Financial Analysis

B9AC106 Financial Analysis

Introduction

Accruing to Lasher (2013), financial analysis is a significant process of the business management. Measuring the financial performance of the company and project is helpful. It also determines financial sustainability of the company.

Typically, the main aim of an organisation behind the conducting the financial analysis is to identify the stable, solvent, liquid or profitable position of a company.

This report includes the financial analysis of Morrison that is UK’s most know retail organisation. In this, the researcher calculates three years financial ratio of the company. At the same time, for developing the comparison, the research takes Tesco as another retail company in the UK.

Computation of five sets of ratio

Computation of ratio is a way of financial analysis in the financial management. It is used to evaluate the various aspect of the company in the monetary terms. It is effective to analyse the strength and weakness of the company (Brigham & Ehrhardt, 2011).

In the context of Morrison, its various ratios are computed including liquidity ratio, profitability ratio, efficiency ratio, shareholder ratio and financial ratio. In this ratio analysis, five sets of the ratio are computed by the researcher for the last three years.

For this, the financial information is taken from the annual report of Morrison. The researcher is computed ratio for financial years 2017, 2016 and 2015. At the same time, the economic performance of the company in 2017 is compared to the financial, economic another retail company Tesco and the overall industry.

In the five sets of the ratio, the researcher computes the liquidity ratio, profitability ratio, efficiency ratio, shareholder ratio and capital structure ratio. These all ratios are computed by using the accurate formulas and techniques. The calculation of 5 sets of the ratio for Morrison is as below.

Ratio Analysis
Ratio Formula Morrison (£m)
Liquidity Ratios   2017 2016 2015
Current ratio (Current assets  ÷ Current liabilities) 0.41 0.48 0.50
Current assets 1,176 1,316 1,144
Current liabilities 2,864 2,755 2,273
Quick ratio (Current assets -Inventories)  ÷ Current liabilities 0.20 0.25 0.21
Inventories 614 616 658
Profitability Ratios:  
Return on capital employed EBIT  ÷ (Total Assets -Current liabilities) *100 7.33% 4.79% -10.09%
  EBIT 468 314 -696
  Total Assets 9,246 9,307 9,171
  Current Liabilities 2,864 2,755 2,273
Net profit margin (Net profit ÷ Revenue) *100 1.87% 1.38% -4.53%
Net Profit 305 222 -761
Revenue 16,317 16,122 16,816
Return on Equity (Profit before Tax ÷ Equity) 8.00% 5.78% -22.04%
PBT 325 217 -792
Equity 4,063 3,756 3,594
EfficiencyRatios:  
Inventory turnover (Costs of Goods sold  ÷ Average Inventory) 25.59 25.17 24.40
Costs of Goods Sold 15,713 15,505 16,055
Average Inventory 614 616 658
Asset turnover (Revenue  ÷ (Total assets – Current liabilities) 2.56 2.46 2.44
Revenue 16317 16122 16816
Total Assets 9246 9307 9171
Current Liabilities 2864 2755 2273
Shareholder Ratios  
Dividend yield (Dividend per share ÷ Market price of share) 0.03% 0.07% 0.06%
DPS (GBX) 0.05 0.13 0.14
MPS (GBX) 179.9 174.5 236.1
Price to earnings ratio (Market price of share ÷EPS) 13.72 18.35 13.12
MPS 179.9 174.5 236.1
EPS (pence) 13.11 9.51 18
Capital Structure
Debt to Asset ratio Debt  ÷ Assets 0.17 0.24 0.27
Total Debt 1,550 2,212 2,519
Total Assets 9,246 9,307 9,171
Debt to Equity ratio Debt  ÷ Equity 0.38 0.59 0.70
Debt 1,550 2,212 2,519
Equity 4,063 3,756 3,594

Comparison of economic performance of Morrison, Tesco and industry

  Ratios in year 2017 Morrison Tesco Industry
Current ratio 0.41 0.79 0.7
Quick ratio 0.2 0.68 0.33
Return on capital employed 7.33 0.22 13.81
Net profit margin 1.87 0.13 3.51
Return on Equity 8 0.96 20.43
Inventory turnover 25.59 22.36 14.5
Asset turnover 2.56 1.25 2.06
Dividend yield 0.03 1.24 5.29
Price to earnings ratio 13.72 193.77 24.95
Debt to Asset ratio 17% 26.16% 25.11%
Debt to Equity ratio 38% 186.28% 76.16%

Interpretation of the ratio

Liquidity Ratio

In this financial analysis, the first ratio is computed that is liquidity ratio. It shows the ability of the company to meet short-term liabilities in the financial year. The liquidity position defines the company’s ability to pay its current liabilities through the current assets.

