Financial Analysis of British Petroleum PLC - Case Study Example

UNIVERSITY OF --------------------------------------- SCHOOL OF BUSINESS Division of Accounting and Finance BР Company [Student Name] AC3650 Risk and Capital Markets [Instructor Name] [Date] Table of Contents Company background 2 Financial analysis 2 Liquidity ratios 2 Efficiency ratios 3 Capital Structure ratios 5 Investment’ ratios 6 Conclusion 7 References 8 Appendix 0 Company background British Petroleum PLC (BP) is public limited company that is registered in UK and is in the energy sector. It is involved in the exploration, extraction of oil and natural gas across the world. Analysis of different financial ratios represents an important approach for understanding the performance of a business enterprise. Financial management texts recommend several ratios. The ratios selected help present a clear picture of the performance and health of the company analysed i.e. BP and help measure its profitability, liquidity, and operational efficiencies. More particularly, when we examine the trends in different ratios over time, a picture emerges of how the enterprise has performed over the past and how one may expect it to perform in the near future barring extraordinary events. All data used comes from of annual reports with the. All numbers are in million or shares except per share calculation. Financial analysis Liquidity ratios This ratio shows the ability of the company to pay off short term obligation as they fall due. In this case two ratios are considered that is Current ratio and Acid test ratio. The Current Ratio is a ratio between the current assets and current liabilities and shows the same indicator of performance as working capital. While Acid Test Ratio is a refinement over the current ratio in that it assumes that inventory current assets may not be easy to convert to cash to pay off current liabilities in a hurry. Therefore, inventories are subtracted from the current assets for calculation of the acid test ratio. This are calculated as shown below the current ratio i.e. current assets as a ratio of current liabilities is not health for BP at between 1.29:1 to 1.44:1 since recommended ration is 2:1 and this shows that their capacity to meet short-term liabilities is moderate. It is in order to infer that BP has poor liquidity ratios and it cannot be able to meet their current obligations if compared with ideal rates at times of agency. The acid test ratio takes only those current assets that are readily convertible to cash i.e. it excludes inventory. This ratio ranges from 0.93:1 to 1.08:1 which shows health position and it is clear indication that the company does not keep large amount of stocks except 2013. Efficiency ratios The ratios used in this case are Inventories turnover ratio, Inventories turnover period, Trade payables payment period, Trade payables payment ratio, Trade receivables collection period and Trade receivables collection ratio (Schweser, 2008). These figures are shown in the appendix but summarized below To begin with is average Inventory Period that is calculated on the Average of the Opening and Closing Inventories. It oscillated between 29.59 days to 31.49 days. This is a good performance because stockholding costs will increase marginally and meaning less stock is being held. The other is average collection period, which are Trade Receivables period. The company’s collection period increased from 39.44 days down to 47.03 days. This means the company policy on collection of sales improved. The Average Settlement Period for trade payables showed an increase from 61.51 days days to 79.81 days. Shows on average, how long it takes the Company to pay its suppliers (Weetman, 2006). This is not a good credit policy, as they take long to collect from credit sales as well as takes more than 2 months to pay suppliers. Care must be taken not to lose suppliers goodwill, or even sacrifice good pricing for longer credit. Capital Structure ratios Gearing Ratio indicates what proportion of the long term debt the company carries compared to its stockholders equity and thus the level of risk. The gearing ratio means that for every dollar contributed by shareholders, the company borrowed $1.11 from creditors in 2015 ($0.96 and $0.79 for 2014 and 2013 respectively). The slowly increasing ratio shows a steadily deteriorating scope for BP to borrow further. Because a Gearing ratio of up to 2.0 is acceptable, thus the situation is not alarming. The equity ratio of lower than 1 indicates that the company has more equity than debts and this determines its ability to pay its debts and low risk. BP numbers are bad making it a risk company from this viewpoint. This is due to the fact that the ratio is more than 1 in all the years. In meeting their obligations to the lenders, from whom the companies have borrowed funds, the