Managing Finance: Financial Ratio Analysis - Coursework Example

? Managing Finance With organizations becoming more and more complex and the level of competition increasing tremendously there is increased need to evaluate the financial health of the organization as adopting ways that helps the company to achieve a competitive against its competitors. The first two sections of the paper focuses on analyzing the financial soundness of Barney Bakes plc as well discuss some the management practices that should be adopted to enhance the profitability of the organization. This includes beyond budgeting and corporate governance. In the last section of the paper we analyze how the firm should management its resources efficiently so as to achieve the optimal profit level. All this practices and analyses are undertaken so to manage the finances efficiently. Section A Financial ratio analysis: Ratio analysis helps in evaluating the financial soundness of the organization. In analyzing the financial statement of a company one can either carry out a trend analysis where he compares from the financial information of a company for certainty duration of time may be three years, while a cross sectional analysis is a comparison of a company financial statement against those of other firm(s) in the industry. In this case we will a conduct a trend analysis of Barney Bakes plc for a period of years from 2007 to 2011. Let commence by introducing the various categories of ratios that will helps evaluate the company performance over the years. Ratios are normally categorized into five categories namely; Liquidity ratios which includes quick ratio, and current ratio; profitability ratios which includes Return on shareholder Funds, Return on capital employed, gross profit margin, operating margin and profit after tax. Efficiency ratio which will include stock turnover, trade debtors, trade creditors, sales to capital employed, sales to capital employed (assets turnover) and sales per employee: gearing ratios, where we will consider gearing ratio: and lastly the investment ratios where we shall consider, dividend payout, dividend cover, dividend yield, Earning per share, and Price/ Earning ratio Using the above ratios we shall evaluate the profitability, liquidity, leverage, and efficiency and investors analysis Profitability analysis In order to conduct a profitability analysis we shall embark on calculation of the Profitability ratios which shall help us ascertain whether the organization has the ability to generate returns on the investment. Profitability ratios can be categorized into those in relation to sale and those in investment Gross margin This ratio helps determine the returns that a firm makes on cost of sales. Gross profit margin indicates the ability of the company sales to generate returns. This ratio is usually expressed in percentage of revenue from sale divided by the cost sales (Palepu and Healy 35) As depicted above, the company has low sales costs, thus being able to make considerable high returns. From the trend analysis, the company has managed to keep the gross profit margin constant over the four years showing that the company has been able to control its cost of sales, thus a higher gross profit. Operating margin The operating margin helps to indentify the amount of return per ? 1 of turnover a business has earned. This ratio is more relevant as compared to gross profit margin since it captures other cost such as marketing and administration costs. From the above table and figure, the company operating profit has worsened over years; this implies that company has been able to minimize its expenses. In the year 2008 we have the highest operating while the following year due to effects of global financial crisis the operating profit decline significantly. Return on capital employed Return on capital employed measure how efficiently the firm has been in using the net assets to generate returns in the business. As delineated above the return on capital employed has declined over the year period. This can be attributed to the decline in the earnings of the firm over the years. Return on the shareholders fund Return on shareholders’ funds ratio measure the efficiency of the firm in using the owner’s capital to generate returns. In this case a higher a ratio indicates that the firm is more efficient. As delineated from the year 2008 the returns to the share holders has decline adversely, this can be attributed to decline in the earning of the of the firm after tax. This implies that the firm is not efficiently utilizing the owner’s capital to generate returns. Profit after tax This ratio compares earning after tax and interest to turnover of the firm it show cases the ability of the firms sales to generate returns As illustrated above profit after tax has decline over the years due to decline in sales and increase in the level of expenses of the firm. Liquidity or solvency analysis This part of the section will concentrate on evaluating the liquidity of both firms. In this case, evaluation of the ability of both firms to meet their current obligations is conducted. In order to achieve this, computation of both current and quick ratio is necessary. Current ratio Current ratio compares the current asset with current liabilities. It is obtained from dividing the total current asset by the total current liabilities. This ratio helps an organization to evaluate its ability to meet its current short term obligation using the resources the organization already has. In addition, current ratio helps in highlighting the efficiency of the company in turning its products into cash (Palepu and Healy 58). In this case the recommended ratio is 2:1 The figures obtained are far below the recommended ones. This implies that the company might have some difficulties in meet its