Discuss about the Value of Financial Statement Verification in Debt Financing.
Each and every organization needs to take proper steps which could add value for the invested capital of the shareholders. This report has been prepared in relation to Debenhams plc to determine whether company has delivered required benefits either in monetary and non-monetary terms to its shareholders. In this report, EVA analysis of Debenhams plc is made to identify economic value added to its shareholders. After that, by analyzing the financial information of company, total shareholder return of the company for the past 5 years including key events and its comparison with the appreciate standard company has been done (Sriram, 2018). In the end, proper judgment and recommendation have been given in the context of financial performance of company.
It is a British multinational company indulged in retail operating activities and it has several departmental stores in United Kingdom with its several franchises and stores. Currently, stock price of company is traded DEB (LON) 12.75 GBX +0.79 (+6.61%). The last year revenue of company in 2017 was 234.17 billion GBP (2017) which is 12% higher as compared to last three year data (Debenhams plc.2017).
It is analyzed that company has negative return on equity which divulges that company has failed to create value on its investment (Goldstein, Jiang, and Ng, 2017). The profitability of company has decreased throughout the time which has also decreased the value of its profitability. In order to assess how company has been successful in delivering value to its shareholders over the past five year, economic value added tool could be used (Lei, Qiu, and Wan, 2018).
The economic value added is a tool for assessing the amount of value created by the company. It assists shareholders and other investors to determine how much value company has created for their investment (Pike, Neale and Linsley, 2015). This tool is used to measure the incremental differences in the rate of return over company’s cost of capital. Essentially, it is used to measure the value company generates from the funds invested into it. However, the positive economic value added reflects that company has created value on the invested capital (Grimm, and Blazovich, 2016).
However, in order to calculate the economic value added for the company, we could use the proper formula which is given as below (Debenhams plc., 2015).
Economic value added= Net Operating Profit After Taxes (NOPAT) – Invested Capital * Weighted Average Cost of Capital (WACC)???
It is analyzed that in order to compute the Economic value added, investors need to compute the weighted average cost of capital of company for the company (Bloomberg, 2017).
Weighted average cost of capital is the amount of average cost of the capital which is needed to pay by company for keeping the investor’s capital invested in the business functioning of organization. However, weighted average cost of capital is used by company to analyze the firm’s cost of capital in which each category of capital is proportionately weighted (Tori, and Onaran, 2018).
Computation of the weighted average cost of capital
Net profit after tax of company= GBP £ 49 Million
Total assets= GBP £ 2210 Million
Total liabilities= GBP £ 1292 million
Computation of the economic value added =
£ 49 million- (2210-1292)*.96% = £ 28.51 million
(Brigham, Ehrhardt, Nason, and Gessaroli, 2016),
|
Computation of Economic value added (GBP in millions except WACC) |
||||
|
Particular |
2015 |
2016 |
2017 |
Mark and Spenser |
|
Net profit |
£ 94.00 |
£ 86.00 |
£ 49.00 |
£ 106.00 |
|
Total assets |
£ 2,143.00 |
£ 2,191.00 |
£ 2,210.00 |
£ 8,292.50 |
|
Total Liabilities |
£ 1,289.00 |
£ 1,307.00 |
£ 1,292.00 |
£ 5,742.10 |
|
Weighted average cost of capital |
1.24% |
0.45% |
2.23% |
1.22% |
|
Economic Value added |
£ 83.37 |
£ 82.05 |
£ 28.51 |
£ 74.96 |
(Please see the attached excel or appendix given below)
This above computation has shown that company has created value on its investment but at the same time has faced high loss in its value chain activities due to the complex business structure. It is analyzed that company has economic value added £40.18 million which divulges that company has created value for its shareholders since last five years (Cassar, 2011). The main goal of economic value added of company is to quantify the charges, cost of capital of the invested capital into the particular projects undertaken by the Debenhams plc. It is analyzed that company has faced high losses while accepting the projects in its busienss and also created high loss in its business.
