Financial Performance Analysis - Case Study Example

Financial Performance Analysis One of the effective methods to analyze performance of a company is to carry out ratio analysis and compare the results with past performance to determine the increase or decrease in performance of an organization relative to the base. The ratios provide insight into various business aspects like liquidity, earning potential, debt and leverage, and asset quality etc. Current Ratio The Current Ratio for Marks and Spencer (M&S) was 1,142.1/2,017 = 0.57:1 in 2006 (1st April) as compared to 832.3/1,237.4 = 0.67:1 in 2005. For the interim period of April to September 2006, the current ratio was 1,025.4/1,971.6 = 0.52:1 as compared to 983.5/1426.9 = 0.689 on October 1st 2005. This shows a continuous decline in current ratio in 2006 onwards as compared to that in 2005, which shows that the company is experiencing liquidity crunch; and this may ultimately lead to insolvency of the company. The desired (benchmark) current ratio is 2:1. The current ration of M & S shows that the short term assets of the company are not sufficient to cover the short term liabilities. Debt Ratio The Debt ratio of M&S was 4055.2/5210.5 = 78% in 2006 which is lower than 3958.1/4867.3 = 81% in 2005. In addition, the interim statements shows a slight increase in the debt to asset ratio to 4289.6/5410.8 = 79%. Overall, the ratio shows that almost 80% of the total assets of the company are financed through debt. When analyzed with current ratio, this shows that the company might be vulnerable to problems arising due to extra loans and debts, and inability to service debt due to lower levels of current assets. Debt to Equity Ratio The Debt-Equity ratio of the company has shown a declining trend as it decreases from 3958.1/909.2 = 4.35 in 2005 to 4055.2/1155.3 = 3.51 in 2006. It shows an increase to 4289.6/1121.2 = 3.83 for the half yearly period in 2006. This relatively lower level of D/E ratio is considered to be safer and shows that the company is not heavily indebted. The debt is only 3.83 times the equity which can be handled even in the illiquid situations at times. Return On Assets (ROA) The ROA (Net income / Total assets) of the company was 523.1/5210.5 = 10% in 2006 as compared to 586.2/4867.3 = 12.02% in 2005, showing a declining trend. The ROA for the period April - September 2006 was 281.3/5410.8 = 5.2%. The decline shows that the company is not doing well in making an effective use of its assets to generate income for 2006 as compared to that in 2005. Total Assets Turnover The asset turnover for the company has been 7797.7/5210.5 = 1.50 in 2006 as compared to 7490.5/4867.3 = 1.54 in 2005 showing a declining trend. It was 3929.4/5410.8 = 0.726 for the half year period in September 2006. The total assets turnover is a critical ratio that measures the efficiency of the organization in using its assets to generate sales. The ratio for M&S is on the lower side showing that assets are not being used efficiently to generate dollar of sales. Management should take a note of this and should take appropriate steps to resolve this issue. Inventory Turnover The inventory turnover (Cost of Sales/Inventory) for the company has been 4812.1/374.3 = 12.86 in 2006 as compared to 4887.6/338.9 = 14.42 in 2005. This shows that on average, inventory has been sold 12.86 times in 2006 as compared to 14.42 times in 2005. The decline might be due to the ineffective inventory management practices, or may also be due to the lack of sales (but the sales have increased in 2006 as compared to 2005). The company should investigate this decline in inventory turnover to appropriately identify and resolve issues. Cost of Goods Sold to Sales & Gross Profit Margin The company did relatively better in reducing the cost of goods sold to sales ratio at 4812.6/7797.7 = 61.72% in 2006 as compared to 4887.6/7490.5 = 65.25% in 2005. This shows that the cost of inputs have been kept to low as compared to the revenue that is being generated from these inputs. This may show efficiencies in production function and indicates that there may be lower wastages at the plants in production. The Gross Profit Margin for the company was 38.28% in 2006 and 34.75% in 2005 showing a healthy sign. Sales have outpaced cost of sales which strengthens the point discussed above about efficient production function. Profit Growth and Sales Growth The growth in profit has been (523.1 - 586.2)/586.2 = -10.76% in 2006 but have increased to (281.3 - 212.6)/212.6 = 32.31% for the interim period in September 2006 (in comparison with the same period in 2005). In general, the company has done better in last six months where the reducing trend of profit growth has been reversed, and there has been an increase in the growth rate. Similar situation is noted in the sales growth which was (7797.7 - 