An insight into Avevas market and business performance

Category: Accounting

AVEVA is a world leading engineering Information Technology (IT) software company and provider to the plant, power and marine industries; AVEVA, Company Profile (http://www.aveva.com/about_us_company_profile.php).[Online].(Accessed 29 Mar. 11). AVEVA was founded in 1967 by the UK government to introduce and promote computers in engineering to British Industry. Headquartered in Cambridge and with 35 offices around the world, the company was known previously as Cadcentre until 2001 when it changed its name to AVEVA to reflect increased diversity in its products and services. Through forty years of consistent growth and continual progression, AVEVA has transformed the IT industry collaborating with major technology suppliers and acquiring a number of companies.

1.2 AVEVA'S Products

AVEVA creates and supplies engineering and technology software tools for engineering, design and construction as well as providing continual support of all types of plants and marine assets. AVEVA, Product and Services (http://www.aveva.com/products_services_aveva_marine.php).[Online].(Accessed 29 Mar. 11) product portfolio can be summarised to include;

AVEVA NET: An information management solution and a core of AVEVA's Product Lifecycle Management that is vital for plants and marine projects. AVEVA NET acts as a hub to control, link and deliver all types of data and documents through a safe and sound means. It is one of AVEVA's new products that is gaining market and it is proving to be beneficial tool for customers who want to integrate data from multiple sources. As a result, AVEVA has invested over the years £27.3m in research and development on AVEVA NET.

AVEVA Plant: This is AVEVA's most comprehensive and powerful integrated set of applications used to create and support plant engineering, design and design management. With AVEVA Plant, AVEVA has been to achieve maximum productivity at minimum cost providing rapid return on investment. Included in the AVEVA Plant is AVEVA PDMS which is recognised as the world's leading 3D plant design application.

AVEVA Marine: This represents AVEVA's top of the class shipbuilding and plant engineering software solution used for design and construction of all types of ship and floating structure. It is used by the world's most productive shipyards and the only shipbuilding solution to support multi-site projects of any size.

1.3 AVEVA'S Market

Through its unique technology and product portfolio, AVEVA is able to support the efficient design, construction and operation of complex engineering projects in the Power, Oil & Gas, Marine, Pulp & Paper, Mining and Chemical industries; AVEVA, Market Sector (http://www.aveva.com/products_services_market_sectors.php).[Online](Accessed 29 March 11). Data from this same webpage indicates that AVEVA support these industries by targeting the following markets;

It provides Power to the North Sea and the Gulf of Mexico where at least 80 per cent or more of production facilities uses AVEVA's solutions. Also in China at least 85 per cent of Class A Certified Power Plant Design Institutes use AVEVA technology. Globally, its power industry customers include major names such as Alstom Power, Babcock & Wilcox, EDF, Foster Wheeler, Hitachi, MHI, Siemens Industrial Turbines.

Globally, 85% of the world's top 50 commercial shipbuilders use AVEVA technology. Japan, Sweden, Russia, Germany, Singapore, UK , Thailand and in the USA also use AVEVA for naval engineering. Currently, India and Korea use AVEVA software to build their Navy vessels while AVEVA's products are also used to design vessels such as aircraft carriers, frigates and submarines.

Twenty seven of the world's top chemical companies operate plant designed using AVEVA technology. Furthermore, over 70 AVEVA's process technologies are operated in 50 countries which it is why companies like BASF, DuPont, Uhde and Aker Kvaerner prefer its process technology.

AVEVA's main customer in the Pulp and Paper market is presently Chile, where a 700,000 tonne/year Arauco Valdivia project was recently executed using AVEVA products.

1.4 Overview of Business Performance

A quick look at AVEVA's five year record from 2005 to 2009 highlights the following statistical overview:

A significant increase in revenue (£57.2m to £164m) indicating a massive 188% growth rate achieved over these years.

Adjusted profit before tax also witnessed huge increase of 528% from £9.969m to £62.623m which boasted a gigantic improvement of 724% increased in profit.

