Ratio Analysis of the Two Companies - Term Paper Example

INTRODUCTION This report provides an insightful and comparative analysis of the two companies Monsoon plc and Blacks Leisure plc. This report has been constructed into three major parts being the companies' introduction, ratio analysis and identification of important factors likely to affect the companies' performance. The ratio analysis in particular, provides the detailed comparison of both the companies' financial position and performance based on the data obtained from the companies' financial statements from the stance of management, lenders and the investors. Background Of Companies Both these companies belong to the retailing industry dealing in clothing and accessories business. Monsoon plc deals in branded variety of clothing, footwear and accessories comprising two major chains i.e., Monsoon and Accessorize. The company caters to a wide range of customers young and old, male and female, babies and children. Apart from clothing and accessories, the company also deals in home ware for instance, bed and bath lines, curtains, and other home products (Company Info, accessed 06.04.2006). Blacks Leisure plc is a high street chain of superstores engaged in outdoor clothing and footwear business all over the United Kingdom having around 104 stores across the country. The company has a diversified customer market and its store design reflect this orientation. It provides clothing and travelling products to a wide range of customers of all ages and kind. It deals in several brands and provides a range of products relating to the outdoor activities and adventure most specifically clothing, tents, outdoor equipments, accessories and instruments Significance Of Comparison The comparison and evaluation presented in this report is significant in the sense that it practically employs a wide variety of financial ratios to assess the financial position and performance of both the companies. The ratios are applied to the companies individually and then their outcomes are compared with each other on the basis of interpretation as per the companies' financial statements. Its significance lies in the fact that the evaluation and comparison will be useful for various users of financial statements that are unable to interpret the information available on a company's financial statements. This comparison would assist these users in forming a rationale for their major decision-making i.e., strategic planning, investment and funds lending etc. RATIO ANALYSIS- BLACKS LEISURE GROUP PLC & MONSOON PLC Ratio analysis is the best tool to evaluate a company's performance and identify problems (Meigs & Meigs, 1993). Riahi-Belkaoui (1998) comments that financial ratios are meant to make the information in financial statements interpretable for the various users of financial statements. Similarly, we will assess and analyse the financial position and performance of the two companies Blacks Leisure plc and Monsoon plc using a broad array of financial ratios from the viewpoints of management, lenders and investors separately. Analysis For Management Management needs to analyse its performance and efforts put into the corporate affairs through the company's financial results so as to realise their strengths and weaknesses. Riahi-Belkaoui (1998, p11) says, "the profitability ratios portray ability of the firm to efficiently use the capital committed by stockholders and lenders to generate revenues in excess of expenses". Therefore, the analysis from the management aspect has been done with the help of following profitability ratios: Ratios Blacks Leisure Plc Monsoon Plc Gross Profit Ratio 53.07% 61.51% Net Profit Ratio 6.54% 15.66% Return on Capital Employed 20.23% 42.76% The Gross Profit Margin Percentage evaluates the percentage of profit earned by a company on sales after the production and distribution activities (Mcmenamin, 1999). It shows how well the company manages its expenses so as to attain maximum profit out of its total sales. Monsoon plc's gross profit ratio of 61.51% reflects that the company has managed its cost of sales more efficiently than Blacks Leisure plc having a gross profit ratio of 53.07% for the year 2005. It further illuminates that Monsoon plc lost about 38% and Blacks Leisure plc about 46% out of their sales revenue on account of production and distribution expenses. The Net Profit ratio shows what percentage of profit a company earns on its sales (Mcmenamin, 1999). It reveals the profit retained by a company after accounting for its various operating costs. The difference between these companies' net and gross profit ratios indicate the amount of profit foregone by them in the course of meeting various selling and administrative expenses. Thus the above graph shows that Black Leisure plc incurs more operating expenses than Monsoon plc reflecting the efficiency of its management in managing various costs. Riahi-Belkaoui (1998, p11) says that the