Evaluating the Financial Results Example for Free

Over the past year, both the retail investment and occupational environment have been more challenging by the twin impacts of austerity at home and the debt crisis in Europe (British Land, 2012). General retailers, who sell a wide variety of goods to the public, are now facing a historically difficult situation due to the retail market in the UK continues to undergo significant change. Based on their 2011 and 2012 annual reports, five British companies operating worldwide will be analysed and compared in this report, which are French Connection Group Plc, Debenhams Plc, Marks & Spencer Plc, HMV Group Plc and Next Plc. French Connection focuses on designing, producing, and distributing fashionable clothing. Next is a UK based retailer offering high quality clothing. M&S is one of the UK's leading retailers, which sells clothing, home products and quality food. Debenhams is a visual department store group, which has a strong existence in key product categories including wears, home, health & beauty with unique and differentiated brands. HMV is a well-known entertainment retailer and now the country's second-largest live music and ticker operator.

Investment Ratios

Accounting statements can be analysed and evaluated in several ways, one of the most important is ratio analysis, which is widely used as a tool in the interpretation of financial statements (Atrill, Harvery and Mclaney, 1995:377). The first ratio to be considered is 'return on capital employed' (ROCE). It is referred to as being the primary efficiency ratio. In the formula, ROCE is comparing profit before taxation and capital employed (Alexander, Britton and Jorissen, 2011). Normally, higher values of ROCE suggest a company has a better performance, which means the management of the company is using its resources effectively (Marcouse, 2008). To compare five firm's ROCE ratios between 2011 and 2012, they all shown a decrease on the previous year, among which the figure of HMV was a negative number. By looking at its consolidated income statement in 2012, the loss before tax was 38.6 million. And the decreases in the use of assets also led to a fall in ROCE. The normal target ROCE of many large companies is about 15% (Thomas, 1999:415). But for Next plc, the ROCE for the latest year was 52.1%. This may due to its huge profit. According to its chairmen's statement, there was a 5% growth in profit from A¿A¡543.4m to A¿A¡570m. ROCE provides an answer to the question of whether the business is worthwhile to invest in, whereas the return on equity (ROE) ratio takes the perspective of the shareholder and tries to answer the question of whether the investment in the share capital of the company is beneficial for the owners of the shares (Alexander, Britton and Jorissen, 2011:238). This ratio is calculated as profit before tax divided by total equity. For those five companies, only Next plc reveal an improvement on ROE from 2011(22.4%) to 2012 (31.3%). This may be due to an increase in the profit before taxation and a drop in the total equity. And because of the loss, HMV still got a negative percentage on ROE. "Earnings per share (EPS) is found by dividing profit attributable to the ordinary shareholders by the number of ordinary shares in issue." (Alexander, Britton and Jorissen, 2011:598) Usually EPS is also used to evaluate company investment performance. As these companies not in a relatively same size and do not have similar numbers of shares, it is difficult to have comparison between them. (Alexander, Britton and Jorissen, 2011:598) Overlook 2011 and 2012 earnings per share figures for these companies, M&S, Debenhams and French Connection had usual EPS, whereas Next and HMV have outlandish EPS. Next has a fairly high EPS in 2011 and 2012, it had a significant growth from 221.9p to 282p. Thomas mentions that a company with a high gearing, the change in their profit will affect their EPS. (Thomas, 1999:414) Base on Next financial statement and notes, for this year the earning increased and the number of ordinary shareholders was less than average which was 25,222,000. In result, each contribution from profit to shareholders improved thus it is reasonable for Next to have high EPS figures. The increase in EPS means a company has a well investment performance and the high EPS help company to attract more external shareholders and retain the continuing shareholders. For HMV, in both 2011 and 2012 they had a negative EPS.

Profitability Ratios

Gross profit margin (GPM) and net profit margin (NPM) are representing the profitability of a company, which is measuring how well a company uses its assets to generate profit and control its cost during business process. The mainly difference between them is the gross profit margin focuses on the cost of goods and services ready for sale, any small changes in it should be highly significant (Weetman, 2011). However, NPM concentrates on the ability to control expenses and the alteration of selling price. Most of these companies had a slightly decrease on GPM and NPM. Particularly, French Connection had the highest GPM, but there was a decline from 51.7% (2011) to 48.1% (2012). Base on its notes, one of the reasons of GPM decrease is the cost of sales increased with the growing on the revenue of clothing and accessories. Meanwhile, the operating expenses increased as well, it led to the NPM dropped by 1.9% during the year. In contrast, the GPM of both Next and Debenhams have gone up by more than 1%, which means they conducted expenditure of goods effectively. Compared with Next, the GPM of Debenhams increased more, that may because it had a largely change on promotional calendar and well sales records that were mentioned on the financial review. Debenhams also had several optimistic changes in NPM, which was due to both lower taxation and interest. Conversely, NPM of Next has risen up nearly by 0.8%, which was higher than Debenhams', and it reflected Next earn more sales per pound of net assets or capital employed in 2012 than Debenhams (Britton & Waterston, 2003:184). HMV seem like the most pessimistic for shareholders or investors, because of the lowest GPM and NPM in comparison with rest of the companies. The net profit margin of HMV had a dramatically decrease from 0.23% (2011) to -4.42% (2012). According to the formula, NPM compares profit before tax with revenue; the lower revenue could be recognized as the essential reason of HMV's gloomy performance. Phillip Rowley, who is the chairman of HMV, declared that owing to worsening economic climate combined with the structural changes, this led to a poor Christmas trading denoting the lower returns. Moreover, in accordance with the business and financial review, for the purpose of improving the financial performance on Next challenge year, HMV invested a quantity of funds to provide training to management team, which result in more expenses in 2012 than 2011. Hence, either the decrease of revenue or the increase of expenditure had a strong affect on the net income of this business.

