Decomposition Framework for Financial Analysis. Kforce Inc. and Morson Group Plc - Essay Example

?Introduction During the 20th and 21st centuries, the economic boom was at its peak. Due to this fact, a substantial number of financial sand companies were founded and traded. Therefore, investors, government, businessmen and institutions were to decide and select the best possible combination of companies to invest so that they could increase their wealth by investing in an appropriate portfolio. Moreover, the investors needed to determine the underlying value of these investments in order to make sure that prices are rightly placed before making any decision related to purchase. These investors are generally called as rational investors who conduct analytical studies before making any decision related to investments. In this regard, the security valuation and financial statement have become very important. Financial analyses are those financial tactics and methods which help in comparing and evaluating the different investment opportunities such as projects and firms, to ensure and evaluate that the available opportunities are appropriate for making investments. Generally, the procedure of conducting financial analysis is based upon the past performance of a firm. The historical data is then used to evaluate the future performance of the company; therefore it is not at all necessary that evaluations are 100% accurate. Financial analysts usually obtain data from a variety of sources available, including income statements, balance sheets, and cash flow statements. Through these financial statements, analysts determine the ability of a firm to meet its liabilities and obligations, stability of a firm, level of profitability and liquidity and then compare them with their competitors in order to provide insights into the firm’s position as compared to the industry or its competitors. In balance sheet, the underlying financial position of of a company is present. The three main categories of which balance sheet is comprised include: assets, which demonstrate the long term and current investments of a firm through which revenues are expected to be generated; liabilities depict the long term and short term claims that stakeholders have; and equity which demonstrates the claim of the owners. This paper aims to analyze a U.K company, namely Morson Group PLC, in comparison with a U.S based firm known as Kforce Inc. The analytical methods utilized in this paper for analysis include: common-size analysis, trend analysis and profitability analysis. Understanding the Industry Companies which want to improve their performance need to provide training to their staff in recruitment centers. Leaders also get training so as to motivate their workers and working with efficient employees. A real competition among organizations has taken place nowadays. Every other company is striving hard to develop the skills of its employees. In this regard, a lot of training and development programs are being established every other day. Subsequently, a new type of competition between employees and management has also taken place. For this reason, companies are looking for recruitment companies so as to develop the special needs of their staff. Recruitment companies play a vital role in improving the facilities and skills of employees. Moreover, they are also looking to maximize their profits. Therefore, they provide best possible offers, contracts, training and development programs through professional lecturers and trainers so as to improve their own credibility. In addition to that, they also offer some special contracts including free contract for more employees, discounts for contracts having longer tenure etc. KforceInc – U.S based firm KforceInc provides professional and technical services specially for staffing companies. This company is primarily based upon four departments which include: Government Solution (GS), Technology (Tech), Health and Life Sciences and Finance and Accounting (FA). The two activities of Tech and FA are delivered in the specific regions of North, Atlantic and Western markets. Morson Group Plc- U.K based firm Among all the recruitment firms of U.K, Morson Group Plc is a pioneering company. The activities which it offers are purely based upon human development, for instance staffing organization, employment business, engineering management, design consultancy, stipulation of technical human resources etc. Quality of Information Provided The financial statements of both the companies are prepared in accordance with the applicable accounting standards. The quality of information provided is basically depends upon as to whether a particular accounting standard is complied with or not. There are generally two accounting principles which are mainly followed by the public listed companies. US based companies are required to follow Generally Accepted Accounting Principles (GAAP) and the rest of the companies belonging to other jurisdictions follow International Financial Reporting Standards (IFRS). In this analysis, Morson is a UK based company which prepared its financial statements in accordance with IFRS. On the other hand, Kforce is a US based entity which adopts GAAP as its accounting standard. Therefore, the quality of information provided