The financial ratios of Rolls Royce and its major competitors - Essay Example

?Introduction Every business, no matter small or large, constantly evaluates its company’s performance by comparing it with competitors, industry andits own past performance. In order to do so, businesses not only look at the figures of sales, profit and costs but also prepare other criterion for measuring performance which helps in reading between the lines of financial statements. The most widely known and reliable approach of evaluating a firm’s performance is by calculating and comparing its financial ratios. The basic reason for doing so is because this information is understandable for every person who has some level of knowledge of financial concepts. By comparing the ratios with the competitor of the firm or with its past performance, a clear idea can be obtained. For this purpose, the company which has been chosen is Roll Royce. It is a diversified company having its operations in the field of aerospace, nuclear market, civil defense and marine and energy. It was founded in 1971 and has its headquarters in London, United Kingdom. This paper examines the performance of Rolls Royce over the several years. For this regard, key financial ratios have been calculated for Rolls Royce. In order to evaluate the performance of the company, the ratios have been compared with its major competitors and Industry Standards. A brief interpretation of the financial ratios of Rolls Royce and its major competitors is also mentioned. Key Financial Ratios In this regard, some key financial ratios help in identifying and assessing the financial position, strengths and weaknesses of a company. These ratios can be broadly divided under the following mentioned categories. Activity Ratio Efficiency Ratio Asset Utilization Ratio Profitability Ratio Leverage Ratio Investors Ratio Activity Ratio Activity Ratio also called as Liquidity Ratio helps a firm in determining the ability of a firm to meet its current liabilities. Activity Ratio is that investment or cash which is used to pay off the short term debts as well as expenses. The most commonly used activity ratios are: Current Asset Current Ratio is determines whether the firm has enough liquidity to pay off its expenses and short term debt. Theoretically, if current ratio is around 2.00 then it is considered as the most preferable. This ratio possesses huge consideration because if this ratio is declining it means that the cash position of the company is getting eroded. For that reason, the quickest way which can increase cash is increasing the amount of sales. Quick Ratio This ratio is also known as Acid Test Ratio. This ratio determines that if inventories are excluded, then is the firm able to pay off its short term expenses? Quick ratio is usually preferable if it is 1 or near to 1. If this number is decreasing, then it means that enough sales are not being generated to pay off the short term debt or day to day expenses. In order to improve such situation, intervention regarding Quick Cash Management is required. Net Working Capital to Sales This ratio determines the company’s performance in relation to its sales, after meeting the short term obligations or liabilities, Efficiency Ratio Efficiency ratio determines the efficiency of a business or in other words, how well the business operations are conducted. These ratios determine how well and quickly the company collects its accounts receivables, how quickly the inventory moves and how much sales are generated by the company’s assets. Efficiency ratios include: Inventory Turnover Receivable Turnover Payable Turnover Days Inventory in hand Debtors Collection Period Creditors Payment Period Inventory Turnover Inventory turnover ratio determines the total turnovers of inventory. This ratio determines the efficiency of inventory management. If inventory turnover ratio is higher, then it means that firm is really efficient in rolling over its inventory. However, in some cases high inventory turnover ratio also means that firm doesn’t have enough inventories on its hand and therefore losing its sales. Receivable Turnover Receivable turnover determines the number of times in which receivables are collected over the fiscal year. It measures the efficiency of a firm in collecting the amounts of its credit sales. This ratio considers and incorporates only credit sales. If cash sales are included, then the essence of this formula can be lost. Payable Turnover Accounts Payable Turnover measures the efficiency of a firm to pay off its suppliers. In essence, this ratio determines how much times the firm pays off to its supplier in a given period of time. Asset Utilization Ratios Asset utilization ratios determine the efficiency of the firm in utilizing its various types of assets so as to generate sales. Some of the most common Asset utilization Ratios are: Fixed Assets Turnover This ratio measures the ability of the firm to generate sales by utilizing the investment made on fixed assets. The higher this ratio, the better is the efficiency of the firm. Total Assets Turnover This ratio measures the efficiency of the firm in utilizing its assets so as to generate sales. The higher this ratio, the better is the efficiency of the firm.  