Financial Ratio Tutorial - Assignment Example

Financial Ratio Tutorial 1.1.1 The Directors’ report of Debenhams provides essential information to the users related to profit earned and dividend paid during the financial year, increase in authorized capital and major events that took place between the year end and the date of authorization of financial statement. In addition, the report also presents the composition of entities having major share holding in Debenhams, the nature and type of contracts entered into during the current financial year in which any of the directors have material interest and donations made during the year. Selling of international brands is one of the core operations of Debenhams. These international brand suppliers would be quite interested in the Directors’ report in order to assess whether it is lucrative for them to continue business with Debenhams, based on its financial highlights. Apart from current and prospective investors, users of financial statements also include the regulatory authorities. 1.1.2 The company has divided its corporate social responsibility into three main activities Environmental, Ethical Trading and Workplace and community. Debenhams recognizes the adverse change in the climatic condition due to the carbon emission and increase in production of waste material. As per the sources, the temperature of the earth has increased by 1.33 degrees Fahrenheit from 1905 to 2005 and it is still increasing. [1] In order to curtail these harmful impacts on the environment, Debenhams has started ‘carbon foot printing’ through which the company is able to understand which is of its operations is generating what amount of carbon dioxide in the environment. Debenhams also ensures that the working environment for its labor force is safe and humane. The company has implemented safety rule and monitors that the workers are following the code of conduct. As per the corporate responsibility report, Debenhams also put great emphasis on the manufacturing of products from organic and harmless material so that the consumers are satisfied and safe. The company is also an active philanthropist and actively takes part in charity both at national and local level. 2.1 The management at Debenhams identified various risk during the financial year which can cause several uncertainties to the operations of the company. Broadly, financial risk can be defined as the risk that a company will not have adequate cash flow to meet financial obligations in future. Unplanned cost management and delayed receivables turn over period can cause shortage of cash flow for the company resulting in serious effects on operations. Since the company’s operations is spread across several countries, one of the major financial risk is the effect of change in exchange rate. Debenhams has implemented vigilant treasury controls, including hedging, in order to divert any foreseeable financial risks and these controls are regularly monitored. Another risk mentioned in the report is the reputational risk. Debenhams’ reputation can suffer some serious damage if it is unable to deliver its social responsibilities. The social responsibilities of Debenhams include implementing health and safety rules for its working force, making donations to philanthropist organization and curtailing the environmental damage caused by its operations. The company strives in providing better working conditions to its workers and makes regular donations. The most significant risk for Debenhams is the strategic risk which may include decline in revenue due to the volatile economic conditions, ineffective marketing and the company’s inability to grow. Company has adopted strategic marketing techniques in order to divert these risks. 2.2 The company’s policy for charging depreciation is on ‘straight line’ basis. Charging depreciation on straight line basis represents that the asset is giving equal benefits throughout its useful life, which also supports the matching principle of assets and expenses. If the assets are depreciated on reducing balance method, in which the depreciation rate is applied on the carrying amount rather than cost, depreciation charge in the initial year of the assets is higher and this will decrease profit significantly. Whereas, depreciation charge calculated on straight line basis will offset the profit with the same amount, every year. 2.3.1 The five ratios which are important to evaluate the financial outlook of Debenhams are Current Ratio, Net Profit Margin, Return on Assets (ROA), Debt ratio and Dividend yield. The current ratio evaluates the liquidity of a company in order to analyze the capability of the company to settle all of its current liabilities. Net profit margin analyzes the increase in profit of the year as compared to the previous financial period. ROA indicates how profitable a company is in relation its total assets. Operational cash flow to sales ratio is significant as it describes the entity’s ability to turn sales into cash and the debt ratio compares the funds which are owed by the company to others and what the others owe to the company. 2.3.2 Ratios 2009 2008 Current Ratio 0.88 : 1 0.54 : 1 Net profit Margin 4.96% 4.19% ROA 4.45% 3.89% Operating cash flow/sales 8.27% 10.41% Debt Ratio 80.09% 93.69% The current ratio of the company has improved which justifies better financial outlook and liquidity as compared to the previous year. Following the same trend, the net profit margin of the company has also increased as the net profit attributable to the share holder has increased by 23% during the current financial year. These ratios explain that the company is carrying out its operations more effectively and has able to curtail its operating expenses. ROA ratio explains that Debenhams has able to take full advantage of its increased asset base and all the major capital expenditures have proved to be financial viable. The cash flow to sales ratio has decreased which is due to the increase in the working capital change during the year. A lower percentage of debt ratio explains that the company is now less dependent on borrowings from third party and is now self sufficient, to certain extent, in financing its own operations. 2.4.1 As per the consolidated cash flow statement of Debenhams, the cash flow from operations has decreased by 17% during the current financial year. Although the revenue from sales increased during the current year, it has been offset by the change in working capital which is the calculated as the difference between opening and closing figure of stocks, trade receivables and trade payables. 2.4.2 Debenhams utilized a major portion of its cash in the repayment of the loan facility which has increased by 50% as compared to the financial year ended 2008. Another area where the company utilized most of its cash funds is the acquisition of Property, Plant and equipment. The company incurred major capital expenditure on the purchase of vehicles, furniture and fixture. These capital expenditures are in line with the opening of new stores during the year. 2.4.3 Cash flow statement is considered a very important document in the preparation of financial statement of any organization. Divided into cash flows from operations, investing and financing activity, a cash flow statement represents the inflow and out flow caused during the course of the business. In comparison with the income statement, the cash flow represents the change in the working capital of the company the management of which is very crucial for the effective operation of any organization. Moreover, the income statement does not present any information pertaining to the major capital expenditure and major financing activities. References [1] Harold Baldwin “Surprising Global Warming Statistics.” ezinearticles.com. Ezine articles, n.d. Web. 28 Sep. 2010. [2] Richard Loth “Financial Ratio Tutorial.” investopedia.com. Investopedia, n.d. Web. 28 Sep. 2010. [3] “Importance of Cash Flow.” buzzle.com. Buzzle.com, n.d. Web. 28 Sep. 2010. Read More