Finance and Accounting: Analysis of BP - Essay Example

? Essay, Finance and Accounting: Analysis of BP September 26, Introduction British Petroleum - BP is a UK based oil exploration and mining firm with operations across the world. It is listed among the top 10 FTSE 100 firms and in 2012; it had revenues of 388.285 billion USD and employed 85,700 people. The main products are petroleum, natural gas, motor fuels, aviation fuels, petrochemicals and it has activities in the upstream and downstream areas. BP operates on more than 80 nations and its average production is 3.3 million barrels of crude per day, a volume that places it at the front ranks of oil producers in the world. In 2010, BP had a loss of -3.719 million USD and this was due to the huge losses incurred in the Gulf of Mexico spills and the penalty/ expenses the firm had to bear. In 2011, thanks to an increasing crude price, profits increased to 25,700 million USD but in 2012, the profits dipped to 11,583 million USD. Reduction was mainly due to increased costs of acquiring new wells in South East Asia (Annual Reports, 2013). This paper provides an analysis of BP financial structure, its cash flows and the dividend policies. a. Finance structure Financial structure also called as the capital structure refers to the mixture of long-term debt of a firm and its equity that it uses to provide funding for its operations (Elliott and Elliott, 2013). The mix is important since it affects the viability, risk holding and valuation of a business. An analysis helps the finance manager to assess the amount of funds that must be borrowed and the optimum mix of debt and equity that must be maintained. If the funds are expensive and this means that the cost of interest burden is high, then the firm can consider obtaining lesser expensive funds. In any case, financial structure is determined and calculated by values for leverage/ gearing, working cash and capital flow management and the dividend policy. In this paper, the theory behind these factors if first discussed and then calculated for BP for the years 2012-2010. Changes in Leverage/Gearing: Leverage, also called as gearing is a financial technique used to multiply gains (Elliott and Elliott, 2013). It occurs when an investor obtains the right to have a return on a certain capital based that is more than the investment where the investor has contributed to a firm or an instrument to obtain the return; Leverage can be achieved by buying fixed assets, through borrowings and through derivatives. However, each of these processes can increase the burden that a firm faces. A change in the gearing ratio over the years tells us the manner in which the firm has managed its risks. If the leverage for a firm is more, then is regarded as risky. Commonly used gearing rations are the debt to equity ratio, total debt and total equity, times interest earned or the EBIT/ total interest; equity ration or the equity/ assets and the debt ratio or total debt/ total assets. A firm with high gearing is more susceptible to a business cycle since it must continue to pay interest and instalments even when sales are less. Among these methods, the equity method is selected since it offers a clearer picture of firm's equity and debt. Please refer to the tables given in Appendix 'A1. BP Extract from Financial Statements 1', 'A2. BP Adjustments to financial data' and 'A3. BP Adjusted Ratios'. Details of the changes (Share Issue/Repayment; Debt Issued/Repaid): Ratios and calculations for various terms are given as follows (Annual Reports, 2013). ROA (equity method investments only) = (100 ? Earnings from jointly controlled entities and associates) / Group share of net assets of jointly controlled entities and associates For 2012, ROA is = (100 ? 