Fluctuating Ratio Aimed at Barratt and Persimmon Capableness - Term Paper Example

Financial Analysis Financial Analysis for Managers By Hamad al-bloushi Eac0212136 Abstract This paper analyses the financial statements and reports of two development companies namely Persimmon and Barratt. These companies are competing in the same platform but the paper obtains that each company has its own competitive edge. Barrat has got a higher liquidity than Persimmon and therefore Barrat stands better chance to meet its short term financial obligations than Persimmon..However, Barratt could face financial constraints and eventual loss in the event that its liquidity capital gets frozen in the assets while persimmon has got a fluctuating Asset turn over.This means that, the efficiency at which persimmon uses its assets to generate revenue is virtually unpredictable. The paper assesses the financial statements of the two companies in relation to economic crisis of 2009. It obtains that they were both hit by economic uncertainity of 2009 economic meltdown but they have fought to remain resilient in the markets with residual demands for homes. The financial statement of Barratt for the year ending 31 December 2012 shows that economic stability has prevailed over the last five years and was not much affected by the economic meltdown of 2009 when compared to its competitor. Table of Contents Financial Analysis for Managers 1 Abstract 2 Table of Contents 3 Introduction 5 Analysis Based on Profitability 5 Profit & Loss account for Barratt 6 Profit & Loss for Persimmon 7 Profitability Ratios 8 Operating Profit 8 Net Profit 9 Return on Capital Employed (ROCE) 11 Operating Profit Margin 12 Stock Turnover 13 Efficiencies 13 Sales Revenue: Capital Employed 13 Asset Turnover(Times) 13 Sales Revenue Per Employee 14 Debtors Turnover Efficiency 15 Creditors Turnover Efficiency 15 Investment Ratios 16 Earning Per Share 16 Price Earning Ratio 17 Dividend Yield 17 Dividend Cover Ratio 17 Liquidity Ratios 18 Acid Test Ratio 18 Current Ratio 18 Gearing Ratio 18 Conclusion 19 Recommendation 20 References 21 Appendices 22 Introduction Persimmon and Barratt Plcs are among the biggest and leading house builders in the United Kingdom (UK). Despite the economic turmoil in the UK, the markets of building homes have remained fairly resilient. The same sector in the USA suffered immensely and bankrupt most financial institutions. The magnitude of the impact depended on how the management of the organization had organized itself. The paper studies the two house building companies in the UK and analyses the annual financial performance of each company over a consecutive three year period and then advises on the way forward regarding investment on either company. The research illustrates the way bankers give their assessment of the company performance and then how managers use non-financial performance indicators to evaluate performance management.Furthermore, the paper analyses profitability portfolios of the two companies, the efficiency of the company in terms of construction, their liquidity and finally the ratio of investment of each company. Analysis Based on Profitability Despite the challenging micro economic conditions, Persimmon managed to sell an approximate of 9,384 homes constructed in 2010 which increased the sales revenue of the year to £1.42 billion and then further to £1.57 billion in 2011. The 2011 turnover of £1. 57billion is an increase of 10.5% from 2010. Pre-tax profit for the year ended 31 December 2010 increased to £95.5 million as compared with the preceding year of 2009 where it recorded £70.0 billion. On the other hand, Barratt which is a Persimmon major competitor in the sector registered arevenue of £877.6million in 2010 and £952.8 million 2011 a group operating profit of £61million and its operating margin improved by 1.4%. This profit increment, when compared with that of Persimmon, is relatively lower. Both companies are recording some improvement, but at different rates, in favor of Persimmon because the company had borrowed non-equity shares from other financial firms to purchase new firms (Jiambalvo, 2009). During the financial year ending 31december 2010, Persimmon recorded an underlying operating profit of £128.7 million minus its exceptional items and goodwill while at the same time increasing its marginal operating cost from 4.0% in 2009 to 8.2%in the year 2010.Also the company realized an exceptional credit amounting to £63.0 million and reduced its net borrowing to £51.0 million through its free cash flows it it generated during the year.On contrary , during the same financial year, Barratt development plc registered an operating profit of £ 90.1million including its exceptional items, which translated to £ 74.3million after deduction of the exceptional items.Also, The company recorded a pre-tax loss of £162.9million although with a substantial decrease in its net debt to £366.9million as compared the previous financial year of 2009. It is the debt burden that has been causing the loss. Therefore, as the debt burden continues to decrease, the loss also continue to reduce as the company heads towards making profit. For instance, there is consistent reduction in the loss in the years 