CHAPTER 1

INTRODUCTION

Background of the Study

Consumer goods are an integral part of a person’s day-to-day life because these

are the products that he or she will use or consume on a daily basis. Basic products like

food, beverages, clothing, and jewelry are all considered consumer goods. They are also

called “final goods” because these are sold for personal use, whether it be for school,

home or leisure purposes (Kenton, 2018). These goods are used to satisfy a consumer’s

wants and/or needs, and they are bought to ultimately be consumed rather than serve as a

tool or a raw material for the production of another good (Wikipedia).

As there is obvious demand for consumer goods every day, there are companies

dedicated to manufacturing goods for the ultimate consumption of consumers. The

consumer goods sector is a classification of stocks and companies that aims to gratify

consumer needs. It includes food manufacturing, packaged goods, beverages, clothing

and many more (Kenton, 2018). Because this sector produces the basic necessities of the

average consumer, competition between the companies within the industry cannot be

helped. The biggest companies in the industry bring in, on average, $59.170 million,

which proves that it is a sector that continues to thrive (CGT, 2018).

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However, despite the industry bringing in millions of dollars every year, the

growth rate seems to be slowing down, even for the top competitors in the sector. Growth

for consumer goods companies decreased from a 6% in 2016 to a mere 2.5% in 2017.

This is due to a number of factors that are hindering the industry’s desire to grow,

including, but not limited to disruptive competitors, technological shifts, consumer

behaviors, customer expectations, and economic pressures (KPMG, 2018).Although

consumer goods are still present in grocery stores and supermarkets, a lot of huge,

established brands are facing a steady decline in the consumer goods business. Among

the world’s top 50 consumer goods companies, only a sheer 15% managed to avoid a

decline in either revenues, profits, or both (Meacham et al, 2018).

Nevertheless, the changes that the industry has been through these past couple of

years does not hinder investors from putting faith in, at least, the globally-known brands.

The introduction of e-commerce in the 21st century enabled companies to reach a wider

audience and to satisfy their needs with convenience on both sides (Zhou, 2018). Though

the rising prices of basic commodities impede consumers from buying a lot of products, it

is unavoidable because of the constant need for them in their everyday lives.

With the fact that investing in the consumer goods industry can sometimes prove

to be a risky move, the Financial Performance of three (3) companies from this industry

shall be compared by means of Ratio Analysis. Since these companies all come from the

same industry, their goals, objectives, and general processes are similar with each other.

All three of these companies aim to be both profitable and solvent throughout their

operational lives, as is the case with all other companies that are established. Although all

companies aim for the same goals, the attainment all lies upon proper management of
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company resources through planning, budgeting, forecasting, control, and decision-

making (Hermanson et al., 1992). Fortunately, a branch of accounting, financial

management, can provide the information through the analysis of a company’s financial

statements.

Financial management is concerned with the effective managing of a company’s

financial functions. These financial functions include accounting, company policies and

procedures, record-keeping and reporting systems, planning and forecasting practices,

budgeting procedures, and financial-oversight responsibilities. Its main goal is to ensure

that the company is operating as a financially sustainable enterprise (RCAP, 2011). It is

one of the important parts of overall management with numerous functional departments.

It covers a wide area with multidimensional approaches (Parmasivan et al., n.d.).

As the study is concerned with the probable profitability and solvency of the three

companies to be presented, it is only fair to use their financial statements in order to

gauge their current financial condition. A financial statement is an official document of

the firm, wherein information about the financial aspects of the firm is presented

(Parmasivan et al., n.d.). It was also defined as “a summary of the accounting of a

business enterprise, the balance-sheet reflecting the assets, liabilities and capital as on a

certain data and the income statement showing the results of operations during a certain

period” (Nyer, n.d.). Basing from these definitions, a financial statement consists of two

important statements: the Income Statement and the Balance Sheet. The Income

Statement reflects the operational position of the company for a particular period. It also

helps to ascertain the profits and losses of the company for the period concerned. The

Balance Sheet reflects the financial position of the company for a particular period. It
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also helps to understand the total assets, liabilities, and capital of the company. Although

various assumptions could be made by merely looking at the financial statements, a lot

can be inferred by analyzing and interpreting them. Thus, using ratio analysis can permit

users to see beyond what the numbers are portraying and enable them to make more

knowledgeable business decisions.