by both companies is very much comparable as well as the level of accuracy and fairness is also quite high, so that both accounting standards are almost converged in most of the accounting treatments. For the purpose of this analysis, the financial statements have been reformulated in order to remove any irregularity and make them more comparable. The other reason behind the reformulation is that the analysis is intended to remain stick on the operating and financing side of both of these companies. Decomposition Framework for Financial Analysis The financial analysis of both firms is conducted in such a manner that the financial statements are analyzed by using the decomposition method. For the matter of financial statements analysis, the reformulated income statements and balance sheets from 2006 till 2010 are taken into consideration, so that the data has been collected from Thomson One Banker database (http://banker.thomsonib.com, 2012). The first part of the analysis is based upon the profitability analysis so that Return on Common Equity (ROCE) for both firms is compared. The formula to obtain ROCE is highlighted as under: ROCE = RNOA + [FLEV ? SPREAD] Where ROCE denotes “return on common equity” RNOA denotes “return on net operating assets” Such that RNOA = Profit Margin (PM) ? Asset Turnover (ATO) FLEV means “financial leverage” Such that FLEV = Net financial Obligation (NFO)/ Common Share’s Equity (CSE) SPREAD indicates “operating spread” Such that Spread = Return on Net Operating Assets (RNOA) – Net Borrowing Cost (NBC) The last part of this financial analysis relates to the trend analysis of both companies so that their performances are compared to the previous years. The base year for this analysis is taken as 2006 and the performance of other years is analysed on the basis of 2006. This trend analysis is also termed as vertical analysis. Financial Analysis As far as the financial analysis process of both companies is concerned, the process is mainly divided into three stages. The first stage is set out in such a manner that the reformulated income statements and balance sheets are taken into consideration for both companies so that operating as well as financial results and position can be appropriately reflected. Profitability analysis is the second stage of this financial analysis process, so ROCE is determined as a base indicator of profitability. ROCE is then further split into other parts which act as a trigger to ROCE for both Morson and Kforce. Subsequently, the third stage of financial analysis encompasses the horizontal and vertical analysis of both companies followed by the concluding comments on the performance of both the companies. 1. ROCE The profitability position of both companies can be best understood with the ROCE, so that this measure actually describes as how much income is earned with respect to the amount of common equity injected in the business. If the above diagram is closely looked at, it can be observed that in a large span of time, both Morson and Kforce experienced ROCE between 0.10 and 0.20 over the last five years. However, there is a sharp fall and rise can also be noticed in the ROCE of Kforce where in 2008 the company experienced steeping decline, but in the very next year, the company managed to bounce back again in the similar fashion and stood at its earlier position. 2. RNOA Return on Net Operating Assets (RNOA) is the next decomposition, so it is actually the factor that triggers the changes in ROCE. If the above diagram is carefully noticed, it is clearly evident that ROCE is actually triggered by RNOA because whatever trend is faced by RONA, similar trend can also be observed for ROCE. There has been a slight decline in RNOA for both companies, sothat it has slipped from 0.2 to 0.1 in the specified period. However, the performance of Kforce remained shaky to th extent that it experienced a sudden fall and a jump in RNOA in 2008, which is recovered immediately in 2009. 3. FLEV If the Financial Leverage (FLEV) is taken into consideration for the companies, it can be viewed that the pattern of both companies is similar, but the magnitude has significant differences between the two. Kforce has remained steady in improving much lesser financial leverage as compared to Morson. Morson experienced massive declines in its beginning years. However after 2008, they improved their leverage position. 4. SPREAD The above figure highlights the SPREAD of the two companies, so that Morson has showed a very steady but slightly declined pattern. Conversely, in case of Kforce, much fluctuation can be observed especially in 2008, it experienced a massive decline and entered into a negative zone. However, it immediately bounced back and gained its lost position even by beating Morson. 5. PM The profit margins for both companies are shown in the above figure. Morson’s steady position describes its consistency with the strategies that it follows, so that it maintained a consistent pattern of 2% in terms of its profit margins. On the other hand, Kforce had an edge over Morson in the initial 2 years but its profits wiped out massively in 2008 and reflected a loss of around 8%. However, the company went out of that disaster immediately and managed to earn 2% profit margin in last two years. 