Financial Accounting of Thomas Cook Group Plc - Essay Example

Corporate Finance and Financial Accounting (CFFA) of Thomas Cook Group Plc Thomas Cook Group Plc Thomas Cook Group Plc is a leading travels agency with a worldwide presence. The business consists of providing holiday packages, foreign exchange facilities, booking hotels and flights, insurance facilities and passport and Visa services. Over the years, the company has played a significant role in international travel and tours. It is also one of the most trusted brands in this industry. Through its online services, flight tickets to any part of the world can be easily booked. One can compare different flight rates and timings and choose the most convenient one. The same applies for hotel booking. Through the insurance facilities, the company offers added security for its travellers. It also provides financing schemes, whereby the travel is funded by the company and the customers are required to pay back later. Travel industry is an ever growing and ever changing domain. Developing, innovating and meeting the market needs seem to be quite a challenge for the firm (Thomas Cook, 2014). This essay throws light on the overall performance of Thomas Cook Group so as to decide upon its acquisition. An acquisition plan requires careful analysis of the target firm’s profits, financial performance and environmental analysis. On the basis of these, it becomes simpler to judge whether acquiring the company would prove as a successful venture or not. Therefore, through the following steps, performance of Thomas Cook Group has been critically analyzed. Step 1- Value analysis of the target company Value analysis is a process, whereby we can deduce whether a firm is financially sound enough. In other words, it refers to estimating the financial position of the company. This analysis is done on the basis of financial statements, such as, profit and loss account and balance sheet. This study also takes ratio analysis and cash flow statement analysis into consideration. Value analysis is an important criterion as it helps to decide whether a firm is financially able to be procured by the parent firm. In this case, since Thomas Cook Group is the target company that is being acquired, it is necessary for the firm to judge self value well before proceeding with the acquiring process. In this analysis, it is highly important to recognize the rival firms of Thomas Cook Group. They shall accordingly be used as benchmark companies for the target company. Since TUI Travel Plc appears to be a significant competitor, it has been selected as the benchmark firm (Hoovers, 2014). Firstly, a descriptive study of the target company as well as its benchmark companies needs to be done on the basis of ratio analysis. Figure 1: Ratio analysis of Thomas Cook Group Plc Source: (The Telegraph, 2014) Figure 2: Ratio Analysis of TUI Travels. Source: (The Telegraph, 2014) P.E. ratio- It is calculated as market value per share divided by the earnings per share. A high P.E. Ratio would mean a high growth. From the above figure, it can be estimate that the P.E. ratio of TUI Travels is higher in comparison to American Express and Thomas Cook. A low P.E. ratio for Thomas Cook signifies that the company is lagging behind in terms of investment. An average P.E. ratio should be at least 20% more than earnings (B. Elliot and J. Elliot, 2013). Enterprise Value (EV) to Sales Ratio- This ratio is calculated by market capitalization + Debt + preference Equity – Cash and cash Equivalents/ Annual sales. In general, if the revenue is low, it results in a lower EV to sales ratio (Ross, Westerfield and Jaffe, 2012). Since from the above it can be seen that Thomas Cook has lower ratios and values than TUI Travels, it can be stated that the EV to sales ratio of Thomas Cook will also be low. Again, the main reason for this is low profits. Enterprise Value to EBITDA Ratio- The scenario in the case of EV to EBITDA ratio is also quite same as the above ratios. EBITDA is nothing, but earnings of the firm before payment of interest on debt. Depreciation being a non-cash expense is added back to the earnings. Therefore, if the earnings are low, it is most likely that the firm will have a low EV to EBITDA ratio. Thus, even in this case, the ratio of TUI Travels will be higher. EBITDA to sales ratio Figure 3: EBITDA to Sales Ratio of Thomas Cook Source: (4-Traders, 2014) Figure 4: EBITDA to sales ratio of TUI Travels. Source: (4-Traders, 2014) From the above figure, it is seen that Thomas Cook has sales of 9315 and EBITDA of 425 in the year 2013. So, the ratio of EBITA to sales would be 0.045. Similarly, TUI has sales of 15051 and EBITDA of 780. So, the ratio would be 0.051. Hence, TUI has a greater ratio. From the above analysis, it