Financial Reliability: A of Lookers PLC - Case Study Example

Financial report Reliability: A case of Lookers PLC

Introduction

According to the 2015 financial report, it is clear that the group turnover has been increasing from the year 2000. This trend has continued with every New Year recording a growth higher than the preceding year except in 2009 when there was a decreased growth . In other words, the growth in 2009 was less than the growth in 2008. This was the only exceptional case. In 2015 for example, the financial report showed that over 70 million pounds in profit was realized by the group which is the highest profit ever achieved by the company. For the case of profitability, the company has been making profits ever even though some years less than the others but not a single year has it ever made a loss. In 2015 for example, the before tax profit was 72 million pounds which was an increase of about 11% from 2014. Such information are used by different stakeholders especially investors who want to invest in the company. However, sometimes such information turns out to be window dressed thus duping investors into making wrong decisions. This trend has led to a situation where people question whether information available to the public by companies are reliable.

Below is an example of a balance sheet statement for Lookers in 2015 December.

£m 31 Dec 2015 £m 31st Dec 2014

Fixed Assets 282.9 215.6

Rental Fleet Vehicles (VRS) 67.0 57.1

Stocks 816.0 548.8

Debtors 252.6 179.4

Current Liabilities (excluding bank loans) 1,002.0 705.0

Non Current Liabilities (excluding bank loans) 115.3 97.2

Vehicle rental fleet finance (VRS) 53.8 46.3

Net Assets 297.8 256.9

Net Debt 161.7 51.9

Gearing 54% 20%

Net Debt / EBITDA 1.61 0.59

This shows a perfect company worth investing in and which has a positive trend of making profit. An investor looking to invest in a company that will be paying him his dividends and returning his investment will not look anywhere but at a company whose balance sheet is something close to this. Whether this is true or not may be a subject of a thorough independent auditing to reveal the truth in this financial reporting.

Financial Analysis Methods

According to , the most commonly used financial statements when analyzing the financials of a company are the income statement, balance sheet and cash flow statement. There are generally three methods of analyzing financials of a company. There is the trend analysis, horizontal and vertical analysis and ratio analysis. Horizontal and vertical analysis compares financial analysis over a sequence of reporting times. Vertical method compares this information using proportion methods where every line of an item represents a proportion of the total assets or gross sales in balance sheet and income statement respectively.

Trend analysis on the other hand includes a review of financial statements of three or more reporting periods with a more relationship with horizontal analysis. The earliest year is the base year, subsequent years are then observed for any change in income or expense. For example in the above lookers Plc balance sheet, 2014 and 2015 reports would be compared to ascertain if the company is making any progress or not. For that case, it is true the company is making progress as the level of net assets has increased in 2015 than it was in 2014.

Financial ratios too are helpful in gauging the financial stability of an organization. These ratios are use as analytical tools or techniques to tell the relative strength or weaknesses of a company. It is however notable that financial ratios vary across industries and thus comparing the strength of companies unrelated by industries on the basis of the financial ratio may be misleading. Ratios are just the mathematical comparison of a number to another.

The most commonly used ratios are; activity ratios, liquidity ratios, solvency and profitability ratios. Activity ratios shows how proper a company uses its assets and hence the overall operational performance of the firm. It may include the turnover ratio which too, measure how often receivables are collected in a year or how frequent stock is replenished. Specifically, inventory turnover is calculated by dividing the cost of goods sold by the average inventory. If the inventory turnover is high, then stock is sold faster which may mean the company is unable to meet its demand. A smaller one too signals a weak marketing. Others include; the receivables turnover, payable turnover and asset turnover.

Liquidity ratio are mostly used by creditors to ascertain the firm’s ability to meet its short term obligations. Under this we have current ratios which compares a company’s assets against its current liabilities. A value higher than 1 percent is better. Quick ratio on the other hand measures the cash, short term securities and accounts receivables to current liabilities. Finally, there is the cash ratio which measures how short term securities and cash can be consumed by short term liabilities.

Similarly, solvency ratios measure a firm’s ability to meet its longer term obligations. It analyzes the firm’s capital structure and the level of financial leverage the firm is using. In other words, it gives insights into the ability of the firm to pay fixed charges like the interest and dividends payments. They include the Debt-to-asset ratio, Debt-to-capital ratio, debt-to-equity ratio, interest coverage ratio.

Finally, profitability ratios which measure the company’s ability an adequate return. It is made of “margins”. This is then compared with a similar company in the same industry like a close competitor. Example include the gross margin, operating profit margin and net profit margin .

Common Size Analysis

This accounting concept is based on the fact that numbers in a financial report can be represented as a proportion of the total assets in the balance sheet. This helps to compare companies in the same industry without the problem of the size. For example in the balance sheet of Lookers PLC above, the representations of figures will be in percentages of the total assets and not in million pounds as recorded. It is also applicable to income statement where the percentage will be of total income. One is able to tell if the amount of money held by the company as a proportion of its total asset is enough to offset current liabilities. In the case of Lookers PLC for example, the rental fleet, stocks and or cash would be expressed as a percentage of total assets and not in pounds as above. The same would be true for current liabilities which would be expressed in form of percentage of the total liabilities.

