In 1970 Rolls Royce Company is bifurcated into Rolls Royce Plc and Rolls Royce Motors limited. Rolls Royce is basically dealing into aero space engine and other ancillary products. Cobham Plc is nearest competitors of Rolls Royce. The basic aim of this assignment is to develop the insight about financial accounting, key accounting polices, impact of change in International accounting Standards and UK GAAP on financial Reporting. Before 2004, Rolls Royce was using UK GAAP and thereafter, accounting reporting was done on the basis of IFRS. The most important aspect here is to learn practical application of ratio analysis. The ratio analysis is carried out on both Rolls Royce plc and Cobham Plc by considering current ratio, Solvency Ratio, Capital Gearing ratio, Profitability margin, return on shareholders return and return on capital employed. The result of ratio analysis depicted that rolls Royce were heaving huge losses in the year ending 2008 due to huge outlay on account of interest payment. But whereas, year 2009 have brought profit in account of Rolls Royce on account of interest income. Dependence of interest income is negative factor here. The ratio analysis facilitates both intra and inters company analysis. The main objective is to understand how financial reporting and financial statement facilitate understandability, Reliability, Comparability, Relevance, Constraints on Relevant and Reliable Information, True and Fair Presentation of Financial Reporting.
Rolls-Royce PLC:
It was created over famous lunch brokered by Henry Edmund at Midland Hotel in Manchester on May, 1904. Edmund brought together Henry Royce a mechanical engineer and Charles Rolls as owner of first car dealer ship. Charles Rolls and Henry Royce had produced their First car in 1904 In 20's Rolls and Royce started the production of car and launched many key Models. In 1921, company opened factory in United States. In that decade, both car and aero division flourished. The touring cars and rolls Royce engine broke the record in 1933. Second world had shifted the focus on aero engines at new factory in Crewe in Chestire. 1960, cars of Rolls Royce become the star of Silver Screen. The year 1970, was very challenging for Rolls Royce. Rolls Royce bifurcated into Rolls Royce Plc for aero division and Rolls Royce Motor Limited for Motor car. Rolls-Royce is a global business providing integrated power system for use on land, at sea and in the air. The Group has a balanced product portfolio with leading market Share. Rolls Royce has wide product portfolio with access to global Markets. It deals into capital goods related to civil, Defense, Marine and energy. It has customer in more than 120 markets.
Cobham PLC:
During 1930, Cobham, made million people to experience flight with his famous Cobham's Flying Circus travelling air exhibition. In 1934, Alan Cobham an aviation pioneer had conceptualized aircraft as means of transport. It is started as an air to air refueling specialist. The Company has four divisions employing more than 12,000 people on five continents, with customers and partners in more than 100 countries and annual revenue of some £1.9bn / US$3 billion. The company's product includes military and civil system. The vision of the company is leveraging innovative technology with exceptionally talented human capital. Its product has played vital role in Berlin Airlift and European Space programme.
Objective:
Critical Analysis of financial reporting on financial health of organization
Role of Accounting Concept on Financial and non Financial performance
Importance, application and limitation of ratio Analysis
Change in Accounting Standards and its impact on Financial Reporting
Impact of national and international news on capital market through share price.
Accounting is the process of identifying, measuring and communicating economic Information to permit informed judgments and decision by users of the information. The objective of accounting information is to provide information for the following purposes.
Making decision concerning the use of limited resource
Controlling the organization's human and material resources
Maintaining corporate reporting
Kieso(1980), that accounting performs three main function, accumulation, measurement and communication of information. Three basic financial statements prepared for external and internal reporting to all stakeholders inclusive of investor are (a) balance sheet or statement of Financial position (b) profit/loss account or income statement and (c) cash flow statement. These statements are the part of annual reports all the companies. To understand the role of financial accounting in measuring the non financial performance, it is necessary to classify non financial performance according to objective, strategy and techniques of business organization. Performance measurement should be done in terms of long term competitive advantage rather than achieving short term profitability. Mostaque hussian(2002), The financial accounting plays a vital role in measuring the financial performance of the organization. Measurement of financial performance is regular and essential for corporate reporting and it is mandatory. Non financial performance is less important and not carried out regularly. Financial are reporting laid down emphasis on financial angle whereas management accounting deals with many contemporary approaches for measuring the non financial performance. Benchmarking, Balance score card, value chain analysis are certain techniques for evaluating the non financial performance.
Britton and Waterson (2006, pp 53) emphasized that one should be familiarized with accounting principal while evaluating the company's financial health. "Given such underlying theoretical principal can radically change the view the Financial statement give an entity, it should be obvious that preparers and users of financial statement should be very clear about the particular principles have been applied". companies were using financial measurement tool for evaluating the performance. All the companies have started using Balance score card for overall performance measurement.
