Financial Health Assessment Of Grainger And Land Security PLC Using Z-Score And Capital Structure Analysis

Z-Score Analysis

The issue of financial healthiness is of great concern for many organizations. A number of models exist for measuring the financial ability of a company. The Z- score model developed by Altman is evidenced to be the most suitable and appropriate tool of analysis. This approach is used in forecasting the likelihood of organizational bankruptcy. In such situations, the multiple discriminate analyses (MDA) are deemed important. The Z-score analysis is applied to monitor and evaluate the financial muscle of a company (Al-Rawi,Kiani,& Vedd,2008).

I will be employing this tool in assessing the financial performance of the two companies in the real estate industry: Grainger PLC and Land Security PLC.I based my report on the data given in the excel template. In my research I discovered that the two companies are not sound financially as they have Z-scores than the benchmark of more than 2.99(Review of accounting studies,2016). The results of the study are important for administrators and investors who are willing to use them in making managerial and investment decisions respectively.

The relevant evaluation of capital structure is conducted by using Net Income Approach if capital structure model. The current capital structure of both the companies is mainly conducted to understand the minimum requirements that needs to be obtained by the company. In addition, the analyses of the capital structure directly help in understanding cost of finance incurred by the company to conduct its operations. The capital structure of Grainger PLC and Land Security PL is conducted to understand the financial position and condition of the company. Hence, with the help of Z-score value and capital structure value the actual condition of the companies are divided in the assessment, which could help in understating the chance of bankruptcy for the two analyzed companies. 

Land Securities Group PLC (LAND LN) – Assignment data
Particulars Save Time On Research and Writing Hire a Pro to Write You a 100% Plagiarism-Free Paper. Get My Paper	FY 2013	FY 2014	FY 2015	FY 2016	FY 2017
Historical Market Cap	6,470.3	8,041.4	9,892.4	8,692.4	8,374.0
Current Shares Outstanding (millions)	781.57	788.65	790.54	790.67	790.75
Share price	8.28	10.20	12.51	10.99	10.59
Dividends per Share (GBP)	0.30	0.31	0.32	0.35	0.39
Growth rate	3%	3%	4%	10%	10%
Cost of equity	6.10%	6.03%	6.29%	13.07%	13.78%
EBIT	651.30	1,075.10	2,236.30	1,271.50	335.00
Interest Expense*	193.80	216.90	206.30	201.70	178.00
EBT	457.50	858.20	2,030.00	1,069.80	157.00
Cost of equity	6.10%	6.03%	6.29%	13.07%	13.78%
Value of Equity	7,500.47	14,229.78	32,267.47	8,182.81	1,139.08
Value of Debt	3,461.40	2,908.70	3,702.90	2,963.90	2,615.00
Total value of the firm	10,961.87	17,138.48	35,970.37	11,146.71	3,754.08
Weighted Average Cost of Capital (WACC)	5.94%	6.27%	6.22%	11.41%	8.92%

The Net Income Approach is calculated in the above table, which helps in deriving the overall WACC of the organization over the period of 5 fiscal years. This derivation helps in identifying the weighted average cost of capital of Land Securities Group PLC. The capital structure relevantly indicates the riskiness of the company’s operations over the period of five fiscal years, which could be derived from the above valuation. The value of debt and value of equity derived in the above calculation has helped in detecting the overall cost of capital required by the company to conduct its operations. The relevant composition of the capital structure helps in detecting the debt and equity, which is used by the organization to complement their finance needs. The Capital structure model such as Net Income Approach directly helps in understanding the changes in overall capital position that is used by the company to conduct its operations. In this context, Barth (2014) stated that with the help of WACC calculation investors are able to detect the minimum required rate of return, which needs to be generated from investment.

Capital Structure Analysis

Grainger  PLC (GRI LN) – Assignment data
Particulars	FY 2013	FY 2014	FY 2015	FY 2016	FY 2017
Total Assets	1,711.30	1,793.90	1,921.60	1,612.90	1,654.60
Total Liabilities	1,245.80	1,256.20	1,356.70	937.70	948.10
Total Current Liabilities	209.00	142.90	229.40	156.20	895.40
Debt to equity ratio	61%	62%	59%	48%	3%
Historical Market Cap	728.1	775.0	991.9	958.8	1,080.4
Current Shares Outstanding (millions)	414.88	416.16	416.29	416.81	416.97
Share price	1.75	1.86	2.38	2.30	2.59
Dividends per Share (GBP)	0.02	0.03	0.03	0.05	0.05
Growth rate	20%	23%	10%	64%	3%
Cost of equity	21.16%	23.89%	11.15%	65.59%	5.13%
EBIT	93.60	98.20	91.10	114.30	111.70
Interest Expense	73.30	66.30	54.00	39.10	–
EBT	20.30	31.90	37.10	75.20	111.70
Cost of equity	21.16%	23.89%	11.15%	65.59%	5.13%
Value of Equity	95.92	133.52	332.61	114.65	2,178.23
Value of Debt	1,036.80	1,113.30	1,127.30	781.50	52.70
Total value of the firm	1,132.72	1,246.82	1,459.91	896.15	2,230.93
Weighted Average Cost of Capital (WACC)	8.26%	7.88%	6.24%	12.75%	5.01%