4,419)/ 17,148 = 25.77% For 2011, ROA = (100 x 6220)/ 26833 = 23.18% For 2010, ROA = (100 x 4757)/ 23539 = 20.21% The values are illustrated in the following graphs. Graph 1. ROA of BP during 2011-2013 It is seen that the PLC earnings of BP that was 4,757 million USD in 2010 increased to 6220 in 2011 and reduced to 4419 in 2012. The item indicates the proportionate share for the duration and the net income of the investee. The main reason for variation was that in 2010, the markets had started to recover and in 2011, some amount of recovery was seen with an increase in the asset value due to increased consumption. However, the accidents of BP and other incidents of fire and oil spills served as a dampening effect and further reduced the gains made in 2011. The group share of net assets that was 23,539 million USD in 2010 increased to 26,883 million USD in 2011 and then further reduced to 17, 148 million USD in 2012. This item stands for the carrying amount of the balance sheet of the entity for its investment in the common stock of the equity method. It is the initial cost adjusted for the share of earnings of the entity and losses of the investee. Based on these figures, the variations in ROA are also observed in the above equations. Current ratio is calculated as (Current assets)/ (Current liabilities) For, 2012, current ratio = 110,981/ 77,586 = 1.43 For 2011, current ratio = 97584/ 84318 = 1.15 For 2010, current ratio = 96853/83879 = 1.15 Financial leverage: It is the degree to which a firm uses borrowed funds for its operations. Firms with a high value of leverage run the risk of increasing debt servicing and a very high ratio can impact its viability (Annual Reports, 2013). It is calculated as = Total debt/ Shareholders Equity The values for 2010-2013 are given as follows (Annual Reports, 2013). Year Financial leverage 2010 2.87 2011 2.63 2012 2.54 From the above table, it is seen that the financial leverage that was 2.87 in 2010 has increased to 2.63 in 2011 and to 2.54 in 2012. The industry standard and performance of rival firms is 2.75 and this indicates that BP is better than its rivals in terms of reduced borrowings of funds for its operations. b. Working Capital/Cash Flow Management For any firm, the manner in which it manages the cash flows and the working capital is very important. These are analysed for BP by considering some important values. Please refer to Appendix 'A5. BP Cash Management and cash flows'. A few ratios are important while assessing the cash management and cash flows. These are calculated for the years 2010-2012 as follows. Comparison with industry standard and performance of rival firms is also given. Inventory turnover: This value indicates the number of times in which a firm sells its inventory and replenished for a certain period. A lower value means that the firm has good demand for its products and that the marketing is effective (Elliott and Elliott, 2013). A lower value can lead to improved cash flow since funds are not stuck in idle inventory. It is calculated as = Sales and other operating revenues/ Inventories For 2012, it is calculated as = 375580/ 27867 = 13.48 Given below are the values for 2012-2010 (LSE, 2013). Year Inventory turnover - Days 2010 11.33 2011 14.63 2012 13.48 From the above table, it is seen that the value was 11.33 in 2010 and this increased to 14.63 in 2011 and to 13.48 in 2012. The industry standard and performance of rivals is 15.22. This indicates that BP has a better inventory turnover leading to better cash flow when compared to rivals. Working capital turnover: It is used to calculate the reduction of working capital to the sales. Working capital is used to pay for the purchase of raw material, to process the goods, pay wages and carry out other operations. A firm should therefore have a shorter capital turnover since it provides for lesser depletion of funds and quicker sales and this means the firm has better cash flow with lesser borrowings (Holmes, et al, 2008). It is calculated in days as = Sales and other operating revenues/ Working capital For 2012, it is calculated as = = 375580/ 33395 = 11.25 days. Given below are the values for 2012-2010 (LSE, 2013). Year Working capital turnover 2010 22.9 2011 28.31 2012 11.85 From the above table, it is seen that the value in 2010 was 22.9 days and this has changed to 28.31 days in 2011 and 11.85 days in 2012. The industry standard and performance of rival firms is 15.85 days. This indicates that BP has a better cash flow and lesser burden on the working capital than its rivals. Payables turnover: It is used to indicate the short-term liquidity and gives the rate at which vendors are paid. A high payables turnover means that a firm has adequate working capital and its funds are not strained. However, if a firm has sufficient sales realisation then it should pay the suppliers early so that a good reputation is maintained and suppliers are willing to supply material (Holmes, et al, 2008). It is calculated as = Sales and other