Performance Assessment of Jacobstowe Plc - Essay Example

Report on Performance Assessment of Jacobstowe Plc. Contents Overall Assessment 2. Profitability Assessment 3. Working Capital utilization 4. Liquidity 5. Gearing and Capital Structure 6. Stock Market Indicators 7. References 8. Annexure (Ratio Calculations) 1. Overall Assessment The year 2007 has not been encouraging for Jacobstowe Plc. With low capital gearing in 2007 Jacobstowe made things complicated for itself from the point of view of meeting its obligations. Profitability has not been encouraging when compared with 2006. Jacobstowe made efforts to increase profitability by increasing turnover, but that did not result into increased profitability nor did it ease the problem of liquidity. The result was increased receivables only. With the result its liquidity position received a jolt. Current and quick ratios have declined rapidly. Jacobstowe found it difficult in 2007 to meet its working capital requirements. With low gearing, tight liquidity problems, working capital could not be utilized to its best. But despite all these adversaries, Jacob declared good dividend in order to maintain the market price of its scrips at certain predetermined level. 2. Profitability Assessment All ventures in the business are executed to earn the profits, and that is one of the most important tasks of business managers. Three ratios are used, namely Net Profit Margin, Return on Assets, and Return on Equity in order to evaluate the profitability of Jacobstowe Plc. a) Net Profit Margins: Jacobstowe Plc.’s net profit margins have gone down to 5.17% in 2007 from 6.42% in 2006. Despite the fact that there is increase in turnover from 5,622m to 5,996m, Jacobstowe has not been able to increase net profit margins. There could be a number of reasons for such a fall in profitability. One would notice that current ratio of Jacobstowe has also fallen in the year 2007 as compared to 2006 even when total ‘Receivables’ have increased; it makes sense here to state that turnover would have increased at the cost of reduction in prices, and thus there are reduction in net margins. Initially with the reduction in prices gross margin would have gone down but as there was also increase in operating costs (those increased from 5099m in 2006 to 5486m in 2007), both factors would have worked together to bring down the net margins. b) Return on Assets (ROA): Another measure to assess profitability is Return on Assets (ROA). Return on assets in 2007 is 4.93 as compared 5.75 in 2006. Assets have performed if not less than their optimum capacity but certainly the performance was what it was in the year 2006. For calculation purposes average capital employed in 2006 is taken as in 2007. This is because of non- availability of information about ‘total assets employed’ in 2005. Profitability on this count was also not very encouraging. c) Return on Equity (ROE): The third method tried to analyze profitability was ‘Return on Equity’ or ROE. As per Return on Equity calculations, the position of Jacobstowe Plc.is almost similar as assessed under ‘net profit margin’ or ‘ROA’. Return on equity in 2007 is 7.64 as compared 9.58 in 2006. Accordingly it can be concluded that from profitability point of view, Jacobstowe Plc. has not performed as good as in the year 2006. Its performance has gone down and effort to increase turnover has not contributed to the results. 3. Working Capital Utilization “Current assets, commonly called working capital, represent the portion of investment that circulates from one form to another in the ordinary conduct of business. … Current liabilities represent the firm’s short term financing, because they include all debts of the firm that come due in 1 year or less” (Lawrence J.Gitman)3. Jacobstowe Plc. has not been able to utilize its working capital effectively keeping in view the decline in current ratio from 1.78 in 2006 to 1.26 in 2007. Current ratio in fact is the barometer to judge how best current liabilities have served the current assets. But the situation for Jacobstowe Plc. On this matter has not been encouraging in the year 2007. There is pressure on current liabilities to meet the firm’s short term debts and other obligations. Current liabilities are already rising at speed. They were 1371m in 2006 and 1673m in 2007 and still not meeting the ever rising current assets. The utilization of working capital is not optimum. The funds are getting blocked in inventories (rising from 556m in 2006 to 681m in 2007). As the inventories are not treated as liquid as cash or receivable, more pressure is on quick assets to rotate them as fast as possible. Rotations under pressure certainly have impact on profitability, as the firm would give more cash discount to convert receivables into cash prior to their maturity. There is huge difference in total current assets and current liabilities. Further short period borrowings will aggravate the situation. Current liabilities are working overtime to meet the current assets demand. Inadequacies of resources are bound to bring in effects on performances. Working capital utilization in not up to the mark of bringing optimum results. The firm must take suitable steps to sort out the working capital problem. 