Financial Structure

'Gearing ratio try to measure the risk involved in the repayment of debt and the ability of a company to meet its debt in the long run' (Alexander, Britton and Jorissen, 2011). For a company, higher gearing ratio means higher financial risk. Whether companies are able to repay their long-term liability or not depend on how much they can generate from operation. Comparing five companies' financial results for 2011 and 2012, it clearly shows that most of them just have slight changes on their gearing ratio. Compared to other four companies, French Connection had the smallest gearing ratio which was 1.25% (2011) and 1.20% (2012), and it means the company had a low financial risk. According to their business review, the reason why it had a low gearing is because company had no borrowing in 2012. Moreover, French Connection had a profit disposal of its stock and it generated 0.4 million net cash. In order to repay its debts and later on if the company is not able to repay its debts; it may have more chance to get external financial helps, as the company has low financial risk. In contrast, Next had an enormous gearing ratio from 310% (2011) to 400% (2012), which means it had a relatively high financial risk. The reason of the increase may due to more long-term liability in 2012. According to business review of Next, it states that group generated A¿A¡200million which shows they made the effort to recover the debts. Nevertheless, they might find difficult to borrow money from bank as bank might take their high gearing into consideration of rejection.

Liquidity Ratio

Liquidity refers to the capacity of a company or generates liquidity from its current operations to repay its current debt (Alexander, Britton and Jorissen 2011:240). The liquidity ratios emphasize the solvency of companies (Riley, 2012). The current ratio makes a contrast between current assets and current liabilities. The higher ratio illustrates no liquidity problem. During a crisis period, due to the payment of short-term creditors, perhaps the feasibility of selling stocks to raise cash is unpractical. Thus, the acid test should be feasible, which uses the liquid assets eliminating the inventories (Weetman, 2011:347). The majority of companies have the acid test below 1, but over 1 is good news for companies in respect that even though it cannot generate cash by selling inventories it is still able to pay its debts (Riley, 2012). Amongst the five companies, French Connection had the highest acid test ratios, 1.24 (2012) and 1.31(2011), which are over 1:1 in both years. From its balance sheet, it shown both the current liabilities and current assets are much lower than the other companies. Furthermore, it had less payable than the other companies and there were no bank borrowings. The cash flows statement indicates that its major investing activity is non-current assets, but the business review demonstrates that additional investment in non-current assets was low recently. As a result, this could be the reason why there were no bank borrowings. Other than that, its inventories were also very low relatively, which might be the cause of the low payable. Besides, there was an upward trend of the acid test in Next. In 2011, its acid test was 0.84, which was below 1, whereas in 2012 it jumped to 1.03, which is good news. The balance sheet displays that from 2011 to 2012, the current assets raised from 1,067.3 to 1,139.9 and the current liabilities fell from 832.9 to 742.4. The notes to financial statements mention that, in 2012 Next repaid the unsecured bank loans which borrowed for the credit facility in 2011, result in the fall in current liabilities. Debenhams, HMV and M&S all had the acid test below 0.5 in both years, which indicated that they might find it tough to pay short-term creditors (Marcouse, 2008:400).

