Financial Analysis for Ipplepen Plc - Case Study Example

Running Head: FINANCIAL ANALYSIS FOR IPPLEPEN PLC Financial Analysis for Ipplepen Plc in APA Style by Registration Number 15 March 2007 Table of Contents 1.0.Executive Summary 3 2.0. Terms of Reference 3 2.1. Background to the Study 3 2.2. Methodology 4 3.0. Company Background 4 4.0. Financial Analysis 5 4.1. Profitability 5 4.2. Liquidity 6 4.3. Working Capital Utilisation 6 4.4. Gearing 7 4.5. Investor Ratios 8 4.6. Cash Flow 8 5.0. Appendixes 9 5.1. Computed Financial Ratios 9 5.2. Ratio Computation 10 6.0. Bibliography 11 1.0. Executive Summary This report evaluates the viability of Ipplepen Plc’s (Ipplepen) stock as an investment through a thorough financial ratio analysis which looks at the profitability, liquidity, gearing, working capital efficiency, investment potential, and cash flow of the business organisation. Ipplepen’s financial strengths lie in its profitability, liquidity, stable capital structure, and generation of stockholder value. However, these are eroded by its primarily by its inefficiency in managing its inventory. 2.0. Terms of Reference 2.1. Background to the Study The utmost aim of a prospective investor is to derive maximum gains from his money. As such, the potential of a stock as a profitable investment is often linked to the company’s ability to maximise shareholder value which in turn, is mirrored in its financial statements. Financial analysis has gained wide acceptance as a tool in assessing the health and well-being of a business entity. This is also considered as a helpful technique which aids investors in ascertaining the gains and the risks involved in buying and holding company’s stocks. This report aims to evaluate the viability of investing in the stock of Ipplepen through the utilisation of an in-depth financial analysis. In so doing, this report will give a brief introduction of the company, its operations, and the recent significant corporate changes. To get a profound evaluation of the financial situation of the organisation, it will diagnose the important aspects of Ipplepen’s financial health which include profitability, liquidity, gearing, working capital utilisation, investment, and cash flow. 2.2. Methodology In order to come up with a comprehensive and accurate assessment of Ipplepen, this report makes use of the company’s financial statements which include the consolidate income statement, balance sheet, and cash flow statement for the fiscal year 2006. The required data for the financial ratio computation are transcribed in Microsoft Excel spreadsheets in order to facilitate more accurate and more convenient data processing. For a more adequate assessment, 2005 is used as a comparative year. After the computations, the financial data and computation are double checked in order to ensure correctness. The interpretation of the computed financial ratios are aided by the concepts and theories presented in various finance books, journals, and articles. 3.0. Company Background Ipplepen Plc operates in the UK fashion industry through the wholesale and retail of clothing, footware, and leisure equipment in the British Isles and Ireland. The business organisation has two core areas of operation: stores, which denotes to its retailing activities of clothing, footwear, and leisure equipment; and Manaton, which refers to its activities as a distribution channel of Manaton products. Aside from these operations, Ipplepen generates income from sub-let property and other property related activities. During 2006, its main operation accounts for 99% of its total turnover. Ipplepen currently employs 3762 part-time and 1786 full-time employees to man its operations. 4.0. Financial Analysis Financial ratio analysis is a very essential tool in assessing the financial health of a business entity. Financial ratios are grouped into five categories, each showing a different aspect of a company’s financial operations. These are profitability ratios, financial leverage ratios, liquidity/solvency ratios, efficiency ratios, and investor ratios. 4.1. Profitability Profitability ratios measure the ability of the company to generate income from its investments less the costs incurred. Ipplepen’s profitability is measured through four computed ratios namely ROCE (Return on Capital Employed), ROSF (Return on Shareholder’s Fund), gross profit percentage, and net profit percentage (Appendix 1). Ipplepen’s profitability appears to be in an uptrend indicated by the growth in ROSF and margins. ROCE, however, declines by 11% which is largely due to the rise in total assets. During 2006, the company’s ability to generate shareholder value is strengthened by the 8% rise in ROSF (from 0.9335 to 1.0095). This implies that every pound in the shareholder’s fund yields an operating income of £1.0095. Ipplepen also reports improvements both in gross profit and net profit margins. In 2006, the company allocates 43% of its turnover for costs of goods sold while keeping approximately 57% of sales as gross profit. This represents a 6% expansion from the 53% reported during the previous year. Net income also increases as a percentage of sales by 7%. Net profit percentage is 0.078, up from the 0.072 in 2005. This improvement seems meager in terms of percentage but for Ipplepen this shows a rise of more than £1 million in net income. 