Financial Analysis Wonderful Home Plc - Essay Example

 Financial Analysis Wonderful Home plc Table of Contents Introduction 2 Background of the study 2 Task 1: NPV and IRR 3 Task 2: Breakeven analysis 4 Task 3: Financial Performance Analysis using ratio analysis 6 Profitability Ratios 6 Liquidity or Solvency Ratios 8 Efficiency Ratios 10 Leverage Ratios 12 Asset Management Ratios 13 Task 4 15 Conclusion 16 References 18 Appendices 19 Introduction The leading organizations in the global market are trying to capitalize on the opportunities that have been created due to globalization. Several global economic distress like the financial crisis, the global recession has affected several potential industries in the UK. It can be identified by their financial analysis. This will analyze the financial stability of their firm. Home and office furniture retail industry are one of the growing industries in Scotland and Wales. Wonderful Home Plc. (WH) is a small but growing organization within the retail industry that used to manufacture and offer office and home furniture to the customers in Scotland and Wales. The organization headquartered in Wales operates with 30 branches in Scotland and Wales. The organizations related to the home and office furniture retail industry deals with the number of factors. The management of the home and office furniture retail firms deal with two types of environments i.e. external environment and internal environment. The slight change of these two types of the environment may affect the company's profitability and wealth creation. The project report mainly deals with the financial position as well as the performance of the home and office furniture retail industry. Financial performance analysis mostly interrelated with the ratio analysis. The key fundamental of the ratio analysis is the annual report of the concerned company. There are different ratios that indicate the financial performance of different sectors of the specific organization. Background of the study Here the research report is totally based on the financial performance of Wonderful Home Plc. (WH). Therefore, the study will significantly analyze the different key ratios which indicate the financial position of the company. The ratio analysis is the mechanism that highlights the financial and operational performance of the chosen company. The primary objective of this report is to ensure the stability of the home and office furniture retail industry and developing new export markets in order to promote national economic development significantly. It is feasible that Wonderful Home Plc. (WH) is approaching one of the leading European banks in order to take loans for business. Moreover, the reason for approaching the bank is to avail the market research data points. It will help the organization to invest in two different projects in order to attain high return. The first projects which the organization is aiming for are to establish a factory of home furniture. Moreover, they are trying to set up their factory in Glasgow, where they can produce home furniture. It will help the Scottish people if the organization effectively runs their business operation. Task 1: NPV and IRR Note: All values are in £ except percentage Project 1 (Cak)   Project 2 (Nat) Initial Investment -4000000   Initial Investment -4200000   Net Cash flow     Net Cash flow Year 1 700000   Year 1 1500000 Year 2 756000   Year 2 1500000 Year 3 816480   Year 3 800000 Year 4 881798   Year 4 700000 Year 5 952342   Year 5 650000 Year 6 948530   Cost of capital 9% Cost of capital 9%   Project cost at year 5 50000 Project cost at year 6 80000   NPV -£23,150 NPV -£2,58,526   IRR 8.7% IRR 6.7%       From the above analysis of net present value and internal rate of return, it can be identified that project Cak has a negative net present value of £258526. On the other, project Nat also has negative NPV but the negative value is much lower than the project Cak. In both, the case project cost at year 6 and rear 5 for project 1 and project 2 respectively have high influence on the net present value of both of the projects because this value is reduced from the cash flow of the respective years. The internal rate of return of project Nat is 8.7% which is around 2% higher than project Cak. In case of project 1 IRR is much lower than the cost of capital but in case of project 2, IRR is very close to the cost of capital. Therefore, the feasibility of project Nat is comparatively better than project 1 through both of the projects should be accepted as both have negative NPV and lower IRR than the cost of capital. Task 2: Breakeven analysis (i) Note: All values are in £ except unit   product Cak product Nat       Fixed costs 600000 600000 variable cost per unit 600 600 Unit selling price 1200 800 Breakeven (Unit) 1000 3000 Breakeven (Sales) 1200000 2400000 The above table shows breakeven sales value and breakeven unit of both of the two projects. (ii) Units 1200 1200 profits/(loss) 120000 -360000 If 1200 units were produced then product Cak will earn the profit of £120000 and product Nat will incur the loss of £360000. (iii) Note: All values are in £ except unit   product Cak product Nat       Fixed costs 600000 600000 variable cost per unit 600 600 Unit selling price 1040 640 Breakeven (Unit) 1364 15000 Breakeven (Sales) 1418182 9600000 The above table shows the breakeven units and breakeven sales of both the projects if unit selling was reduced by £160. Task 3: Financial Performance Analysis using ratio analysis Profitability Ratios Gross Profit Margin The gross profit ratio draws the comparison between gross profit and the sales revenue of the company. This ratio determines the cost-effectiveness business operation of the company and therefore, economies of scale is also indicated by this financial indicator. The above graph shows