Financial Performance of EMI Group PLC - Case Study Example

Introduction This report is devoted to the analysis of the financial performance of EMI Group PLC in the financial year ending March 31, 2005. At first a brief background of the company is introduced. Next the analysis of the profit and loss account, balance sheet, and a cash flow statement is made basing on the company's Annual Report 2005. Further on, changes in profile and profitability ratios are explained with the help of the information found in notes to financial statements, statement of accounting policies, board members' reports, corporate governance issues, and press releases, one by one. The report concludes with the summary of the EMI Group's financial performance in 2005. Brief description of a company EMI Group PLC is a large company specializing on the music industry. The firm has a long history dating back to 1887. Since that time EMI Group has developed from a small recording enterprise into a major player of both music recording and music publishing markets. It is divided in to two divisions: EMI Music operates in the recording industry, while EMI Music Publishing is among the largest and the most successful music publishers. EMI Group operates directly in more than 50 countries with licensees in additional 20 and employs more than 6,600 people (EMI Group 2005a). EMI Music has about 6,000 employees worldwide, and EMI Music Publishing employs 630 staff. The strategy of the company is to deliver music - the main product of EMI Group - "in any form [including compact discs, tapes, and digital formats], at any time, and any place" (EMI Group 2005a). In line with this formula it is important to stress that EMI Group rapidly develops its departments focused on digital music sales. "By the middle of 2005 digital revenues accounted for just under 5 per cent EMI Group's total revenues, with that figure expected to reach 25 per cent in five years" (EMI Group 2005a). The catalogue of music published by EMI contains over 1.5 million titles of both classic and contemporary genres. The company offers songs of every genre to customers. Profit and Loss Account Profit and loss account of the company provides a record of all revenues and expenditures and totals the profit or loss over a given period of time (in our case the financial year ending March 31, 2005). To analyze the profit and loss account of EMI Group we will look into the following types of profit: gross profit (revenues from sales minus costs of goods sold), net profit (gross profit minus overheads), pre-tax profits (net profit plus one-off items), and profits after tax (pre-tax profits minus tax). The analysis of the profit and loss account is made in order to identify trends in sales, gross profit, expenses, stability of income, and growth in earnings per share. Group turnover for EMI Group is 1,942.8 m in 2005, while in 2004 it was 2,120.7 m (EMI Group Annual Report 2005b, p. 69). However these figures cannot give us enough information about the changes in profitability of the company. Cost of sales indicated in 2005 were 1,225.3 m in compare with 1,404.7 m in 2004 (EMI Group Annual Report 2005b, p. 69). Therefore, EMI Group sold fewer goods in 2005 than in 2004. The gross profit in 2005 was 717.5 m, while in 2004 it was 716 m. This gives us the notion that the profit from sales is slightly rising in compare to previous year. Analyzing the net or operating profits one can see that group net profit was 182.2 m in 2005 and 60.1 m in 2004 (EMI Group Annual Report 2005b, p. 69) - the net profit has risen significantly in 2005. Pre-tax profit aggregates 91.8 m, and profit after tax is 60.6 m in 2005, while it was a loss of 52.8 m and 72.5 m correspondingly in 2004. However absolute numbers can give us only partial information. Deeper analysis requires examining relative figures, such as profit margin (pre-tax profit divided by sales). According to the information from FAME (2005) the average profit margin was 6.49 for EMI Group in the past ten years. In 2005 it was 4.73, while in 2004 profit margin was -2.50, and in 2003 it was 14.68. Thus we can conclude that, while sales are decreasing, the profitability of the company is rising in compare to previous year, although it is still lower than average. Such results are achieved due to cutting expenses, which can be clearly seen from the difference in the net profit of 2004 and 2005 (note that gross profits for both years are very close). Stability of income leaves much to be desired as the profit margin fluctuates wildly from year to year. Finally losses per share of 9.1p in 2004 have changed to earnings per share of 7.2 in 2005 (EMI Group Annual Report 2005b, pp. 68-69) which is a positive change, however it cannot be perceived as a trend because of low stability on income. Balance Sheet The balance sheet shows the