Statement of profit and loss analysis
Analysis of sales
Looking at the revenue of Hi-Tech PLC, it is observed that total sales of the company increase by 25.02% in 2017. Prior to this year, the amount was reported at £2022 million and it changed to £2528 million in 2017. Reason behind such upsurge is the expansion plan of the company, in which it has supplied new range of products in the market at the start of 2017. The core products of the company are computers, laptop, tablet and other It devices. The sale of laptops makes the highest contribution in the total revenue of Hi-Tech PLC. The sale of tablets has also increases the company’s revenue as well as stimulates growth in business IT markets. It is expected that it will become Hi-Tech’s main product by 2019.
From increased sales, it is reflected that company is performing better in its industry and is focused on achieving its objectives as well as making profits.
Gross profit ratio
It is basically a financial metric used for assessing the financial health of a company. The amount of gross profit is shown as a percentage of total sales, which is known as gross profit margin (Vogel, 2014).
|
Gross Profit Margin |
2017 |
2016 |
|
Gross Profit (A) |
541 |
517 |
|
Sales (B) |
2528 |
2022 |
|
GPR (A/B) |
21% |
26% |
In 2017, the ratio was 21% which was less than the GPR of 26%, reported in 2016. The reasons behind the decline are:
It is also one of the financial metric used for measuring the profitability of the company. It is expressed in terms of percentage and indicates the amount which is earned as a part of total revenue (Jenter and Lewellen, 2015).
|
Profit Margin |
2017 |
2016 |
|
Net Profit (A) |
130 |
82 |
|
Sales (B) |
2528 |
2022 |
|
NPR (A/B) |
5% |
4% |
Unlike Hi-tech’s GPR, its net profit margin has improved in year 2017 and shown an upsurge of 1% in the amount of net profit.
This ratio indicates the capability of a company to generate profits from its shareholders investments. It is basically the amount of net income shown in terms of percentage of shareholders equity (Parrino, Kidwell and Bates, 2011).
|
Return on Equity |
2017 |
2016 |
|
Net Profit (A) |
130 |
82 |
|
Shareholders’ equity (B) |
1069 |
939 |
|
ROE (A/B) |
12% |
9% |
Hi-Tech’s ROE increases by 3% in year 2017. In 2016, the ratio was 9% which rose to 12% in 2017. Reason for this upsurge are:
Efficiency ratios: Inventory turnover ratio
It reflects the number of times; company’s inventory is replaced and sold during a specific period. In other words, it defines how fast an organization converts its inventory into cash. (Tracy, 2012).
|
Inventory Turnover Ratio |
2017 |
2016 |
|
COGS (A) |
1987 |
1505 |
|
Inventory (B) |
290 |
120 |
|
ITR (A/B) |
6.85 |
12.54 |
The ITR of the company reduces to 6.85 times from 12.54 times. Reason being:
|
Days Inventory Outstanding (DIO) |
2017 |
2016 |
|
Days (A) |
365 |
365 |
|
ITR (B) |
6.85 |
12.54 |
|
DIO (A/B) |
53 |
29 |
The period taken by the company to sell its stock is measured in terms of days, which is known as inventory days. The upsurge in the inventory levels also pushed up the inventory days of Hi-Tech PLC from 29 days to 53 days in 2017. This represents 45% increases in the number of days.
Debtor turnover shows that how quickly a company collects its receivables or convert them into cash during a specific period of time (Bragg, 2012).
|
Debtor Turnover Ratio |
2017 |
2016 |
|
Revenue (A) |
2528 |
2022 |
|
Accounts Receivables (B) |
378 |
253 |
|
DTR (A/B) |
6.69 |
7.99 |
|
Receivable days |
2017 |
2016 |
|
Days (A) |
365 |
365 |
|
DTR (B) |
6.69 |
7.99 |
|
Receivable days (A/B) |
55 |
46 |
Due to reduced DTR, receivable days have also increased from 46 days to 54 days. This means in 2017, company has taken 4 more days to collect its receivables in 2017. Efficiency of Hi-Tech PLC is reduced in collecting its debtors (Nikolai, Bazley and Jones, 2009).
