An Accounting Ratio Analysis of the Performance of BHP Billiton Plc - Case Study Example

An Accounting Ratio Analysis of the Performance of BHP Billiton Plc Introduction In part A of this write- up an accounting ratio analysis has been carried out to assess the performance of BHP Billiton Plc on account of profitability, liquidity, capital structure, and activity performances for the years 2008 and 2009. Part B of this paper contains the assessment of the movement of share prices during the relevant two years. A. Interpretation of accounting ratios Profitability Performance Ratios used to analyze the profitability performance of BHP Billiton Plc are operating profit ratio, net profit margin ratio, and return on capital employed. The operating profit ratio “measures the percentage of each sales dollar remaining after all costs and expenses other than interest, taxes, and preferred stock dividend are deducted.” (Lawrence J. Gitman, 2006)i This ratio comments upon the way the business of the entity is conducted during a period. BHP Billiton is a mining producer and one of the leading companies in the field of diversified resources in the industry of mining. During 2009 the company achieved an operating profit margin of 24.22% which is depleted performance when compared with 40.6% ratio of 2008. There are two reasons for this poor operating performance. The first is decline in revenue from $59473m in 2008 to $50211m in 2009. The other is increased operating expenses from $35976m in 2008 to $38640m in 2009. Poor operational performance has also affected the net profit margin that has come down from 26.84% in 2008 to 12.62% in 2009. In fact the net finance cost has come down from $662m in 2008 to $543m in 2009. It is the poor operational performance that has brought down net profits. Return on capital employed ratio (ROCE) “expresses the relationship between the operating profits generated during a period and the average long term capital invested in the business during that period.”(Peter Atrill and Eddie McLaney, 2010)ii. The downfall pattern is also being reflected in ROCE ratio. This ratio has come down from 31.77% in 2008 to 15.44% in 2009. Profitability wise the company has performed very poorly in 2009, as this performance is almost half of what it was in 2008. Liquidity Liquidity is the blood line of any business, and liquidity position is reflected very truly by current ratio. Current ratio “measures the firm’s ability to meet its short term obligations.” (Lawrence J. Gitman, 2006)iii Liquidity reflects the short term solvency of the firm. The BHP Billiton has performed very well on this account. The current ratio of 2:1 is considered optimum in any type of industry. That is to say that the ratio of 2:1 is the ideal current ratio. BHP Billiton has achieved almost that ratio. Its current ratio in 1.9:1 in 2009 that has improved tremendously from 1.32:1 in 2008. The company is meeting ably its short term obligations as and when those become due. Capital Gearing Capital gearing or leverage of capital structure is reflected by the firm’s debt ratio. In fact it provides an idea as to how the firm has financed its assets. If debt capital used for financing the assets is more than equity capital, the firm is said to have a highly geared capital structure, and vice versa. Debt ratio exceeding 50% indicate high leverage or gearing of the capital structure, and less that 50% ration describes the low gearing of the capital structure. The debt ratio of BHP Billiton in 2009 is 48.32% that is almost similar to 48.63% in 2008. Though this reflects that debt capital invested in BHP Billiton Plc is lower than equity capital, but it is certainly not a low geared to the extent that it has to worry about fixed interest liabilities of debt capital. It is almost rightly geared as the debt ratio is more or less near to 50%. Activity performance Activity ratios are the reflection of efficiency with which the firm has converted its sales into cash. The activity ratios employed to assess the efficiency of BHP Billiton are average collection period and average payment period. “The average collection period measures how many days, on average, the company’s credit customers take to pay their accounts.”(Gallagher and Andrew, 2007)iv. The lesser the period the better it is. In 2008 BHP Billiton used on an average 60 days to collect its debtors, and this ratio came down to 37 days in 2009. This shows the efficiency of the company in cashing its credit sales in 2009. Similarly average payment period ratio reflects the average days taken by the entity to pay its creditors. The creditor period enjoyed by BHP Billiton Plc on account of its credit operating expenditures have also come down reducing its overall credit period. Such reduction of average payment period increases the requirement of working capital. In 2009 reduction in average payment period has been greatly offset by decrease in average collection period. That is the reason BHP Billiton has an efficient current ratio in 2009. B. Assessment of Share Price Movements “The change in price per share is important to current stock holders, so the perception is that the same level of importance applies to would be buyers as well.” (Michael C. Thornsett, 2002)v The share prices of BHP Billiton Plc have fluctuated tremendously over the last two years as is clear from the following figures: Date Price per share at LSE (Amt. in £) 1 June 07 881.62 3 Dec. 07 1247.22 31 March 08 1225.32 30 June 08 1335.95 17 Nov.08 619.10 19 Jan. 09 904.39 04 May 09 1235.59 29 June 09 1097.05 The above figures clearly indicate that prices of BHP Billiton Plc have been greatly affected by the market trends caused by recent recessionary impacts. Though prices fell for period immediately after declaration of dividends, but above prices are not for those periods. It is true that operational performance of the company is depressing during 2008-09 when compared to performance in 2007-08. But it must be noted that company’s share prices have not been impacted by this low performance of the company. Otherwise, how come the prices were at peak in May 2009? There is a great fall in earning per share in 2009. EPS (basic) in 2008 was US cents 275.3 and that came down to poor US cents 105.46 in the results declared by the company for 2008-09. Still prices maintained a high level in May 2009 and came down slightly in June 2009. This may be the effect of market corrections. It is stressed again that poor operational performance of the company has not affected the movements of shares in 2008-09. The effect on share price movements is greatly from the market forces, particularly recessionary forces prevalent during this period. That is why prices went down to £ 619.10 on 17 November 2008. Conclusion Accounting ratio analysis reveals that BHP Billiton Plc has not performed well in 2009 when compared with its operational performance in 2008. Liquidity wise, the company is quite well placed to meet its current obligations. The capital structure of the company is normal, neither highly geared nor too low geared. The movements of share prices of the company, that are important for present as well as future stakeholders, are not affected by the poor operational performance of the company in 2009. It has been greatly influenced by other market forces. Word Count: 1295 Annexure: Ratio Calculations References Read More