can be seen that TUI has outperformed Thomas Cook in multiple ways. Nonetheless, it should also be kept in mind that TUI being one of the best firms of the industry is likely to perform well. If some smaller firm was selected as a benchmark, instead of TUI, then perhaps the results of the above comparison would have been different and ratios of Thomas Cook would have been higher. However, this analysis points out that even though Thomas Cook figures are low, it is not lagging behind much. With proper financial planning, the position can be improved. Step 2- Environmental analysis of Thomas Cook (SWOT) Strengths Thomas Cook Group has a good market base. Initially, its market position was quite strong; but at present, the revenues are noticed to reflect a declining trend. This is due to existence of strong competitors such as, American Express and TUI Travels. The firm needs to concentrate on developing better strategies by which it can attract more customers and maintain, if not lose, its existing market. Even so, high goodwill in the market has helped Thomas Cook to be counted among one of the best travel agents. The company’s strong financial plans and innovative measures can surely help to retain the market position. Their online client base is also very strong, which has increased considerably over the years. Another notable plus point for the firm is its team of dedicated employees. The STARS (Senior Training and Recognition Scheme) program has helped the company to develop skills of their employees with the changing requirements of the business. The firm has a sound management model that has played a significant role in conducting expansion across nations. It aims to provide the best travel experience for its customers; and therefore, the firm invests in high class airplanes and other luxury travel options. One of the main reasons of the company’s success is its worldwide presence (Samples of College Essay, 2012). Weaknesses Lack of investments is the main weakness of Thomas Cook Group. The company needs to improve on its market strategies in order to be able to tap a greater segment of the market. Although Thomas Cook’s performance has been quite well, it is very likely that it might enter a down phase in case reforms are not made. For instance, if the company wants to incorporate a new system in its operation, it needs to train the workforce that is spread worldwide. This is a costly venture. With a weak financial position, this may not be possible. Another major setback for the company is that growth of smaller travel agents in specific nations. This incidence has led to loss of market. These smaller firms provide more specialized travel solutions, given that they are well-acquainted with travelling needs of their target segments (Samples of College Essay, 2012). Opportunities The company has over the years been successful in building a global network. It can cater to anyone in need of a travel and tour operator across the globe. Thomas Cook has its main client base in UK and Europe; but, it has a better holding in the Asian markets compared to TUI Travels. It has been able to deliver high satisfaction to its customers. Thomas Cook also provides financing solutions to their customers, which have again significantly helped them to bring in more revenue, especially in the eastern market of the world. Financing travel and logistics has been a successful venture for Thomas Cook Group. Another significant matter to be considered is that the company had been able to sustain the global meltdown in the recent past, while many travel related organizations were facing huge revenue crunches. Thomas Cook was able to survive the tide without much damage (Samples of College Essay, 2012). Threats Although the company has a stable financial condition, it has not been able to grow much in last few years. The growth position has almost been stagnant. This might lead to declining revenues in future. Also, significant growth of TUI Travels and American Express poses quite a threat for the company. The reason why the firm has not been able to grow is the lack of modernization, which again requires huge investments. Furthermore, it has not been able to come up with effective market strategies in the past few years. The firm needs to develop on its capabilities and take preventive measures to cut down the fall in profits (Hill and Jones, 2011). Step 3: Financial modelling and integration In order to formulate a suitable business plan, it is important to first analyze the balance sheet and Profit and loss account of the firm thoroughly. On the basis of this, insight is developed relating to the operations, capital structure and investment patterns of the firm. The balance sheet and profit loss account are main statements that help