This ratio gives investor an idea about the credit worthiness of the company. In other words, it shows how many times a company is paying its accounts payables. CTR measures the capability of a company to pay its creditors quickly (Bragg, 2012).
|
Creditor Turnover Ratio (2017) |
$M |
$M |
|
COGS (A) |
1987 |
1505 |
|
Accounts Payables (B) |
245 |
138 |
|
CTR (A/B) |
8.11 |
10.91 |
It is said that if the ratio falls from one period to another, it means the company is taking longer to pay its creditors. The same is the case with Hi-Tech PLC. Its CTR falls from 10.91 to 8.11 in 2017. Reason being;
|
Payable days |
2017 |
2016 |
|
Days (A) |
365 |
365 |
|
DTR (B) |
8.11 |
10.91 |
|
Payable days (A/B) |
45 |
33 |
Just like debtor days, payable days also increases from 33 to 45 days. It means Hi-Tech takes longer to set off its short term financial obligations, which makes the company less worthy and less efficient. (Lee, Lee and Lee, 2009).
It compares the firm’s net sales with its total assets and determines the ability of the firm to make revenue by utilizing its assets (Gibson, 2011).
|
Total Assets Turnover |
2017 |
2016 |
|
Sales (A) |
2528 |
2022 |
|
Total Assets (B) |
1632 |
1177 |
|
ATR (A/B) |
1.55 |
1.72 |
Despite of increased revenue, the ATR of Hi-Tech reduces from 1.72 to 1.55 times.
From all the efficiency ratios, one thing is clear that though Hi-Tech has strong profitability position but it is not efficient in managing its operations and assets.
The potentiality of a company to pay its current liabilities from its current assets is ascertained by calculating the current ratio for that period (Saleem and Rehman, 2011).
|
Current ratio |
2017 |
2016 |
|
Current Assets (A) |
668 |
507 |
|
Current Liabilities (B) |
338 |
138 |
|
CR (A/B) |
1.98 |
3.67 |
In fiscal year 2016-2017, the CR of Hi-Tech PLC declined by 1.7, reaches to 1.98 which is even lesser than the ideal benchmark of 2:1. However, the same can vary according to different industries. Lesser CR represents that the company is having difficulties in meeting its current financial obligations. Reasons for this fall are:
It also measures the liquidity position of a company by disclosing its capability of paying short term liabilities with its quick assets. The ideal quick ratio is 1:1 (Godwin and Alderman, 2012).
|
Quick ratio |
2017 |
2016 |
|
Quick Assets (A) |
(668-290) |
(507-120) |
|
Current Liabilities (B) |
338 |
138 |
|
QR (A/B) |
1.12 |
2.80 |
Just like current ratio, Hi-Tech PLC’s quick ratio also worsens in 2016-17. It reduces from 2.80 to 1.12 in the last year. However, it was more than the standard ratio.
Both the ratio shows that Hi-Tech does not have a sound liquidity position and the company has faced cash flow problems during the fiscal year 2016-17.
It is a financial gearing ratio which shows the portion of debt taken by the company against its equity capital. A high D/E ratio indicates that most of the company’s assets are financed through debt and includes high financial risk (Higgins, 2012).
|
Debt to Equity Ratio |
2017 |
2016 |
|
Debt (A) |
225 |
100 |
|
Equity (B) |
1069 |
939 |
|
D/E (A/B) |
21% |
11% |
A £25 million increase was there in Hi-Tech’s long term borrowings. Compared to which, the equity capital of the company raised to £1069 million in 2017 from £939 million. Reason for high D/E ratio:
This ratio shows the number of times a company make its interest payments from its operating profits. Generally, a high ratio is more favourable because a low ratio indicates that the firm has more debt expenses and is not pay to pay its interest expenses (Kimmel, Weygandt and Kieso, 2010).
|
Interest Coverage Ratio |
2017 |
2016 |
|
EBIT (A) |
225 |
151 |
|
Interest Expense (B) |
25 |
6 |
|
ICR (A/B) |
9.00 |
25.17 |
Talking about Hi-Tech PLC, the ICR of the firm shows a huge decline in year 2016-2017. It was 25.17 in 2016 and it falls to 9 in 2017. Reason being,
Looking at the cash flows from operating activities of Hi-Tech PLC, it is observed that the net cash used in the activities is £28 million. Though the operating profit has increased but the adjustments for changes in working capital has reduces it to £67 million. The amount was not enough for paying the interest and income tax expenses and as a result of which a negative figure is derived from the operating activities. Cash flows from investing activities shows that company has invested more in purchasing property, plant and equipment worth £294 million and £30 million cash is used for purchasing intangible assets. No sales proceeds were there which gives the overall result of net cash used amounted to £324 million in investing activities.