In order to correctly analyze financial statements, the figures in them must be

compared and related to each other or to other relevant data. The usage of ratio analysis

accomplishes this task. Ratios are an effective method of analyzing financial statements

because it compares 2 figures with each other, either in terms of percentages or in

absolute values. However, for a ratio to be relevant, there must be comparisons not just

with figures within a single financial statement, but also with other ratios, competitors,

and over time results. Therefore, important business decisions can be made if financial

statements are properly analyzed with the help of ratios.

The consumer goods industry is one of the riskiest industries to invest in because

it has constantly been declining as the years go by. Among the industry, the three biggest

contenders are as follows:

Nestlé. Nestlé is a Swiss food and beverage company. Currently claiming the

number one spot for the consumer goods company rankings for the year 2018, it is the

largest food company in the world. Founded in 1866 by Henri Nestlé when he developed

milk-based baby food and began to market it. This saw the work of Daniel Peter’s seven-

year perfection of his invention, the milk chocolate manufacturing process. In 1879,

Nestlé merged with Peter. In 1904, François-Louis Cailler, Charles Amédée Kohler,
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Daniel Peter, and Henri Nestlé collaborated in the creation, development, and marketing

of Swiss chocolate which later on became milk Nestlé. In 1905, the companies merged to

become “Nestlé and Anglo-Swiss Condensed Milk Company,” retaining the name until

1947. Their growth during the early 1990s until the 20th century was favorable, with trade

barriers disappearing and world markets being more open. Acquisitions of other food

companies and its perseverance to transform itself into a nutrition, health, and wellness

company in order to fight off the declining sales of confectionery products and the

approaching government regulation on such products allowed the company to survive in

the industry for as long as it has.

Procter & Gamble. Procter & Gamble is an American consumer goods

corporation. Currently at the number 3 spot for the consumer goods company rankings

for the year 2018, it was founded in 1837 by William Procter and James Gamble. The

company specializes in personal care and hygiene products, and has been grouped into

segments such as beauty, grooming, health care, home care, and baby, feminine and

family care. The company used to also manufacture foods, snacks, and beverages before

streamlining and dropping off 100 brands to focus on its income-generating 65 brands.

Their focus on their income-generating goods allowed them to have a “simpler, much less

complex company of leading brands that’s easier to manage and operate,” according to

the company president and CEO, David Taylor.

Unilever. Unilever is a British-Dutch consumer goods company. It is currently

sitting at the number 5 spot for the consumer goods company rankings for the year 2018.

It was formed in 1929 by a merger of operations of the Dutch Margarine Unnie and the

British Lever Brothers, the name “Unilever” being a portmanteau of the two companies’
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names. The company manufactures food and beverages, which makes up for about 30%

of its revenue, cleaning agents, beauty products, and personal care products. It is also the

seventh most valuable company in Europe and one of the oldest multinational companies

in existence.

Review of Related Literature

Financial Reports

Financial statements containing financial data of a company are essential in

evaluating the business’ earning ability. Financial statement analysis is used in making

decisions regarding investments and had been tackled by a number of authors. J.

AOhison (2012) stated that financial statements come with a balance sheet (or statement

of financial position) and income statement which describes the flow of resources, profit

and loss, and the profit’s distribution or retention. According to Meigns et al. (2013),

financial statement depicts certain attributes of a business which are considered to fairly

represent the company’s financial activities. The rate of return on investment (ROI) tests

the efficiency of a management in utilizing procurable resources.

It was discussed by Richard Bourley (2013) that the main purpose of a financial

statement analysis is to examine the quantitative as well as qualitative data in order to

find out the quality and protection of assets and the quantity of earnings. In the words of

Patrick J. et al. (2014), when business failures are common in periods of recession, the

balance sheet takes on an increase in importance because the question of liquidity is what

first comes to the minds of many in the business community and when business
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conditions are good, the income statement receives more attention since it provides the

information of the transactions occurred in a certain period of time called accounting

period.

The article of Frank C. (2016) focuses on a firm’s assets, liabilities and equity

which shows the financial position at a point in time in two sub accounts of balance

sheet. Assets account is the first one, which includes all the current and fixed assets of the

company. The other sub account includes all the liabilities and equity. According to

Timothy J. et al. (2016) statement of cash flow shows the overall net increase or decrease

in cash of the firm in terms of operating, investing and financing activities.

