Financial Status of Simon Everly Plc - Essay Example

? Simon Everly PLC Financial analysis and decision making QUESTION B: FINANCIAL STATUS OF SIMON EVERLY PLC In thissection of financial analysis we will not discuss all the financial ratios calculated in question A (calculations in Appendix 1), but we will only interpret the financial ratios that are capable of showing us the financial status of Simon Everly PLC. The financial ratios interpreted in this section include: all the liquidity ratios, some of profitability ratios (Return on equity and return on capital employed), gearing ratios, interest cover, and some of the investors ratio. Questions C and D have been answered in appendices 2 and 3 respectively. INTERPRETATION OF LIQUIDITY RATIOS Liquidity of an organization is its ability to meet its short term duties (obligations), and it is amongst the major measures of organizations’ financial health (Brigham & Ehrhardt 2011). The liquidity ratios for Simon Everly PLC determined in this task involved: Current Ratio and Acid Test Ratio. Interpretation of the Current Ratio This ratio shows the ability of an organization to pay its short liabilities using its short term Assets (Brigham & Ehrhardt 2011). Current ratios of orgainzations should be equal to or more one (1). If the ratio is either equal to one (1) or more than one (1), the organization is capable of satisfying its short term obligations using its current Assets (Brigham & Ehrhardt 2011). A current ratio that is less than 1 (one), on the other hand, means that cannot satisfy the needs of its short term liabilities, and therefore, is facing liquidity problems (Brigham & Ehrhardt 2011). Simon Everly’s Current Ratio The current ratios for the organization as of the 2011/12 and 2010/2011 financial years were shown in the below: Current Ratio as of 2011/12 Financial year was 1.72. Current Ratio as of 2010/11 Financial year was 1.94. Simon Everly’s current ratios for both the financial years (2011/12 and 2010/2011 financial years) were more than one (1). Therefore, the organization’s financial health in terms meeting the obligations of short term liabilities using its current assets was sound. It is, however, noted the ratio had declined by 13 per cent as compared with current ratio of the previous year. This shows that even though the organization’s current ratio liquidity was more than one (1), it was on the down trend, and if proper actions are not taken on time the organization may be faced with liquidity problems in future. The consequences of this downward trend can be solved by the proposed strategy to obtain more funds for additional investments. Interpretation of the Acid Test Ratio The use of current ratio alone is not sufficient to determine liquidity for organisations since it involve certain current assets such as inventory that may be hard to convert to cash. Therefore, Acid test ratio which eliminates these assets (Assets that are difficult to convert into cash such as inventories) will give the real picture of the organization’s liquidity (financial health) (Thukaram 2007). Its interpretation is same as that of current ratio. That is, if it is more than one the organization is financially healthy in terms of liquidity and vice versa if it is less than one (Thukaram 2007). Simon Everly’s Acid Test Ratio The Acid Test ratios for the organization as of the 2011/12 and 2010/2011 financial years were shown in the below: Acid Test Ratio as of 2011/12 Financial year was 0.9055 Acid Test Ratio as of 2010/11 Financial year was 1.19. While the Acid Test Ratio for 2010/11 Financial year was more than one (favourable, 1.19), the one for 2011/12 Financial year was less than one (unfavourable, 0.9055). This means the organization was able to meet the all obligations of short term liabilities using its current assets during the 2010/11 financial year. As of the financial year 2011/12 the organization’s liquidity was questionable. Therefore, necessary actions are required in order to improve the organization’s liquidity. It is suggested that the some of the funds which will obtained from the proposed funding to be used to improve the organization’s liquidity. INTERPRETATION OF GEARING RATIOS For purposes of simplicity Gearing ratio 3 was the only interpreted in this analysis. It is , however, important to mention that other values of other gearing ratios were calculated, and the results are shown in the Appendix three. Gearing ratio can be defined as an organization’s ratio of