Predictability of Important Economic Events - Case Study Example

Introduction This report provides an insightful study on evaluation of the financial performance and position of the company Clinton Cards plc. Thefinancial performance for shareholders has been analysed using the profitability ratios whereas the financial position has been depicted with the help of liquidity analysis of the company. All the data for the financial ratios has been taken from the company's financial statements. The second part of the report deals with the break-even analysis of the company's sales, its calculation and the factors that are likely to change the break-even point. A projected profit and loss account of Clinton Cards plc has also been included in this part to add to the analysis. 1- Shareholders Ratios Shareholders need to analyse the management's performance and efforts put into the company affairs through the financial results so as to realise its strengths and weaknesses. Riahi-Belkaoui (1998, p11) says, "the profitability ratios portray ability of the firm to efficiently use the capital committed by stockholders and lenders to generate revenues in excess of expenses". Therefore, the analysis for the shareholders has been done with the help of following profitability ratios: Clinton Cards Plc 2005 2004 2003 2002 2001 Gross Profit Ratio 11.68% 11.26% 11.19% 10.43% 9.82% Net Profit Ratio 5.63% 5.19% 5.12% 4.63% 4.59% Return On Capital Employed 31.28% 29.76% 31.36% 29.28% 30.53% Return On Assets 12.34% 17.93% 17.86% 13.03% 13.10% 2- Analysis For Shareholders The above chart depicts the profitability ratios for Clinton Cards plc indicating the financial performance of the company over the last five years. Shareholders are interested in the company's profit records and being the real owners of the firms, they constantly need to appraise the company's performance. If the company is able to generate a stable profit for its shareholders out of its business activities, then it is said to be a good performer in the financial sense. The Gross Profit Margin Percentage evaluates the percentage of profit earned by a company on sales after the production and distribution activities (Mcmenamin, 1999). It shows how well the company manages its expenses so as to attain maximum profit out of its total sales. Clinton Card plc's gross profit ratio shows that the company is sustaining a stable profit margin with a slight increase in profitability. It further illuminates that the company manages to keep about 11% of its total sales revenue out of all the production and distribution expenses. This can also be inversely stated that the company loses about 89% of the total turnover in meeting cost of sales. The Net Profit ratio shows what percentage of profit a company earns on its sales (Mcmenamin, 1999). It reveals the profit retained by a company after accounting for its various operating costs. The difference between the company's net and gross profit ratios indicate the amount of profit foregone by them in the course of meeting various selling and administrative expenses. Thus the above graph shows that the company manages to retain about 6% of the total sales after accounting for various operating costs. The company's net profit margin is also rising sparingly at a stable rate showing the management's efficiency in managing costs. Riahi-Belkaoui (1998, p11) says that the return on capital employed ratio "indicates how efficiently the capital supplied by the common stockholders was employed within the firm". Clinton Card plc's return on capital employed ratio reveals that the company is having a slightly fluctuating rate of profit on the funds invested by the shareholders. However the rate of fluctuation is not high and thus the graph shows that the company gains profit as about 30% of the total equity funds. The return on asset ratio indicates the returns or profits generated after utilising the financial resources of the company determine the company's financial performance throughout the year (Meigs & Meigs, 1993). The company in consideration has had a significantly fluctuating rate of profit on its assets. In the year 2001, the profit came out to be about 13% of the company's total assets while it jumped to about 18% in the year 2004 and then again came back to 12% during the last year. However as noted above, the company has had a stable rate of profit on sales, so the fluctuations in returns on asset ratio highlights the changing number of total assets in the company. Analysis of the above profitability ratios from the vantage point of shareholders exposes that Clinton Card plc is performing well to utilise the funds invested by shareholders in the company and its management is efficacious enough to generate profits through sales and retaining those profits out of the effectual management of all the expenses. 