Predicted Financial Position of BT Group Plc - Case Study Example

Business Finance 2) Predicted Financial Position and performance of BT Group Plc. Introduction: The performance of BT Group Plc. has been analyzed in this write up from the point of liquidity, profitability, and its capital leverage position. Based on its earlier performances, the predictions of the performances of the company in coming years have also been discussed, so that regulatory steps are taken wherever the company suffers leakages that harm its progress. Contents: Introduction Contents Liquidity Profitability Capital Leverage Conclusion References Appendix Liquidity Basically, the liquidity of a company reflects its ability to pay its short term obligations as those become due. BT Group Plc. is not at all enjoying a comfortable position so far as its liquidity is concerned. During 2008 its current ratio was just 0.67:1. That means current liabilities were more than current assets, and the company was not in a position to meet its current obligations. In any industry liquidity is judged through its current ratio. ‘The current ratio, one of the most commonly cited financial ratios, measures the firm’s ability to meet its short term obligations. Generally the higher the current ratio, the more liquid the firm considered to be.’(Lawrence J Gitman )1. The current ratio of 2:1 is considered optimum in any industry unless some special circumstances warrants otherwise. The ratio of 0.67: 1 is very delicate and it may threaten the solvency of BT. Considering the delicate liquidity situation it is important that some concrete measures are taken. Keeping this in view and also the fact operational activities in 2009 are expected to increase by 20%, it is envisaged that BT put an embargo in dealings with Derivative Financial Instruments, as even otherwise the economics of stock markets is not providing a favorable trend. This will confine the entire concentration of the group on its operational activities. This will also save the company to raise funds for the purpose of solving liquidity position. If these measures are adopted, it is predicted that current ratio of the BT Group Plc. will be around 1.24: 1; and that will be a quite comfortable condition when compared to 2008 performance depicting current ratio at 0.67:1. Slowly the situation will be under control by the ending financial year 2010. Profitability Profitability of a firm can be judged in two ways. One is profitability in relation to sales and second in relation to investments. In relation to sales, operating profit margin ratio is used to analyze and predict the performance of BT Group Ltd.; and from the point of view of investment two ratios are used in this analysis, i.e., Return on Total Assets and Return on Common Equity. “Operating profits are pure profits earned on each sales dollar. Operating profits are pure because they measure only the profits earned on operations and ignore interest, taxes, and preferred stock dividends. A high operating profit margin is preferred’ (Lawrence J Gitman)2. BT Group Plc. earned an Operating profit margin of 11.38% in 2008, and it is envisaged that next year the operating profits would be 11.24% of sales. The prediction is almost similar for 2009 basically because the company would be operating on present infra structure. There are no predictions of big changes in the market. No fresh investments are being on assets and also the product range is similar. Accordingly when compared with sales, BT Group will be maintaining the performance in 2009 as good as in 2008 despite the fact that revenue is expected to rise by 20%. However, in order to maintain the same level of performance BT may have to bring in extra efficiency from resources as the next year’s performance will be on already used assets and other infra structure. Return on total assets (ROA) show how effectively the assets have been utilized. The ROA in the year 2008 was 5.92% and it is expected that company earnings would be 5.08% of total sales during 2009. The turnover ratio is in fact a function of efficiency with which the various assets are managed. BT Group Plc. is managing the assets in a very effective way as the ratio of 5.92% is considered healthy in the industry in which BR group exists. Though, the assets are getting depreciated each year, it is expected that BT will maintain its performance in 2009 near to 2008. It appears the increased turnover will take care of disefficiency of depreciated assets. Return on equity is also called rate of return and reflects the earning power on shareholders’ investment. Return on equity is the measure to check profitability on shareholders’ investments. The higher the ratio, the better it is. BT Group Plc. earned a ROE of 8.85% in 2008. It is expected to fall down marginally to 7.49% in 2009. The reason for this fall is that company is putting a sort of embargo dealings in derivative financial instruments, in order to ensure that liquidity of the company is utilized mainly for operations of the company. With such a step financial income may not increase as was expected. Bt this will bring back the company’s liquidity on track, which is already threatening the solvency of the company. It is hoped that BT will maintain the tempo of profitability as has been during the previous years. Capital Gearing Capital gearing, also called the leverage of capital, is the measure to judge how the assets of the company have been financed. Whether owned capital or debt capital has been used for financing assets and if so, what is the ratio of such finance? This leverage is calculated with reference to debt ratio. In other words debt ratio reflects the relative proportion in which debt funds have been employed. When more of debt funds are employed the company is called high geared and when more of equity funds are used the company is said to be low geared. The debt ratio or debt equity ratio of BT Group Plc. in 2008 was 1.22 and as our prediction it will be 1.17 in the coming year 2009. The company is high geared. That means equity holders will be losers during the periods of low profits, as after meeting the fixed rate liabilities like interest on loans and dividend on preferred capital, all remaining profits belong to equity holders. Accordingly, during the periods of good profits equity holders are the real gainers of high geared capitalization. It must also be noted that ratio of debt to equity varies according to the nature of the business and the volatility of cash flows. For example an electric utility company, with very stable cash flows, usually will be have higher debt ratio as compared to a machine tool company, whose cash flows are far less stable. BT Group Plc. debt ratio indicates that more than half of company’s assets have been financed through debt capital. The BT Group Plc. degree of indebtedness is greater because of this higher debt ratio, and accordingly it has high financial leverage or gearing. Conclusion BT Group Plc. is certainly suffering from liquidity problems and strict and disciplinary measures are needed to correct this liquidity crunch. Profitability wise, the company is performing well and it is predicted that company will continue to perform in same way once the liquidity crunch is over. Though the company is highly geared, it may provide the real advantage to equity holders during the periods of high profits. Word Count: 1229 Read More