The above calculation mainly helps un deriving the WACC of Grainger PLC, which depicts the minimum required rate of return that needs to be generated by the company. The composition of capital structure directly affects WACC of the company, which changes the required level of returns from investment. The current WACC of the company is relatively low and close too cost of equity, which is due to the low debt acquired by the company. Baum, Mackmin and Nunnington (2017) argued that assumption of debt and equity cost does allow investors to understand the financial requirements of the organization, as there are different factors, which is used by the management in making capital expenditure.

YEARS	2013	2014	2015	2016	2017
WC	883	1030	1045.2	906.5	169.10
A	1,711.3	1793.9	1921.6	1612.9	1654.6
R1	0.517	0.574	0.544	0.562	0.102

WC= Working Capital,

A= Assets,

R₁=Working Capital/ Assets

NB =Assets for this calculation and others that follow means total assets. 

From the data tabulated above, I noted that the Working capital in relation to assets of Grainger PLC was in the range of 0.102 to 0.562 over the period. This company ratio kept fluctuating from year to year. The total assets increased year by year for four years except in 2016. This means that the company devoted huge efforts and resources investing in fixed assets. The working capital increased constantly over the period except in years 2016 and 2017 which is satisfactory (Al-Rawi, Kiani and Vedd 2008). This analysis is essential for the financial health of the company.  

YEARS	2013	2014	2015	2016	2017
RE	311.1	382.7	411.7	527.7	553.4
A	1711.3	1793.90	1921.6	1062.7	1062.7
R2	0.182	0.213	0.214	0.497	0.525

RE = Retained Earnings,

A= Assets,

From the table it can be depicted that ratio of retained earnings to that of assets increased every year. This ratio shows the part of assets financed that has been financed by retained earnings. Greater ratios therefore show that a company has greater financial stability during periods of losses and indicates that the company uses its earnings as a cheap source of financing instead of debt financing. It is evident that Grainger Company has a fair retained from 2013 to 2017. This gives an implication that the company has remained profitable for over 5 years. It is thus true that the company has been utilizing retained earnings to finance its day to day operations. The increasing ratio of retained earnings during the period of study gives an indication that the company is growing (Begley, Ming and Watts 1996).

YEARS	2013	2014	2015	2016	2017
EBIT	93.6	98.20	91.1	114.3	111.7
A	1711.3	1793.90	1921.6	1062.7	1062.7
R3	0.055	0.055	0.047	0.108	0.105

EBIT = Earnings before interest and taxes,

A= Assets,

R₃= EBIT / Assets 

EBIT to assets ratio assess the operational performance and earning power of company. The profits of Grainger Company increase every year except in 2015 and 2017. However, when compared to assets, assets increased more.

YEAR	2013	2014	2015	2016	2017
MVeq	414.88	416.16	416.29	416.81	416.97
L	1245.8	1256.2	1356.7	937.7	948.1
R4	0.333	0.307	0.307	0.444	0.440

Working Capital Analysis

Computation based on values extracted from the given data from the two companies.

MVeq= Market Value of Equity,

L= Liabilities

X3= MVeq / L

Observation

The table indicates that the equities market value rose only in 2014 and then remained constant over the rest of the years while total liabilities increased in 2014 and 2015 then decreased the rest of the years. Equity Market value of equity to total liabilities ratio gives an indication of the part of shareholders investment in relation to debt. In circumstances where liabilities are more, the company is obliged to pay financing expenses in the form of interest to creditors; hence the risk of the stockholders will increase. Decrease in this ration was experience by the company in the year 2014, remained the same in the year 2015, increased in 2016 and finally decreased in the year 2017 (Baum, Mackmin and Nunnington 2017). This fluctuation is not good for the financial health of the company. 

YEAR	2013	2014	2015	2016	2017
SALES	283.2	319.1	202.3	225.7	232.8
A	1711.3	1793.9	1921.6	1612.9	1654.6
R5	0.1655	0.1779	0.1053	0.1399	0.1407

The table above presents sales to assets ratio. Sales revenue has a very important role in the general performance of the business since all company operations depend on it. Sales to assets ratio determines the ability of an asset to generate revenue. Greater ratio indicates sound performance while lower ratio shows low performance. From this table we can make an inference from the trend that the sales revenue increased in 2014 and then dropped in 2015 and then increased further in 2017. This shows that there is an increasing trend except in 2015 (Celli 2015). 

