Stagecoach's Accounting Ratios Essay: Evidence Of Cash Flow Crisis.

This case study is related to the ongoing transport crisis in UK because of the aftermath of the Covid-19 pandemic. Amid the crisis, National Express is considering a potential takeover of Stagecoach which will result in brining together two of the largest transport-based companies of the country. The deal value of this transaction has ascertained Stagecoach to be valued at £ 445 million and will result in National Express owning 75% stakes in the new combined company. National Express believes that this merger will help slash costs which will result in an annual savings worth £ 35 million expecting to attain 25% of this goal within the end of the first year. This case presents the income statement and balance sheet of Stagecoach for the recent three financial years through 2018-2020. The only fundamental issue in the case is that Stagecoach lacks enough cash to purchase new buses and this could very well be a problem if sales were to increase.

The main purpose and objective of this report is to calculate as many numbers of accounting ratios possible for Stagecoach based on the financial statements presented in the case study in order to understand the evidence of the supposed ‘cash flow’ crisis of the company. This report looks to analyse the calculated financial ratios over the last three years for understanding the adversities in trends and will finally recommend National Express to accept the merger or refrain from this potential takeover.

On observing the annual financial statements of Stagecoach, the relevant financial information have been extracted for calculating the accounting ratios. Accounting ratios are then calculated with the help of quantitative formulas based on the extracted financial information line items. The financial information extracts and the calculation of financial ratios have been presented in the Appendices section of this report.

This section of the report looks to analyse the calculated financial ratios to understand the supposed cash flow crisis and will also understand the adversities in performance trends over the last few financial years. The analysis will be divided on the basis of different types of accounting ratios which are discussed as follows:

The profitability position of Stagecoach is evaluated with the help of different margin and return ratios. The gross profit margin ratio can be interpreted as the total proportionate margin of sales which is left behind after covering the direct expenses of the business which are its cost of sales (Weetman 2019). At first glance, the total sales of the company can be analysed to be increasing year on year through 2018-2020. However, the gross profit margin on the other hand is decreasing with each year from 59.00% in 2018 to 54.55% in 2019 to 53.57% in 2020. The only possible explanation for this is because of rising costs and inflation which is resulting in an increase in the total cost of sales. Hence, the company is losing out on their cash flows. A similar trend can also be noticed for the operating profit margin ratio. This metric is the total margin of sales which is left behind after covering the direct expenses as well as the indirect expenses (McLaney and Atrill 2020). The distribution and administrative expenses for the company can be observed to remain constant at 2018 and 2019 but increases in absolute terms in 2020. Consequently, the operating profit margin ratio declines from 39.00% in 2018 to 36.36% in 2019 and to 33.93% in 2020.

The net profit margin ratio is one of the most common measures of profitability. This is because the metric evaluates the margin of sales left behind after covering the total expenses that have been incurred during the year (Baker 2018). The metric showcases a similar trend declining from 21.00% in 2018 to 14.64% in 2020. This decline is further aggravated because of an increase in other costs and interest expenses over the last three financial years. Hence, there certainly exists a cash flow issue for the company. Irrespective of sales increasing each year, the total expenses are increasing at an even higher rate which is the main cause of declining margins and the persistent cash flow issue. The company is lacking in terms of efficiently using their resources. This is further reflected upon from the return on capital employed ratio which has also deteriorated from 28.00% in 2018 to 20.54% in 2020. There exists an inefficiency in making use of the total capital for generating profits.

The overall liquidity position of the company is sound. The term liquidity is referred to as the availability of current assets for meeting the current liabilities which is relying upon the short-term resources to meet the short-term debts and obligations (Rashid 2018). The current ratio is one of the most popular indicators of the liquidity performance which gauges the reliance a company can place upon its total current assets for meeting its total current liabilities (Brewer et al. 2015). The current ratio of the company is increasing year on year from 1.89 times in 2018 to 2.32 times in 2020. While having a high liquidity level is good as it helps protect a business from exposure to liquidity risk, a higher current ratio is not recommended. This is because funds are getting blocked in the current assets. The reason for the increasing current ratio is because the total current assets are increasing year on year. A substantial portion of current assets comprises of stock and debtors which needs to be managed efficiently. The increasing year on year value of both these line items suggests inefficiency in managing inventories and credit sales which will be discussed in the subsequent section. The quick ratio and absolute cash ratio also reflects a similar trend with a year-on-year increase through 2018-2020. Overall, it has ample short-term resources for meeting its current liabilities.

