Importance Of Measurement Of Company Performance - Case Study Example

Importance Of Measurement Of Company Performance Table of Contents Overview 3 FedEx 3 UPS 3 Performance Measurements 3 EVA (Economic Value Added) 4 MVA (Market Value added) Analysis 4 Ratios Defined 4 Analysis 7 Conclusion 19 Reference 20 Introduction 3 Overview 3 FedEx 3 UPS 3 Performance Measurements 4 EVA (Economic Value Added) 4 MVA (Market Value added) Analysis 4 Ratios Defined 5 Analysis 7 Conclusion 19 Reference 20 Bibliography 23 Introduction UPS and FedEx are the most renowned names in the global logistics industry. This report compares the financial performance of the two global behemoths on different aspects. The analysis is designed mainly in two parts, the first part provides overviews of two companies; the second part presents a conceptual approach to different methods of performance measurements like financial ratios, Economic Value Added (EVA) and Market Value Added (MVA). This is followed by the analysis where each company’s performance has been explored individually as well as in comparison to other company in different periods. Finally a conclusion has been drawn based on the entire analysis. Overview FedEx FedEx, based in U.S., was established in the year of 1973,. With annual revenues of $36 billion in 2009, this company provides customers and business worldwide with a broad portfolio of transportation, e-commerce and business services. From there till recent year FedEx has proven its credibility to its customers with high quality services they provide (FedEx, 2008). UPS United Parcel Service Inc, one of the world’s largest package delivery companies, was founded in 1907 as a private messenger delivery service. Their business primarily include the time-definite delivery of packages and documents worldwide. The operations are mostly divided in three segments under U.S. Domestic Package operations, International Package operations, and Supply Chain & Freight operations. In the year of 2007 they provide service to around 2 millions shipping customers in over 200 countries and territories (UPS, 2007). Performance Measurements Measurement of performance for the company has been done through comparison of respective years’ financials (NASDAQ, 2009). The analysis is divided mainly in two dimensions. The very first one makes a comprehensive comparison of financial ratios of the companies individually among different periods. The other one extends the comparison of financial ratios among the two companies, FedEx and UPS. The performance measurement those would take part in this analysis are briefly portrayed below. EVA (Economic Value Added) EVA is measured as the value added or deducted each year by deducting a charge for capital from the firm’s net operating profit after taxes (NOPAT).EVA tells management whether shareholders’ value is created or not, measuring whether the profit after tax is greater than the capital charge . EVA= Operating Profits – Capital Charge =NOPAT- k* Capital, K is the cost of capital here .To reach at the capital charge, the capital needs to be multiplied by the cost of capital. MVA (Market Value added) Analysis MVA is another measure of creating shareholders’ value. If the market value of any firm is greater than the capital invested, the firm has created shareholders’ value. It’s calculated as, MVA= Company’s total market value – Capital Invested. Ratios Defined Profitability of any company can be measured in many different traditions like gross profit margin, net profit margin, return on assets, return on equity etc. Gross Profit Margin: Gross Profit Margin is defined as the gross profit of per unit of revenue and is calculated as Gross Profit Margin =Gross Profit / Sales Net profit Margin: Net profit margin is often measured as Net profit Margin = Profit after tax/ Sales. While calculating for the above ratios I have taken ‘revenue’ to represent ‘sales’.Net profit margin ignores the profit those are paid out to its debt investors as interest and because of it, this ratio is not so effective while comparing between firms having different capital structures . Return on Assets: Financial managers often measure the performance of the firm by the ratio named return on assets. Return on assets is measured as Return on assets = Net Income /Average total assets; A certain amount of high value is desirable. Although a low ROA ratio doesn’t entail that the assets could have produced better results if invested elsewhere. Return on equity: Another way to look at the firm’s performance is return on equity. It can be measured as Return on equity (ROE): Net Income/Average Equity; Although equity holders like to see their firm earning high return on equity, consumers and regulators often assume high return as evidence that the company is charging high prices for their products. The liquidity ratios come next. It’s very much important for a firm to keep a certain level of liquidity in its portfolio, so that in need it can lay its hand on the liquid assets. These ratios may change rapidly as its components i.e. both the short terms assets and liabilities can get easily changed over time periods. Current Ratio: Current ratio= Current assets / Current liabilities. Current assets consist of cash and other assets who can be turned into cash within very short period of time .Firm’s current liabilities consist of payments which is payable in