	Years	2013	2014	2015	2016	2017
R1	WC/A	0.517	0.574	0.544	0.562	0.102
R2	RE/A	0.182	0.213	0.214	0.497	0.525
R3	EBIT/A	0.055	0.055	0.047	0.108	0.105
R4	MVeq./A	1245.8	1256.2	1356.7	937.7	948.1
R5	Sales/A	0.1655	0.1779	0.1053	0.1399	0.1407
	Z-score	1.422	1.5306	1.397	2.1332	1.603

In order to determine financial health of this company, in my report I used Z- score model that gives an indication of the financial progress of an organization. The above table indicates the Grainger Z- score values. The Z scores remained below 2.9 for this company throughout the years. This shows poor performance. according to Altman’s model the company’s financial status is experiencing healthiness if the Z- score value is greater than 2.9 and at risk of bankruptcy when it is below 2.9 (Begley, Ming &Watts, 1996).

YEARS	2013	2014	2015	2016	2017
WC	-266.8	-250.1	81.6	286	-122
A	11,785.9	12171.7	14877.3	14990	14844
R1	-0.0205	-0.0205	0.0055	0.0191	-8.252

WC =Working Capital,

A= Assets,

R₁=Net Working Capital/ Total Assets

I noted that the working capital to total assets ratio of Grainger PLC had been around -8.252 to 0.0205. This ratio of company is too low. The assets increased each year except in 2017. This reveals that Lands security PLC invested more on fixed assets. Working capital is increasing except on 2017. The low levels of net working capital are very worrying especially to a short-term creditor since the company might not be able to meet its short term financial obligations in case they arise (Jauch and Watzka 2016).

Retained Earnings Analysis

YEARS	2013	2014	2015	2016	2017
RE	6590.3	7522.5	9708.7	10800.8	10615
A	11,785.9	12171.7	14877.3	14990	14844
R2	0.5592	0.6180	0.6526	0.7205	0.715

RE = Retained Earnings,

A= Assets,

From the table we can tell that there is an increase in retained earnings to assets ratio. Retained earnings for Lands Security PLC is good hence it is shows that the company has a profitability potential since retained earnings can be used to finance the day to day operations of the business which is less risky compared to the use of debt. Lands Security Company has a growth potential in the future.

YEARS	2013	2014	2015	2016	2017
EBIT	651.3	1075.1	2236.3	1271.5	335
TA	11,785.9	12171.7	14877.3	14990	14844
R3	0.0553	0.0883	0.1503	0.0848	0.0226

EBIT = Earnings before Interest and Taxes,

A= Assets,

R₃= EBIT / Assets

Profitability potential of lands security is high since the EBIT is increasing except in the year 2017.  Therefore, we can conclude that the company is profitable since the profits generated from the assets are also increasing. 

YEAR	2013	2014	2015	2016	2017
MVeq	781.57	788.65	790.54	790.67	790.75
L	4299.2	3753.4	3291.1	3291.1	3328
R4	0.1818	0.2101	0.2402	0.2402	0.2376

MVeq = equities market value

L= Liabilities

R4= MVE / TL

Observation:

Above table indicates that equities market value increased in 2014 & 2015 then remained constant for the rest of the years while total liabilities decreased in 2014 ,2015 remained constant in 2016 and increased in. This ratio increased over the years except in 2016 and 2017. This shows that the company also uses more debt in its financing hence it is risky since they will be paying more interest as the debt increases (Kivuvo and Olweny 2014).

YEAR	2013	2014	2015	2016	2017
SALES	736.6	716.5	770.4	945.5	787.0
A	11,785.9	12,171.7	14,877.3	14990	14844
R5	0.0624	0.0589	0.0518	0.0629	0.0530

From the table we can make an inference from the trend that the sales revenue decreased in 2014 and then increased in 2015 and then increased further in 2016 after which it dropped in 2017. This shows that there is an increasing trend except in 2014 and 2017.However the sales to asset ratio ranges from 0.0518 to 0.629 hence suggesting that the performance of this company is not bad.

