Liquidity and Working Capital - Case Study Example

 «Liquidity and Working Capital» Table Of Contents «Liquidity and Working Capital» 1 Table Of Contents 1 Introduction 2 Strategy and Forward Planning 3 Accounting Methods 3 Technical Analysis 4 Ratio Analysis 7 Management Performance 7 Cash Flow 8 Vertical Analysis 8 Liquidity and Working Capital 9 Gearing 10 Interest coverage 10 Comparison between Zotefoams and Craigelaw Plc 11 Non Financial Performance Indicators 12 Questions to Finance Director 13 Introduction Zotefoams is considered as one of the leading providers of block foams in the world serving different markets and providing high performance foams. Zotefoams works in a very specialized market offering products which are used for different purposes including sports, medical, leisure etc. The overall long term strategy of the firm is focused on the development of new markets with an aim of offering innovative products and great customer services. Trends for the last five years indicate that the firm’s debt has reduced to a great extent and despite the reduction in the debt, firm has been able to invest into its plant and machinery indicating strong emphasis on the managing the firm in most optimal manner. At the same time, firm’s export sales have increased by almost 6% during last five years whereas its capital expenditure has increased by £3.4 m during 2009. It is also important to note that the firm is extremely efficient at generating the cash from its operations which provides it relatively stable level of liquidity and lessen its reliance on external debt. This paper will attempt to present critical financial analysis of the firm and will assess its historical performance since last four years. Strategy and Forward Planning The main study focus of the firm is to seek the international expansion and enter into new and untapped markets in order to achieve growth. It is because of this reason that the firm gives too much importance to the export sales and regularly reports the changes in its export sales. This strategy is achieved through the development of innovative and creative products which can be used in different markets with diversified range of uses in various industries including sports, medical etc. The firm focuses on the development of market for its existing product of Polyolefin foams whilst also emphasizing on the development of alternative products of high performing polymer material. The firm is also continuing to expand its production capacity as well as increasing its research and development efforts in order to excel in its existing product line of Polyolefin foams. Zotefoams has many projects which focuses on the development of its capacity in this line of business thus investors can be relatively satisfied with the fact that the firm is strengthening its core competencies and improving its competitive edge over others. Forward looking actions of the firm include the development of alternative line of products in polymers. It has also developed three different ranges of products in this line of business and has been able to increase the sales in this segment by more than 100% during recent times. The sales in this segment of the business comprises of 5% of the overall Group revenue thus making it a viable business for the firm to pursue. Accounting Methods Zotefoam uses consolidation accounting for consolidating the accounts of the parent company as well as its subsidiaries. Further, the accounts are made on the historical cost basis whereas company assets are recognized on cost while at the same time taking into consideration the impairment losses. Technical Analysis Liquidity Ratio Calculation for 2009  Zotefoams Plc Current Ratio 15086/5950 2.54 Quick Ratio (15086-4382)/5950 1.80       Management Efficiency Ratio     Inventory Turnover 21941/4382 5.01 Average Collection Period 7729/31816 * 365 87.45 Fixed Asset Turnover 27840/31816 1.14 Total Asset Turnover 42926/31816 0.74       Gearing Ratios     Debt Ratio 15244/42926 0.36 Debt-to-Equity 15244/27682 0.08 Times Interest Earned 4325/1168 3.70       Profitability Ratios     Gross Profit Margin 9875/31816 31.04% Operating Profit Margin 4325/31816 13.59% Net Profit Margin 2467/31816 7.75% Return on Total Assets (ROA) 2467/42926 5.75% Return on Capital Employed (4325)/(42926-5950) 11.70% Return on Equity (ROE) 2467/27682 8.91%       Investors Ratio     Earnings Per Share 2467/37780 0.07 Dividend Yield 0.03/0.91 0.03 Price/Earnings Ratio 0.91/0.07 13.94 Dividend Cover 0.07/0.03 2.33 A closer look at the financial statements of the firm and the emerging trends would indicate that the firm’s sales have declined in 2009 compared to its previous years. However, the pattern is relatively stable over the period of four years wherein the growth in sales remained positive. Similarly, changes in the gross profitability of the firm is erratic too as gross profit jumped by almost 9% during 2008 however, it subsequently declined in 2009. It is also the case with the operating and net profit margins which remained volatile and have demonstrated abnormal changes over the period of time. These changes into the different key indicators of profitability therefore indicate that the firm’s overall performance may have been affected by the current financial instability. Most large economies are facing difficult economic conditions and as such it is difficult for entities to retain their competitiveness. This fact, therefore, may be relatively more difficult for a firm which relies heaving on export sales. From investment perspective, this