debt to equity (Gibson 2012). A high gearing ratio shows that an organization is using its debts to pay for its various operations (Gitman & McDaniel 2008). In case of a financial problem the organization may find it difficult to repay the debts, and may even risk facing bankruptcy (Nikolai, Bazly, & Jones 2009). Organizations should, therefore, do what is possible to keep this ratio as low as possible, preferably at 100 per cent or less. Simon Everly’s gearing Ratio The organization’s gearing ratio was as calculated below: Gearing ratio3 Gearing ratio3 as of 2011/12 Financial year was: Gearing ratio3 as of 2010/11 Financial year was: The gearing ratio for 2010/11 Financial year was less than 100 per cent (92.16 per cent), and that for 2011/12 Financial year was 100.36 per cent. This meant this ratio was favourable during both the financial years; however, the ratio is on an increasing trend. Though the value for 2011/2012 was favourable, it was slightly above the 100 per cent. Therefore, necessary actions need to be taken in order to keep this ratio to favourable values. Suggested ways to keep Gearing Ratio to favourable levels In order to keep this ratio to favourable values the management of the organization should go ahead with the proposed sale of shares. Sale shares will increase the number of equity, thereby reducing the gearing ratio value to favourable levels. If the proposed sale of shares is not approved by the management, the organization should request its lenders (both long term and short term) to convert their debts to shares. This will reduce the debts while at same time increasing total equity. The consequent result of this will is reduction in the gearing ratio value. INTERPRETATION OF INTEREST COVER Organization’s interest covers should be kept as high as possible, otherwise, they may risk being bankrupt (Thukaram 2007). Interest covers should be kept at values that are more than 1.5. A value that is equal to or less than 1.5, means that an organization is spending more on paying for interests than it is actually earning (Thukaram 2007). An interest cover that is more than this value (more than 1.5) means an organization is financially healthy, and is capable of paying its interest from its earnings. Simon Everly’s Interest cover The Interest cover for the organization as of the 2011/12 and 2010/2011 financial years were shown in the below: Interest cover as of 2011/12 Financial year was 6.62 Interest cover as of 2010/11 Financial year was 11.25 For both the financial years, the values for interest cover were more than 1.5, that is, the organization was able to comfortably pay for interests using its earnings. Even though Simon Everly’s interest covers for both the financial years were favourable, the rate at which it is reducing is worrying. Comparing the values for both the financial years it is realized interest cover has reduced by almost 50 per cent. Therefore, if corrective actions are not taken on time the organization may face bankruptcy in further. The following are suggested measures to keep this reduction in interest cover at bay. Suggested corrective measures preventing interest cover from further increasing Just as the gearing ratio the interest can be prevented from increasing further by encouraging the lenders to convert their debts into shares. This will reduce the organization’s debts thereby reducing amount of money paid as interest on the debts. QUESTION E: EVALUATION OF THE PROPOSED WAYS OF RAISING FUNDS In order to increase its market share, profitability and competiveness, the organization has decided to rise additional funding either through the rights issue or convertible bond. EVALUATION OF THE PROPOSED RIGHTS ISSUE The organization has proposed to rise the additional funding through issuing of rights issue at share price that is lower than the current market share price. If the organization decides to issue shares it is expected to issue 33,683,211 shares. These shares are expected to generate an approximate of (33,694,211 X 1.974= ?66,495,633 million). Effect of the proposed funding on Gearing Ratio Gearing ratio is calculated using the formulae: (Net Debt/Total Equity) X 100. An increase in either denominator or numerator of the above formulae will affect the value of gearing ratio. Therefore, either increasing or decreasing Net Debt while keeping Total Equity constant will increase gearing ratio. If Net debt is kept constant while Total Equity is increased, the effect is that gearing