Showing the Z-scores of Lands Security PLC for 2013-2017

	Years	2013	2014	2015	2016	2017
R1	WC/A	-0.0205	-0.0205	0.0055	0.0191	-8.252
R2	RE/A	0.5592	0.6180	0.6526	0.7205	0.715
R3	EBIT/A	0.0553	0.0883	0.1503	0.0848	0.0226
R4	MVeq./A	0.1818	0.2101	0.2402	0.2402	0.2376
R5	Sales/A	0.0624	0.0589	0.0518	0.0629	0.0530
	Z-score	1.16409	1.3169,5	1.57905	1.51846	2.26152

The table above indicates Z- score values of. Z scores remained below 2.9 for this company for the all the years. This shows poor performance of the company since it is below the Altman’s threshold of above 2.9. Hence this firm faces a threat of bankruptcy.

From the above studies it is evident that the financial position of the two firms is below threshold. They fell below 1.8 with regard to the analysis done using the Altman’s Z – score analysis. This therefore suggests that in the near future, the two firms are likely to face financial crisis. Investment in current assets is also not that appropriate (Barth et al. 2014). They invest more on fixed assets compared to current assets hence they are likely to be unable to mitigate their day to day financial challenges. 

EBIT to Assets Ratio Analysis

The Creditability of derived results is relatively high, which could help support the derivation of capital structure model and Z-test model that is conducted in the assessment. This relevantly helps in understanding the financial performance of both Grainger PLC and Land Security PLC. The capital structure of Grainger PLC is relevantly high, as it needs to the least WACC for conducting its operations, which is not achieved by Land Security PLC in 2017. This capital structure also states that Grainger PLC has the least accumulated debt in comparison with Land Security PLC. However, Jauch and Watzka (2016) criticizes that with the derivation of accurate cost of equity eh weighted average cost of capital for the firm is not derived, which is an essential measure used by investor while making investment decisions. 

From the evaluation of above Z-score model the Grainger PLC is identified to have Z-score value less than 2.9, which according to the Altman’s model indicates low financial status of the company. In addition, the chances of bankruptcy for the company is relevantly high, as the company’s value for Z-score did not cross 2.9 value in any of the years. Moreover, the Z-Score of Land Security PLC does not excess the values of 2.9 over the period of 5 years, which indicates the low financial stability of the company over the period. In addition, the z-score value also indicates that the chance of bankruptcy for the company as its z-score values is less than 2.9. On the other hand, Kivuvo and Olweny (2014) criticizes that he Z-score model does not always portray the accurate results to the investor, as the assumption and risk factor of companies differs from one industry to other. 

References and Bibliography

Al-Rawi, K, Kiani, R. and Vedd, R.R. (2008). “The Use of Altman Equation for Bankruptcy Prediction in an Industrial Firm (Case Study)”, International Business & Economics Research Journal, 7(7): 115-127

Attema, A.E., Krol, M., van Exel, J. and Brouwer, W.B., 2018. New findings from the time trade-off for income approach to elicit willingness to pay for a quality adjusted life year. The European Journal of Health Economics, 19(2), pp.277-291.

Awais, M., Hayat, F., Mehar, N. and Ul-Hassan, W., 2015. Do Z-Score and Current Ratio have Ability to Predict Bankruptcy?. Developing Country Studies, 5(13), pp.30-36.

Barth, M.E., Landsman, W.R., Young, D. and Zhuang, Z., 2014. Relevance of differences between net income based on IFRS and domestic standards for European firms. Journal of Business Finance & Accounting, 41(3-4), pp.297-327.

Baum, A., Mackmin, D. and Nunnington, N., 2017. The income approach to property valuation. Routledge.

Begley J., Ming J. and Watts S. (1996). “Bankruptcy classification errors in the 1980s: An empirical analysis of Altman’s and Ohlsons models”.

Celli, M., 2015. Can Z-Score Model Predict Listed Companies’ Failures in Italy? An Empirical Test. International Journal of Business and Management, 10(3), p.57.

https://blogs.harvard.edu/bankruptcyroundtable/2017/12/05/optimal-capital-structure-and-bankruptcy-choice-dynamic-bargaining-vs-liquidation/

https://www.gsb.stanford.edu/faculty-research/working-papers/optimal-capital-structure-bankruptcy-choice-dynamic-bargaining-vs

Jauch, S. and Watzka, S., 2016. Financial development and income inequality: a panel data approach. Empirical Economics, 51(1), pp.291-314.

Kannan, V. and Monisha, V., 2016. Financial Soundness of Selected Indian Automobile Companies using Altman Z Score Model.

Kivuvo, R.M. and Olweny, T., 2014. Financial Performance Analysis of Kenya’s SACCO Sector Using the Altiman Z Score Model of Corporate Bankruptcy. International Journal of Business and Social Science, 5(9).

Review of AccountingStudies,1(4):267284https://doi.org/10.1007/BF00570833Sanesh, C. (2016). The analytical study of Altman Zscore on NIFTY 50 Companies.