Buzzard Ltds Financial Position and Performance - Case Study Example

INTRODUCTION This report has been designed for the company’s shareholders. It is based upon a case study and provides an insight of the company’s financial position and performance concerning the financial statement analysis. It also identifies the company’s major internal and external strengths, weaknesses, opportunities and threats, in order to evaluate the company with respect to a shareholders’ point of view. According to the case study, the company has achieved a favourable position among its customers and suppliers with all the efforts. However, this does not guarantee a company’s strength and potential in terms of investment. To evaluate and analyse this aspect of the company’s position, certain financial ratios have also been used in the report. BUZZARD LTD-- SWOT ANALYSIS The SWOT analysis of Buzzard Ltd as derived from the analysis of case study is presented as follows: Internal Strengths Enhanced Research and Development technology High quality of products Trust and popularity among suppliers Greater customer satisfaction Word leader in design, manufacture, and supply of innovative automotive systems Internal Weaknesses Declining profit Hike in uncontrollable costs and expenses Poor working capital availability and decreasing cash Increasing number of employees resulting in decline of profits Less investment potential Inefficiency of workers Increasing payment of interest Sudden increase in long-term borrowings External Opportunities Growing market share Grants from the government Stepping and expanding into new markets, for instance Japan External Threats Increasing wages of the employees in the market Fluctuating foreign exchange rates causing losses to the company BUZZARD LTD -- INTERNAL AND EXTERNAL RISKS An analysis of the case study and the research on the UK automotive industry will lead us to the evaluation of major internal and external risks faced by the company: Internal Risks The greatest internal risk faced by the company is the declining of profit over the last financial year, if this trends continue to take place, the company will be generating no more funds for investment and even there would be left nothing in the company to be transferred to the shareholders in the form of dividends or earnings per share. The company also confronts with the risk of losing all its business because of the costs incurred during the production and distribution of goods, and also the other operating expenses incurred during the year. The company seriously faces the risk of running out of cash in future. The working capital has been declined over the year. The company does not offer any attractive investment potential due to the deteriorating profit margin. Therefore, the company faces a risk of losing a substantial part of its investors. External risks According to Wells and Nieuwenhuis (2001), the automotive industry in UK has been highly saturated and the companies need to face great competition from other companies in the same industry. Hence, there is a high risk of increasing competition. Wells and Nieuwenhuis (2001) further specify that the competition is not the only risk a company has to confront with, there are certain other factors that increase the risk of doing business in UK automotive industry. These factors are globalisation, consolidation, and continuous innovations in the technology. Bordenave and Lung (1996) says that the most important risk a company faces in the automotive industry in UK is due to the increasing outsourcing activities on the part of the manufacturers. Therefore, a geographical risk arises in such a situation where supplier and manufacturer are from geographically distant and different places. REPORT FOR SHAREHOLDERS—BUZZARD’S PERFORMANCE The company’s financial position and performance can be analysed with the help of following financial ratios, grouped in terms of profitability, efficiency, liquidity and investment ratios: PROFITABILITY RATIOS Analysing the profitability of Buzzard Ltd lies in assessing the company’s profit with respect to various other items from income statement and balance sheet. This can be done with the help of the following ratios: Gross Profit Ratio 2004 13.08% The Gross Profit ratio analyses the company’s profit margin before accounting for various operating costs (Mcmenamin Jim, 1999). Therefore, it represents the profit margin after accounting for cost of sales. The gross profit margin of Buzzard Ltd is 13.08% for the year 2004, which shows that the company manages to retain only 13.08% out of its sales as gross profit for the year whereas loses almost 87% of the sales revenue on the cost incurred on production and distribution of goods. It therefore, reflects that the company needs to cut down on its costs in order to generate more profits, which can consequently be transferred to the shareholders. Net Profit Ratio 2004 1.01% The net profit ratio analyses a company’s profitability after taking into account all the operating costs and interest expense etc (Mcmenamin Jim, 1999). The net profit ratio of Buzzard Ltd is 1.01%, which means that the company manages to retain only about 1% of the total sales revenue as profit after accounting for the expenses incurred during the business activities and operations. These expenses account for about 99% of the company’s total sales revenue. It reflects that the company has a very poor position with respect to profitability and needs to cut down its operating expenses to a great extent in order to retain more profit. Return on Assets 2004 3.08% The Return on Investment ratio is used to analyse a company’s position in terms of the return or profit it gains on the funds invested in the company’s assets (Meigs & Meigs, 1993). It shows the effectiveness and performance of the company’s management to obtain more returns on the company’s investment in assets. The Return on Investment ratio for Buzzard Ltd is only about 3.08% of the