Role of Management accounting coupled with Financial Accounting for evaluating financial and Non Financial Performance of Company: Marcus Heidmann et.al (1934), accounting systems (MAS) are financial System which provides information to the internal and external environment to managers. Bouwens & Abernethy (2000) say that AS includes reports, performance measurement systems, and computerized information management information systems, planning, budgeting, and forecasting processes required preparing and reviewing management accounting information. Therefore, AS facilitate both strategic and operational decision making on the basis of information. Chenhall & Morris (1986), Traditional Accounting system has narrow information scope and is internally used. It is ex post in nature and has financial perspective. Role of management Accounting has external use and ex ante in nature. It has both Financial and non financial orientation. The new role of Financial accounting is to observe strategic issues. The reason given is that broad scope of information is expected improve observation and interpretation of strategic issues. The other side of management accounting Miller (1993), can mask uncertainty through filtering may limit search behavior.
Key Accounting Polices of Rolls Royce: Role of accounting concept & Corporate reporting on Financial and Non financial Performance (Rolls Royce Annual Report 2009 pp 97-110)
Historical Cost concept: The financial statements have been prepared on the historical cost basis except where Adopted IFRS requires the revaluation of financial instruments to fair value.
Revenue Recognition: Revenues comprise sales to outside customers after discounts, excluding value added tax. Sales of products are recognized when the sale price agreed with customer and risks and ownership of the goods are transferred to the customer along with the receipt of payment can be assured.
Interest receivable/payable is credited/charged to the income statement using effective interest rate Method. Borrowing cost is capitalized as part of specific asset because of acquisition, construction and Production.
Taxation: The tax charge on the profit or loss for the year comprises current and deferred tax. Current tax is the expected tax payable for the year, using tax rates enacted or substantively enacted at the balance sheet date, and any adjustment to tax payable in respect of previous years. Deferred tax is provided using the balance sheet liability method.
Loans and receivables and other liabilities are held at amortized cost and not revalued (except for changes in exchange rates which are included in the income statement).
In case of Financial Lease, lease amount are capitalized at their fair value and depreciation is provided on the basis of the Group depreciation policy.
Inventory and work in progress are valued at the lower of cost and net realizable value on a first-in, first-out basis. Cost comprises direct materials direct labour costs, overheads, including depreciation of property, plant and equipment that have been incurred in bringing the inventories to their present location and condition. Net realizable value represents the estimated selling prices less all estimated costs of completion and costs to be incurred in marketing, selling and distribution.
Change in International Accounting Standard and UK GAAP
(Annual Report Rolls Royce PLC 2009)
All European Union Listed companies are required to prepare financial result on the basis of International Financial Reporting Standards from 2005. Rolls Royce Plc has restated the 2004 result on IFRS basis to understand it adequately. The following are certain effect on group's financial performance.
Amendment to IAS 1: it requires changes in presentation rather having impact on reported result. This amendment requires comprehensive income in place of statement of recognized income and expenses. If there is a change in accounting policy, a balance sheet at the beginning of comparative period should be prepared. Statement of changes has to be prepared as a primary statement.
IFRIC 14 IAS 19 The Limit of a Defined Benefit Asset, Minimum Funding Requirements and their Interaction: this interpretation applies where regulatory funding requirements for pension schemes will result in an unrecognisable surplus arising in the future. It has been adopted with effect from January 1, 2008. An additional liability of £491 million was recognised at that date. Further details are shown in note 18.
IFRS 8 Operating Segments: this standard amends the requirements for disclosure of segmental performance and does not have any effect on the Group's overall reported results. The key change is that the basis for reporting the segmental results is the same as that used internally, which is equivalent to the underlying results, reported as additional information in prior years.
Importance and Role of ratio Analysis
Ratio analysis is a tool used for determining the overall financial condition of the organization. It helps to put the information from a financial statement into an overview, which is helpful in spotting the financial patterns that are beneficial or may threaten for your company.
Financial ratios allow for comparisons
Between companies
Between industries
Between different time periods for one company
Between a single company and its industry average
For example, comparing ratios can indicate whether a business is holding too much inventory or collecting receivable too slowly. This comparison provides a new outlook into ways in which your business can improve its operations. The company Rolls Royce has been compared with Cobham balance sheet to facilitate inter firm comparison through ratio analysis. Ratio Analysis Facilitate
Time series analysis
Cross-Sectional Analysis
Industry Analysis
Benchmarking
Credit analysis
Performance analysis
The ratios used for measuring the financial performance of the marked companies are as follows.
Current Ratio
Solvency Ratio
Profit Margin Ratio
Gearing Ratio
Return on Shareholder's Fund
Return on Capital Employed
Current ratio:
Current ratio is computed by dividing current asset by Current liabilities. A ratio greater than one means that firm has more current assets than current liability. Thefirm's current liabilities in the denominator show the amount of short-term obligations the firm faced at the balance sheet date; the current assets in the numerator indicate the amount of short term assets the firm could use to pay these obligations. Higher the ratio, the greater the margin of safety. (Baker & Powell, 2005, Pg 48)
[Current Ratio = Current Assets / Current Liabilities]
By comparing Rolls Royce with COBHAM, we can make inference that for the year 2009 current ratio of Rolls Royce is greater than Cobham Plc. The average of Current ratio of Rolls Royce is 1.55 which is greater than Cobham 1.24 which implies that Rolls Royce enjoys more short term Solvency. Rolls Royce Plc is basically dealing in aero engines and other capital goods. Here in such case inventory turnover ratio can not be smaller value. Hence current ratio has to be greater.
