La Suite East Plcs Performance and Financial Position - Assignment Example

La Suite East Plc’s Performance and Financial Position Overview Hara’s Holdings Limited is an investment company and is the major investor in La Suite East plc’s equity. The purpose of this paper is to present a report required by the Board of Directors of Hara’s Holdings Limited regarding the feasibility of the investment to be made in La Suite East’ equity pertaining to their planning for building a new hotel. In order to prepare a report on the investment feasibility, an in-depth analysis of the relevant data of La Suite East has been duly undertaken. The data considered for this report include summarised financial statements for the last four years along the circular of the Chief Executive of La Suite East plc. Evaluating La Suite East Plc’s Performance and Financial Position In the circular, the Chief Executive of La Suite East plc asserted that the company has been performing well and has very strong financial position. In this regard, the CEO has emphasised the last four years operations of the company and outlined the diversification of the company mentioning the acquisition of various businesses engaged in the different types of activity. The CEO asserted that through diversification, the company has been dramatically able to reduce the risk for its shareholders. Furthermore, it has been asserted that the turnover of the company has expanded to more than double since last four years. Here, the CEO mentioned that increasing sales for the company is accompanied with the constantly rising profit and prosperity of the business. In order to judge the validity of the CEO’s statement, the summarised financial statement for the last four years has been closely analysed. From the analysis of the financial statement pertaining to last four years, it has been identified that turnover of the company has shown unprecedented acceleration. Correspondingly, it has been recognised that during the year 2010 the total turnover of the company was £260 million which had increased to £296 million during the year 2011 and £392 million in 2012. However, as compared to the total turnover of the company in 2010, it has been observed that the total turnover of the company during the year 2013 had achieved unprecedented growth of more than double which is ascertained to be £544 million. Reflecting upon the turnover rate of the company, it clearly depicts its extraordinary performance over the last four years. Besides, from the shareholder point of view, it would be worth mentioning that shareholders of the company are also significantly benefitted with this growth. Evidently, the dividends for the shareholders are also been steadily increasing along with the operating profit of the company. Moreover, it has been observed that the current ratio of the company is 1.1 which reveals that it has adequate capability to meet its short-term financial obligation. At the same time, it can be observed that the quick ratio of the company is 0.80 which signifies that it has sufficient cash in hand to meet its current liabilities. Although it is slightly less than the thumb rule ratio but it cannot be considered as poor. Moving to the next point, it is determined that the debt ratio of the company is 40%. Correspondingly, it can be stated that the company shares little financial risk in terms of its ability to settle its long-term debt. Based on the figures that have been analysed above, it can be firmly stated that the CEO of La Suite East plc is justified in asserting that “the company has been performing well and has very strong financial position.” Assessing the Validity and Reliability of La Suite East Plc’s Strategies It has been recognised that the company is planning to expand its operations through opening a new luxury hotel with 400 rooms near Padstow in Cornwall. According to the CEO of the company, the new hotel will result in increasing the shareholder value in the form of significant increase in the share prices of its shareholders. Moreover, CEO believes that opening of a luxury hotel will facilitate the company to capture the untapped market opportunity existing in the UK market and at the same time it is expected that the hotel will contribute towards realising the broad corporate objectives. Furthermore, it is expected that the new luxury hotel will facilitate in maximisation of shareholder wealth. In this regard, it would be vital to test the soundness of the proposed luxury hotel in order to judge its feasibility and its prospect towards enhancing the shareholders’ value. It is worth mentioning that the all the activities of the company including hotel, publications, skating rink, gymnasiums, bus company car hire and theme park have done extraordinarily well over the last four years. However, it is vital to note that the hotel segment of the company has performed extremely well as compared to other business segments of the company. Accordingly, there has been considerable upsurge in the turnover and profit from the hotel segment. In this context, it is observed that the turnover from the hotel segment during the year 2010 was £157 million and the profit stood to be £29million which leaped to £377 million and £36 million respectively during the year 2013. Clearly, it can be ascertained that market