The Financial Statements of Reckitt and McBride - Term Paper Example

 Introduction: This paper seeks to analyze and discuss the financial statements of Reckitt and McBride, where Reckitt is taken the main company and comparing it’s with McBride and with the industry index in terms of analyzing the ratios. The result of the analysis will be used for giving advice to a potential investor on what his or her best course of action would be with respect to that company’s shares. 2. Analysis and Discussion The following summary is of financial ratios are extracted from the financial statements of Reckitt and McBride and industry data to facilitate analysis in terms of profitability, liquidity and solvency (Droms, 1990; Helfert, Erich, 1994) of the company. McBride McBride Reckitt Reckitt Post Post Exceptional Exceptional 2006 2005 2006 2005 Net profit margin 0.05 0.16 0.03 0.04 Operating Margin 0.06 0.22 0.05 0.06 (0.42) Gross Margin 0.19 0.55 0.34 0.35 Return of Assets 0.12 0.16 0.06 0.07 Return of Equity 0.36 0.36 0.18 0.22 Roce 0.30 0.35 0.18 0.23 (0.16) Quick ratio 0.36 1.05 0.91 0.88 Current ratio 0.48 1.23 1.01 0.94 Debt to Equity ratio 2.07 1.27 1.90 1.98 Source: 2006 Annual Reports from Reckitt Benckiser (2007) and McBride (2007) and Telegraph.co.uk (2007) 2.1 Profitability: Reckitt’s profitability is obviously higher than McBride. Based on net profit margin for years 2006 and 2005, Reckitt had 0.05 and 0.16 as compared with McBride’s 0.03 and 0.04 for the same years respectively. The same behavior may be observed in terms of operating margin. Although for the 2005 it may be observed that McBride had a higher gross margin, the higher net profit margin for Reckitt should be controlling for purposes of measuring profitability. For purposes of comparing the company’s operating margin of the two companies against the industry average, Reckitt and Mcbride are definitely better. The average for operating margin for the industry is taken from those companies engaged in similar business as that of the companies. The Return of Assets for Reckitt are 0.12 and 0.16 for the years 2006 and 2005 respectively are also higher than that of McBride which reflected ROA of 0.06 and 0.07 for the same years respectively. The results of these ratios further confirmed earlier observation in net profit margin hence. The same better profitability is further observed in terms of Return of Equity where Reckitt showed 0.36 and 0.36 for the years 2006 and 2005 respectively which are definitely higher than that of McBride which 0.18 and 0.22 for the same years respectively. While ROA measures how efficient management of company was in terms of assets employed in business ROE measures how much management is compensating resources invested by stockholders. By comparing the two ratios, it would seem that the management of both companies have shown leverage in using company’s assets since ROE’s are higher than ROA for both companies with management of Reckitt showing better performance than McBride. The profitability of both companies is further confirmed when compared with the rest of the industry of dealing in household goods. This is using the Return on capital employed (ROCE) where Reckitt showed 0.30 and 0.35 for 2006 and 2005 respectively as against that of that McBride at 0.18 and 0.23 for the same year respectively and against (0.16) industry average for 2006. The ratios indicate that while the rest of the firms in the industry are experiencing negative profitability in the industry, Reckitt and McBride surprisingly are doing better. As a general rule every business should have profitability as its primary goal in all of its business ventures for without which the business will not survive in the long run, thus the need to measure current and past profitability as well us making projection of future profitability. Basically profitability is only measuring income and expenses. A company as a rule must have higher income than expenses. The relationship of the two accounts are not actually as simple as being defined since it could happen that expenses become higher than income. Before comparing the two it must be made clear that income is money generated from the activities of the business but said activities had cost and they are called expenses. Before expenses could be incurred however, the business entity must have assets. Assets are either generated from the investment of the owners or from the assets provided by the company creditors. Profitability is therefore simply measured in the income statement with the desired effect of having more revenues over expenses. The said accounting information could however be further manipulated by converting them into ratios as used in this paper. 