In the context of Morrison, it is found that the company has 0.41% current ratio for the financial year 2017 that indicates to worst liquidity position. At the same time, Tesco has 0.79% current ratio in the same financial period. It depicts that Morrison is not good in liquidity position.

The current industry ratio is recorded 0.7 at the same time. These all things show that Morrison is not performing well in liquidity position (Muller, 2011).

The quick ratio is also part of the Liquidity ration in the financial analysis. It measures the ability of the company to pay its current liabilities through most quick assets. In the reference of Morrison, it is identified that company has 0.2 quick ratios for the year ended 2017.

In the same period, Tesco has quick ratio of 0.68 that draws the liquidity position of Morrison. At the same time, the quick ratio of industry is recorded by 0.33. However, it can be said all including Morrison, Tesco and Industry are not good in the liquidity position.

It is because a good current ratio should 2.00 and the quick ratio should 1.00. But, Morrison has not sufficient current and quick ration. It means that liquidity position of the company is not due to this company can face liquidity problem to pay its short-term liabilities (Kelly, 2015).

The reason of weak liquidity position of the company may be that Morrison is not effective to generate the cash from the debtors. Due to this, it is possible that company can face issues to pay its short-term debt. Morrison liquidity position is below than the industry that depicts that company has a relatively lower liquidity position than its competitors.

Profitability Ratio

Profitability ratio is also the main element of the financial ratio analysis. It is the most important ratio that measures the profitability position of the company. It shows the overall financial performance and efficiency of the company (Mandelbrot, 2013).

In this context, Morrison has 7.33% returns on the capital ratio as compared to Tesco 0.22%. In this, it can be interpreted that Morrison is on good track compared to its competitor Tesco. But, at the same time, it found that Morrison is not good compared to industry return on capital ratio because industry return on assets is 13.81%. Furthermore, net profit margin shows the efficiency of the company to generate profit after all the expenses.

The financial analysis of Morrison depicts that the company has 1.87% net profit margins. On the other hand, the competitor company Tesco has 0.13% net profit margins. It shows that both companies are not performing well in the retail industry because the net profit margin of the industry is recorded at 3.51%. Hence, it can be said that Morrison is not performing well compared the industry.

Return on equity is also part of profitability ratio. It determines the profit of the company on the invested equity. The above table shows that in the financial year 2017, return on equity ratio for Morrison, Tesco and Industry are 8.00%, 0.96% and 20.43%.

On the basis of this result, it can be said that Morrison is good compared to Tesco and industry result is better compared to Morrison (Olson and Dolgui, 2015). Therefore, it is found that profitability ratio of Morrison is below than industry. It is because company is selling the product on the lower price due to this it is not generating sufficient money or revenue from the market.

Efficiency Ratio

In the ratio or financial analysis, efficiency ratio is computed to analyze the how well a company uses its assets and liabilities in the business operation. In the efficiency ratio, Morrison turnover ratio is recorded 25.59 as compared to 25.1in the previous year 2016.

At the same time, Tesco inventory ratio is recorded 22.36 that show that Morrison has better efficiency in comparison of Tesco in the retail industry. Overall, retail industry ratio shows that both companies are performing well compared to other firms in the industry. In 2017, Morrison sold its inventory 25.59 times while the industry performance was recorded at 14.5 times (Singh, et al. 2016).

Assets turnover ratio shows the organisational efficiency to generate sales. Assets turnover ratio depicts the value organisational sales or revenue relative to the value of its assets. In this contrast, it is found that Morrisons, Tesco, and industry have 2.56, 1.25 and 2.06 assets turnover ratio respectively.

On the basis of above findings, it can be interpreted that Morrison situation is good compared to Tesco and the overall industry. It is because the assets turnover ratio depict that Morrison gets 2.56 million sales on its 1 million assets.

On the other hand, Tesco’s situation is some bad compared to Morrison. At the same time, the industry assets turnover ratio is found by 2.06 that depict that Morrison is performing good compared Tesco and other retail companies (Wilson, 2015).

Shareholder Ratio

In financial management, shareholder ratio shows that how much a company will achieve of the company has to liquidate its assets.