short-term obligations as they fall due. From the trend analysis the company liquidity can be said to have improved over time as the current ration become stronger and stronger. Quick ratio Quick ratio is tighter than the current ratio, in that it ignores inventories and prepayments. As current ratio, it measures the ability of the organization to meet its current obligations. In this case the recommended ratio in this case 1:1 (Palepu 69), although a trend analysis shows improvement in the case of the firm in its solvency. The figure obtained after the calculation of the quick ratio are alarming since this indicate that the firm to revise its working capital management policy since it seems to have difficulties in meeting obligations as they fall due. Gearing ratios These ratios help in evaluation of financial risk of a firm, i.e. the probability that a firm will not be able to pay up its debt, usually the more debt the firm has the higher the financial risk. This measures how a firm has been financed by the non-owners supplied funds in relation to the amount financed by the owners (Palepu 89) As illustrated above in overall the gearing ratio has increased over the period of the years implying that the vulnerabilities to financial risk have increased over the period. Efficiency ratio It measures the efficiency with which the firm is using various assets to generate sales revenue or how active has the firm been (Palepu 104). Stock turnover In overall stock turn over in terms days have increased meaning that the level at which the firm turns into sales has declined. This is not good for the company as it illustrate reduced activity level in the case of the firm. Trade debtors in days This represents the number of days that a firms’ debtor takes before they can pay their debts. In this case the lesser the days the better A trend analysis over the four years shows that the days that a debtor takes to pay the debts to the firm have increased over years. This is not good for the firm since it might lead to working capital management problems Trade creditors (days) This represents the number of days that the firm takes before it can pay the trade creditors funds after they supply to the firm. As illustrated in the table the number of days that the firm takes before it pays the creditors have increased overtime, this good for the firm as can first use the fund for other pressing needs. Sales to capital employed (asset turnover) This measure the efficiency with which the firm is using capital employed to generate sales As observed from the table in overall the efficiency with which the firm uses it assets to generate sales have worsened. Therefore the firm needs to adopt measures that would reverse the current situation. Sales per employee The sales per employees have increased over the period of the four years even though the number of employees has not increased proportionately. This can be attributed to the increase in the level sales thus indicating that the employees productivity have increased over the time. Investment ratios They measure the relative value of the firm and returns expected by the owners of the firm. They also try to look at the overall performance of the firm and its going concern (Palepu and Healy 112) Dividend payout This represent the proportion of the the companies earnig distributed to the shaeholders This ratio can be said to improve in overall thus making the firm stock attractive to the investors. Dividend cover Dividend cover represents a ratio of the company earnings attributable to the shareholders to the dividend disbursed to the shareholders. In this case a ratio higher than 2.0 is consider to be safe. In this case in overall dividend cover can be said to have favorably increased, also most of the figures obtained are above the recommended 2.0. Dividend yield This represents the return amount expected by a shareholder for every share held in the business. As observed from the table the yields expected for every share held has increased over the period of the four years. This good for the company investors as their returns are fostered. Earning per share It indicates the returns that investors expect for every pound they have invested in the enterprise. According to this ratio expectation have remained relative constant for the three years period from the year 2008 to 2010. In 2011 the EPS has worsened, this is not good for the firm as investors may have mixed reactions. Price/ earning ratio This is a valuation ratio that compares the compare market value of share with the earning per share. It can be observed that the P/E ratio is gradually declining. This implies that investors are not expecting higher returns in the future, this not good for the company, since it might scare away the investors. Section B With increased competition and the need for efficient management that is participative in nature there is need to change from the tradition budgeting to new styles that cost efficient and foster the competitive edge of the organization on such styles is beyond budgeting and incorporation of corporate governance practices. Beyond budgeting Traditional budgeting is slowly being faced, to incorporate betters procedures that inculcates progress in an organization. Barney Bakes plc has being using an incremental budgeting technique, which has been established to impede progress by managers. Employees and managers have viewed budgets as times consuming in preparation, too complex as may require a lot expertise in preparation and inflexible since the organization cannot adapt to the changes in the market with the outmost urgency that is required. In addition to these, the incremental budgeting techniques also do not motivate the employees. The employees just aim at attaining the organization targets thus just putting the effort enough to