Business accounting - Essay Example

 Business Accounting Introduction The economic environment worldwide is ever changing taking into mind the recessions the world has experienced particularly the latest downturn of 2008/2009. Considering Europe in which one of the strongest economies, UK reside, is going through bad times including the case of Euro zone debt crisis which has affected the whole EU as well as the countries relating to it in any means. Europe, which was once considered one of the most successful world segment and was analyzed to take over US as the super power has now been dipped into the midst of debts and turmoil, especially the most indebted cities including Greece, Italy and Spain. Many other hurdles have struck Europe as well, comprising of inflation, hike in interest rates and currency fluctuations, to talk about a few. These have obstructed the smooth flow of operations in companies in the United Kingdom and price rises, cost increments, demand fluctuations, supply problems and macroeconomic hurdles have attacked sales and profitability. According to the Consumer Prices Index and Retail Prices Index report of 2011 published by the Office for National Statistics, clothing and footwear constitute a CPI weight age of 6.2% and the observed and analyzed variations in price changes in them have been considered as ‘HIGH’ so the apparel and clothing sector is hidden under such inflationary pressures (Gooding 2011). Such is the case with Next Plc which is surrounded with most of these troubles but has coped a lot efficiently and effectively with the use of sound planned strategies and implementations which have been reflected in the company’s financial statements and records. Analysis The company has performed well in this year up to January 29, 2011 in terms of mainly its revenue and net profits which have both escalated by 1.4% and 10.14%. There were quite abysmal supplier conditions in the domestic and international market but Next incorporated strategies which were in line with their corporate objectives and which helped cater to current and future consumer demands. To have a much comprehensive analysis of the company’s trading position and performance, accounting ratios have been computed in an excel file with the results shown in the appendix section. Liquidity Analysis Talking about liquidity, the company is performing fine but in contrast to the previous year, it has lacked in some areas. The current and quick ratios have decreased by 0.092 and 0.127 from 2010 to 2011 showing a decrease in liquidity and this is mainly because of a larger increase in current liabilities compared to current assets. Moreover, inventories have increased from a considerable 19.19% from £309 million to £368.3 million in 2011, mainly due to the company’s policy of fulfilling market demand and solving out supplier constraints by buying stocks way earlier than required. Though the cash available before share and bond buybacks is a considerable £92 million, the company has less cash liquidity available in 2011 with a decrease of more than 60% in the cash and cash equivalents balance and the cash ratio falling from 9.83% to only 3.66%. This might obstruct the company in opening and extending new stores and repurchasing more shares in the upcoming year, which has been forecasted at aggressive levels. However, this cash balance can increase in the following year with the rise in the trend of cash customers relative to credit customers or account holders especially in the case of Next Directory; this will in turn definitely decrease the level of accounts receivable and bad debts (CPAClass.com 2011). The manner of collection of receivables and payments to creditors has remained almost the same from 2010 to 2011. But as the inventories have risen, the inventory conversion period has escalated from 47 days to 55 days, which has in turn helped in increasing the cash conversion cycle from 30 to 42 days. The creditor payment duration is quite fine (81 days) which means cash saved for this time can be utilized in other aspects of operations but this also bears some cost. The increased cash conversion cycle can harm future operational growth (eNotes 2011). Profitability The profitability has elevated in the reporting year up to January 2011 by 10.14% to £400.9 million