available resources of the company (assets), resources committed to others (liabilities), and the investment in the company (equity). The assets of the company are critical to its performance; without resources the company cannot drive sales and profit. Current assets divided by current liabilities comprise the liquidity ratio, which is the ability of the company to meet its requirements for cash. Little liquidity stunts growth and leads to bankruptcy, while great liquidity can detract from profits, because liquid assets are low returning investments. Fixed assets of the EMI Group changed from 702.5 m in 2004 to 642.0 in 2005 (EMI Group Annual Report 2005b, p. 70). It decreased mainly due to the decrease of music copyrights (448.7 m in 2004 and 302.8 m in 2005) and of tangible fixed assets (202.7 m in 2004 and 183.1 m in 2005). Current assets have also decreased from 1,184.2 m in 2004 to 1,071 m in 2005 (EMI Group Annual Report 2005b, p. 70). This change was mainly caused by the decrease of cash at bank, and in hand and cash deposits (compare 343.4 m in 2004 and 240.9 m in 2004). Therefore, the liquidity of the company has fallen from 0.83 to 0.79 in 2004 and 2005 correspondingly (FAME 2005). Note that 0.83 for 2004 was the highest number in a decade with an average liquidity ratio of 0.63 (FAME 2005). Thus, also the liquidity of EMI Group is still comparatively, it was rising in 2003-2004. 2005 shows the decrease of liquidity, however the reasons observed do not allow us to predict this decrease becoming trend. Most likely it is a fluctuation caused by EMI Group's investments in the organizational changes in order to reduce internal expenditures: "Among the initiatives taken, we have reorganized our North American recorded music operations, consolidated back office functions and streamlined certain labels in Continental Europe" (EMI Group Annual Report 2005b, p. 5). Thus it can be concluded that the liquidity of the company will continue to rise. Cash Flow Statement Cash flow statement shows sources and uses of cash. The categories of sources and uses of cash are operating, investing and financing. The net cash inflow from operating activities has decreased from 309.4 m in 2004 to 221.4 m in 2005 (EMI Group Annual Report 2005b, p. 72). Further on, the increase of cash outflow from returns on investments and servicing of finance from 98.9 m in 2004 to 101.6 m in 2005 (EMI Group Annual Report 2005b, p. 72) also presents a slightly negative trend. Net cash from capital expenditure and financial investment has changed from inflow of 22.7 m in 2004 to outflow of 35.6 m in 2005 (EMI Group Annual Report 2005b, p. 72) - however this change cannot be perceived as negative, because the positive figure of 2004 was achieved with sales of tangible fixed assets valued 78 m. In 2004 EMI Group purchased a significant amount of businesses, valued 73.3 m, while in 2005 the company paid a deferred consideration of 64.1 m (EMI Group Annual Report 2005b, p. 72). These were the main driving factors for the change of cash outflow from acquisitions and disposals: 89 m in 2004 and 72.9 in 2005 (EMI Group Annual Report 2005b, p. 72). Equity dividends paid were almost the same: 62.7 m in 2004 and 62.9 in 2005. While the year 2004 was marked for the increase in cash of 236.2 m and 2005 indicated a decrease of 81.7 m (EMI Group Annual Report 2005b, p. 72) this cannot be perceived as negative. The company has taken significantly less loans (128.9 m against 398.5 m), and repaid less loans (127.1 m against 209.4 m) in 2005 than in 2004. The net debt of the EMI Group at the end of year has increased from 748.7 m in 2004 to 829.5 m in 2005 (EMI Group Annual Report 2005b, p. 72). Although the net cash inflow has decreased, there is a positive element: almost all of the cash inflow in 2005 came from net operating profit, while in 2004 only 60.1 m came from net operating profit (EMI Group Annual Report 2005b, p. 73). Generating cash from operations indicates financial health of a company, and along with less loans taken, less assets sold, and slightly more equity dividends paid EMI Group looks much healthier than in previous year. Profile and Profitability Ratios of EMI Group PLC Notes to Financial Statements It should be noted that the profitability of the company in 2005 has risen in compare to 2004 due to reengineering structure and cutting expenditures referred to salaries. The profit margin has increased from -2.50 to 4.79, and the profit per employee ratio has changed from -6,603 to 13,759 (FAME 2005). The explanation can be found in the significant reduction of losses in operating exceptional items and amortization of EMI Music division: compare 132.7 m in 2004 to 7.9 m in 2005 (EMI Group Annual Report 2005b, p. 76). Looking deeper into the matter a serious decrease of employees in EMI Music can be seen: from 7,373 (2004) to 6,043 (2005); especially in European (except for UK) and North American departments: 2,338 to 1,623 and from 2,464 to 2,124 correspondingly (EMI Group Annual Report 2005b, p. 76). Closing some of the EMI Group's departments has reduced the turnover, but more importantly has increased the effectiveness leading to better performance of the company. Accounting Policies The accounting policy on pension costs also serves as an explanation for such changes in losses in operating exceptional items and amortization. In accordance with SSAP 24: Pension costs are charged to the profit and loss account so as to spread the costs of pensions over the working lives of employees within the Group employer expense in respect of the main scheme, which cover s employees in the UK, has been taken as nil for each of the two years ended 31 March 2005. (EMI Group Annual Report 2005b, p. 74) Therefore losses in operating exceptional items and amortization comprise operating exceptional items of nil (2004: 138.3 m) and amortization of goodwill and music copyrights of 50.7 m (2004: 50.9 m). Thus pension costs were spread on other years, reducing expenditures in 2005 and eventually increasing the profitability ratio. Chairman's Statement Chairman's statement identifies further issues affecting profile and profitability ratios of EMI Group, such as: negative impacts of currency movements weakening US Dollar against Sterling and reducing the turnover (EMI Group Annual Report 2005b, p. 14); restructuring initiatives including outsourcing of manufacturing that lead to cost savings projected of 50 m annually (EMI Group Annual Report 2005b, p. 13), but one-off exceptional cash cost of restructuring and outsourcing has negatively reflected on cash flow statement of this year: the net debt has increased from 748.7 m to 828.5 m (EMI Group Annual Report 2005b, p. 14). The explicit look on the performance of each of the divisions clarifies that, although the organisational costs were significantly reduced, the performance of EMI Music was disappointing this year, with turnover decreased from 1,722.8 m to 1,542.1 m (EMI Group Annual Report 2005b, p. 14). On the contrary, EMI Music Publishing had a very strong year balancing the performance of the whole group with the increase of turnover from 397.9 m to 400.7 m (EMI Group Annual Report 2005b, p. 15). Chief Executive Officers' Review A detailed analysis of the low performance of EMI Music operations show s that the reason was in the release schedule changes, and lower than anticipated reorders in the fourth quarter affecting the second-half performance. "For the year, EMI Music sales declined by 7.4% at constant currency and market share fell to 12.9% from 13.5% in the prior year. Prior year global market share has been restated to reflect exchange rate movements" (EMI Group Annual Report 2005b, p. 20). Geographical analysis indicates underperforming on North American and Japanese markets. Revenue sources of EMI Music Publishing division indicate a decline of mechanical revenues, derived from sales of recorded music products; along with the increase of performance (live or broadcast), synchronization (audiovisual works), and other (e.g. print, stage production) revenues (EMI Group Annual Report 2005b, pp. 27-28). EMI Group devotes much attention to the development of digital music: "Our digital sales grew sharply during the year, contributing over 14m to our revenues, and were up 90% at constant currency from the prior year" (EMI Group Annual Report 2005b, p. 29), bringing confidence in the future performance of EMI Music Publishing. Financial Review Financial director points out two main focus areas of EMI Group affecting profitability ratios: cutting costs and cash management (EMI Group Annual Report 2005b, pp. 33, 35). Declines in turnover have resulted in lower adjusted profits before tax: 141.9 m from 163.3 m. However, the reduction of administration expenses by 31.6 m has resulted in the gross margin improving from 35.3% to 35.7% (EMI Group Annual Report 2005b, p. 33). There were also a slight changes indicated in funding, with the increase of liquidity the company became able to repay debts faster than in previous years: "The average term of the net debt at 31 March 2005 was 5.9 years against 7.1 years as at last year end." (EMI Group Annual Report 2005b, p. 35). Thus, while EMI Group still experiences difficulties associated with the turnover, lower than in previous year, its financial performance is improving as can be seen from rising liquidity ratio. Director's Report According to director's report there was an interim dividend of 2.0p per ordinary share. As long as the Board is recommending a final dividend of 6.0p per ordinary share with the same total of 8.0p as in previous year (EMI Group Annual Report 2005b, p. 46), it can be concluded that the management