The positive economic value added has reflected that Debenhams plc has created value on its all the invested capital and delivered positive results for its shareholders (Acharya, and Xu, 2017). Company has profitable busienss and wealth of the organization has been increased with the increase in its overall profit. However, the main reason of profitable busienss and positive EVA of Debenhams plc has been possible as company has very less tangible assets such as technologies and research and development department. In 2013, company had £120.84 million which has decreased to £39.25 million in 2017 (Debenhams plc., 2016).
It is analyzed that total shareholders return of the company is based on the earning per share and net profit earned by company. It could be defined as benefits and other capital gain to shareholders which could add value to shareholders capital. Total shareholder return is the internal rate of return of all the cash flow of the investors during the holding period of an investment (Véron, and Wolff, 2016). It could be determined as total amount of returned to investors. In this case, Debenhams plc has lower down its total shareholder return due to the decrease amount of profitability. In order to calculate the total shareholder return, firstly analysis would be made on the dividends received during the time of the shareholders ownerships (Debenhams plc., 2017).
|
Description |
Formula |
DEBENHAMS PLC ADR (DBHSY) |
Mark and Spenser |
||||
|
2013-08 |
2014-08 |
2015-08 |
2016-08 |
2017-08 |
|||
|
Net profit Margin |
Net profit/revenues |
6% |
4% |
4% |
4% |
2% |
7% |
|
Return on equity |
Net profit/Equity |
17% |
11% |
11% |
10% |
5% |
8.5% |
|
Earnings per share |
Net profit/ Share outstanding |
0.50 |
0.25 |
.1.5 |
0.65 |
0.45 |
.79 |
After analyzing above given table, it is given that net profit margin of company has decreased to 2% in 2017. It is analyzed that company should have focused on increasing the overall return to shareholders. The profitability capacity of company has gone down due to the less effective business plans and non-effective business functioning. This above given table has shown that company has decreased its overall net profit to 2% in 2017 which is 4% lower as compared to last four year data (Aiyar, Calomiris, Hooley, Korniyenko, and Wieladek, 2014).
However, Mark and Spenser has higher profitability which reflects positive indicator for the future growth of the business (Ehiedu, 2014).The main reason of decrease in its overall net profit has been sluggish market condition which company has faced. It is analyzed that company has high employee turnover and less effective business functioning which reflects the negative business outcomes. The return on equity of company has also decreased to 5% which is 12% lower as compared to last five year data. This level of decrease in its overall return on equity has resulted to destruction in the business and decreased due to the increased overall cost of capital. However, Mark and Spenser have maintained 7.5% return on equity which reflects that company is consistently increasing its overall return on equity. It has reflected that company has failed to manage its business which might be negative indicator for the business functioning.
In addition to this, in order to evaluate the total shareholder return of Debenhams plc, investors could analysis the changes in the share price of company (Hoskin, Fizzell, & Cherry, 2014).
After analyzing the share price movement of company, it is considered that in 2016 company has stable share price movement and after due to the sluggish market condition and reduced profitability, company had faced high destruction in their businesses which have negatively impacted the business functioning of organization. This downfall in the stock price has reflected the negative business output which might negatively impacted the business output and share price movement. On the other hand, Mark and Spenser has shown the decrease in its share price value since last three years. Investors of Mark and Spenser has faced high amount of loss in their value investment.
It is further observed that company has also created good value in its business but due to the low amount of profitability and negative return on capital employed shareholders and investors will face negative value creation on its invested capital (Yahoo Finance, 2017).
This analysis is used to identify the actual company of company and resource invested in the busienss of Debenhams plc. Total stakeholder return is computed by using the overall financial benefits generated for the stakeholders. The Debenhams plc has lower down its overall total stakeholder return. The main reason of decrease in its overall return to its shareholders is related to increased cost of capital and less effective business functioning of organization. Shareholders and investors take their investment decisions based on the return on investment and capital employed of company (Weygandt, Kimmel, and Kieso, 2015).
