Fundamentals of Financial Management of Excellent Clothing Company - Essay Example

Financial Analysis By + Introduction Excellency Clothing Company is one of the popular companies inthe United Kingdom’s clothing sector. Despite the company enjoying long periods of profitability and excellent performance in most of its activities, currently it has experienced a profit drop. Since this is not the norm of the company, the company’s directors and shareholders are concerned of the drastic financial performance of the company and are in need of a detailed explanations of the causes of these changes. In order to explain the current profit drop of the company the performance analysis of the company has to be conducted. First, it would be reasonable to determine the absolute changes that occurred between different items of the financial statements. The percentage changes can then be computed to facilitate comparisons between the changes that occurred in the items of the financial statement. Comparisons of different items and financial ratios can also be determined to identify areas that have problems and might have caused a decrease in profit. The financial ratios will aid in determining the managements efficiency (Brigham and Houston, 2004). Discussion This section will entail performing several calculations to get the absolute changes, percentage changes, comparison changes, and financial ratios of different items in the financial statements. The changes will then be explained according to financial, industrial, and economic angles to try to explain the reasons behind the changes. Later in the section, various recommendations and suggestions will be made to the management in a bid to improve the financial situation of the company. Absolute and Percentage Changes Workings (All values in ‘000 pounds): Revenue: 21563 – 255063 = -39440 % change: (-39440 / 266063) * 100% = -15.46% Cost of Sales: 84500 – 96800 = -12300 % change: (-12300 / 266063) * 100% = -12.71% Gross profit: 131123 – 158263 = -27140 % change: (-27140 / 158263) * 100% = - 17.15% Administration expenses: 29640 – 32984 = -3344 % change: (-3344 / 32984) * 100% = -10.14% S & D expenses: 81459 – 102457 = -20998 % change: (-20998 / 102475) * 100% = -20.49% Finance costs: 350 – 835 = -476 % change: (-476 / 835) * 100% = -57.01% Profit before tax: 19665 – 21987 = -2322 % change: (-2322 / 21987) * 100% = -10.56% Taxation: 6489 – 7241 = -752 % change: (-752 / 7241) * 100% = -10.39% Net profit: 13176 – 14746 = -1570 % change: (-1570 / 14746) * 100% = -10.65% Cost of Sales / Revenue: In 2014: (84500 / 215623) * 100% = 39% 2013: (96800 / 255063) * 100% = 38% The company’s revenue had a drop of 39440000 sterling pounds, resulting to a 15.46% decrease in sales. This shows that the company’s current performance was quite low from the previous year’s performance. Deeper scrutiny in this issue at hand revealed that there was a drop in the average industrial revenue of the clothing sector. This was mainly because of the economic conditions that prevail currently. The economy is currently at a recession making consumers to substitute purchasing clothes from luxury brands such those Excellent Clothing Company produce. The company is also faced with intense competition from the new entrants in the industry. The competition reduces the market share of the company resulting to a significant reduction of revenue (Retail-excellence.com). The company’s cost of goods has also had a drop 12300000 sterling pounds, resulting to a 12.71% fall in cost of revenue. This fall is due to the fall of the company’s revenue over the two-year period. If the fall could have been by 15.46% such as the one experience in revenue, attention would not have been but since the fall of 12.71% does not correspond that of revenue, further scrutiny has to be made. The little fall in cost of goods shows that the cost of goods went up despite having a fall in revenue. The entire clothing industry was impacted by an increase in inputs. Due to the poor economic conditions that prevail, most of the raw material such as cotton, which the companies in the sector rely on, had their prices increased. The gross profit had a drop 27140000 sterling pounds. This is a 17.15% decrease in gross profit. This decrease is very significant since a continuation of such a decrease will cause several financial disturbances for the company making it have threats of bankruptcy. The large fall in gross profit is because of the large fall in revenue lacking corresponding fall in cost of goods. This is illustrated by the increase in the cost of sales to revenue ratio from 38% to 39%. If the cost of goods would have decreased by the same percentage revenue fell then the fall in gross profit would have been slightly lower (Zazzle.com). The administration expenses had a fall of 3344000 sterling pounds resulting to a fall of 10.14%. This fall is entirely due to the management’s internal operations. Industry and economic factors did not have any impact on the administration expenses since most of the other companies in the sector maintained the same level. The cutting of these expenses was a good move by the management as it intended to match the fall in profit. The selling and distribution expenses also had a decrease of 20998 sterling pounds. This 20.49% decrease is very desirable since it is slightly higher than the decrease in gross profit therefore reducing the percentage decrease of the profit before tax. The fall in revenue in the entire industry and the poor economic conditions made most company in the sector cut on their selling and distribution expenses to mitigate the reduction of the gross profits. The finance costs had a fall of 476000 sterling pounds. This made it to have the most drastic fall of 57.01%. This fall is the most desirable cut in expenses that the company experiences since it helps reduce the resultant fall in gross profit. The company having offset majority of its short term and long-term debts caused the fall (Robinson, 2009). The company did not borrow extra finance from the market since the poor economic conditions that exist currently are characterized by high interest rates. The profit before tax of the company had a fall of 2322000 sterling pounds, which is a 10.56% decrease. Though a drop in profit is not desirable, this drop is very much appreciated since it does not