopted to carry out its different business operations (Weigand, 2014).

Management of Companies

The management of both the companies have adopted new technologies and improved processes and procedures for the purpose of increasing their production capacity for the purpose of meeting the needs of its customers. Besides this, the companies have also adopted effective and efficient strategies for the purpose of achieving the goal of the business. There is a requirement to bring transparency in the operations of the business in order to increase the competitiveness of the company (Doss, et al., 2013).

Financial Analysis

This is the second step of the company analysis in which the financial statements are analyzed by the stakeholders of the company in order to make effective decisions. The financial performance and position of Rio Tinto is better than BHP Billiton as the company has earned profit. The liquidity position of the company is also better of Rio Tinto as compared to BHP Billiton. From the investment point, Rio Tinto is preferred over BHP Billiton as it is more profitable company. In addition to this, shareholders are attracted towards the company as it helps in paying more dividend in comparison to BHP Billiton. This is because BHP Billiton has made loss in the year 2016. In addition to this, market value of BHP Billiton is better than the Rio Tinto which indicates that investors are attracted towards BHP Billiton to make investment in the company (Bell, Brooks and Prokopczuk, 2013).

Bottom-up Analysis

The bottom up approach does not focuses on the movements occurred in the security market but emphasizes on the individual securities. It makes an assumption that the companies are performing well in the industry. There is a need to review the performance and position of the company as it helps the stakeholders to make effective decisions. In this approach, emphasis is given on a single company rather than on industry and gain knowledge regarding its products and services, research reports and financial stability. The bottom up approach facilitates in providing accurate forecasts of the financial data as it emphasizes on the in depth analysis of the company in terms of products and services, financial performance and position and availability of different business opportunities (Vernimmen, et al., 2014).

Rio Tinto

Particulars

2015

2016

Current Assets

15261

15055

Current Liabilities

10046

9362

Inventory

3168

2937

Net Profit

-1719

4776

Sales

34829

33781

Total Assets

91564

89263

Dividend

2.2

1.51

Earnings per share

-0.47

2.55

Market Price per share

23.58

20.73

Shareholders’ Equity

37349

39290

Current Ratio= current assets/ current liabilities

1.519112

1.608097


For the purpose of carrying out bottom up analysis of the companies, there is a requirement to conduct ratio analysis which helps in providing information related to different aspects of financial performance and position so that different stakeholders can make effective decisions related to having interest in the company in terms of getting return. In order to assess the liquidity position of the company, two ratios such as current and quick ratio is evaluated. These ratios provide information related to the ability of the company to meet its current liabilities by the use of current assets. The above table indicates that there is an increase in the current ratio of the company from 1.5 in 2015 to 1.6 in 2016. This indicates that the company has sufficient current assets to meet its current liabilities (Wahlen, et al., 2014).

Besides this, the quick ratio provides the true measure of the liquidity position of the company as it does not consider inventories and prepaid expenses in the current assets as it is slightly takes time to convert them into cash and cash equivalents to meet the current liabilities. There is also an increase in the quick ratio from 1.20 in 2015 to 1.29 in 2016. Besides this, majority of the funds are blocked in the inventories due to which, there is a need to adopt strategies that helps in converting the inventories into cash and cash equivalents (Brigham, 2014).

In addition to this, the company has also made loss in the year 2015 and has able to recover the loss and attain a tremendous increase in the net profit margin of 14.13% in the year 2016 from a loss of 4.93%. The main reason behind it is that there is a decline in the revenues generated from the sale of different products offered by the company. Besides this, it also takes into consideration all the expenses incurred in carrying out different business operations of the company. The company has made loss in the year 2015 due to which, it is unable to convert its assets effectively to generate profits for the company. It has made tremendous profit in the year 2016 and converts its assets effectively to generate profit for the company. The return on assets for the company has increased from -1.8% in the year 2015 to 5.35% in 2016. This indicates that the company has improved to make efficient use of its assets to make profit for the company (Wahlen, et al., 2015).

Besides this, the company is paying increased dividend to its shareholders every year which results in attracting more investors to make investment in the company as the company is able to pay high return on their investment by exploiting different business opportunities which helps in increasing their profits. In addition to this, there is also an increase in the earnings per share of the company to 2.55 in 2016 from -0.47 in 2015. This shows that the shareholders of the company would earn 2.55 on each share in which they invested if whole of the profit earned by the company is distributed among them. Along with this, there is also an increase in the price earnings ratio from -50.17 in 2015 to 8.12 in 2016. This indicates that the investors such as shareholders and other investors are expected to make increased investment in the company in order to earn high returns on their investments. The company has strong financial performance and position in the market relative to industry average (Brief, 2013).

