The Financial Performance of Devro Plc - Case Study Example

Advanced Corporate Reporting of Introduction This paper seeks to explore and assess the financial performance of Devro plc for the last three and its exposure to current risk failure. This will also assess the impact of the revised requirements for revenue recognition upon the company’s results for the year, exploring the need for reporting accountants to practise within the ethical codes prescribed by the accounting professional bodies. 2. Discussion and Analysis 2.1 Explore and assess the financial performance of Devro plc for the last three and its exposure to current risk failure. To assess the financial performance of the company for the past three years entail looking at the company’s profitability, efficiency, liquidity and gearing ratios (Kieso, et al, 2007) as summarized in Table A below. Table A – Comparative Ratios for Three Years vs Industry Average (Devro, 2015a, 2015b; Reuters, 2015) 2.1.1 Profitability and Efficiency By looking at the company average profitability for the past three years , it is evident that that company has exhibited lower return on assets (ROA) and return on equity (ROE), gross margin and operating margin as against industry average as shown in Table A above. Only in net profit margin that the company has slight advantage as against the industry. By doing the analysis on a per year basis, it can be observed that the performance of the company for the year 2012 and 2013 only, was actually higher in almost all the profitability ratios than average except in net operating margin. As such it in 2014 that serious decline was most noticeable. From more than 16% net operating margins for 2013 and 2012, it went down 2.76% in 2014, which caused the sudden nosedive on net profit margin which average to above 13% but declined to 1.89% in 2014. See Table A above A restructuring of the company’s plants caused exceptional cost which reduced company income for 2014. See Table A above But in terms of gross revenues, there was only minimal decline and revenues further increased from 2013 to 2014. This means that company were delivering growth in revenues and market share but it was the level of its expenses that increased suddenly due to the need to restructure its operations. See Table A above. 2.1.2 Liquidity When operations shows decline, it should normally affect the liquidity or the capacity of the company to meets its currently maturing obligations (Khan & Jain, 2007) The company has exhibited current ratios of 2.04, 2.31 and 1.68 for the years 2012, 2013 and 2014 respectively or an average of 2.01. Its average current ratio for 3 years is evidently higher than industry average of 01.68. It quick ratio also registered 1.11, 11.09. and 0.88 for the years 2012, 2013 and 2014 respectively or an average of 1.03, which is lower r than industry average of 1.49 this time Both its liquidity ratios are indeed very high despite having lower quick as against industry average. See Table A above in Relation to Appendix A. 2.1.3 Solvency or Gearing Business entities are meant to stay long at its need to build a long-term value for shareholders. Thus its growth requires additional assets from time to time that must be financed by either debt or equity or both. It is the mix of these two sources of capital that will establish the capital structure of the company. The same structure must be optimized in order to help the company to minimize cost of capital and maximize wealth for shareholders (Khan & Jain, 2007). Gearing helps then in measuring the leverage as way of ensuring the optimum capital structure of the company. Thus gearing is measured by dividing total liabilities with total equity (Khan & Jain, 2007). Devro reflected debt to equity ratio of 0.99, 0.88 and 1.54, for the years 2012, 2013 and 2014 respectively or an average of 1.14 for the last three years. This is higher than industry average of 0.68. See Table A above. This means the Devro has less superior risk position compared with average. This gearing ratio is relevant in exploring the exposure of the company to corporate failure as now discussed in the next subsection 2.2 Devro’s current exposure to risk of corporate failure The company is exposed to different risks of corporate failure as stated in its 2014 Annual Report. The company management admits of its financial risks associated with capital, interest rate, foreign exchange, credit and liquidity. By prohibiting speculative trading in financial instruments as part of its financial policy. The company claims to have done this policy in the past and to continue the same in the future (Devro, 2015a). The company is very transparent in the way it manages its capital, by asserting that its objectives including safeguarding its business as a going concern, providing returns to sits shareholders and benefits for its other stakeholders, and maintaining an optimal capital structure. Its capital is the same gearing that was discussed earlier and it strategy to maintain an optimum capital structure consists in making continuous