Financial Performance of British Petroleum plc - Case Study Example

Report Table of contents Introduction 3 Profitability of the company 3 Liquidity position 6 Efficiency of management 7 Leverage ratios and long-term solvency 11 Investor’s ratio 13 Investment strategy for the investor 14 Reference 16 Bibliography 18 Introduction British Petroleum plc or BP plc, as it is commonly called, is the world’s third largest energy producing company. It is UK’s largest corporate body and has the ranked third worldwide. It’s headquarter is in St James’s City of Westminster, London. The company is listed in both London stock exchange as well as in New York stock exchange. BP was established in the year 1901 by William Knox D’Arcy (PB-a, n.d.). The company has almost world wide existence and it is basically in production and distribution of different petroleum products like aviation fuel, caster motor oil. It is also in service stations solar panels business (BP-b, n.d.). To understand the financial performance of the company, its profitability, liquidity, solvency, efficiency and market performance throughout the last five years were analyzed. For such analysis, different financial ratios were calculated and then interpreted. Profitability of the company In the year 2008, company’s sale increased by $361143 million, which was 27 percent higher than the last years sale, but on the same time company’s gross profit increased almost 12.65 percent and net profit just 2.3 percent. To develop a better understanding regarding the company’s profitability, few profitability ratios were calculated and interpreted for the last five years. Gross profit margin ratio = (Gross profit/Sale*100) It helps to understand how well the company is performing in terms of its gross profitability. Higher the value to this ratio, more profitable is the company’s operations (Abrams & Kleiner, 2003, p.331) The ratio indicates with passage of time the company’s gross profit margin is declining. The data published by the company in their annual report reflected, though the company’s sale is increasing constantly, but increase in the gross profit has not so high, but the good thing is company’s managed to retain the gross profit in a constant trend. Net profit margin = (Net Profit/Sale*100) It helps to determine net profitability of the company throughout the financial year. A higher net profit margin is always desirable. Throughout the five years, net profitability of the company has fallen drastically. The reason behind such fall was high operating costs as well as non operating costs. Return on capital employed = (EBIT/Total Assets-Current liabilities*100) It is a ratio commonly used to determine how well the company can generate profit from its employed capital. Higher the value better is the performance of the company (Glynn, 2008, p.399). After undertaking the ROCE ratio for the last five years it can be concluded that company’s ROCE never maintained a constant trend, but the ROCE ratio is showing a positive growth in 2008, so the company’s profitability might improve in coming years. Liquidity position Liquidity refers the company’s ability to handle short term solvency. Both cash and cash equivalents are used for calculating the liquidity ratios. Few common liquidity ratios are shown below; Current ratio = (Current Assets/Current Liabilities) This ratio helps to determine the company’s ability to pay current the liabilities arising within a year. Higher the ratio more is the company’s ability to pay its current liabilities. To have a stable position, this ratio should be at least one (Friedlob & Welton, 2001, p.158). The company’s five years current ratio values indicates the company’s liquidity fluctuate year-on-year basis, but it remains within the range of 0.95 to 1.05. Hence company has the ability to meet its short term liability, but the liquidity state is at a risky position. Keeping the changing market condition the ratio should be higher than 1. Quick ratio = (Current assets-inventory)/Current liabilities To understand the exact liquidity state of the company, quick ratio was calculated as it is more stringent then current ratio. The benchmark value of this ratio varies from industry to industry and higher ratio is always beneficial to overcome short term solvency state (Mladjenovic, 2006, p.312). BP’s quick ratio value is showing a positive sign as it has maintained an upward trend from 2007 onward. So undertaking all the liquidity ratios it can be concluded at present the company’s position is more or less stable and it has the ability to pay the short term liabilities which will arise in near future. Efficiency of management Efficiency ratios help to determine how well the company is utilizing its resources (capital, row material, receivables and payables). The different turnover ratios were calculated for BP to determine its efficiency throughout the last five years. Inventory turnover ratio = (Sales/Inventory) This ratio helps to determine how well the company can rotate its inventory. A higher ratio reflects higher efficiency because less working capital will be required if inventory have higher turnover ratio (Fleming, 1991, p.113). The BP’s ITOR has improved quite well from 2007 which indicate higher level of efficiency and less blockage of working capital in inventory. The reason behind such improvement was hike in sale for the year 2008 and huge fall in inventory. Asset turnover ratio = (Net profit/total assets) This ratio helps to determine how well the company uses its assets for generating sales. A higher ratio is always preferred by the management which indicates better management of assets. BP’s ATOR showed a fluctuating trend as it declined from 2005 to 2007 but again took an upward trend from 2007 onward. So it can be concluded company’s efficiency in managing its assets is improving. The company’s total assets are growing which reduces the ratio, but now it seems the company is trying to develop a balance. Debtor turnover ratio = (Sales/Receivables) and Debtor turnover period = 365/DTOR Debtor turnover ratio indicates how well the company manages its receivables or its debtors and debtor turnover period (cycle) indicates the days taken by the