Financial Management Principles: Thorntons Plc - Case Study Example

Running Header: FINANCIAL ANALYSIS FOR THORTONS PLC Financial Analysis for Thorntons Plc in Harvard Style by Name University Executive Summary Business finance and financial accounting are closely interrelated. While accounting deal s with recording financial transactions, business finance turns this data into a system which makes it easier for stakeholders to understand the financial performance of a business entity. Thorntons Plc is a manufacturer and distributor of chocolates, toffee, ice creams, candies and other confectionery. Its commitment for product quality and innovation has enabled it to capture a large portion of its market. In order to assess the financial performance of Thorntons Plc, financial ratio analysis has been conducted classifying the measures into four categories: performance; working capital efficiency; financial status; and investor ratios. Based on the performance ratios computed, Thorntons' profitability is declining together with its ability to turn revenue into profit. However, the company shows improvement in efficiency evidenced by the declining inventory, debtors' and creditors' ratio. Thortons' current assets are able all its immediate obligation yet most of its liquid assets are tied up in inventory. The company is able to service its interest expense through its operating income. Thorntons' is more dependent on creditors in financing its resources. As an investment, the company's stocks might be unattractive due to the declining earnings per share and return on equity. For a competitor, Thorntons might not post a formidable threat. Supplier will find the company a good customer because of its liquidity and improved creditors' ratio. For a customer, the reduction in inventory ratio might signal less possibility for spoilage. For a potential acquirer, Thorntons might be a good target but still needs a good management for improvement. Introduction to Accounting and Financial Management Financial management is very much essential in ensuring the health and well being of a business organization. Business finance, in the simplest sense, is concerned with the goal of a firm to maximize shareholder value (Keown, et. al. 2004). It should be noted that finance is all about managing the financial resources of a business entity into those opportunities which will yield maximum value for stockholder's wealth. This involves generating cash in order to support the operations of the company and choosing among competing ends of investment opportunities present in the market. Horngren, et al. (2002, pp. 6) defines accounting as the "information system that measures business activities, processes that information into reports, and communicates the results to decision makers." Accounting is generally classified into fields according to the intended users of financial data. Financial accounting focuses on providing information for people outside the firm like creditors and outside investors. Management accounting on the other hand focuses on giving internal decision makers information which aids them in making financial and operational strategies (Horngren, et al. 2002). Accounting and business finance are closely interrelated. The business arena often refers to accounting as "the language of business" implying that a better understanding of the accounting language will aid making better financial decisions (Horngren et al. 2002). Thus, in general, accounting is a prerequisite in understanding the important concepts used in financial accounting. Basic knowledge in accounting is imperative in understanding finance. As stated earlier, concepts which are commonly used in accounting appears in financial management. For instance, a company which needs to determine the profitability of an investment needs to be acquainted with the effects of different transactions on the income statement of the business organization. With this, knowledge in accounting becomes imperative for financial managers. Accounting acquaints individuals with the necessary knowledge in business and financial terminologies. It also becomes a foundation of financial skill. Thus, decision makers need to be adept in speaking the language of business in order to be able to come up with financially efficient business decisions geared to help in attaining the financial goals of a firm. Financial accounting which is more concerned with the reporting of historical financial information becomes a reflection of the how the financial aspect of business is managed. The financial statements of business organisation can reveal a great deal of information about the attractiveness of a firm. These documents clearly show how the business organization is performing in terms of income, capital structure, asset growth and other numerical information (Horngren et al. 2002). The profit or loss in the financial statement, the growth in total assets, and how they resources are financed becomes an indication of how well a business organization is attaining its financial goals. Financial accounting is a yardstick revealing how business finance is achieving its goal of maximizing shareholder value. With this, financial accounting is very important in ascertaining the efficiency of financial decisions in a company. In order to fully assess the financial performance and relative attractiveness of a business organization, ratio analysis is typically used. Financial ratio analysis is a very essential tool in assessing the financial health of a business entity. It enables a financial analyst to spot trends in a business and to compare it with the performance of similar business enterprises within the same industry. Financial ratios are grouped into five categories, each showing a different aspect of a company's financial operations. These