7490.5)/7490.5 = 4.1% in 2006 (for 52 weeks) and then increased to (3929.4 - 3541.5)/3541.5 = 10.95% for the 26 weeks period in April - September 2006 (as compared to same period in 2005). This supports the point that the company is doing well in sales generation. Corporate Governance Section Review The Corporate Governance section of the financial statements, in general, provides information about the company's management structure, strategic management process, the sub-committees of the board of directors that are developed to address a specific purpose and need, and provides a brief overview of the performance and audit of the management for stakeholders. The key information provided by corporate governance section and the users of this information are highlighted and discussed below: Composition of the Board The Board of Directors for Marks and Spencer consists of 11 members including the Chairman, Deputy Chairman, Chief Executive, two executive directors and six non-executive directors. Their specific responsibilities have been provided in the section so that the readers of the financial statements get to know the top management and based on their good name and repute in the market, can get an idea of the transparency of financial statements and the operations of the company. This also serves to satisfy the requirements of regulators. The changes to the board composition have also been provided. Committees of the Board A detailed description has been provided about the committees of the board of directors including the Audit Committee (to monitor and supervise the integrity of financial statements to shareholders, to liaise with external auditors, and to review the systems of internal controls for risk management purposes); the Remuneration Committee to appropriately reward and recognize the efforts of top management and executive employees of the company; the Nomination Committee for effective planning and implementation of training, succession planning and other matters, and the Corporate Social Responsibility Committee to take care of the company's social policy initiatives. The frequency of meetings of these committees has also been provided in the annual report of M&S. The presence and functions of these committees provides an assurance to the regulators and shareholders that the company is aware of its responsibilities and is doing adequately to carry these out in an organized manner. Performance Evaluation and Succession Planning Several initiatives taken by the top management and the board to evaluate and improve performance of the company have been discussed in the annual report. This information is helpful for shareholders who like to see the company growing and improving, in order to secure future benefits of their investments. This also provides an insight into the succession planning procedures adopted by the company so that the stakeholders can be assured that policies that are developed by the existing members of the board will continue even if the composition of the board changes. Risk Assessment and Internal Controls The annual report documents that the board reviews the group risk profile every six months to identify and evaluate the significant risks that the organization faces, and to supervise and monitor the risk mitigation processes and procedures. The report also presents significant risks applicable to all the businesses of the company and the existing controls that have been applied to mitigate and controls the exposure to the company resulting due to these risks. The report also presents the assurance provided by the audit committee of the board of directors that internal control system of the company is effective in reducing the risks to an acceptable level. This assurance, not only serves as compliance with the requirements of regulators (Sarbanes Oxley requirement), but also provides a level of comfort to the existing and potential new shareholders that the company is protected against the risks that might cause setbacks to shareholders' investments, if not controlled. Conclusion The Corporate Governance section of the annual report shows that the top management of the company is aware of, and supports a culture where strategic policies are developed for the company, risk management is carried out to protect against risks, and there is an effective oversight body that takes care of stakeholders' interests. References Marks and Spencer Group Plc. (2006). Annual Report and Financial Statements 2006. Retrieved February 25, 2007 from the World Wide Web: http://www2.marksandspencer.com/thecompany/investorrelations/annual_review06/a/a.shtml Marks and Spencer Group Plc. (2006). Interim Results: 2006/07. Retrieved February 25, 2007 from the World Wide Web: http://www2.marksandspencer.com/thecompany/mediacentre/pressreleases/2006/fin2006-11-07-00.pdf Read More