Financial Ratios

Financial ratios exist to simplify the assessment of an organization’s financial

data and they come in different categories based on the many financial aspects of a

business. In an article written by Tanuaria M. L., it was stated that financial ratio is

calculated when two data are compared with one another while the financial data is

provided by the financial statements of relative years. According to Manuel E. (2015),

Profitability ratio (also known as performance ratio) is used to assess if the business is

over or under-spending by determining if profit is being earned and if there is return on

their invested resources. Kitces, et al. (2015) expounded on the net profit margin under

profitability ratio as the ratio between net sale and net profit that shows how much

earnings of a company can be converted into profit excluding the expenses less all taxes,

interest, and preferred stock dividends. Robles N. (2014), on his book Financial Ratio

Analysis, discussed about how the Liquidity ratio can show the company’s ability to pay
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its obligations due without utilizing all their resources and leaving enough to sustain the

company’s current operations. Dominguez, C. (2015) wrote that the Basic Accounting

Leverage Ratio determines if a business can keep the level of control in business while

obtaining funds from outside of the company.

Comparative Financial Studies

According to Florenz C. Tugas (2012), the exploratory and quantitative context

design used on the study of three listed firms in the education subsector for three periods

(2009 – 2011) analyzed financial statements using the rule of thumb and ratio trends, and

after conducting a comprehensive financial ratio analysisFEU (44 points) ranked first as

the most financially healthy, followed by Malayan (40 points), then CEU (36 points). The

total points for each ratio category were then computed to arrive at an overall basis for 63

analyses. According to Miralao F. (2015), The Philippines implemented a nationwide

reform in its education system in June 2012. The main change was an increase of the pre-

university education cycle from 10 to 12 years. Financial ratio analysis contributes in the

significant investment in the education system’s human resources and facilities, which

prompted the legislators to increase the education budget in 2014 to 4.3% of the

country’s gross domestic product.

According to Gilberto Lianto (2012) Philippine credit cooperatives have help

thousands of members build up their savings and access low cost credit for diverse needs

using ratio analysis that defined their company’s performance.Systematic risks in the

Philippine economy were heightened in 2013. Nicholas Tan et al. (2013) of the

International Monetary Fund Country Report No.13/102 because the current levels of
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debt in the economy is still far from the cause of past financial crises since high leverage

levels cause a stir and anxiety in the economic sector of the Philippines. According to

Patrick et al (2014), one rich source of information for financial statement analysis is the

audited financial statements and financial statement analysis from the standpoint of

management relates to all of the questions raised by creditors and investors because these

user groups must be satisfied in order for the firm to obtain capital as needed.

According to Pamela Peterson (2015), there are some reasons that make the result

for book value be less than the market value when computing the equity of a company:

the earnings are recorded according to accounting principles which does not well reflect

the economic situation, and because of inflation, the current value of money does not well

reflect. Therefore, when using the value for denominator in total shareholder’s equity for

calculating the D/E ratio, the market value of equity is more preferable. According to

Cadsawan G. et al. (2015), they used three instruments to analyze and access Banco De

Oro’s financial and operational performance, the first is a financial ratio analysis

covering years 2011-2013; the second is the SWOT Analysis; and the third is Porter’s

Five Forces Model. After computing for the ratios, the researchers then interpreted the

findings and show that in terms of resources, gross customer loans, deposit liabilities,

capital funds and net income, BDO is doing well and improving as all the figures are

increasing.

It is important to note that no one measure of financial performance should be

taken on its own. Rather, a thorough assessment of a company's performance should take

into account many different measures. According to, Mohammadi, et al. (2012), this

study investigates the financial performance of an investment company in Malaysia for a

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three-year period from 2009 to 2011, which is assessed using financial ratios. The

findings pointed out that overall company performance reduced remarkably in the last

year of the analysis. This study principally emphasizes on how accounting information

aids budgetary decision-makers to evaluate the company financial performance,

determine its future obligations, and make better investment decisions. According to a

research, the role of profit margin is considered to be important not only about the

amount of profit that the owners can extract from the business, but also about a line of

defense for an advisory firm facing a decline in revenue when a bear market occurs.

