Fundamentals of Finance - Case Study Example

Fundamentals of Finance Executive Summary Marks and Spencer is a respected in the international retail industry. This project attempts to analyse the fundamental financial position of the company. To meet its objective, the performance of the company for the last five years has to be studied to understand its trend. Once the comparative study is initiated, the financial ratios will be analysed to arrive at a holistic conclusion. To determine M&S’s position in the global retail industry, these ratios were compared with the industry average. The analysis revealed that despite the drop in sales during recession, it still managed to revive its financial state. Therefore, it can be said that M&S possesses a sound fundamental financial position. Table of Contents Executive Summary 2 Introduction 4 Marks and Spencer (M&S) 4 Performance in 2009/2010 5 Financial performance and past trend 6 Ratio analysis and its comparison with that of the industry 10 Conclusion 12 Reference 13 Appendix 14 Introduction In order to analyse the efficiency of a company, it is necessary to quantify its financial performance. Not just the investors, but other stakeholders like suppliers, credit providers and banks also consider the financial performance of the company as a parameter of its efficiency. Such analysis is often done in two stages. Initially, the performance of the company is analysed for the past few years (atleast five or more years). Historical data reflects the past trend and fundamentals of the company. However, one should not rely only on historical performance; rather the performance of the company in the last financial year should also be taken into consideration. Tools like ratio analysis should be used to make the process more transparent and holistic. Moreover, the performance of the company should be compared against the industry to arrive at a more authentic conclusion. In the given project, financial performance of Marks and Spencer will be analysed by taking into consideration its last five years performance. Later on, essential ratios will be analysed and compared against the industry benchmark to have a more comprehensive understanding. Marks and Spencer (M&S) Marks and Spencer is one of the leading retailers in UK. Data published by the company reveals that in a single week more than 21 million customers visit its stores. The company is engaged in selling high quality clothes and home products along with quality food. The supplier base of the company comprises more than 2,000 suppliers from different parts of the world. Approximately 76, 000 people are employed by UK and other stores located in 41 overseas territories. Till date, the 125 years old company is committed to its core value of “Quality, Values, Services, Innovation and Trust” (Annual report, 2010). The company was founded by Michael Marks and Thomas Spencer in the year 1884 for selling specifically British products. However, with time, the company had to break this policy to gain competitive edge in the international market. At present, it is the largest retail company in UK with a remarkable presence in other international markets. The customers view this company as a symbol of quality and reliability. This assists the company to retain its position in one of the highest competitive industry, the retail sector. The company has introduced Plan-A on January 15, 2007 with an aim to increase the environment sustainability for the business conducted by it. According to the estimation, this plan will cost approximately £200 million. The company has introduced almost 100 commitments to be covered within the time frame of five years. These criteria are based on five themes. These are waste, climate, sustainable raw material, change, health and fair practices. The company is introducing required changes in their policies to achieve the goals by 2012. Performance in 2009/2010 According to the financial report published by the company, in 2009, M&S retained its position as the largest clothing retailer in UK. In 2009, this sector witnessed a growth of 4.0 percent following sales of £4.1 billion. In UK market, the performance of the food sector was also quite satisfactory. The sales of £4.3 billion reflect growth of 1.8 percent on y-o-y basis. Direct sale in UK was £413 million, which implies 27 percent growth. For the year 2010/2011, the company has targeted to achieve £500 million. Marks and Spencer also performed quite well in the international market. With total sales of £949 million, the sales grew by 5.7 percent on y-o-y basis. On an average, the group revenue increased by 5.2 percent. This has resulted in the growth of 9.8 percent in operating profit of the group for 2009/2010. Group Revenue Adjusted Group Operating Profit (Source: Marks & Spencer, 2010, p.10) The company said that growth has been noticed in core UK business. The market share of apparel industry increased by 11.0 percent and the footwear business experienced a growth of 11.2 percent. These information indicates that the company is performing quite satisfactorily in the post recession phase. The UK market plays a vital role in the total revenue and profitability of the company but a slow recovery rate in UK poses as a potential market risk for the company. Financial performance and past trend Before analysing the company’s performance in the previous year, it is necessary to understand how Marks and Spencer has performed in the last five years. These historical data assist in developing a fair picture of company’s potential for acquiring sustainable growth. To collect historical data, financial statement of the company will be used from 2006 to 2010. Using this information, vital components like sales, operating profit, net profit and other vital financial indicators will be analysed. The trend followed by the company in the last five years will also be analysed to find out the fundamental financial position of the company. The revenue of the company kept increasing with every passing year. Compared to UK market, growth in revenue was high in the international market, although the UK market has a much higher share in the total revenue of Marks and Spencer. Although the revenue went on increasing but with onset of recession, operating profit of the company began to decline. In 2008, it was £ 1,211.30m and in 2009 it turned out to be just £870.7. This fall of 28 percent negatively affected the operational profitability of the company. Even in 2010, the operating profit of the company failed to register any improvement. The same change was seen in the net profit generated by M&S in the last five years. However, the only difference is that in 2010, the net profit of the company increased marginally. Along with revenue and