return on capital employed ratio "indicates how efficiently the capital supplied by the common stockholders was employed within the firm". Again, Monsoon plc utilised its shareholders' funds more efficiently during the financial year having ROCE ratio of 42.76% as compared to Blacks Leisure plc with 20.23%, almost half the difference as revealed in the chart displayed above. Analysis of the above companies from the vantage point of management exposes that Monsoon plc is much profitable company than Blacks Leisure plc and its management is efficacious enough to generate profits through sales and retaining those profits out of the effectual management of all the expenses. Analysis For Lenders- Short Term A company's short-term lenders need to explore the company's liquidity position and its ability to meet its short-term obligations. Riahi-Belkaoui (1998) says that the analysis of a company's liquidity is particularly important for the short-term creditors and lenders of the company so as to ensure that the company would be able to pay off its debts whenever the time comes. The analysis from the viewpoint of short-term creditors has been done below with the help of liquidity ratios: Ratios Blacks Leisure Plc Monsoon Plc Current Ratio 1.67:1 1.59:1 Acid Test (Or Quick) Ratio 0.6:1 1.1:1 The current ratio measure's a company's abilities to pay off its short-term liabilities out of its current assets (Meigs & Meigs, 1993). The current ratios for both the companies reflect their working capital position i.e., the amount needed in a company to meet its short-term expenses and debts whenever such need arises. The above chart displays that Blacks Leisure plc has a much better liquidity position than Monsoon plc having '1.67 for each '1 liability. The quick ratio tests the short-term solvency of a company after keeping aside its stock from the current assets (Mcmenamin Jim, 1999). Here, the analysis reveals an entirely opposite scenario i.e., after removing stock from our consideration of current assets Blacks Leisure plc's working capital strength fell down while Monsoon plc remained quite stable. This shows that the former company has most of its assets tied up into stock, which is not always easily convertible into cash at the time of need. Thus the liquidity analysis reflects that Monsoon plc has a better liquidity position for its short-term lenders and is more able to meet its short-term debts and obligations as compared to Blacks Leisure plc. Analysis For Lenders- Long Term Riahi-Belkaoui (1998, p10) illuminates that the analysis for long-term lenders can be done with the help of leverage ratios that are "used to assess the long-term solvency risk of the firm". The probable solvency risks lying in both the companies are evaluated with the help of following ratios: Ratios Blacks Leisure Plc Monsoon Plc Debt Ratio 32.19% 38.37% Gearing Ratio 47.46% 62.24% The debt ratio analyses the extent of a company's total assets that is financed with the long-term debts (Meigs & Meigs, 1993). The debt ratio for Monsoon Plc reveals that about 38.37% of its assets have been financed by external funds and borrowings, whereas in Blacks Leisure Plc about 32.19% of the assets have been funded with debts. The Gearing ratio exposes the capital structure of a company i.e., to what extent the company relies on borrowed funds as compared to the equity funds for the purpose of financing its business operations (Meigs & Meigs, 1993). It illuminates the capital structure of a company by evaluating the ratio of debt and equity funds employed by the company to finance its operations. The gearing ratio as calculated above reflects that although both the employ almost a mix of both the equity and debt funds to run their business operations, but Blacks Leisure plc is less geared than Monsoon plc by about 15%. The long-term solvency assessment of both the companies indicate that Blacks and Leisure plc is less risky for lending purposes than Monsoon plc because it relies more on the equity funds than the borrowed capital currently and therefore confronts with less chances of bankruptcy. Meyers (1997) says that the companies with high leverage have less potential for investment as these companies may consequently fail to obtain further debt from the lenders to finance their operations. Analysis For Investors Analysis of a company from the viewpoint of its existing and potential investors i.e., its investment potential is highly important as if a company cannot satisfy its investors and provide a strong return for their risk, it should fear losing a substantial amount of funds invested. The investment analysis for both the companies can be done with the help of the following ratios: Ratios Blacks Leisure Plc Monsoon Plc Earning Per Share 28.34p 19.34p Dividend Per Share 10.0p Nil Dividend Cover Ratio 0.35 times Nil "Common shareholders and potential investors in common stock first look at a company's earning record" (Meigs & Meigs, p934, 