Activity Ratios

The stock holding period measures the average period during which stocks of goods are held before being sold or used in the operations of the business (Weetman, 2011:347). The lower the ratio the more efficiently the business progresses (Alexander, Britton and Jorissen 2011:238). From 2011 to 2012, French Connection and HMV had downward trends, while Next, Debenhams, M&S had upward trends. French Connection had the highest stock holding period, which were 143 days (2012) and 144 days (2011) amongst the five companies. It had a slight reduction but it still remained relatively long, it might because its marketing areas are clothing and accessory and it is unnecessary to sell them immediately. Instead, it can store the clothing and accessory, if they are out of date and sell them with discounts. Thus, the inventories were supposed to be less than 2011. Nonetheless, the business review explains that in 2012 there were poorer sales in the autumn season, which resulted in more inventories than 2011. It is possible that the company donate some clothing to charity or the storage contains damaged inventories. Among these companies, HMV has the greatest change in the stock holding period. According to its financial statements, both the inventories and the cost of sales had dropped since 2011. The inventories had a greater change relative to the cost of sales, which led to a relatively big downward trend (from 60 days to 44 days). Debtors collection ratio evaluates the average period of a company to collect debts owed by customers. An increase normally suggests that a company takes longer time in collecting money. However, a decrease might imply that customers used shorter time to pay. Creditors payment ratio shows the average period of a company pay off the bill to its suppliers. An increase of the ratio often advises that a company takes longer period time to pay for the suppliers. Conversely, a decrease usually proposes that companies take less time pay to the creditors. Marcouse (2008) comments that "If a business has a lower figure for creditors payment than debtors collection, it means that it is settling owe debts quicker than it is receiving from its debtors." In other word, if a business has a lower figure for debtors collection than creditors payment, thus a business is receiving from its debtors sooner than it is settling owe debts. Debtors collection and creditors payable days of French connection and Next have both increased. On average French Connection customers took 16 days to pay in 2011 and 19 days to pay in 2012, and its suppliers had to wait 69 days to be paid in 2011 and 74 days in 2012. Similarly, on average Next creditors had to wait 80 days to be paid in 2011 and 84 days in 2012, and its customers took 68 days to pay in 2011 and 75 days in 2012. One of the explanations could be these companies had bad debts build up, it makes a company has less efficiency on generating cash to pay back to suppliers. On their cash flow statement, the sum of inventories and trade receivable is more than trade payment. The other reason why these companies paid for suppliers slower might be they were trying to improve their cash position. Once a company has an appalling reputation of paying bill late, it might lead an end of business relationships with current suppliers and reduce potential creditors' interests of further cooperation. In contrast, these two ratios of HMV have both gone down. On average, its customers took six days to pay in 2011 and only two days in 2012 whereas its creditors had to wait 37 days to be paid in 2011 but mere 27 days in 2012. It may imply that HMV managed to collect money from customers faster and then pay to the suppliers sooner. On its cash flow statement, increase trade payment is greater than sum of increases in trade receivable and inventories, which shows that it used more cash to pay for the suppliers. It brings a better reputation to the companies in order to make suppliers willing to corporate with them in the future. However, if companies pay their debts too rapidly it might worsen their cash position. There is a slight difference in M&S and Debenhams' cases, their debtors collection days remain the same. Their strategies might be ensuring customers' satisfaction to retain them. The sum of inventories and trade receivable is less than trade payment. It also implies that these companies may be trying to reduce risks, controlling cash outflow with holding more cash in hands.

Other Methods to evaluate company performance

Ratio analysis works better with other aspects to evaluate a company's performance, as it has several limitations. Quality of the products or services and quality of management are non-monetary factors will affect the business performance as well, but they are not reflected on financial statements. The ratio analysis is also limited by time, since it is mere based on historical information for a certain period of time. Moreover, inflation, price changes and different foreign currencies could render the whole of ratio analysis of an organisation (Alexander, Britton and Jorissen 2011). As these five companies are retailers, their customers more concern about non-monetary factors. For example, negative attitudes of sales assistants, sales man have less understanding of the products, poor quality of goods may be the reasons of making customers purchase in competitor companies. Therefore, how well these companies operating cannot rely on ratio analysis completely, share price could be one of other elements to determine company performance. According to London Stock Exchange, from 2011 to 2012, share price in both Debenhams and Next had an increase trend, while French Connection and HMV had a dramatically decrease in their share price. Furthermore, share price of M&S is fluctuated. Share price might affect by other factors, such as, company reputation, news reports and the general market trend (Pratten, 1993). For example, as BBC News commented that 'HMV may sell live music division as sales fall again', which is negative information for HMV. This may result in a fallen in share price.

Conclusion

In conclusion, judging how well a company has been operating, it is necessary to consider ratio analysis, business reviews, movement of share price and external factors, such as environment of the market. The chancellor, George Osborne has seized that the economy has emerged from double-dip recession, growing by 1% in the third quarter of 2012. It emphases on that the largest market, UK economy has struggled for growth in this year, at least in the first two quarters. It is necessary to point out that, most of these companies financial year ended before middle of this year, apart from Debenhams. Consequently the recession might also affect their business presentations. Under this circumstances, Debenhams performed well in 2012, even though there was a faintly decrease in ROCE and ROE, this company still get the profit maximum by using the appropriate promotion strategy. For HMV in 2012, it has come through a challenging year, as their revenues have decreased by 20.8% and the group has a loss before tax. Next achieved an excellent result this year, where the revenue has increased by 4.3% and profit before tax has improved by 5.0%. The performance of French Connection for 2012 was worse than 2011 due to the poor sales. However, it used the board policy to preserve liquid funds to endure its future progress. Different from these four companies, in 2011/2012 M&S has an unimpressive performance, with sales only increasing by 2%. (3066 words)

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