achieve the targets outlined in the budget of the organization. Some scholars have gone further to classify budgets as “a tool of repression” where the figures estimated by the budget do not help the firm to foster its competitiveness in the market. A study conducted by KPMG has revealed that the budgeting process consumes considerable managers and controllers’ time approximate 20% to 30% that would have other being used productively elsewhere. Today competition has become very intense such that firms need to divert their strategies from concentrating on attaining internally agreed figures which do not necessary inculcate motivation that increase the competitiveness of the firm in the market. Since the postulation of the budgeting concept much has changed, organization activities are becoming more and more complex each day, internal dynamics has also significantly changed. This Occasions the need to redesigning the tools of planning in order to obtain a competitive edge in the market. Company roles have changed a lot from producing and selling products to setting up strong long-term relationship with clients and key employees, establishing good relationship in the medium term with business partners, developing the right products in the right market, and operating profitably. Budgets as management tool are inflexible to achieve the desired roles in the dynamic environment. This necessitates introduction of better management tools that would help the organization achieve this objectives effectively and efficient. This has lead to introduction of instruments such as value based management (improving the image of the organization at the eyes of the investors), balance scorecard, and benchmarking (Hope & Fraser 2003). . The main aim of beyond budgeting is to bridge the gap arising through the use of incremental budgeting. Studies have proved that, a company can became successful even without the use of budgets, fixed plans, product orientation, absolute targets and central marketing. This can be observed in the case of Svenska Handelsbanken which without any fixed plans and budgets since the year 1970 has grown to name one of the most successful banks in Europe (Hope & Fraser 2003). The beyond budgeting model introduces two the management view and controlling view. The two views yield the 12 principles of beyond budgeting. They include, Creating a climate of performance management that compares the success of the organization against the competitors in the market. Motivate personnel by conferring to them clear values, responsibilities and through challenges. Delegation of responsibilities to operating managers who make informed decision based on the experience on the firms operations. Empowering operating managers in way that they act free and independently this may be achieved through making the resources that would foster their capability to act independently (Hope & Fraser 2003). The organizations operations and decisions are customer oriented; in addition employees should always ensure that profitable customers are satisfied beyond their expectations (Hope & Fraser 2003). Inculcate transparent and open information systems that support “truth” through the entire organization. Goals and targets are based on agreed benchmarks against the market leaders. The organization personnel are motivated and the rewarded as rather than as an individual (Hope & Fraser 2003). Strategies and strategic actions are continuously designed and normally delegated to the operating managers (Hope & Fraser 2003). Resources use is based on locally availability of such resources and usually under predetermined parameters (Hope & Fraser 2003). The dexterity process coordinates utilization of resources based on the requirement of the internal markets (Hope & Fraser 2003). The capacity and controlling procedures yields swift and open performance information that is conducted at multilevel control (Hope & Fraser 2003). Now let us turn our attention on the potential benefits that the beyond budgeting model will yield to our organization, Lower costs When a firm shifts from traditional budgeting to beyond budgeting the mindset of traditional budgeting that advocated for establishment of maximum and minimum cost will be abolished , thus motivating employees to question costs being faced by an organization and try to control such costs, thus establishing long-term cost reductions which are sustainable many of Inculcating a culture where the processes of the organization are customer oriented leads to improvement of the quality of the products as well as the cost used in the production of such product. According the operating managers independency and providing the necessary resources, ensures that unnecessary activities that add to the cost of operations are eliminated. This based on the assertion that operating managers will always request for resources that are needed rather than requesting because it is their “entitlement” (Hope & Fraser 2003). Customer loyalty Beyond budgeting is customer oriented as the main objective of beyond budgeting is customers satisfaction, this implies that the company only adapt process that are aimed satisfying the needs of the customers. This induces customer loyalty since customers feels appreciated where their needs are met. Beyond budgeting support fast response to the customers which one of the factors that customer uses in making decisions. This strengthens the bond between the company and the clients thus inculcating loyalty. This implies that for quick decision making the usual bureaucracy in decision making should be abolished, to facilitate the front line personnel the authority to make decisions within a short time as compared to a situation where the bureaucracy are involved. This makes the company more competitive than their competitors thus company