4.2. Liquidity Liquidity or solvency ratios are used as measures of the company’s ability to finance its short-term obligations by its cash and near cash items. Like profitability, Ipplepen’s liquidity has remarkably improved in 2006 relative to 2005 (Appendix 1). Both fiscal years under consideration record current ratios which are more than one, indicating that the current assets of Ipplepen can more than pay off all its short term liabilities should they become due immediately. In 2005, Ipplepen’s current ratio reached 1.682 and posts a growth rate of 8% when it peaks at 1.8272 last year. The company also improved in terms of quick ratio (from 0.6212 to 0.6707). However, the large discrepancies between the computed current and quick ratios indicate that most of the company’s current assets are tied up in inventories. During 2003, stocks comprise 63% of the Ipplepen’s current resources. Therefore, even if the ratios indicate liquidity improvements, the composition of current assets reveals that large proportion of less liquid resources. Large level of inventory causes to company to incur stock holding costs and questions the company’s efficiency in turning these stocks into sales. 4.3. Working Capital Utilisation Working capital ratios are also called efficiency ratios because they reveal the company’s ability to manage their working capital efficiently. This report computes ratios including stock, debtor, and creditor turnover to show the working capital utilisation of Ipplepen (Appendix 1). Generally, Ipplepen’s working capital efficiency is in a decline. Even though the business organisation manages to improve its collection period of accounts receivables from 9.7828 to 8.0248 days, this is eroded by the worsening of the stock turnover and creditor’s turnover. Consistent with what is indicated by its current ratio, Ipplepen Plc appears to be having problem in moving its inventories. During 2005, the company’s stocks stay in the warehouse for more than four months (123.8045 days) before being sold. This gets worse in 2006 as it now takes more than five months (154.8469 days) before inventories are disposed. Payments of trade payable also deteriorate from 47.8620 to 54.9557 days which can possibly harm Ipplepen’s relationship with its suppliers in the long run. 4.4. Gearing Financial leverage ratios provide an indication of the long-term solvency of the firm. They indicate the extent of non-owner claims on the firm’s profits as well as the firm’s operating capability to meet its obligation. Ratios in this category are gearing and interest coverage. Generally, there is a change in the capital structure of Ipplepen indicated by the large difference in the 2005 and 2006 gearing (from 0.0178 to 0.0622). This reveals the company’s preference for riskier financing, debt to finance its current assets. During 2006, debt accounts for over 5% the total capital employed by the company as opposed to the 1.7% recorded during the previous year. It should also be emphasized that this is still a healthy figure considering the industry where the company operates. Also, Ipplepen has more than enough profit to pay off its interest liabilities. Even though there is a large decline in the company’s interest coverage ratio from 20.9785 to 13.3119, this does not serve as a caution for stockholders. 4.5. Investment Ratios Investor ratios are financial ratios especially designed to convey to investors the profitability of the company’s stock as an investment. Based on the computed ratios, Ipplepen is generating adequate gains for its shareholders (Appendix 1). Earnings per share is at 34 pence during 2006 while dividend yield has ballooned by 10% from 0.0168 to 0.0185. In terms of capital gains, Ipplepen’s stocks prove to be very attractive for potential investors with the continuous appreciation in its market value. In fact, the price earnings ratio is 16.0833 which signal an overvaluation of this stock. This becomes a challenge for Ipplepen to deliver the value according to the expectation of shareholder in the face of its decreasing dividend cover (from 6.1585 to 4.9550). 4.6. Cash Flow The cash account of Ipplepen increased by an annual rate of 22% from £11,175 thousand in 2005 to £13,708 thousand in 2006. Cash and cash equivalents comprise 19.14% of the company’s total current assets. A large portion of the company’s cash is held as short term deposits which can be readily withdrawn should immediate need arise. The company’s cash flow statement indicates that even though the cash account grows, this increase is relatively lower than the amount in the previous year. Also, it is notable that cash generated from operations declines by more than £3 million due to the rapid increase in inventory. 5.0. Appendixes 5.1. Ratios for the Fiscal Year 2006 and 2005 5.2. Ratio Computation 6.0. Bibliography Fraser, L. & Ormiston A 2004, Understanding Financial Statements, Pearson-Prentice Hall: Upper Saddle New Jersey Horngren , C. et. al.. 2000,  Accounting. 4th ed.  New Jersey: Prentice Hall Keown, A.J., Martin, J.D., Petty, J.W., and Scott Jr., D.F, 2005, Financial Management principles and applications, Pearson/Prentice Hall International Edition, 10th Edition. Read More