Furthermore, adjusted earnings per share increased from 9.29p to 67.33p, indicating yet another massive increased of 624%. As a result, dividend per share increased by 361%.

Most noticeably was movement in net current assets with an enormous 869% up from £11.478m to £111.26 compounded with shareholders' fund increasing from £41.369m to £143.131m a raise of 246%.

Although these figures indicate massive growth rate and changes, the general trend seems to be slightly different. The summarised consolidated results over the years show that there was a continuous high growth in profit between 2006/2008 (£8.076 to £34.246) and when compared with changes in 2008/2009 (£34.246 to £42.154) this growth depicts significant drop although 2009 did achieve profit increased. In addition, dividend per share had an upward trend until 2008 but has since then experienced a slower growth rate. Furthermore, net current assets had a steady growth between 2005/2006, a steep growth between 2007/2008 but seem to have slowed down between 2008/2009. This trend is almost same with shareholder's funds except in 2008/2009 its growth trend has experienced significant drop.

1.5 Detailed Review of Business Performance

The year 2008/2009 proved to be another record year for AVEVA as the company achieved strong growth in revenue, profit and cash. Key financials showed that revenue increased considerably which can be attributed to increase growth in the Asia Pacific and Central, Eastern and Southern European (CES) markets. Beginning with the balance sheet, overall detailed review of business performance showed that:

1.5.1 Review of Balance Sheet

Increase in Non Current Assets (from £36.378m to £42.219m): This account for a 12% increase and could be attributed to two things; increased in property, plant and equipment (from £5.403m to £8.096m) and deferred tax assets (from £2.743m to £5.514m). Reference to note 16 showed that during the year the company incurred additional expenditure on fixtures, fittings and office equipment of £2.338m and this falls in line with the Group's Chairman statement to expansion of existing regional offices in Mexico and Russia and the opening of a new office in Brazil. Furthermore, note 24 referred to deferred tax and showed increased retirement benefit obligations of £2.105m. This is acknowledged in the Finance Director's review which states increased expenditure in equipment and investment in the company's overall computer network and telephone system.

Expansion in the Elements of Working Capital: First of all, trade and other receivables increased by 31% (from £43.184m to £56.768m). According to note 18, trade receivables terms fall between 30 to 90 days and analysis of trade receivables during the year showed that this increase was due to trade that was neither past, due nor impaired as well as trades that were less than four months old. Second, cash and cash equivalent increased by 52.3% (from £82.849m to £126.164m) and note 19 indicated that there was a small rise in cash at bank and in hand but much of the increase came from short term deposits (from £50.383 to £87.673m. Further justification was from the Finance Director's review stating good cash management as a reason for the strong cash position. This is because during the year cash conversion, which is a measure of cash generated from operating activities before tax as a percentage of profit from operations, dropped to 104% as opposed to 126% in 2007/08 and because the board believes it is important for the business to maintain a strong cash position given the current economic climate where banks limit credit facilities. Third, increased in non-current liabilities (£3.657m to £10.353m) caused by increase in retirement benefit obligations in of £7.6m as indicated in note 25 and which according to the Finance Director's review is mainly related to deficit in the UK benefit pension plan. The deficit caused by a devaluation of the benefit pension scheme's assets during the year due to current economic crisis. And finally an apparent debt capacity indicated on the consolidated balance sheet as at 31 March 2009 which shows AVEVA's non-current assets £42.219m when compared with non-current liabilities (£10.353m). This is a clear indication that AVEVA is able to offer enough security if it wants to borrow money and to pay for its long term debts as they fall due.