does not only inn the loyalty of the existing customer but also attract new clients. Innovative strategies Beyond budgeting give the employees opportunities to express their freedom of professionalism, workers operate in self managed and open environment. This offers employees a chance to become more creative and innovative in carrying out their duties (Hope & Fraser 2003). This model outlines governance principles, this principles inculcates a climate that facilitate establishment of mutual trust that essential so as to enable the employees share knowledge as well as best practices(Hope & Fraser 2003). This creates the right climate that help the employees to convert their ideas in projects that help the firm increase its competitiveness. The transition from the traditional budgeting where the incentive to perform is locked by the targets outlined by the fixed plans which inhibit cooperation and sharing to reward based performance in relation to the co-employees. This creates avenue for establishment of innovative strategies, thus offering the firm a competitive edge against their competitors. Faster Response Beyond budgeting does not involves a lot of bureaucracy thus operations are simple and fast. Simplicity emanates from reduced bureaucracy in management process, where the operations personnel are vested with the authority to act immediately and with certainty within the organizational values, clear principles and strategic boundaries (Hope & Fraser 2003). In conclusion Beyond budgeting make the operation of the organization to be flexible in a way that the organization personnel are able to act with haste and responds to the needs of the clients by the reconfiguring the process of the organization. Beyond budgeting makes the process of formulating strategies adaptive, continuous, and open process. This enables effectively the organization to respond opportunities and threats arising as compared to fixed budgets which are usually outdated. Corporate governance Introduction Corporate governance refers to guidelines and regulations which are aimed at protecting the stakeholders who are not involved in the management of the day to day activities of the firm, against Directors and managers entrusted with the management of the firm organization (Colley, 2005). There are four pillars of corporate governance, fairness, independence, transparency and accountability. The principles of corporate governance advocate for accountability of the management to the board of directors, while the board directors should be accountable to the shareholder. Corporate governance aims at ensuring fairness; the rights of the shareholders are protected, ensure that all shareholders are treated equally including the shareholders, and also offer remedy for any violation. The third pillar of corporate governance is transparency; where corporate governance aims ensuring all disclosure which are material are accurately disclosed and in time , the performance of the firm, the ownership , the financial situation of the organization, as well as matter relating to corporate governance. The fourth and the last pillar is the independency where corporate governance articulates that the management should have independence so to facilitate professionalism in the management of the organization activities (Colley, 2005). In addition corporate governance advocates for sustainability where organization strategies to achieve short- term goals do not jeopardize future profitability of the firm. Sustainability also considers right of the concerned stakeholders and also support co-operation between the stakeholders and the management. As delineated above corporate governance can simply be termed as good management practices that incorporates the four pillars discussed above. The elements of corporate governance include control environment, transparent disclosure, board commitment, good board practices, and shareholders rights (Colley, 2005). In summary we can describe corporate governance as system who is solely vested in directing and controlling the company. Having discussed the concept of corporate governance, let us discuss the benefits of corporate governance, Advantages of corporate governance Careful management Corporate governance ensures that the organization is carefully managed that is the organization is stakeholders are consider in the decision making process of the organization, e.g. the firm aims at maximizing the wealth of the shareholders or the improvement of the societal welfare. Adherences to such practices lower instance of corruption, increased transparency in management and improved risk assessment. This based on the assertion that corporate governance can be measuring, encouraging and forecasting the level of integrity ( Kim & Nofsinger, 2007). Stability of stock prices Corporate governance has great influence on efficiency of the stock prices. Stability in the stock is achieved if and only if good corporate governance is incorporated in the management of the organization. Investors have a tendency to be attracted to institutions that transparent, high degree of financial accountability and well governed. This implies firms seek finances much conform to guidance by corporate governance, this correlated to the stock prices stability where these measure the level of risk on the funds invested (Kim & Nofsinger, 2007). Training of directors One of the elements of corporate governance is “good board practices” in order satisfy this element there is need to train the directors such that they can be able to respond to the practices as required by corporate governance( Kim & Nofsinger, 2007). Directors are mandated with the decision making process of the organization, thus forming an integral part of the organization. Training the directors instills honesty and transparency; this fosters