According to Krishna Prasad Upadhyay (2012), different measures like return on

investment, return on equity, return on assets, earning per share, dividend per share, and

asset utilization ratio are used to assess the profitability of the companies and he

concluded in his study that the solvency position of their business is not sound and credit

creation capacity is good in its aggregate. BalaRamaswmy, Darrylong and Mattew C.H.

Yeung (2012) has found empirical evidences that firm size and the firm ownership are

important determinants of financial performance in the Malaysian palm oil sector-

findings and it lend support to industry analysts who have highlighted that profitability is

higher in privately owned firms. According to Kellermann&Schlag (2013), debt coverage

ratios or leverage ratios are regarded as the appropriate instruments to safeguard the

system of financial regulation and supervision against failure in risk assessment (The

BCBS 2009).

According to Yahya, F. et al. (2013), Unilever Foods is better corporate than

National Foods (further results are discussed in the Significant Analysis for Financial)

since results showed that horizontal analysis is somehow better analysis than vertical
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analysis as it shows negative or positive trend of variables while the other shows the

gradual fluctuation of total assets and sales. However, ratio analysis is seems to be the

best analysis as it gives concise and paramount review of firm’s performance.

According to JagannadhaRao (2014), by the use of ratio analysis, he found out

that the poor state of financial performance of the company is the cumulative result of

unfavourable factors such as continuous low capacity utilization of the units, fall in sugar

recovery in some of the units, poor operational performance, high cane price advised by

the State Government and paid up by the company, low levy price of sugar. Remedy for

the poor financial performance is better the operational performance of the sugar units

particularly the sick units, paying reasonably high cane price, reducing the cost of

production by improving capacity utilization, and taking advantage of free quota to make

good the losses suffered due to low levy price.

According to Phuong'Dao (2016), this research aims to analyze air travel

performance of Finnair and Scandinavian Airlines (SAS) based on financial ratios since

the airline company has a strong relationship with other kinds of business and economic

factors; therefore, small changes in these businesses might lead to a dramatic effect on

the airline companies. A comprehensive investigation into profitability, debt coverage

and market value ratios will help stakeholders have an exact evaluation and broader point

of view about two rival airlines in the Nordic region. Two analyses are conducted based

on financial data extracted from financial statements of Finnair and SAS and other

relevant sources. Besides, there are mathematical calculations to support the ratio

analysis. All financial ratio interpretations of the two companies are shown in each ratio

analysis which gives the most correct reflection of the companies’ performances. Finally,
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measurement of the overall analyses presents better result of profitability, operational

efficiency and decision-making process to identify the better airline.

Theoretical Framework

Prospect Theory

This is a theory in cognitive psychology that describes how a person chooses

between options that involve risks, wherein the probability of the outcomes cannot

always be certainly predicted. The theory states that most people would make decisions

based on the potential losses that they may incur rather than the gains that the investment

may give them.

Bertrand’s Box Paradox

This is a paradox of elementary probability theory wherein the situation is as

follows:

There are three boxes. The first box contains two (2) gold coins, the second box

contains two (2) silver coins, and the third box contains one (1) gold coin and one (1)

silver coin. The problem presented is in the probability that if one was to choose a box at

random and was made to pull out a coin, also at random, and it happens to be a gold coin,

of the next coin drawn from the same box also being a gold coin.

This gives the conclusion that one cannot simply pick the best option (the box

with two [2] gold coins) just by picking out a single coin and basing their entire decision
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only on that single gold coin. One must evaluate all the boxes in order to come to the best

conclusion among the options.

Conceptual Framework

Below is the conceptual archetype used by the researchers which illustrated the

variables examined on the research paper and their relationships with one another.

INPUT PROCESS OUTPUT

• The 3 biggest • Identify the • Comparison of the
companies within appropriate ratios 3 biggest
the consumer to use for the companies within
goods industry evaluation of the industry
• Financial Financial • Presentation of the
statements of the 3 Performance ratio analysis
companies for last • Calculate the conducted
5 years necessary figures
from the financial
statements

The framework demonstrated how the researchers used the variables in order to

analyze and compare the profitability and solvency of the selected consumer goods

companies. On the input variable, it contains the names and financial statements of the

companies selected. On the process variable, the researchers determined which financial

ratios to use in order to calculate the needed figures in order to make comparisons

between the selected companies. Lastly, on the output variable, the researchers compared
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the information acquired from the ratio analysis and presented the differences between

the companies selected.