2.2 Liquidity The company’s liquidity shows the capacity of the company to meet currently maturing obligations and the same could be measured by the Quick ratios and current ratios. Reckitt’s quick ratios showed 0.36 and1.05 for the years 2006 and 2005 respectively as against the McBride’s quick ratios of 0.91and 0.88 for the same years respectively. Quick asset ratio is which is measured by dividing quick assets by the total current liabilities yielded a better result also Reckitt in 2005 compared with Mcbride but the same better liquidity was no longer observed in 2006 as Mcbride performed better with 0.36 as quick ratio for Reckitt as against 0.91 for Mcbride. The same behavior may be observed in the current rations of the two companies. The same behavior of the company’s liquidity may be observed in terms of current ratios. Reckitt’s current ratios reflected 0.48 and 1.23 for the years 2006 and 2005 respectively as against McBride’s current ratios of 1.01 and 0.94 for the same years respectively. As observed in the quick ratios Reckitt also showed less liquidity for 2006 than McBride, as compared with better liquidity for Reckitt in 2005. Comparing quick ratio from current ratio, it may be noted that quick ratio is better measure for liquidity since the same excludes inventory in the composition of the quick assets. It may be observed however that the results of the profitability analysis appear to create some inconsistency in the resulting liquidity ratios of the Reckitt and McBride. As a general rule for a company to have a good liquidity, the ratio of current or quick assets to current liabilities should be at least one since this would mean that a company must be able to match 1 British pound sterling from it current assets to every pound sterling of its currently maturing obligations. Failure of a company to do this could mean bankruptcy and may force the company to stop operation. This must be so since the salaries of its employees which must come every payday cannot wait longer for people need to have their living expense. The ready quick assets there of a typical company to match maturing obligations include cash, marketable securities, short term investments, accounts receivable and notes receivable. To make quick assets into current assets, one may just add inventory from the listing. Using this knowledge therefore in the case of the Reckitt and McBride, it may be noted that quick ratios for both companies in 200g were less than 1.0 for both companies, hence there is evidence to conclude the both have weak liquidity particularly that of Reckitt which had reached below 0.50 or half of the regular liquidity. It is only in current ratio that McBride managed to have more than 1.0 at 1.01. As quick asset ratio is more refined ratio than current ratio, the same normally carries a lower figure than that of the current ratio, as confirmed in this analysis. What may be surprising to note is the decline in the liquidity of Reckitt as compared with McBride despite the greater profitability for Reckitt as earlier analyzed. This could be an indication that McBride was trying to improve its liquidity. This behavior may be explained by the fact the Reckitt has higher increase in its current liabilities in its current liabilities which were recorded at £2.74 billion in 2006 from £1.5 billion 2005 as against the decrease in its currents assets which were recorded at £1.3 billion in 2006 from £1.8 billion in 2005. The decline therefore in liquidity was expected for Reckitt. What happened for Reckitt was a shift from it current assets to more investment in long terms assets, hence the company showed increase in current assets in 2006 as compared to 2005. 2.3 Solvency In the language of finance, solvency like liquidity has also something to do with the ability of an enterprise to pay its debts with available funds like cash which is presumed to exist but this time this is different from liquidity since solvency must be long term or it must speak for the financial stability of the company to survive short term problems at it has sufficient investment from stockholders (Meigs and Meigs, 1995; Ross et. al ; 1996; Van Horne,1992) to match long term debt of the company together with currently maturing obligation. It is also a different concept from profitability, as the former refers to the ability of a company to earn a profit so businesses may show a profitable result of its operation without being solvent as in the case where these companies are on the stage of expanding rapidly in the early part of business. On the other hand business entities can be solvent even while not being profitable like when they try destroying future cash flows, as may be found when accounts receivable are being sold. Thus ideally a company must be both profitable, liquid and solvent since a business gets bankrupt when it is losing money due to unprofitability and could eventually become insolvent. Solvency