Financial Management & Control - Honeywell Plc Company - Case Study Example

Financial Management & Control Name: Unit: Course: Professor name: Submission Date: Part A Q1 In the previous year to the current year, there is an increase in the ratio of return on capital employed (ROCE). In 2015, the percentage of the ROCE was at 18.33% and then later in the year 2016 the percentage increased to 26.58%. Since ROCE is a profitability ratio which measures the company’s efficiency and how it can generate profits or the gains from the capital invested. Therefore, it means that the profits which are generated by Honeywell Plc Company, by comparing net operating profit to capital employed has led to the following increase in the ROCE experienced (Raheman 2007 p.280). This shows that the investors’ capitals were huge and so there were greater profits realized in every capital employed. ROE is more than a measure of profit; it's a measure of efficiency. Return on shareholders’ Funds (ROSF) in terms of profitability assessment, it is considered as a narrow one. When ROSF is compared to ROCE on profitability basis, it is narrower and so, the shareholder is given an expounded insight of the profitability they are apprehensive about. A rising ROSF in this case where it increases from 6.95% to 11.37%, signifies that Honeywell Plc company has enough profit for shareholders and it is also profitable. As of Gross profit margin (GPM) is usually referred to as the percentage of gross profit comparative to the income earned during a period (Mayer et al., 2005 p.600). As it is indicated in the company’s performance, there is an increase in the margin from 56.95% to 63.71%. Generally, an increase in the GPM is necessary as there are implications that there are greater chances of earning larger profits in the company. Therefore, it is desirable that there are higher GPM so as to avoid increased cost of production. Quick ratio enhances the current ratio by determining the most liquid current asset which can be used to cover the current liabilities. It excludes other current assets and inventories unlike current ratio. In Honeywell Plc company, quick ratio has decreased from 1.05 to 0.64 between 2015 and 2016. This means it has decreased drastically and hence the company is at a lower liquid current position. In addition, when a company’s quick ratio is less than 1.0 it means that a company is not eligible its short-term obligations (Padachi 2006 p.60). Therefore, a decreasing quick ratio suggests that either the company’s sales are decreasing or its balance sheet is over-leveraged. According to Raheman (2007 p.275), the ability of the company to pay short-term and long-term obligations is known as current ratio and it can be used to measure the same hence it becomes part of the liquidity ratio. In this case, the company current ratio is indicated to reduce from 1.63 to 1.31. Generally, when current ratio is below 1, the company’s ability to pay for the financial obligations is said to be at a corner stone. And its liabilities are said to be greater than its assets. In this case, even though there is a decrease in current ratio, it has not dropped below 1. Therefore, it clearly means that the company is still capable of paying its obligations but not as it would have paid in previous year. A gearing ratio is a financial ratio that compares or rather measures owner's equity to borrowed funds. Honeywell Plc company experiences an increase in gearing ratio and that is, from 21.37% to 34.19% between 2015and 2016 respectively. Therefore, when there is rise in gearing ratio it is evident that there is a great financial leverage which puts the company at a great risk of using the debt to pay to ensure the existence of its operations. On the other hand, the interest coverage ratio is usually a profitability ratio and debt ratio that is always used by a company to determine the means of paying interest on unpaid debt. Raheman explains (2007 p.280) when a company has lower interest coverage ratio, the more the company’s liability overwhelms the company (Gill et al., 2010 p.7). Its debt expenses burden the company. And also, when it is at 1.5 or below, the company may be at risk or may default. For instance, even though the company’s ratio is above 1.5 but it is declining from 7.18 to 3.52, then stakeholders can possibly have some wary as this indicates that the company might later on be in a position of on paying its debts. When the accounts receivable collection period (ARCP) is lower, then it is said to be favorable as compared to when the ARCP is higher. For instance, as per the case of Honeywell Plc Company, the ARCP of the previous year is lower than the current year, 2016. This indicates that the company is collecting payment slower. Account payable payment period (APPP) is the rate at which the suppliers are being paid off. Generally, it is evident that the company’s turnover drops from 132.21 days to 106.46 days. And it is interpreted that when such a fall is experienced, them the company is taking much time to pay its suppliers (Garrison et al., 2010 p.794). However, inventory turnover shows the frequency at which inventory is sold and replaced at a particular time. Since the company’s turnover ratio increases from 126.51 days to 167.29 days, it means that there are robust sales and large discounts. Part A Q2 Working capital cycle is the time duration between procurement of goods to manufacture products and creation of cash revenue on selling the products. Generally, it is believed that the shorter the working capital cycle, the faster the company frees up its cash in working capital. And when the capital does not earn any returns because it was locked, then the working cycle takes too long. Therefore, the shorter the working capital cycles in a company, the short-term liquidity condition is improved and increase in efficiency (Padachi 2006 p.57). Honeywell Plc company’s cash in the 2015, has its cash locked for 41 days. Which might be in need of more funds to continue with the operations as the creditors would require 132 days to be paid off. Unlike in 2016 where liquidity of the company is not in better condition because of the duration of working capital cycle of the company which is longer. As compared to 2015 which has a shorter working capital cycle within 365 days of its operations, then it means in the previous year the company purposefully resolute to the aspects of the working capital cycle on individual terms (Padachi 2006 p.57). However, in 2016, for the company to shorten the time for the working capital, it should work on reducing the period taken for