operating revenues/ Trade payables For 2012, it is calculated as = 375580/ 29703 = 12.64 days. Given below are the values for 2012-2010 (LSE, 2013). Year Payables turnover - Days 2010 10.8 2011 12.59 2012 12.64 As seen from the above table, the value was 10.8 days in 2010 and this has increased to 12.59 days in 2011 and 12.64 days in 2012. The industry standard and performance of rival firms is 11.47 days. This indicates that BP pays its vendors on an average later than its rivals. This value must be reduced and vendors must be paid as early as possible without affecting the cash flow. Receivables turnover: It gives the extent to which a firm can extend credit and collect out standings. A lower value means that the firm is able to recover its receivables quickly and this improves the cash flow (Holmes, et al, 2008). It is calculated in days as = Sales and other operating revenues/ Trade receivables For 2012, it is = 375580/ 25977 = 14.46 days Given below are the values for 2012-2010 (Annual Reports, 2013). Year Receivables turnover - Days 2010 12.25 2011 13.45 2012 14.46 It is seen from the above table that the receivables turnover that was 12.25 days in 2010 has increased to 13.45 days in 2011 and 14.46 days in 2012. The industry standard and performance of rival firms is 11.64 days. This clearly indicates that BP is slower than its rivals in recovering its sales when compared to its rivals and this value must be reduced to improve the cash flow. Some more calculations and financial ratios are analysed in Appendix 'A5. Other financial ratios for working capital calculations'. Calculations and analysis are provided for Cash conversion cycle, Average Payables Payment Period, Operating cycle, Average Receivable Collection Period and Average inventory processing period. c. Dividend Policy Dividend policy is about the financial policy about paying of cash dividend or paying more dividends at a further stage. Issue of dividends and the amount to be paid out is based on a firm's excess cash and the long term earning power. When firms have sufficient cash, they a certain amount for each share and this helps to increase the share price. Firms that offer dividends regularly are regarded as good performers. BP pays dividend every three months to its shareholders. This alone indicates that BP has very strong earnings and with the price of crude increasing, the firm makes greater sales. The dividend policy of analysed for the years 2012-2010. The following data is important in the analysis (Y Charts, 2013). Current share price = 42.06 USD EPS for Q1 and Q2 of 2013 = 3.63 USD No. of shares of common stock outstanding = 3,189,291,886 Growth rate = 7.77% Please refer to the following table that gives the value of dividend/ share in cents and the dividend growth rate for 2010-2013 (Annual Reports, 2013).   Dividends/ share cents Dividend growth rate 2010 4.33 -30.94 2011 18.14 13.81 2012 21.75 3.61 Due to the accident in the Gulf of Mexico and other problems, the 2010, dividend was paid only for the first quarter. In 2009, BP had a healthy business, mainly owing to the rise in crude prices that had seen less than 40 USD/ barrel in 2007 to around 80 USD/ barrel in 2009-10. In 2011, the average crude price was 90 USD/ barrel and in 2012, it was at 88 USD/ barrel. Due to the accidents the Mexican gulf and because it sold off its wells in Nigeria, the firm suffered extra expenses in settling the disputes and more than 2 billion USD was paid out. In any case, the firm paid 18.14 pence per share as dividend in 2011 and this was a growth of 13.81 pence over 2010. In 2012, BP paid a dividend of 3.61 pence. The trends indicate that 2013 will be a good year for shareholders since the firm in the first two quarters has paid out 11.59 cents as the dividend/ share (BP Dividends, 2013). Given below is a graph of the dividend payout for 2010-2012. Graph 2. Dividend / share and growth Earnings per share - EPS is the ratio of total earnings of a firm divided by the number of shares that are outstanding. Calculation is done by using annual earnings paid after interest and taxes and after deduction of the preference share dividends so that the part from the total profit attributable to ordinary shareholders is obtained (Annual Reports, 2013). Year EPS 2010 -1.24 2011 11.36 2012 8.79 As seen in the above table, EPS is 2010 turned negative and it was -1.24. The reason is that in Q2 of 2010, there was a sharp increase in the expenses and dividend was not paid out for the quarter leading to a negative EPS of -5.48. However, 2011 proved a better year and the EPS rose to 11.36 and this was mainly because of the steady crude prices, reduction in penalties imposed on BP. The year 2012 saw a slight dip in the EPS that was 8.79. The first three quarters showed EPS of 1.94, 1.38 and 1.42 respectively and this value rose to 3.63 in Q4. Given below is a graph of the EPS values. Graph 3. BP - EPS for 2010-2012 Please refer to Appendix 'A4. 