BHP Billiton

Particulars

2015

2016

Current Assets

16369

17714

Current Liabilities

12853

12340

Inventory

4292

3411

Net Profit

2878

-6207

Sales

44636

30912

Total Assets

124580

118953

Dividend

2.48

1.56

Earnings per share

0.71

-2.4

Market Price per share

29.75

20.96

Shareholders’ Equity

64768

54290

Current Ratio= current assets/ current liabilities

1.273554812

1.435494327

Quick Ratio = (Current Assets- Inventory)/ current liabilities

0.93962499

1.159076175

Net Profit Margin = (Net Profit/ Sales)*100

6.447710368

-20.07958075

Return on assets = Net Profit/ Total Assets

0.023101621

-0.052180273

Dividend Yield = Total Dividend Payments/ Market value per share

0.083361345

0.074427481

Price Earnings Ratio = Market Price per share/ Earning per share

41.90140845

-8.733333333


The current ratio and quick ratio provides the information related to the liquidity position of the company. It indicates that the company has sufficient current assets which can be used to pay off its current liabilities. There is an increase in the current ratio of the company from 1.27 in 2015 to 1.43 in 2016. In addition to this, the true measure of the liquidity position of the company is quick ratio as it does not consider inventory while calculation of the ratio i.e. it only considers those current assets that can be quickly converted into cash and cash equivalents to meet its current liabilities in an effective manner (Samonas, 2015).

There is also a tremendous increase in the quick ratio of the company to 1.15 in 2016 from 0.93 in 2015. This indicates that the company has good liquidity position. The company has made loss in the year 2016 as compared to the year 2015 as it fails to earn increased revenue from the sales and there is an increase in the expenses incurred by the company due to which the net profit margin of the company in the year 2016 is -20.07% as compared to 6.44% in the year 2015. The net profit margin ratio shows that the profit generated from the sales of the company after meeting out all the expenses incurred in different business operations of the company. In addition to this, due to the company has made loss in the year 2016, the return on assets is also negative in the year 2016 to -0.05 from 0.023 in the year 2015 which indicates that the company is unable to make efficient use of the its assets to generate sales of the company (Wahlen, et al., 2015).

The company is able to pay dividends to its shareholders as a return on their investment in the company which attracts more number of investors towards the company. There is also a slightly decline in the dividend yield of the company from 0.083 in 2015 to 0.074 in the year 2016. The company has negative earnings per share in the year 2016 to -2.4 from 0.71 in the year 2015. This indicates that the shareholders of the company are not able to earn an income on the shares held by them. The price earnings ratio is negative as -8.73 in the year 2016 from 41.90 in the year 2015. This shows that investors are reluctant in making investment in the business. Thus, it can be said that the profitability position of the company is not strong in the year 2016 as compared to the year 2015 (Fleisher and Bensoussan, 2015).

Summary and Recommendations

It can be summarized that the financial performance and position of Rio Tinto is better than BHP Billiton. Besides this, these are close competitors of each other. In addition to this, it can also be summarized that the mining industry deals in the exploration, processing and extraction of the mineral resources such as iron ore, bauxite and so on. In addition to this, it can be recommended that the companies should exploit different business opportunities for the purpose of expansion of the business and increase their profits and liquidity position of the company.

References

Bell, A.R., Brooks, C. and Prokopczuk, M. (2013) Handbook of Research Methods and Applications in Empirical Finance. USA: Edward Elgar Publishing.

BHP Billiton. (2016) Annual Report. [Online]. Available at: [Accessed on: 1 September 2017].

Bouchard, B., Chassagneux, J.F. (2016) Fundamentals and Advanced Techniques in Derivatives Hedging. USA: Springer.

Brief, R.P. (2013) Corporate Financial Reporting and Analysis in the Early 1900s (RLE Accounting). UK: Routledge.

Brigham, E.F. (2014) Financial Management Theory and Practice. USA: Atlantic Publishers & Distri.

Doss, D.A., Sumrall, W.H., McElreath, D.H. and Jones, D.W. (2013) Economic and Financial Analysis for Criminal Justice Organizations. USA: CRC Press.

Fleisher, C.S. and Bensoussan, B.E. (2015) Business and Competitive Analysis: Effective Application of New and Classic Methods. USA: FT Press

Latimer, C. (2016) The top ten trends for mining in 2016. [Online]. Available at: [Accessed on: 1 September 2017].

Office of the Chief Economist. (2016) Australian Industry Report. [Online]. Available at: [Accessed on: 1 September 2017].

Rio Tinto. (2016) Annual Report. [Online]. Available at: [Accessed on: 1 September 2017].

Robinson, T.R., Henry, E., Pirie, W.L., Broihahn, M.A. and Cope, A.T. (2015) International Financial Statement Analysis, Third Edition (CFA Institute Investment Series). USA: John Wiley & Sons.

Samonas, M. (2015) Financial Forecasting, Analysis and Modelling: A Framework for Long-Term Forecasting. USA: John Wiley & Sons.

Stanley, M. (2017) Value of Western Australian resources sector picks up for first time in three years. [Online]. Available at: [Accessed on: 1 September 2017].

The Conversation. (2015) Australia’s ‘five pillar economy’: mining. [Online]. Available at: [Accessed on: 1 September 2017].

Vernimmen, P., Quiry, P., Dallocchio, M., Fur, Y.L. and Salvi, A. (2014) Corporate Finance: Theory and Practice. USA: John Wiley & Sons.

Wahlen, J.M., Baginski, S.P. and Bradshaw, M. (2014) Financial Reporting, Financial Statement Analysis and Valuation. USA: Cengage Learning.

Wahlen, J.M., Jones, J.P. and Pagach, D. (2015) Intermediate Accounting: Reporting and Analysis. USA: Cengage Learning.

Weigand, R.A. (2014) Applied Equity Analysis and Portfolio Management: Tools to Analyze and Manage Your Stock Portfolio. USA: John Wiley & Sons.

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