Unlike the above two activities financial activities shows a proceeds from long term borrowings worth £125 million in the year 2016-17. However, such proceeds were not enough to set against the cash used in operating and investing activities. As a result of which, cash flow statement depicts a net decrease of £227 million in the amount of cash. This overall analysis of the statement represents that the cash position of Hi-Tech PLC got worse in 2017 as compare to 2016. The company lacks the availability of cash in the business which reduces its efficiency and affects its liquidity position to a great extent.
|
2017 |
2016 |
|
|
Inventory days |
53 |
29 |
|
Receivable days |
55 |
46 |
|
Payable days |
45 |
33 |
|
Operating cash cycle = (Inventory days + receivable days) – Payable days |
63 days |
41 days |
Operating cash cycle of the company in 2016 is 41 days which increases to 63 days in 2017. This increase depicts that company is not acquiring the cash quickly, taking more time in paying its creditors and collecting its debtors and lastly taking more time in converting its inventory into cash. Reason behind such increase is high inventory and receivable days. Generally, a shorter conversion cycle is favourable but in case of Hi-tech PLC, the cycle has increased and deteriorates the cash position of the firm. Large amount of cash is been tied up in the non-current assets, inventories and debtors of the company. Overall, it can be said that Hi-Tech is no longer cash rich and has experienced a shortage of cash in fiscal year 2016-17.
It is generally carried out to know about the balance product mix which is to be developed and marketed to replace those products which are in decline. In 2017, Hi-Tech PLC succeeded in implementing its phase one expansion strategy, result of which can be shown in the increased revenue of the company. The overall revenue increases to £2528 million in 2017, showing the biggest contribution the sale proceeds of Laptops. The increased sales allow Hi-Tech to achieve high profit margins in the same year.
Its overall N.P. margin rises by 1% and ROE boosted up by 3%. Also the reduction of 20% in selling prices of desktops, laptops and tablets reduces the level of competition in the market. The strategy followed by Hi-Tech PLC has increased its market share and enhanced its customer base. Along with the expansion planned required an additional investment in its UK situated manufacturing the unit. The units are located in the area which is supported by Hi-Tech’s existing suppliers.
However, the company has no cash balance as of 2017, but previously it was known to be a cash rich business and regularly pay dividends. Also as per the payment terms of the company, the standard customer days are 30 days but in 2017, this was increased due to the delay in payment from one of the Hi-Tech’s main customer. However, it can be said that the new product line of Hi-Tech will improve its performance and enhance its financial position.
Management forecast
The further finance required for the expansion is £500 million. Against which, it is expected that the revenue in 2019 and 2020 will be £300 million and £560 million respectively. The amount will continue to rise in the subsequent years. Along with this, the forecast stated that the variable cost will be more in the starting two years which resulted in a contribution of £60 million and £112 million respectively. Apparently, management forecast does not take into account the fixed cost, which is also a part of contribution. In the fifth year, the contribution will be more than the triple of the amount reported in first year.
It is the method which measures the time taken by a project to recoup its initial investment. In case of Hi-Tech PLC, the non-financial managers may not understand the calculation of contribution but surely knows that the expansion project in Asian markets will take 4 years to return the £500 million. With help of this method, managers can identify those projects which will give faster returns. Therefore, for a company like Hi-Tech PLC whose cash position is worse, it is very much necessary to recover the cash as soon as possible. High amount of cash is expected in year 3 and 4 and by the end of fourth year whole amount of cash outflow will be recovered. The main drawback of this technique is that it does not consider the time value of money like NPV (Baker and English, 2011).
In this method, the accounting profit arising from the proposal is represented in terms of percentage of the investment made. The targeted ARR of Hi-Tech PLC was 10% and the calculated one was 18%. It makes it easier for the company to take decision as its calculated ARR was greater than the targeted one. It also takes into account the whole five years if projects. Along with this, the margin of safety between the targeted and calculated is also high. It shows a difference of 8% which is enough for the project having 5 years of life. This implies that the result will not deviate and the rate will remain higher than the standard rate (Bierman and Smidt, 2012).