'BP P/E and other ratios' where the P/E, P/OP, P/S and P/BV ratios are given for 2012-2010. The P/E ratio or the price to earnings ratio tells the amount that an investor pays per USD of current earnings. For BP it is seen that from 2011, the P/E increased from 5.69 to 11.21, almost 100% rise. This ratio is impacted by non-recurring earnings and the capital structure. The price to operating profit is therefore used and in 2011, the p/OP was 3.67 and this increased to 6.58 in 2012. Conclusion The above sections have given an analysis of important financial indicators for BP. The financial structure and leverage indicates that the firm has shown a slight reduction in performance in 2012 when compared to 2010. For cash flow, nine financial ratios were analysed and it is seen that BP has performed better than its rivals for seven indicators have. For the rest, the performance is about 4-5% less than the industry performance. It is also seen that BP has paid out dividends consistently since 2010. In 2010, due to its operation performance, dividend was not paid for Q2. The conclusion is that BP has a healthy financial performance. References Annual Reports, (2013). Archive of BP annual Reports. Accessed 27 September 2013 from http://www.bp.com/en/global/corporate/investors/annual-reporting/archive.html BP Dividends, (2013). BP cash dividends - ordinary shareholders. Accessed 27 September 2013 from http://www.bp.com/en/global/corporate/investors/shareholder-information/dividends/dividend-history/bp-cash-dividends---ordinary-shareholders.html Brealey, R. A. and Myers, S., (2000). Principals of Corporate Finance, 6th Edition. London: Irwin McGraw-Hill Elliott. D., and Elliott. J., (2013). Financial Accounting and Reporting. London: Pearson Education Holmes. G., Sugden. A., Gee. P., (2008). Interpreting Company Reports. London: Pearson Education LSE, (2013). Stock Analysis of BP. Accessed 27 September 2013 from. http://www.londonstockexchange.com/exchange/prices-and-markets/stocks/summary/company-summary.html?fourWayKey=GB0007980591GBGBXSET0 NASDAQ, (2013). BP p.l.c. Dividend Date & History. Accessed 27 September 2013 from http://www.nasdaq.com/symbol/bp/dividend-history Y Charts, (2013). BP EPS Diluted Quarterly. Accessed 28 September 2013 from http://ycharts.com/companies/BP/eps Appendix A1. BP Extract from Financial Statements 1 Given below are important extracts from the financial statements for three years. BP Extracts from Account Statement All figures in USD $ in millions   Dec 31, 2012 Dec 31, 2011 Dec 31, 2010 TNK-BP – 16,172 14,686 Jointly controlled entities 17,945 16,495 12,054 Associates 3,270 3,865 4,024 Non-current assets 21,215 36,532 30,764 TNK-BP – 4,210 4,500 Jointly controlled entities 4,374 4,613 3,595 Associates 2,399 2,273 1,989 Current assets 6,773 11,096 10,084 Total assets 27,988 47,628 40,848 TNK-BP – 3,086 3,284 Jointly controlled entities 3,014 2,553 1,615 Associates 2,126 2,149 1,888 Current liabilities 5,140 7,788 6,787 TNK-BP – 6,416 5,283 Jointly controlled entities 4,410 3,980 2,701 Associates 1,290 1,744 1,914 Non-current liabilities 5,700 12,140 9,898 Total liabilities 10,840 19,928 16,685 TNK-BP – 10,013 9,995 Jointly controlled entities 14,895 14,575 11,333 Associates 2,253 2,245 2,211 Equity 17,148 26,833 23,539 TNK-BP – 867 624 Minority interest – 867 624 Total liabilities and equity 27,988 47,628 40,848 TNK-BP 24,675 30,100 22,323 Jointly controlled entities 16,237 15,720 11,679 Associates 11,965 12,145 10,031 Sales and other operating revenues 52,877 57,965 44,033 TNK-BP 4,405 5,992 3,866 Jointly controlled entities 1,331 1,918 1,730 Associates 906 958 1,215 Profit before interest and taxation 6,642 8,868 6,811 TNK-BP -84 -132 -128 Jointly controlled entities -129 -134 -122 Associates -16 -13 -22 Finance costs -229 -279 -272 Profit before