that the gross profit ratio of Wonderful Home is an increasing trend. The gross profit rate increased in 2012. Gross profit ratio of the company shows that near about 55% to 60% of the revenue goes to sales related expenses especially production cost, distribution cost etc. Still, this ratio indicates good profitability of the company. Net Profit Margin The indicators reflect every pound of net sales revenue in the amount of that sales level of return. Generally, the index larger, indicating the profitability of business sales stronger. If an enterprise can maintain a good margin of sales growth, which means the financial position is good and vice- versa (James, 2011, p.51). The net profit margin of the company is also in increasing trend like gross profit margin. This is because the rise in revenue or sales is higher than the rise of total expenses of the company. This indicates cost efficiency of the company. The annual report shows that the company benefited on the net profit front by better utilizing its fixed cost centers. But the excessive variable cost influences the net profit of the company. Therefore, the ratio is significantly lower than the standard net profit margin of a company i.e., 25% to 30%. The high inflation rate of UK is the main reason of increasing the variable cost (Friedloband and Schleifer, 2003, p.32). Return on Capital Employed It is a measure of business efficiency indicators, reflecting the non-operating costs without considering the circumstances, business managers through management to get profitability. The higher operating profit margin, illustrating the company ￡100 goods sales provide more operating profit, the better the profitability of the enterprise, instead, the ratio is lower, the company profitability is weak (Berman, 2006, p.142). From the above graph, it has been seen that ROCE is opposite reflection of gross and net profit margin trend. Here, the ROCE of the company shows that it is in decreasing trend during the year 2011 and 2012; the ratio is increased significantly due to the increase the sales revenue. This ratio indicates the ineffectiveness of Wonderful Home. The management of the company is unable to generate the sales by optimum use of the net assets. Liquidity or Solvency Ratios It is a rigorous test to measure whether a company has enough short-term assets, without the need to sell stock to solve their short-term liabilities. Current Ratio The current ratio shows the comparison between current assets and current liabilities. Commonly believed that the ratio of 2:1 or more. It shows the current assets, are twice current liabilities. It should be noted that this ratio is not the higher the better, when it too higher, current assets relative to current liabilities too much, or it may be holding too much cash in hand or both (Rees, 2010, p.78). The analysis shows that the current ratio of the company is an increasing trend, though it is much less than the ideal ratio of 2. The critical working capital position is the reason for double current liability of the company than its current assets. Though increasing trend in the current ratio of the company is a healthy indicator of investment in the company current ratio signifies current asset is very much less to pay off the current liabilities. The current ratio of 0.67 in 2012 implies that the company has current assets which are 0.65 times the current liabilities an i.e. current asset is near about 70% of its current liability. Quick ratio The quick ratio is another important indicator of liquidity position of a company which determines that how much company is capable to pay its short-term obligations without the help of its inventory. Therefore, it implies whether the company has to wait till solvency of its current inventory to pay the creditors, suppliers and other short-term payables. From the above graph of the current ratio of last two years, it can be seen that this ratio is also much lower than the ideal ratio of 1. The scenario shows that deducting the inventory, rest current asset of the company is only 25% to 30% of current liabilities of the company. This indicates a critical and very much poor liquidity position of the company and it also signals the higher possibility of the bankruptcy of the company in near future. Here, it has been seen that the trend of current as well as the quick ratio is same and implies poor liquidity position of Wonderful Home. So, it can be concluded from the liquidity ratio analysis is that the inventories highly influence the liquidity and the company need to have high concern about its inefficient working capital management. Efficiency Ratios Inventory Turnover Ratio This ratio is used to reflect the inventory turnover rate i.e. the ratio between liquidity and stock funds of inventory turnover amounts, whether reasonable. Encourage company to ensure continuity of production and management, while improving efficiency funds using and enhances short-term debt solvency (Moeley, 2010 p.115). The slight decrease in the turnover ratio is also a major indicator towards the inefficiency of the company since higher inventory turnover ratio indicates greater efficiency in inventory management. The inventory turnover ratio gives a rough idea of the barrels available to be sold in the market against the actual order of barrels for WH. Days Sales Outstanding In case of Wonderful Home, the days’ sales outstanding period is close to 1 month in 2012 which is reasonably more than four times higher than the previous year’s ratio. This indicates major growth in company’s efficiency. It is also good for the company in the current competitive market scenario (Maguire, 2007, p.87). Leverage Ratios These ratios can detect the size of the company's ability to expand operations and reveal the extent of use of shareholders' equity. The higher ratio, the