The main objective of this assignment is to understand financial performance and utilization of company resources long term and short term. Companies selected for analysing financial performance in this assignment is belong to construction industry. Construction industry in UK has been enjoying a massive growth in all sectors this industry is very important for economy, Gold group (2010) argues that construction industry in UK has a great impact & also contributes almost 8% of GDP. The construction industry provides more than 1.7 million of employment and also plays important role in social and environmental development within a country.
The main company selected for financial analysis is Eleco plc, which has been doing its operations in many countries. The second company which is also belongs to construction industry named as GallifordTry plc selected for comparison reason. The both organizations are similar in nature of business and performing under sub sector of materials and fixtures.
Eleco is basically focussing on key mechanism of up to date construction project. In fabric of the building Eleco used different Building Products, to deal with the construction projects they used Software tools, and to develop environmental performance they do Sustainable construction. Eleco is listed on the LSE Alternative Investment Market (AIM). Over 500 staff is working n UK, Sweden, Germany and South Africa that Eleco employs. (ELECO, 2010)
Objectives of Eleco plc:
According to (Dobbins R, Lowes B, 1978) theory of financial management propose that every organization objective is to maximize the wealth of shareholders. The operating objective of an organization is to maximize the variation in between operational expenditures and operational receipts along with investment, on the other hand minimizing the risk arising therefore.
According to annual report of Eleco (2010) company is looking for the benefits of both business partners and colleagues Eleco is struggling to foresee and meet up the requirement of the construction industry by using a modern and developmental approach to the build process as clearly stated in mission & vision.
The main objectives of Eleco is to convert such businesses in building business that are making losses with the intention of changing those losses into profits. Elimination of remaining losses in the visualisation software business and sale of surplus freehold property and termination of surplus property leases. The for most objective of Eleco is to make considerable reduction in central costs and some fundamental changes in restructure building system businesses, increasing the turnover by changing operation and meeting market needs. (Eleco, 2010)
Ratio Analysis of Eleco PLC:
Brigham F. E & Ehrhardt C. M (2005) argues that analysis of financial statement helps managers to identify deficiencies and performance of the company. Financial analysis also helps managers to improve performance and also helps them to take effective actions for the betterment of the company's future. Ratio analysis is an effective tool to find out company performance with respect to competitors or industry.
The main ratios used for this assignment are, Profitability ratio, Liquidity Ratio, Efficiency (working capital management ratios) and long term solvency ratios. All ratios are important and helpful as long as they correctly interpreted. Ratios play very particular part in summarizing financial data and to produce right question but keeping in mind of undesired answers, they are only considered as detectives to use with evidence to obtain final solution. (Jones, E. 1994)
Profitability Ratios
profitability of any organization is necessary for its survival and growth, as all managers and debt holders are interested in earning/profits of organization because only profitability of organization is main source from which they will receive their dues. Only three profitability ratios has been used for proposed organization.
Return on Capital employed (ROCE)
A table below shows a result of ROCE for two years. The ROCE of 2010 is in negative 14% whereas in 2009 percentage was negative 3%. As we can see the difference between two figures has increased and these changes are addressed in financial report of 2010 that a main reason of the downfall of ROCE is the reduction of revenue by 18% which was mainly caused by less turnover of building system businesses
Year 2010
Year 2009
Return on Capital Employed =
-14%
-3%
Gross Profit Margin Ratio:
The gross profit margin ratio is considered to be the most important ratio in financial analysis, the more the margin, the more profitability. The table below shows the gross profit margin ratio results for two years.
Year 2010
Year 2009
Gross Profit Margin Ratio =
37%
42%
Current year the gross profit margin is reduced by 5% from last year 2009. The difference of 5% in this ratio is mainly caused by the reduction of 18% in sales figure. The decline of sales is caused by several factors including the disposal of Eleco Bauprodukte GmbH ("EBP) plant and also due to industry recession.
Net Profit Margin Ratio:
In case of Eleco plc. Net profit margin ratio is showing a difference of 8% less as compare to last year. According to annual report (Eleco, 2010) chairman statement shows the profit of 0.5m in last year whereas this year, company had a loss of 5.5m.
Year 2010
Year 2009
Net Profit Margin Ratio =
-9%
2%
The main reason of decline in net profit margin ratio is turnover of the company and increase in distribution cost and exceptional items which include restricting cost for future cost reduction and improvement in sales & marketing. (Eleco, 2010)
Liquidity Ratios:
"Liquidity ratios" deals with this basic question: will the company be able to payout its debt on their due date may be next year or so? There are two commonly used liquidity ratios, current assets over current liabilities and acid test ratio, which are implemented on Eleco plc to find out the firm's ability to meet short term obligations.
Current Ratio:
The current liabilities are considered the most because they are the one's which comes first in payment. In Eleco plc. Current ratio analysis showed a decline in current asset ratio.
Year 2010
Year 2009
Current Asset Ratio =
1.18 times
1.26 times
A slight increase can be seen in the current liability in 2010 on the other hand assets decreased. The main reason identified for this fluctuation was money collected from trade receivables and also a usage of hard cash in operations & small acquisition. (Eleco, 2010)
Acid Test Ratio:
Inventories are the most likely to occur loss in case of bankruptcy. The result shows that company quick ratio reduced from 1.06 to 0.96 times.
Year 2010
Year 2009
Quick, or Acid Test Ratio =
0.96 times
1.06 times
Efficiency Ratios
Efficiency ratios can be used to find out the inventor turnover management and accounts payable for payment of liabilities and calculated the days for receivables.