and which represents a net profit margin of 11.61% (an increase of almost 1% from the previous year). The Return on Assets (ROA) have increased slightly by 0.87% but there has been a massive decrease in the Return on Equity (ROE) by almost 100% to 172.58% from January 2010 to January 2011; this can be related to the massive increase in shareholders’ equity (SHE) by more than 73% due to mainly a rise in Retained Earnings. There have been avenues of growth discovered by the company and considering Overseas Online Next International division, a growth of almost 100% is forecasted in the annual revenue from the segment in 2012 but the profitability is projected to decrease due to aggressive marketing by 4% to 20%. Next Sourcing faced a fall in its profits by a massive 25.2% due to aggressive competition and efficiency in the operations of the rivalry in the market (Next Plc 2011). Capital Structure The capital structure of Next Plc is mainly comprised of debt with a debt ratio of 87.03% which depicts that a massive proportion of assets have been financed by debt and only 12.97% of them by equity. The debt ratio has fallen by 5.09% from 92.12% in 2010. In analyzing the capital structure, the debt to equity ratio for the year 2011 came about to be 6.715 times (2010: 11.677 times). The decrease in the debt ratio means that the gearing of the company has decreased reducing its financial and insolvency risk as well (Bizwiz Consulting 2011). This is supported with the increased interest coverage ratio in 2011 from 16.505 to 26.611 times. This is because of a fall in the interest expense due to a fall in the market interest rates (Peavler 2011). Market Performance The company’s dividend payout ratio came out to be 35.15% in the year 2011 with a slight rise of 0.14% from the previous year. This means that the company is retaining and reinvesting a considerable share of 64.85% back into the company. Satisfying shareholders with growing annual dividends and at the same time reinvesting earnings to experience growth and expansion is a commendable strategy of Next plc. The dividend yield is though very less, 0.039% due to the company’s huge four digit market price, £1,977 as of January 31, 2011. Next Plc - Investment Perspective The company, if considered from an angle of investing is quite stable and rewarding but its position in the capital market, London Stock Exchange in this case, is a little bit skeptical. This is because of its abnormal Price to Earnings Ratio in 2011 of more than 890 times which has decreased from a massive 1043 times in the previous year. This means that the company’s share is trading at 890 times its earnings which depict Next as a very expensive share but in contrast to the previous year, its share has gone through a discount with a reduced P/E ratio. The normal practice in the market is of buying shares with a P/E ratio of maximum 20 times but in this case, speculation seems to have happened in the market and the share seems to be overvalued. Taking into account the current market performance of Next’s share, this share should be sold rather than bought or kept at hold as the market price seems to fall in the future. But the decreasing trend of the P/E Ratio shows that the share is going to a discount and chances might be that the share can transform to an undervalued script in the market. Supportive to this, Analyst Opinion at Yahoo! Finance suggests Next’s share as an overall good buy for the current month as majority of the votes of analysts went towards Strong Buy and Buy (Yahoo! Finance 2011). Moreover, Fitch Rating have uplifted the company’s Short-term Issuer Default Rating (IDR) from ‘F3’ to ‘F2’ whereas Next’s Long-term IDR and senior unsecured rating are both unaffected at a rating of ‘BBB’ and the outlook for the long-term tenor is quite stable according to these ratings (Morningstar 2011). Conclusion The company, on an overall basis, is quite stable and it has formulated, planned and implemented quite efficient and effective policies to retain its competitiveness in the market domestically as well as internationally. The company’s new growth opportunities are encouraging and if this pace is consistently attained in the future, the company can perform even better and expand effectively. But the company has to prepare for even