Profitability Ratios Profitability Ratios determine the financial profitability of the firm in various aspects. These ratios provide an idea about what makes up the income of the company and is usually expressed in the form on each dollar of sales. Some of the most common profitability ratios are: Net Profit Margin Operating Profit Margin Return on Assets  Return of Fixed Assets Return on Equity Return on Capital Employed Return on Working Capital Leverage Ratios Leverage ratios, also known as risk ratio determines the part of the company’s income which belongs to the people who are outside the company. In other words, it means that how much amount the company owes to others or how much amount can be spent for creditors. Debt to Asset Ratio Long-term Debt to Asset Ratio Debt to Equity Ratio Investors Ratios  Also known as shareholders’ ratio, investors ratio specifically relate to the shareholders. These ratios determine various components of shareholding for instance how much the company pays off to its shareholders, how much earnings does it provide to shareholder, what amount of dividend does it declare and distribute to shareholders etc. These ratios are always considered by investors before making investment in stocks. Some of these ratios are: Earnings per Share  Dividend Payout Ratio Price Earning Multiple Dividend Yield Ratio Analysis The following discussion encompasses the in-depth analysis of ratios of Rolls Royce along with the other industry participants. For the purpose of this analysis, three big firms from the aero defense and engines industry are selected as the operations of Rolls Royce is basically more towards manufacturing of heavy engines for vehicles. The other participants of the industry also deal in manufacturing of engines but on different scales. In this analysis, the overall performance of Rolls Royce for the year 2010 is compared with BAE Systems, Honeywell International and the Boeing Company. The ratios have been divided into six distinct categories for the purpose of understanding and convenience. Those categories are: Activity, Efficiency, Asset Utilization, Profitability, Leverage and Investors Ratios. Each category has been analyzed for the perspective of Rolls Royce in comparison with other industry participants. Liquidity Ratios As far as liquidity ratios are concerned, three basic ratios are calculated namely as Current Ratio, Quick Ratio and Net Working Capital to Sales. In terms of Current ratio, Rolls Royce has outperformed among other industry participants by generating a Current Ratio of 1.37 which is the highest. Similar pattern can also be observed in terms of Quick Ratio where Rolls Royce is on a leading side with 1.03. Overall Net Working Capital to Sales Ratio of Rolls Royce is also far better than the other competitors with 23.87%. Thus it can be concluded that the Rolls Royce has effectively managed its liquidity position and operating activities as the company has a higher edge in this regard over others. In order to cover its current liabilities, the company has remained successful in generating sufficient current assets. The following table shows the overall performance of all four companies in terms of Liquidity Ratios. Ratio Rolls Royce BAE System Honeywell Int Boeing Liquidity Ratios             Current Ratio 1.37 0.65 1.32 1.15     Quick Ratio 1.03 0.60 0.99 0.45     Net Working Capital to Sales 23.87% -19.16% 11.63% 8.05%           Efficiency Ratios If the performance of Rolls Royce is closely monitored as how effective the firm has utilized its working capital, the company’s performance has remained average in this respect such that the inventory turnover ratio and day inventory in hand comes to third rank among all four companies which is not good sign for company’s inventory management perspective. There are only 3 to 4 turnovers that are undertaken by the company and each turnover takes around 100 days. In terms of receivable, Rolls Royce’s performance has been of a disappointing side with the worst performance among all four companies. The company took barely 3 receivable turnovers a year and the company takes around 130 days to collect its debts from the debtors which shows that company’s cash is largely blocked in its receivables which is again a bad indicator for the company. However, if the performance of the company is analyzed in terms of creditor’s management, the company has outperformed the other participants such that it ended up with only 3 turnovers in 2 years time. In terms of days, the company makes the payment in around 243 days to its creditors, which is a good sign as the company can use that cash elsewhere. The following table highlights the performance of all four companies in respect of efficiency of its working capital. Ratio