Financial Forecasting for Compass Group Plc - Case Study Example

Running Head: FORECASTING Business Finance: Compass Group Plc - Projected Consoli d Income ment and Consoli d Balance Sheet & Financial Statement Analysis [Student Name] [Course Title] [Instructor Name] [Date] Business Finance: Compass Group Plc - Projected Consolidated Income Statement and Consolidated Balance Sheet & Financial Statement Analysis PART A Projected Financial Statements: Selected Approach The overall approach for preparation of both projected consolidated income statement and balance sheet is using previous 5 years published annual reports. A growth rate will be projected based using CAGR techniques on different elements of financial statements and develop a projection for the year ending 30 Sept 2009. It is noted that the company prepares its financial statements under IFRSs and for projections same approach will be used for projected financial statements. All elements of both financial statements have been used for projections. However for the purpose of the current paper the main headings of both financial statements are shown in calculations and also additional disclosures are made to assist the financial statement analysis in Part B. Furthermore, for taxation purpose and interest payment assumptions are made based on the company’s disclosure in their latest annual report 2008. In part B for the purpose of carrying out the financial ratio analysis a time series approach has been used by comparing ratios calculated on the basis of new projections with those based on the annual report of 2008. Issues of Projected Financial Statements Developing projected financial statements are important accounting procedures which company heavily invest in. These projections help companies to plan and overseas their operations to highlight any variations between actual and expected figures. However preparation of projected financial statements needs to address certain issues. Most importantly the accuracy and relevance of the information projected is subjective. It is a common practice that companies develop projected financial statements based on the past experiences. The availability and accuracy of data collected from previous years is crucial. The basis used for projections vary from company to company however justification for the basis to be acceptable to its users is important. This ensures that the company’s overall objective are achievable and managers who are believed to For companies it is important to form acceptable basis for projections as managers tend to understate their targets and employees often feel overburden by targets set from above. Investments decisions based on such projections depend upon the credibility and correctness of the assumptions made by accountants when preparing their forecasts. It is therefore very important to make reasonable projections. Moreover, companies often change their accounting policies which could have impact on recognition and measurement of different elements of financial statements. Therefore these changes should be clearly identified in future projections. The projections should be also prepared with consideration to external factors which may affect the business including political, social, legal, technological and economical conditions surrounding businesses. There are also ethical issues which need to be addressed which may involve the professionalism and experience of accounting staff as weak projections could hinder the company’s objectives. The projected financial statements could be used for evaluating new business ventures and strategic decisions therefore it is useful to prepare these projections under different scenarios to allow well directed decision making process (Swanger & DeZoort, 2000) Calculation of CAGR The projected consolidated income statement and consolidated balance sheets are prepared using Compound Annual Growth Rate (CAGR). Both financial statements are attached in Appendix I and II of this paper. CAGR is commonly used as growth indicators where there are altering cash flows and simplified growth rate will result in obtrude results which would surely be misleading (Darst, 2006). The CAGR is calculated through MS Excel using the formula: (End Value/Start Value)(1/(Periods – 1) -1 The figures for beginning value are taken from the annual report 2004 while the ending values comprises of figures from annual report 2008 of the company. In the following the CAGR is calculated using the figures for sales of the company and the sales figure for the projected income statement is calculated by multiplying the figure of 2008 by the CAGR. In the same way all other elements of consolidated income statement and consolidated balance sheet from annual report 2009 are adjusted using their respective CAGR. The calculation of each projected element is shown in the included Appendices. This way the projected financial statements under IFRSs are prepared for the current paper. Furthermore, it is also mentioned here that the use of regression and correlation analysis could result in better projection which involves determining the most appropriate value using different variables e.g. demand for company’s products, adjusted price index and movement in exchange rates. Calculation of CAGR for Sales Revenue For Example   2004 2005 2006 2007 2008 Sales Revenue 11,772 12,704 10,267 10,268 11,440 Using the above provided formula we have CAGR = -0.71% Finance Costs: The company is currently borrowing from banks, the public markets and the private placement markets. In company’s annual report 2008 it is expected that the finance costs for the year 2009 will