ratio will be reduced, and consequently the organization’s financial health increased. This type funding is expected to increase the organization’s total equity (shareholder’s equity) (Philips 2008). The consequent result of this (assuming that the organization’s debts remain constant) is that the gearing ratio of the organization will be reduced, thereby improving its financial health. Therefore, if the organization approves issue of rights as a way of funding the proposed investments the gearing will be reduced to more favourable values (values less than 100 per cent). Effect of the proposed funding on Profitability ratios This type of funding (issuing of shares) is expected to greatly affect profitability ratios with direct effect on Return on Equity (ROE). Other profitability ratios will be affected by the type of funding, however, due to limited amount data (information) provided; they will not be discussed; only Return On Equity (ROE) will be discussed in this paper. The effect is as shown in the projections below: Financial Projections and effects of issuing ordinary share on Return On Equity. Projected Ordinary share capital after rights issue = 80000000 + 66,495,633 = ?146,495,633 million for the 2012/2013 financial year and 2013/2014. Therefore, projected Equity for 2012/2013 will be 146.5 + 46 +25+66.2= ?283.7million (Assuming the retained earnings remained the same for both the financial years). The projected Total Equity for 2013/2014 will also be ?283.7million if it is assumed that retained earnings remained the same. Projected profit after tax = ?54 million for 2012/2013 financial year, and ?58.32 million for 2013/2014 financial year. The projected Return On Equity (ROE) will be: (54/283.7) X 100 = 19.03 per cent for 2012/2013 financial year while that for 2013/2014 financial year is projected to be (58.32/283.7) X 100 = 20.27 per cent. Assuming that retained earnings remained the same for both the financial years, the effect of issuing of shares on ROE is significant and is shown in the projections above. For example, it is expected that Return on Equity to be reduced (reduced to 19.03 per cent from 19.56) during the 2012/2013 financial year, and slight increase during the 2013/2014 financial year (20.27 per cent). The expected slight reduction in the Return on Equity (ROE) may be due to the effect of dilution of existing shares by the newly issued shares (Philips 2008). EVALUATION OF THE PROPOSED CONVERTIBLE LOAN In this type of funding the organization is expected to obtain the funding from loans that may be converted into shares any time as from the year 2015. For investors do not wish their money to be converted into shares will be paid back their money plus the expected coupon rate (interest). Therefore, this type of funding is expected to increase debts of the organization particularly during 2012/2013 and 2013/2014 financial years when the loan will not be mature enough to be converted into shares. This type funding is normally preferred by investors over the shares due to several advantages, some of which are as discussed (Baker 2005). First, convertible bonds or loans normally offer greater security to the investor (Baker 2005). This is due to the fact that in case of failure to pay them back, their money can be converted to shares (Baker 2005). In addition, conversion of these loans into shares has the advantage of reducing gearing ratio (Tailor 2003). Secondly, the cost issuing convertible bonds or loans is normally lower than that of issuing shares, therefore, the organization will spend less amount of money in issuing convertible bonds if it is approved as the source of funding (Tailor 2003). Thirdly, interest earned on converted loans or bonds are normally tax deductible. This is as opposed to dividend on shares which are normally subjected to taxes (Tailor 2003). Finally, in this type of funding there is no immediate dilution on shareholders’ shares since the loan is not immediately converted into shares. In the case of issuing shares, the shareholders’ shares are normally diluted immediately. Effect of convertible bonds on gearing ratios Just as earlier mentioned, gearing ratio is normally calculated using the formulae: (Net Debt/Total Equity) X 100. An increase in either denominator or numerator of the above formulae will affect the value of gearing ratio. Therefore, either increasing or decreasing Net Debt while keeping Total Equity constant will increase gearing ratio. If Net debt is kept constant