correspond the 17.15% fall in gross profit. The company’s management did a good job to cut most of the expenses in a bid to reduce the drop in profits. The company’s tax expenses also had a drop of 752000 sterling pounds, which is a 10.36% decrease. However, the decrease in taxation expense is desirable it does not much the drop in profit before tax. The drop is slightly lower than that of the profit before tax. Since it is the company’s policy to compute taxes in deferment of one year this fall was not impacted by the fall in gross policies but by the management’s effort of taking advantages of the tax benefits. This slightly lower fall in tax expenses made the company’s fall in profit after tax of 1570000 sterling pounds to a have higher percentage than that of profit before taxation. It had a decrease of 10.65% (Rodgers, 2008). Recommendations From the analysis on the absolute changes, percentage changes and comparison of different items in the financial statements it is evident that the drop in the company’s profit is caused by company’s operational factors as well as industry and economic factors. It is therefore very necessary to make some recommendations to the company’s management to improve the situation financial performance of the company by increasing the profit back to its initial performance (Palepu, Healy, and Bernard, 2000). First, in a bid to increase the company’s revenue, which has significantly dropped, the management should invest heavily in the marketing of their products and services to compete favourably in the market and outshine their competitors. Their marketing strategy should be well structured to facilitate the increase in sales. In a bid to increase the sales, the company’s management should also practice price reduction of their products and services. This move will attract more customers and as a result increase the sales units. The management should reduce the cost of goods to match the drop in revenue. This will reduce the percentage in which the gross profit falls. The management can look for alternative cheaper raw materials to use in production in order to reduce the cost of goods. Since the gross profit of the company has dropped by a large percentage, the management should match the prices of goods with the increase of cost of goods. This increase in prices of their products and services will be due to the poor economic conditions prevailing and the harsh financial conditions facing the company and the entire industry at large (Friedlob and Schleifer, 2003). The company management did a good job by cutting the administrative expenses, but they need to reduce them further so that the percentage reduction in administration changes could match the percentage reduction of gross profit. The management’s effort of reducing the selling and distribution expenses is a good signal effort. It should be maintained since it works positively to reduce the resultant fall in the profit before taxation. The massive fall in finance costs is also very desirable and the management should maintain it since it also reduces the dropping gap of the profit. Despite the management not being in control of the tax rates, it should try to take advantages of the tax benefits to reduce the tax expenses in order to match the fall in profits (Fridson and Alvarez, 2002). Financial Ratios: In a bid to determine the management’s efficiency, the efficiency ratios of the company has been computed to determine if a drop in the efficiency might have caused the drop in profit. Workings (all values in ‘000 pounds): Fixed assets turnover = Sales / Fixed assets In 2014: 215623 / 46523 = 4.63 2013: 255063 / 36690 = 6.95 Total assets turnover = Sales / Total assets In 2014: 215623 / 160044 = 1.35 2013: 255063 / 126409 = 2.02 Receivables turnover = Sales / Receivables In 2014: 215623 / 34592 = 6.23 2013: 255063 / 30124 = 8.47 Inventory turnover = Cost of Sales / Inventory In 2014: 84500 / 68973 = 1.23 2013: 96800 / 50982 = 1.90 The fixed assets turnover represents the amount of revenue that each dollar of fixed asset earns. It measures management’s utility in determining utilizing the fixed assets to generate sufficient revenue (Bull, 2008). Higher ratios imply the management’s efficiency is high. The total assets turnover is also similar to this one as it represents the amount of revenue that each dollar of total asset earns. High ratios likewise signify high levels of management’s efficiency. The receivables turnover on the other hand represents the management’s efficiency in collecting the company’s receivables. High ratios imply efficient management. Lastly, the inventory turnover measures the number of times the inventory of a company is used in a given accounting period. The higher values in this ratio imply better management efficiency (Wiehle, 2005). Conclusion It is evident that the company’s profit has significantly dropped. The absolute and percentage changes have shown the extent of the fall in profit and the possible causes. Apart from the industry and economic conditions, the management is also to blame. According to the efficiency ratios computed in the last segment of the essay. All the ratios declined from the previous year showing a fall in management’s efficiency. (Number of words in the essay: 1925) References Brigham, E., and Houston, J. (2004). Fundamentals of financial management. Mason, Ohio: Thomson/South-Western. Bull, R. (2008). Financial ratios. Oxford: CIMA. Fridson, M. and Alvarez, F. (2002). Financial statement analysis. New York: John Wiley & Sons. Friedlob, G., and Schleifer, L. (2003). Essentials of financial analysis. Hoboken, N.J.: John Wiley. Palepu, K., Healy, P., and Bernard, V. (2000). Business analysis & valuation. Cincinnati, Ohio: South-Western College Pub. Retail-excellence.com, (2015). Team Retail Excellence Business Consultancy Düsseldorf. [Online] Available at: http://www.retail-excellence.com/en/team/kompetenzpool.php [Accessed 14 May 2015]. Robinson, T. (2009). International financial statement analysis. Hoboken, N.J.: John Wiley & Sons. Rodgers, P. (2008). Financial analysis. Oxford: CIMA. Wiehle, U. (2005). 100 IFRS financial ratios. Wiesbaden: Cometis AG. Zazzle.com, (2015). Excellence T-shirts, Shirts, and Custom Excellence Clothing. [Online] Available at: http://www.zazzle.com/excellence+tshirts [Accessed 14 May 2015]. Read More