Financial Reporting Theory Practice - Essay Example

Introduction Strategic management guidelines have been developed with regard to analysing and writing up case studies. The goal of a case study analysis is to determine the value of a company as expressed through its choices of strategy and structure. A case analysis of a company it is critical that it be systematic (Hill and Jones C1). The place of financial information is critical in the analysis and presentation of a case study analysis. Awareness of a company’s financial position at a given point in time represents the tangible outcomes of the company’s business strategies and structure. Ratio analysis is an excellent way to determine an entity’s current financial standing (Godfrey, Hodgson and Holmes 534). Performance ratios are calculated using financial information from the balance sheet and the income statement of the company. There are five categories of ratios; profit; liquidity; activity; leverage and share-holder returns ratios (Hill and Jones C3). Generally, these financial ratios are compared to an industry standard and/or to the company’s prior performance. However, when financial ratios deviate from the average this is not always a negative, as it acts as an indicator for further investigation (Godfrey et al. 534). As well as financial ratios, the company’s cash flow position needs to be evaluated to identify the actual amount of cash the entity posses. Assets, liabilities and owner’s equity are all information that is reported in financial statements and reflects real-world economic factors. Investment analysts require financial statements to take into account the assets controlled by a company, as well as the claims that exist against the entity. Useful accounting data is represented in financial terms because it is a common link between assets and claims and because users are interested in information that has financial value. From here the most recent strategies will be assessed, with recommendations made to fill clear gaps. Each recommended strategy will point out the clear way it can take advantage of company strengths to exploit environmental opportunities, for example, ethanol. Environmental threat controls will also be identified by away of the corporate social responsibility report review. Operation of the Business Looking first to Profit Ratios, the investment analyst would take interest in the return on invested capital that is a measure of profits earned on the capital that is invested in the company. The profit ratios would inform an investor about the reliability of the company in the use of its resources. The more reliable and efficient a company the more profitable it will be. ROIC is of value as a benchmark for Morrisons or other investors to compare the company to competition in the marketplace, as well as to compare subsidiary companies that Morrisons envelopes (Hill and Jones C3). Over time, profit ratios can show if a company’s performance is improving or declining. There are many types of profit ratios, for Morrisons the Return on Investment Capital ratio (ROIC) will be analysed: ROIC = Net profit/Invested capital = ₤ 93.4 million (over 25 weeks)/ ₤ 3, 662.4 million Thus, profits were down, before tax being ₤ 61.5 million (as compared to ₤ 332.2 million for 2005) (Morrisons Annual Report 6-12). Although the overall financial result was disappointing for Morrisons in 2006, achievements were made (e.g., Safeways; distribution improvements; common product file for Group operational systems); so it was a period of dramatic changes. Benchmarking has had a strong focus at Morrisons over the past financial year, and a range of company labelled products has been adapted and extended to meet market demands. Also, the retraining of almost 90, 000 Safeway employees has led to progress in the contributions of experience, skills, competencies and knowledge that are of deemed value to the Morrisons team (Morrisons’ Annual Report 5). It appears from the Annual Report published by Morrisons, that ROIC weaknesses are being buffered by a pro-social approach, and the highlighting of the contributions and inclusiveness of the company’s employees in decision-making processes, responsibility and accountability. Further that the transformation into a national operation offsets losses due the lessons learnt over the past year. It must also be kept in mind that Morrisons conversion to the International Final Reporting Standards has incurred financial costs, although it is anticipated by the Board, based on previous Groups financial performance that profit recovery will occur, over time, and that it is appropriate to write it off as goodwill at this time (i.e. for Safeways; ₤103.2 million) (Morrisons’ Annual Report 6). Turning now to Liquidity ratios, these are a measure of the entity’s ability to meet short-term obligations. If