while Total Equity is increased, the effect is that gearing ratio will be reduced, and consequently the organization’s financial health increased. The convertible loans are not normally immediately converted into ordinary shares, and as of the case Simon Everly PLC if this type of funding is approved, the loans the loans may be converted into shares anytime from 2015. This means that during the 2012/2013 and 2013/2014 financial years; the convertible loans will be debts. The consequent result of this is that amount of Net debt (both short term and long term debts) will be increased during the financial years. This will increase the numerator of the gearing ratio formulae, thereby increasing the gearing ratio. An increase in gearing ratio means that financial health of the organisation will be questionable, that is, it will be more than 100 per cent. The projected effect will be as shown below: Amount of money to be generated by convertible loans = ?66,495,633 million, this means that the organization’s net debt will increase by ?66,495,633 million. Therefore, Net Debt for both the financial years will be = (66.5 + 255.5) = ?322million. The projected gearing ratio for both the financial years (assuming that Total Equity remained the same at 217.2 for both the financial years will be) will be: (322/217.2) X 100 = 148.25 per cent. This value will be very high. QUESTION F: EXECUTIVE SHARE OPTION SCHEME The executive share option scheme can be defined as a situation in which the senior executives of organizations are opportunities to purchase company’s stock at a fixed in future dates (Baker 2002). Therefore, scheme can be adopted in company in future, that is, when the organization has started realizing the benefits of its intensive investment and performance financially is healthy (Manas 2003). The price of the stocks should be fixed such that they are lower than the then market share prices. Advantages of the Executive Share Option Schemes to the Company Organizations normally strive to retain their senior executives, particularly those that have contributed towards their success (Pyper 2010). Therefore, Introduction of this scheme will enable the organization to retain its top executives, particularly those that directly contribute towards the success of the organization; therefore, the organization will be able to retain its top brains (Mathis & Jackson 2010). Another advantage is that it is also a way of generating capital to the organisation (Pepper 2006). The generated capital can be used for further investment opportunities. Advantages of the Executive Share Option Schemes to the Executives When the share prices of the organisation have risen as predictable by the organization, it is expected that the senior executives will get high returns for their investments, thereby, increasing their chances of being wealthy (Pepper 2006). Weaknesses of Executive Share Option Schemes to the Executives In case of the reduction in share prices the executives risk losing part of their money, and consequently a reduction in their dividends (Pepper 2006). This is worse when the share prices fall below the fixed executive share prices (Pepper 2006). Weaknesses of Executive Share Option Schemes to the Organization Additional shares normally dilute shares of organizations, thereby reducing the share prices of organization’s stock. References Baker, R., 2002. Project Financing Guide. The Journal of Bank Cost & Management Accounting, 5(7), p. 5. Baker, R., 2005.Convertible Bonds and Stock. The Journal of Bank Cost & Management Accounting, 5(7), p. 5. Brigham, E., & Ehrhardt, M., 2011. Financial Management. London: Springer. Gibson, C., 2012. Financial Reporting and Analysis: Using Financial Accounting Information. Chicago: Cangage Learning. Gitman, L., & McDaniel, C., 2008. The Future of Business: The Essentials. Boston: Springer. Learning. Manas, T. M., 2003. Creating a Total Rewards Strategy. New York: AMACOM Div American Mgmt Assn. Mathis, R., & Jackson, J., 2010. Human resource management (11th Ed). Mason, OH: Cengage Nikolai, L., Bazly, J., & Jones , J., 2009. Intermediate Accounting. Chicago: Cangage Learning. Pepper, S., 2006. Senior Executive Reward: Key Models And Practices. Hampshire: Gower Publishing, Ltd. Philips, M., 2008. Rights Issue as source of business financing. Manson: Canage Learning. Pyper, D., 2010. Total Reward and Total Remuneration. New York: HayGroup. Tailor S., 2003. Sources of organizations’ Finances. The Journal of