of the company is confident about its future performance. Profile ratios show the return on capital employed change from -10.63% to 23.52% this year, which is higher than average of ten years of -5.05%. Therefore, the Board's confidence is justified, although shareholder funds are slightly decreasing from -784,000 to -795,000, which is associated the increase of net debt. Cutting costs have also affected charitable and fundraising activities (1 m in 2005 and 1.1 m in 2004), and also research and development (40,000 in 2005 and 100,000 in 2004). Most likely, however, these cost savings will not seriously affect the overall profitability of the group. Corporate Governance The corporate governance of the annual report presents almost no structural changes to EMI Group's policy. Chief Executing Officers of both EMI Music and EMI Music Publishing departments report to executive chairman of the group. "The Board considers that, for the present, the structure outlined above is the most effective for EMI and is in the best interests of both the Company and its shareholders." (EMI Group Annual Report 2005b, p. 48). Therefore it may be concluded that the course taken by the EMI Group will not change in the next few years. Positive changes in performance of the EMI Group throughout the 2005 can serve as a base for expectations of gradual improvement within the company reflecting in better than previous year profile and profitability ratios. Press Releases The information found in press releases confirms the company's extensive use of outsourcing. For instance, Toshiba-EMI manufacturing plant in Japan was sold to a consortium led by Memory-Tech Corporation in the scope of EMI outsourcing strategy on manufacturing facilities (EMI Group 2005c). Focusing on the core activities along with cost reduction through outsourcing has already indicated the growth of performance of EMI group this year. Further implementation of the current strategy will lead to the increase of net profit through reduction of exceptional costs. The reduction of turnover in the second-half of 2005 has forced EMI Group to implement more region-oriented policies, including shifts in the senior management. Tim Maunder, the chief financial officer of Clear Channel International appointed as a chief financial officer of the whole EMI Music in October 2005, brought the knowledge and expertise of local divisions to the Board (EMI Group 2005d). However, it is still hard to predict, whether the market share of EMI Music will increase due to such changes in management. Conclusion The overall financial performance of EMI Group in 2005 was better than in previous year. Despite the decrease of turnover the company has managed to increase profits leading to better profitability. This was mainly achieved through a cost-cutting strategy implemented by management. Of course, restructuring and outsourcing serves a company well, however a decrease of market share of EMI Music division requires more aggressive regional policies implemented. EMI Group devotes much attention to the development of digital music departments, prospecting the tremendous increase of digital music industry in future. Currently the company has a net debt of 829.5 m which is 80.8 m larger than at the end of previous year. The company's liquidity is rather low, although high enough to avoid the risk of bankruptcy. The negative net value is mainly associated with on-off changes in restructuring and outsourcing made by EMI this year. Despite, the stability of the company is still low, it may be concluded that continuing the same course as it is now, EMI Group will further improve its financial performance. (3028 words) References EMI Group. (2005a). Company Overview. Updated on November 2005. Retrieved December 15, 2005 from http://www.emigroup.com/About/Overview/. EMI Group. (2005b). Annual Report. Retrieved December 15, 2005 from http://www.emigroup.com/NR/rdonlyres/AD78D8B4-E8B2-42D8-BD0E-EFC25668F458/353/EMI_Annual_Report_2005.pdf EMI Group. (2005c). EMI completes its manufacturing outsourcing strategy with agreement to sell Toshiba-EMI manufacturing plant in Japan. Published on December 13, 2005. Retrieved December 15, 2005 from http://www.emigroup.com/Press/Default.htmyear=2005 EMI Group. (2005d). EMI Music appoints Clear Channel's Tim Maunder as chief financial officer. Published on October 27, 2005. Retrieved December 15, 2005 from http://www.emigroup.com/Press/Default.htmyear=2005 FAME. (2005). EMI Group PLC. 2. A. The cash flow statement serves its purpose to report the sources and uses of cash during the reporting period. It is important to identify al the costs and revenues of the business e.g. to determine its profitability. The information on profitability of the company is required by financial analysts, investment bankers, creditors, individual investors, credit