Financial Performance Assessment of William Hills - Essay Example

Financial Performance Assessment of William Hills Introduction This write up contains discussion on two issues pertaining to William Hills Ltd. The first issue is financial performance assessment of William over a period of four years since 2006 with the help of ratio analysis with particular emphasis on profitability performance and returns on investments in the company. In the second part the issue of management accountancy has been taken up as to how techniques and tools of management accountancy can help in reporting, assessing and analyzing the activities and performance of William Hills Ltd. Financial Performance Assessment The matrix used to assess the financial performance of William Hills is its profitability assessment over the last four years and the satisfaction of investors in terms of returns on their investments. The tool of ratio analysis is used for assessing such financial performances of William Hills. In order to assess the profitability the ratios that are considered for the four year performance are operating margin, net margin, return on total assets (ROA), and return on common equity (ROE). Let us start with operating profits. “Operating profit margin measures the percentage of each sales dollar remaining after all costs and expenses other than interest, taxes, and preferred stock dividend are deducted. It represents the pure profits earned on each sales dollar. Operating profits are pure because they measure the profits earned on operations and ignore interest, taxes, and preferred stock dividends.”(Lawrence J Gitman, page 67)i The assessment of operating margin ratios of William Hills suggests that profitability performance is sliding down since 2006. The operating profit margin was 32.68% in 2006, 30.7% in 2007, 28.91% in 2008, and then down to 25.31% in 2009. One of the reasons for this sliding performance is poor response to newly introduced online gambling business. In fact “the online business of William Hills has tarnished the group’s reputation for management excellence by mismanaging the online sports book technology project.”(Betting Market, Viewed on 19th May 2009)ii The analysis of profitability on basis of net profit margin is also very interesting because “the net profit margin is indicative of management’s ability to operate the business with sufficient success not only to recover from revenues of the period, the cost of merchandise or services, the expense of operating the business (including depreciation) and the cost of borrowed funds, but also to leave a margin of reasonable compensation to the owners for providing their capital at risk. The ratio of net profit (after interest and taxes) to sales essentially expresses the cost price effectiveness of operations.”(M.Y.Khan, Khan, and Jain, page 6.19)iii Net profit margins ratios of William Hills depict a mixed and fluctuating profitability performance. From an attractive 18.65% net profit margin in 2006, it came down to 16.86% in 2007, then a huge jump to 24.28% in 2008, and finally flopping down to poor 8.14% in 2009. May be recession has forced the gamblers to slow down because of decreasing liquidity. But that does not appear to be the real reason as the turnover of William Hills in 2009 was £997.9 as compared to £963.7 millions in 2008. However B.Solomon(March 4th, 2010)iv has even observed that “William Hills derives from three-quarters of its turnover from its retail arm and despite its revenue dropping 4% throughout 2009, the company’s recently remodeled joint venture online business with Playtech saw a 63% increase in revenue to £203.5 million” Accordingly recession cannot be blamed for low net profitability in 2009, and probably it is the low margins on line gambling ( a comparative new venture) that is causing the real impact in lowering net margins. Return on total assets (ROA) is another profitability ratio that is used to discuss the profitability performance of William Hills. In fact “the return on total assets (ROA), often called return on investments measures the overall effectiveness of management in using its assets to generate returns.”(William L.Megginson, page 48)v From 2006 to 2008 ROA has shown a reasonable encouraging trend. It has increased from 9.77% in 2006 to 12.75% in 2008. The management has shown effective management of using assets even though in 2007 the ROA dipped a little bit as compared to 2006. But 2009 appears to be an exceptional year. Even though investments in total assets have increased marginally from £1835.9m in 2008 to £1850.4m in 2009, the ROA has gone down from 12.75% to a mere 4.39% in 2009. The assessment of profitability shows similar scenario when Return on Equity (ROE) is used to assess the profitability. ROE “is widely reported and many money managers rely on it as a key gauge of a company’s profitability.”(Harry Domash, page 189)vi ROE was reasonably static after falling from 87.56% in 2006 to 67.52% in 2007, as it was 65.44% in 2008. However, 2009 showed a big fall and the ROE came down to just 10.74%. The reasons for such fall appear to be both mismanagement of resources as well the general economic recession faced by the world at large. Investment ratios are also good indicators of financial performance of an entity. Earning per share is considered both a profitability ratio as well as investment ratio. EPS is “simply the earnings of the company divided by the number of shares of stock outstanding. When you examine a company’s earnings over a period of several years, a pattern of growth or contraction may become apparent. Reducing the company’s total earnings to a measure of earnings per ownership share helps an investor determine how successful the company is in creating earnings per individual shareholder.”