taxation 6,413 8,589 6,539 TNK-BP -979 -1,333 -913 Jointly controlled entities -458 -480 -433 Associates -201 -214 -228 Taxation -1,638 -2,027 -1,574 TNK-BP -356 -342 -208 Minority interest -356 -342 -208 Profit for the year 4,419 6,220 4,757       Earnings from jointly controlled entities and associates 4,419 6,220 4,757 Group share of net assets of jointly controlled entities and associates 17,148 26,833 23,539 ROA (equity method investments only) 25.77% 23.18% 20.21% A2. BP Adjustments to financial data   Dec 31, 2012 Dec 31, 2011 Dec 31, 2010 Weighted average percentage interest in affiliates 100.00% 100.00% 100.00% Adjustment to Current Assets       Current assets (as reported) 110,981  97,584  96,853  Add: Current assets of affiliates (adjustment) 6,773  11,096  10,084  Current assets (adjusted) 117,754  108,680  106,937  Adjustment to Total Assets       Total assets (as reported) 300,193  293,068  272,262  Less: Group share of net assets of jointly controlled entities and associates (adjustment) 17,148  26,833  23,539  Add: Total assets of affiliates (adjustment) 27,988  47,628  40,848  Total assets (adjusted) 311,033  313,863  289,571  Adjustment to Current Liabilities       Current liabilities (as reported) 77,586  84,318  83,879  Add: Current liabilities of affiliates (adjustment) 5,140  7,788  6,787  Current liabilities (adjusted) 82,726  92,106  90,666  Adjustment to Total Liabilities       Total liabilities (as reported) 180,573  180,586  176,371  Add: Total liabilities of affiliates (adjustment) 10,840  19,928  16,685  Total liabilities (adjusted) 191,413  200,514  193,056  Adjustment to Minority Interest       Minority interest (as reported) 1,206  1,017  904  Add: Minority interest of affiliates (adjustment) – 867  624  Minority interest (adjusted) 1,206  1,884  1,528  Adjustment to Sales And Other Operating Revenues       Sales and other operating revenues (as reported) 375,580  375,517  297,107  Add: Sales and other operating revenues of affiliates (adjustment) 52,877  57,965  44,033  Sales and other operating revenues (adjusted) 428,457  433,482  341,140  A3. BP Adjusted Ratios Dec 31, 2012 Dec 31, 2011 Dec 31, 2009 Current Ratio       Reported current ratio 1.43 1.16 1.15 Adjusted current ratio 1.42 1.18 1.18 Net Profit Margin       Reported net profit margin 3.08% 6.84% -1.25% Adjusted net profit margin 2.70% 5.93% -1.09% Total Asset Turnover       Reported total asset turnover 1.25 1.28 1.09 Adjusted total asset turnover 1.38 1.38 1.18 Financial Leverage       Reported financial leverage 2.54 2.63 2.87 Adjusted financial leverage 2.63 2.82 3.05 Return on Assets (ROA)       Reported ROA 3.86% 8.77% -1.37% Adjusted ROA 3.72% 8.19   Current assets (USD $ in millions)   110.981 97,584  96,853  Current liabilities (USD $ in millions) 77,586  84,318  83,879          Current ratio1 1.43 1.16 1.15 Adjusted: from Equity Method to Proportionate Consolidation     Adjusted current assets (USD $ in millions) 117,754  108,680  106,937  Adjusted current liabilities (USD $ in millions) 82,726  92,106  90,666          Adjusted current ratios 1.42 1.18 1.18 A4. BP P/E and other ratios   Dec 31, 2012 Dec 31, 2011 Dec 31, 2010 Price to earnings (P/E) 11.21 5.69 – Price to operating profit (P/OP) 6.58 3.67 – Price to sales (P/S) 0.35 0.39 0.5 Price to book value (P/BV) 1.1 1.31 1.57 Profit (loss) for the year attributable to BP shareholders (in millions) 11,582  25,700  -3,719 Earnings per share (EPS) 3.63 8.13 -1.19 Share price 40.71 46.23 47.74 A5. BP Cash Management and cash flows   Dec 31, 2012 Dec 31, 2011 Dec 31, 2010 Turnover Ratios       Inventory turnover 13.48 14.63 11.33 Receivables turnover 14.46 13.45 12.25 Payables turnover 12.64 12.59 10.8 Working capital turnover 11.25 28.31 22.9 Average No. of Days       Average inventory processing period 27 25 32 Add: Average receivable collection period 25 27 30 Operating cycle 52 52 62 Less: Average payables payment period 29 29 34 Cash conversion cycle 23 23 28 Source: Based on data from BP PLC Annual Reports Ratio Description The company Inventory Turnover Dec 31, 2012 Dec 31, 2011 Dec 31, 2010 Selected Financial Data (USD $ in millions)       Sales and other operating revenues 375,580  375,517  297,107  Inventories 27,867  25,661  26,218  Inventory Turnover, Comparison to Industry       BP PLC1 13.48 14.63 11.33 Industry, Oil & Gas 15.22 16.55 14.82 Source: Based on data from BP PLC Annual Reports 2012 Calculations 1 Inventory turnover = Sales and other operating revenues ? Inventories = 375,580 ? 