Bank Cost & Management Accounting, 7(17), p. 22 Thukaram, R., 2007. Management Accounting. New York: New Age International. APPENDICES Appendix 1: Question A Question a: The key financial ratios for Simon Everly PLC for the years 2011/12 and 2010/2011 The main financial ratios that were calculated for Simon Everly PLC for the years 2011/12 and 2010/2011 included: profitability ratios (4 in number), Liquidity ratios (2 in number), Activity ratios (5 in number), Investor ratios (6 in number) and capital gearing ratios (4 in number). The financial analysis of Simon Everly PLC was started by calculation of these ratios, and the calculations for each of the above ratios are as shown below. PROFITABILITY RATIO Profitability ratios include: Net profit margin, Gross profit margin, Return on equity ratio, and return on capital employed. a) Gross Profit Margin was calculated using the equation below: As for the Simon Everly PLC, the gross profits and Turn over for each of the financial years was using the table below. 2011/12 Financial year 2010/11 Financial year Turnover (? millions) 590.00 550.00 Gross Profit (? millions) 167.5 169.5 Therefore, Gross Profit Margin as of 2011/12 Financial year was: Gross Profit Margin as of 2010/11 Financial year was: b) Net Profit Margin was calculated using the equation below: As for the Simon Everly PLC, the Net profits before interest and Tax and Turnover for each of the financial years were using the table below. 2011/12 Financial year 2010/11 Financial year Turnover (? millions) 590.00 550.00 Net Profit before interest and Tax (? millions) 69.5 67.5 Therefore, Net Profit Margin as of 2011/12 Financial year was: Net Profit Margin as of 2010/11 Financial year was: c) Return on equity ratio (ROE) was calculated using the equation below: As for the Simon Everly PLC, the Net profits after interest and Tax and Turnover for each of the financial years were using the table below. 2011/12 Financial year 2010/11 Financial year Turnover (? millions) 217.2 197.7 Net Profit after interest and Tax (? millions) 42.5 44.3 Therefore, Return on equity ratio as of 2011/12 financial year was: Return on equity ratio as of 2010/11 financial year was: d) Return on capital employed (ROCE) was calculated using the equation below: As for the Simon Everly PLC, the Net profits before interest and Tax, Total Assets, Current Liabilities, and Total Assets less Current Liabilities for each of the financial years were using the table below. 2011/12 Financial year 2010/11 Financial year Net Profit before interest and Tax (? millions) 69.5 67.5 Total Assets less Current Liabilities 345.7 274.7 Therefore, Return on capital employed (ROCE) as of 2011/12 Financial year was: Return on capital employed (ROCE) as of 2010/11 Financial year was: LIQUIDITY RATIOS Liquidity ratios include: Acid Test Ratio and Current Ratio. a) Current Ratio was calculated using the equation below: As for the Simon Everly PLC, Total Current Assets and Total Current Liabilities for each of the financial years were using the table below. 2011/12 Financial year 2010/11 Financial year Total Current Assets (? millions) 218.5 204.0 Total Current Liabilities (? millions) 127.0 105.2 Therefore, Current Ratio as of 2011/12 Financial year was: Current Ratio as of 2010/11 Financial year was: b) The Acid Test Ratio was calculated using the equation below: As for the Simon Everly PLC, Current Assets less Inventories, and Total Current Liabilities for each of the financial years was using the table below. 2011/12 Financial year 2010/11 Financial year Total Current Assets (? millions) 218.5 204.0 Inventories (? millions) 103.5 79.0 Current Assets less Inventories (? millions) 115 125 Total Current Liabilities (? millions) 127.0 105.2 Therefore, Acid Test Ratio as of 2011/12 Financial year was: Acid Test Ratio as of 2010/11 Financial year was: ACTIVITY RATIOS Activity ratios include: Net Asset Turnover, Working Capital Cycle, Trade Receivables, Trade Payable and Stock holding Inventory. a) Net Asset Turnover was calculated using the equation below: As for the Simon Everly PLC, Turnover and Total Assets less Current Liabilities for each of the financial years was using the table below. 2011/12 Financial year 2010/11 Financial year Turnover (? millions) 590 550 Total Assets less Current Liabilities (? millions) 345.7 274.7 Therefore, Net Asset Turnover as of 2011/12 Financial year was: Net Asset Turnover as of 2010/11 Financial year was: b) Stock holding Inventory (Period) was calculated using the equation below: As for the Simon Everly PLC, Inventories held, and Cost of sales for each of the financial years was using the table below. 