company’s total investment in assets. Therefore, it shows that the company is inefficiently utilising its assets towards the generation of profit. Once again, this ratio illuminates poor profitability stance of the company. LIQUIDITY RATIOS- SHORT TERM A company’s short-term liquidity specifies its ability to meet its short-term debts and obligations. This is only possible when the company has enough liquid assets to meet its current liabilities without any hassles. This ability of the firm is assessed by the following ratios: Current Ratio 2004 1.02:1 The current ratio measure’s a company’s abilities to pay off its short-term liabilities (Meigs & Meigs, 1993). It therefore allows the shareholders to assess how convenient it is for the company to meet its day-to-day expenses without running out of necessary cash. The current ratio for Buzzard Ltd shows that for every 1$ worth of liabilities, the company has $1.02 worth of assets to pay off these liabilities. It is however not an ideal situation because the company should maintain its investment in current assets up to a level so that they may be significantly higher than the company’s current liabilities, so that the company may not fall into problems when it comes to paying them off all of a sudden. The company therefore needs to improve considerably on its liquidity position by investing more in current assets. Acid Test (Or Quick) Ratio 2004 0.7:1 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 for Buzzard Ltd reflects that after ignoring stock out of the company’s current assets, it will only be able to meet 70% of its current liabilities. It further shows that about 25% of the company’s investment in current assets has been tied up in the stock. It is an asset that may sometimes take time to get converted into cash; therefore, this ratio does not reveal a healthy position of the company in terms of liquidity. LIQUIDITY RATIOS- LONG TERM A company’s long-term liquidity analysis enables the shareholders to assess the company’s solvency position i.e., how strong is the company to avoid bankruptcy. If the company has more long-term debts and fewer resources to pay them off, it tells a story that the company is nearing bankruptcy and therefore, cannot prove to be a sound investment. The long-term liquidity analysis for Buzzard Ltd can be done with the help of the following ratios: Debt to Equity /Gearing Ratio 2004 25% The debt-to-equity ratio exposes the capital structure of a company i.e., to what extent the company relies on borrowed funds as compared to the equity funds for the purpose of financing its business operations (Meigs & Meigs, 1993). The debt-to-equity ratio for Buzzard Ltd indicates that the total amount of borrowed funds the company is using equal to just 25% of its total equity funds. It is therefore evident that the company tends to rely more on equity capital to finance its activities rather borrowed funds. It is a healthy sign for the company’s long-term liquidity position Debt Ratio 2004 13% The debt ratio analyses the extent of a company’s total assets that is financed with the long-term debts (Meigs & Meigs, 1993). The debt ratio for Buzzard Ltd reflects that about 13% of the company’s total assets have been financed with the borrowed funds. It therefore shows a healthy position of the company in terms of long-term solvency and the shareholders can rest assured that the company is utilising more of the equity funds to finance its assets. EFFICIENCY RATIOS The efficiency evaluation of Buzzard Ltd lies in the assessment of the company performance in utilising its different assets to generate sales and profit for its business. This can be analysed with the help of the following ratios: Total Asset Turnover 2004 174% The total asset turnover ratio measures how efficiently or productively the firm is using its total assets, (fixed assets plus current assets), to generate sales. In general terms, the higher the total asset turnover ratio the better; it suggests the business is utilizing its assets productively (Mcmenamin Jim, 1999). The asset turnover ratio for Buzzard Ltd shows that the company’s total turnover is significantly higher than the company’s total assets. This therefore, reveals that the company is performing well in utilising its assets towards the generation of sales. Stock Turnover 2004 17.6 Stock turnover ratio calculates the company’s ability and efficiency to finish its entire stock and generate sales during the year (Mcmenamin Jim, 1999). The stock turnover ratio of Buzzard Ltd shows that the company’s management has worked efficiently to generate sales and it was successful in turning out the entire stock for about 18 times a year. It is therefore a convincing sign of the company’ efficiency and performance towards the generation of sales. Debtors Turnover 2004 57 days The debtors’ turnover ratio shows the efficiency of a company’s management in collecting cash out of credit sales (Mcmenamin Jim, 1999). This ratio reveals how long a company’s cash remains tied in the receivables and debtors account. The debtors’ turnover ratio for Buzzard Ltd reveals that it takes the company about 57 days to collect its cash from the debtors and customers, which is a highly risky situation. It means that the company has been allowing longer credit periods to its customers in order to generate more sales. This might have been the reason behind such an improvement in the company’s sales over the financial year. INVESTMENT RATIOS The feasibility of a company in terms of investment is of great importance to the company’s investors and shareholders. The shareholders need to get a substantial return as a reward for their short and long-term investment of funds in the company. The investment analysis for Buzzard Ltd can be done with the help of following ratios: Earnings Per Share 2005 $0.05 “Common shareholders and potential investors in common stock first look at a company’s earning record” (Meigs & Meigs, p934, 1993). The investment is made