3- Analysis For Liquidity Position Of The Company A company's short-term lenders need to explore the company's liquidity position and its ability to meet its short-term obligations. Riahi-Belkaoui (1998) says that the analysis of a company's liquidity is particularly important for the short-term creditors and lenders of the company so as to ensure that the company would be able to pay off its debts whenever the time comes. In order to better evaluate the liquidity position of the company, the use of following liquidity ratios is very important: Liquidity Analysis 2005 2004 2003 2002 2001 Current Ratio 0.61: 1 1.16: 1 1.09: 1 1.02: 1 0.95: 1 Acid Test (Or Quick) Ratio 0.23: 1 0.36: 1 0.44: 1 0.57: 1 0.39: 1 The above chart displays two distinct ratios for the analysis of the company's liquidity position. Liquidity refers to the state of a company signifying sufficiency of financial resources that could be turned into cash quickly to enable the company to meet its short-term obligations. Both the ratios depicted in the graph evaluate a company's liquidity position following different criteria. The current ratio measure's a company's abilities to pay off its short-term liabilities out of its total current assets (Meigs & Meigs, 1993). If the discussion is carried on in this dimension, the current ratio for Clinton Cards plc reflect that the company has a seriously declining state of liquidity, i.e., it keeps only about 0.6 of assets to pay off 1 worth of current liabilities. Furthermore, the company is constantly reducing its investment into current assets i.e., cash and cash-equivalents leading to a significant deterioration in the company's liquidity state. The current ratio also highlights a company's working capital i.e., the amount in terms of money needed in a company to meet its short-term expenses and debts whenever such a need arises. The company's working capital position is highly unsatisfactory and its current assets are greatly insufficient to meet its current liabilities. The quick ratio tests the short-term solvency of a company after keeping aside its stock from the current assets (Mcmenamin Jim, 1999). The quick ratio also reveals the same position for the company in terms of liquidity. It further shows that the company has most of its assets tied up into stock, which is not always easily convertible into cash at the time of need. The ratio illuminates that the company has had a significant reduction in its investment in the quick current assets over the five-year time period. Thus, after keeping aside stock from current assets, the company remains with about 0.2 to meet its liabilities of worth 1. Thus the liquidity analysis reflects that Clinton Cards plc has a deteriorating liquidity position for its short-term lenders and it does not have the capability to meet its short-term debts and obligations out of its current assets. This situation poses high threats to the company in the short run and can even lead the company to bankruptcy. According to Flamholtz (1986), most of the companies in California at a time filed for bankruptcy and the reason of which was that the companies gradually ran out of necessary cash. Without necessary cash, the company is forced to close down no matter how better its profitability position might be. 4- Causes Of Changes In The Break Even Point-Cash Flow Statement Analysis The factors bringing about a change in the company's break-even point can be analysed using the company's cash flow statement. As the statement shows the inflow and outflow of cash in the form of expenses and revenues, it also indicates the changes occurred to various expenses affecting cash. The reasons for change in break-even point are discussed below: Net cash inflow from operating activities also includes all the expenses summed up in the figure. The fixed costs are also included in the sum and therefore the change in the amount by about 24% is also an indicator of change. Capital expenditures in the cash flow statement also involve fixed costs and the changing expenses signal a change in break-even point. 