an asset is deemed liquid it means it can easily be converted into cash. For example, cash, marketable securities, accounts receivable (Alexander and Archer 214). A common measure is the Current Ratio: Current Ratio = Current assets/Current liabilities = ₤ 714.7 million/₤ 1 819.2 million The Group has a policy to ensure that there is a continuity of funding. This requires that there is a clear differentiation between short-term overdraft facilities, deposits made overnight and longer-term loans. There is enhanced short-term flexibility that is achieved by using overdraft facilities (Morrisons’ Annual Report 6-12). In regard to Activity Ratios, these determine how effectively a company is managing its assets. A useful ratio is: Inventory turnover = Cost of goods sold/Inventory = ₤4 359.3 million/₤ 3 368 million the cost of goods sole is a better indicator of turnover than sales as the cost of the inventory of items is taken into account. The inventory is taken at the balance sheet date for a simple method. More complex methods involve the calculation of a beginning inventory and ending inventory (Hill & Jones C4; Vault 174). For Morrisons, customer spending was up, as illustrated in Figure 1. Figure 1. Customer spending for Morrisons, comparing 2005 and 2006. As for Leverage Ratios, these can identify if a company is using more debt than equity and so determine it to be highly leveraged. Capital structure is the balance between debt and equity (Salvadore and Reckers 133). Debt has a lower cost as creditors take less risk as they know that they will get their interest and principle. Although, debt may be risky for a company if enough profit is not made to cover the interest and principal payments, this is when bankruptcy occurs. A common ratio is the Debt to Assets Ratio: Debt to Ratio = Total debts/Total assets =₤ 1 930.6 million/₤6 613.8 million The net debt of Morrisons was reduced despite the significant drop in profits (reduced to ₤ 1.5 billion). This may be largely because the proceeds of the disposal of some of the Safeway stores contributed to the costs of other store conversions. In terms of Shareholders-Return Ratios, these can measure the return that shareholders can earn from the stock that they hold in the company. As the company has a responsibility to maximize shareholder wealth by providing them with an adequate rate of return (Gregoriou and Gaber 15). An analyst would be interested in comparing one company’s share price with that of other companies in the same market, to ascertain their ability to deliver to the demands of shareholders. Earnings per share are important for analysts as it relates to dividens, higher the earnings per share thane the market value increases. A common equation is: the Price-Earnings Ratio: Price-Earnings Ratio = Market price per share/Earnings per share As this information requires knowledge about the total number of shares and fluctuating share prices, this ratio goes beyond the scope of this paper. In general market shares are calculated for the first of the year, and so dividend yield is in reference to return on investment made at the beginning of the year (Hill and Jones C5). Hence, Morrisons must decide how much of its profits to pay to the stockholders and how much should be reinvested back into the company. An established company such as Morrisons has maintained its position from strong growth in previous years, and it is expected that dividends would be high at this stage (closing price on the 25th October, 2006 at 17:17 was ₤ 258.50). The underlying logic is that shareholders are able to invest money elsewhere when a company is not growing. An ideal ratio is dependant on the company itself and whether it is able to produce better returns that may be earnt elsewhere by an investor (Hill and Jones C6). For Morrisons, market share of trade has stabilised due to the disposal of stores that were determined not to be converted or refitted for Morrisons. The Board has decided to keep total dividend to 3.7p per share, as reflected in 2005, to show confidence in the future earnings recovery. Further, the cash flow position of Morrisons would be needed to show their position in regards to the difference between cash received and cash distributed. The overall net cash flow can be determined from statements of cash flow. This is an important factor as it indicates the financial needs of a company. Strong positive cash flow allows a company such as Morrisons to invest in future ventures without having to borrow and so avoids having to pay interest or dividends (Hill and Jones C12). Morrisons, as a successful and mature company, is in a strong cash flow position as their investment needs are not substantial and it is no longer a strong-growth industry. This is pictured in Figure 2. The internal cash flow generated within the company is calculated