The process of Strategic Financial Analysis (SFA) can be described as the task of preparing the financial plan for development of business goals and objectives to be achieved. The financial plan is developed for determining the ways that a business can adopt for achieving its strategic goals and objectives. It can be regarded as a value-creating framework that helps senior executives to examine the business strategy, evaluate its performance and thereby valuing the business. The financial analysis is regarded to be very important for businesses to undertaken an overview of the financial position of a company that can assist in its future financial planning process. The financial management decisions help a company to make important investment decisions regarding its future growth and development. The financial analysis enables a company to develop adequate financial strategy that results in maximization of shareholder value. The financial strategy developed though conducting financial evaluation helps a company to gain an insight into the financial resources possessed for achieving its strategic goals and objectives (Ehrhardt and Brigham, 2016).
The main objective of the report is to conduct a critical assessment of the principal method used for analyzing the financial position of a company as an outsider. The method of financial analysis includes calculation of financial ratios, vertical and horizontal and DuPont analysis. Also, it intends to present the major drawbacks that re present within the financial analysis methods and proposed more effective methods that can be sued for overcoming these drawbacks. The overall financial analysis is carried out by presenting working examples from the selected listed companies that are Booker Group PLC & Tate &Lyre PLC.
Booker Group PLC is recognized as the largest food wholesale operator within the UK that is involved in providing both branded and private label goods to about 40,000 customers. It operates convenience stores, grocers, pubs and restaurants and as such the group comprises of Booker Wholesale, Booker Direct, Classic Drinks, Family Shopper and many other business units. The major product of the company includes grocery, fresh food, beers, wines, tobacco and alcoholic products. The non-food product items of the company include stationery, furniture, office equipment and clothing (Booker, 2017).
On the other hand, Tate & Lyle PLC is recognized as a global supplier of food and beverage ingredients to industrial markets. The company is headquartered within the UK and has attained a leadership position within the food and beverage industry at a global level with the use of its innovative technology to transform the raw materials and developing large-scale manufacturing plants. The high manufacturing capabilities of the company has enabled it to produce high quality ingredients for the customers. The company aspired to attain a global position in providing special food ingredients and solutions.
Ratio Analysis
The method of ratio analysis has proved to be very effective for gaining an analysis of the financial position of a company. It is regarded to be a quantitative method of analysis that can be effectively sued for evaluating different financial aspects of a company such as determination of its efficiency, liquidity, profitability, solvency and others. The different financial ratios are calculated with the use of financial information disclosed by a company in its financial statements.
Vertical Analysis
Vertical analysis can be regarded as a method of comparing the financial statement in which each line item can be expressed as a percentage of base figures such as income statements can be expressed as a percentage of gross sales (Gibson, 2008).
Horizontal Analysis
It is also known as trend analysis that involves expressing the financial items in the financial statements as a percentage of the amount in the baseline year and taking the baseline amount to be 100%.
DuPont
The method of financial analysis involves analyzing decomposing the different metrics of return on equity for assessing the financial performance of a company (Monks and Lajoux, 2010).
Net Profit margin
Net profit margin can be described as the amount of profit realized by a company after meeting all the operational expenses and is calculated as: (Arnold, 2013)
Net Profit Margin=Net Income/Total Revenue
The comparison of the net profit margin ratio’s of both the companies over the financial year 2013-2017 have depicted that its net profitability have increased over the selected financial period. The comparison of the ratio with its competitor Tate &Lyle have revealed that its net profitability is higher than Booker over the selected financial period. This means that Booker need to reduce its operational costs for realizing higher profitability for outperforming its competitors.
Return on Capital Employed
It is a financial ratio that is sued for measuring the profitability and effectiveness of a company in using the capital base. It is calculated as: (Ackert and Deaves, 2009)
ROCE=Earnings before interest and tax (EBIT)/Capital Employed
The ratio of the company BK has increased from 2013-2017 stating that its efficiency to use capital for generating profits is on increase. On the other hand, the ratio of the company Tate &Lyle is lower in comparison to BK depicting that its efficiency to utilize capital base is not so effective in comparison to Booker. Booker is having high capital turnover which indicates that it trades more for each dollar of capital invested. Tate & Lyle has realized a constant decrease in its ROCE despite of increase in the net profitability which can be linked to its poor management by the Chief Financial Officer.
