Accounting and Ratio Analysis of Marks & Spencer Company - Case Study Example

Full topic and Section # of Introduction Accounting and ratio analysis are two keys to successful interpretation and financial decision making. This paper analyzes the role of accounting within the organization and discusses the ratio analysis. It then presents a ratio analyzes of Marks & Spencer Company and finally concludes whether an investment in M&S is a profitable one or not. 1. Role of Accounting Within the Organisation with respect to Reporting and Decision Making Accounting plays an important role in the organization. The accounting records firstly provide accurate information about the financial position of the company to the employees of the company and also the investors, shareholders and other stakeholders of the company. And secondly it enables the organization to understand which products or assets of the company are producing more revenues for the company, how efficiently these are being utilized and which products or assets are not profitable and should be replaced or eliminated. From the reporting perspective, accounting provides the bookkeeping of day-to-day activities and every transaction that is taking place. This essential role of reporting enables the company to evaluate itself and avoid any frauds or misinterpretations. Form the decision making perspective, the decisions to evaluate the growth opportunities for the organization, for analyzing the performance of the company, for analyzing the company’s ability to pay its suppliers and shareholders etc. a number of operational and strategic decisions like budgeting and investigating are made though accounting. 2. What is Ratio Analysis? Ratio Analysis is basically analyzing the relationship between different sections of the various financial statements and this analysis is based on a comparison. Ratio analysis can be of two kinds: Comparative Analysis in which the ratios are compared with the industry average ratios and Trend Analysis in which the ratios of the same company are compared on a periodic basis i.e. a year is compared with the previous year. In this paper, trend analysis will be used as the industry averages are not available. 3. Ratio Analysis of M&S This section of the paper covers the ratio analysis for Marks & Spencer. The ratios have been compared over the years, i.e. trend analysis has been done of years 2006 and 2007. 3.1. Profitability Profit Margin on Sales Profit Margin on Sales = (Net Income / Sales) x 100 For year 2006: = 523.1/ 7797.7 = 6.71% For year 2007: = 659.9/ 8588.1 = 7.68% Return on Assets Return on Assets = (Net Income / Total Assets) x 100 For year 2006: = 523.1/ 5258.9 = 9.95% For year 2007: = 659.9/ 5381 = 12.26% Return on Equity Return on Equity = (Net Income / Common Equity) x 100 For year 2006: = 523.1/ 1203.7 = 43.46% For year 2007: = 659.9/ 1648.2 = 40.02% The profitability ratios show that overall the company is in profits and will achieve more profits in future. This is because the profit on sales is higher than the previous year and also the return that the company is getting on its assets has been increasing. Although the return on equity has been decreased which makes the shareholders to resist from investing in future but the shareholders are still expected to invest because the return they are getting is still high and not very low considerably. 3.2. Liquidity Current Ratio Current Ratio = Current Assets/ Current Liabilities For year 2006: = 1142.1/ 2017 = 56.62% For year 2007 : = 846.4/ 1606.2 = 52.69% Quick Ratio Quick Ratio = Current Assets - Inventories / Total Current Liabilities For year 2006: = 1142.1- 374.3/ 2017 = 38.06% For year 2007: = 846.4 – 416.3/ 1606.2 = 26.77% The liquidity ratios portray that the company’s liquidity has been decreased over time and less cash on hand is present. This portrays that the company is investing more and is therefore low on liquidity. But these liquidity ratios are more important for the suppliers or debtors as they need to continue to receive payments but from an investor point of view this company can still be brought as being less liquid is better off. 3.3. Working Capital Efficiency Days Sales Outstanding (DSO) DSO = Total Accounts Receivables / (Annual Sales/ 364) For year 2006: = 210.5 / (7797.7/ 364) = 9.82 days For year 2007: = 196.7/ (8588.1/ 364) = 8.33 days Inventory Turnover Inventory Turnover Ratio = Sales / Total Inventory For year 2006: = 7797.7 / 374.3 = 20.83 times For year 2007: = 8588.1 / 416.3 = 20.63 times Asset Turnover Asset Turnover Ratio = Sales / Total Assets For year 2006: = 7797.7 / 5258.9 = 1.48 times For year 2007: = 8588.1 / 5381 = 1.59 times Accounts Payables to Sales Ratio Accounts Payables to Sales Ratio = [Accounts Payables / Sales] x 100 For year 2006: = [867.8 / 7797.7] x 100 = 11.12% For year 2007: = [1043.9/ 8588.1] x 100 = 12.15% M&S is an established company and therefore its tendency to collect receivables and its inventory and asset turnover are almost similar throughout the years. It collects its receivables on an average of 8-9 days which is a good practice for such a huge company. The inventory turnover is high which represents that M&S is holding inventory; but the business they are into requires holding inventory. The asset turnover has been increasing indicating that the assets are being utilized more efficiently. Also the accounts payables to sales ratio shows that previously 11.12% of M&S sales were being funded by its suppliers and now 12.15% are being funded. This indicates the company is being a little more leveraged. 