Just like payback, ARR also does not consider the time value of money which is main drawback of this method.
This technique is used to determine the present value of cash inflow and outflow, which is then used for measuring the viability and profitability of a project. It is the most appropriate method as it takes into account the time value of money and shows the future profits made by the company (Weygandt, Kimmel and Kieso, 2009). In case of Hi-Tech PLC, the NPV of the project is £110 million discounted at the rate of 5%. The value of NPV is positive which implies that the project is profitable and can be accepted.
In order to fund the investment of £500 million in its Asian project, Hi-Tech needs to find out the sources for raising finance. Looking at the internal sources, it is already observed that company is lacking the availability of cash in the business. In fact, it has zero cash balance in year 2017. Also, it has good return on its assets, which means there is no asset to dispose. Hence, in such situation issue of share is the more practical approach which is to be applied. Improvement in profitability ratios in 2017 can help the company to increase its share prices. However, Hi-Tech has not paid any dividends in 2017, so it may be possible that it has to pay the same in the coming years due to the expansion project.
Looking at the external sources, the only way is to take the long term loans because shot term will not be appropriate according to the project life. However, the company already has high debt ratio and low interest cover. This indicates that company is not in a condition to generate more from loans. Borrowings may increase the financial risk for Hi-tech, therefore the company should focus on making money from share issue (Barthwal, 2007).
Hi-Tech previously operates in Western Europe and North America, having its headquarters in United Kingdom since 1980. Now the company is first time expanding its operations in Asian markets. A proper market research can help the company to properly understand the difference between the market segments such as demand for the IT products and many more.
The second which is to be kept in mind is the prevailing competition in IT industry and competitors’ behaviour in the Asian markets. The collective strategy of the competitors may outperform Hi-tech PLC. In addition to this, the company also needs to plan about its targeted customer in the area of expansion. Their habits of using IT devices, their taste and preferences all are required to be analysed.
References
Baker, H. K. and English, P. (2011). Capital budgeting valuation: Financial analysis for today’s investment projects (Vol. 13). New Jersey: John Wiley & Sons.
Barthwal, R.R., (2007). Industrial Economics: an introductory text book. 2nd ed, New Delhi: New Age International.
Bierman Jr, H. and Smidt, S. (2012). The capital budgeting decision: economic analysis of investment projects. 9th ed. New York: Routledge.
Bragg, S. M. (2012). Business ratios and formulas: a comprehensive guide (Vol. 577). New Jersey: John Wiley & Sons.
Bragg, S. M. (2012). Financial analysis: a controller’s guide. New Jersey: John Wiley & Sons.
Gibson, C. H. (2011). Financial reporting and analysis. USA: South-Western Cengage Learning.
Godwin, N., and Alderman, C. (2012). Financial ACCT2. USA: Cengage Learning.
Higgins, R. C. (2012). Analysis for financial management. New York: McGraw-Hill/Irwin.
Jenter, D., and Lewellen, K. (2015). CEO preferences and acquisitions. The Journal of Finance, 70(6), 2813-2852.
Kimmel, P. D., Weygandt, J. J., and Kieso, D. E. (2010). Financial accounting: tools for business decision making. New Jersey: John Wiley & Sons.
Lee, A. C., Lee, J. C., and Lee, C. F. (2009). Financial analysis, planning and forecasting: Theory and application. Singapore: World Scientific Publishing Co Inc.
Nikolai, L. A., Bazley, J. D., and Jones, J. P. (2009). Intermediate Accounting. USA: Cengage Learning.
Parrino, R., Kidwell, D. S., and Bates, T. (2011). Fundamentals of corporate finance. John Wiley & Sons.
Saleem, Q., and Rehman, R. U. (2011). Impacts of liquidity ratios on profitability. Interdisciplinary Journal of Research in Business, 1(7), 95-98.
Tracy, A. (2012). Ratio analysis fundamentals: how 17 financial ratios can allow you to analyze any business on the planet. RatioAnalysis. Net.
Vogel, H. L. (2014). Entertainment industry economics: A guide for financial analysis. Cambridge University Press.
Weygandt, J.J., Kimmel, P.D. and Kieso, D.E., (2009). Managerial accounting: tools for business decision making. 5th ed. USA: John Wiley & Sons.
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