companies are required to pay interest to the lender as also fixed charges. Interest coverage ratio provides a clear picture of the ability of a company to service its borrowings. BP earns more than 20 times its interest expense for 2012 and 2013 but it reduced 2014 to 7.63 before dipping to a negative value. This makes it clear to lenders that the company will be not able to pay interest charges as and when they become due in 2015. The conclusion is that BP provides unsecure position for its creditors. Investment’ ratios Certain ratios derived from the balance sheet and the current market price of the stock of a company help make investment decisions. The EPS (Earnings per share) is the simplest ratio that compares the earnings attributable to shareholders. EPS calculation shows the net income of the company per share is the income per share outstanding. However, warrants, stock options, convertible shares outstanding can potentially decrease EPS. Therefore, EPS calculations must account for the total shares as well as the shares that can come from conversions or exercise of options. BP appears to be doing badly for the last three year before going to negative 2015 in terms of its EPS as shown below The second ratio is the market price (of the shares) to earnings PE ratio and indicates the wealth creation power of the company. A low PE thus represents a low price of the stock compared to the earning potential of the company and a ‘good buy’ and vice versa. The PE ratio for BP is 11.63 times in 2012 and 32.88 in 2014making it slightly overvalued on the bourse. However, in 2015 it shows an astronomical undervaluation with a PE ratio of -15.36 times. The market to book value for the two companies is similar at 2.6 and 2.1 respectively. In addition, the company continues to pay its shareholders attractive dividends year after year, making it one of the most admired companies in the U.K. The company’s 4-year average dividend yield is 5.7375%. The dividend yield for BP is 4.91% in 2012 and 5.8% in 2014, in 2015 it shows an astronomical increase to 7.45%. However, dividend covers showed fluctuating results before going negative 2015. Dividend cover for the company has little relevance compared to the ratios that account for the earnings aspect, for over time the earnings that are more important as they will determine investor wealth growth through dividend payments and increase in stock prices. This implies that the company’s management effectiveness at utilizing assets to generate revenue is impressive, further adding to the company’s attractiveness. The conclusion is that while the recommendation on the BP share can only be a SELL. Conclusion The analysis reveals BP as a ‘rock solid’ company showing all round improvement in performance on all fronts thereby underlining why it is one of a blue-chip company. Comprehensive analyses of financial statements of companies, which do not fall into a single industry, tend to be more complex than those that fall in one industry. They have a poor liquidity position, which decreased as both the current, and quick ratios are low and deteriorating. Gearing ratio shows that the company has improved its ability to usage debt and reduces risk. For any cooperation stakeholders are given the first preference. The wealth of these stakeholders is increased in which it is the main goal of the management. The stakeholders were able to receive its return from the BP for all the years. However, in 2015 the returns had reduced. The debt level is low which means that it is basically financing through its equity. When it comes to cash, BP is able to keep a better cash level which means it is able to even pay off its short term obligations. This is due to the current ratio which is being steady. The accounts receivable of the firm is less which means that the firm does not owe to anyone Even when the inventory turnover is low for the firm, the customers are not affected in any way. The accounts receivable is being taken on time and no delay is being made by the firm in this aspect. The customers are able to receive the best credit facilities by the firm. With this it is understood that the customers are having good relationship with the firm. In a way the firm gives the full assurance to the customers where the customers can still keep the business with the firm. References Besley, S. & Brigham, E F., 2009. Principles of Finance. Mason, OH: South- Western, Cengage Learning. BP PLC annual reports, 2013 and 2015 Brag, S. 2002. Business Ratios and Formulas: Comprehensive Guide. 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Financial statement analysis: the investor’s self-study guide to interpreting and analysing financial statements. New York: McGraw-Hill Publishers. Appendix Efficiency ratios: Capital Structure ratios: Liquidity ratios Investment’ ratios: Read More