Chelsea Plc Financial Ratios - Case Study Example

Analyse the result from the calculation and case study provided Contents Task 3 Question 3 Task 5 Question 2 5 Task 2 7 Question 3 7 Task 3 9 Question 2 9 References 12 Task 1 Question 1 Chelsea Plc is on the verge of expansion of its business through acquisition of another company operating in the same industry. The financial ratio of Kensington and Wimbledon is compared. Profitability ratio, activity ratio and liquidity ratio of the companies are compared for evaluating the financial stability. The return on capital employed is considered as one of the best method in determining the profitability of the firm. It determines the ability of the organization in utilizing its debt and equity for generating adequate return. It depends on the earning of the company before payment of interest and taxes and the capital employed by the entity which is the difference between the total asset and total liabilities. It is observed that Wimbledon experiences more ROCE as compared to Kensington which indicates that Wimbledon is able to generate more return from its business operation. On the basis of Return on Equity also it is observed that Wimbledon is able to generate more profit from its shareholders investment as compared to Kensington. This implies that the former company is experiencing sound equity position required for financing its funds. Net profit margin of the company is determined after meeting all operating expenses off the business. On the basis of the net profit margin it is analyzed that Kensington is experiencing an increase in the net profit margin of the company. It is able to earn more profit as compared to the industry average. The net profit margin is considered as most efficient technique for determining the financial performance of the company. Kensington is also able to derive an increasing rate of gross profit and it is able to generate more gross profit ratio than the industry average. It determines the amount available with the company after paying of the cost of goods sold. From the above profitability ratio it indicates that Kensington is able to generate more ROCE and ROE as compared to Wimbledon, whereas Kensington is able to earn more gross and net profit. This indicates that on one hand the equity position of Wimbledon is sound and on the other hand the revenue generating capacity is more for Kensington. On the basis of the activity ratio of the both the companies it is observed that the total asset and noncurrent asset turnover of Wimbledon is more as compared to Kensington which indicates that the former company is able to utilize its asset efficiently for generating adequate revenue for carrying out its business operation. The lower receivables collection period experienced by Wimbledon as compared to Kensington signifies that the company is able to receive the amount due from its customers within short period of time. But Wimbledon is facing lower inventory holding period which is not favourable for the company. The liquidity ratio of both the companies are analyzed, on the basis of which it is observed that the current ratio of Kensington is more as compared to Wimbledon which resembles that the company has a strong current asset base for meeting its current liabilities. On the other hand the acid test ratio of Wimbledon is more than Kensington; it indicates that the former company is able to pay off its short term obligations by excluding its inventory from its total current assets. Kensington experiences a higher debt to equity ratio which is not at all favourable for company since it replicates that the concern is more dependent on borrowing from other sources for meeting its obligations. Therefore on the basis of the above analysis of the ratio it can be suggested that the concerned Plc must acquire Wimbledon as compared to Kensington since the former company experiences a sound equity position when compared with the other company and the industry average and the activity or the liquidity ratio is also favourable , on the other hand Kensington although it is able to generate adequate revenue required for carrying out its business efficiently, it experiences low equity and high debt structure as compared to the industry average which is not at all favourable for the business (Shapiro, 2005). Task 1 Question 2 The financial ratios of the two companies are compared and evaluated for taking decision about the company that should be acquired by the concerned company. From the ratio analysis of the company we can compare the revenue generating capacity of both the firms and the equity and debt financing of the companies. In order to determine the financial stability and feasibility of both the companies various factors are required to be considered. The data of the last five year performance is required for analyzing the trend of its development or movement. The increase or decrease in the various ratios such as the liquidity, activity and the profitability ratio of both the companies may assists the concerned company in evaluating the financial performance of the company. The solvency and the efficiency ratios are required to be analyzed. The past performance helps in forecasting the future performance of the organization. In order to provide adequate and appropriate advice to the concerned Plc , various types of financial analysis which includes the external, internal, vertical, horizontal and short term analysis are required to be performed (Parker, 2007). The trend analysis is considered as one of the most important tool in analyzing the financial performance of the company or the organization. The trend analysis will help in detecting whether the financial health of the business entity is improving or deteriorating. The working capital calculation of both the companies is computed since it determines the difference between the current asset and liabilities of the company. The statement of changes in working capital must be prepared for determining the amount of working capital generated by the company for meeting the day to day expenses of the company. Decision cannot be taken by analyzing the ratio of both the companies for a single financial year. It must be compared with the financial ratio of the previous years. The past records helps in understanding the ability of the company. There are various external factors which affects the financial performance of the firm or the entity. Therefore the uncertainties and the adverse situations are also required to be considered in judging or evaluating the potentiality of the company or the organization. In order to analyze the financial performance of the company, liquidity, activity and profitability are calculated. But the investment ratio of both the companies is not calculated, it is regarded as an important ratio for determining the ability of the company to pay off its investors. The investment ratio such as the earning per share, price earnings ratio and the dividend yield are required to be calculated. The investors are interested in the investment ratio since the earnings per share of the company increases with the increase in the profitability. The solvency ratio and the interest coverage ratio are also required to be computed for determining the feasibility of the company to carry out its operation for a long period of time. In order to determine the solvency ratio of the company, gearing ratio must be calculated. Therefore before providing the final decision about the company that should be acquired by the concerned Plc, the trend analysis revealing the performance of the company for the last five years, the investment ratio and the solvency ratio must be determined. The price earnings ratio which determines risk on capital of the business must be calculated. And the ratios of the last three to five years are expected to be analyzed before providing the final decision about the financial performance of both the companies and identifying the financial stable company among the two companies (Jackson, 