Cons of Financial Analysis Method

Financial ratios suffers the problem of inability to consider inflationary effects, when records of transactions are taken the effects of inflation are not considered hence compromising the actual value arrived at by ratios. This is in addition to being historical and failing to consider human aspect in the firm. The latter is also true for trend analysis and vertical and horizontal analysis methods. This can be seen in the Lookers balance sheet for 2014 and 2015 above. There is no allowance for depreciation of assets, there is no allowance for inflation or even human aspect of the organization yet the latter is even the most important.

Ratios are also not important for companies in different industries. A higher inventory turnover in a grocery company may be desirable but may be a sign of a weakness in sales in the computing industry, then the possibility of window dressing is also eminent. Ratios analysis can’t detect a window dressed financial information. A balance sheet or income statement can be manipulated by the management to portray what they want the investors to see yet financial ratios are not having mechanism to detect this ..

Different companies may use different accounting practices especially in stock valuation which has been found to be different with each method. This may compromise the final answer arrived at by the use of ratios .

Reliability of Financial Analysis by All Public Available Information

According to Moses Bukenya in his journal on Quality of Accounting Information and Financial Performance of Uganda’s Public Sector, accounting is the process of identifying, measuring and communicating economic information to allow for informed judgments or decisions by the targeted audience here being the public . The audience being referred to here are all stakeholders to the company including the employees, investors, customers, government agencies, creditors, suppliers, lenders just to mention a few. It is for this reason that the Accounting Standard Board set out certain characteristics to be followed by organizations when reporting financial information. These characteristics can be summarized into reliability, accuracy, relevance, timeliness and understandability. In his research about the companies in Uganda, Bukenya found out that the companies appreciated the above characteristics and influenced their reporting. With this revelation about some companies, it becomes easier to trust what they display as their financial reports.

On the contrary, since there are many different stakeholders to a company, each has his or her interests. The manager who often represents the company is always interested in making the company a darling of many in fact all stakeholders. On the other hand, investors are interested in a company that is worth investing in without getting worried about losing his/ her investment. Employees on the other hand want to know how the company is performing so that they too can be sure of their future. Suppliers and lenders too would only continue doing business with the company if it is and shows future ability in fulfilling its debt obligations.

These information can only be sourced from the financial reports it makes public. This report even though is guided by certain criteria listed above, is still prone to manipulation by the manager. Since the manager is interested in keeping all the stakeholders stuck with the organization, it is easier for him or she to manipulate data that he gives to the accountant a process often called window dressing. Nevertheless, many scholars argue that financial information especially those on public traded securities of international or national corporations are subjected to international standards of accounting and are monitored by the bodies charged with the same. For that matter, it is hard for them to cheat the public by misrepresenting information. Therefore, the information can be relied upon.

Business Valuation Methods

These are methods used in calculating a business value. There are asset-based business valuation methods, income-based business valuation methods, market-based business valuation methods and the use of multiple methods. Asset based business valuation method estimates the value of a business by calculating the total costs required to create a business of equal economic utility. The methods under this approach are Asset accumulation method and excess earnings methods. The former is a framework for calculating the market value of a business asset and liabilities. The business value is the difference above. The capitalized Excess earnings in addition to business value calculation, allows one to also determine the value of intangible property of the business.

Income based business Valuation is based on the income producing capacity and risk. It normally employs the use of capitalization of earnings, discounted earnings, and multiple discretionary earnings. Market based business valuation methods on the other hand helps in estimating the subject business value by comparing it with the recent selling prices of similar businesses. This is especially for similar businesses that were sold in the recent past. The use of multiple methods in business applies the number of business valuation methods for accurate determination of business value. The consideration of so many businesses valuation methods to get the value of a business is sometimes called the business value synthesis.

Asset Accumulation

This is another way of valuating a business commonly used in small businesses. It determines the value as the difference between the current asset value and the current liabilities. What makes it unique is that it considers all market values of the assets in addition to book values and also considers intangible assets, key distribution and customer contracts, strategic partnerships, pending legal judgments, property and income tax and environmental compliance costs.

Discounted Cash Flow Method

Discounted cash flow is another valuation method which enjoys the advantage of being foolhardy. It’s not easy to manipulate cash register as it is easier to do with ratios. It utilizes the estimated future cash flow projections by discounting them using the weighted average cost of capital to get to the present value of the investment. It is basically to estimate the money that one can get from an investment when time value is adjusted. There only problem is that they are complex and look like a mechanical structure where figures are entered and computed. This can be prone to manipulation and hence wrong presentation. In addition, a small change in input can result to a big change in the value of the company.

Market Value

The market value is the amount which a product would sell in a free market. It is also used to refer to the market capitalization of publicly traded company by multiplying the outstanding company shares and by their current prices. It is an indicator of how investors perceive the business and fluctuate depending on the sector, its profitability, debt load just to mention a few.

Conclusion

It is a common feature to find that companies misrepresents information about their performance to the public. This does not in any way imply that the information about Looker PLC copied above from their websites is wrong. It is also not in any way implying that they are the true representation of the actual data. This is why it is suggested herein that such information can be verified for authenticity using an independent auditor. Financial analysis methods used also tend to have weaknesses that threaten to compromise the results obtained thereafter. Ratios have avalanche of problems while analyzing financials on the basis of trends too have their weaknesses. A proper method would be that which does consider all the methods while putting emphasis on human contribution and inflation as these are what lacks in most of these methods. Conclusively, publicly availed financial information can be reliable but only when the company adheres to the standards set by the bodies governing the accounting although this varies with countries. An independent audit maybe required to be certain of such information.