be £95 million therefore we have used the same for our projections. However, the figure shown is the net interest as the company also receives interest from its investments. Corporate Tax: The company is subject to UK corporate tax laws for large corporations which are generating profit above £1.5mn in an accounting period. The rate for the period 2008/09 is 28%. For the projections made this rate is applied to the net profit after interest figure. Exceptional Items: In 2007/08 the company recognised £197million profit as exceptional item and this actually increased company’s reported profits. This exceptional item is unlikely to occur in the year ending 30 Sep 2009. Therefore this amount will be deducted from the profit before tax in the projections for 2009. Irregularity: Any discrepancy in the projected consolidated balance sheet is only due to fact that certain elements of balance sheet are combined together to give a complete view of the business. PART B Report to the Management Compass Group Plc. Introduction Compass Group Plc, U.K. has a leading position in the UK food industry and has achieved great reputation of providing highest standards in food and selected support services to its customers. The company offers cooked food services to its clientele that includes workplaces, schools, colleges, hospitals & old age homes, sports & leisure providing companies and even defence, offshore and remote sites (Compass Group Plc, 2009). The company has poised itself to be a great success over the years and has successfully tackled the competitors to become the market leader in its industry. The company also enjoys great results from its operation through its worldwide offices. The purpose of the current report is to undertake analytical review using the company’s projected financial statements and using time series approach to compare them with previous year’s performance. Financial Ratio Analysis The analytical review of the company’s financial position and performance is carried out using financial ratio analysis which could be very useful for evaluating company’s liquidity, solvency and profitability. The financial ratio analysis for the year 2008 and projected 2009 for Compass Group Plc is attached at the end of this report as Appendix III. Ratio Analysis for the year 2007/08: The liquidity ratios evaluate the company’s capability to pay its liabilities usually short term obligations. The current ratio is 0.80 that is below 1 and is considered to be weak for a company in food industry. This means that the company’s current assets are lesser than its current liabilities. This is due to its high creditors’ value and lower trade receivables. This is mainly due to the reason that the company does not hold larger inventories and the quick ratio of 0.73 affirms the result of the current ratio. The company could have liquidity problems if its current obligations become due and the company does not generate sufficient cash. The receivables turnover ratio is low which suggests that the company’s sales are on credit terms and the company is having problems with collection of these payments. The company should review its credit terms and devise better collection procedures as the average collection period is above 50 days which seems out for a company in fresh food industry and it may run into cash problems to finance its operations. This could in fact lead to further borrowing and increased finance costs. The inventory turnover ratio of 50.63 remains on the higher side which seems to be in line with the food business as company tends to maintain lower level of inventories at all times. This is confirmed by lower days in inventory of 7.21 days as the company’s inventory consists of perishable items that are not held for longer periods. The solvency ratios evaluate the company’s ability to generate sufficient funds to pay off its debts. The debt to total assets ratio is weak that is only 0.68 which indicates that the company’s total assets are few compared to its total liabilities. On liquidation the company will have problems paying off its total liabilities by selling its assets. The interest coverage ratio highlights that the company is generating sufficient funds from its operating activities to pay off its interest payment commitments. The company finance department is of the opinion that the finance costs of £93 million which the company is expected to pay in 2009 is expected to further as British pound showed weakness against major currencies in which company’s borrowing is denominated. This could dampen the company’s profits in the years to come. Finally the results from profitability ratios confirm the company’s low profit margin policy. The company has maintained this strategy in periods of high economic activity as it faced strong competition from its rivals however this could lead to problems for the company as the economic downturn will surely require further squeezing of its profits. The company is incurring high operating costs compared to its sales revenue that implies smaller gross profit margin of 5.76% and profit margin ratio of only 3.47% which could be considered to be very low for any business. The company has high borrowing and has to incur high finance costs which results in lower profit before tax of just £566 mn for the year compared to £11,440mn. As we have discussed that the company holds lower value of total assets the asset turnover ratio is very high of 165.29% and return on assets remains low at 5.74%. The EPS is 23.7p and dividend cover is 2.11 which may seem healthy perspective for the company who have invested in company’s shares. Comparison with