by adding back its depreciation provision to profits after interest, tax, and dividend payments (Hills and Jones C12). Morrisons’ financial statement clearly indicates that there is sufficient cash flow to negate the need to borrow funds or to reduce investment in R&D. However, an excess of cash flow as compared to the expected investments means the company could use the excess to increase its liquidity (by way of financial assets), or to repay loans ahead of due dates. Figure 2. Operating cash flow for Morrisons remains strong. Morrisons Corporate Social Responsibility Policy It appears that Morrisons is aware and supportive of Corporate Social Responsibility (CSR), in that they state their understanding and management of the relations between trading operations and the economy, environment and community in which the company exists (Annual Report 30). The vision of Morrisons is to be recognised as a company that balances social, environment and economic values with long –term brand development and commercial successes. As such, the company’s mission statement is inclusive of the expectations and needs of all stakeholders; customers, suppliers, other businesses, staff and shareholders. Group-wide policies provide a standardized approach to corporate governance, employment, health and safety and welfare of all stakeholders, ethical trading and responsible business practices. All of which illustrate a post-modern socially responsible and accountable organisation. Morrisons is also able to increase its dividends by way of standardisation of processes, and the implementation of compliance practices for CSR and other workplace ethical policies. Time is saved and accuracy increases when colleagues are able to trust each other to complete a task, and when the company takes an accountability stand for how their decisions and activities affect their stakeholders. The goal of Morissons to reduce their environmental impact is admirable and utilizing a programme of continuous improvement is the most effective way to achieve such a positive outcome. Environmental awareness reduces risks and negative impacts as well as adds value to the company by virtue of it being able to enhance its commercial operations. This is of benefit to shareholders in that the public will have more confidence in the brand which will increase purchasing behaviours and so increase the market price and subsequent dividends. The implementation of a Steering Committee provides leadership with regard to CSR issues. And to define clear strategies and be responsible for the management of development and implementation of policies shows the commitment to responsible business practices that Morissons has for CSR. For example, their fundraising contributions saw them awarded the “Charity of the Year” for 2005 with regard to their Breast Cancer Campaign, seeing over 1.5 million pounds being donated. Conclusion In summary, although Morrisons operated at a profit loss at the mid-way of the financial year for 2006, debt was down, team-work had been enhanced amongst the company, and International Standards for Financial Reporting had been adopted. The massive changes during the financial year, such as the acquisition of Safeways and the development of ethanol as an alternative fuel source, have tapped into environmental opportunities to be exploited. It is anticipated that revues will increase over the forthcoming year, and future financial terms. Solutions and Recommendations It is recommended that Morrisons focus on its alternative fuel sources supply of ethanol at SAAB has recently manufactured a model of car that operates 85% on ethanol. As this leading company sets the standard for other manufacturers and purchaser decisions it would be in the interest of Morrisons to cultivate its ethanol R&D to increase fuel competitiveness and so increase profits. It is also highly suggested that Morrison maintain its focus on continuous improvement with staff as their inclusiveness in decision-making will add to the corporate culture and working efficacy of the company as a whole. Also, continued support and innovation in CSR will ensure Morrisons positive brand image, as well as cut costs in terms of time, money and employee and customer frustrations, and of course, environmental impact. Works Cited Hill, Charles and Jones, Gareth. Strategic Management Theory: An Integrated Approach. Houghton Mifflin Company, New York. 2004. Godfrey, Jayne, Hodgson Allan and Holmes, Scott. Accounting Theory. Wiley & Sons, Sydney. 2003. Gregoriou, Greg and Gaber, Mohammed. International Accounting. Elsevier, Oxford. 2006. Morrisons’ Annual Report. n.d. 24 October, 2006. < http://www.morrisons.co.uk/AnnualReport06.pdf> Salvadore, Carmona and Reckers, Phillip. Advances in Accounting. Elsevier, Oxford. 2006 Vault. The Business School Buzz. Vault, New York. 2005. Read More