Financial Report of Yule Catto &Co Plc - Case Study Example

Yule Catto Table of Contents Introduction 2 Strategy and forward planning 3 Accounting methods 4 Interpretation of technical analysis 4 Trend analysis 6 Vertical Analysis 9 Ratio analysis 10 Non-financial indicators 13 Questions to the Financial Directors 13 Reference 16 Bibliography 19 Appendix- 20 Introduction Yule Catto is a British trading company that was founded in the year 1863 by Andrew Yule & Co. With time, the company became a chemical manufacturer of international repute. The core activity of the company is “Application of water-based polymer science”. The three main divisions in which the company is operating are: Polymer Chemicals: The key products are emulsions, synthetic lattices, adhesives, natural rubber latex, polyvinyl alcohol and acetate, etc (Yule Catto-b) Pharma Chemicals: The key products are generic and ethical pharmaceutical actives, pharmaceutical actives of clinical phase compounds (Yule Catto-c). Impact Chemicals: The key products are inorganic specialities (Yule Catto-d). The company is listed in London Stock Exchange as FTSE Small Cap and FTSE All Share. The company is well known in the chemical sector of UK. In UK, the chemical industry is considered as the heart of the manufacturing sector because the output of this sector is often used as the raw material for other sectors. This sector is of economic importance. The turnover of this sector is quite good and it contributes 12 percent of the value added goods in the manufacturing sector. In totality it adds 1.5 percent of the total GDP of the nation. Though the international chemical sector is becoming highly competitive, innovation and high value addition to the UK’s chemical industry gives it the necessary competitive edge (AZoM News, 2010). Like most of the developed companies, Yule Catto was also a victim of economic recession. In 2007, the revenue of the company declined, which affected its profitability and market image. However, the performance of the company is improving with time and in future it is expected to perform better. Strategy and forward planning The performance of Yule Catto was quite satisfactory till December 2009. The chairman of the company was found to have said that the operating profit in all the three sectors in 2009 was higher than the year preceding it. In that financial year, the group pre-tax profit had increased significantly and there was a substantial reduction in net debt. All these were indicators of sustainable growth for the company in years to come. The financial performance for 2008-09 was the result of increased revenue in UK, which was up by 13.2 percent whereas in other European markets growth in revenue was 36.5 percent. Asia also emerged as a good market for the company where the sale was 298.5 percent high on y-o-y basis. On the eve of 2009, the company had planned to suspend the dividend and reduce the net debt by £100 million or below this target. This restructuring was expected to be introduced within the time frame of 24 months. The financial performance of the company was highly satisfactory as it managed to exceed the annual target of restructuring the debt component. The chairman thereby announced that in 2010, the company will announce dividend for the investors. The company is aware of the fact that in the next year, demand in developed nations may not increase considerably because the economies are recovering from the recession phase at a slow pace. However, Yule Catto is more optimistic about high demand in Asian countries. As a result, the company is paying special attention to diversify its business. Accounting methods Yule Catto & Co. is incorporated in UK and thus the financial reports are prepared in Pounds sterling because this is the primary currency in majority of the economies where the company is operating. In 2009, the company revived ‘IAS 1 Presentation of Financial Statements’ and introduced changes in the way financial information is presented. Amendment of IFRS 7 Financial Instruments has been used to provide an in-depth discloser of fair value measurements and liquidity risk associated with the company. Interpretation of technical analysis To determine the financial position of the company, its past performances have been analysed. For better understanding, financial data for the last two years has been derived and horizontal analysis carried out. “Horizontal analysis is a time series analysis of the financial statements covering more than one accounting period” (Single, et al., 1997, p.151). Changes that have taken place in few of the vital financial indicators are presented below. 1. Revenue: As compared to 2008, the overall revenue of the company declined by 10 percent. This data is derived from the IFRS continuing operations. This change in revenue is attributed to the slow recovery of the UK market. However, the international sector in Asian countries performed comparatively well. 2. Operating profit: Operating profit is low by 49 percent on y-o-y basis. This could be on account of the rise in the operating costs of the company. 