(G. Thomas Friedlob and Ralph E. Welton, page 147)vii Earning per share of William Hills has been static hovering around 31% from 2006 to 2008, but in 2009 it dropped down to 20.5%. This might be a temporary effect but the fact that company maintained a constant rate for a period of three years might have given boost to investors about the regularity of income over the period. Price Earnings (P/E) ratio is a sort of owners’ appraisal of share value. “The P/E measures the amount that investors are willing to pay for each dollar of a firm’s earning.” (Lawrence J Gitman, page 69)viii The ratio calculated for William Hills indicates that investors were willing to pay 0.19 times of one pound of its earnings in 2006 and 2007, and thereafter only 0.1 times of earnings of one pound of William Hills. On the other hand Market/ Book (M/B) ratio “provides an assessment of how investors view firm’s performance. It relates the market value of the firm’s shares to their book- strict accounting- value.” (Lawrence J Gitman, page 69)ix M/B ratio calculations of William Hills indicate that investors have been paying a constant increasing value of the earnings per pound of the company. In 2006 it was mere £0.53 per pound of earnings and that rose to £1.18 per pound of earnings in 2009. This reflects that shares of the company are an attractive proposal among investors even after a reported downfall of the financial performance in 2009. The company still attracts investors on the basis of constant performances from 2006 to 2008. Management Accounting and business of William Hills Ltd. Management accounting in a gambling business where stakes are attached to games and gambling can be of tremendous help. This is because the business of likes of William Hills is basically connected with manipulation of data and information. The information produced by any accounting system for a business has to be of relevance to the business. Accountancy producing irrelevant information does not serve any purpose and is considered useless and may be tagged as irrelevant accounting. Information from management accounting is of utmost importance for the business of William Hills because of its following attributes: “It reduces uncertainty. Rapid feedback of information helps to reduce uncertainty. This is the main rationale for the introduction of any information system. It may be true or false. If the recipient of false information believes it to be true the effect is the same as if it were true. It may be incremental It may update or add new increments to information already available. It may be correction of past false information. It may correct existing information. Note that such information may be of value because it increases the recipient’s perceptions of the correctness of the information. It has surprise value. This is the attribute which above all determines the information contents of a message or report. The greater the probability of an event occurring the smaller will be the amount of information in a message saying that the event has occurred. The greater the surprise, the more informative the message.” (Terence Lucey, page 101)x William Hills is in the industry of games of chance and betting on sports. In simple words, customers bet and gamble for an event to happen. William Hills has to make future payments to customers who win their betting. Therefore, future cash outflow of the business is to be planned for such a business. As the total estimated outflow may run into millions of pounds some time, it is very necessary that present net worth should be known to William Hills for the purpose of planning of future cash outflow. Management accounting provides a tool of making such calculations of present value of future cash flows. “Present value is a future amount discounted to the present by some required rate.”(James C. Van Home, page 34)xi Present value is important as everyone knows that money has time value. “This means that a dollar in our possession today is preferred over a dollar we expect to receive at some point in the future. Postponing the use of dollar means postponing consumption. To convince us to postpone consumption and lend or invest our money, we demand a return over time either in the form of interest or some other form such as capital gain. This means a specific dollar amount invested today grows to a greater dollar amount in the future (assuming annual returns are reinvested). Conversely, a specific dollar amount to be paid or received in the future is worth less today in the present.”(Time Value of money, viewed on 20th May 2010)xii Keeping this fact and meaning of present value concept of management accounting, William Hills can plan the future payments on the basis of present value of future cash out flow. Capital budgeting is another concept of management accounting that may provide a lot of assistance to William Hills in making capital expenditures say in setting up of betting shops. “Capital budgeting measures are divided into two groups, i.e., ROI and payback method forming one and measures like internal rate of return (IRR) and NPV forming the other.”(J. Timothy Sale, page 105)xiii Capital budgeting through one or two of these techniques will provide comparative results helping the management in taking decisions. This is because successful administration of capital budgeting involves: “Generation of investment proposals Estimation of cash flows for the proposals Evaluation of cash flows Selection of projects based on an acceptance criterion, and Continual revaluation of investment projects after their acceptance.” (James C. Van Home, page 151)xiv Information for all these features can be gathered through the use of management accountancy. For example estimation of future cash flow is commonly used exercise of management accountancy. Then management accountancy provides specific methods that help in making evaluation of the ensuing capital project. These methods are popularly known as average rate of return, payback period, internal rate of return, and net present value. Average rate of return is such a management accountancy tool that “measures the return on a project in terms of income as opposed to using a project’s cash flow. Income is not equivalent to cash flows because of accruals and deferrals used in computations.” (Don R Hansen, Maryanne M. Mowen, page 568)xv One of the main reasons for William Hills to adopt management accountancy techniques is the growing competition in the trade. As has been reported, “the key trend currently is changing regulations, with more countries establishing a legal framework for online gambling. This is a complex area with each country taking a different approach.”(Henry Birch, viewed on 22nd May 2010)xvi In other words William Hills is going to face a highly competitive market during the years to come, particularly in online business of gambling. Here the management accountancy assists an entity to plan for the future and the tool provided by the management accountancy for such work is called ‘budgeting and forecasting.’ William Hills has to plan for the future in order to create a competitive edge. Budgeting can be of real help in making financial forecasting of the business. Normally budgeting and forecasting are the terms that are used simultaneously, but practically there is difference in approach and their use if the entity has to take optimum advantage by using these management techniques. “A major difference in budgeting and forecasting is that budgeting is normally viewed as a process that covers a longer period of time than forecasting. Budgeting often results in a formal, long range plan, normally expressed in terms of dollars over time. On the other hands forecasts are generally prepared to establish staffing levels. Long range budgeting is, therefore, a form of strategic planning.” (Michael J. O’Fallon and Denny G. Rutherford, page 396)xvii It is often seen that small gambling dens near casinos often face losses. The reason normally is lack of forecasting and work according to a plan. Small or large business, budgeting and forecasting should be a necessary exercise in order to visualize a successful venture. Considering these aspects and features of management accountancy, budgeting and forecasting can provide following advantages to William Hills in order to create a competitive edge: Gambling business is often heavily taxed and it is seen that consequences of not adhering to state laws are dangerous for the business. This is because “in practice state legislature time and again refused to stick to promises of earmarked funds. Instead they let the gambling revenues pay for promised public works, and gambling revenues become just another part of state’s giant budgetary pie.” (Rex M. Rogers, page 5)xviii In order to avoid the devasting impact of not adhering to state’s tax laws, the business like William Hills must use the techniques of budgeting and forecasting on their way to all round success in the society, as this is the society that accept the businesses like gambling only for enriching the state’s coffers. As per Garry Robert (page1)xix, there are six main benefits of budgeting to any business. These are planning, organizing, controlling, coordinating, communicating, and motivating. In a business like of William Hills these ingredients are going to provide stimulus to all factors involved in achieving the goal of maximizations of revenue and profitability. Gambling is highly risky both from the point of view of organizers and gamblers. In order to mitigate the gambling risks certain parameters are required to be set up as benchmarks. For example there may be higher limit to put money on stake or persons who are not adult are not allowed to gamble as per state laws. These parameters whether set up state or by the company itself are taken into account while envisaging revenue and expenditure in order to reduce the risks both for the company and gamblers. These considerations are those rules and principles of forecasting and budgeting that help in setting strategic goals in gambling business. Budgeting “forces management to express in figures its future intensions and provides a mechanism to control in detail the revenue, costs, cash, and expenditure”(Sue Nugus, page 197)xx in a business of gambling. Gambling is performance on the part of organizers and mostly luck for the gamblers. William Hills, being organizer, has to plan a performance based budget as it “links the program activities to budgeting and policy making. It moves the budget process away from who gets how much to what benefit is derived for how much.”(Jack Rabin, page 895)xxi; and that exactly is the objectivity of William Hills. Introduction of online business has made William Hills an international company dealing in multiple currencies of different nations. This involves a lot of reporting to authorities as well as problems of internal financial management. Management accounting brings for the techniques that will help William Hills in meeting such situations with precision and timely actions. “The company with foreign operations is at risk in various ways. Apart from political danger, risk fundamentally emanates from changes in exchange rates.” (James C. Van Home, page 770)xxii Management accounting provides techniques to mitigate both systematic and unsystematic risks measured through betas. In fact techniques like CAPM “assumes that all risks other than systematic risks can be diversified away” (James C. Van Home, page 770)xxiii by using a hybrid portfolio. By using management techniques, William Hills can introduce games in order to develop relative costs, attributes or characteristics to attract gamblers. In fact “a firm’s market share depends on the attributes provided by its products and consumer tastes and on the supply of the attributes by the competitors. By matching costs with benefits firms can compare whether revenue generated from benefits exceed their costs.”(Colin Drury, page 574)xxiv William Hills can use the management accounting technique of Activate Based Costing in order to identify costs with actual activity and thereby reducing the costs of unnecessarily burdened activities. This will help in settling the prices and rates of games in a scientific way, and the results or profits from such games become easily predictable. Thus cash flows, capital budgeting, present values computation techniques, rate of return computation, NPV techniques, budgeting and forecasting, activity based costing, and many other techniques of management accounting can help William Hills in planning its business of games and gambling with precision in order to attain an all weather increasing graph of profitability. Conclusion The financial performance assessment of William Hills Ltd over a period of four years has indicated that William Hills has maintained almost a fluctuating rate of profitability growth during first three years. But in the year 2009 the company’s success nosedived to an all time low. This may be the effect of general recession or because of introduction of online business. The use of techniques of management accountancy is very important in modern day business and William Hills is no exception. By using the techniques of cash flows, capital budgeting, present values computation techniques, rate of return computation, NPV techniques, budgeting and forecasting, activity based costing and others, William Hills not only can provide a healthy competition to rivals but also attain an ever increasing graph of success. Word Count: 3450 Ratio Calculations References Read More