are profitability ratios, financial leverage ratios, liquidity/solvency ratios, efficiency ratios, and investor ratios. This report will examine the financial stability and well being of Thorntons Plc (Thorntons) in order to examine whether it will be a good target for acquisition for our business organisation. The succeeding section will give an overview of Thorntons Plc and its business activities. Next, the financial performance of the company will be assessed through different financial ratios. In order to shed light to how these ratios are applied, this report will examine the implication of the computed figures from the point of view of a competitor, a supplier, a customer, and a potential acquirer. Thorntons Plc: An Overview Thorntons Plc traces its roots in the early 1911 when it was established by Joseph William Thornton. With its commitment of providing high quality chocolates, toffee, ice cream, and other confectionery, the company has risen from its humble beginning to become a 180 million company. Today, the company distributes its premium and hand crafted box chocolates and seasonal candies in 395 stores and 181 outlets in the United Kingdom. Thorntons also harnesses the advancement in technology by opening its virtual store where every customer can view and buy its products with just a mouse-click (Thorntons Plc 2006). The company states its unique strategy as follow: "Thorntons strategy is realizing the potential of brand within the UK confectionery market by driving profitable sales in all customer channels and improving the quality and costs of the products" (Thorntons Annual Report 2006). With this strategy, the company continues to harness the opportunities in the rapidly growing chocolate market. It should be noted that Thorntons strategy rests on key tenets which are innovation and quality. The chocolate manufacturer strongly believes that a company's success is dependent on how responsive it is to the different market situation and trends. Thorntons continues to create products which are appropriate and are highly demanded by its market. Product quality is also ensured by the company's strong standards. Thorntons threefold guiding principle is as follows: using natural ingredients with a strong provenance in all our products; applying artisan skills on a large scale to the appearance and design of our products; and personalization of products, packaging and services" (Thorntons Annual Report 2006). Thorntons distributes products through four different channels namely, Thorntons Direct, commercial, its own stores, and franchise. Thorntons Direct is the virtual store created by the company to cater to households and business consumers. Though the company generates only 6.4% of its total revenue from this channel, it expects that it has more growth potential considering the popularity and wide usage of internet in shopping. With this distribution channel, Thorntons allows customers to personalize their orders through a user-friendly interface. The company also offers its products in commercial establishments like groceries and malls. Thorntons owes a lot to this channel as this made the company a favorite among shoppers. The company also has its own stores and cafes where its products are being distributed. It should be noted however, that slump in sales has been experienced by this channel because of Thornton's decision to lessen the number of its outlets. The company plans to compensate for this by "improving the front and fascia" of half its stores and refitting 24 stores. The chocolate manufacturer and distributor also offer franchise which outlets are usually located in smaller towns within the United Kingdom (Thorntons Annual Report 2006). Financial Ratio Analysis Performance Ratios Performance ratios measure the ability of the company to generate income from its investments less the costs incurred (Fraser & Ormiston 2004). Return on capital employed is a variant of return on investment. Return on capital employed is a measure how well the company is utilizing its capital. The computed sales profit margin, which is the ratio of operating income to sales measures as a percentage of sales, the excess revenue from sales over cost of normal operation excluding financing. Asset turnover measures the amount of sales generated by every pound in the company's assets. Net profit margin, on the other hand, is the ratio of net income to sales (Fraser and Ormiston 2006). Logically, higher performance ratios indicate a healthier financial condition. Table 1 shows the computed performance ratios for Thorntons Plc. In order to fully assess the financial well-being of the chocolatier, this report will benchmark the 2006 figures from the ones reported in 2005. Table 1. Based on the computed performance ratios tabulated above, Thorntons' financial performance seems to have declined from the 2005 level. It can be seen that all ratios have decreased indicating the company's inability to more efficiently utilize its resources in order to generate revenue and profit. The company's return on capital employed has diminished by 5% while asset turnover decreased by more than 40%. Looking at the raw figures, this is brought about by the slump in the total revenue generated by Thorntons in 2006. The chocolatier's weakening ability to convert sales to profit is also apparent. In 2006 the company's sales margin is down to 4.14% of total revenue from the 5.59% recorded in 2005. The same is true with Thornton's net profit margin. Working Capital Efficiency Ratios Activity ratios are operating efficiency measures, which determine the ability of a company to maximise its output given a certain level of resources (Fraser and Ormiston 2004). These ratios significantly gauge the asset, investment, and cost management performance of the business entity. Ratios under