1993). The earnings per share records of both the companies show that Blacks Leisure plc is plc is transferring more returns to the company's shareholders in the form of earnings per share i.e. 28.34p. Monsoon plc on the contrary, has passed on an EPS of 19.34p to its shareholders showing a difference of about 32%. Here, it should also be noted that according to our profitability analysis above, Monsoon plc remained to be the most profitable company of the two yet its earnings per shares are lower than Blacks Leisure plc reflecting the higher number of shares issued. The dividend per share is of importance to the investors and shareholders who are interested in the company's potential to pay dividends on the annual and interim basis (Mcmenamin, 1999). The dividend per share as mentioned in the companies' annual reports shows that Monsoon plc does not satisfy this concern of its shareholders at all by paying nothing to them in the form of dividends. Whereas Blacks Leisure plc has paid a dividend of 10p per share to its shareholders, which is about 0.35 times and 35% of its net earnings as indicated by the dividend cover ratio mentioned in the chart above. From the investment point of view, Blacks Leisure plc is indeed more profitable company for the investors in terms of both earnings and dividend as compared to Monsoon plc. FINANCIAL AND NON-FINANCIAL FACTORS AFFECTING FUTURE PERFORMANCE The financial and non-financial factors likely to affect the future performance of both the companies are discussed below: Blacks Leisure Plc Cost Management: Blacks Leisure plc appears to be less efficacious in managing its production, distribution, and SG&A expenses in order to attain a maximum percentage of sales revenues as profit at the year-end. The company pays more than half of its sales revenues on the above-mentioned expenses and finally is left with a net profit of just about 6%. If this trend continues to follow, the company will not be able to gain much out of its sales and generate operating cash for business. Cash and Working Capital: As evident from a review of the company's balance sheet, its investment in the most liquid assets i.e., cash and cash equivalents is terribly low. Most of its investment in current assets about 64% remain tied up in stocks with an investment of 17% in cash. It is therefore imperative that the company should reconsider its investment in current assets so as to remain as much liquid as possible. It should invest more into cash. Monsoon Plc Decreasing Net Cash: An analysis of the company's cash flow statement reveals that the company is losing its operating cash significantly every year. The company's balance sheet shows an increase in cash reserves but as exposed in the cash flow statement, the decrease in cash has resulted due to the capital and financial expenditures. Dividends: The Company's financial statements reveal that it has not been paying a single penny as dividends to its shareholders for about two years. It is not a good sign for the company's investment potential as most of the investors are willing to pour their funds in a company returning substantial dividends to them both annually and semi-annually. If the trend continues in the future, the company will lose most of its potential as well as existing investors and shareholders. APPENDIX- ''000 Blacks Leisure Monsoon Gross Profit Ratio Gross Profit x 100 = 156,531 223,683 Sales 294,952 363,671 = 53.07% 61.51% Net Profit Ratio Profit before interest and tax (PBIT) x 100 = 19,286 56,952 Sales 294,952 363,671 = 6.54% 15.66% Return On Capital Employed (ROCE) Operating profit = 19,286 56,952 Equity shareholders fund 95,342 133,193 = 20.23% 42.76% Current Ratio Current Assets___ = 72,722 128,525 Current Liabilities 43,760 80,897 = 1.67:1 1.59:1 Acid Test (Or Quick) Ratio Current Assets- Stock = 72,722-46,483 128,525-41,384 Current Liabilities 43,760 80,897 = 0.6:1 1.1:1 Debt Ratio Total Debt Finance x 100 = 45,254 82,904 Total Assets (Fixed + Current) 140,596 216,097 = 32.19% 38.37% Gearing Ratio Total Debt x100 = 45,254 82,904 Total Shareholders' equity 95,342 133,193 = 47.46% 62.24% Earning Per Share Provided in Annual Report = 28.34p 19.34p Dividend Per Share Provided in Annual Report = 10.0p Nil Dividend Cover Ratio Dividends Per Share = 10.0p -- Earning Per Share 28.34p -- = 0.35 Nil References Ahmed Riahi-Belkaoui (1998), "Financial Analysis and the Predictability of Important Economic Events", Quorum Books Company Information, accessed April 6, 2006 from the World Wide Web: http://www2.monsoon.co.uk/comphistory.htm Home, accessed April 6, 2006 from the World Wide Web: http://www.blacks.co.uk/blacks.storefront/default.aspx Meyers S. (1977), "The Determinants of Corporate Borrowing", Journal of Financial Economics, (5) Meigs & Meigs (1993), "Accounting: The Basis For Business Decision Making", Mc Graw Hill: New York, p934 Mcmenamin Jim (1999), "Financial Management: An Introduction", Routledge, London Read More