for the hotel is at peak in the UK and there is greater propensity of earning substantial profit from this segment. Moreover, the price/earnings (P/E) ratio of the company is ascertained to be 0.6 times which distinctly define the increasing opportunity for the shareholder to maximise their wealth. Thus, it can be stated that the strategies followed by the company have greater possibility to increase the shareholder wealth. Determining Any Possible Errors in the CEO’s Statement It can be observed from the extract of the chief executive’s circular that La Suite East plc has considered consultant’s cost of £60,000 and total capital cost of £50 million required for the construction of the hotel till it is operational. Besides, 10% annual capital allowance for the capital expenditure after commencing the hotel is also clearly projected in the circular. The aspect of depreciation is ignored as it does not relate to cash flow. Subsequently, the construction cost generally incorporates cost associated with labour, material, contractor’s overhead, general requirements and equipment’s required during the construction process. However, in order to become operational other costs such as furniture and equipment along with cost associated with legal procedure need to be considered. Correspondingly, it can be stated that the CEO’s statement fails to reveal cost associated with furniture and equipment as well as cost pertaining to legal procedure. Measuring the Worthiness of the Proposed Investment In order to measure to the project worthiness, it is often emphasized testing the financial worthiness of the project (Kettering & Brooks, 1980.) It is often advocated to examine the financial statements in comparison with the actual record of financial activities of the particular company or the business in order to make decision regarding whether to make investment or not. Financial forecasting is considered to be an effective approach for gaining better understanding the performance of the company as well as for measuring the effectiveness of the project. In order to analyse financial statement, one of the viable tools is considered as financial ratios. Financial ratios often provide a clear picture regarding the financial condition and the performance of the company. Financial ratio is categorised into liquidity ratios, profitability ratios, market trend ratios and debt management ratio. Liquidity Ratio Liquidity ratios are applied to measure the ability of the company to fulfil its short-term obligations. It establishes the associations between the company’s cash and other assets to its current liabilities. Two major liquidity ratios include current ratio and quick ratio (Lutz, 1945). Current Ratio In this regard, current ratio postulates the affiliation between liquid assets and payment commitments. According to the thumb rule, the standard current ratio for a company is 200% or 2 and if the ratio is below 100% or 1, it is regarded as threat to the company (Björnsdóttir, 2010). Correspondingly, the current ratio of La Suite East plc is above 1 that entails 1.1 which signifies that the company has sufficient ability to fulfil its current liabilities effectively. This implies that the proposed investment from this point is worthwhile. Quick Ratio Next, the quick ratio is another liquidity ratio that is considered to be worth for measuring the viability of the proposed investment. As per the thumb rule, the ratio should surpass 100% i.e. it should be more than 1(Kirkham, 2012; Björnsdóttir, 2010). Accordingly, it has been ascertained that the quick ratio of La Suite East plc is 0.8 which can be considered to slightly less than the standard thumb rule. From this viewpoint, it can be stated that the proposed investment is not much worthwhile but it can be vague to totally state that the project is not feasible. Profitability Ratio Profitability ratios measure the ability of a company to generate profit. The ratios are generally focused upon sales, asset and debt of the company. The profitability ratios taken in consideration for the measuring the worthiness of the proposed investment include operating profit margin, return on equity return on operating assets and asset turnover ratio (Cara Scatizzi, 2010). Operating Profit Margin Operating profit margin ratio measures the ability of a company to generate profit from its current operations (Loughran & Ritter, 1997). The operating profit margin for La Suite East plc is ascertained to be 22%. This signifies that the company earns 0.22 on per Pound Sterling which is relatively good from the investors’ point of view. Accordingly, the proposed investment can be considered to be worthwhile. Return on Equity Return on equity is a measure for profitability of shareholder’s investment. Higher value is considered to be favourable for the shareholders. In this regard, 16.5% of return on equity for La Suite East plc implies that shareholders of the company are provided with fair returns on their investments. Thus, from this viewpoint, the proposed investment can be considered to be worthwhile (Easton & et. al., 2002). Operating Return on Asset This ratio measures the operating income generated per Pound Sterling invested in the total assets which is calculated taking EBIT (Earnings Before Interest and Taxes) into account. Accordingly, the