Current Ratio
It measures the ability of a company to meet effectively its financial obligations from the asset base and can be calculated as: (Moles and Kidwekk, 2011)
Current Ratio=Current Assets/Current Liabilities
The current ratio of Booker is under 1 over the selected financial period has depicted that it has not maintained adequate current assets for covering its current liabilities. This indicates that it not maintain effective liquidity which can pose a financial risk for the company in meeting its financial obligations. On the other hand, Tate&Lyle have maintained a sufficient liquidity base as the ratio is higher than 1 over the selected financial period. This indicates lower liquid financial risk for the company in meeting its future financial obligations. However, the ratio has depicted a decreasing trend over the financial year 2014-2016 but has increased from the year 2015-2017.
Quick Ratio
It is used for assessing the short-term liquidity position of a company with the most liquid assets present within a company and is calculated with the use of following formula:
Quick Ratio= (Cash Equivalents + Accounts Receivable)/Current Liabilities
The quick ratio of Booker is under 0.5 for the selected financial period years and thereby it can be said that the company has not maintained enough liquid assets for meeting the current liabilities. On the other hand, Tate &Lyle have maintained a higher quick ratio in comparison to Booker but have been reduced considerably over the years 2014-2017 depicting that its liquidity management have experienced a setback which can lead to shortage of liquidity within the company in future context.
Day of Sales Outstanding
The ratio is used for assessing the efficiency of a company in collecting the amount of its credit sales (Madura, 2014). The formula for its calculation is as follows:
Day of Sales Outstanding=Accounts Receivable/Average sales per day
The ratio of both the companies is on increase over the financial year 2013-2017 which cannot be regarded good for the future growth of the companies as it can lead to shortage of cash flows. However, it can be stated that management of Booker is proper than Tate&Lyle in collecting the amount of credit sales. This is because Tate&Lyle is collecting the amount due from the customers in more than 30 days while Booker time period is relatively short of 4-6 days.
Total Asset Turnover ratio
It can be described as an efficiency ratio that depicts the ability of a company to generate sales from the asset base. The formula for calculation can be stated as follows:
Total asset turnover ratio=Net Sales/Average total assets
The ratio of the company over the selected financial period has decreased for both the companies as depicted in the graph above. Booker has maintained a higher ratio as compared to Tate&Lyle which means that it is utilizing the asset base more effectively for generating sales. Thus, it can be said that the efficiency position of Booker is better as compared to Tate&Lyle but it need to take effective steps for improving the ratio as it has depicted a decreasing trend.
EPS (Pence)
The ratio is calculated for assessing the amount of profit allocated to each share of outstanding share and serve as an important indicator of company profitability (Davies and Crawford, 2011). The formula used for its calculation is stated as follows:
EPS=Net Income/Number of shares outstanding
It can be stated form analyzing the EPS ratios of both the companies that Booker is having a higher EPS in comparison to Tate&Lyle. Its EPS ratio has depicted an increasing trend over the selected financial period which means that company is having good market performance. On the other hand, Tate&Lyle EPS depict a decreasing trend and also significantly low mainly due to its poor management.
Dividend Payout Ratio
The ratio is used for depicting the part of earnings realized by a company that is paid to the shareholders as dividends (Damodaran, 2011). The ratio can be calculated as follows:
Dividend payout ratio=DPS/EPS
The dividend payout ratio of Booker has increased over the selected financial period. However, it has experienced a downfall over the years 2014-2015 but has been subsequently improved after it. On the contrary, Tate&Lyle has depicted a higher growth in the ratio over the selected financial period and as such it can be said that it paying more dividend to the shareholders in comparison to Booker Plc.
(Booker, 2013 to 2017) and (Tate & Lyle, 2013 to 2017)
(Booker, 2013 to 2017) and (Tate & Lyle, 2013 to 2017)
(Booker, 2013 to 2017) and (Tate & Lyle, 2013 to 2017)
(Booker, 2013 to 2017) and (Tate & Lyle, 2013 to 2017)
(Booker, 2013 to 2017) and (Tate & Lyle, 2013 to 2017)
(Booker, 2013 to 2017) and (Tate & Lyle, 2013 to 2017)
Du Pont analysis also referred as Du Pont model which uses return on equity as the main element to assess performance of company in respect to increase the total earnings on equity. As investors wants entity to provide maximum return on their investment that makes it essential for the companies to assess return on equity at regular interval. Du Pont model decompose the return on equity on three main components and they are profit margin, total asset turnover ratio and financial leverage. It means as per Du Pont model, company can improve the return on equity through high profit margin, increasing asset turnover ratio and leveraging assets more effectively.
