Retshop Plc - Financial Analysis - Example

Retshop Plc Retshop Plc Introduction This report has been prepared for the consideration of the investment committee in which financial performance of Retshop plc for subsequent three years from 2010 to 2012 has been analyzed together with the financial position. The purpose of this report is to enable the investment committee to make a decision regarding the investment in Retshop plc to either retain it or dispose of the holding of 20% share holding. Profitability Ratios Gross Profit Margin Gross profit margin declined from 28% in 2010 to 25% in 2012. There are obvious reasons behind the continuous decrease in gross profit margin, that the manufacturing costs, especially cotton prices and wages, are increasing continuously and there is a tough competition in the market. In fact sales prices have increased by 5% from 2010 to 2011, but the increase in the cost was much greater than the increase in sales prices resulting in net decline. Net Profit Margin (NPM) Net profit margin also decreased by 4% from 2010 to 2011 however; in the year 2012, a slight improvement is shown where it reached 8% in from 7 % in 2011. The factors behind the decline are the increased in the manufacturing cost as well as operating cost as highlighted by the director finance Retshop plc in his presentation. Return on Capital Employed (ROCE) Return on capital employed indicates the efficiency of the management in generating revenue from its available resources(Gibson, 2010). It is a positive sign that Retshop has very high ROCE in all three years. Although it has declined by 21% from 2010 to 2012, but still the company is able to maintain a very high ROCE percentage. The major reason behind the decline in ROCE is the increase in the capital employed due to the increase in retained profit over the years. Cash Flow Ratios Cash Return on Capital Employed (CROCE) This ratio indicates the cash generated from operations using all resources available the company(Norton, et al., 2007). Retshop plc has a very healthy figure for CROCE in all three years. There is a decline of 21% from 2010 to 2012. The reason behind the significant fall is the increased level of retained earnings over three years time, which reached to £53 million in 2012 from £30 million in 2010. Cash Interest Cover Cash interest covers reflects how many times greater the cash is generated from operations as compared to interest payments(Fridson & Alvarez, 2011). There is a sharp decline of 7.58 times from 2010 to 2011 but there is a slight improvement of 1.5 times in 2012. The major reason behind the change is the net profit which is affected by continuously increasing operating cost. Free Cash Flow per Ordinary Share Free cash flow per ordinary shares indicates the cash generated on each share. There is a declining trend since 2010 and onward. Cash flow per share has fallen to £1.8 per share in 2012 from £3.8 per share in 2010. The main reason for this fall is the lower cash flows from operations due to the lower net profits in the subsequent 2 years. Liquidity Ratios Current Ratio Current ratio over the period of three years is showing continuous improvement. There was a slight increase in 2011 where current ratio increased to 1.33 from 1.31 in 2010 but, there is a significant increase in 2012 from 1.33 to 1.85. This is because of the fact that Retshop plc is holding a significant amount of inventories in 2012 than in previous two years in anticipation of the raise to cotton prices. Acid Test Ratio As far as this ratio is concerned the position of the company doesn’t look satisfactory. There is an increase in the acid test ratio from 0.38 in 2010 to 0.48 in 2012. When comparing it with current ratio it is clearly indicating that Retshop is holding a significant amount of inventories n the current assets leaving the less liquid assets available against the current liabilities resulting in the lower acid test ratio. Inventory Turnover Inventory turnover implies the number of time the inventory has been sold in a year and replaced in a year(Nikolai, et al., 2009). Inventory turnover is least in the year 2012 that is 5.69 times. It was increased to 8.21 in 2011 from 7.67 in 2010. The major reason for the lower inventory turnover in 2012 is that the Retshop is current holding a significant amount of inventory as compared to last 2 years due to the reason that the cotton prices are continuously raising. Trade Receivable Collection Period The lower trade receivable collection period is a positive sign for the Retshop. The collection period of 10.67 days in 2012 is highest amongst the last three years which is still reasonable. The lower collection period is due to the nature of the business of the Retshop plc where there are minor sales on credit and the major revenue is generated through cash sales. Trade Payable Payment Period There is no major change in the payable time period in all three years. Payable period remained between 25 days to 27 days from 2010 to 2012. The major reason behind the consistency is the minor changes in payable balances and cost of sales value in all three years. Financial Position/ Solvency Ratios Gearing Gearing measures the portion of the debt as compare to the portion of the equity to finance the business(Fridson & Alvarez, 2011). The lowest gearing is 20% in 2012 in comparison to 49% in 2010. There are two factors for this decline. One of them is the significant increase in retained