3. Net interest: As the company is in the process of reducing the debt component, there has been a fall in the total interest paid by the company. In 2009, the net interest paid reduced by 6 percent. This implies that the company has reduced its debt exposure in the year resulting in low interest costs. 4. Profit after tax: Major change was noted in the net profit of the company. There has been a fall of 76 percent in profit after tax on y-o-y basis. In 2009 the company witnessed a fall in the revenue. This may be one of the reasons for the steep fall in the net profit of the company in the year. Together with this the rise in the administrative expenses of the company contributed to the fall in profitability. 5. Earnings per share: Because of decline in profit earned by the company, the EPS reduced by 82 percent in 2009 as compared to 2008. 6. Dividend per share: The Company is in the process of minimising the debt and thus it is paying more attention to internal sources of funding. As a result in 2009, the company paid no dividend to its investors. Trend analysis Analysing the past and present performance of the company does not quite reveal the true potential possessed by the company. Hence, it is necessary that one takes into account the trend followed by the company for at least last five years. The term ‘trend’ can be defined as “Long term movement or direction” (Wilson, Dell & Anderson, 1993, p.28). The trend followed by the company is one of the vital indicators been discussed below. In 2005, the company was performing quite well but a drastic decline in the company’s performance was registered from 2006 onwards, which continued till 2007. The revenue of the company started declining from 2006 and in 2007 it hit the rock bottom. However, it improved in 2008, followed by a further decline in 2009. Fall was also noted in the operating profit in 2006. However, 2007 and 2008 were comparatively stable years. In 2007 the operating profit of the company moved up despite a fall in the revenue. In the following year the revenue of the company moved up but the operating profit of the company failed to keep in pace with this rise as there was a decline in the operating profits of the company. In 2009, the revenue as well as operating profit declined. However the decline in the profit was much steeper at 48 percent as compared to a fall of 9 percent in the revenue. Profit after tax followed almost the same trend. The decline in 2006 and 2009 can be attributed to external economic factors and market conditions in UK and other nations. With time, the company managed to reduce the interest needed to be paid for its long term debt. Thus the risk associated with long term solvency resulted in restructuring programme followed by Yule Catto. The decline in the interest outflow signifies that the company has been reducing its debt exposure over the years. Vertical Analysis Vertical analysis provides a bird’s eye view of the company’s fundamental financial position. In such analysis, the current year’s balance sheet of the company is used to determine how it is performing. Such analysis is also called common size analysis (Fess, n.d., p.1). While analysing the income statement of the company, the revenue for 2009 was considered as the base. While analysing the balance sheet for 2009, the total assets possessed by Yule Catto has been used as the base to determine the financial risk associated with the company. It can be summarised that the company’s operating profit is just 4 percent of the total revenue whereas the net profit is merely 2 percent. The proportion of operating profit as a percentage of revenue was higher at 7% in 2008 but there was a decline in the proportion of operating profit in the following year. The interest payable is also around 2 percent. The company possess a financial cost which is 3 percent of the total revenue of the financial year. In 2008 the proportion of profit was 10% of the revenue but this declined significantly in 2009 to 2% on account of fall in the revenue and rise in the operating and other expenses of the company. Vertical analysis of the balance sheet shows that Yule Catto possesses 53 percent non-current assets against 47 percent of current assets. The current liabilities are 45 percent of the total assets and noncurrent liabilities were 43 percent. A comparison with the last year reveals that the proportion of current and non-current assets has remained the same over the years under comparison. There has been an increase in the proportion of non-current liabilities and current liabilities as compared to 2008. Ratio analysis Ratio analysis is a commonly used management tool that assists in understanding and analysing the financial statement of a company (Storey, 1987, p.177). To analyse the financial performance of the company, the following ratios have been derived. 