It is analyzed that while computing the net assets value, it is also required to compute the financial leverage and assets turnover of company (Pike, Neale and Linsley, 2015). The financial leverage of company is 1.1 in 2013 which has increased to 1.2 points. It is analyzed that company has increased its overall financial risk due to the increase debt capital. However, Mark and Spenser have kept higher financial leverage in market with a view to keep its cost of capital low.
|
Description |
Formula |
DEBENHAMS PLC ADR (DBHSY) |
Mark and Spenser |
|||||
|
2013-08 |
2014-08 |
2015-08 |
2016-08 |
2017-08 |
||||
|
Profitability |
||||||||
|
Financial leverage |
EBIT / EBIT – Interest |
1.1 |
1.1 |
1.1 |
1.1 |
1.2 |
5.5 |
|
|
Asset turnover |
total assets / total sales *365 |
341.2 |
339.0 |
336.7 |
341.5 |
345.5 |
445 |
The assets turnover ratio has also increased to 345.5 points in 2017 which reflects the positive value creation in its business. There is another financial change of Debenhams plc which is used to assess the total shareholder return. The free cash flow of company to its shareholders. It is determined on the basis of cash outflow in terms of dividend paid to shareholders. The dividend is the amount paid by the company to its shareholders as return for their invested capital (Zeff, 2016).
Computation of the free cash flow to identify the net present value of company
|
Description |
DEBENHAMS PLC ADR (DBHSY) (GBP IN Million) |
|||||
|
2013-08 |
2014-08 |
2015-08 |
2016-08 |
2017-08 |
||
|
Free cash flow |
£ 79.00 |
£ 84.00 |
£ 87.00 |
£ 48.00 |
£ 20.00 |
|
|
Terminal value (20%) |
0.401877572 |
0.482253 |
0.578704 |
0.694444 |
0.833333 |
|
|
Net present value |
£ 31.75 |
£ 40.51 |
£ 50.35 |
£ 33.33 |
£ 16.67 |
(Please see the excel file attached)
After analyzing all the details of the cash flow of company, it is analyzed that company has decreased its overall free cash flow since last five year. This has shown that company has destructed its busienss and will eventually decrease the overall return on capital employed and return to its equity shareholders (Omar, et al. 2014).
|
Description |
Formula |
DEBENHAMS PLC ADR (DBHSY) |
Mark and Spenser and other rivals |
||||
|
2013-08 |
2014-08 |
2015-08 |
2016-08 |
2017-08 |
|||
|
Price / earnings ratio |
Market value per share / earnings per share |
25.50 |
50.60 |
27.00 |
22.23 |
28.11 |
37 |
|
Dividend yield ratio |
dividend / current share price |
(0.06) |
(0.05) |
(0.05) |
(0.05) |
(0.05) |
(.7) |
This dividend ratio has shown that company has kept the dividend payout ratio to 50% in 2017 which is 10% lower as compared to last year data. In addition to this, as compared to Mark and Spenser, Debenhams plc has strong financial position. Mark and Spenser has issued 37 points price earnings ratio which is 10 points higher as compared to Debenhams plc. It has shown that company has decreased its overall profitability of the company which eventually impacted the dividend payment (Ehiedu, 2014). The price earnings ratio has increased to 28.11 points in 2017 which is 3 points higher as compared to last year. This has increased due to the decrease number of shareholders. Therefore, it could be inferred that total shareholder return of company has decreased throughout the time. Since last five years, company has destructed its busienss value and eventually the total return to its shareholders has also decreased. It divulged that company has destructed the busienss value and its overall profitability since last five years (Grimm, and Blazovich, 2016).
Conclusion
This report has reflected how well company has created value on its investment. Company has decreased its profitability throughout the time and the economic value added of company has decreased due to the decrease in the profit of the organization. It is analyzed that company has faced high loss in its several business units and resulted to loss in organization. Now in the end, it could be inferred that Debenhams plc has faced high loss in its business and destructed its business throughout the time. The main issue arises due to the negative profitability and less efficiency of company in creation of business output.