Inventory days
In this case company takes 40 days to sell the inventory to customers whereas in 2009 company took 33 days. This increase in days are caused by many reasons as discussed above that industry was undergoing recession.
Year 2010
Year 2009
Inventory Days Ratio =
40 Days
33 Days
Receivable Days ratio:
This ratio analyses explains that how many days will it take to convert its receivables into cash. The ratio analysis of Eleco indicates that company take almost 60 days to convert its receivables into cash whereas in last year it was 55 days. The increase of days shows the company diminishing liquidity of accounts receivables.
Year 2010
Year 2009
Receivable days Ratio =
60 Days
55 Days
Payables Days Ratio:
The results of Eleco indicate the reduction of days in payable days which means company taking less days for repayment as compare to last year.
Year 2010
Year 2009
Payable days Ratio =
74 Days
80 Days
Working capital cycle days:
Eleco plc ratio has increased which means company is taking long to sale out its inventory (40 days) and also taking long to receive money from accounts payable in 60 days, at the same time company suppliers are paid within 74 days. All these factors & economic conditions are collectively influencing the company working capital ratio.
Year 2010
Year 2009
Working Capital cycle Days Ratio =
26 Days
Days
Long Term Solvency Ratios:
The best protection for long term liquidity risk is to produce regular profits and this generation of surplus profit will help the company to survive in long run. These ratios has greater implication on management, here we only discuss gearing ratio which has good importance for management and all other parties.
Gearing Ratio
This is the comprehensive ratio which gives an overview of the company solvency, regardless of the company performance. If company has large amount of loan capital compared to shareholders' equity then it means company is highly geared. Similarly if company has small amount of capital loan as compared to shareholder's equity then its low geared
Year 2010
Year 2009
Gearing Ratio =
28%
19%
The increase of gearing ratio from last year implying a slightly riskier capital structure, however this ratio doesn't provide the real picture of business risk. Analyst should consider all others factors before making any critical decision.
Financial Ratio comparison with Competitors:
In this section a comparison has been taken to analyse the performance of the company in the same industry. GallifordTry Plc selected for comparison with Eleco plc because both organizations are listed in London stock exchange under the same head of construction industry. Both organizations are effected by construction industry crisis. Every organization has its own strengths and value propositions which help them to differentiate from their competitors and strengthen company position in critical times. Grant, H.J & Prescott, E.J. (1988) describes the importance of understanding the industry and their competitor, the strong understanding of market situation and competitive analysis helps organizations to formulated effective strategies. The results of both organization ratios are given below in table.
Table:1 Ratio comparison with competitor
Financial Ratios
Eleco plc 2010
GllifordTry plc 2010
ROCE
-14%
17%
Gross profit margin
37%
10%
Net profit Margin
-9%
2%
Current Ratio
1.18
1.598
Acid Test Ratio
0.96
1.596
Inventory days
40 days
0.36 days
Receivable days
60 days
24 days
Payable days
74 days
31 days
Working capital cycle days
26 days
-7 days
Gearing Ratio
28%
66%
*see Appendix for detailed calculations
According to the resulted extracted from ratios both organizations are seems to be affected by the economic down turn. The first ratio results indicates a big difference with competitor, i.e. positive 17% whereas Eleco having a negative 14% as explained earlier construction industry was undergoing crisis (Construction survey, 2010). Eleco plc had sold one of there business unit and also a reduction in revenues is main reasons, whereas GallifordTry Gross is performing well and able to reduced there exceptional cost by £44.5 million.
The gross profit margin of Eleco is 37% whereas GallifordTry has only 10% Gross margin which doesn't mean Eleco is performing well as compare to competitor if we look at the Net profit margin ratio Eleco is paying more operating expenses as compare to GallifordTry because Eleco has spent extra money on exceptional items such as Distribution cost and restructuring cost of organization. Board of directors hoping these expenses will bring positive feedbacks in coming future, just similar with GallifordTry did in 2009 by spending £51.4m on exceptional items.
The comparison of liquidity ratios helps to measure the short term solvency of organizations, in contrast with Eleco; GallifordTry is in better position to fullfill debt obligations. Both organizations are in a good position to fulfil short term debts when they come to due date. Eleco has more closing stock with respect to GallifordTry because competitor has utilized its inventories at maximum level which brought good results in company liquidity. (GallifordTry 2010)
The efficiency ratio analysis gives an insight about companies performance that how organizations are utilizing there assets and liabilities. The results indicates that Eleco takes more days to receive money from receivables and it also takes almost 40 days to sell the inventories along with that company pays money to payables in 74 days. The comparison shows that GallifordTry keeps low inventory, minimum days for receivables but only 31 days for repayment to payables. The working capital cycle days is explains both efficiencies clearly. Eleco has 26 working capital days cycle which means company takes long time circulate its working capital figure as compare to competitor is -7 which is quite good. A negative working capital indicates that company has enough cash to invest and grow.
Pike, R. & Pass, C. (1988) argues that two goals of profitability and liquidity of organization conflicts with each other very often, attempt to produce profitability out of working capital can create liquidity problems similar with the case of too much concentration on liquidity will diminish the profit margins. The long term solvency analysis reflects that Eleco is more liquid which more then 72% of investments are funded by shareholders, whereas GallifordTry has higher long term obligations and considered as highly geared.