27,867 = 13.48 Receivables Turnover   Dec 31, 2012 Dec 31, 2011 Dec 31, 2010 Selected Financial Data (USD $ in millions)       Sales and other operating revenues 375,580  375,517  297,107  Trade receivables 25,977  27,929  24,255  Receivables Turnover, Comparison to Industry       BP PLC1 14.46 13.45 12.25 Industry, Oil & Gas 11.64 11.33 10.37 Source: Based on data from BP PLC Annual Reports 2012 Calculations 1 Receivables turnover = Sales and other operating revenues ? Trade receivables = 375,580 ? 25,977 = 14.46 Payables Turnover   Dec 31, 2012 Dec 31, 2011 Dec 31, 2010 Selected Financial Data (USD $ in millions)       Sales and other operating revenues 375,580  375,517  297,107  Trade payables 29,703  29,830  27,510  Payables Turnover, Comparison to Industry       BP PLC1 12.64 12.59 10.8 Industry, Oil & Gas 11.47 11.58 10.63 Source: Based on data from BP PLC Annual Reports 2012 Calculations 1 Payables turnover = Sales and other operating revenues ? Trade payables = 375,580 ? 29,703 = 12.64 Working Capital Turnover   Dec 31, 2012 Dec 31, 2011 Dec 31, 2010 Selected Financial Data (USD $ in millions)       Current assets 110,981  97,584  96,853  Less: Current liabilities 77,586  84,318  83,879  Working capital 33,395  13,266  12,974  Sales and other operating revenues 375,580  375,517  297,107  Working Capital Turnover, Comparison to Industry       BP PLC1 11.25 28.31 22.9 Industry, Oil & Gas 15.85 24.07 19.38 Source: Based on data from BP PLC Annual Reports 2012 Calculations 1 Working capital turnover = Sales and other operating revenues ? Working capital = 375,580 ? 33,395 = 11.25 Average Inventory Processing Period   Dec 31, 2012 Dec 31, 2011 Dec 31, 2010 Selected Financial Data       Inventory turnover 13.48 14.63 11.33 Average Inventory Processing Period (no. of days), Comparison to Industry   BP PLC1 27 25 32 Industry, Oil & Gas 24 22 25 Source: Based on data from BP PLC Annual Reports 2012 Calculations 1 Average inventory processing period = 365 ? Inventory turnover = 365 ? 13.48 = 27 Average Receivable Collection Period   Dec 31, 2012 Dec 31, 2011 Dec 31, 2010 Selected Financial Data       Receivables turnover 14.46 13.45 12.25 Average Receivable Collection Period (no. of days), Comparison to Industry   BP PLC1 25 27 30 Industry, Oil & Gas 31 32 35 Source: Based on data from BP PLC Annual Reports 2012 Calculations 1 Average receivable collection period = 365 ? Receivables turnover = 365 ? 14.46 = 25 Operating Cycle   Dec 31, 2012 Dec 31, 2011 Dec 31, 2010 Selected Financial Data       Average inventory processing period 27 25 32 Average receivable collection period 25 27 30 Operating Cycle, Comparison to Industry       BP PLC1 52 52 62 Industry, Oil & Gas 55 54 60 Source: Based on data from BP PLC Annual Reports 2012 Calculations 1 Operating cycle = Average inventory processing period + Average receivable collection period TRUE Average Payables Payment Period   Dec 31, 2012 Dec 31, 2011 Dec 31, 2010 Selected Financial Data       Payables turnover 12.64 12.59 10.8 Average Payables Payment Period (no. of days), Comparison to Industry     BP PLC1 29 29 34 Industry, Oil & Gas 32 32 34 Source: Based on data from BP PLC Annual Reports 2012 Calculations 1 Average payables payment period = 365 ? Payables turnover = 365 ? 12.64 = 29 Cash Conversion Cycle No. of days Dec 31, 2012 Dec 31, 2011 Dec 31, 2010 Selected Financial Data       Average inventory processing period 27 25 32 Average receivable collection period 25 27 30 Average payables payment period 29 29 34 Cash Conversion Cycle, Comparison to Industry       BP PLC1 23 23 28 Industry, Oil & Gas 24 23 26 Source: Based on data from BP PLC Annual Reports 2012 Calculations = 27 + 25 – 29 = 23 A5. Other financial ratios for working capital calculations Given below are some other financial ratios. These are supplementary to the calculations and analysis provided in section ' b. Working Capital/Cash Flow Management'. Cash conversion cycle: This measure calculates the period needed by a firm to convert funds invested in its operations to cash received from the operations. It is calculated as the sum of average inventory processing period and average receivables collection time less the average payables payment period (Holmes, et al, 2008). Cash Conversion Cycle