6. ATO The above diagram reflects the asset turnover of both Kforce and Morson over a period of five years. From 2007 till the end, both companies have reflected pretty much similar behaviour and their asset turnover remained steady. There is a gap of 2 in between the asset turnover of the two companies where Morson’s asset turnover remained higher than that of Kforce. Overall, the asset turnover performances of both companies have remained satisfactory. Trend Analysis: Morson Group: Reformulated Income Statement GBP GBP GBP GBP GBP (in millions) 12/31/10 12/31/09 12/31/08 12/31/07 12/31/06 Operating Income           Revenues 457.64 436.63 431.45 393.98 326.83 Cost of sales 421.72 401.05 393.93 359.68 299.54 Gross margin 35.92 35.58 37.51 34.30 27.29 Operating expenses 27.30 24.48 25.05 22.03 18.59 Other operating income (expense) 1.08 -1.10 -2.91 0.00 -0.04 Operating income from sales(before tax) 9.70 9.99 9.55 12.27 8.66 Operating income from sales (after tax) 7.83 7.56 7.48 9.02 6.19 Comprehensive income to Common 6.98 7.19 5.81 6.87 3.62 There has been an increasing trend in the revenues for Morson even in the times of recession, which is quite a healthy sign for the company. Gross Profits Margin has also increased but in the last three years it remained slightly stagnant. Income after tax has been quite steady in the last three years but still quite far from the 2007 results where the company made the highest earnings. Comprehensive Income to Common Shareholders has shown a volatile trend over the past five years. REFORMULATED BALANCE SHEETS GBP GBP GBP GBP GBP (in millions) 12/31/10 12/31/09 12/31/08 12/31/07 12/31/06 Total operating assets 125.86 106.45 112.84 112.15 93.87 Total operating liabilities 40.58 38.09 32.07 27.38 27.95 Net operating assets (NOA): 85.27 68.37 80.77 84.77 65.92 Net financial assets (obligations) (NFA/NFO) -23.23 -11.00 -27.85 -34.74 -22.76 Common Shareholders' Equity (CSE) 61.39 57.27 52.87 50.00 43.13 If the reformulated balance sheet of the company is taken into consideration, there are few areas where the company has performed reasonably well. In respect of Total Operating Assets, the company managed to increase them by more than 25%. Similarly, Total Operating liabilities have also increased in the similar manner. If financing side is noted, Net Financial Obligations have remained quite steady whereas Common Shareholder’s Equity has increased by around 41%. Kforce Inc: Reformulated Income Statement USD USD USD USD USD (in millions) 12/31/10 12/31/09 12/31/08 12/31/07 12/31/06 Operating Income           Revenues 990.81 910.14 997.02 1,036.92 938.45 Cost of sales 678.39 624.16 652.37 664.57 612.35 Gross margin 312.41 285.98 344.65 372.34 326.10 Operating expenses 277.79 262.07 300.30 300.86 268.74 Other operating income (expense) -0.04 -0.68 -129.29 0.00 0.10 Operating income from sales(before tax) 34.58 23.23 -84.94 71.49 57.46 Operating income from sales (after tax) 21.89 14.21 -89.18 45.41 36.97 Comprehensive income to Common 20.63 12.87 -91.44 40.37 32.52 Kforce has experienced massive volatilities in respect of its financial performance over the period of five years. The revenues for Kforce increased its peak in 2007 but after that, it never got back to 1 billion. Gross Profits of the company have remained on a lower side especially in the last 2 years. Income after tax for the company struggled in the period, so that it incurred a huge loss in 2008, but after that it has started gaining some momentum. Comprehensive income to Common Shareholder’s has also remained at a relatively lower level. REFORMULATED BALANCE SHEETS USD USD USD USD USD (in millions) 12/31/10 12/31/09 12/31/08 12/31/07 12/31/06 Total operating assets 381.08 326.63 339.53 475.05 441.03 Total operating liabilities 113.90 97.94 92.11 106.81 88.17 Net operating assets (NOA): 267.18 228.70 247.42 368.24 352.86 Net financial assets (obligations) (NFA/NFO) -13.36 -1.97 -41.57 -55.78 -90.94 Common Shareholders' Equity (CSE) 253.82 226.73 205.84 312.47 261.93 So far as the reformulated balance sheet of Kforce is concerned, its total operating assets have been declining sharply. But there has been a significant increase in total operating liabilities of the company. Net Operating Assets of the company has also remained at a lower side for Kforce. However, there has been a major decrease in Net Financial Obligations of the company and it has improved in a decent manner. Common Shareholder’s Equity increased quite high in 2007, but overall it remained steady. 6. Conclusion This article mainly highlighted the financial performance of Morson and Kforce, so that their profitability is determined by utilizing ROCE as a major indicator. RNOA turned out to be the most significant trigger in shaping up ROCE. Overall financial performance of Morson has remained steady as well as satisfactory. However, Kforce struggled especially in the times of the 2008 recession where it incurred huge losses. Overall patterns of other financial indicators have also shown more volatility as compared to Morson. It is important to note that from the last two years, both the companies have started gaining the momentum to get back to pre recession time and heading them in a rather smoother way. References Baker, H. 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