2011/12 Financial year 2010/11 Financial year Inventories (? millions) 103.5 79.0 Cost of sales (? millions) 422.5 380.5 Therefore, Stock holding period as of 2011/12 Financial year was: Stock holding period as of 2010/11 Financial year was: c) Trade Receivables was calculated using the equation below: As for the Simon Everly PLC, Trade receivables and Turnover for each of the financial years was using the table below. 2011/12 Financial year 2010/11 Financial year Trade receivables (? millions) 101.5 115.0 Turnover (? millions) 590 550 Therefore, Trade Receivables as of 2011/12 Financial year was: Trade Receivables as of 2010/11 Financial year was: d) Trade Payables was calculated using the equation below: As for the Simon Everly PLC, Trade Payables and Turnover for each of the financial years was using the table below. 2011/12 Financial year 2010/11 Financial year Trade Payables (? millions) 87.0 74.5 Cost of Sales (? millions) 422.5 380.5 Therefore, Trade Payables as of 2011/12 Financial year was: Trade Payables as of 2010/11 Financial year was: e) The Working Capital Cycle was calculated using the equation below: As for the Simon Everly PLC, Stock holding period, Trade receivables and Trade payables for each of the financial years was using the table below. 2011/12 Financial year 2010/11 Financial year Stock holding period (days) 89.53 75.78 Trade Payables (days) 75.2 71.5 Trade receivables (days) 62.79 76.32 Therefore, Working Capital Cycle as of 2011/12 Financial year was: Working Capital Cycle as of 2010/11 Financial year was: CAPITAL GEARING RATIOS Capital Gearing ratios include: Capital gearing ratio1, Gearing ratio2, Gearing ratio3, Interest cover and Capital gearing. Assumptions made Long term debt is the same as Total Non-current Liabilities, and is equal to ?128.5 million for 2011/12 financial year, and ?77.0 million for 2010/11 financial year. Long term borrowing is the same as Loans, and is equal to ?104.5 million for 2011/12 financial year, and ?57.5 million for 2010/11 financial year. Short term debt is Total current Liabilities, and is equal to ?127.0 million for 2011/12 financial year, and ?105.2 million for 2010/11 financial year. a) Capital gearing ratio1 Total Equity = ?217.2 million for 2011/12 financial year, and ?197.7 million for 2010/11 financial year. Therefore, Capital gearing ratio1as of 2011/12 Financial year was: Capital gearing ratio1as of 2010/11 Financial year was: b) Gearing ratio2 Gearing ratio2 as of 2011/12 Financial year was: Gearing ratio2 as of 2010/11 Financial year was: c) Gearing ratio3 Gearing ratio3 as of 2011/12 Financial year was: Gearing ratio3 as of 2010/11 Financial year was: d) Interest cover e) Capital Gearing Assumption Market Capitalizations = Shareholder’s funds = 217.2 for 2011/12 Financial year and 197.7 for 2010/11 Financial year. Long term borrowing = Loans. INVESTORS’ RATIOS Investors’ ratios include: Dividend per share, Earning per share, Dividend Cover, Price earnings, Dividend Yield and Earning Yield. Dividends (Total ordinary dividend) = ?23 million for both the financial years, Ordinary share Capital= 80000000, and Nominal Share value =?0.25 Therefore, a) Dividend per share Dividend per share as of 2010/11 Financial year was 7.19% just as the current year since the funds set aside for dividends remained unchanged at ?23 million for both the financial years. b) Earnings per Share c) Dividend Cover d) Price Earning e) Dividend Yield f) Earning Yield Appendix 2: Question C Right Issue calculations 1. Number of new ordinary shares to be issued: two new shares for every nineteen existing shares Therefore, 2. Theoretical Ex-right price Share type and number Price per share Total share price 19 existing shares 2.35 44.65 2 New shares 1.974 3.948 21 shares ? 48.598 19 existing shares @ 2.35 = 44.65 2 New shares @ 1.974 = 3.948 Therefore: Theoretical Ex-right price = 48.598 ? 21 = 2.3142 3. Value of rights per one new share = Theoretical Ex-right price – Right issue price = = 2.3142 – 1.974 = 0.3402 Appendix 3: Question D (Convertible loans) 1. Conversion price per bond: Bonds can be converted to ordinary shares at 32 ordinary shares per ?100 nominal value of bond stock. Therefore, Conversion price per bond = 100 ? 32 = ? 3.125 2. Conversion Premium = Conversion price – Current share price = 3.125 – 2.35 = 0.775 Read More