1.5.2 Review of Consolidated Income Statement

For the year ended 31 March 2009, AVEVA's consolidated income statement point out the following:

Increase in revenue: In the year ended 31 March 2009, AVEVA's revenue increased by 29% from £164.041m to £127.561m. This growth in revenue can be attributed to growth in AVEVA's global market, services and technology and products. This is evident in the CEO's review which shows that: Asia Pacific experienced strong business growth with revenue £67.1m (2008 - £50.8m in) due to increase demand in AVEVA's Marine products to complement growing demand of Power and Oil & Gas in the region. This growth was further boasted by the partnership with Hyundai Heavy Industries which led to sales of new Marine design tools. The Marine Technology Centre in Korea also increased capacity generating more revenue; Latin America also achieved significant growth following the opening of new offices in Mexico and the initiating of a new strategy of direct sales and service in Brazil, a dominant economy in Latin America and a growing market for the group; while Central, Eastern and Southern Europe experienced continuous growth in Oil related projects particularly Germany, Austria and Switzerland which won more business from their competitors. As a result of these and as highlighted in the Finance Director's review all three main AVEVA's services saw a massive revenue growth in 2009 indicated as follows: recurring revenue was up 57% from £66.1m to a massive £94.2m due to customers renewing their annual and rental fees as well as growth in new customers opting for rental fees because it offers flexibility; initial licence fee (ILF) increased to £57.7m (2008 - £52.9m) due to success with AVEVA's Marine business in China and Korea while the CES region contributed a significant amount of £16.5m (2008 - £13.1m); services revenue was up 41% from £8.6m to £12.1m as a result of services to customers. Other revenue generating venue includes the maturity and introduction of the new version of AVEVA NET which is in high demand in the market and sort after by customers.

Increase cost of sales and operating expenses: AVEVA's consolidated income statement as at 31 March 2009 showed total cost of sales increased by 26% from £29.793m to £37.612 with increased in operating expenses of 28% from £54.607m to £69.780m. According to the Finance Director's review the increase of additional headcount recruitment of 113 in sales and local support personnel as well as hired specialists to Research, Develop and support the AVEVA NET product in selling and distribution accounted for this.

A stable operating profit: Though sales revenue increased by 29% between 2008/09, both cost of sales (26%) and operating expenses (28%) rose by a similar amount leaving both gross profit and particularly operating profit (31% from £43.161m to £56.649m) relatively stable.

1.5.3 Review Cash Flow Statement

Looking at AVEVA's consolidated cash flow statement for the year ended 31 March 2009, cash generated from operations for 2009 (£58.681m) was slightly better than 2008 (£54.626m). But net cash generated from operating activities for 2009 (£43.572m) when compared with 2008 (£43.301m) indicated very little change. This is in contrast with the high profit in 2009 of £42.154m as oppose to £34.246m in 2008. A plausible reason will be the increase in trade and other receivables of £15.550m in 2009 which in 2008 was just £6.475.

Furthermore, there was net cash flow from investing activities of £2.545m in 2009 and £0.111m for 2008. This showed a large increase of cash outflow in 2009 comparatively to 2008 caused by acquisition of subsidiary iDesign Office Pty Ltd, a small Australian company for £1.7m as well as increase expenditure in the purchase of fixtures, fittings and office equipment. These expenditures were expected as the acquisition of iDesign Office Pty Ltd was needed to develop and improve other product based as well as AVEVA is expanding in South America and Asia Pacific and needed to expand its offices in these areas.

Other cash outflows include, a fairly major cash outflow to pay dividend holders (2009- £5.318, 2008-£3.093) which was proposed and approved by shareholders at the Annual General Meeting.

1.6 RATIOS

The following ratios will be used to evaluate the profitability, efficiency, liquidity, gearing and investment potential of AVEVA Plc:

Return on Capital Employed (ROCE)

Sales per £1 Capital Employed

Operating Margin

Gross Margin

Sales Revenue per Employee

Trade receivables

Gearing

Interest Cover

Table 1 below shows all calculations for these ratios as at 31 March 2008/09 (all figures are stated in million pounds) and table 2 is a summary of table 1which shows trends in 2008 and 2009.

1.6.1 Profitability and Efficiency

The ROCE ratio depicts AVEVA has achieved huge performance between 2008 and 2009 effectively showing an upward trend of 29% (from 39% to 68%) when compared with the operating profit. Changes in both profitability of sales (operating and gross margin) and efficiency in the use of capital will help explain this performance.