to judge the true financial state of the company. Figure 5: Financial statements of Thomas Cook. Source: (Redmayne Bentley, 2014) Operations Analysis- From the above data, it is observed that the firm has achieved a positive operating profit in comparison to its previous two years. This means that considerable efforts have been made to increase sales, reduce costs and generate larger returns on investments. If the trend is followed, it is likely that the company can prevent losses in its operations in the coming financial years. For this, however, it is important that the company either sorts out a way to increase its revenue by a large margin or take substantial cost cutting measures. Another effective way is to invest on growth and expansion; although this drains a lot of funds in the beginning, it assures high returns as sales increase in future. Even so, such a step might not show immediate results. Its effect upon operating profit can be only visible in a couple of years. Capital Structure- From the above data, it is observed that the company’s prime component in its capital structure is equity. This is not a favourable scenario at all. This is a low capital gearing structure, where there is little or no leverage due to absence of debt fund. The only leverage the firm can enjoy is that which arises out of preference shares. A sound capital structure constitutes a perfect trade off between risk and returns. Nonetheless, considering the fact that Thomas Cook had negative profits in the last financial year, low debt fund is suggested. Debts need to be accompanied only when there is sound cash flow. Having debt fund in the capital structure would mean that the company needs to pay fixed interests on such debts, irrespective of the profit scenario. In case of equity, dividends are paid only after meeting all other expenses, out of residual profits. If the company has low profits, it requires paying low rates of dividend. Investment structure- From the balance sheet above, it is noticed that fixed investments of the firm have a decaling trend. The primary cause for this is low revenue generation. Investments lead to increased returns and growth by virtue of expansion of business. Yet, a declining trend in investments proves that financial condition of the firm is not sound. The company needs to take drastic steps for attaining profit objectives, which is the only way for the firm to sustain. Free Cash flow analysis Before forecasting the cash flows, it is necessary to first look into the free cash flow scenario of the company as of the previous financial year. Figure 6: Cash flow Statement. Source: (FE Investigate, 2013) From the above data, it is seen that the free cash flows have increased subsequently in the year 2013 as compared to 2012. The primary reason for this is a notable increase in EBITDA and working capital. Now, a forecasted cash flow is required to be prepared. In order to calculate the forecasted or discounted cash flow, a discounting factor is required. This factor is nothing, but weighted average cost of capital of equity; based on which, the cash flows are discounted. CAPM model- In order to develop a Capital Asset Pricing Model (CAPM), the following aspects are considered: Risk free rate of return (Rf) –This risk free rate of return is taken to be 0.34, on the basis of UK Treasury bill yield rate (Financial Times, 2014). Beta factor- This is taken to be 1, given that we are considering yield rate on treasury bills that have low volatility (Financial Times, 2014). A beta factor of one is applicable for neutral security, generally not affected by market movements and is a strong contributor to the market index. Market rate of return (Rm) - this is taken to 5% (as already specified). Thus, the CAPM is calculated as - Rf + Beta (Rm- Rf) = 0.34 + 1 (5- 0.34) = 1.34 (4.66) = 6.24 (approx) (Berk and DeMarzo, 2013). WACC (weighted average cost of capital) of equity- From the CAPM model above, we have calculated the cost of equity. For the purpose of calculating WACC, proportion of equity in the balance sheet and the book value of equity are required. The shareholders fund above shows a value of 509.3, which is taken to be the book value of equity. Since capital structure of the firm mainly consists of shares, we take the weight of equity to be 1. Accordingly, the WACC is computed as follows - Weight of equity*specific cost of equity =1*6.24 =6.24 So, the WACC is 6.24 (Berk and DeMarzo, 2013). Forecasted cash flows- Based on the above CAPM and WACC calculations, the cash flows can be discounted. An estimated cash flow has been shown below for 5 years, taking the original values of 2011, 2012 and 2013; whereas, values of 2014, 2015 and 2016 are estimated based on the discounting factor of 6.24. Figure 7: Forecasted Cash Flow Source: (4-Traders, 2014) It is seen from the above analysis that the cash flows after discounting have substantially augmented. This means that if the firm continues to earn profits at the same rate of increase, then higher revenue can be generated. Now, based on the discounted values of EBITDA, we can calculate whether the firm has positive Net Present Value or otherwise. In order to ascertain the NPV, total initial cash outlay from the year of calculation of EBITDA needs to be found out. The total discounted cash flow or EBITDA from the above figure is 3015. The difference between the forecasted cash flow and the initial cash outlay is the net present value. So, the firm can only have a positive net present value, if cash outlay is lesser than 3015. Thus, while acquiring Thomas Cook, it is important to consider this aspect in order to prevent over investment and hence, a negative NPV. A negative net present value implies that the firm is not generating enough revenues so as to cover existing investments. The revenue may be growing, but such is not adequate (Tirole, 2010). Recommendations for improving the financial position Enhancing liquidity- Thomas Cook needs to seriously focus on maintaining a decent level of liquidity. This would help to give greater momentum to its financial operations. This also offers an opportunity to the firm to earn interests by giving financial assistance to customers. A higher liquidity would also mean that the firm’s repayment capacity would increase, paving way for acquiring short-term debts (Joehnk, 2012). Cost cutting schemes- This is one of the most common methods of generating revenue at times of poor development. By way of cost cutting, Thomas Cook Group had managed to earn sufficient returns in the fiscal year of 2013. Then again, this is not a very effective way to deal with revenue shortage. Cost cutting hampers growth and innovation in a major way. Performance appraisal- Business is mainly teamwork. A collective and collaborated effort of people renders a business successful. In business, no work is completely isolated. Adequate steps must be taken so that the firm can appraise correctly. Departmental performance appraisal refers to analyzing how efficiently sector goals are met. So, standards of appraisal need to be set and performance should be analyzed accordingly. Business appraisal as a whole means appraising the entire firm for a given period of time. Effective comparative analysis can also be done here by comparing one firm’s performance with another. Acquisition Decision- Thomas Cook Group Plc is one of the leading firms of the travel industry, which is quite developed and is growing day by day with the world becoming one global village. People like to spend money on vacations and holidays for a break from the hardships of daily life and to have a good time with friends and family. This concept has allowed travel industry to remain successful. Hence, investing in a travel agency has great advantages. Although in comparison to the market, performance of Thomas Cook has not been too good, it does not necessarily imply that the company is unsuccessful. The only problem is slow growth. If the company takes a few profitable measures with regards to its financial structure and market strategies, it can surely do well. Moreover, Thomas Cook’s brand name is also an aspect that cannot be ignored. Therefore, acquiring the company shall be a good venture. Through this acquisition, the firm might gain the financial support that it needs to improve. Reference List 4-Traders., 2014. Thomas Cook-Financials. Available at: < http://www.4-traders.com/> Berk, J. and DeMarzo, P., 2013. Corporate Finance. New Jersey: Pearson Education. Elliot, B. and Elliot, J., 2013. Financial Accounting and Reporting. New Jersey: Pearson Education. FE Investigate, 2013. Thomas Cook Group Final Results. Available at: [Accessed 10 March 2014]. Financial Times, 2014. Bond and Rates. Available at: [Accessed 10 March 2014]. Hill, C. and Jones, G., 2011. Essentials of Strategic Management. Connecticut: Cengage Learning. Hoovers, 2014. Thomas Cook Group Plc Competition. Available at: [Accessed 10 March 2014]. Joehnk, G., 2012. Fundamentals of Investing. New Jersey: Pearson Education. Redmayne Bentley, 2014. Thomas Cook Group. Available at: [Accessed 10 March 2014]. Ross, S., Westerfield, R. and Jaffe. J., 2012. Corporate Finance. New York: McGraw-Hill Education. Samples of College Essay, 2012. Swot of Thomas Cook. Available at: [Accessed 10 March 2014]. The Telegraph, 2014. Fundamentals. Available at: [Accessed 10 March 2014]. Thomas Cook, 2014. About us. Available at: [Accessed 10 March 2014]. Tirole, J., 2010. The Theory of Corporate Finance. New Jersey: Princeton University Press. Read More