2010 and 2011 since the pretax loss recorded is £11.5m in 2010. In 2011, the company makes a pre-tax profit of £ 100 m. However, the improvement in the performance of the company cannot match with that of Barratt because the rate of borrowing of the company is higher and hence shareholders earnings becomes low due to inadequate flow of cash During the financial year ending 31 December 2011, Persimmon recorded an impressive pre-tax profit of £147.2million and collected a revenue of £1.54 billion which was £0.3billion less than for the year ending 31 December 2010. Its average home selling price reduced from £169,339 to £166,142 which translated to a 2% decrease.The underlying share cost and net assets per share increased by 48% and 5% respectively.The final year dividend per share clocked 6.0pounds per share translating to an increase of 33% with strong forward sales gaining by 9.4%. On the same financial year, Barrat development plc recorded an operating profit of £127.3 million when operating exceptional items has been deducted. After taxation, the group achieved a loss of 13.8 million.Consequently the group achieved its profit of 42.7million before deduction of the the exceptional cost but later on made a loss of 11.5 million before tax.The statistical analysis to this rep[ort shows that, the company made such a loss because of of the high interest rates that they had to pay to the bank for loans they had acquired and payments to debtors. (Jiambalvo, 2009). Profit & Loss for Persimmon Year Ended 31 December 2012 2011 2010 2009 2008 £ millions Turnover 1721.4 1535.0 1569.5 1420.6 1755.1 Operating Profit 219.9 161.9 204.1 128.5 -715.4 Net Interest 1.9 -14.7 -50.4 -50.2 -65.4 Profit Before Tax 221.8 147.2 153.9 77.8 -780.0 Profit After Tax 170.2 109.0 115.3 74.1 -625.0 Total Dividend n/a n/a n/a n/a n/a Retained Profit / Loss n/a n/a n/a n/a n/a During the financial year ending 31 December 2012, Persimmon development plc registered a pre-tax profit of 221.8 million and 170.2 million profit after tax respectively which was a gross margin of 17.5% up from 14.5% in the year ending 2011. The profit margin was mainly driven by the fact that, the group opened 125 sites during the year. Barrat on the other hand recorded a pre-tax and after tax profits of 100.0 million and 67.4 respectively when operating at a profit capital base of 191.1million (Jiambalvo, 2009). Profitability Ratios Operating Profit This the income gauge used by anybody wishing to invest in Persimmon plc and Barratt plc to determine how the revenue collected by either group eventually turns out to be the group’s profit. In this case, the operating profit for Barrat plc is calculated by the formula; Operating profit =Revenue – Cost of the houses sold and other expenses incurred in line with the groups business. Note: Another name for revenue is turnover. The calculation of the operating profits for the years 2010 through 2012 is illustrated in Appendix 1. From the above operating profit analysis grids, it can be seen that, Barratt development plc has been in a gradual operating profits curve in the subsequent years of 2010, 2011 and 2012 as compared with Persimmon development plc where its operating profit for the same years has been fluctuating. The operating profits for Persimmon though fluctuating in the three years, are higher than that of Barratt because of the strategy that Persimmon employed, which involves cutting the costs of houses and selling more houses. The drop in operating profit in the year 2011 was caused by few home buyers in the market. It is advisable therefore, to invest in Barratt development plc since its operating profit figures are rising steadily over the three years. Net Profit Definition: Net profit can be defined as the amount of sales in pounds remaining after deduction of operating expenses which include taxes and dividends from the stock from the total revenue of a company. Basically, Net profit = Total Revenue – Total Expenses Barrats net profit for the three year period are as follows; 2010: £2035.2 - £2075= £-39.2 2011: £2035.4 - £1955=£80.4 2012:£2323.4 - £2143=£180.4 Net profit for persimmon plc over the three year period 2010: £1569.5 - £1365=£204.5 2011: £1535.0 – £1373=£162 2012: £1721.4 - £1502=£219.4 From the net profit analysis above, it can be seen that Barratt has got a steady rising net profit as compared with Persimmon which has a net profit that is fluctuating.This is because of the unstable selling prices over the period. In this case, both companies adopted format two version of profit and loss accounts and it becomes challenging to calculate the net profit unless otherwise the net profit margin which is; The net profit margin of Barratt development plc over the three year period is shown in Appendix 2; From the net profit margin analysis, it can be seen that Barrat has almost an insignificant profit margin that is strengthening as compared with Persimmon having a profit margin of significant values, though fluctuating. Its profit trend from 2009 to 2012 has been rising all through from 34.2m to 142.1m in 2012. Therefore it is advisable to invest in a company such as Barrat due to its strong, predictable and stable profit margin. The graph below shows the rise in net profit