the director’s competency in performing their duties. Participation of all the stake holders Corporate governance advocates that all stakeholders should participate in the management of the organization so as enhance the productivity and efficiency of the firm in carrying out its operations. All stakeholders are supposed to be furnished with information regarding the situation of the firm form time to time. Therefore, corporate governance increase the involvement of all parties involved thus enhancing productivity. Enhanced shareholder communication Corporate governance encourages share holders to exercise their voting right. This is one the ways that shareholders communicate to the management and since corporate governance aims at protecting the rights of the investors and other stakeholders ( Kim & Nofsinger, 2007). Therefore, corporate governance is used in enhancing communication between the shareholders, investors and the company. Talented workforce Employees are the key to the success of the organization, highly skilled and trained employees are likely to increase the productivity of the organization as compared to a workforce that is unskilled and inexperienced. Adoption of corporate governance attracts employees who are talented and highly experienced and thus creating a good image for the company. Goodwill and market reputation Corporate governance ensures that the organizations develop long-term relationship with the customers and also enjoy a good reputation. In the presence of corporate governance the goodwill of the firm is enhanced, since they are no fraudulent activities that may damage the image of the company. In conclusion, corporate governance can help improve management of institutions and eliminating instances of fraudulent activities, thus fostering the transparency and accountability of organization. Therefore, the corporate governance should be incorporated in management. Section c Determination of contribution Strawberry Orange Mint ? ? ? Selling price per batch Less: ?20.50 ?26.50 ?27.00 Direct materials per batch 1.20 1.50 1.90 Direct labor cost 2.4 5.0 6.5 Manufacturing overhead per batch: Variable 1.40 1.50 2.80 Selling and administration per batch: Variable 1.20 1.25 1.30 Contribution 14.3 17.25 14.5 Determination of the Fixed Overhead recovery rate Fixed overhead recover rate is given as 1/ FOAR where FOAR is given as fixed overhead absorption rate FOAR is given ? 2400000/ 50000= ? 48 per machine hour Fixed overhead recovery rate is given as 1/ 48 x 100%= 2.08% Determination of Number of units produced per machine hour Strawberry Orange Mint Fixed Manufacturing overhead 4.0 4.8 6.0 Machine hours per unit 0.08 0.1 0.125 Number unit produced per hour is 0.08+ 0.1+ 0.125 =0.305 hour’s requirement to produce each product. In one machine hours 3 units of each product are produced 1/0.305= 3.3 Strawberry Orange Mint Contribution 14.3 17.25 14.5 Limiting factor 0.08 0.1 0.125 Contribution/ limiting factor 178.75 172.5 116 Rank 1 2 3 Allocation of machine hours Products available hours output hours utilized Strawberry 50000 264000 21120 Orange 21120 200000 20000 Mint 8880 71040 50000 Optimum product mix that maximizes profit Products number of units produced Strawberry 264000 Orange 200000 Mint 71040 Determination of maximum profit Profit= total contribution less fixed cost Products Strawberry 264000 x 14.3 =3775200 Orange 200000 x 17.25= 3450000 Mint 71040x 14.5= 1,030,080 Total contribution 8255280 Less fixed costs Fixed manufacturing overhead ( 2400000) Fixed selling and administration costs (3600000) Net profit ?2255280 Bibliography Beams, F. A. (2006). Advanced accounting (9th ed.). Upper Saddle River, NJ: Pearson Education. Colley, J. L. (2005). What is corporate governance?. New York: McGraw-Hill. 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Appendix Assessment Part 1 Appendix 1 Ratios from 2007-2010 Barney Bakes plc A Profitability Ratios 2011 2010 2009 2008 2007 1 Return on Shareholders Funds 11.45% 20.93% 21.03% 23.46% 20.37% profit after tax/total equity 2 Return on Capital Employed 9.62% 24.46% 25.10% 29.63% 26.10% (Assume Capital Employed equals Total Equity plus Total Non-Current Liabilities) total equity+total non-current liabilities 260,085 237,593 176,483 161,015 161,878 3 Gross profit margin 61.82% 61.67% 61.49% 62.33% 61.98% Gross profit/sales 4 Operating Margin 5.36% 7.36% 7.05% 8.14% 7.67% operating profit/sales 5 Profit after Tax 3.14% 5.22% 4.95% 5.83% 5.36% profit after Tax/sales B Efficiency Ratios 2010 2009 2008 2007 1 Stock Turnover (days) (average) 18.74 15.92 16.64 15.15 14.06 [(closing stock + opening stock/2)/Cost of sales]*365 2 Trade Debtor (days) 0.47 0.39 0.22 0.13 0.13 trade receivables/sales*365 3 Trade Creditor (days) 67.79 50.53 40.07 48.88 43.13 trade payables/purchases*365 4 Sales to Capital Employed (asset turnover) 3.065 3.324 3.560 3.64 3.40 sales/(equity+non-current liabilities) 5 Sales per Employee (?) 41966 41,474 32,358 31,142 ? 29,032 (sales/no.e'ees)*1,000 C Liquidity Ratios 1 Current Ratio 0.71 0.83 0.53 0.54 0.66 total current assets/total current liabilities 2 Acid Ratio 0.57 0.69 0.37 0.41 0.54 (total current assets-stock)/total current liabilities D Gearing Ratios 1 Gearing Ratio 15.96% 17.05% 16.17% 9.58% 10.49% total non-current liabilities/capital employed E Investment Ratios 2010 2009 2008 2007 1 Dividend payout 40.44% 41.45% 48.42% 52.56% 30.32% Dividend/ Profit for year *100 2 Dividend cover 2.47 2.41 2.07 1.90 3.30 Profit for year/Dividend 3 Dividend yield 50.13% 45.03% 42.65% 38.33% 19.91% Dividend per share/(1-t) /share price Dividend per share... 0.9267 1.58018 1.46952 1.69292 0.79738 4 Earnings per share (pence) 2.29 3.81 3.04 3.22 2.63 Profit for year/number of shares 2 Price/Earnings Ratio 89.64 102.27 126.12 152.37 169.16 share price/total basic EPS Read More