inventor to convert into sales. And for the 92.31 days, it means that the company has its capital locked in for that entire duration. Part B Q1 Analysis of the break-even point is a measurement system of calculating the margin of safety by comparing the number of units or revenues. However, when comparing the number of units to the revenue, then it must be based on how many units that need to be sold to cover variable costs and fixed costs associated with creating the sales (Garrison et al., 2010 p.802). The break-even point of Honeywell Plc company in the year 2014 is 10,050 units. This implies that 10,050 is the total number of units that have to be sold in order for the company to create enough revenues to cover all of its expenses. Also, in the following year, 2015, there was an increase in the break-even point of the company to 11,902 units. The increase or the change might have been brought by the reduction in contribution margin or increase in company's fixed costs. The break-even point changes in total sales dollar from 4.02 dollars to 5.74 dollars. Meaning, there is less contribution margin. And with less contribution margin, more sales will be required so as to cover for the fixed expenses and fixed costs. Therefore, for this increase in break-even point to occur, there must have been a decrease in selling price of the available units. Whereas the company’s margin of safety (MOS) in 2014 it is seen to be lower as compared to the year 2015. It majorly identifies to the company that much reduction of profits results in breakeven. Generally, the company’s MOS in 2014 is higher as compared to the year 2015. The risk of business experiencing loss will be lower as it would be in 2015. Therefore, it is common that the higher the MOS the better the company is. Possibly in every dollar of sales revenue lost, the profit will not be realized and hence a big loss. Break-even analysis becomes vital during practical application of cost functions. It is always used as a determinant whenever cost functions are involved. Generally, its application is said to go in hand with the following three factors; profit, sales volume and cost. Its major application is to the relationship that exists between the overall costs and sales volume of a company. On the other hand, several companies refer to it as cost-volume-profit analysis. And when the company breaks even it is believed that sales have reached a point similar to all expenses incurred that would enable the company attain sales levels. Part B Q2 The break-even analysis is based on certain set of assumptions in attaining that level of sales; Costs can be reasonably classified into fixed and variable constituents. Whereby it ignores the semi variable costs; This assumption reasonably explains or supports that the model can be applied in todays diversified world of business. In this assumption, all the fixed costs involved in the business can easily be identified. These include depreciation expenses, rental expenses salaries and other fixed costs that are part of company expenses. Consequently, variable costs, including materials used and cost of direct labor can also be classified. Even though there might be problems that are likely to be encountered in determining the semi variable expenses, but still, the business can be in a position of separating the expenses into fixed and variable costs for business operation purposes. For instance, it can be of importance for the business to use such expenses in minor or major maintenances. There is linearity in all cost-volume-profit relationships; this assumption is the second one that maintains that the cost and revenue utilities must remain linear. In the business world of today, this is valid since most of the businesses use it in analysis of reasonable range of operations. Normally, a company expects the costs and the revenues to remain the same when dealing for example with a volume change of plus or minus 15 percent (Garrison et al., 2010 p.800). In case of a scenario where the business needs to realize the effects of doubling its level of operations, a new correlation between costs and revenues would be developed instantly. Therefore, the particular relationships would be considered to either be linear r nonlinear. Such relationship brings the effect of determining likable financial results of a business. There is no particular change of sales prices with changes in volume; as the assumption, it clearly explains that whatever the factor the factors that affects the business operation, there is no possibility that any other factor apart from sales volume can alter costs and sales revenue. Though it is a bit unsubstantiated because it is considered as subcategory of the second assumption it economically becomes of importance to the modern world of business operations (Van 2002 p.15). Economic theory explains that a business experiences price increase in a normal business environment after all the undue effects of inflation have been excluded. It is normally or always accompanied by a decrease in sales volume and vice versa as far as business economical operations is concerned. The assumption then comes to be clearly recognized after the nonlinear breakeven event is examined. It becomes reasonable in the diversification of the world business when dealing with reasonable range of prices. Part C Q1 Retained profit is one of the internal sources of finance that could be used by companies to finance capital investment programmes. This means is considered by most of the profitable institutions as the most important and significant source of finance. It generally has a simple principle where when a net profit is earned in the company, it is the choice for the shareholders to either extract the profits from the company as dividends, or reinvest on it by leaving equal gains in the business. In every institution that is after making profits, retained profit is always the end product of running every operation in the company. In most companies, they are drawings by the capital owners or the profits that are left after deducting all the dividends paid to the shareholders. Generally, most of the retained profits rest in the banks, some when a company needs to spend on additional plant and machinery (Ross et al., 2002 p.9). Or some institutions recommend that they use a portion of it to reduce overdrafts or loans and reinvest some in more inventories. Retained earnings have strange earnings which is completely contrary on how best it may work as source of finance. Since they are always realized from the profits which are never distributed amongst the shareholders, a long-term