in Barratt. Return on Capital Employed (ROCE) This is a type of ratio which compares the profit earned before intertest and tax to the funds used in generation of sales. Normally its the preffered way of assessing profitability because it is a vital way evaluation of a companys performance. ROCE = The ROCE for Barratt development plc over the three year period is as shown in Appendix 3. Based on the evaluation of return on capital employed, It is apperent that, Barrat obtained negative returns in the first and the second years of focus but it it looks steady on rise on the third year.Persimmon on the other hand obtained positive returns per capital employed 6.95,8.3% and 12.2% before interest and taxes were deducted, but due to fluctuations in its profit margins and net, its future on investment is not certain to the investors in terms of whether it will produce good returns or not. This further leaves Barratt as the best option to invest in due to the steady and predictable rise in performance. Operating Profit Margin This is a ratio which expresses the operating profit of a company as apercentage of its sales and is normally viewed as the ultimate indicator in the ability of management to perform the basic activeties as buying and selling. This ratio regarding to Barratt and Persimmon can be calculated as follws;  During the three year period, Barratt’s operating margin profit were as shown in Appendix 4; Analysing the profit margins of the two companies, it can be seen from the calculations that Barratt’s profit margin is increasing steadily as it is pulling out of the negative side.This is because of the increased deffered tax assets and thus the company’s future operating profit margins can be predicted as compared with Persimmon where its percentage profit margin is lower at the second year than the first year, but higher on the third year. This shows fluctuation in its returns and an investor cannot be certain of whether to expect good returns or bad ones from such a company in future. Based on this therefore, an investor can be comfortable investing in Barratt whose profit margin is predictable and rising steadily. Stock Turnover This is the ratio aimed at establishing an average period for which the company sells and replaces its stock. Since stock is the actual representation of the business, include will be the homes that the two development companies sell and build others for sale compared to the total stocks of each.This ratio is normally expressed in days using the formula; The stock turnover of Barratt development plc over the three year period was as shown in Appendix 5; The stock turnover for the two companies over a three year period shows a higher and ascending turnovers by the two companies only that Barratt a higher stock turnover value than Persimmon.This means that, in this front, Barratt scored well because the stock turn over ratio is 10 days compared to Persimmon’s stock turn over ratio of 2 days. For investors, Barratt remains to be the best choice since it is selling more houses and replacing them by building others compared with Persimmon, which is selling less houses and replacing them. Efficiencies Sales Revenue: Capital Employed Asset Turnover(Times) This is the ratio which is used in determining how efficient a company uses its assets to generate sales. All current and fixed assets are taken into account in this ratio.For the two companies, it can be calculated as follows; During the three year period, the asset turn over of Barratt development plc was as shown in Appendix 6; Also, it can be noted that the asset turnover efficiency of Persimmon is higher than the turnover efficiency of Barratt. The only difference is that , Barrat’s number of times efficiency is increasing in a steady manner while Persimmon’s number of times was steady between the first and the second year but dropped on the third year. Although Persimmon’s efficiency is higher than Barratt’s, it can be said that, Barratt’s good effiency is attributed to the use of its assets to generate sales because it has had a steady ratios between the three year period (Alexander & britton, 2004). Sales Revenue Per Employee This is the measure of how each of the two development companies efficiently utilizes its employees. Therefore, a relatively high revenue per employee is positive and vice versa.It is calculated by dividing the company’s revenue by the total number of workers Sales Revenue per employee=  In the calculation of this efficiency,the number of employees in the two companies has been assumed to be constant over the three year period. This is because of logistics of part time employees and the retiring employees. The sales revenue per employee of Barratt development plc over the three year period is as shown in Appendix 8. From the revenue per employee efficiency, it can be noted again that Barratt’s efficiency is lower than Persimmon’s but Persimmon’s efficiency is fluctuating.It can therefore be said that , Barratt utilizes its employees efficiently than Persimmon due to the fact that,its efficiency output has been increasing all through the three year period (Alexander & britton, 2004). Debtors Turnover Efficiency This is the efficiency which an investor uses to measure