1. Management ratios: These are also called efficiency ratios because it reflects the efficiency with which the assets and liabilities are managed by the company to generate sales (Hunt, 2009, p.32). A higher inventory turnover ratio indicates that the company is able to convert its stock into inventory resulting in low levels of unsold stock. Yule Catto has been able to improve this ratio over the last year even though marginally. The inventory turnover ratio of the company is close to that of Cragielaw Plc of 8.05 suggesting that the company is not far behind its rival in terms of inventory management. The asset turnover ratio of the company is 1.19 in 2009 indicating a marginal fall over the previous year. This is less than the turnover ratio of Cragielaw Plc at 1.24 suggesting that the asset utilization of the company is not at par with that of its rival. 2. Cash flow ratio: Cash flow ratio reflects company’s ability to generate cash (Nikolai, et al. 2009, p.286). The operating cash flow ratio of the company indicates to what extent the current liabilities of the company can be covered by the cash flow generated from operating activities. This ratio is low for 2008 at 0.09 but there has been a marginal improvement in this ratio in 2009. But still it is less than the operating cash flow ratio of Cragielaw Plc implying that the cash flow generated by the company is not sufficient for taking care of its short term obligations. 3. Liquidity & working capital ratio: These ratios indicate how the company utilises its working capital to manage the short term liquidity problem (Deitz & Southam, 2008, p.389). The liquidity position of the company is fair as suggested by the current ratio of 1.05 and 0.97 in 2009 and 2008 respectively. Ideally this ratio must be 2:1. Although there has been an improvement in this ratio over the last year but still the company can improve it further. The liquidity position of Cragielaw Plc is better than the company. 4. Leverage ratio: These ratios show the financial gearing maintained by the company (Gibson, 2008, p.260). The company possess a high leverage ratio which can lead to high insolvency risk in future. Both debt-equity ratio and debt ratio are higher than the industry benchmark followed by Cragielaw plc. This implies that the company is overexposed to debt and is not a good sign. It is important that the company reduce its debt to reasonable levels. 5. Investor’s interest: The investors are generally interested in the returns that the company is able to generate on their funds. The ROE of the company was 84% in 2008 and this fell sharply to 21% in the following year on account of fall in the net profit. This is less than one-fourth of the ROE generated by Cragielaw Plc in 2009. Analysis of financial strength or weakness- The financial condition of the company is not very sound as suggested by the leverage and profitability ratios of the company. The high debt content in the capital base can result in serious financial exigencies for the company. Liquidity position of the company is also not very favourable as suggested by the current ratios. Even though the company has been able to improve it over the last year but still it is less than satisfactory. The decrease in the operating profit of the company is high when there is a fall in the revenue but the increase in operating profit fails to match with the rise in the revenue. This implies that the company management is not able to exercise control over the operating costs. Overall the financial picture of the company is not very convincing. Non-financial indicators The company is paying attention towards its corporate social responsibility (CSR) and thus it has taken several measures to minimise harmful effect on the environment due to its operational activities. The annual report of 2009 revealed that Yule Catto’s Safety Health and Environment (SHE) performance was satisfactory (Yule Catto & Co plc, 2010, p.14). The company had conducted regular meets and auditing to verify whether SHE programme is performing as per the plan. This will assist the company to acquire sustainable growth and added advantage in chemical industry of UK. Questions to the Financial Directors 1. Do you feel this sector possess healthy growth prospects in the international market? Reason- The increase in revenue over the last few years has not been very substantial. One way of improving revenue is to diversify and expand business operations. With the integration of the businesses across the world the company can tap the developing markets. 2. Do you think in days to come, Yule Catto will be able to further diversify its business in developing economies to minimise its dependency in UK market? Reason- The developing countries offer good growth prospects and can form an important source of revenue for the company. The slow growth in the revenue over the years In UK market can be tackled by tapping the international markets. 3. How does the company plan to improve its operating costs? Reason- The decline in the operating profit of the company is more than in proportion to the decline in revenue. One reason for this could be the failure of the company to control the operating costs. 