4. Liquidity Liquidity is another factor that, if not comfortable, can disturb the entire working of the firm. Liquidity is normally measured with reference to Current ratios and Quick ratios. Lawrence J. Gitman2 in his book ‘Principles of Managerial Finance’ has stated that ‘The Current ratio, one of most commonly cited financial ratios, measures the firm’s ability to meet its short- term obligations. A current ratio of 2.0 is occasionally cited as acceptable, but a value’s acceptability depends on the industry in which the firm operates” Liquidity considered from the current ratio presents does not a rosy picture for Jacobstowe Plc. The current ratio is 1.26 in 2007 and 1.78 in 2006. The financial institutions consider a decline of 0.52 a huge decline putting pressure on current liabilities. Liquidity can be more accurately and intensely assessed with reference to Quick ratio. “One drawback of current ratio is that inventory may include many items that are difficult to liquidate quickly and that have uncertain liquidation values. Quick ratio is an alternative measure of liquidity that does not include inventory in the current assets.” (Financial Ratios)1. This ratio has decreased from 1.78 in 2006 to 0.79 in 2007. A great fall in quick ratio was bound to create liquidity troubles for Jacobstowe Plc. That means from the point of view meeting short term obligations, Jacobstowe Plc. is not in position to meet those obligations as they become due. All the time the firm has to be on its toes to meet such eventuality. .5. Gearing and Capital Structure Capital structure plays a dominating role in resource mobilization for the benefit of the firm; and here also gearing or leverage is such a technical manipulating tool that sometime high geared capital structure brings in more than expected profitability, particularly in highly inflationary and charged economic atmosphere. “Capital gearing is generally accepted to be the expression of net debt as percentage of shareholders’ funds.”4 Capital gearing is also called ‘Leverage’. If the firm uses more of debt capital into its capital structure, the firm is said to be highly geared; whereas when debts are low as compared to share capital the firm is ‘low geared’. Gearing of the capital structure can be tested through debt ratios, debt equity ratio, and Times-interest- earned ratio among other testing. From the calculations of debt ratios in the annexure, the picture appears to be dismal as the Jacobstowe Plc.is very low geared entity in its capital structure. The debt ratio is only 0.04 in 2007 as compared to 0.12 in 1996. The Debt equity ratio has again trembled down to 0.04 in 2007 from 0.14 in 2006. It appears that most of the interest- bearing loans have been paid off in 2007. Interest- bearing loans has reduced from 539m in 2006 to only 176m in 2007. Times- interest-earned ratio depicts the firm’s ability to meet its fixed debt obligations. ‘Times interest earned ratio’ has declined to 3.85 in 2007 from a figure of 4.96 in 2006. The smaller the ratios, the less able the firm is to meet fixed loan payments and interest thereon. That means Jacobstowe Plc. is now less efficient in meeting its commitments with regard to external borrowings. 6. Stock market Indicators The best market indicators are ‘Pay out ratio’ and ‘Earning per share’. Pay out ratio of Jacobstowe Plc. is very encouraging from the point of view of maintaining the market for its shares. Payout of dividend in 2007 has increased to 0.47 from o.35 in 2006.The firm is taking brave steps in view its discouraging performances on profitability and liquidity fronts. On the other hand ‘earning per share’ has gone down to 38.1p per ordinary share in 2007 from 48.0p per ordinary share in 2006. This is reflecting the actual performance of Jacobstowe Plc. in 2007. How far the company can maintain its position in the markets by declaring good dividends is a matter to be decided by the performances in the coming years. Reference: 1. Financial Ratios, http://www.netmba.com/finance/financial/ratios 2. Lawrence.Gitman, Principles of Managerial Finance, ninth edition, Financial Statement Analysis, Chapter 4, Page no. 133. 3. ibid, page no. 616 4. Capital Gearing, http://www.competition-commission.org.uk/rep_pub/reports/1989/fulltext/244a4.4.pdf Annexure (Ratio Calculations) Read More