In the financial analysis of Morrison, dividend yield ratio, price to earning ratio are calculated (Pingle, 2013). In this, it is found that Morrison has 0.03 dividend yield ratio as compared to 5.29 industry ratio. The company is not offering good profit to its share holders.

At the same time, Tesco has 1.24 dividend yield ratio. At the same time, it found identified that price earning ratio of Morrison, Tesco and Industry are 13.72, 193.77 and 24.95 respectively. In this, the performance of the company is looking worst because Tesco price earning ratio is very high. It provides a high return to its investors.

On the other hand, industry price earning ratio is calculated 24.95 in the financial year 2017. Therefore, it can be said that Morrison should concern on this.

Capital Structure Ratio

The capital structure ratio also plays an important role in the financial analysis. It includes the debt to assets ratio and debt to equity ratio. It is significant to analysis the financial performance of an organisation.

In this financial analysis, it is calculated that debt to assets ratio for Morrison is 17% in the current financial year 2017. On the other hand, Tesco has 26.16% debt to assets ratio. It shows that Morrison is less aggressive in financing its growth with debt.

Even though, it is found that industry average is 25.11%. According to this, it can be said that Morrison has sufficient degree of leverage and financial risk (Sabre and Ketz, 2014).

At the same time, debt to equity ratio for Morrison, Tesco and industry are 38%, 186.28% and 76.16% respectively.

This result draws that Morrison has more financial stable business compared to Tesco. But, the industry average is looking more appropriate because a debt to equity ratio 1 indicates that investors and creditor have an equal stake in the business (Shepherd, 2015).

Initiative for Morrison to improve the performance

In the business environment, valuation is a process of determining actual or current market wroth of the company.

There are many methods and techniques that can be used measure the value of the company and investment. The responsibility of measuring the actual value of the company can be given to the business analyst (Squire, 2013). In this financial analysis for Morrison, the profit multiplier stock valuation method can be applied.

Liquidity ratio

From the above financial analysis, it is found that Morrison Company has low liquidity ration and capital structure which affects the company position and performance in the highly competitive market.

While analyzing the liquidity condition of the company, it is found that company is not having a stable liquidity condition. For achieving the stable liquidity position, then the company is suggested to reduce its overhead cost which includes rent, insurance, and utilities as well as mandatory licenses for industry membership (Vanhove, 2012).

In addition, Morrison Company is also suggested to remove or reduce all unnecessary assets for increasing the liquidity. For achieving the high liquidity ratio i.e., 1:1 then company is required to reduce its all extra expenses and purchasing of assets which directly or indirectly affects the company liquidity condition.

Moreover, the company Morrison is also recommended to cut down its unprofitable products and services that are offered to local churches and non-profitable organizations.

It is recommended because the company offers its product and services as a charity and donation in order to contribute to society and develop company reputation.

But this contribution to society welfare affects the company liquidity position to a large extent.  On the other hand, the company is also suggested to manage its all accounts like account receivables and account payable in order to reduce the negative impact of liquidity (Warren, et al. 2013).

For increasing the liquidity, a business should maintain consistent and regular accounts for receivables and payables so that it becomes easily and develop surety that customers receive bills on time.

Capital structure ratio

Further, in this study, it is determined that for companies capital structure plays an important role as it helps in making/taking capital decisions for operating the business efficiently.

At the same time, for increasing the optimal capital structure ratio, then the company is recommended to develop a balance between the debt- to equity and for that firm is required to minimize the cost of capital (Baum, 2012). While doing financial analysis, it is found that company is facing problem in maintaining its capital as well as making capital decision efficiently.

Morrison Company is required to keep financial flexibility in order to develop the firm’s ability to raise the capital. For improving the capital structure, Morrison is recommended to focus on market conditions as capital structure of the company has a significant impact on the company’s financial condition.

But in addition, Morrison also needs to reduce the business risk in order to increase the capital structure ratio due to which company achieves a stable financial condition (Berger, 2011).

Moreover, Morrison Company must focus on managing the lower optimal debt ratio for which company is required to an emphasis on the improving the company financial leverage.

On the other hand, the company is required to develop effective inventory management system for which company debts are required to be reduced.

Finally, the company is recommended to an emphasis on the increasing the capital and reduction in debt to capital ratio in order to manage the financial stability and condition effectively (Collis, et al. 2011).

Valuation of 10% investment

In the business environment, the term investment refers to the assets held by an organisation to make the profit by the different activities. In this, assets held as the common stock are not an investment. Investment valuation is a way of measuring the value of the investment. In order to calculate the value of 10% investment the below method can be used.