5- Break Even Point-- Break-even point of the firm is a point where the company's net earnings equal to costs giving the company an ability to cover all is costs through sales (Meigs and Meigs, 1993). Clinton Cards plc's break-even point for the last two years are shown below: Year Break-Even Sales Volume 2005 49,569 2004 42,275 Causes For Changes: It is evident from the above graph that the company's break-even point in 2005 equals to 49,569, while in 2004 it had been 42,275. It shows that the company's break-even point required less sales volume in 2004 than in the year 2005. The volume of sales required to cover the company's costs has risen by about 17% within just two years. The major causes behind this change in break-even point is discussed below: -- Changes in Fixed Costs The company's fixed costs are taken as a sum of all the operating expenses incurred during the year. Clinton Cards plc's total fixed costs has increased by about 21% in 2005 than in the year 2004. The fixed costs have changed due to an increase in the operating expenses such as loss on sale of operating fixed assets, amortisation of goodwill, and other administrative and exceptional causes. All these factors have brought about a change in the company's total fixed costs. It reflects that whenever a company's fixed costs rises, the total cost also goes up influencing a change in the company's break-even point. -- Changes in Variable Costs Variable costs are referred to as the important component of the total costs other than the fixed costs. Any changes in the variable costs also bring about a change in the company's break-even point for the year. The total cost of sales can be termed as the variable costs because these costs are not fixed in nature and directly vary with the Sales. In the year 2005, the company's total cost of sales increased by about 16% causing a significant change in the calculation of break-even point. In this context, it can be said that the company's volume of sales required by a company only to meet its various costs regardless of any revenues, the company needs to analyse its break-even point. As the calculation of break-even point depends on the total costs, which comprises both fixed and variable costs, any changes in these two costs can bring about a change in the break-even point. 6- Forecasted P&L Account Increase In Sales Volume Estimated: 10% Clinton Cards Plc Forecasted Profit and Loss Account For the Period Ended _________ '000 Turnover1 432050.3 Cost Of Sales (346,895) Gross Profit 85155.3 Administrative expenses Loss on sale of operating fixed assets (1,136) Amortisation of goodwill (1,827) Other (10,348) Other - exceptional items (300) (13,611) 71,544.3 Other operating income 653 _ Operating Profit 72,197.3 Analysis All the figures (costs and income) except for turnover have been kept the same because we assume that only sales volume is estimated to increase by 10%. Increase in Sales volume, as depicted in the above forecasted profit and loss statement has resulted into a rise in operating profit by 119.31% i.e., more than a double increase in profit margin. References: Ahmed Riahi-Belkaoui (1998), "Financial Analysis and the Predictability of Important Economic Events", Quorum Books Annual Reports (2005, 2004, 2003, 2002), Clinton Cards Plc Flamholtz, Diane T. (1986), "Financial Accounting", Boston, MA: PWS-KENT Publishing Co Mcmenamin Jim (1999), "Financial Management: An Introduction", Routledge, London Meigs & Meigs (1993), "Accounting: The Basis For Business Decision Making", Mc Graw Hill: New York Appendix- I Profitability Ratios 2005 2004 2003 2002 2001 Gross Profit Ratio Gross Profit x 100 Sales 45,878 392,773 11.68% 37,944 336,735 11.26% 35,190 314,397 11.19% 30,173 289,251 10.43% 26,403 268,832 9.82% Net Profit Ratio Profit After tax (PBT) x 100 Sales 22,106 392,773 5.63% 17,468 336,735 5.19% 16,092 314,397 5.12% 13,399 289,251 4.63% 12,350 268,832 4.59% Return On Capital Employed (ROCE) Operating profit x 100 Equity shareholders fund 32,920 105,242 31.28% 27,055 90,919 29.76% 25,051 79,886 31.36% 20,339 69,452 29.28% 18,521 60,659 30.53% Return On Assets Operating Profit x 100 Total Assets 32,920 266,724 12.34% 27,055 150,865 17.93% 25,051 140,266 17.86% 20,339 156,122 13.03% 18,521 141,361 13.10% Liquidity Ratios 2005 2004 2003 2002 2001 Current Ratio Current Assets Current Liabilities 93,403 152,963 0.61:1 58,883 52,783 1.16:1 57,352 52,906 1.09:1 79,232 78,096 1.02:1 69,432 72,546 0.95:1 Acid Test (Or Quick) Ratio Current Assets- Stock Current Liabilities 34,604 152,963 0.23:1 18,812 52,783 0.36:1 23,373 52,906 0.44:1 44,673 78,096 0.57:1 28,626 72,546 0.39:1 Appendix II- Sales= Variable Costs + Fixed Costs + Net Income Assumption: Total Costs= Cost of Sales + Operating Expenses = 360,506 -> 2005 = 310,009 -> 2004 Variable Costs= 88% of total costs Fixed Costs= 12%of total costs Year 2005= 0.88S + 43,261 + 0 0.88S = 43,621 S = 43621/ 0.88 S = 49,569 to break-even Year 2004= 0.88S + 37,202 + 0 0.88S = 37,202 S = 37,202/ 0.88 S = 422,75 to break-even Read More