The operating margin shows a slight improvement in performance compared to 2008 which reflects the overall positive net contribution made by sales in generating profit. Whereas, in 2008 operating margin was 33.8% after paying the costs of sales and operating expenses for 2009, the profit margin 34.5% went up slightly by 0.7%. This means that AVEVA's huge performance in 2009 can be attributed to a drop in its operating expenses (that is, selling and distribution and administrative expenses) and partly by reasons connected to the increase in gross margin and AVEVA's strong market position while operating in highly competitive markets. Events in the CEO and Finance Directors' review explained some of the reasons in this 2009 drop in operating expenses include. The CEO's review stated that a greater portion of revenue generated by AVEVA came from the CES market which is a mature market that has continued to win businesses from competitors. This means that, though AVEVA generated more revenue it invested very little in developing customers. Furthermore, effective management of its intellectual property rights over the years by issuing customers licensing rights to use the application rather than selling or licensing the computer source code has been able to substantially reduce its risks which helps maintain sales. This is because AVEVA's success depends on its intellectual property rights which could damage sales if not well managed. The world economic trend is another contributing factor. Substantial amount of AVEVA's revenue comes from customers whose business depends on growth in the Oil & Gas, Power and Marine markets and the CEO explained that unlike previous downturns, in 2009 AVEVA still generated high revenue because most Oil companies were cash rich and the Marine sector had good sales of both the AVEVA Marine product and AVEVA NET. Moreover, AVEVA persuaded a new strategy of direct sales with customers which mean by bypassing third party agents AVEVA was able to curtail costs and position itself to better understand and serve its global markets. Increased administrative expenses of 6% in 2008 as expressed in the Finance Director's review is another reason for the 2009 slight increase in operating margin. In addition to these are reasons associated to changes in the gross margin.

Table 2 above shows that in 2009, AVEVA's gross margin increased slight by 0.4%. Though not a significant increase, this ratio indicates that gross profit was higher relative to sales revenue in 2009 when compared to 2008. This upward trend is not surprising as the Chairman stated that AVEVA has over the years carried out considerable investment in developing new product range as well as expanding its global markets to maintain a leading position in the markets in which it operates. The CEO statement further clarified this when it mentioned the company has continuously expanded its Asia Pacific market and in2009 signed a new deal with Hyundai Heavy Industries that led to the sales of Marine design tools, with sales expected to increase in 2010. Latin America also experienced growth in its markets as new offices were opened in Mexico. Strong sales in AVEVA's products, technology and services also contributed to the gross profit upward trend. The CEO mentioned the new version of AVEVA NET gained high demand in the market especially in the Western Europe, Middle East and Africa (WEMEA) market where it supported the enhancement, research and development activity that brought new ideas in that market. Other product related improvement for the year was the completion of AVEVA's data technology with Marine products acquired in 2004 as well as the completion of some products set out in 2006 and which have evolved into new products. Alternatively, this upward movement in gross profit ratio was due to management effectively controlling costs. To improve on cost efficiencies, the CEO mentioned a new restructuring programme that led to the merging of two major regional organisations, WEMEA and CES thereby rationalising the number of reporting regions from 4 to 3. Further cost maximisation was done in the reduction of high cost subcontractors, employees pay freezes, use of part-time workers, career breaks, voluntary redundancy and some compulsory redundancy. This resulted in cost savings of approximately £5.0million.

Profitability was also influenced by efficiency in the use of capital. From table 2, although it took additional two days in 2009 for AVEVA to collect revenue as compared to 2008, sales per £1.0 capital employed improved by 0.82 caused by increased sales revenue per employee of £20.0m. Part of the reason for this improved sale per employee is because of the effective cost savings strategy that AVEVA implemented during the year. Through the restructuring programme and introduction of flexible initiatives to strengthen human resource base, AVEVA's employees had to improve their performance during the year and only high efficient employees were retained. Other reasons for improved employees performance include: training and development schemes initiated in 2008 and the hiring of profession human resource staffs to improve on employees productivity.

From the above analysis and events that occurred during the year, all ratios except increase in trade receivables of 2 days, clearly indicates in 2009 that AVEVA is performing well in terms of profitability and this is shown in the massive ROCE upward trend in 2009 when compared to 2008.