in the shares of stocks; therefore Earning Per Share determines the market value of a company’s shares. The company’s financial statements show that the company’s earnings have declined substantially over the years. Therefore, it is not able to transfer considerable earnings to its shareholders and ends up in providing less worth of the their investment in the company. Interest Cover 2005 2.3 times The interest cover ratio shows that the ability of a company to meet its interest liability with the amount of profit generated as a result of its operations (Mcmenamin Jim, 1999). It is of interest to the company’s shareholders as an investment analysis because it lets them assess the company’s potential to earn profit and pay the interest expense, the failure to do so may lead the company towards bankruptcy. The interest cover ratio for Buzzard Ltd reveals that the company was able to pay its interest about 2.3 times out of its operating profit. This shows that the company is although a less profitable investment, yet it also a less risky one. FINANCIAL PERFORMANCE OF BUZZARD LTD AND SHAREHOLDERS’ SATISFACTION The financial performance of the company Buzzard Ltd can be properly evaluated with the help of the above analysis. The company might have been performing well in handling the suppliers and customers effectively, however, when it comes to the financial performance of the company, a shareholder might feel sceptical regarding the present returns and future safety of the funds invested in the company. The potential scepticism of a shareholder regarding the company’s financial performance may be assessed in the following aspects: Declining Profit As indicated in the company’s profit and loss account, the company’s performance during the year has resulted into a sharp decline in its profit margin. The company profit for financial year has declined from £2944m in the year 2003 to £1170m in 2004. Although the profit and loss statement also reports a considerable increase in the company’s total turnover, yet it shows that the company is seemingly less focused on generating profit and consequently transferring returns to the shareholders as a reward for their investment. Therefore, the company’s performance in terms of profit generation is not at all satisfactory for the shareholders. Hike in Expenses The reason behind the failure of sales generation towards profit maximisation is the substantial hike in the company’s expenses during the year. The company has seen an increasing trend in not only cost of sales, but also its operating expenses. The increase in sales during the year has been far less in proportion to the increase in expenses. This has been the major cause of declining profit and thus, it also exposes an inefficient performance of the company’s management in organising and minimising costs. Deteriorating Liquidity Position Apart from the revenues and expenses factors, a shareholder may feel doubtful regarding the company’s investment in current assets that are an important element to assess the working capital of the company. Every company needs a substantial amount of this capital in order to be safe in terms of meeting all the short-term expenses and liabilities of the company. The balance sheet of Buzzard Ltd shows that the company has although increased its investment in current assets to some extent, but its current liabilities have also faced a substantial increase simultaneously. This makes the company deprived of its working capital as compared to the previous year. It can be highly risky for the shareholders because a company does not only go bankrupt if it mishandles its long-term debts, but even a shortage of current assets or working capital can lead the company towards insolvency. Therefore, after a proper analysis of the company’s annual accounts, a shareholder cannot be fully satisfied with the financial performance of the company and its management. CONCLUSION As evident from the analysis presented in above report, the company may have stronger position among the customers and suppliers due to its strong management of relationships, but the company does not have a healthy position in terms of investment potential. An analysis of the company’s financial statements reveals that the company has had a sharp decline in its profit margin for the last year, which shows that the company has not been managed well towards continued profit growth. A company that does not make profit for itself cannot transfer returns to its shareholders as well. This is the reason that the company’s earnings per share has been very low and there has been no payment of dividends to the shareholders. The shareholders are either looking to gain from the market price of the company’s shares (i.e., EPS) or from the dividends paid to the shareholders at annual or interim basis. But as can be seen in the above analysis, the company does not currently offer any such prospects to the potential investors and shareholders and therefore, it is not a recommendable investment. APPENDIX Gross Profit Ratio 15110 *100 13.08% 115554 Net Profit Ratio 1170 *100 1.01% 115554 Return on Investment (ROI) 2038 *100 3.08% 66108 Current Ratio 23908 1.02 23274 Acid Test (Or Quick) Ratio 23908- 5702 0.7 23274 Debt to Equity Ratio 8620 *100 25% 34214 Debt Ratio 8620 *100 13% 66108 Total Asset Turnover 115554 *100 174% 66108 Stock Turnover 100444 17.6 5702 Debtors Turnover 18202 57 days 115554/365 Earnings Per Share 1170000 $0.05 22714000 Interest Cover 2038 2.3 868 References Bordenave, G. and Lung, Y. (1996), “New Spatial Configurations In The European Automotive Industry”, in European Urban and Regional Studies, vol. 3, no. 4 Meigs & Meigs (1993), “Accounting: The Basis For Business Decision Making”, Mc Graw Hill: New York, p934 Mcmenamin Jim (1999), “Financial Management: An Introduction”, Routledge, London Wells, P. E. and Nieuwenhuis, P. (2001), “The Automotive Industry – A Guide”, Cardiff, Centre for Automotive Industry Research Read More