Rolls Royce BAE System Honeywell Int Boeing Efficiency Ratios             Inventory Turnover 3.66 32.76 6.47 2.13     Receivable Turnover 2.81 5.93 4.73 11.86     Payable Turnover 1.50 2.11 4.74 5.47     Days Inventory in hand 99.78 11.14 56.43 171.20     Debtors Collection Period 129.83 61.57 77.19 30.78     Creditors Payment Period 242.79 172.74 77.01 66.74           Asset Utilization So far as the performance of Rolls Royce is concerned in respect of its asset utilization, very disgusting patterns can be observed that show that the company could not utilized its assets efficiently to make higher sales. It can be noticed that fixed asset turnover of the company has remained significantly lower than other participants with only 1.73 turnovers a year which is the least among all the firms. The company generated hardly ?1.73 per ?1 invested in its fixed assets. Similar patterns can be observed in terms of total assets utilization which the company managed to generate hardly ?0.68 per ?1 invested in the total assets of the company. The overall performance in this regard is substantially sluggish and the company needs to take large steps in order to improve the performance of its assets so that they can generate high volume of sales in the future. The table given below assesses the overall performance of all four firms in respect of asset utilization. Ratio Rolls Royce BAE System Honeywell Int Boeing Asset Utilization Ratios             Fixed Assets Turnover 1.73 7.77 6.85 2.30     Total Assets Turnover 0.68 0.88 0.86 0.94           Profitability Ratios If the overall profitability position of the company is analyzed, the performance of Rolls Royce has remained reasonable. The net profit margin of the company stands at third position with 4.90%. For operating profit margin, the company comes at second position be generating around 10.19% operating profits of its overall sales. Return on assets of the company has remained the poorest among all the companies with just 3.34%. Return on Fixed Assets is also quite depressing with 8.47% and stands at third position beating Boeing Company only. Return on equity also shows disappointing results among all four companies with merely generating around 13.65% which is the least. Return on capital employed has also shown the similar profitability patterns as generating hardly 6% return on the capital employed by the company. The company has remained on third position in terms of return on working capital by generating around 20.52%. The overall picture of the profitability of Rolls Royce is quite disgusting and the company should concentrate on increasing its profits by deploying better business strategies. The following table outlines the overall profitability position of all the four companies. Ratio Rolls Royce BAE System Honeywell Int Boeing Profitability Ratios             Net Profit Margin 4.90% 3.29% 6.29% 5.15%     Operating Profit Margin 10.19% 7.75% 76.42% 7.73%     Return on Assets 3.34% 4.50% 5.38% 4.83%     Return of Fixed Assets 8.47% 39.83% 43.08% 4.83%     Return on Equity 13.65% 20.01% 18.87% 115.69%     Return on Capital Employed 6.00% 8.74% 7.79% 9.97%     Return on Working Capital 20.52% -26.74% 54.09% 63.88%           Leverage Ratios Leverage position of any company is quite important as it highlights the risk position. The overall leverage position of Rolls Royce is again not up-to-the-mark such that with the exception of Boeing Company, the company’s risk position is quite higher. The overall Debt to Asset ratio of the company is around 75% which is in line with the current industry practices. However, the company has taken raised substantial amount of long-term debt which is a question mark upon the leverage position of the company as long term debts constitute around 31.27% of the total assets. The debt to equity position of the company is reasonable with the ratio of 3.08:1 which is aligned with the industry norms. Ratio Rolls Royce BAE System Honeywell Int Boeing Leverage Ratios             Debt to Asset Ratio 75.49% 77.52% 71.49% 95.83%     Long-term Debt to Asset Ratio 31.27% 8.88% 15.21% 95.83%     Debt to Equity Ratio 3.08 3.45 2.51 22.96 Investor Ratios The investor ratios particular reflects the company’s overall profitability position and the sound nature of its operations. As Rolls Royce has experienced significant downgrades in terms of its profitability position, therefore, the investors’ ratios are also on disappointing note. Earning per share of the company is the least with generating income of only ?0.29 per share as compared to other companies. However, the company has maintained a consistent dividend pay-out ratio in line with the other industry participants such that around 55% of the income is distributed to the shareholders in the form of dividend. Despite of the sluggish performance in most of the areas, the share price of Rolls Royce is quite higher than expected as it manages a price/earning multiple of 28 which is the highest among all the competitors. There is a