management of its cash flow in adjusting the amounts paid to its shareholders, the amount of return capital given to shareholders, the proper amount of newly issued shares and when proper by selling assets to reduce debt of the company (Devro, 2015a). As proof of company optimizing its capital structure, its average P/E-high for five years at 116.37 has surpassed industry average of 37.78 but its average P/E low ratio for five years at 10.16 was lower as against industry average of 14.49. The ratios mean that despite having higher risk position than industry it was able to attain high P/E price earnings ratio at certain points in time by considering time when investor overreacts. But during low price, Devro could not beat industry average simply because it has higher risk position. A more careful balancing may be in order as revealed by excessive liquidity as against higher risk position against the industry. See Table A above. 2.3 Assess the impact of revised requirements for revenue recognition upon the company’s results for the year, exploring the need for reporting accountants to practise within the ethical codes prescribed by the accounting professional bodies. (25 marks) The new requirement for revenue recognition is making the manner recognition under a contractual perspective where the focus of the new standard is on the transfer of control of the use of the assets to the buyer to justify recognition of revenue. A five-step model is used to guide revenue recognition and more professional judgement would be given to the accountant to recognize the proper amount of revenue but there requirements for more disclosure to inform users on the status of contracts entered into between buyer and seller which allow more than one time recognition of revenues. The possible impacts of such new standard for revenue recognition would be expected in have the probability of more revenues being recognized by the company. Such is logically connected with more freedom to recognize revenue based since standard principles-based rather rules-based. This is if course with due consideration to increased professional judgement of preparer of accounts or the accountants. The new requirement can be classified as principles-bases standard, rather than rules-based (Jones and Pagach, 2013). Because of the availability of the five-step model under new standard, accountants can still be properly guided o practice within the ethical codes prescribed by their professional bodies since they not at liberty to recognize revenues if the new guidelines or standard do not allow the same. In fact, it is expected that accountants would be more formal and more disciplined notwithstanding the increased judgement being given by to them. The new standards would be expected to eliminate transaction-and-industry-specific accounting guidance unlike the old standards provide for separate rules for software, construction and telecommunications companies (Jones and Pagach, 2013). It should be noted however, that increased is coupled greater responsibility due to the need for more disclosure about contracts with customers than presently practiced under the existing standards. When applied to Devro’s current results for the year, an expected revenue increase without increase the level of expenses would surely cause also higher profitability. With increased profitability the same should cause investors to react more favourable in giving more value for the company’s stocks price because of the related expectation of increase revenues and profits in the years to come after the new standards for revenue recognition will be put to use by the company. 3. Conclusion The companys performance in terms of profitability is still almost within the industry average but a decline in 2014 was notable due the restructuring of its plants. The revenue and profit performance without that exceptional item on restructuring is still solid for Devro. Its liquidity is high but its risky position is higher than industry averages. The company realizes the need to manage its cash flows and capital structure if it has to attain its objective of delivering shareholder increased value. Reducing its gearing and liquidity at the same time is advised to company to attain an optimum capital structure. References: Devro. 2015a. 2014 Annual report. Available at: http://www.devro.com/investors/annual-report/. Accessed 11th April 2015 Devro. 2015b. 2012 Annual report. Available at: http://www.devro.com/uploads/tx_sbdownloader/Devro_Annual_Report_2012.pdf Accessed 11th April 2015 Jones, J. and Pagach, D. October 2013. The Next Step for Revenue Recognition Examining the New_principle-Bsed Five Step Model: Examining the New Principles-Based Five-Step Model. The CPA Journal Khan & Jain. 2007. Financial Management. Uttar Pradesh: Tata McGraw-Hill Education, Kieso, et al. 2007. Intermediate Accounting. New Jersey: John Wiley and Sons Reuters. 2015. Industry Averages. Available at: http://www.reuters.com/finance/stocks/financialHighlights?symbol=DEITF.PK Accessed 11th April 2015 Appendices: Read More