debt is never incurred. And when a company does not retained earnings in terms of proper utilization, it then has the benefit of avoiding the cost of investment (Padachi 2006 p.57). In such a case, the cost of investment would not be incurred in any way or if stocks were to be sold to the public. Retained profits serve the core objectives of the management when it comes to investment. In some projects, investing retained earnings, with IRR becomes a progress when compared to ROI of the business. This factor will have a direct positive impact on the shareholders wealth but positively. It will enable the management to factor in and factor out the undesirable objectives which would not put the retained profits into use (Ferguson 2003 p.432). Hence, they are considered flexible and they can be reinvested and some portion kept. A company may seek for external sources of finance when they need to generate more finance. It normally comes when the possibilities of getting finances from the internal sources becomes limited. One of the external sources of finance for a company can be the share capital. Most of the limited companies may look for additional share capital. It may originate from the venture capital funds or from the private investors. For instance, those providing the venture capital funds are always after investing in those businesses which are always dynamic. When investing, mostly on the shareholders side, they always benefit from the protection offered by limited liability. Their liability is on the amount they invest in share capital. But not on the overall company’s debt. In most of the companies which are considered as startups, investors are likely to invest in the share capital (Ross et al., 2002 p.7). And this would guarantee them a full control over the company. And so, an investor may use more personal sources just to acquire or rather to purchase the shares. According to Ferguson (2003 p.432), all the funds raised by the company in exchange for shares are the share capital. They can either be preferred shares or common stock. With time, this is an investment that changes over a period of time because of the amount of share capital used for financing such an investment. Therefore, when a company wishes to raise more equity there must be a full authorization issue or even selling an additional number of shares. As a result, more finance would be acquired as share capital would definitely increase. Question 2 The payback period is the selection criteria used by most business firms in selecting capital projects. In real life, most of the businesses find payback period to be more useful criteria whenever selected for business purposes. Majorly, with the small businesses, the owners would prefer to look into the period which would normally make them take back their previous investment in a capital project. Payback period despite of its ups, there exists some downs too. For instance, when determining the economic lives of particular asset, there are possibilities of indifferences. Therefore, payback is criteria that may not analyze the lives of the assets, for examples, lives of the plants and machineries it is evaluating. And a major deficiency that might be seen in the method when it comes to today’s business operations, payback period rarely considers the value of money. For instance, when it is scheduled that the cash inflows are to be received at a particular time then it later happens that it takes longer or shorter time as it is expected, then it becomes non-reliable (Van 2002 p.12). On the other hand, payback period may have an advantage when the management is working on estimating the returns expected from the initial capital of a given project. Accounting rate of return(AAR) is simply a rate of return that a business receives. Arithmetically, it becomes valuable when a company needs to quickly evaluate its profitability. And most of the companies apply ARR to generalize and compare various projects by evaluating their performances. In businesses today, most returns are based on the amount of investment made. AAR does not focus more on cashflow to evaluate the kind of investment selected by the investors. But rather, it works with the expected net operating income instead. AAR does not consider the factor of time value of money. In the business today, when it is greater than the required AAR, then the project is accepted and vice versa. When it comes to comparing the investments done in the business, there should be a higher AAR (Mayer et al., 2005 p.600). Therefore, the more attractive the investment will remain. A company will then prefer AAR whenever choosing on any project. It has a disadvantage that there are risks for long term investments. In addition, a business can neither be manipulated with any factor apart from changes in depreciation methods. When the net present value (NPV) is positive, then there is a clear indication that a business projected earnings exceed the expected cost. Generally, profitability is realized when there is a positive NPV as compare to when the business has a negative NPV. Hsieh et al. (2008 p.190) states that this will make the business experience a greater net loss. The concept of both positivity and negativity of the NPV determines the position of the company in terms of profitability. And as a rule, it generally states that the investments with positive NPV values are the only investments which should be put in place. Most of the companies today use internal rate of return IRR to determine the worthwhileness of an expenditure or a project. And calculating the IRR can literally show whether there is a loss or profit in a company or when investing on a project. Therefore, with the IRR, it would be easy to make a conclusion or even measure the profitability or the position of a given investment (Hartman & Schafrick 2004 p.142). On the other hand, in most cases, IRR might help in comparing the profitability of one investment to the another. Usually, when the IRR goes beyond the business cost of capital then it is recommendable to invest on the business. And when various investments are aligned, investment with highest IRR is considered. Also, for this to happen, in the diverse business world of today, there must exist a combination of shareholders equity, company’s long-term debt and even preferred stock. References Raheman, A. and Nasr, M., 2007. 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Sources of funds and investment activities of venture capital funds: evidence from Germany, Israel, Japan and the United Kingdom. Journal of Corporate Finance, 11(3), pp.586-608. Read More