3.4. Debt Management (Solvency) Debt to Equity Ratio Debt to Equity Ratio = Total Liabilities / Total Equity For year 2006: = 4055.2/ 1203.7 = 3.368 times For year 2007: = 3732.8/ 1648.2 = 2.26 times Debt to Asset Ratio Debt to Asset Ratio = Total Debt / Total Assets For year 2006: = 4055.2 / 5258.9 = 77.11% For year 2007: = 3732.8/ 5381 = 69.37% Times-Interest-Earned (TIE) Ratio Times-Interest-Earned (TIE) Ratio = EBIT / Interest Charges For year 2006: = 850.1 / 134.9 = 6.3 times For year 2007: = 1045.9 / 143 = 7.3 times The debt to equity ratio of the company was almost 77:23 and has changed to almost 70:30 which shows that the company has financed through debt lesser over the years. But M&S is still financing 70% of it through debt which shows that it is a highly leveraged company. Also the debt to asset ratio has reduced over the years and the assets of the company are financed to a less extent through debt. But still about 70% of assets are being financed with debt. Creditors prefer low debt ratios because then they have greater cushion against losses in the event of liquidation. But the shareholders demand high debt ratios as it increases their earnings. Therefore the company attracts more and more shareholders to invest in and therefore will be a profitable venture. TIE ratio is an important ratio to be considered here. It measures the extent to which operating income can decline before the firm is unable to meet its annual interest costs. M&S interest was covered 6.3 times before and 7.3 times after which indicates that M&S has increased its margin of safety. And now even if M&S borrows more funds it wont face difficulty as it has increased its margin of safety. 3.5. Market Value or Investors Ratio Note: Market price on 29 Dec 2006, 717p is taken as the share price. Market price on 31 Dec 2007, 560p is taken as the share price. Price/ Earnings (P/E) Ratio Price/ Earnings (P/E) Ratio = Price per Share / Earnings per share For year 2006: = 717p / 31.4 = 22.8 times For year 2007: = 560p / 40.4 = 13.86 times Book Value per Share Book Value per Share = Common Equity / Shares outstanding For year 2006: = 1203.7 / 1667 = 722 p For year 2007: = 1648.2 / 1688.6 = 976 p Market/Book Ratio Market/Book Ratio = Market price per share / Book value per share For year 2006: = 717 / 722 = 0.99 times For year 2007: = 560 / 976 = 0.57 times The P/E ratio has decreased. This is due to the fact that M&S is an established company and its growth potential has been decreasing. But the book value per share has been increasing which is good on the side of the company. The market price is relatively lower times the book value although the return on equity is high. Therefore, although the market price of the shares is being decreasing but its book value is increasing which indicates that the company still will grow in future. 4. Limitations of Ratio Analysis Although ratio analysis reveals a lot about the performance of a company and helps to a great extent in the financial decision making but the entire decision can not be taken on the basis of ratio analysis. This is because there are other market conditions that impact the company’s performance and the economic indicators of the economy also have a great impact on the financial decisions. If any single ratio is not favouring the company, it doesn’t mean that the company is performing badly or its chances for growth are limiting. Therefore, the intuition and judgement of the managers is an important factor as well that needs to be considered. 5. Conclusion After a thorough ratio analysis of M&S and also keeping in mind the limitations of the ratio analysis, it can be suggested that it will be a good to make an investment of buying M&S. this is because the profitability ratios show that the company will be profitable in the future. Although the company is less liquid as compared to the past but it isn’t harming its profitability. The company is a highly leveraged one which motivates further stockholders to invest as more debt increases stockholder’s earnings. Also the price earnings ratio has decreased which is a bad indicator but since the economic conditions can be a reason and since all other ratios indicate an overall positive investment, it will be profitable to invest in buying M&S. 6. Bibliography 1. Eugene F. Brigham & Louis C. Gapenski. (1997) Financial Management: Theory and Practice. Eighth edition. Dryden Press. Harcourt College Publishers. 2. Scott Besley & Eugene F. Brigham (2000). Essentials of Managerial Finance. Twelfth edition. Dryden Press. Harcourt College Publishers. 3. Freerk A Lootsma (1999) Multi-criteria Decision Analysis Via Ratio and Difference Judgement. Springer Publisher. 4. Martin S. Fridson, Fernando Alvarez (2002) Financial Statement Analysis. John Wiley and Sons 5. Alexander Wall, Raymond William (2006) Ratio Analysis of Financial Statements: An Explanation of a Method of Analysing Financial Statements by the Use of Ratios. Harper Publishers. 6. Robert C. Higgins (2004). Analysis for Financial Management. R.D. Irwin 7. Lakshmi Chandra Gupta (2007) Financial Ratios for Monitoring Corporate Sickness: Towards a More Systematic Approach. Oxford University Press. 8. J. J. Potgieter, Anton P. Frank (2007) Ratio Analysis And Interfirm Comparisons As A Means Of Providing Management Information In The Small Business Sector. Published by University of Zululand. 9. David E. Tyrrall (2008) Financial Analysis. Open University Course Team 10. Marks & Spencer – Recovery under the Spotlight. theshareholder: Case study. [Internet]. Available from > [Accessed 14 November 2008] 11. Marks & Spencer Historical Share Prices. Yahoo Finance. Available from [Accessed 14 November 2008] Read More