References
Acharya, V. and Xu, Z., 2017. Financial dependence and innovation: The case of public versus private firms. Journal of Financial Economics, 124(2), pp.223-243.
Aiyar, S., Calomiris, C.W., Hooley, J., Korniyenko, Y. and Wieladek, T., 2014. The international transmission of bank capital requirements: Evidence from the UK. Journal of Financial Economics, 113(3), pp.368-382.
Bloomberg, 2017, [Online]., Available at https://www.bloomberg.com/asia, , [Accessed on 21st , August, 2018]
Brigham, E. F., Ehrhardt, M. C., Nason, R. R., and Gessaroli, J. 2016. Financial Management: Theory and Practice, Canadian Edition. Nelson Education.
Cassar, G. (2011). Discussion of the value of financial statement verification in debt financing: Evidence from private US firms. Journal of Accounting Research, 49(2), PP. 507-528.
Debenhams plc., 2015., Annual report., [Online]., Available from https://phx.corporate-ir.net/phoenix.zhtml?c=196805&p=annual-report., [Accessed on 21st, August, 2018]
Debenhams plc., 2016., Annual report., [Online]., Available from https://phx.corporate-ir.net/phoenix.zhtml?c=196805&p=annual-report., [Accessed on 21st, August, 2018]
Debenhams plc., 2017., Annual report., [Online]., Available from https://phx.corporate-ir.net/phoenix.zhtml?c=196805&p=annual-report., [Accessed on 21st, August, 2018]
Ehiedu, V.C., 2014. The impact of liquidity on profitability of some selected companies: The financial statement analysis (FSA) approach. Research Journal of Finance and Accounting, 5(5), pp.81-90.
Ehiedu, V.C., 2014. The impact of liquidity on profitability of some selected companies: the financial statement analysis (FSA) approach. Research Journal of Finance and Accounting, 5(5), pp.81-90.
Goldstein, I., Jiang, H. and Ng, D.T., 2017. Investor flows and fragility in corporate bond funds. Journal of Financial Economics, 126(3), pp.592-613.
Grimm, S.D. and Blazovich, J.L., 2016. Developing student competencies: An integrated approach to a financial statement analysis project. Journal of Accounting Education, 35, pp.69-101.
Hoskin, R. E., Fizzell, M. R., & Cherry, D. C. (2014). Financial Accounting: a user perspective. Wiley Global Education., pp. 22-33
Lei, J., Qiu, J. and Wan, C., 2018. Asset tangibility, cash holdings, and financial development. Journal of Corporate Finance, 50, pp.223-242.
Omar, N., Koya, R.K., Sanusi, Z.M. and Shafie, N.A., 2014. Financial statement fraud: A case examination using Beneish Model and ratio analysis. International Journal of Trade, Economics and Finance, 5(2), p.184.
Pike, R., Neale, B. and Linsley, P. (2015). Corporate Finance and Investment: Decisions and Strategies. 8th edition. London: FT/Prentice-Hall.
Sriram, M., 2018. Do firm specific characteristics and industry classification corroborate voluntary disclosure of financial ratios: an empirical investigation of S&P CNX 500 companies. Journal of Management and Governance, pp.1-18.
Tori, D. and Onaran, Ö., 2018. The effects of financialization on investment: Evidence from firm-level data for the UK. Cambridge Journal of Economics, 42(5), pp.1393-1416.
Véron, N. and Wolff, G.B., 2016. Capital Markets Union: a vision for the long term. Journal of Financial Regulation, 2(1), pp.130-153.
Weygandt, J.J., Kimmel, P.D. and Kieso, D.E., 2015. Financial & managerial accounting. John Wiley & Sons
Yahoo Finance, 2017, Available from ‘Debenhams plc, https://in.finance.yahoo.com/quote/DEB.L/., , [Accessed 21st, August, 2018]
Zeff, S.A., 2016. Forging accounting principles in five countries: A history and an analysis of trends. Routledge.
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