greater the ability of companies to expand the business, the more equity can be fully utilized, more income to shareholders, but more leverage to bear higher risk (Butter, 2009, p.124). Debt ratio This again is a very important ratio as regards the financial leverage and diversity in the source of fund. The company has around 60% liabilities including borrowed funds of its total assets. Liability position is also 60% compared to the total funds of the company. This shows that the cost of debt of the company is high as the borrowed funds are the most expensive source of funding though it reduces the tax payables significantly. Debt to Equity Ratio This ratio indicates the capital structure of the company i.e. contribution of creditors compared to contribution shareholders in the total capital of the company. This ratio of the company shows that debt position is quite higher 1.5 times than equity which quite differs from standard debt to equity ratio of 1 (Chatton, 2010, p.25). Asset Management Ratios These ratios are evaluations of the efficiency of enterprise asset management important financial ratios, which encourage company, explore potential, enhancing asset utilization efficiency, in general, the higher the value, indicating that the company total assets turnover speed is more quickly. Fixed Asset Turnover Ratio During the year 2011 – 2012, due to the significant impact of recent euro debt crisis in UK market, the company is unable to generate the appropriate sales from the fixed asset. This ratio is in decreasing trend which is a negative sign for the growth of the company because it can decline the operational as well as net profit of the company (Thomas, 2010, p.47). Total Asset Turnover Ratio The above graph shows that the total assets ratio of the Wonder Home is fluctuating gradually which indicates the current assets of the company influence the revenue. Task 4 Financial information disclosed by the companies are the main information which helps to evaluate the overall financial status of a company. Important financial information is income statement and balance sheet and cash flow. Ratio analysis is one of important tool or method of business accounting through which financial status of a company i.e. profitability, liquidity, efficiency, financial leverage etc can be evaluated with the help of financial information disclosed by the companies. Due to the global recession, the market for office and home furniture has not grown significantly since last few years. Therefore, the retail industry has evidenced very limited growth in the marketplace. Considering the current market scenario the organization has committed to increasing their market share. At the present time, the market has become very fragmented. 75% of market share is coming from the small retails, while the market share of Wonderful Home Plc. stands at 20% and it is an impressive figure. The organization has effectively come up with several unique strategies. Strategy to invest in corporate and home marketing, as well as promotion, is slowly and gradually becoming an effective strategy. It is assumed that the particular strategy may help the customers to achieve several benefits in terms of home and corporate office furniture. In order to achieve the business objectives Wonderful Home Plc. have decided to undertake several financial approaches. They are trying to approach one of the leading European Bank in order to apply for a loan of 5 million Euros. It is repayable over 8 years in order to enable its operational funds and can supply as many people as possible. As the marketplace is becoming competitive enough every organization is trying to undertake effective strategic planning. The implementation of strategic plans may increase the core competency of Wonderful Home Plc. Conclusion Above in-depth ratio analysis of Wonder Home Plc clearly reflects the fact that the company is in a critical situation in terms of liquidity. The current liquidity position of the company also signals some extent of bankruptcy possibility in near future if the company does not concern in this crucial financial area. Apart from liquidity, other key indicators of ratio analysis like profitability, efficiency and financial leverage indicate the quite good financial position of the company. Asset performance of the company is not good enough and is the major constraints high profitability growth. Different financial ratios and fundamental analysis have indicated the fact that the company is an attractive investment and the price of the shares of this company is due to a new high in the near future. Therefore, the overall financial position of Wonder Home Plc is not good. Poor liquidity position is the major constraints behind this financial scenario and it also minimizes the short-term creditworthiness of the company. This will affect the company by not getting efficient suppliers and short-term credit in emergency situations. References Berman, H. 2006. Ratio analysis: a technique for financial management. 6th Edition. Causeway Press: North Somerset. Butter, R. 2009. Strategic investment decisions. 7th Edition. Fourth Estate: Manchester. Chatton. G. 2010. Financial analysis: the next step. 5th Edition. Harper Press: Liverpool. Friedlob, G. T., and Schleifer, L. L. F. 2003. Essentials of Financial Analysis. John Wiley & Sons: New Jersey. James. D. 2011. Financial analysis: the next step. 4th edition. Thurber books: USA Maguire, M. 2007. Financial Statement Analysis. GRIN Verlag: Germany. Moseley, M. 2010. Ratio analysis. 4th Edition. Blackwell Science Ltd.: Conway. Rees. Z. 2010. Financial analysis. 7th edition. Coleway press. Sweden. Thomas. C. 2010. Essentials for finance. 5th Edition. Elsevier Limited: Sandwell. Appendices Financial statements of Wonderful Home Plc for the year ended 2012. Ratio Analysis Read More