The assignment focuses on using financial data to measure and assess performance. The financial data may rely on published financial reports and data:
- For comparison, trend analysis and decision-making.
- Analysing strengths and weaknesses of financial data in judging performance.
Using any company listed on the London Stock Exchange:
1) Critically analyse the changes in financial performance and health over the last five years. Relate these changes to the following areas: Liquidity, profitability, efficiency, capital structure and stock market performance.
2) Explain any problems or limitations of your analysis.
3) Recommendations for any improvements to the areas listed in above.
Liquidity
The report analyzes the changes in health and financial performance of Next Plc over the last five years. Next Plc is British Multinational clothing, home products and Footwear Corporation listed on London stock exchange (nextplc.co.uk 2017). Objective of group is to deliver long-term returns to shareholders through a combination of sustainable growth in payment of cash dividends and earnings per share (Anderson et al. 2015). For the analysis purpose, reports demonstrate the calculation of profitability ratio, liquidity ratio, capital structure, efficiency ratio and performance of stock market. Under all the ratios, various ratios have been calculated for the purpose of analysis. Later part of report discusses about the limitations that have been observed in the analysis of such ratios. It also includes recommendations for making any improvement in the identified areas.
Liquidity is the ability of company to meet their financial obligations and liquidity is mainly concerned with the liabilities and assets of organization. It depicts the ability of organization to pay off its current debt using current assets. In the present assignment, few liquidity ratios have been calculated and this involves current ratio, quick ratio and time interest earned ratio. Quick ratio and current ratio are considered as the vital determinant of financial well-being of company. The capacity of company to honor its day-to-day financial obligations is determined by such ratios and creditors and investors are heavily reliable on liquidity ratios (Aouni et al. 2014). Positive cash flows are significant and the value more than one is considered desirable.
Current and quick ratio:
(Source: created by author)
Current ratio is calculated by dividing current assets of organization by current liabilities. It shows how many times a firm can pay off their debt obligations using the current assets. Over the past five years, current ratio of Next Plc has been increasing steadily and consistent rise in ratio reflects that liquidity position of organization is very strong. Over the past five years, retailer has managed to maintain current ratio of more than 1.3. This has resulted in further consolidating the position of Next plc. In addition to this, quick ratio has been increasing in the earlier year of analysis and there was a considerable fall in year 2015-2016. In year 2016-2017, quick ratio increased to 1.754 as against 1.109 and 1.357 in year 2015-2016 and 2015-2014 respectively. Quick ratio of 1.754 in year 2016-2017 depicts that Next Plc is adequately cushioned with liquid assets and cash for meeting the obligations of creditors. Since liquidity ratio considers the most liquid assets that can be easily converted into cash, brownie points are received by such ratio in determining the liquidity of Next Plc (Balvers et al. 2016). Calculation of quick ratio does not involve inventories and consistency maintained in quick ratio is clearly shown in calculated figures. Therefore, considering these two ratios it can be said that Next Plc has a commanding liquidity position.
Profitability
Another ratio calculated for determining the liquidity position is time interest earned ratio. This ratio measures the ability of company to honor its debt payments. It is regarded as the solvency ratio of company as it depicts the organization’s ability to make debt service and interest payments. Time interest earned ratio is obtained by dividing the income earned before taxes and interest-by-interest expenses. It is favorable for company to have higher value of time interest earned ratio as it is indicative of the fact that company has generated sufficient earnings for clearing of its debt obligations.
Times interest earned ratio:
(Source: created by author)
From the above graph. It can be seen that there has been steady rise in time interest earned ratio since year 2012. However, in year 2015-2016, there was a sharp decline in ratio. It is considered desirable to have higher ratios compared to lower ratios. There was a significant increase in ratio from 23.969 in year 2012 to 27.443 in year 2015-2016. The substantial fall in the ratio is witnessed in year 2016-2017 and it declined to 21.897. Fall in ratio is indicative of the fact that currently organization is experiencing credit risk. Investors and creditors favors organization having higher time interest ratio.