and quantify the effectiveness of a company in extending of credits and collecting debt.It is calculated by dividing net credit sales by the Average Accounts receivables. Debtors Turnover= In the three year period, the debtors turnover efficiency for Barratt development plc were as shown in Appendix 7. On this front, it is clear that Barrat fambled with inconsistency whereas Persimmon was steady in its efficiency of extending credits and collecting debts from its customers.Therefore, Persimmon scored well on this. Creditors Turnover Efficiency This is the efficiency used gauge the effectiveness of a company to pay those who are in debt with. The faster the better.It is normally calculated by the formula; Creditors Turnover efficiency = Since both companies adopted format two profit and loss statement,the turnover eficiency ratio of the two companies becomes challenging but from the overall trend of events , it can be said that, Barratt stands better in paying those who are in debt with than Persimmon because it has demonstrated credit turnover consistency on a number of occasions (Alexander & britton, 2004). Investment Ratios These are ratios which are of primary importance to the investor who wishes to invest in a certain company and for this case Mr. Lukaku.These are some of the factors he should look into before deciding to invest in either Barratt development plc or Persimmon development plc. Earning Per Share This ratio enables an investor to put profit of the desired company into perspective in an indepth analysis. This ratio is normally analysed from the views of the share holders. Investment ethics do not advise on the comparison of share earnings of different companies because of capital structure but for this case, an assumption is made that , what if the two companies were given the same capital. Earnings per share indicates that, in every subsequent year, the percentage increase of share earning increased all through over the three year period for Barrat development plc as compared To persimmon. Therefore it is safer for mr lukaku to invest in Barratt development plc because its future looks bright in terms of returns on shares (Alexander & britton, 2004). Price Earning Ratio This ratio will in itself advise the client on cost per share of the company he or she desires to invest in the perspective of profits currently being generated. A high PE indicates that the markets favor company growth while low PE suggest low expectation of the company in the near future. From the collected data, it is quite clear that, the price per share of Persimmon is higher than Barratt’s only that flop of the share prices of Persimmon is not pleasing to an entry investor. Dividend Yield Potential investor uses this ratio to asses the cash return of the shareholders following their investment in a company.This ratio is calculated by dividing an ordinary share with theordinary share market price. From the profit and loss analysis chart, The total dividend shares for the three year period were termed unapplicable but from its assets and liabilities, it is clear that Persimmon could have a higher dividend per share but its yearly share cannot be predicted due to its fluctuation in the in profits. Dividend Cover Ratio This ratio shades light to the investor on the future fate of shares in a company.It depicts the number of times the dividend goes into the profit where the company with low dividend cover face an uphill task in paying the same amount and a possible depreciation dividends profits. Comparing the fate of shares of the two companies from 2010-2013, there is possibility that, Barratt’s shares will surge in the near future due its stability of a number of ratios and profits.This means that, Barratt has a higher dividend than Persimmon will have an easy time in paying for the same dividends (Alexander & britton, 2004). Liquidity Ratios Acid Test Ratio This ratio can also be called quick ratio and it measures current/short term liquidity and position of a company. In this case the short term liqiudity of persimmon and Barrat with their respective position.This ratio is measured by weighing current assets against current liabilities of each of the two companies. Weghing the current assets and liabilities of the two companies, Barratt has got a far higher number of assets and liabilities than Persimmon development plc and this gives Barratt a company of status. Current Ratio This ratio can be termed as the measure of a company’s liquidityby use of financial performance of the balance sheet. This ratio determines whether each of the two companies under study are in a position to pay their debt in a projected 12 month period. Gearing Ratio This ratio is related to the solvency ratio and bring the comparison each of the two company’s owner equity and the its borrowed funds.Since Barratt and Persimmon belong to the same industry, Debt-to-equity ratio of the two companies shows that, persimmon is more vulnerable to downturns in its operation than Barratt because it has a high gearing ratio.This is because during the period of economic crisis, the gearing ratio for persimmon increased from 0.3844 to 0.6254 in 2008 whereas Barratt did fairly good because it was protected courtesy of its higher