near future. Thus current ratio tells us how much current assets is available to cover up the current liabilities. Quick ratio: Some assets are closer to cash more than other assets. In trouble time these more liquid assets can be used to repay the current liabilities. These kinds of assets mainly consist of cash and cash equivalents, short term securities and receivables from customers. Thus quick ratio is measured as Quick ratio = (Cash+ Short term securities+ Receivables)/Current Liabilities. Financial analysts take up another ratio to judge how efficiently the firm is using its investment in current and fixed assets. Asset turnover ratio: Asset turnover ratio tells about how hard the firms’ assets are being put in use and can be précised as Asset Turnover Ratio= Sales/ Total Assets. While doing calculations I have used revenue in place of sales. Stock Turnover ratio: This is another ratio to measure the effectiveness of one’s inventory management. How well a company turns over its inventory is measured by this ratio. Stock Turn Over Ratio= Cost Of Goods /Total Inventory. (Brealey, et al.,2007) Analysis The table shows financial ratios of FedEx (1999 - 2003), taken from the case itself (The Battle For Value,2004: FedEx Corp. vs. United Parcel Service, Inc., 65). The liquidity analysis shows ratios for five years starting from 1992. The current ratio is highest for the year 1994. Even it’s having the highest cash ratio in those 12 years. From 1993 to 1994, this company might have increased on their current assets or might have been able to cut on their current liabilities. If the company has increased on their current assets, it is very much probable that they might have increased their most liquid assets like cash and marketable securities. The liquidity figures for this company for 12 years starting from 1992 shows that the company preferred to have a high debt level at the beginning and later on in those 12 years it has decreased to 0.28 in 2003. The Times interest earned has gradually increased to a very high value of 10.51 in 2003, which is definitely a good sign for this company. That means they are very much able to pay back their interest. Profitability measured by net profit margin is highest in year 2000, although shareholders might be most happy with the year 1996, as this year hatched the highest return on total equity. The recent data of FedEx has been shown below. FedEx Period Ending: 5/31/2008 5/31/2007 Liquidity Ratios     Current Ratio 135% 122% Quick Ratio 120% 111% Cash Ratio 29% 29% Inventory Turnover 8725% 10418%       Profitability Ratios     Gross Margin 27% 28% Operating Margin 5% 9% Pre-Tax Margin 5% 9% Profit Margin 3% 6% Pre-Tax ROE 14% 25% After Tax ROE 8% 16% Cash Ratio is almost equal in the years 2007 and 2008, while in current ratios there has been a different between these two values. In 2007 FedEx used to carry more cash like liquid assets within their current assets than in 2008.The rationale is visible from the above graph. The above one is the graph of the profitability ratios of FedEx for the year 2007 and 2008.The 2007 results were anytime better than the results of 2008.Though in gross margin both the values have a very little margin, but the difference is very much visible in case of other profitability ratios. One of the reasons could be in 2008 FedEx has paid more tax than in 2007.This rationale has found place in the financial data provided by the case itself. The below table, picked up from the case, is a snapshot of the performance of UPS in years starting from 1992 till the year 2003. As per liquidity ratios are concerned the current ratios are highest for the year 1999.At the same year they had also increased on their cash ratio. It seems that in that year the company preferred to have more current assets in the form of most liquid cash like assets. The debt equity ratio for UPS shows that UPS always preferred to maintain a low debt level, lower than a ratio of .Times interest earned is highest for UPS in the year 2003, the value has been higher than that of FedEx. Regarding the net profit margin for this company, it has been noticed that net profit margin has been increased almost gradually till the year 1998.In 1998 UPS has seen a drop in its net profit margin from 7.02% to 3.26%.But thereafter most of the times the company has seen growth in its net profit margin. The below mentioned is a snapshot of the recent data for UPS. Like FedEx, here also it can be seen that there was a decrease in values in 2008.From quick ratio till the cash ratio; the lines are almost parallel, giving rationale that the values might have changed proportionately. But unlike FedEx, the profitability ratios for 2008 have shown good signs than those in 2007.Though gross margin ratio was bit higher in 2007,UPS has seen higher profit margin ratio in 2008. Performance comparison between UPS and FedEx Performance in the year 2008 All the below graphs are snapshots of the performance comparison between FedEx and UPS in the year 2008 (FedEx, 2008). The above graph shows the liquidity ratio performance for both the companies in the year 2008.As it’s visible from the diagram that the red bars are high in every case, it seems FedEx preferred to have more current assets as well as more cash like liquid assets in its portfolio (UPS, 2008). Profitability ratios are shown in the previous picture. All the profitability ratios