The Profitability of a Companies - Report Example

Name of the student Name of Institution Date of submission Profitability It measures the company’s return on its investment, that is, the income that is left after deduction of all the costs and expenses incurred in producing the product (Gombola & Ketz, 2003). It includes the following ratios: Gross Profit Margin: - this is a profitability ration that measures the returns on goods and services. It shows how much it cost to produce the products. The information provided by Express PLC was as follows 2011 2012 2013 2014 Gross Margin 30% 29% 33% 35% Higher ratio means Express PLC is selling its electronic components at a higher profit percentage. Therefore as indicated above, in 2011, Express PLC sold its electronics at a profit percentage of 30% which reduced in the year 2012 to 29%, the subsequent year of 2013 had an improvement since the gross profit margin arose to 33% and in 2014 to 35%, this indicates significant improvement in returns from the sale of the electronics and the Board of Directors should consider increasing production. Return on Equity:-It states how much Express PLC makes against each euro that shareholders have invested in the company, that is, the firm’s ability to generate income from the shareholders’ investment (Gombola & Ketz, 2003). This is a clear indication of how effectively Express PLC can utilize investors’ funds to generate the net returns. Return on Equity is profitability ratio from the shareholders’ point of view. The information shared by Express PLC shows 2011 2012 2013 2014 Return on Equity 3.1% 4.3% 4.5% 4.3% According to Gombola & Ketz (2003),a high ratio indicates that the Express PLC’s management is effectively utilizing the shareholders to generate net income, however, to same has to be compared to other companies’ ratios who operate in the same industry. Therefore, the data above confirms that in 2011, the shareholders’ investment generated 3.1% of the net income, this improved in 2012 where the generated net income from investors’ investment was 4.3%, in 2013 the performance improved yet again, generating 4.5% of net income. Unfournately, in 2014 the net income generated from shareholders’ investment dropped to 4.3 % which Board of Directors should establish and share with the investors. The return on equity from a competitor in the same industry was 7.8% in 2014 with the normal expectations being 9.0%, therefore the BOD of Express PLC should strive to improve its performance since their shareholders may opt to invest in their competitor because they are performing better than them. The competitors are almost hitting the target of 9.0% in terms of generating net incomes based on shareholders’ investment. Liquidity It measures the ability of Express PLC to meet its short term debt obligations, that is, its ability to settle the short term debt involved in the day to day running of the business (Shen & Yeh, 2009). It includes the following ratios Current Ratio: - As reported by Shen & Yeh (2009), this is the ability of the company to settle its current liabilities based on its current assets. This demonstrates the liquidity position of the company. The following information was provided by Express PLC 2011 2012 2013 2014 Current Ratio 3.5 3.4 3.2 3.1 A higher ratio indicates the company’s ability to meet its short term debts based on the current assets it has (Shen & Yeh, 2009). In 2011, the company had 3.5 times more current assets than current liabilities hence could easily settle their short term debts, in 2012 the ability to pay off short term decreased to 3.4 and in 2013 it declined further to 3.2 and in 2014 to 3.1, this shows that the company’s ability to offset short term debts keeps declining hence Board of Directors should strategize to increase its current assets. In comparison to the competitor’s current ratio of 2.5 in 2014 and the target of 2.1, Express PLC is better positioned since it was at 3.1, therefore, investors and creditors still have faith on them. Quick Ratio:-This is the company’s ability to meet its short term debt using its most liquid assets. These current assets include cash and those that can be easily converted into cash (Shen & Yeh, 2009). Based on the information below 2011 2012 2013 2014 Quick Ratio 2.4 2.2 1.85 1.7 A high quick ratio is preferable because it confirms the company’s ability to settle the short term debts using its quick assets. As shown above the company had the ability although the ability keeps declining from 2011 to 2014. Therefore, BOD should consider increasing its quick assets value depending on the increment on the short term debts. When compared to its competitor the ability its low since the competitor ability in 2014 stands at 1.8, this means that the investors and creditors may prefer their competitor to them. Although, Express PLC is within normal target of 1.7 Efficiency It explores how well the company utilizes its assets and liabilities within (Lewellen, 2004). It includes: Debtors Collection Period:-This demonstrates how quickly the credit sales are paid off. As indicated below 2011 2012 2013 2014 Debtors Collection Period 76 88 93 111 A higher value is unfavorable because it shows that Express PLC are not doing enough to recover their debts hence may affect the operations of the company. According to the company records, the collection period keeps increasing from 2011 to 2014 and therefore BOD of Express should strive to improve on its debt collection. Their competitor’s collection period in 2014 was 51, which was better than the normal target of 68 days. Therefore, competitor’s performance is far much better and reinforcement Express PLC is necessary. Creditors Payment Period:-it indicates how fast the company can pay off its debts. 