The ability of company to generate profit from their operations is depicted in profitability ratios. It focuses on return on investment made by company in inventories and other assets. Investors and creditors of companies to judge the return on investment made by companies on its relative level of asset and resources use profitability ratio. Some of the key ratios for judging the profitability of an organization are gross profit margin, net profit margin, return on equity and return on capital employed. Gross profit margin ratio makes the comparison of gross margin of business with net sales. It indicates the profitability of company in selling its inventories and merchandize. Gross profit margin is obtained by dividing gross margin divided by net sales. An organization having high gross margin ratios indicates that they have more money for paying off their operating expenses such as utilities, salaries and rents (Brigham and Ehrhardt 2013).
Gross profit margin of Next Plc has been consistently increasing since year 2012. Ratio stood at 31.60% in year 2012-2013 as against 33.59% and 34.78% in year 2014-2015 and 2015-2016 respectively. This increase in ratio is indicative of the fact that Next plc has enough liquidity for meeting up their expenses. Nevertheless, the ratio declined in year 2016-2017 to 33.84%, although the fall was not significant.
Efficiency
Profitability ratio:
(Source: created by author)
Net profit margin measures the amount of net income that is earned for each dollar of sales. This is achieved by comparing the net sales and net income of the company. Ratio indicates the efficiency of the organization in converting their sales into net income (DeFusco et al. 2014). High net profit margin depicts that company is expenses are less and it is favorable to them. On the other hand, lower net profit margin indicates that expenses are too high and it is required by management to cut budget and expenses. Net profit margin of Next Plc in year 2014-2015 stood at 14.79% as against 15.96% in year 2015-2016. However, there was slight fall in ratio to 15.51% in year 2016-2017. It shows that organization expenses has increased in the recent year that has lowered their net profit margin.
Return on capital employed (ROCE) shows the efficiency of company in generating profits of company from its capital employed by making comparison of net operating profit to the capital employed. Long-term profitability ratio depicts whether the assets are performing efficiently while considering long-term financing. ROCE is obtained by dividing net operating profit of company by employed capital. ROCE initially increased from year 2012 until year 2015, when there was significant increase in ratio to 74.79%. Ratio fell considerably to 49.27% in year 2016-2017. A higher ratio is considered favorable to the company as it shows that more profits are generated by each dollar of capital employed. A fall in ratio depicts that Next Plc has not been efficiently its employed capital. Year 2016-2017 has experienced drastic fall in the ratio that is not favorable for the company, as the assets are not being efficiently utilizing.
The ability of organization to generate profits from the investment made by shareholders is measured by Return on equity (ROE). Profit generated by each dollar of shareholders equity is measured by the ratio. ROE is obtained by dividing net income of company by shareholders equity (Petty et al. 2014). Efficiency in utilizing the money or investment but shareholders is depicted using this ratio. It is preferable for companies to have higher ROE. Return on equity of Next Plc has been increasing since year 2012 and the increase was significant year on year. Ratio stood at 178.08% in year 2012-2013 as compared to 213.86% in year 2015-2016. Ratio reduced to almost half in year 2016-2017 to 124.45%. Therefore, it can be said that Next Plc has not efficiently utilizing the investors or shareholders money for generating profits.
Capital Structure
This involves relationship between short-term liabilities and short-term assets of organization. Working capital management involves the calculation of working capital turnover and asset turnover ratio. Assert turnover ratio indicates the utilization of assets in the operation for generating sales. On other hand, inventories forms an important part of current assets and it measures the frequency at which the inventories are cleared. Working capital turnover acts as performance indicator and company does not bear the risk of overstocking and understocking.
Working capital turnover and asset turnover ratio:
(Source: created by author)
Asset turnover ratio is obtained by dividing revenue generated by firm by current assets (Uechi et al. 2015). Ratio of Next Plc is more than one but it is being reduced subsequently that is not considered favorable. On other hand, working capital turnover has reduced in the initial years of analysis, it increased, and thereafter it declined. Working capital turnover stood at 9.09 in year 2012-2013 as against 5.48 in year 2014-2015. Ratio increased to 8.85 in year 2015-2016 compared to 4.39 in year 2016-2017.