company to convert its receivables into cash (Fleming, 1991, p.113). BP’s ability to manage its debtor is improving constantly as this ratio has shown an upward trend. This was due to two main reasons; the company’s receivables have reduced gradually and sales figures have improved constantly. This clearly indicates, in future the company will able to manage a better liquidity as the debtor turnover period is constantly reducing. Creditors turnover ratio (CTOR) = (Sales/Payables) and Creditor turnover period = 356/CTOR This ratio helps to determine how well the company can manage its payables or creditors and creditors’ turnover period indicates the days taken by the management in paying to the creditors. Many companies believes the early they can pay to their creditors the better will be their creditworthiness in market (Gowthorpe, 2005, p.293). From 2005 onwards the company’s creditor turnover period is decreasing which is a good sigh and indicates better creditor management. Leverage ratios and long-term solvency These ratios determine the company’s ability to manage their long term solvency. This also assists in knowing the degree of company’s financial leverage and the risk which arising to company’s profitability. To analyze BP’s leverage state the following ratios were calculated. Gearing ratio = (Total Liability/Shareholders Equity) This ratio is also known as debt-equity ratio as it helps to determine for one dollar of debt how much equity the company maintains. As a convention this ratio should be greater then one (Siegel, 2006, p.251). In 2005 the company had quite high debt-equity ratio, but from then onwards it is gradually decreasing. The company’s total liabilities are increasingly and on the other hand shareholders fund is decreasing. As the world is facing a worldwide economical rescission, so such high risk can lead to negative impact on company’s profitability. Interest coverage ratio = (EBIT/Interest) This ratio analyzes the company’s ability to pay interest generating on debt instrument used in the capital structure (Stickney, et al., 2009, P.271). The company’s Interest cover ratio is showing a download trend which indicates that company’s ability to pay the interest is decreasing gradually and the net profitability is might suffer in future. Investor’s ratio This ratio is basically used by the investors to find out how profitable will be investing in a particular company. Few important ratios are discussed below. Price earning ratio = (Market price at the end of financial year /EPS) This ratio determines, for earning one dollar in the company, an investor have to invest how many dollars. The price earning ratio of the company was improving from 2005 till 2007 at a slow rate, but from 2007 onwards it has fallen drastically. It means the investors have to pay less for earning a single dollar; hence the company seem more attractive to the long term investors. Book value to market value ratio = Book value/Markey capitalization Book value of a company indicates the total assets less intangible assets. This ratio helps us to understand where the company is under value or over valued (Siegel & Shim, 2006, p.257) At present the ratio is less then one so the share are under valued; hence it can be said with passage of time, market value of the share will increase and the investor will be benefited. Investment strategy for the investor If an investor having £25,000, investing in BP will be a good choice. The fundamentals are sound but from last two years due to economical slow down company’s liquidity and efficiency has declined. As soon as the economical conditions will recover, it will be back on higher profitability track. Most importantly the price earning ratio is low and the book value to market value ratio is also showing an attractive position for purchasing the share. It is equally important to consider the share pries movement graph for an investor to determine the company’s performance against market’s performance. Comparative chart BP Market Brent Oil Daily:26/11/2009 (Source: BP-c, n.d.) The annual graph shows, market is improving and movement of the company’s share price is related to the market’s movement, so more the correction in capital market, the better will be the performance of BP’s share. Hence it can be concluded for a long-term investor, BP is a good investment. The company is undertaking many new projects which will improve company’s performance in coming years, but due to high volatility in market, it might not prove so profitable for a short term investor. So the investor with £25,000 should go for long to medium term investment. Reference BP-a. No date. Our centenary. About BP [Online]. Available at: http://www.bp.com/productlanding.do?categoryId=9028486&contentId=7014016 [Accessed on November 26, 2009]. BP-b. No date. Products and services. About BP [Online]. Available at: http://www.bp.com/productsservices.do?categoryId=37&contentId=2007985 [Accessed on November 26, 2009]. BP-c. No date. Interactive analyst. Investors tools. [Online]. Available at: http://www.bp.com/investortools.do?categoryId=145&contentId=2014277 [Accessed on November 26, 2009]. Abrams, R. & Kleiner, E. 2003. The successful business plan: secrets & strategies. 4th ed. The Planning Shop. Fleming, M. I. A. & McKinstry, S. 1991. Accounting for business management. Taylor & Francis. Friedlob, T. & Welton, E. R. 2001. Keys to reading an annual report. 3rd ed. Barrons Educational Series. Glynn, J., Abraham, A., Murphy, M. & Wilkinson, B. 2008. Accounting for Managers. 4th ed. Cengage Learning EMEA. Gowthorpe, C. 2005. Business accounting and finance for non-specialists. 2nd ed. Cengage Learning EMEA. Mladjenovic, P. 2006. Stock Investing For Dummies. Wile. Siegel, G. J. & Shim, K. J. 2006. Accounting handbook. 4th ed. Barrons Educational Series. Stickney, P. C., Weil, L. R. & Schipper, K. 2009. Financial Accounting: An Introduction to Concepts, Methods and Uses. 13th ed. Cengage Learning. Bibliography Seyhun, N. J. 2000. Investment intelligence from insider trading. MIT Press. UAH. Financial & Operating Ratios. Library Research guide. [Pdf]. Available at: http://www.uah.edu/library/pdf/ratios.pdf Annexure For the year 2008 Read More