profitability, one should also take into account the debt possessed by the company because high debt in the balance sheet reflects high risk of solvency. From 2006 to 2008, debt volume increased at high rate but from 2009 onwards it kept reducing. This is a healthy sign because this reduction in debt reduces the risk of solvency in the long run. From the above given charts it can be concluded, that in the last five years, the performance of the company deteriorated. This fall is nothing abnormal because many external factors were responsible for it. Among several financial indicators, return on equity was the one most affected. It shows a drastic fall from 2008 onwards. This can be because of the onset of recession in mid of 2008. On an average, a fall of 44 percent has been registered from 2006 to 2010. Next highest fall was seen in the debt equity ratio of the company. A total decline of 30 percent reflects reduction in risk associated with long term solvency. With time, return on asset reduced. Until 2007, return on asset showed a healthy increase of 24 percent but from then onwards it went on declining. On an average, from 2006 to 2010, the return on asset declined by 25 percent. This reflects that the company is losing its efficiency in generating sales by proper utilisation of assets. However, from 2009 onwards there has been a bounce in the value of this ratio. It can be assumed that recovery of UK and other international market will enhance the company’s efficiency. P/E ratio is often used to analyse the sentiment of it potential investors. In 2007, P/E increased and showed a healthy growth but again in 2008 there was a fall of approximately 28 percent. This clearly reflects the negative sentiment of the investors. This fall continued till 2009 because of poor market condition throughout the world. With improvement in market conditions, investors regained their lost confidence and thus the P/E ratio increased from 8.5 in 2009 to 10.4 by 2010. While analysing the financial performance of a company, it is quite essential to determine different risks associated with it. Interest coverage ratio is one such ratio that reflects the potential of a company to pay back the interest generated each year. From 2006 to 2008, the company’s interest coverage ratio kept increasing but in 2009, there was a decline of 58 percent. This indicates the company’s ability to pay the interest has reduced to a great extent. In 2010, this risk of solvency is reduced and it can be assumed that with time, the company’s ability to pay the interest will grow further. Ratio analysis and its comparison with that of the industry Financial ratio analysis is an effective tool that assists in examining the financial performance of a company. For better understanding of the company’s performance, these ratios will be compared with that of the industry. (Source: msn money, 2010) The debt equity ratio of the company is 1.27, which is higher that the industry’s standard of 0.96. Higher debt equity ratio reflects a risky proposition for M&S as there is a risk of long term insolvency. Even the interest coverage ratio of M&S is much lower than that of the industry reflecting a high risk of interest payment default. Financial position of a company should also be analysed in terms of short term liquidity maintained by a company. At present, the current ratio of Marks and Spencer is 0.8 whereas the industry standard is 1.0. Therefore, the liquidity position of Marks and Spencer is low against the industry average. For better understanding of cash and cash equivalent position held by the company, quick ratio should be taken into account. This is also known as the acid test ratio. M&S possess 0.5 whereas the quick ratio of the industry is 0.6. This reflects poor liquidity state of the company. Source: (Source: msn money, 2010) Apart from the risk associated with liquidity and long term solvency, one should also analyse management’s efficiency in generating revenue. Marks and Spencer’s income per employee and revenue per employee is lower than that of the industry standards. This implies that M&S’s efficiency to manage its human resource is not as per the industry benchmark, thereby resulting in high operational cost. For a company engaged in retail business, it is necessary that the inventory rotates at a high rate. A higher inventory turnover rate of M&S implies better inventory management efficiency of the company. However, the asset turnover ratio of M&S is low as compared to the industry average. This means that the company should revive its asset management efficiency to enhance its revenue and profitability. (Source: msn money, 2010) The investment ratios reflects that M&S has a higher return on equity, return on assets and return of capital as compared to the industry average. Thus, it is evident that M&S possesses a higher efficiency to generate returns. Conclusion After analysing the fundamental financial position of M&S, it can be concluded, that till 2008 the company enjoyed a satisfactory performance. Revenue as well as profitability of the company was growing at moderate rate. However, it experienced a reversal of fortune when the financial recession engulfed the developed nations. Recession not only lowered its sales but also affected its managerial efficiency. Nonetheless, with economic situations recuperating in UK and other overseas countries, financial performance of M&S has also geared up. A comparison of financial ratios of M&S with that of the industry has revealed results, which have made it imperative for the company to exercise additional caution with its short term and long term liquidity or face the consequences of insolvency. On the other hand, investment ratios of M&S indicates a strong performance in the industry; attesting its strong market image among the potential investors. Despite its share of pros and cons, the company has been able to curve out a distinct identity as an institution having a strong financial position. Reference Marks & Spencer. 2010. Annual Report and Financial Statements 2010. Marks and Spencer plc. 2010. Five year record. Investors. [On line]. Available at: http://corporate.marksandspencer.com/investors/fin_highlights/five_year_record [Accessed on October 28, 2010]. mns money. 2010. Marks and Spencer Group PLC. [On line]. Available at: http://uk.moneycentral.msn.com/investor/invsub/results/compare.asp?Page=InvestmentReturns&Symbol=GB%3amks [Accessed on October 28, 2010]. Appendix Table 1: Consolidated Income statement Table 2: Consolidated statement of Comprehensive Income Table 3: Consolidated Statement of Financial Position Table 4: Consolidated Statement of Change in Equity Table 5: Consolidated Cash flow information Table 6: Five year record (Source: Marks and Spencer plc, 2010) Read More