4. Do you feel this company possesses the required competitive edge to combat the growing competition that has been plaguing this industry? Reason- The fundamentals of the company are weak when compared with the competitors. The return and profitability of the company was not good in 2009. Therefore it is important to know how the company plans to re-establish itself in the market and improve fundamentals. 5. Do the financial fundamentals provide the necessary confidence for investing in Yule Catto or not? The ROE of the company declined significantly in 2009 raising serious questions about investor interest. The fall in returns has a negative impact on investors’ confidence. An explanation to Q5 will help in knowing how the company plans to revive the confidence of the investors in the company’s stock. Reference AZoM News. Performance Analysis on UK Chemical Industry. [Online]. Available at: http://www.azom.com/news.asp?NewsID=21991 [Accessed on November 8, 2010]. Fess, W. R. No date. Financial Statement Analysis. Instructional Technology Development Center. [Doc]. Available at: http://webenhanced.lbcc.edu/acctgkc/acctg1bkc/coursedocs/Ch%2015%20Fin%20Statement%20Analysis.doc [Accessed on November 8, 2010]. Gibson, C. H. 2008. Financial Reporting and Analysis (Book Only). Cengage Learning. Hunt, P. A. 2009. Structuring mergers & acquisitions: a guide to creating shareholder value. Aspen Publishers Online. Nikolai, L. A., Bazley, J. D. & Jones, J. P. 2009. Intermediate Accounting.i Cengage Learning. Single, J. G., Shim, J. K., Hartman, S. W. & Hartman, S. 1997. Schaum's quick guide to business formulas: 201 decision-making tools for business, finance, and accounting students. McGraw-Hill Professional. Storey, D. J. 1987. The Performance of small firms: profits, jobs and failures. Taylor & Francis. Wilson, P. F., Dell, L. D. & Anderson, G. F. 1993. Root cause analysis: a tool for total quality management. American Society for Qualit. Yule Catto-a. No date. Investor Relations. [Online]. Available at: http://www.yulecatto.com/yulecatto/site.nsf/page!openform&page=investorhome [Accessed on November 8, 2010]. Yule Catto-b. No date. Polymer Chemicals. [Online]. Available at: http://www.yulecatto.com/yulecatto/site.nsf/page!openform&page=polymerhome [Accessed on November 8, 2010]. Yule Catto-c. No date. Pharma Chemicals. [Online]. Available at: http://www.yulecatto.com/yulecatto/site.nsf/page!openform&page=pharmahome [Accessed on November 8, 2010]. Yule Catto-d. No date. Impact Chemicals. [Online]. Available at: http://www.yulecatto.com/yulecatto/site.nsf/page!openform&page=impacthome [Accessed on November 8, 2010]. Yule Catto & Co plc. 2010. Being part of all our lives. Annual report For the year ended 31 December 2009. Bibliography Bragg, S. M. 2007. Business ratios and formulas: a comprehensive guide. John Wiley and Sons. O'Shaughnessy, J. P. 2005. What works on Wall Street: a guide to the best-performing investment strategies of all time. McGraw-Hill Professional. Laughlin, R.., Gray, R. & Wilson, R. M. S. 1988. Financial accounting: method and meaning. Taylor & Francis. Pratt, S. P. 2000. The lawyer's business valuation handbook: understanding financial statements, appraisal reports, and expert testimony. merican Bar Association. Riahi-Belkaoui, A. 1998. Financial analysis and the predictability of important economic events. Greenwood Publishing Group. Velde, M. V. D., Jansen, P. & Anderson, N. 2008. Management Research Methods. Wiley. Appendix- Ratio analysis for 2009 Yule Catto Yule Catto Cragielaw plc   £’000 £’001 £’000   2009 2008 2009 Management ratios       Sales 527,948 584,373 2,082 Inventory 56,145 63,507 258.7 Inventory turnover ratio (Sales/Inventory) 9.40 9.20 8.05 Inventory days (365/ITOR) 38.82 39.67 45.36 Sales 527,948 584,373 2,082 Receivables 99,006 126,136 378 Receivable turnover ratio (sales/receivables) 5.33 4.63 5.51 Days sales outstanding (365/RTOR) 68.45 78.78 66.28 Sales 527948 584,373 2,082 Payables 125,609 152,621 472.6 Payable turnover ratio (Sales/Payables) 4 4 4 Days payables outstanding (365/PTOR) 87 95 83 Sales 527948 584,373 2,082 Total assets 442,681 528513 1681 Total assets turnover ratio (Sales/total assets) 1.19 1.11 1.24         Cash flow ratios       Cash flow from operations 47,167 22,731 246.4 Sales 527948 584,373 2,082 Cash flow from operations to sales (Cash flow from operation/sales) 0.09 0.04 0.12 Cash flow from operations 47,167 22,731 246.4 Current Liabilities 199,089 256,521 646.3 Operating cash flow ratio 0.24 0.09 0.38         Liquidity & Working capital ratios       Current assets 209,298 250,106 717.1 Current liabilities 199,089 256,521 646.3 Current ratio (CA/CL) 1.05 0.97 1.11 Inventory 56,145 63,507 258.7 Quick ratio (CA-liabilities)/CL 0.77 0.73 0.71         Leverage ratios       Debt 189,055 212,677 227.2 Equity 54,537 66,692 105.2 Debt/Equity ratio (Debt/Equity) 3.47 3.19 2.16 Total liabilities 388,144 469,198 906.8 Total assets 442,681 528513 1681 Debt ratio (Total liabilities/total assets) 0.88 0.89 0.54         Investors interest       Net profit 11,888 56,563 95.6 Equity 54,537 66,692 105.2 Return on Equity (%) 21.80% 84.81% 90.87% Read More