Solvency Ratio:
It measures the firm's ability to meet long term obligations. Solvency ratio measures the size whether cash inflows are sufficient as compared to long term debt. Ti reveals how company are going to meet its debt obligation. Solvency ratio very from industry to industry. Solvency ratio greater then20% is considered financial Healthy.
Cobham Plc is solvency ratio is much better than Rolls Royce plc from 2009 to 2003.
If we compare year 2009 with 2008, Rolls Royce solvency ratio has increased by 7.57%. Year 2008 was loss making year due to which solvency ratio went down . In this year, Rolls Royce operating profit margin fell down and company has also incurred on Interest outlay. Solvency ratio matters for further borrowing and it also affects company leverage and earning capacity. Lower value of solvency ratio signifies Financial Risk of company which indirect affects the market price of Rolls Royce Plc.
Net Profit Margin Ratio:
This ratio measures the firms capacity to with stand worst economic condition. High net profit margins suggest a firm can control its cost or has a solid competitive position within its industry that is not threatened by cost-cutting competetitors. (Baker & Powell, 2005, Pg 62)
Net Profit Margin Ratio (After Tax Margin Ratio) = net profit after tax / sales.
Rolls Royce were having negative profitability of 20.83% in the year 2008. but in the year of 2009, Rolls Royce were enjoying profit of 28.39% due to interest received amounting to 2276 mil GBP and increased operating profit margin 1172 mil GBP. The other reason for loss in year 2008 is outlay of 3186 mil GBP on interest where as in year 2009, it was just 491 mil GBP. Dependence of interest income for profitability is not good indicator. But in case of Cobham, operating income has increased to 28600 from 128500 GBP that is positive indicator. The dependency of Interest income had fallen to 37600 from 56500 GBP.
Gearing Ratio:
Gearing ratio is the relationship between amount financed by the owners of the business and amount contributed by externals. It basically determines to what extent long term debt lenders factor in the capital structure of the firm. Gearing ratio reveals the inherent risk to the company. It tells the relationship between long term liability and capital employed. Higher answer reveals the company's dependency on debt in capital structure. This also shows that company is prone to liquidity and interest rate risk.
Gearing Ratio = long term debt / shareholders equity.
In case of both Rolls Royce Plc and Cobham Plc, gearing ratio has reduced which shows the company had reduced the debt in capital structure. But still number of gearing ratio is very high which signifies that borrowing exposes the firm to financial risk. It signifies that lenders would not get investment repayment and interest income. Shareholders may be disadvantaged due to lower EPS and Dividend Payment. Leveraging also firms to get advantage of trading on equity.
Return on Shareholder's Fund:
Shareholders are entitled to the residual profit. The rate of dividend is fixed. Earnings can be distributed or retained in the business. Shareholder's return are calculated by dividing profit after tax by shareholders fund. It can be shown as follows:
[Return on share holder's investment = {Net profit (after interest and tax) / Share holder's fund} Ã- 100]
Rolls Royce return on shareholders fund got doubled in 2009. In case of Cobham Plc. There is increase of return on shareholders fund but not substantial like Rolls Royce Plc. In year 2008, Rolls Royce were having 75.02 % loss. This loss of 2008 got converted into profit of 78.19 percent.
Return on Capital Employed:
It is a ratio that indicates the efficiency and profitability of a company's capital investment. Return on Capital employed signifies the relationship between the amount invested in the business and the return generated on those investors. It is always desirable to be as high as possible.It can be calculated as follows:
It is a profitability ratio establishes the relationship between profit after tax and long term investment. Because of negative profit margin, Rolls Royce plc had negative return on capital employed. But thereafter, because of interest income and incearsed operating profit company achieved highest Return on capital employed in year 2009 and greater than Cobham Plc with 15.92%.
Limitation of Ratio analysis
(Brigham and Ehrhardt pg 464-465):
Although Ratio Analysis can provide useful information concerning a company's operations and financial condition, it does have limitations that necessitate care and judgement. Some potential problems are listed below:
Many large firms operate different divisions in different industries, and for such companies it is difficult to develop a meaningful set of industry averages.
Most firms want to be better than average. As a target for high level performance, it is best to focus on the industry leader's ratios. Benchmarking helps in this regard.
Firms can employ "window dressing" techniques to make their financial statements look stronger.
Difference in accounting standard and International Financial Reporting System will make interpretation difficult.
Ratios are generally calculated fro the past financial data and thus are no indicator of future.
It is calculated at a point of time are less informative and defective.
Effective use of financial ratios requires that the financial statements upon which they are based be accurate.
Hidden short term fluctuation
Conclusion:
Ratios help to highlight the financial strength and weakness of Firm, but it cannot, buy it selves explain why those strength and weakness exist. While comparing cobham with Rolls Royce Plc, it is evaluated both firms have different accounting polices and principals, therefore distorting true comparison. The basic aim of the financial reporting and Financial statement is to present true and fair view of Business affairs to all the stake holder's to facilitate inter and intra comparison keeping in mind UK GAAP and IFRS.