Profit multiplier method

In the organisational value method, Profit multiplier method is well known and mostly used method. It is used to measure the actual market value of the company. In this method, the value of the organisation is calculated by multiplying its profit (Edmonds, et al. 2015).

For instance, if an organisation’s adjusted net profit is $50000 per year, it uses the multiplier 4. In this situation, the value of the company will be calculated as $50000 * 4 = $200,000. In the views of the market buyers or potential buyer of the company, this method is suitable when a company is earning approx equal profit from last few years.

If in this situation, on investor invests to buy the business then it can cover investment in 4 years. It will get 25% return on this investment. In the same concern of this, the market value of the Morrison can be measured in below way.

Market value of the company = Net profit of the year * weight

Net profit of the year = £305 million

Weight = 4

= 305* 4

= £1220 million

Value of the 10% investment = £1220 million * 10%

= £122 million

Stock valuation method

Stock valuation is also a significant method of measuring the market value of an organisation. It is helpful for a business analyst to measure the actual value of the organisation.

In this method, the business analyst multiplies the market value of the share by the total share issued in the market for investors (Field, 2012). It provides the market value of the organisation on the basis of the stock of the company. In the business environment, this method is used at the time of merger and acquisition.

Valuation of investment = Total share investment * price of the per share

Price of per share = £246 GBX

Total share issued = 23414 *10%

= 2341.7

Value of the investment = 2341.7 * 246

Value of the investment = £57.6 million

Conclusion

From the above discussion, it is found that it is essential for an organisation has strong financial position to sustain the long term in the business environment. This report depicts that Morrison is not performing good in the context of liquidity position.

It is because the current and quick ratios of the company are less form the industry and competitor firm. At the same time, it is also found that capital structure of the company is also not good because the company is more depended on the equity.

Therefore, it is recommended to the company it should develop the effective strategy to improve the liquidity position. Along with this, it should also release some money of the shareholders, so that debt and equity can be brought equal in the company.               

References

Baum, M. B. (2012) Service Business Costing: Cost Accounting Approach for the Service Industry, Springer Science & Business Media: Germany.

Berger, A. (2011) Standard Costing, Variance Analysis and Decision-Making. Germany: GRIN Verlag.

Brigham, E. F. & Ehrhardt, M. C. (2011) Financial Management: Theory and Practice. USA: Cengage Learning.

Collis, J., Holt, A. and Hussey, R. (2012) Business Accounting: An Introduction to Financial and Management Accounting. UK: Palgrave Macmillan.

Edmonds, T., Nair, F., Olds, P. and Edmonds, C. (2015) Fundamental Financial Accounting Concepts. USA: McGraw-Hill Higher Education.

Field, R. (2012) Planning and Budgeting Skills for Health and Social Work Managers. UK: Sage.

Kelly, J.M. (2015) Performance budgeting for state and local government. Me sharpe.

Lasher, W. R. (2013) Practical Financial Management. USA: Cengage Learning.

Mandelbrot, B.B. (2013) Fractals and Scaling in Finance: Discontinuity, Concentration, Risk. Selecta Volume E. Germany: Springer Science & Business Media.

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Olson, D.L. and Dolgui, A. (2015) Decision making in enterprise risk management: A review and introduction to special issue.

Pingle, M. (2013) BASIC ACCOUNTING CONCEPTS: A Beginner’s Guide to Understanding Accounting. USA: Xlibris Corporation.

Sabre, R. M. and Ketz, J. E. (2014) Corporate Planning and LAN: Information Systems as Forums. USA: Academic Press.

Shepherd, R. W. (2015) Theory of Cost and Production Functions. USA: Princeton University Press.

Singh, R.J., Ghosh, B.N., Sharma, N.K., Patra, S., Dadhwal, K.S. and Mishra, P.K., (2016) Energy budgeting and emergy synthesis of rainfed maize–wheat rotation system with different soil amendment applications. Ecological Indicators, 61, pp.753-765.

Squire, L. R. (2013) Fundamental accounts, Academic Press: California.

Vanhove, N. (2012) Economics of Tourism Destinations. UK: Routledge.

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Wilson, T.C. (2015) Value and Capital Management: A Handbook for the Finance and Risk Functions of Financial Institutions. USA:  John Wiley & Sons.

 

 

 

 

 

 

 

 

 

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