deteriorating times to come ahead with adverse situations ranging from inflation, rising interest rates, a weakening Euro and fluctuations in other currencies, increasing competition and switching customer preferences and demand. Overall, the company is a good choice to be invested in, taking into account its considerable dividend payout ratio and retention of earnings back into the business for expansion. Appendix ACCOUNTING RATIOS COMPUTATION - NEXT PLC (For the years ended Jan 29, 2011 and Jan 30, 2010)   FINANCIAL DATA 2011 Change (in %) 2010 (Amounts in £ million) (Amounts in £ million) Current Assets 1,067.3 2.51% 1,041.2 Current Liabilities 832.9 9.87% 758.1 Inventories 368.3 19.19% 309.0 Net Income 400.9 10.14% 364.0 Total Assets 1,792.3 5.83% 1,693.5 Shareholders' Equity (SHE) 232.3 73.88% 133.6 Revenue 3,453.7 1.39% 3,406.5 Earnings Per Share (EPS) - Basic (in £) 2.219 17.72% 1.885 Number of common shares outstanding (Weighted average shares for basic EPS) 180.7 -6.42% 193.1 Accounts Receivable 645.6 4.70% 616.6 Cash and cash equivalents 39.1 -61.78% 102.3 Accounts Payable 544.6 -1.04% 550.3 Cost of Sales 2,445.0 1.47% 2,409.6 Total Liabilities 1,559.9 -0.01% 1,560.1 Earnings Before Interest and Tax Expense (EBIT) / Operating Profit 574.8 8.49% 529.8 Interest Expense 21.6 -32.71% 32.1 Net Debt 530.4 32.57% 400.1 Market Price as of Jan 31, 2011 and Jan 29, 2010* 1,977.0 0.56% 1,966.0 Dividend Per Share (DPS) (in £) 0.78 18.18% 0.66 *Source: Yahoo! Finance, 2011 - Adjusted Closing Prices     RATIOS COMPUTATION     Liquidity Analysis Ratios   Current Ratio (CA / CL) 1.281 1.373 Quick Ratio [(CA - Inventory) / CL] 0.839 0.966 Cash Ratio (Cash and cash equivalents / CA) 3.66% 9.83%   Profitability Analysis Ratios   Return on Assets (ROA) (Net Income / TA) 22.37% 21.49% Return on Equity (ROE) (Net Income / SHE) 172.58% 272.46% Net Profit Margin (Net Income / Net Sales) 11.61% 10.69% Earnings Per Share £2.219 £1.885   Activity Analysis Ratios   Assets Turnover Ratio 1.93 2.01 Accounts Receivable Turnover Ratio 5.35 5.52 Receivable Collection Period (Days) 68 66 Inventory Turnover Ratio 6.64 7.80 Inventory Conversion Period (Days) 55 47 Payable Deferral Period (Days) 81 83 Cash Conversion Cycle (Days) 42 30   Capital Structure Analysis Ratios   Debt Ratio (Total Liabilities / Total Assets) 87.03% 92.12% Debt to Equity Ratio (Total Liabilities / SHE) 6.715 11.677 Interest Coverage Ratio (EBIT / Interest Expense) 26.611 16.505   Capital Market Analysis Ratios   Price to Earnings Ratio (P/E) (Mkt Price / EPS) 890.942 1,042.971 Dividend Payout (DPS/EPS) 35.15% 35.01% Retention Ratio (1 - Payout Ratio) 64.85% 64.99% Dividend Yield (Almost negligible) 0.039% 0.034%   Note: The ratios highlighted in red are the important ones computed, the remaining are to give an idea about the company’s performance in the respective heads of ratios analyzed. References Bizwiz Consulting (2011), Interest Coverage Ratio. Available online, from, http://www.bizwiz.ca/interest_coverage_ratio.html CPAClass.com (2011), Accounting Ratios for Financial Statement Analysis. Available online, from, http://cpaclass.com/fsa/ratio-01a.htm eNotes (2011), Cash Flow Analysis and Statement. Available online, from, http://www.enotes.com/cash-flow-analysis-statement-reference/cash-flow-analysis-statement Gooding, Philip (2011), CPI and RPI Basket of Goods and Services, 2011. Office for National Statistics. Available online, from, http://www.ons.gov.uk/ons/rel/cpi/cpi-rpi-basket/2011/index.html Morningstar (2011), Next PLC, PRESS RELEASE: Fitch Upgrades Next plc's Short-Term IDR to 'F2'. Available online, from, http://tools.morningstar.co.uk/uk/stockreport/default.aspx?tab=3&vw=story&SecurityToken=0P00007ONZ%5D3%5D0%5DE0GBR$$ALL&Id=0P00007ONZ&ClientFund=0&CurrencyId=GBP&story=155144956750460 Next Plc (2011), Annual Report and Accounts 2011. Available online, from, http://www.nextplc.co.uk/~/media/Files/N/Next-PLC/pdfs/reports-and-results/2010/2011-03-24a.pdf Peavler, Rosemary (2011), What is the debt to asset ratio, how is it calculated, what does it measure? Available online, from, http://bizfinance.about.com/od/financialratios/f/Debt_Asset_Ratio.htm Yahoo! Finance (2011), Next Group plc (NXT.L), Analyst Opinion. Available online, from, http://finance.yahoo.com/q/ao?s=NXT.L+Analyst+Opinion Read More