likelihood that the share price of the company may fall in the future as it seems to be overvalued. The dividend yield of the company is also quite low as the company pays a nominal amount of dividend upon the purchase of shares on its existing share price. Investors’ ratios are highlighted in a brief manner in the following table. Ratio Rolls Royce BAE System Honeywell Int Boeing Investors Ratios             Earning Per Share 0.29 0.31 2.61 3.27     Dividend Payout Ratio 0.55 0.56 0.46 1.36     Price Earning Multiple 28.63 10.36 22.70 23.02     Dividend Yield 1.91% 5.41% 2.04% 5.92%           Recommendations It is advised to the management of Rolls Royce to take a review of all of its business activities as the current financial position of the company is quite depressing. The company needs to develop more growth in all areas of the business especially in terms of its profitability which is quite sluggish at the moment. Appendix Ratio Formula   Rolls Royce   BAE System   Honeywell Int   Boeing   Activity Ratios                         Current Ratio Current Assets 9,824 1.37 7,616 0.65 15,486 1.32 40,572 1.15   Current Liabilities 7,178 11,658 11,724 35,395       Quick Ratio Current Assets - Inventories 9,824-2,429 1.03 7616-644 0.60 15486-3822 0.99 40,572-24317 0.45   Current Liabilities 7,178 11,658 11,724 35,395       Net Working Capital to Sales Current Assets – Current Liabilities 9,824-7,178 23.87% 7616-11658 -19.16% 15486-11724 11.63% 40572-35395 8.05%   Sales   11,085   21,097   32,350   64,306   Ratio Formula   Rolls Royce   BAE System   Honeywell Int   Boeing   Efficiency Ratios                     Inventory Turnover Sales 8,885 3.66 21,097 32.76 24,721 6.47 51,843 2.13   Inventories 2,429 644 3,822 24,317   Receivable Turnover Sales 11,085 2.81 21,097 5.93 32,350 4.73 64,306 11.86   Receivable 3,942 3,559 6,841 5,422   Payable Turnover Sales 8,885 1.50 19,761 2.11 19,903 4.74 42,194 5.47   Payables 5,910 9,352 4,199 7,715   Days Inventory in hand 365 365 99.78 365 11.14 365 56.43 365 171.20   Inventory Turnover 3.66 32.76 6.47 2.13   Debtors Collection Period 365 365 129.83 365 61.57 365 77.19 365 30.78   Receivable Turnover 2.81 5.93 4.73 11.86   Creditors Payment Period 365 365 242.79 365 172.74 365 77.01 365 66.74   Payables Turnover   1.50   2.11   4.74   5.47   Ratio Formula   Rolls Royce   BAE System   Honeywell Int   Boeing   Asset Utilization Ratios                     Fixed Assets Turnover Sales 11,085 1.73 21,097 7.77 32,350 6.85 64,306 2.30   Fixed Assets 6,410 2,714 4,724 27,993       Total Assets Turnover Sales 11,085 0.68 21,097 0.88 32,350 0.86 64,306 0.94   Total Assets   16,234   24,030   37,834   68,565   Ratio Formula   Rolls Royce   BAE System   Honeywell Int   Boeing   Profitability Ratios                     Net Profit Margin Profit After Tax 543 4.90% 694 3.29% 2,035 6.29% 3,307 5.15%   Sales 11,085 21,097 32,350 64,306   Operating Profit Margin Operating Profit 1,130 10.19% 1,636 7.75% 24,721 76.42% 4,971 7.73%   Sales 11,085 21,097 32,350 64,306   Return on Assets Profit After Tax 543 3.34% 1,081 4.50% 2,035 5.38% 3,307 4.83%   Total Assets 16,234 24,030 37,834 68,565   Return of Fixed Assets Profit After Tax 543 8.47% 1,081 39.83% 2,035 43.08% 3,307 4.83%   Total Fixed Assets 6,410 2,714 4,724 27,993       Return on Equity Profit After Tax 543 13.65% 1,081 20.01% 2,035 18.87% 3,311 115.69%   Shareholders' Equity 3,979 5,403 10,787 2,862       Return on Capital Employed Profit After Tax 543 6.00% 1,081 8.74% 2,035 7.79% 3,307 9.97%   Total Assets – Current Liabilities 16,234-7,178 24030-11658 37834-11724 68565-35395       Return on Working Capital Profit After Tax 543 20.52% 1,081 -26.74% 2,035 54.09% 3,307 63.88%   Current Assets – Current Liabilities   9,824-7,178   7616-11658   15486-11724   40572-35395   Ratio Formula   Rolls Royce   BAE System   Honeywell Int   Boeing   Leverage Ratios                         Debt to Asset Ratio Total Debt 12,255 75.49% 18,627 77.52% 27,047 71.49% 65,703 95.83%   Total Assets 16,234 24,030 37,834 68,565       Long-term Debt to Asset Ratio Long term Debt 5,077 31.27% 2,133 8.88% 5,755 15.21% 65,703 95.83%   Total Assets 16,234 24,030 37,834 68,565       Debt to Equity Ratio Total Debt 12,255 3.08 18,627 3.45 27,047 2.51 65,703 22.96   Shareholders' Equity   3,979   5,403   10,787   2,862   Ratio Formula   Rolls Royce   BAE System   Honeywell Int   Boeing   Investors Ratios                         Earning Per Share Profit After Tax 543 0.29 1,081 0.31 2,022 2.61 3,307 3.27   Number of Shares Outstanding 1,860 3,544 775 1,012       Dividend Payout Ratio Dividend 0.16 0.55 606 0.56 1.21 0.46 4.45 1.36   Profit After Tax 0.29 1,081 2.61 3.27       Price Earning Multiple Current Share Price 8.36 28.63 3.16 10.36 59.26 22.70 75.23 23.02   Earning Per Share 0.29 0.31 2.61 3.27       Dividend Yield Dividend per share 0.16 1.91% 0.17 5.41% 1.21 2.04% 4.45 5.92%   Current Share Price   8.36   3.16   59.26   75.23   References Baker, H. 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