may be measured using debt to equity ratio (Bernstein, 1993; Brigham and Houston, 2002). Applying the knowledge in the case of the company, debt to equity ratios for Reckitt are 2.07 and 1.27 for the years 2006 and 2005 respectively while Mcbride has reflected debt to equity ratios of 1.90 and 1.98 for the same years respectively. The ratios are better this time for the company if they are lower. Hence in 2006, Reckitt has shown better poorer solvency than that of McBride but for 2005 Reckitt was better because of lower ratios. The behavior in the solvency ratios appear to confirm the behavior of liquidity that was earlier described as Reckitt has shown lower liquidity in 2006 despite the higher profitability of Reckitt in 2006. This may explained by what happened in the current ratio of Reckitt for 2006 where there was a higher increase in its current liabilities which were recorded at £2.74 billion in 2006 from £1.5 billion in 2005 as against the decrease in its currents assets which were recorded at £1.3 billion in 2006 from £1.8 billion in 2005 as a result of the shift of investments from it current assets to more long terms assets. 3. Conclusion Given the profitability of Reckitt which was even proved to better than McBride and the rest of the players of household goods industry, investing in its stock may be a good idea to be entertained. The rates of double 0.36 return on equity for the years 2006 and 2005 are really very attractive to consider. This is however the company will have to fix it liquidity which is below 0.5 in 2006 since poor liquidity could be a sign of mismanaged funds and can sacrifice its relationship with short term creditors. With increase in debt to equity ratio and proved by analysis Reckitt may investing more in long term assets to prepared a better solvency in the future, hence investing with the company could really be a good option but again liquidity must not made to suffer at least in the short term. Reflective Statement 200 words Each member of the group must also include a 200-word Reflective Statement detailing what he or she has gained from carrying out the assignment and how the assignment might be developed for future students I really learned much in discussing my assignment with group mates and in the efforts that I put into the process of learning. Since the decision derived from the activity is the available options of prospective investors in the stocks of the company, I have felt really that I am making a real life recommendation which may involve a great amount of risk if our group’s recommendation would turn out to be wrong. I would say that I have learned more about report writing as I used my power of expression in coining the proper words to described and explain things in my analysis. If have felt that I could not just write words without meaning we are required to have clarity of language and analytical logic as well originality and effectiveness of structure and presentation. I needed therefore to understand every concept before I could make correlations in my analysis I also learned how to apply depth in analysis by using various analytical techniques. If found out the financial ratios brought me into understanding the relationship of the accounts in the financial statements of the companies under consideration. Improving my research skill was also an added value as far as this assignment is concerned. I felt I really need to read more books just to make logical connections of materials I needed for the paper. References: Bernstein (1993) Financial Statement Analysis, IRWIN, Sydney, Australia Brigham and Houston (2002) Fundamentals of Financial Management, Thomson South-Western, London, UK Droms (1990) Finance and Accounting for Non Financial Managers, Addison-Wesley Publishing Company, England Helfert, Erich (1994), Techniques for Financial Analysis, IRWIN, Sydney, Australia McBride (2007) Company Website, Annual Report for McBride for 2006, {www document} URL,http://mcbride.hemscott.com/servlet/HsPublic?context=ir.access.jsp&ir_client_id=2908&ir_option=RNS_HEADLINES&transform=home&rightnav=home&disclaimer=2 Meigs and Meigs (1995) Financial Accounting, McGraw-Hill, London, UK Reckitt Benckiser (2007) Company Website, Annual Report of Reckitt for 2006, {www document} URL, http://www.reckittbenckiser.com/, Accessed November 24, 2007 Ross et. al (1996) Essentials of Corporate Finance ,IRWIN, London,UK Telegraph.co.uk (2007), Industry data from Household goods industry, {www document} URL, Accessed November 24, 2007 http://shares.telegraph.co.uk/company_performance?package_name=&orderby_field=security_name&action=&colour_field=&username=&ac=&security_classification_id=104670&country_id=1, Accessed November 24, 2007 Van Horne (1992) Financial Management and Policy, Prentice-Hall International, London, UK Read More