operating return on asset for La Suite East plc is observed to 8.5% which can be attributed as favourable from the shareholders’ perspective. Thus, it can be determined on the basis of this ratio that the proposed investment is favourable (Loughran & Ritter, 1997). Total Assets Turnover It is generally the measure of company’s efficiency that entails the amount of sates generated per Pound Sterling of assets. Accordingly, it has been determined that the total assets turnover for La Suite East plc is 0.6 times which signifies that their lies greater opportunity for the shareholders’ to attain return from the proposed investment. Market Trend Ratio Market trend ratios are associated with earnings and dividend. It involves price/earnings ratio and price/book ratio (Ashgate Publishing, n.d.). Price/Earnings (P/E) Ratio P/E ratio is related with current share price of a company compared to per-share earnings. It can be determined that the P/E ratio for La Suite East plc is 16 times which is relatively favourable from the shareholders’ point of view. Thus, the proposed investment can be considered to be worthwhile. Price/Book Ratio This ratio compares the market value of stock to its book value. Lower ratio is considered to be unfavourable (Agrawal & et. al., 1996). It has been observed that for La Suite East plc, it is 2.5:1 which implies favourable to shareholders. Debt Ratio Management Debt ratio management is concerned with how the management or the company uses its debt relative to its assets. Debt ratio management considered for measuring the worthiness of the proposed investment includes debt ratio, interest coverage ratio and average collection period (Connexions, 2010). Debt Ratio Debt ratio measures the percentage of debt that is used by a company to finance its assets. High debt ratio signifies that the company is significantly relied on borrowing while low ratio represents lower reliance on borrowing. Correspondingly, the debt ratio for La Suite East plc is ascertained as 40% which can be considered to be favourable as the company reveals lower financial risk (Connexions, 2010). Examining the Position of Room Rate and Occupancy Rate The Chief Executive in his circular conveyed that “the room rate is more critical factor for the viability of the hotel project than the occupancy rate”. In order to examine the validity of this statement, it would be vital to derive an understanding regarding both the aspects including room rate and occupancy rate. Correspondingly, it can be argued that room rate is not much essential for deriving value from the revenue management system. The goal of the revenue management system should not be the associated with increasing the room rate but it is essential to augment occupancy rate instead. The increased occupancy leads to generating additional revenues. Occupancy rate facilitates in effective strategic planning along with enhancing the management practice. Besides, occupancy rate is considered to be a major factor that motivates investors to invest (Marek & Brewer, 2006; O’Neill & Mattila, 2004; Law, 1998). Thus, it can be stated that the Chief Executive’s thinking that room rate is critical for the viability of hotel project than occupancy rate is not valid. Factors that Need to be Considered for Investment Other than Financial Data It is worth mentioning that investment appraisal based on the financial data provides scientific -decision making approach for the investors. However, financial data do not reveal the clear picture, it is thus essential to consider other factors as well prior to making investment decisions. In this regard, accuracy of market research can be considered to an imperative factor as failure to acquire accurate information regarding the market trend can result in heavy financial loss. Besides, the aims of the company need to be carefully analysed in order to attain a clear picture of the company. Apart from reliability of financial data, business ethics of the company and personnel within the company are essential components to be considered prior to making investment decisions (Financial Accounting Standards Board, 2008; Ward & et. al., 1990). References Ashgate Publishing, No Date. Financial and Stock Market Ratios. Section 3, pp. 41-54. Agrawal, S. P. & et. al., 1996. Price to Book Ratio as a Valuation Model: An Empirical Investigation. Finance India, Vol. X, No2, pp. 333-344. Björnsdóttir, A. R., 2010. Financial Feasibility Assessments. University of Iceland, pp. 1-67. Cara Scatizzi, 2010. Profitability Ratios. Fundamental Focus, pp. 20-21. Connexions, 2010. Debt Management Ratios. Summary. [Online] Available at: http://cnx.org/content/m15608/latest/ [Accessed February 28, 2014]. Easton, P. & et. al., 2002. Accounting Research Center, Booth School of Business, University of Chicago. Journal of Accounting Research, Vol. 40, No. 3, pp. 657-676. 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O’Neill, J. W. & Mattila, A. S. 2004. Hotel Branding Strategy: Its Relationship To Guest Satisfaction And Room Revenue. Journal of Hospitality & Tourism Research, Vol. xx, No. x, pp. 1-10. Ward, K. & et. al., 1990. Marketing Investment Analysis: The Critical Success Factors For Financially Evaluating and Effectively Controlling Marketing Investment Decisions. Cranfield School of Management, pp. 1-19. Read More