this category are inventory, creditors' and debtors' ratio. The inventory ratio measures how many days the stocks sits in the company's distribution center or warehouses. The debtors' ratio reveals the efficiency of a business organisation in collecting its account receivables while creditors' ratio shows the umber of days the company is able to pay its suppliers. Lower numbers are preferred in this ratio classification (Fraser and Ormiston 2004). Table 2. Table 2 shows the computed working capital ratios for Thorntons Plc. Note that the values are expressed in number of days. Based from the figures, Thorntons working capital efficiency has improved from 2005 to 2006 as all the ratios have significantly declined. Thorntons reduced the total number of days its inventory stays in the warehouse by almost six days. The company's suppliers are also paid 20 days earlier than in 2005. However, Thornton's ability to collect receivables stagnates at 24 days. Financial Status Ratios Financial status ratios measure three aspects of business performance: liquidity, solvency, and leverage. Liquidity ratios are used as measures of the company's ability to finance its short-term obligations by its cash and near cash items. Included in these ratios are current and quick or acid-test ratios. Current ratio expresses the "working capital' relationship of current assets available to meet the company's current obligations while acid-test ratio removes the inventory from the current assets to cover the company's immediate liabilities (Fraser and Ormiston 2004). Solvency refers to the company's ability of servicing its financial obligations after covering its costs of operation. The interest coverage ratio which is the ratio of the company's profit before interest and taxes and interest expense measures the extent to which earnings cover the interest obligation of the company (Fraser and Ormiston 2004). Financial leverage ratios provide an indication of the long-term solvency of the firm. They indicate the extent of non-owner claims on the firm's profits. Gearing or debt to equity ratio shows the relationship between the financing provided by creditors against the stockholders (Fraser and Ormiston 2004). Table 3. In terms of liquidity, Thornton has improved from 2005. The company's current assets are more than enough to cover the chocolatier's immediate obligations. However, it can be seen that most of the company's liquid assets are tied up in inventory as evidenced by the large-gap between the acid test and the current ratios. In terms of solvency, the company's interest coverage ratio has declined but nonetheless, Thornton's has more than enough operating profit to service its interest obligation. In terms of leverage, it can be seen that the company's resources are mostly financed by debt. Thorntons has a 60:40 asset structure in favor of liabilities. Investor Ratios Investor ratios are financial ratios especially designed to covey to investors the asses the profitability of the company's stock as an investment. The return on shareholders fund assesses the rate of return on the investments of common stockholders in the company Earnings per share shows the return to common stock shareholder for each share owned (Fraser and Ormiston 2004). Table 4. Table 4 shows the Throntons investor ratios. It can be seen that both ratios have declined from the 2005 level. Return on shareholders fund decreases from 0.83 to 0.54, while earnings per share drops from 8.5 p to 5.6 p. The Financial Performance of Thornton's for Stakeholders Competitor From the point of view of a competitor, Thorntons is not a strong threat. The declining profitability, ability of the company to turn revenue, into profits together with its choice or riskier financing and declining returns for investors is an indication of weaknesses. However, a competitor will also be cautioned of the Thorntons' increasing efficiency in inventory turnover and supplier payment. Supplier A supplier will mainly look at Thornton's creditors', liquidity, and profitability ratio. Though Thornton's might not be showing an uptrend in profitability measures, a supplier will find it worthwhile to have the company as a customer because of its shortened data of accounts payable payments. Customer A customer often doesn't look at the financial performance of a business organization as a basis for his/her purchases. If a customer is buying a good which has low shelf life or perishable like chocolates, ice creams and other confectioneries, he/she is most likely to note Thornton's inventory ratio. For Thornton's the reduction in the days that its product stays in the warehouse can encourage customers to purchase from the chocolatier. Potential Acquirer For a potential acquirer, Thornton's might be a good target for acquisition. The company's large market share in UK's confectionery market indicates the huge potential of Thornton. However, should a business organization acquire Thorntons, it needs to find ways on how to manage cost efficiently in order to turn more revenues into profit as well as maximize shareholder value to attract more potential investors. References Fraser, L. & Ormiston A 2004, Understanding Financial Statements, Pearson-Prentice Hall: Upper Saddle New Jersey Horngren , C. et. al..2000, Accounting.4th ed. New Jersey: Prentice Hall Keown, A.J., Martin, J.D., Petty, J.W., and Scott Jr., D.F, 2005, Financial Management principles and applications, Pearson/Prentice Hall International Edition, 10th Edition. Thorntons Annual Report 2006, Retrieved 21 November 2006, from http://www.thorntons.co.uk/PUBLIC/THT_CM/investor_information/docs/Annua l_Report_2006.pdf Thorntons Plc 2006, Retrieved 21 November 2006, from http://www.thorntons.co.uk Thompson, A. & Strickland , J 2002,Strategic Management.3rd ed. New York McGraw- Hill Read More