aspect of financial management may be of concern for investors as it may indicate towards the potential risks involved in the business. Ratio Analysis Management Performance Inventory turnover of the firm has declined indicating that the management must have taken efforts to control the inventory and better utilize its resources in order to achieve more efficiency. However, it is also critical to note that the average collection period has increased indicating the relatively lose credit policy controls of the management. Both these ratios are in-line with the other firm Total asset turnover is close to 1 (0.74 in 2009) indicating that the firm’s management has the ability to utilize firm’s assets in most optimal manner and generating enough returns to justify their use. However, this ratio is lower than Craigelaw Plc which is over 1 indicating a better utilization of assets by other firm. Cash Flow Cash flow from operations is positive. However, it is on the declining trend suggesting that the firm may be finding it hard to generate enough cash flows from its operations. This can be also due to the fact that sales are declining owing to difficult economic conditions. It is also important to note that the cash flow from operations is considered as the main indicator of the firm’s ability to generate enough cash flows. In this case, Zotefoams has managed to generate positive cash flows of £1.088m in 2009 however; this trend is declining suggesting that the firm’s operations may not be generating enough cash flows to keep the firm liquid. Vertical Analysis A closer look at the vertical analysis of the data would suggest that the cost of sales continued to decline as the % age of sales. This indicates that the firm has been able to control its costs and improve the profitability. As a result of this decline into the cost of sales, the gross profitability of the firm has also improved too. Distribution expenses of the firm have increased over the period of time also indicating that the firm’s sales may have been increased at the expenses of incurring the higher distribution expenses. What is also important to note that the firm has been able to reduce its general/admin expenses indicating that the firm has been able to rationalize its organizational structure and control its costs? Operating profit and the net profit of the firm has increased too as percentage of the sales indicating that the firm has been able to make profits over the period of time due to further cost rationalization as well as the cost cutting. It is also important to note that the firm has been able to reduce its current assets indicating that the firm has been able to manage its inventory as well as other current assets in a better manner. Reduction of current assets as %age of total assets also indicates that the firm has been able to rationalize its working capital management since current assets are mostly unproductive in nature. Firm’s accounts payables have increased too as percentage of total assets indicating that the firm might have been able to improve its working capital management. Data further indicates that the firm’s overall performance is satisfactory and trends indicate that the firm has been performing well. However, there are still certain areas which require critical evaluation in order to ensure that the firm performs well and its performance remains sustainable over the period of time. Liquidity and Working Capital Current ratio of the firm has decreased initially however; it is also increasing whereas the quick ratio of the firm is still above 1 which is a good sign of the firm’s better financial management. Generally a current ratio of over 1 is considered as ideal as the firm tends to have enough current assets to meet its current liabilities. Further, quick ratio is a more conservative measure because it takes into consideration only those current assets which are readily saleable therefore inventory is deducted while calculating the quick ratio. Gearing The overall debt ratio is within the range of 0.31 to 0.36 indicating an acceptable range of debt ratio. Further debt to equity is relatively low signaling towards the fact that the firm is less reliant on external debt and prefers to expand either through its own internally generated funds or by issuing new equity. The gearing for Craigelaw Plc is also in the same range indicating that both the firms enjoy low level of gearing with an acceptable risk profile. An acceptable level of gearing also indicates that the firm’s overall risk profile is good and that the firm can actually borrow at relatively favorable terms. It is also imperative to note that a low level of debt may also result into a low level of earnings per share because of the impact of taxes and the debt. Interest coverage Interest coverage ratio indicates the ability of a firm to earn interest from its profits to pay it off. Interest coverage therefore indicates that the firm’s operations are profitable enough to generate enough profits to pay off the interest charges for the year. Times interest earned ratio for this firm is relatively strong indicating that the firm’s operations are providing enough profits to pay off the interest expenses. Times interest earned ratio increased during the period reflecting upon the fact that the firm’s low debt situation may have resulted into lower interest payments and thus higher interest coverage. Firm has an interest coverage of over 3 however, it is still less than the Craigelaw Plc indicating that the firm may not be performing well as compared