profit from 2010 to 2012 and the other is the repayment of £10 million against long term debt in 2011. Interest Cover Interest cover has declined to 6.5 times in 2011 from 13.37 times in 2010 due to the lower profit from operations and net increased finance cost of £2 million. However, situation is slightly better in 2012 where interest cover is 7.83 times, since the profit in 2012 is £7 million higher than in 2011. Net Assets Turnover Net assets turnover is showing a declining trend from 2010. It dropped to 4.02 times in 2012 from 4.78 times in 2010. This shows the company is slightly inefficient in generating revenue from its resources. The main reason behind the decline is the lower growth of in revenue then in capital employed. Non Current Asset Turnover There are minor changes in the non current asset turnover ratio in three years. Turnover ratio of 5.43 in 2012 is slightly better than the turnover ratio of 4.92 in 2010. There are no special reasons for this minor change except a little increase in sales revenue. Price Earnings Ratio There is no permanent trend can be seen in P/E ratio. This was highest of 23.86 in 2011 and lowest of 13.33 in 2010. The change in the P/E ratio is due to the change in share prices. In 2010 EPS was 360 pence which resulted in higher share prices in 2011. Lower EPS in 2011 again resulted in fall in share prices from £52.5 to £46 in 2012. Capital Expenditure to Depreciation ratio This ratio is continuously decreasing since 2010, which means that Retshop plc is not investing heavily in the noncurrent assets. The major reason for the low investment on fixed assets is current competitive situation in the market which minimizes the chances of growth. The current demand for the goods can be satisfied with the use of available fixed assets so no more investment is needed. Cash Dividend Cover Ratio This reflects the company’s strength to meet the dividend payments from the cash generated from operations(Norton, et al., 2007). Cash dividend cover is declining due to the reason that the cash generated from the operation is significantly affected by the raise in the manufacturing and operating cost from 2010 to 2012. Net decline in three years is 2.42. Investors Ratios Dividend Yield There is not a significant movement in dividend yield from 2010 to 2011. In all three years Retshop plc has paid a fixed dividend of £1.3 per share. The changes in the dividend yield are due to changes in share price as a result of EPS. Higher EPS resulted in increased market price for shares in 2011 and vice versa in 2012. Dividend Cover Dividend cover declines from 2.77 to 1.5 from 2010 to 2012. The decline is due to the fact that the earnings of Retshop are continuously falling from 360 pence in 2010 to 270 pence in 2012 but it is still paying dividend at a fixed rate since last three years. Conclusion On the basis of detailed financial analysis the Retshop plc. is reasonably sound as far as the liquidity and solvency is concerned. The cash flows also show a satisfactory position but the profitability has been greatly affected by the tough competition in the industry and increased cost. Share prices are rising due to the increase in EPS. On the basis of these facts it can be concluded that the retention of investment in Retshop plc. will be a good decision until a better opportunity is available. Cash Flow ratios Cash Return on capital employed (Cash return/Capital employed)*100 81% 61% 60% Cash Interest cover (Times) Cash return/Interest paid 15.25 7.67 9.17 Free cash flow per share (Pounds) Cash flow per ordinary shares/Number of ordinary shares 3.8 2.6 1.8 Financial position / Liquidity ratios Current ratio (Times) Current Assets/ Current liabilities 1.31 1.33 1.85 Acid test ratio (Times) (Current assets-inventory)/ Current liabilities 0.38 0.30 0.48 Inventory Turnover (Times) Cost of sales/Inventories 7.67 8.21 5.69 Trade receivable collection period (Days) Receivables/Revenue*365 4.56 4.65 10.67 Trade payable payment period Creditors/ Cost of sales*365 26.98 25.39 27.09 Financial position / Solvency ratios Gearing Net Debt / Equity 49% 29% 20% Interest cover (Times) Profit from operations/Interest expense 13.75 6.5 7.83 Net Assets turnover (Times) Revenue/ Capital employed 4.78 4.36 4.02 Noncurrent Assets turnover (Times) Revenue/ Noncurrent assets 4.92 4.69 5.43 Price earnings ratio Current market price per share/Earnings per share 13.33 23.86 17.04 Capital expenditure to depreciation ratio (Times) Capital expenditure/Depreciation 1.67 1.00 0.38 Cash dividend cover ratio (Times) Cash for ordinary shareholders/ Equity dividend paid 3.80 2.00 1.38 Investors ratios: Dividend yield (Dividend per share/Market value per share)*100 2.71% 2.48% 2.83% dividend cover (Times) Earnings per share/Dividend per share 2.77 1.69 1.50 Appendix 2 List of References Fridson, M. S. & Alvarez, F., 2011. Financial Statement Analysis: A Practitioners Guide. New York: John Wiley & Sons. Gibson, C. H., 2010. Financial Reporting and Analysis: Using Financial Accounting Information. Mason, OH: Cengage Learning. Kimmel, P. D., Weygandt, J. J. & Kieso, D. E., 2009. Financial accounting: Tools for business decision making. Hoboken, NJ: John Wiley & Sons. Nikolai, L. A., Bazley, J. D. & Jones, J. P., 2009. Intermediate Accounting. Mason, OH: Cengage Learning. Norton, C. L., Diamond, M. A. & Pagach, D. P., 2007. Intermediate Accounting: Financial Reporting and Analysis. Mason, OH: Cengage Learning. Read More