equity where its gearing ratios reduced all through the economic turmoil period (Alexander & britton, 2004). Conclusion Following the analysis of the financial statements and reports of the two developments of companies, this analysis paper finds out that both companies compete on tha same platforms but each has got its own competitive edge.Barratt has got higher liquidity than Persimmon and thus it can meet its obligation with ease as compared withPersimmon.However the profit generated by Persimmonis a bit higher than the profit generated by Barrat owing to the fact that , pertsimmon has got a higher asset turnover than Barrat. Financial statement of Persimmon year ending 31 december 2012 acknowledge that the company was hit hard by economic uncertainity by the economic crisis of 2009 but they have fought to remain resilient in the markets with residual demands for homes.This is one of the reason why its profitability of the financial year ending 2011 showed some slag in the percentage profit generated. The financial statement of Barratt for the year ending 31 December 2011 shows that economic stability has prevailed over the last five years whidch is attributed to putting in place the refinancing package set ion place for the group ,operation of the exceptional items and the increase in the second half housebuild operating margin.This is the reasons why was not much that affected by the economic meltdown of 2009. Therefore, due to its stability, it can be concluded that, Barratt has a bright trading future and returns are guaranteed. Recommendation From the findings of this analysis, I would recommend Mr. Lukaku to invest his fortunes in Barratt development plc because over the three year period, it has demonstrated stability and resilience in the market.This is because it has got a clear future strategy on areas requiring improvement which include land buying and investment and the operational efficiency. The net profit of barratt development plc ascended from £74.3m, through £127.3m and £191.1m in 2012 while Persimmon net profit staggered from £204.1m, £161.9m, and finally to £219.9m.This is a strong indicator on sight that gives an investor like Mr Lukaku confidence to trust his fortunes with Barratt development plc. Also net price income per share of Barrat annually rose at an average percentage of 35% while Persimmon had no justifiable percentage of its share price trend.Therefore I can strongly advice Mr. Lukaku to invest in shares offered by Barratt development plc but to certain amount because its income though small but rewarding. References Alexander, D & Britton, A 2004, Financial reporting. London, Thomson. Jiambalvo, J 2009, Managerial accounting. Hoboken, N.J., Wiley. Mergent FIS Inc. & Mergent Inc. 1999, Mergent international news reports. New York: Mergent FIS. Great Britain 2008, Department for Communities and Local Government: Planning for homes : speeding up planning applications for major housing developments in England. London. Moody's Investors Service & Mergent FIS Inc. 1981, Moody's international manual. New York: The Service Barratt Development Inc. 2012, Annual Report 2012 . Available from: < http://www.barrattdevelopments.co.uk/barratt/en/investor/results?year=2012 >. [12 Sep 2012]. Barratt Development Inc. 2011, Annual Report 2011. Available from: http://www.barrattdevelopments.co.uk/barratt/en/investor/results?year=2011. [16 Nov 2011]. Mergent FIS Inc., & Mergent Inc. 1999, Mergent international news reports. New York: Mergent FIS. Persimmon PLC. 2011. A solid foundation for growth. Available from: . [December 2011]. Persimmon PLC. 2012. A solid foundation for growth. Available from: http://corporate.persimmonhomes.com/~/media/Files/P/Persimmon-Homes- V2/investor/reports/2012/Annual-report-2012-new.pdf.>. [December 2012]. Appendices Appendix 1 Therefore, Operational profit for financial year 2010: £ 2035.2 - £1960.9 = £74.3m Operating profit for financial year 2011: £2035.4 - £1908.1 = £127.3m Operating profit for financial year 2012: £2323.4 - £2132.3 =£191.1m Also , the operational profit for Persimmon development plc can be calculated as follows; Operational profit for financial year 2010: £1569.5 - £1365.4 = £204.1 Operational profit for financial year 2011: £1535.0 - £1375.1 = £161.9 Operational profit for financial year 2012: £1721.4 - £1501.5 = £219.9 Appendix 2 2010:  £-19.2 2011: 7.39 Profit margin for persimmon plc development over the three year period 2010 :*100 = £6.59 2011: 8.6 2012: 13 Appendix 3 2010:  = -0.062 2011:   = 0.033 The return on capital employed on Persimmon development plc 20100.059 2011= 0.061  = 0.080 Appendix 4  -8.005%  0.56% =4.3% Over the three year period, Persimmon’s operating margin profit were as follows; *100=9.80% =9.5% *100=12.88% Appendix 5 =9.967 =11.03 =11.159 Persimmon stock turnover for the three year period was as follows; 2.67 2.88 2.94 Appendix 6 =34 37 Persimmon’s three year assets turnover was as follows; =45 =51 =47 Appendix 7 =332.0  =321.46  =330.95 Persimmon over the three year period had a turn over effiencies as follows;  =352.61  =367.32  =382.74 Appendix 8 =0.45 =0.452 =0.51 The sales revenue per employee of persimmon development plc for the three year period was; =0.64 =0.63 =0.70 Read More