The analysis of efficiency ratios will shed more depth into the persistent cash flow issue which the company is facing. The analysis of profitability ratios showcased how rising costs is one of the reasons for the issue. The analysis of efficiency ratios will showcase how an inefficiency in managing their working capital assets is also another contributing factor to the supposed cash flow issue (Kimmel, Weygandt and Kieso 2018). The business is lacking in managing their inventory levels efficiently as suggested by the day’s inventory outstanding ratio. This metric evaluates the total time it takes for the business to sell its average stock levels in a financial period (Yhip and Alagheband 2020). The metric has increased from 167.90 days in 2019 to 175.48 days in 2020. This increase is as a result of a higher stock level which the company is maintaining resulting in investments stuck in their stock which is taking comparatively more time to recover from sales.

Discussion

Another cause of concern with respect to cash flows are an increase in debtors. This is evaluated with the help of day’s sales outstanding ratio. This metric is interpreted as the total time it takes for a business to recover debts from its customers to whom sales are made on credit (Griffin and Mahajan 2019). The metric has increased from 36.50 days in 2018 and 2019 to 45.63 days in 2020. This indicates that it is comparatively taking more time for the business to recover cash from debtors which is also hurting the operating cash flows of the business. The day’s payable ratio measures the total time it takes for the business to pay off its creditors for the materials or goods that are purchased on creditors (Williams and Dobelman 2017). This metric has declined from 169.15 days in 2018 to 154.42 days in 2020 which means that the business is paying off its creditors promptly. In a nutshell, the business is taking more time to recover cash in terms of inflows and at the same time spending cash even quicker which increases the outflows. This is best gauged with the help of cash conversion cycle which has increased year on year from 45.40 days in 2018 to 58.40 days in 2019 to 66.68 days in 2020. The cash conversion cycle is interpreted as the total days it takes for the business to realise cash from their working capital cycle (Robinson 2020). As a result of inefficiencies, it is taking more time to recover cash which causes the cash flow issue.

The company’s exposure to gearing is relatively low. It cannot be considered as a highly geared company. This is because the company’s gearing ratio and total debt ratio is under check. The company has more proportion of equity in their overall capital structure and relies upon equity to finance its assets as opposed to debt. Therefore, their exposure to financial leverage is low. However, the overall solvency position of the company is compromised because of their times interest earned ratio and their cash coverage ratio. These metrics gauge the total number of times a company is able to cover their interest expense from their available operating profits (EBITDA & EBIT) respectively. The metrics have been compromised due to decline in operating profitability of the business because of rising costs.

On the basis of analysis of accounting ratios that have been presented and discussed in this report, a potential merger is not recommended to National Express in their best interests and it is advised that they should walk out from this deal. This is because the main motive for merging with Stagecoach was an expectation of reducing their annual spending each year. However, from the accounting ratio analysis of the financial performance of Stagecoach, it is seen that the company themselves are in the middle of a hurdle of rising costs which are resulting in an unfavourable profitability position causing the margins to decline. Additionally, the analysis presented above confirms the cash flow issue because of rising costs and an inefficiency in working capital management. These issues will also plague the new merged entity if a merger does indeed happen. Moreover, since Stagecoach are exposure to cash flow issues, according to the case study, they do not have the needed cash to purchase new fleet of buses. This will result in a decline in growth levels for the business. Based on these considerations, it is advised that National Express does not accept the merger.

References

Baker, A.J., 2018. Business decision making. Routledge.

Brewer, P.C., Garrison, R.H. and Noreen, E.W., 2015. Introduction to managerial accounting. McGraw-Hill Education.

Griffin, P.A. and Mahajan, S., 2019. Financial Statement Analysis. Finding Alphas: A Quantitative Approach to Building Trading Strategies, pp.141-148.

Kimmel, P.D., Weygandt, J.J. and Kieso, D.E., 2018. Accounting: Tools for business decision making. John Wiley & Sons.

McLaney, E. and Atrill, P., 2020. Accounting and Finance. Pearson Education, Limited.

Rashid, C.A., 2018. Efficiency of financial ratios analysis for evaluating companies’ liquidity. International Journal of Social Sciences & Educational Studies, 4(4), p.110.

Robinson, T.R., 2020. International financial statement analysis. John Wiley & Sons.

Weetman, P., 2019. Financial and management accounting. Pearson UK.

Williams, E.E. and Dobelman, J., 2017. Financial statement analysis. Quantitative Financial Analytics. London: World Scientific, pp.109-69.

Yhip, T.M. and Alagheband, B., 2020. Financial Statement Analysis. In The Practice of Lending (pp. 47-94). Palgrave Macmillan, Cham.