2011 2012 2013 2014 Creditors Payment Period 45 47 52 50 A high value is favorable because it shows that the company can utilize the money in other investments before paying off its creditors. In 2011 it took 45 days before paying, while the number increased to 47 days in 2012 while in 2013 it increased to 52, in 2014 the days reduced to 50. Their competitors took 45 days to pay their creditors hence will win suppliers’ trust compared to Express PLC. However, Express days the debt paid their debt within the required time of 52 days. Investment These are mechanisms that can be used to determine the valuation of an existing investment opportunity (Hays, 2009). It includes Price Earning (P/E Ratio):-it determines what market is able to pay for its stock based on the market current value. Express’ information was as follows 2011 2012 2013 2014 P/E Ratio 15.88 14.78 11.02 10.77 A higher ratio shows positive performance based on the expected price of a share compared to its earnings (Hays, 2009). The trend above shows declining price of shares compared to their earnings hence investor may be discourage from investing. The competitors P/E ratio was 12 in 2014 compared to Express hence the investors may opt to invest with them. The BOD of Express should strive to improve since they performance was below the target of 19 in 2014. Earnings per Share:-it indicates the amount of net income earned per share of stock that is outstanding. 2011 2012 2013 2014 Earning per share 0.8 0.94 0.98 0.81 Hays (2009) stated that higher ratio is favorable since it shows the company is more profitable hence shareholders can benefit as well. The trend above indicates an improvement from 2011 to 2013, but it dropped in 2014. When compared to the competitor, the competitor was performing better hence the value of its shares is likely to rise compared to Express. The Express value of stock in 2014 was even below target of 1.2 Gearing It indicates the proportion of company’s borrowed funds to its invested equity. It determines the risk that a business is prone to since excessive debt leads to financial difficulties (Frank & Toliyat, 2009). The information as provided by Express PLC was as indicated below. 2011 2012 2013 2014 Gearing 35% 55% 64% 74% According to Frank & Toliyat (2009), a higher ratio is dangerous because it indicates that the company relies so much on debt to finance its continued operations. The trend above indicates the company’s increasing reliance on debt to finance its operations. In comparison to its competitor who had a gearing percentage of 52% in 2014, the competitor is performing well since its only relying on 52% of debt to support its operations. Likewise, Express has to take initiative to reduce dependence on debt since it surpassed the allowed percentage of 49% in 2014. Factors to consider before making an investment decision The duration of time it will take to recover the initial capital invested in the project. The time a given investment project will take to start generating output is very vital and thus should be established before considering to invest. Q3 The optimal investment policy in this case would be the most viable between the previously discussed. In case of project D and E, the Net Present Value method would be the most appropriate since:- It will determine the amount of income the two projects will generate at a given predetermined rate of return as demonstrated below However, if the projects were indivisible, it would be difficult to establish the viability of the project since the appropriate discount rate cannot be determined (Garvin, 2000). 4. Difficulties encountered in capital investment appraisals They don’t give accurate result in case of mutually exclusive investment projects. They tend to ignore cash flows after the recovery of the initial invested capital Resolutions BIBLIOGRAPHY Gombola, M. J., & Ketz, J. E. (2003). A note on cash flow and classification patterns of financial ratios. Accounting Review, 105-114. Lewellen, J. (2004). Predicting returns with financial ratios. Journal of Financial Economics, 74(2), 209-235. Hays, F. H., De Lurgio, S. A., & Gilbert Jr, A. H. (2009). Efficiency ratios and community bank performance. Journal of Finance and Accountancy, 1(1), 1-15. Garvin, M. J., Wooldridge, S. C., Miller, J. B., & McGlynn, T. H. M. J. (2000). Capital planning system applied to municipal infrastructure. Journal of management in engineering, 16(5), 41-50. Frank, N. W., & Toliyat, H. A. (2009, April). Gearing ratios of a magnetic gear for marine applications. In Electric Ship Technologies Symposium, 2009. ESTS 2009. IEEE (pp. 477-481). IEEE. Shen, C. H., Chen, Y. K., Kao, L. F., & Yeh, C. Y. (2009, June). Bank liquidity risk and performance. In 17th Conference on the Theories and Practices of Securities and Financial Markets, Hsi-Tze Bay, Kaohsiung, Taiwan. Read More