1.6.2 Liquidity

A quick glimpse at the figures in table 3 show that cash and cash equivalent has increased by a big margin of £43,315m for 2009. Note 19 on the consolidated statement shows that a greater amount of this cash is a result of short term deposits during the year. Added to this, is AVEVA's management policy to maintain a strong cash position because of situational factors surrounding current manner in which banks issue credit. The increased in cash would partly explain why payables have dropped to £9,409. This means with enough cash and cash equivalent during the year, AVEVA was able to pay for its trading activities and paid some of its carried forward payables from 2008. But receivables increased by a massive 140% during the year and this partly explain why management insist on maintaining a strong cash position as well as the global economic crisis affecting AVEVA's customers. This means that though AVEVA have achieved high performance and strong cash position, it is still faced with the problem of getting most of its cash from customers. This will probably explain the massive increased in short term borrowing during the year. This is a problem and added to a statement by the CEO that during the year some projects were either slowed down or postponed because of falling prices and difficulties in raising investment funds. Although AVEVA is effectively managing its cash and payable accounts, failure by management to take quick and appropriate action with its account receivables and short term borrowing will cost the company more and might impact on operating profit and performance in the near future.

1.6.3 Financial Gearing

Table 2 shows that there was a significant increased in the gearing ratio from 3.46% in 2008 to 7.23% in 2009. This means there was a substantial increase in long term lenders to the financing of AVEVA. Interest cover also moved from 21.8 times in 2008 to 24.7 times in 2009 caused by a decrease in borrowing during the year and only goes to justify the dramatic increase in the level of operating profit. This is important as it signifies lower risk to lenders that interest will be met as well as lower risk to shareholders because interest will be covered long before lenders can take any actions to the AVEVA. This risk is further minimised by AVEVA's treasury policy which aims to ensure that capital held is not put at risk by holding deposits for up to three months and that policies are also designed to reduce the financial risk when conducting trading activities such as currency and credit risk. Therefore, AVEVA was able to manage its risk to both lenders and shareholders and that is why the Finance Director review stated increase dividend to 9.36pence (6.5pence final plus 2.86 pence interim) in 2009. A total 41% dividend increased.

1.6.4 Investment portfolio

For the year ended 31 March 2009, AVEVA's endings per share moved from 50.8pence in 2008 to 62.27pence, an increase of 23%. This upward trend shows a high potential for investors to invest in AVEVA's shares.

Summary

2.0 WORKING CAPITAL MANAGEMENT

2.1 Introduction

Working capital management defines the management in the short term of the relationship between a company's current assets and liabilities. The most common elements of working capital will include inventory, receivables and payables which represent the operating working capital (OWC) held by a company usually within a year. Fig.1 below shows the interaction between these elements of OWC.

The goal of OWC management is to ensure that a company has enough cash flow, measure in terms of liquidity, to satisfy its short term debts and continue to support its day to day operations. Most articles and books discuss the significance of OWC in terms of obtaining an optimal balance between inventory, receivables and payables, McLaney E. and Atrill P., Accounting: An Introduction (Prentice Hall, 2008). Abraham et al., Accounting for Managers, (Cengage, 2008) further expatiates on this critical importance and state that most organisations invest between 25 - 40% of their net assets on OWC which represents a major short term investment. However, these books present a generic methodology to OWC and do not consider a firm's unique nature, industries or size. Furthermore, this significance of working capital will depend on its size and composition and will vary between industries such as Rolls Royce Plc a manufacturing company will place particular attention to its high inventory levels and payables unlike British Airways Plc a service provider with no inventory. Thomas M. Krueger, An Analysis of Working Capital Management Results Across Industries, American Journal of Business, 2005, vol 20 presented a research based on the annual ratings of working capital management across industries published in CFO magazine. The result indicated that there was a consistency in working capital measures within industries but the working capital measures were are not static over time. In an online article Philip McCoster (2003), Accountancy: The Importance of Working Capital, (http://www.accountancy.com.pk/articles_students.asp?id=77).[Online].(Accessed 28/03/11) agrees with this dynamic nature of working capital and highlights this importance in more subtle way that most organisations are profitable on paper but are forced to cease trading because they cannot meet short term debts. According to him, small businesses in particular are prone to fail especially during start up because they ignore the importance of working capital problems.