is: (Average inventory processing period + Average receivable collection period) - (Average payables payment period) For 2012, it is = 27 + 25 – 29 = 23 Please refer to the following table that gives the values for 2010-2012 (Annual Reports, 2013). Year Cash Conversion Cycle - Days 2010 28 2011 23 2012 23 It is seen that the cash conversion cycle has reduced from 28 days in 2010 to 23 days in 2011 and 2012. The industry standard and period for BP rivals is 24 days. Thus, BP has managed to be better than the industry standard and this improves the cash flow. Average Payables Payment Period: It is calculated as the number of days that a firm takes to pay the vendors. A higher period means that the firm has sufficient time to pay its customers and it can purchase material and pay for it as per its means. However, a long period would mean that while the cash flow is better, vendors face problems and there would be delays in supplies besides loss of reputation (Holmes, et al, 2008). Average payable payment period = 365 / Payables turnover For 2012, it is calculated as = 365/ 12.64 = 29 Given below are the values for 2012-2010 (Annual Reports, 2013). Year Average Payables Payment Period Days 2010 34 2011 29 2012 29 It is seen from the above table that the average payables payment period has reduced from 34 days in 2010 to 29 days in 2011 and 2012. The industry standard is 32 days. This indicates that BP has better dealings with its vendors and pays due bills before its rival firm do. Operating cycle: This important ratio specifies the days needed to process one cycle of inventory and the receivables from its sales and other income. A shorter period means that a firm can clear its inventory early and obtain its payables from sales. This in turn helps in better cash flow (Holmes, et al, 2008). Operating cycle = Average inventory processing period + average receivables collection period For 2012, it is = 27+25 = 52 Given below are the values for 2012-2010 (Annual Reports, 2013). Year Operating Cycle - Days 2010 32 2011 25 2012 27 It is seen that BP has improved the operating cycle from 32 days in 2010 to 25 days in 2011 and it has increased to 27 days in 2012. The industry standard is however 31 days and this indicates that BP has a better performance for cash flow when compared to its rival firms. Average Receivable Collection Period: This is the average days needed by a firm to collect its receivables and the funds it is owed from sales. Firms need to give credit to customers since cash and carry sales are not always possible especially for large firms such as BP. A lower period of Average Receivable Collection Period means that the firm recovers it money quickly, this improves the cash flow, and hence lesser funds need to be serviced through debt (Holmes, et al, 2008). It is calculated as = 365 ? Receivables turnover days For 2012, it is = 365/ 14.46 = 25 days Given below are the values for 2012-2010 (Annual Reports, 2013). Year Average Receivable Collection Period - Days 2010 11.33 2011 14.63 2012 13.48 From the above table, it is seen that the Average Receivable Collection Period has increased from 11.33 days in 2010 to 14.63 days in 2011 and 13.48 days in 2012. However, the industry standard of rival firms is 15.85 days. Hence, BP has a better collection period but it need to bring it down to at least the 2010-year values. Average inventory processing period: This is used to give the period taken by a firm to obtain specified units of inventory and sell it. It is also the average inventory holding days. A shorter number of days mean that the firm has good demand for its products and that it can sell its stock quickly. This can lead to shorter cash conversion (Holmes, et al, 2008). It is calculated in days as = Sales and other operating revenues/ Working capital For 2012, the value = 375,580/ 33,395 = 11.25 days Given below are the values for 2012-2010 (Annual Reports, 2013). Year Average inventory processing period - Days 2010 12.25 2011 13.45 2012 14.46 It is seen from the above table that in 2010, the values was 12.25 days and this has increased to 13.45 days in 2011 and 14.46 days in 2012. The industry standard and performance of rival firms is 11.64 days. Clearly, BP is performing at less than average when compared to its rivals. BP has to tighten its supply chain and reduce the period so that cash flow can be improved. Read More