Overall Financial Assessment of a Nichols Company - Essay Example

Nichols Plc. – A Financial Analysis Overall Financial Assessment Nichols Plc. is one of the leading companies in the industry of soft drinks. Its performance is remarkable during the year 2006 despite the fact that total turnover of the company has gone down as compared to the year 2005. Profitability before taxes and interest has increased by ₤1.036m.The company is performing efficiently as inventory turnover and assets turnover are very effective in maintaining profitability to a very good standard. The company’s position is not comfortable from the liquidity point of view as its current and quick ratios are below the required standards. The company may face problems in meeting its short term obligations. The company has not raised long term debts and its long term liability is only pension liability. Accordingly the company is very low geared. Earning per share and dividend per share are so attractive that company will get oversubscribed whenever the company will go public. The detailed financial analysis follows: Profitability Profitability of Nichols Plc. have been analyzed from three angles, namely, Net Margins, Return on Assets(ROA) , and Return on Equity (ROE). Financial statements for Nichols Plc. have presented the profitability for 2006 (and restated figures for 2005) before and after taking into account exceptional items. Accordingly the profitability analysis have been made from both angles, i.e., before and after the exceptional effects on profitability. The following ratio calculations have helped in reaching an investigative analysis: Net profit margin “also called the Return on sales ratio, it shows after tax profit(net income) generated by each sales dollar by measuring the percentage of sales revenue retained by the company after operating expenses, creditor interest expenses, and income taxed have been paid.”(BDC)1. Net Profit Margins have shown a tremendous jump from 7.37 % to 10.01 despite the fact the sales revenue has been reduced from 63.336m in 2005 to 52.296m in current year 2006. That means Nichols has worked on some strategic issues and kept the qualitative business alive that generates the real profits for the company. This fact is clearer when a reference is made net profit margins after the exceptional adjustments; the increase in net margin is by huge 5.54%. Also the Chairman’s Statement makes the issue of profitability absolutely clear when it states that, “the progress made in underlying profitability is actually much greater than the headline figures suggest, due to distorting effects of Balmorals disposals completed in January 2006.” As far as Return on Assets (ROA) is concerned, we see a marginal increase of 0.28% before exceptional figures, but after exceptional adjustment ROA has increased by 2.59%. This all is due Balmorals disposal effects. In fact assets during the disposal period were not working to their potential; and naturally this would have affected the ROA. from recurring business. But over all assets are performing consistently well. Return on equity has improved a lot mainly because of jump in net margins. The important point to note is that despite increase in shareholders funds due to earlier years’ profitability, ROE is showing a consistent growth. It has gone up from 28.72% in 2005 to 37.32 % in 2006. Overall Nichols Plc. is doing exceptionally well on profitability front. Efficiency The efficiency in an all round performance of an entity may be judged by a review of its Gross Profits, Inventory Turnover, and Assets Turnover. “Gross profit is one of the key performance indicators. The gross profit margin gives an indication on whether the average mark up on goods and services is sufficient to cover expenses and make profits.”(Benchmark Your Business) 2 Gross Profit ratio in 2006 for Nichols is 52.65 % as compared to 52.11% in 2005.There appears to be routine fluctuations; otherwise Nichols is maintaining is making stability in making contributions towards expenses and profits. Inventory turnover is an indication of overstocking or under stocking. On this count Nichols is efficient in rotating its stock 45.1 times of turnover as compared to 54.9 times in 2005. The rotation of stock in 2006 is less than 2005 is reflected from the fact that turnover in 2006 has decreased tremendously in 2005. The reason is the effect on turnover of discontinued business of Balmorals. Accordingly the real efficiency test of inventory could only be made in the coming years. Assets turnover conveys the extent of exploitation of assets for the business; and whether assets were under utilized or over burdened. “Generally, the higher a firm’s total asset turnover, the more efficiently its assets have been used. This measure is probably of greatest interest to management, because it indicates whether the firm’s operations have been financially efficient.” (Lawrence J. Gitman, 2000)6. In 2006 asset turnover was 1.14 times as compared to 0.87 times in 2005. It appears that despite discontinuation of some businesses and related use of their assets, Nichols is exploiting assets in an optimum way, as the profitability