(Booker, 2013 to 2017) and (Tate & Lyle, 2013 to 2017)
On the basis above graph it is clearly reflected return on equity is much higher than return on assets in case for both the companies for last five year. It shows that both companies use maximum part of shareholder’s fund to run their business (Brigham and Michael, 2013).
Above graph represent shows value of return on equity through using Du Pont 3 factor model. The division of each component of Du Pont model is provided on below graphs.
(Booker, 2013 to 2017) and (Tate & Lyle, 2013 to 2017)
Booker has very good asset turnover ratio and lower financial leverage while T&L has lower assets turnover ratio and good financial leverage. Booker has very low net profit margin as compared to T&L so it is highly suggested to Booker to improve their net profit margin through reducing the expenses and increase the revenue. It is also recommended to Booker to tighten the financial leverage through increasing the debt capital and balance both capitals in well balanced manner. It will help to improve the return on equity in case of Booker Plc (Brigham and Michael, 2013).
The financial analysis of both the companies carried out above with the use of ratio, horizontal, vertical and Du-Pont analysis are also associated with some merits and demerits. These are discussed as follows:
Merits
Demerits
Merits
Demerits
Merits
Demerits
The CAPM (Capital Asset Pricing Model) has made an important contribution towards the understanding of the capital markets in comparison to other methods of financial analysis. The model has been constantly used by the corporate finance manager’s to assess the cost of equity capital. The method has proved to be highly effective for determining the expected returns on capital investments and its relationship with the risks that need to be undertaken by an investor. It can be easily applied by the investors or financial managers for taking investment decisions.
The most significant advantage of EVA method over other method of financial analysis is that it enables investors in taking investment decisions by considering whether a particular company is worthy of investing by analyzing its goodwill. It measures the performance of a firm in relation to the value added for the shareholders. It is also relatively easy to be calculated and los less time-consuming to evaluate the financial performance of a firm in comparison to other methods of financial analysis such as trend or ratio analysis (Günther, 2014).
The model is largely being used by the investors or financial analysts to study the behavior of share prices of securities within the capital market. The their ha stated that the current price of an asset fully reflect all the publicly available information and therefore the market prices of a security quickly absorb all the new information. As such it is not possible for the investors to realize higher returns by predicting the future income to be realized by a security. The investors can base their investment decisions on the basis of publicly available information of the companies (Cope, 2015).
Conclusion
It can be stated from the overall analysis carried out that Booker has high potential of growth as its financial performance is better than Tate& Lyle. The profitability of Booker is though lower than its competitor Tate& Lyle but yet it is providing higher returns due to its good turnover position. Tate & Lyle efficiency, liquidity and the return on investment is lower as compared with Booker. Thus, it is recommended to the investors to invest in Booker for realizing higher returns in the future period of time. Also, the finance managers of Booker should place emphasis on improving the company’s operational efficiency by taking measures to reduce the operational costs that enhances its net profitability position.
References
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Davies, T. and Crawford, I., 2011. Business accounting and finance. Pearson.
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Ehrhardt, M. and Brigham, E. 2016. Corporate Finance: A Focused Approach. Cengage Learning.
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Madura, J. 2014. Financial Markets and Institutions. Cengage Learning.
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Monks, R. and Lajoux, A. 2010. Corporate Valuation for Portfolio Investment: Analyzing Assets, Earnings, Cash Flow, Stock Price, Governance, and Special Situations. John Wiley & Sons.
Tate & Lyle. 2013. Annual Report 2013. [Online]. Available at: https://www.tateandlyle.com/investors/annual-reports [Accessed on: 16 December, 2018].
Tate & Lyle. 2014. Annual Report 2013. [Online]. Available at: https://www.tateandlyle.com/investors/annual-reports [Accessed on: 16 December, 2018].
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