Generally the importance of working capital is indisputable and whether its elements are managed as a whole or individual, its management is still important in order for an organisation to effectively manage its cash flow to continue operation. But while this is most said in papers, it seems rather paradixocal that in reality the importance OWC is ignore and most companies find themselves at the point of bankruptcy as was the case in the winning margin game.

As a production manager in the 'Winning Margin game', I realised that the decisions I made especially in forecasting and managing machines output was very critical to the overall amount of finished goods inventory needed to achieve a positive OWC. This was clearly depicted in year two when two critical decisions;

Forecasted a total production output of 11 costing $40 (appendix: Production and Sales Plans For The Year Ahead).

Purchase of two additional Mark II machines (See appendix: Balance Sheet)

This resulted to an increase in the amount of inventory to contracted amount although some inventory was tied up in Work in Progress and Finished goods leading to a drop in operating working capital (Year 2 Cash Flow Statement). Furthermore, the cash spent on new machines also led to a drop in the operating cash flow of the business. Therefore, in real life the production manager role is strategic and has a big impact on working capital and the overall business objective but his/her decisions can only be as effective when taken in collaboration with other departmental heads.

2.2 BUDGETING

McLaney E and Atrill P., Accounting: An Introduction (Prentice Hall, 2008) defined a budget as a short term financial plan prepared by a business as an integral part of its strategic plan framework. A budget is use by managers to examine and compare between the actual to what was planned in a process known as the budget control. By using this technique, Group E benefited from the budgetary process in many ways:

Forward thinking and identification of short-term problems: During the planning process of year 2, we realised that we had to budget for additional machine as well as additional loans. Doing this in good time gave us time to consider alternatives and chose the best course of action to take.

Improved co-ordination: Doing planning each year meant we had to co-ordinate with each other. This was crucially beneficial because it improved visibility and decisions making as all activities were linked together. For example, decisions on production depended on sales estimates, raw material availability and funding to finance it.

It provided a system of Control: At the beginning of each year, we had to compare year 1 and 2 performance and established areas of concerned. This provided a system of control and better planning for year 3.

It created a system of authorisation: By deciding on a master plan of action for each year, this helped set expenditure limits especially as I, the production manager, wanted to increase amount of machine purchased in year 2 but was restricted.

The budget motivated us to perform better: By establishing responsibilities to each member of the group, was beneficial to the whole team as each member's felt they had contributed to the overall business objectives. Hence improving the team's spirit to perform.

2.3 Absorption Costing

Absorption costing is a method of calculating the full output cost by charging direct costs with a fair share of indirect costs. The essence of absorption costing is to make costing simpler and easier so that management can make informed decisions. In the 'Winning Margin' game, the use of this technique was beneficial to our group in several ways:

Helpful in making output decisions: Absorption costing technique made calculating planned sales easier and as a team we were able to make informed decisions on production and cash flow.

Exercising control decision: absorption costing is often used as a basis of budgeting and budget control. Therefore, it was beneficial to the team as it formed the basis of our budget and we were able to exercise control over our budget and plans

Furthermore, the technique was particular useful to achieve efficiency since we were able to make decisions that compares alternative costs of doing similar things. For example we compared the costs of buying a Marked II or Mark III machine in year 2 as well as deciding between the various types of product to produce.

In addition to this, absorption costing technique was significant as we were able to assess our team's performance. Its use made calculating yearly production cost, sales, profit and other financial data easier. This made facilitated the process of assessing our business and team performance for any given year.

Although widely practiced, in real life the use of absorption costing technique will not be as simplistic as in the game. Moreover, the technique has been criticised for its use of past costs which are considered irrelevant in the decision making process as decisions need to reflect the future not the past. Other costing techniques such as variable costing are recommended. (Words 300)