2007). Task 2 Question 3 In order to provide appropriate and preferable suggestion to the clients in determining whether the project should be selected or rejected, the Net Cash Flow, Net present value, Internal Rate Of Return and the Payback Period of the firm is required to evaluated. It is observed that the company experiences a cost of capital of 12%. The annual cash flow of the project is computed for the last five years. The number of units sold for the sales service increased from the 1st year till the fourth year and then it decreased in the fifth year. The net cash flow or the contribution of the project indicates that it is successful in generating positive net cash flow for the five years. The average rate of return is computed, it is also known as the accounting rate of return. It does not considers the time value of money, but the investment made for generating adequate return are taken into consideration. The Average Rate of Return of the company after considering the depreciation for a period of five years is 16000.The depreciation is calculated on the basis of straight line method. The amount of depreciation is deducted from the net cash flow generated by the company in each year for calculating the net profit of the project. It is observed that the net profit of the project increased from the 1st year to the 4th year and it declined in the fifth year. On the basis of the total profit generated by the company for the consecutive five years it is observed that the concerned company is able to earn a profit of 1, 20,000. Average Rate of Investment is computed which indicates that the company is able to earn a return of 40% which is favourable , but the project is likely to earn more than 50% from its investment in order to increase its feasibility position . This method is adopted for determining the profitability position of the firm. The average rate of return lacks time value of money. But the average rate of return is more adequate when the return or profitability of two companies or two different projects is compared. The payback period of the concerned company is calculated. It is observed that the company experiences a payback period of 2.6 years. Payback period is defined as the time required for recovering its cost of investment. Longer pay back period is not suitable for the company. The payback period of the company is 2.6 years which is suitable for the business. The shorter payback period indicates that the concerned company is able to recover its outflow by the cash generated from the investment. Since the average rate of return and the payback period does not considers the time value of money, therefore the net present value of the concerned organization is calculated. It is observed that with the discount factor of 12%, the company is able to generate a net present value of 53280 pound. The company is able to generate positive net present value which is favourable for the business. It determines the profitability of the business. It is considered as the difference between the present value of the cash outflow and the present value of the cash inflow (Higgins, 2008). The internal rate of return determines the rate of return from an investment. It is considered as an important tool in ranking the company. The project with higher internal rate of return is generally preferred. The concerned project is able to generate an adequate internal rate of return of 29.16% which indicates that the company is able to earn return from its investment. Therefore on the basis of the above calculations it can be concluded that the company must accept the project since the above tool indicates that the project is profitable (Helferty, 2001). Task 3 Question 2 Budget is defined as the financial plan of the business which mainly comprises of the revenue generated by the firm and the cost incurred by the entity within a definite period of time. Budget is the estimate of the income or revenue generated by the company in advance to identify the variances in the revenue generated and the cost incurred by the company. Budget assist the company is forecasting the cost or the expenses that the company is likely to bear in the future course of time. Budgeting provides many advantages to the business organization. It helps the managers to conduct proper forecasting. The managers are required to identify and monitor the changes in the business environment in order to determine its impact on the business. The predictions or the assumption made by the managers helps in forecasting the future expenses. It facilitates in communicating the business plan to the different levels of management. Budgeting provides a method for using and allocating the resources effectively and efficiently. It allows planning in advance for setting money aside for meeting the emergency cost and expenses incurred by the business. The companies may face problem of insufficient fund, in that case it may resort to debt or borrowing from financial institution or outsiders. But debt is considered as bad for the financial health of the business. Therefore budgeting assists the company in determining the amount of debt that the company must take in order to meet its requirements. Budgeting helps in accomplishment of the goals or the objectives set by the organization. Budgeting assists in avoiding unnecessary spending or expenditure on the services that do not contribute significantly towards the accomplishment of the task. Budgeting is regarded as one of the most value added activities within the perspective of financial management. Budgeting process is mainly adopted by the organization for allocating and controlling the resources that can be used in future course of time. Budgeting should be easy to understand and compute. When the manager adopts new planning, the budgeting process is required to be developed in such a way that it readily accepts the new data. The budget must be calculated and revised on the frequent basis of time in order to except the necessary changes and the adjustment made (Brown, 2003). The process of budgeting is a dynamic process within the strategic planning. Budgeting is considered as the foundation for continuous improvement of the financial health of the company. It requires the enhancement of the budgeting process. It must be developed in such a way that it will justify the application of funds for planning the future spending not exceeding the available funds. The regular access of the financial information is important for success of the business. It must be able to provide timely and frequent information. The budgeting process is very difficult to understand; therefore it must be constructed in such a way that is easily understandable. The budget that is mainly computed by the organization includes sales budget, cash budget, operating budget and the personnel budget. The companies are now focusing on the budgeting software that will integrate all important data of the organization and focusing on the benefit of the analysis and the ability of the company in establishing relation with the planning assumptions. This software will assist the organization in updating the budget frequently ion daily basis. The process of budgeting is required to be developed in such a way that it must transform its data into meaningful information thus shortening the decision making process time and streamlining the budgeting process (Brigham and Ehrhardt, 2011). References Brigham, E. and Ehrhardt, M., 2011. Financial Management: Theory and Practice. Boston: Cengage Learning. Brown, K., 2003. Investment Analysis and Portfolio Management. Boston: Thompson Learning Helferty, A., 2001. Financial Analysis: tools and techniques. New York: McGraw Hill Higgins, R., 2008. Analysis for financial management. New Jersey: McGraw Hill. Jackson, J., 2007.Financial Management. New York: Cengage learning. Parker, R., 2007.Understanding Company Financial Statements. London: Penguin Books Shapiro, A., 2005. Capital budgeting and investment analysis. New Jersey: Pearson Hall. Read More