Statement of the Problem

Many of the recipients and users of financial statements do not know how

to properly analyze the information presented in said documents. Some may not even

know that the figures stated in the financial statements can be compared with one another

in the form of ratio analysis in order to come up with information that can be helpful for

decision-making processes. Because information stated on financial statements are

summarized and consolidated and may not reflect the operations conducted within the

reporting period, it is crucial to analyze and interpret these data by using financial ratios

to aid management and various stakeholders in understanding them.

The main intention of the research is to make comparisons between the three

biggest companies within the consumer goods industry by comparing their financial

performances. The study aimed to answer the following inquiries:

1. What is the financial performance of the following selected consumer

goods companies with respect to their:

1.1 Profitability

1.1.1 Gross Profit Margin

1.1.2 Net Profit Margin

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1.2 Solvency

1.2.1 Quick Ratio

1.2.2 Debt to Equity Ratio

1.3 Asset Management.

1.3.1 Return on Total Assets

1.3.2 Debt to Asset Ratio

1.3.3 Financial Leverage Ratio

2. What is the financial performance of the selected consumer goods

companies when categorized as an industry?

3. What is the financial performance of the selected consumer goods

companies when compared to the consumer goods industry averages?

Null Hypothesis

Ho: There is no significant difference in the overall average financial performance

between the selected companies of the consumer goods industry.

Significance of the Study

Beneficiaries of the study are the sectors as listed below:

Management of the selected companies. The results of the study can serve as a

reference in order to guide them in their decision-making processes.

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Potential investors. The study may aid potential investors in deciding on which

company from the consumer goods industry to invest in.

Students and other researchers. This study can be used as a reference for

students to augment and expand their proficiency on ratio analysis. Researchers on the

consumer goods industry can, likewise, use this study as a reference and guide on coming

up with their own studies.

Scope and Limitations

The scope of the study is limited to the collection of data from the selected

companies’ annual published financial statements. The study is covered a period of two

(5) years, from the years 2013 until 2017.

The ratios used in this study are limited to the companies’ Quick Ratio, Gross

Profit Margin, Net Profit Margin, Return on Total Assets, Return on Common Equity,

Debt to Asset Ratio, Debt to Equity Ratio, and Financial Leverage Ratio.

Annual financial statements gathered and analyzed were from the companies

Nestlé, Procter & Gamble, and Unilever.

Definition of Terms

The researchers defined the following words and phrases in context to how they

were used and utilized in this research study.

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Balance sheet. A part of a company’s financial statement which shows the

financial position of the organization. It is composed of the assets, liabilities, and capital

line items of the business at a particular point in time.

Consumer goods sector/industry. A category of stocks and companies that

relate to items purchased by individuals for personal consumption rather than by

manufacturers and other industries.

Consumer goods. These are goods that are produced and subsequently purchased

to satisfy the current wants and needs of the buyer.

Quick Ratio. It is a liquidity ratio that tests a company’s ability to pay off its

short-term liabilities.

Debt to equity ratio. It is used to compare the resources provided by the creditors

with the resources provided by the company’s shareholders.

Financial leverage ratio. It is the amount of total assets financed by the

company’s common equity.

Financial management. It is defined as dealing with and analyzing money and

investments for a person or a business to help make business decisions.

Financial performance. It is a subjective measurement of how well a company

can utilize its assets from its primary operations and generate income.

Financial statements. These are written records that convey the business

activities and the financial performance of a company. This includes the balance sheet,

income statement, and cash flow statement.

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Gross profit margin. It is the percentage of gross profit compared to the net sales

during a specific period of time.

Income statement. It is one of the primary tools used to assess a company’s

performance and financial position. It summarizes the revenues and expenses generated

by the company over the entire reporting period.

Profitability. It is the company’s ability to generate profit.

Ratio analysis. It is a quantitative analysis of information contained in a

company's financial statements.

Return on total assets. It is a profitability ratio that tests whether management is

using its funds and resources wisely.

Return on total equity. It is a measure of profitability that calculates how many

dollars of profit a company generates with each dollar of shareholders' equity.

Solvency. It is the measure of a company’s ability to pay its long-term debts.