rating agencies, etc. Most often cash flow statements are divided into three sections: cash flows from operating activities (e.g. cash receipts from sales, payments to suppliers and contractors, rent, utility, and tax payments); cash flows from investing activities (e.g. purchases of property or equipment, proceeds from the sales of equipment, etc.), and cash flow from financing activities (proceeds from loans, debts, dividend payments, etc.). The cash flow statement is needed for the internal governance in order to make the business for effective. Determining costs allows not only to predict profitability but also to enhance it by reducing or terminating unnecessary costs. For instance, healthy business has its operating activities as the main source of cash inflows. If the core activity is not giving profit, then it should be either enhanced or eliminated. To create a cash flow statement one should analyze the cash and bank accounts to identify cash flows during accounting period. Some entries that affect net income but do not reflect in cash flows (e.g. earned income, but not received, amortization of prepaid expenses, etc.) should not be considered in this accounting period. In the Winning Margin my role was a cashier. I had to keep records of cash flows going out and in the organization with the help of sales checks. Later, when accounting period comes to an end, the cash flow statement is created on the base of the information provided by checks which indicate cash inflows from operating activities, payments to employees, etc. In real life a cashier creates the initial record of each of the cash changes, which go through a cash register. It includes cash receipts from customers, cash payments for inventory, cash paid to employees, cash paid for operating expenses, taxes and interests paid etc. Later, when a cash flow statement is prepared it shows the profitability of the product, by summing up all the costs of the company and all its revenues. If the revenues acquired from the sales of a particular product are divided by all the costs associated with the production of this product (i.e. profitability ratio) exceeds 1 then the product brings profit. (416 words) 2. B. Absorption Costing Method is a costing model that involves all manufacturing costs, specifically including direct materials, direct labor, and variable and fixed manufacturing overhead, in the cost of a product. Therefore, the application of this technique implies to treat fixed overhead as a product cost, until the product is sold. Production costs per unit under this method consist of variable costs and total fixed costs divided by the production rate. Since all products require all of the production costs to be taken into account during pricing, the absorption costing method perfectly suits for specific order costing. If our company applied an absorption costing in the Winning Margin, then all the fixed costs of the production (i.e. line 27) should not be included in the end year, but rather they should be divided on the rate of the produced units and included into the product costs the same way as the variable production costs (e.g. line 11). It would have made the pricing of the unique products easier and more accurate, because all the product costs would have been considered, and the company received an economic benefit in future. However, the absorption costing system has implications in real life. Managers may production rate regardless of sales levels only to defer product costs on the next accounting period. Activity based costing is an accounting technique that focuses on activity centers and assigns costs to products and services based on the number of events or transactions involved each of the activities. ABC allows managers to easily determine the profitability of each of the products or services provided to customers by connecting each of the costs to a certain activity. For example, to determine a customer's profitability one should deduce costs to serve this customer and product costs from its price. With the help of activity based costing it is easy for a manager to separate value added activities from non-value added. Placed in the context of the Winning Margin, the ABC requires determining all the activities of a company at first. After that each of the costs in the cash flow statement should be assigned to at least one activity. Comparing costs of each activity to the value it adds to a final product or service gives us the notion of whether this activity is important for profitability, or it can be either eliminated, or at least reduced. In such a way ABC technique would allow to reduce costs to minimal, increasing profitability. The cash flow statement in this case was arranged by activities (e.g. activity "manufacturing" is followed by all of the costs associated to it). (436 words) Read More