Projected Financial Statements All elements of projected consolidated income statement and balance sheet are prepared using CAGR and other related assumptions including that of exceptional items, financing cost and taxation in particular. When the financial ratios of the year 2008 are compared with those of projected financial statements the analysis tends to present similar outcomes. The comparison shows similarities in the results of the current ratio and quick ratio which are not expected to improve in the current year as well. The reasons are company’s continuing poor credit terms and low levels of inventory. The cash debt coverage is projected to fall to 0.14 which shows that the company will incur higher interest costs compared to its ability to generate funds from operating activities. The receivables turnover ratio is forecasted to be 7.45 and not much improvement in the collection period. Inventory turnover ratio is expected to become further weak however the company is showing sign for improvement in the days in inventory ratio from 7.21 to 7.19. The results from solvency ratios are expected not to show any improvement as the finance cost will rise but will improvement in profit generation the times interest earned ratio is expected to improve from 7.09 to 7.11. The company is continuing its low profit margins policies where competition is getting tougher and economic conditions are not improving. The asset turnover will improve as company has scraped its non-profit generating units and assets in the year 2008 however ROA will decline from 5.74% to 3.84%. The lower EPS and dividend payouts are expected as the company has announced its plans to improve its operations Conclusion On the whole the projected consolidated financial statements are not showing any signs of improvement and the company is expected to continue its pull back with declining returns and high interest payments. References Compass Group Plc. (2009). About Us. Retrieved April 1, 2009, from Compass Group Plc: http://www.compass-group.com/aboutus/ Compass Group Plc. (2008). Consolidated Annual Report 2008. London: Compass Group Plc. Compass Group Plc. (2004-2008). Financial Reports . Retrieved April 1, 2009, from Compass Group Plc: http://www.compass-group.com/ir/Financial+Reports/ Darst, D. M. (2006). Mastering the Art of Asset Allocation: Comprehensive Approaches to Managing Risk and Optimizing Returns. New York: Mc Graw-Hill Professional. Swanger, S. L., & DeZoort, F. T. (2000). The Effect of Auditor Involvement with Projected Financial Statements on Loan Officers’ Lending Decisions for Start-Up Companies. Journal of Forensic Accounting , 251-274. Appendix I: Projected Consolidated Income Statement   2004 2005 2006 2007 2008 CAGR 2009* Sales 11,772 12,704 10,267 10,268 11,440 -0.71% 11,375 Operating Costs 11,276 12,404 9,812 9,743 10,785 -0.89% 10,689 Operating Profit 500 302 457 529 659 5.68% 696 Net Interest (130) (130) (134) (93) (93) -6.48% (87) Profit before tax 370 171 323 436 566 8.87% 402 Tax on profit on ordinary activities (152) (134) (61) (124) (169) 113 Profit after tax 218 37 262 312 397 289 Source: (Compass Group Plc, 2004-2008) In 2008 Profit before tax £566mn and we have deducted £197mn (exceptional profit) from this figure and used the figure of profit before tax as only £369mn (£566mn-£197mn = £369mn) for our projections and finally made the projection for the year 2009 as £402mn (profit before tax) without including exceptional item. Tax is calculated at 28% (U.K. Corporation Tax Rate for 2008/09) Appendix II: Projected Consolidated Balance Sheet   2004 2005 2006 2007 2008 CAGR 2009* Fixed Assets 6,058 5,797 4,783 4,059 4,532 -0.71% 4,500 Inventories 279 263 212 179 213 -0.71% 211 Trade and Other Receivables 1,855 1,968 1,424 1,343 1,577 -0.71% 1,566 Cash 266 318 848 839 579 -0.71% 575 Current Assets 2,400 2,549 2,503 2,373 2,389 -0.71% 2,372 Total Assets 8,458 8,346 7,286 6,432 6,921 6,872 Current Liabilities (2,872) (3,000) (2,533) (2,241) (2,968) -0.71% (2,947) Non-current Liabilities (3,104) (3,062) (2,441) (2,021) (1,747) -0.71% (1,735) Total Liabilities (5,976) (6,062) (4,974) (4,262) (4,715) -0.71% (4,682) Total equity shareholders funds 2,462 2,284 2,312 2,170 2,206 -0.71% 2,190 Source: (Compass Group Plc, 2004-2008) Appendix III: Financial Ratio Analysis 2008 Calculation 2009* Liquidity Ratios Current ratio Current Assets/Current Liabilities 0.80 =2372/2947 0.80 Quick Ratio Current Assets-Inventories/Current Liabilities 0.73 =(2372-211)/2947 0.73 Current Cash Debt Coverage ratio Cash from Operating Activities - Dividend Paid/Total Debt 0.28 =648/4682 0.14 Receivables Turnover Ratio Sales/Average Receivables 7.25 =11359/1566 7.25 Average Collection Period (Average Age of Receivables) 365/Receivables Turnover Ratio 50.32 =365/7.25 50.34 Inventory Turnover Ratio Cost of Sales/Average Inventory 50.63 =10708/211 50.75 Days in Inventory (Average Age of Inventory) (Days) 365/Inventory Turnover Ratio 7.21 =365/50.75 7.19 Solvency Ratios Debt-to-Total Assets ratio Total Debt/Total Assets 0.68 =4682/6872 0.68 Times Interest Earned (Interest Coverage) ratio Profit (Loss) for the year/Finance Cost 7.09 =654/92 7.11 Profitability Ratios Gross Profit Rate Gross Profit/Total Sales 5.76% =654/11359 5.76% Profit Margin Ratio Net Profit (Loss)/Total Sales 3.47% =264/11359 2.32% Asset Turnover Ratio Total Sales/Total Assets 165.29% =11359/6872 165.29% Return-on-Assets (ROA) Net Profit (Loss)/Total Assets 5.74% =264/6872 3.84% 2008 Calculation 2009* Earnings per Share Net Profit / Avg Outstanding Shares 0.237 =264/1726 0.152 Dividend cover EPS/Dividend Per Share 2.11607 1.875 Read More