of the company is increasing despite decrease in turnover. Though Nichols is maintaining stable efficiency but the performance is mixed bag mainly because of low inventory turnover in 2006 as compared to 2005. Liquidity Liquidity is conventionally tested on the basis of current and quick ratios. “Current ratio is an indication of company’s ability to meet short term debt obligations. The higher the ratio, the more liquid the company is.” (Investors words)3 A current ratio 2.0 is commonly treated as acceptable, but everything depends on the industry in which the company operates. Though liquidity wise, the position of Nichols has improved in 2006 as compared to 2005, but it cannot be called a comfortable position. Current ratio is mere 1.30 in 2006 as compared to struggling 0.99 in 2005. It is clear that Nichols is facing problems to meet its short term creditors’ liabilities. The situation with quick ratio is also the same as in current ratio. Quick ratio is part of current ratio that is calculated taking into account most liquid of the current assets. “The quick ratio method is a model for measuring the liquidity of a company by calculating the ratio between all assets quickly convertible into cash and all current liabilities. It specifically excludes inventory. It is an indicator of the extent to which a company can pay current liabilities without relying on the sale of inventory” (Value based management. net)5. A quick ratio of 1.0 is occasionally recommended, but as current ration, an acceptable value depends upon the concerned industry. Nichols has quick ratio of 1.26 in 2006 as compared 0.96 in 2005. Liquidity wise Nichols Plc. is tightly placed. Any problem in collect of receivables would bring the Nichols in a difficult position to meet the ends with regard to payments of current creditors. Gearing “Gearing or leverage, describes the mix of long term corporate funding provided internally (by shareholders) to that contributed externally (by lenders)”.(Malcolm Anderson, Aug. 2000)4 Capital gearing is also called the leverage of capital structure. The amount of leverage in a company’s capital structure, i.e., the mix of long term debts and equity maintained by the company, has a significant effect on its value of manipulation in the return and risk. Generally speaking, the term ‘capital gearing’ is the expression of net long term debts as a percentage to company’s shareholders’ equity. If the firm uses more debts into its capital structure it is called ‘high geared’; and where debts are low as compared to equity there it is called ‘low geared’. The gearing in the capital structure of a company is judged through its debt ratio, which in case of Nichols Plc. is calculated as under: The only long term liability is the pension liability in case of Nichols Plc., and that has been considered for the purpose of calculations of debt ratio. The result is that its debt ratio is meager 0.2 in 2006 and 0.27 in 2005. In fact debts have not been used for capital structuring, and long term liability (treated as debt for calculation purposes) is the result of internally accrued liability. Accordingly, Nichols Plc. is very low geared corporation since its obligations under long term are only 0.2 in both the years. It appears that Nichols Plc. does not believe in capital structuring through debts. Therefore at present, Nichols Plc. has no significance of capital gearing because huge contribution of its profitability into retained earnings. Market Indicators Investors are basically interested in Earning per share and the company’s dividend payouts. The Nichols Plc.’s figures in this regard are as under: Earning per share (EPS) represent the amount earned during the accounting period on each outstanding share of common stock. The basic EPS in 2006 is tremendous 15.94p that has risen from 10.82p in 2005. Even the diluted EPS is 15.92p in 2006 as compared to 10.79p in 2005. EPS is closely watched by the investing public and is considered the indicator of corporate success. From this point of view Nichols Plc. stands in a very strong position, if we consider EPS along with dividend pay out, that was 9.40p per share in 2006 and risen from 8.95p per share in 2005. Nichols is bound to be a success whenever it will go public mainly because of its EPS and dividend payouts. References 1 BDC, Net Profit Margins, viewed on January3, 2008, http://www.bdc.ca/en/business_tools/calculators/netprofitmargin.htm?cookie%5Ftest=1 2 Benchmark your business, ANZ, viewed on January 3, 2008, http://www.anz.com/australia/business/calculator/businessbenchmark/gross_Profit.asp 3 Investors Words, Current Ratio, viewed on January3, 2008, http://www.investorwords.com/1258/current_ratio.html 4 Malcolm Anderson, Gearing, ACCA, 1 August 2000, http://www.accaglobal.com/archive/2888864/31074 5 Value based management.net, Quick Ratio Model- A method for measuring liquidity, viewed on January 4, 2008, http://www.valuebasedmanagement.net/methods_quick_ratio.html 6 Lawrence J. Gitman, Principal of Managerial Finance, ninth edition, Part I Chapter 4, page no. 137 7 Annual Returns containing financial statements of Nichols Plc., www.nicholsplc.co.uk Read More