are higher for UPS, while gross margin and pre tax ROE are much higher than those of FedEx. To reach at operating profit, operating expenses need to get deducted from gross profit. Now looking at the red line from gross margin till the operating margin, it looks as if UPS has a large amount of operating expenses. For this reason, though they had a very good gross margin but comparatively much lower operating margin. Performance in the year 2007 Here are the graphs analyzing the performance of both the companies in the year 2007. The competitive results are not much different from FedEx, but are less intensified. FedEx has higher current and cash ratios, but the intensity is much lower. From this position, both the companies have increased their liquidity in 2008, but in comparison FedEx did it more severely. This is the profitability graph for both the companies in the year 2007 (UPS, 2007).Performance of UPS is quite disappointing in this year .Their gross margin has been higher in this year, but for some reason their operating margin has dropped drastically, even lower than FedEx. The reason seemed to be same as that was in 2008.The operating expenses might have been quite higher for UPS. So deduction of such a large amount from its gross margin kept them with extremely low operating margin. EVA and MVA Below are certain formulas, those have been taken into account while calculating for EVA and MVA. Invested capital = Total assets – non-interest-bearing liabilities (NIBL) With NIBL = Total current liabilities – short-term debt & Cost Of Capital= (Equity/Firm Value)*Cost Of Equity+ (Debt/Firm Value)* Cost Of Debt (Green, et. al., 2009) The below table summarizes the EVA and MVA of both the companies in different periods. Regarding the EVA calculation, in 2002 the capital charge for FedEx was much higher than its net operating profit after tax. Hence in that particular year FedEx slipped to create shareholders' value. Although in 2003 FedEx tried ways to recover from previous state and was able to create a certain amount of shareholders' value but then it was much lower when compared to the economic value added by the company UPS. In both the years UPS has been able to create a good amount of economic value to its shareholders. While about the MVA calculation, it has been seen that in these two years FedEx has been able to create value to its shareholders by keeping up market value higher than its book value (BusinessWeek, 2009) The above graph compares the EVA values for both the companies in those five years. In 2008 both the companies were able to create high shareholders’ value .Though looking at the below snapshot of MVA, it appears both the companies were unable to mark any height in creating market values. EVA looks at the firm’s performance in a certain specified period .As in contrast to EVA, MVA is largely a cumulative measurement, therefore tells about how market values affect the firm’s performance. So there can be a difference between these two values. Adverse market conditions can be liable for such a low, even negative MVA (Worthington, et. al., 2001). Conclusion Overall FedEx had been able to show a superior performance when compared to that of UPS in most of the aspects.UPS used to have a very high gross margin, but that didn’t result high net profit margin. The reason seemed to be that UPS accounted for very high operating expenses, which in turn vetoed them to mark high in net profit margins.UPS should have a look at their expenses and try to lower those as much as possible. In 2002 and 2003, UPS was able to capture high Shareholders’ value than those of FedEx, but in the year 2008 FedEx managed to recover from their earlier position and marked a very high EVA value with greater intensity. The battle is still on. Both UPS and FedEx will drive to enhance their positions in coming years .Now let the future reveal how the competition will change in coming years. Reference Brealey, A. R., Myers, C. S., Allen, F. & Mohanty, P. 2007. Principles Of Corporate Finance. New Delhi: Tata McGraw-Hill Publishing Company Limited. UPS. 2008. UPS Annual Report 2008. [Pdf]. Available at: http://files.shareholder.com/downloads/UPS/798417707x0x281044/fa0304b6-7a81-457d-bf70-49179fe7b22a/UPS2008ARlores.pdf [Accessed on December 17, 2009]. UPS. 2007. UPS Annual Report 2007. [Pdf]. Available at: http://files.shareholder.com/downloads/UPS/798937250x0x181935/97051c3e-35b4-482d-910d-6fa5e4fe1c54/UPSAnnualReport.PDF [Accessed on December 17, 2009]. FedEx. 2008. FedEx. [Pdf]. Available at: http://files.shareholder.com/downloads/FDX/798481231x0x223284/b51e2e11-6edc-44a3-bcad-e5379c70a765/fedex08ar.pdf [Accessed on December 17, 2009]. FedEx. 2007. FedEx. [Pdf]. Available at: http://files.shareholder.com/downloads/FDX/798481231x0x128714/E5AF0091-BF6C-4A6C-A835-49FF605AC1E1/FDX_2007annualreport.pdf [Accessed on December 17, 2009]. Worthington, C. A. & West, T. 2001. Economic Value-Added: A Review of the Theoretical and Empirical Literature. [Pdf]. Available at: http://eprints.qut.edu.au/2568/1/2568.pdf [Accessed on December 17, 2009]. FedEx. 2008. FedEx Milestones. [Online]. Available at: http://fedex.com/gb/about/story.html [Accessed on December 17, 2009]. NASDAQ. 2009. FedEx Corporation (FDX) Company Financials. [Online]. Available at: http://www.nasdaq.com/asp/ExtendFund.asp?symbol=FDX&selected=FDX [Accessed on December 17, 2009]. Read More