to the Craigelaw plc. Comparison between Zotefoams and Craigelaw Plc A closer analysis of the data would suggest that Craigelaw Plc has performed better than the Zotefoams Plc. However, since both the firms work in different industries therefore it may be difficult to make a reasonable comparison between the two. Craigelaw’s financial analysis indicators suggest that it is enjoying better returns as well as its working capital management policy seem to be more conservative. Craigelaw Plc has been able to delay its payments to its trade creditors therefore utilizing this spontaneous source of financing in more optimal manner for the firm. It is also important to note that the return on equity of Craigelaw is better than the Zotefoams during the period. This may be due to the fact that both the firms work in different industries and therefore may be facing different demand and supply dynamics which ultimately affect their sales generating capability. Profitability of both the firms however, is within the same range and it seems that Zotefoams Plc specially has been able to control its costs in most effective manner. This is also important owing to the fact that Zotefoams Plc faced difficult times in recent past due to global recession and its exports sales have been suppressed. However, this period has allowed it to reconsider its existing systems and procedures and control the costs in better manner. Non Financial Performance Indicators There are various non- financial performance indicators which can potentially indicate towards the overall direction and performance of the firm. First, the product development process is one of the significant indicators of how the firm is actually looking forward towards maintaining their market share as well as making successfully entry into the new markets. It is important therefore to note that the firm has aligned its strategy with that of its financial objectives therefore both the non financial as well as financial key performance indicators of the firm are showing the overall strength of the firm in the market. Operational management control system of the firm is another important indicator of how the firm is performing. It is critical to note the total asset turnover of the firm was near to 1 which is corroborating the fact that the firm has some excellent operational management control systems in place. Strong operational control systems and procedures therefore indicate as to how the firm is performing in terms of containing the losses and reducing the overall risk to the business. It is also critical to note that the performance in terms of human resource management as well as the management of intangible assets of the firm. The firm’s focus on innovation itself is an indicator of how the firm is actually attempting to manage its intangible assets and what sort of importance is attached to them. Since the main focus of the firm is to gain access to the international markets it is therefore critical that the firm focus on the development of its research and development capabilities in order to generate the level of performance which can provide a sustainable competitive advantage in the industry at a domestic as well as an international level. Questions to Finance Director 1) The company plans to enter into new markets. However, it has not come up with a very detailed plan of the countries it is actually contemplating to concentrate more. Since the overall geo-political and socio-economic environment of each country and region is different it is therefore important that the company must provide a definite and concise plan of action in terms of potential markets where it is willing to enter and what are the risk mitigation strategies which it is contemplating upon to introduce? 2) Firm’s sale as well as profitability is declining since last few years. Though this may be due to global financial crisis however, it is still unclear as to what policy options the firm has looked into in order to ensure that it can keep itself competitive in a volatile market. Since the firm focuses on international markets and relies heavily upon export sales therefore in such circumstances what are some of the measures which the firm is undertaking in order to ensure that its profitability will not be reduced to a dangerous level? 3) Firm’s debt situation is though favorable but it is too low as the firm’s debt to equity ratio is very low. Though it may be possible that the firm is focusing on consolidation in the troubling times however, low debt may hamper the growth potential of the firm especially in times when equity markets are suppressed. How is the firm is going to tackle the situation when it is faced with raising the new funds for its expansion? 4) Most of the focus of the firm is on one product however, the firm is looking towards the development of new products also. Considering this fact, how will the firm will be able to compete with the new competitors who can offer better and more innovate but diverse range of products? This question is critical in the sense that it can provide an insight into the firm’s ability to insulate itself from the potential new entrants. 5) Is it possible that the firm may be considering the option of diversifying into a new line of businesses in order to mitigate risk? Since Zotefoams is reliant mostly on one product, this question will provide a further insight into the future plans of the firm and how it is going to minimize its overall business risk and manage the upcoming challenges which it may face in the future. Read More