Days of inventory:
(Source: created by author)
Days of inventory is an efficiency ratio that measures the average number of days for which the company holds the inventories before selling it. Inventory holding period increased significantly throughout the year of analysis, which indicates that company is taking long time to clear their stocks. However. Days of inventory fell in year 2017. Days of inventory stood at 49.69 in year 2012-2103 compared to 65 days in year 2015-2016. Days of inventory fell to 60 days in year 2016-2017. This indicates that stock holding period has decreased that means stocks are being cleared in lesser time. Lower days of inventories is more favorable than higher days as inventories are cleared frequently (Baños et al. 2014).
Capital structure of company is provided by gearing ratios that depicts the ability of organization to maintain cost of capital. This includes the calculation of ratios such as debt ratio, debt to equity ratio and equity ratio.
Debt and equity ratio:
(Source: created by author)
Debt ratio is obtained by dividing total liabilities of Next Plc by total assets. Debt ratio has been changing year on year by fewer points throughout the year of analysis. Ratio stood at 0.84 in year 2012-2013 compared to 0.866 in year 2015-2016. It fell to .78 in current year. Declining debt ratio indicates that organization dent proportion to their total assets has fallen. Equity ratio is obtained by dividing total equity by total assets (Churet and Eccles 2014). Equity ratio has increased in current year of analysis. Ratio was changing by fewer points from year 2012 until year 2015.
Stock Market Performance
Debt to equity ratio:
(Source: created by author)
On other hand, the above graph shows that debt to equity ratio has fallen considerably in year 2016 as compared to rest of year. For year 2013-2014, debt to asset ratio stood at 6.49 compared to 3.71 in year 2016-2017. Decrease in debt to capital ratio indicates that company has become less dependent debt and they are relying more on equity for financing their capital requirement (Williams 2014).
Stock market performance of Next Plc over the last five years:
(Source: markets.ft.com 2017)
From the above chart, it can be seen that there have been significant fall in share price of Next Plc since the middle of year 2015. Share price was consistently rising since year 2013and the highest price was recorded at £ 7869.51 as on 1st October, 2015. Current share price as on June, 2017 stood at £ 4047. Therefore, it is depicted from the chart that share price of Next Plc has fallen considerably in current year of analysis. The slump in share price of organization was due to lower actual profit than expected. Price slumped more than 14% in the current year due to rising inflation and lower sales and thereby lower profits. This was attributable to the fact that sale of gift voucher by next has fallen and reduced popularity of clothing that has significantly hit the sales (Lasher 2013). Compared to its rivals, Next Plc has underperformed and there was lots of distressed discounting made by the organization. It was also ascertained that the additional fall in profits are coming from revaluation of business rates, living wage, apprenticeship levy and increased taxes on energy. These factors are likely to further reduce the profits and thereby performance of stocks of Next plc (Grinblatt and Titman 2016).
The data used for calculating ratios are completely reliable on historical data. Based on such data, ratio analysis forms the basis of investment decisions for investors. However, it is quite possible that predicted future and present cannot be same. It is required by organization to maintain uniformity in the accounting methods used in the calculation of ratio or for the purpose of analysis, and then only the comparison of ratios will become meaningful. Ratio analysis becomes a very complicated task when it is done just by looking at data. Strategies employed by different organization forms the basis of ratio analysis. Comparison does not give the satisfactory results if the organization operates on different lines of activities. External factors causes discrepancies in the calculation of ratio. True position of company cannot be reflected by using ratio analysis (Bodie 2013).
Limitations of Analysis
Next Plc is required to gain competitive advantage by performing efficiently and is needed by group to focus towards striking the balance between highly leveraged capital structures. In order to improve the cash flow, Next Plc should concentrate on their credit collection and payment periods. It is essential for the organization to start preparing itself beforehand to weather off the bad economic phases. After the fall in share value due to disappointments, Next plc has recently purchased share value of £ 10 million for the seventh times. While paying special dividends to shareholders, company was held guilty for breaching the companies act. The prospects of company are not being affected by dividend payments and meeting the cash flow are one of the most important criteria that are to be met.
Conclusion:
From the above analysis, it can be said that the overall financial position of company was prosperous throughout the year of analysis. However, in the recent year, the few ratios calculated depicts the unfavorable position of company. It can be said that Next Plc is a consistent performer in the market and ratio analysis is one of the tool for measuring the performance of organization. Investors are required to make further analysis by incorporating several other tools before making any investment decisions.
References:
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