Consistent Performer in the Market

Question: Explain about the Next plc is a consistent performer in the market but the Debenhams is gradually losing their position? Answer: Criterion 1 Tesco plc is one of the largest plc among the retail sectors in UK. The company incorporated in the year 1919 in a small town of London. It has a large collection of women wear and accessories. The company is now operating almost 12 countries in the world. The following income statement is extracted from the annual report of TESCO for the year 2013 and 2014. The table shows that there is some change in the figures for both the years. Consolidated income statement of TESCO plc Particulars 2014( m) 2013 ( m) Change Continuing operations Revenue 63,557 63,406 151 Cost of sales -59,547 -59,252 295 Gross profit 4,010 4,154 -144 Profit and losses arising on property-related items 278 -290 568 Administrative expenses -1,657 -1,482 175 Operating profit 2,631 2,382 249 Finance income 132 120 12 share of post tax profit of joint venture and associate 60 72 -12 Finance cost -564 -517 47 Profit before tax 2,259 2,057 202 Taxation -347 -529 -182 profit for the year from continuing operation 1,912 1,528 384 Discontinued operation Loss from the discontinued operations -942 -1,504 -562 Profit of the year 970 24 946 Attributed to Owners of the parent 974 28 946 Non controlling interest -4 -4 970 24 946 Note: here the change of the figures includes both increase and decline. The positive change includes the increase in the figure from the previous year, and the negative change includes the decrease in the figure from the previous year. Probable reasons for changes Change in revenue The revenue has increased by 151 m. The reason should be either increase in the selling price of the product or increase in the number of units to be sold. Revenue includes some other incomes apart from the sales. It may increase due to some realization of cash from debtors or any other income that may drive in the particular year (Annual report, 2014). Change in cost of goods sold The cost of sales of in the year 2014 has also increased. It indicates that the total cost of producing and selling the product is increased. The reason may be inflation due to which the price increases adoption of new technology in the production process or due to the need of making a quality product in order to compete in the market (Anon, 2013). Change in gross profit The gross profit in the year 2014 has declined by 144 m. The reason that is visible from the annual report is the increase in the cost of goods sold. Though the revenue has also increased but from the above table it is shown that the increases in the revenue is less than the cost increases, so there is a decline in the gross profit. Change in profit and loss of property In the income statement, this change is a positive one, and the change is mainly due to the change in the market price of the assets. If the asset that is sold in the market is very old then its written down value is also very low, and the disposal value create a loss on the sale. Change in administrative expenses It is also a positive change. It means the expenses relating to the salary, office maintenance, etc. increases compared to the previous year. Change in operating profit The company shows a good sign by increasing the operating profit in spite of declining gross profit. The main reason for increasing the operating profit is that in the year 2014 the company has a profit on the sale of property that offset the reduction in gross profit due to more cost of sales. Change in financial income The financial income of the company has increased due to the increase in the interest receivable and the income from cash and cash equivalents. Change in finance cost The finance cost for the current year has increased because the company has to pay more amounts of bank interest and net pension financial cost. Moreover, the interest payment on USD bond is also high in the present year (Shim and Siegel, 2008). Change in PBT The above table represents a positive trend of profit before tax. The probable reason of increasing PBT is due to the increase in operating profits and increase in finance income. Change in tax expense The tax expense is reduced in this year whereas the profit before tax is more. The reason should be a change in the tax rate, or the company may get some rebate or subsidy in this year (Shim, 2009). Change in net profit From the income statement, it is found that there is a drastic change in the net profit of the company. In the year 2013 the net profit was only 24 m, and it has changed to 970 m in the year 2014. The revenue from operation in 2013 is lower than 2014, but the gross profit was high. The main reason for low profit in 2013 is due to heavy loss from its discontinued business. This loss also existed in 2014, but the amount was very high in 2013. Moreover, the taxation expenses were also very high in 2013. These two reasons probably be the main reason for increasing the net profit in 2014 (Zimmerman and Yahya-Zadeh, 2011). Criterion 2 The breakeven point is the point of the output level of a business concern during a certain period at which total sales revenue is exactly equal to the total cost. In other words, it is that point that breaks the total cost and the sales value evenly to show the level of output or sales at which there arises neither profit nor loss (Hoque, 2005). The breakeven point can be better understandable by the following example: Suppose ABC Limited has manufactured a certain product "M" and the information related to that particular product is as follows Selling price $ 20 Variable cost $ 12 Total fixed cost $ 80000 Present output and sales 20000 units Therefore the breakeven point of the product is = (Fixed cost / PV ratio) = (80000/40%) = $ 200000 (BEP in value) = BEP in value / selling price per unit = 200000/20 = 10000 units Following is a chart which represents the detail analysis of the BEP Outputs (units) Variable cost per unit($) Total variable cost($) Total fixed cost($) Total cost ($) Selling price per unit($) Total sales ($) Total profit($) 0 12 0 80000 80000 20 0 -80000 2000 12 24000 80000 104000 20 40000 -64000 4000 12 48000 80000 128000 20 80000 -48000 6000 12 72000 80000 152000 20 120000 -32000 8000 12 96000 80000 176000 20 160000 -16000 10000 12 120000 80000 200000 20 200000 0 12000 12 144000 80000 224000 20 240000 16000 14000 12 168000 80000 248000 20 280000 32000 16000 12 192000 80000 272000 20 320000 48000 18000 12 216000 80000 296000 20 360000 64000 20000 12 240000 80000 320000 20 400000 80000 Explanation From the above table, it is clear that at 10000 units of output the company is having a no profit and no loss situation. At 10000 units, the contribution is just sufficient to meet the total fixed cost. Again, then both the fixed and variable cost can be recovered exactly from the sales revenue without leaving any surplus or deficit (Shapiro and Sarin, 2009). Fixed cost is that type of cost which is remaining same at every level of activity even if there is no production. So it is the part of cost that is fixed in total (Hansen and Mowen, 2006). Now at this point of time if the company can produce more output then per unit fixed cost will be reduced and the company will start to generate more profit. On the other hand, the variable part of the cost varies with the change in the production outputs, and if there is no production, there will not be any variable cost. Now if any company cannot be able to earn that much of revenue to recover its cost, then it will face a loss and ultimate ly tends to the shutdown point. So it is very necessary to produce at least that much of product which can recover its total cost. In the above table, it is observed that before reaching to the breakeven point the company is facing a loss as its total cost cannot be recovered at that much of production and sales. At the breakeven point, the profit and loss are equal to zero because the sales revenue is exactly offset by the total cost of the company (Groot and Selto, 2013). After the breakeven level i.e. after 10000 units the company started to earn a profit and as the number of the unit increases the amount of profit is also increases. The main reason is at 10000 units the company recovers whole of its fixed cost and after that level it has to incur only the variable cost as the variable cost is proportionate to the selling unit, so the profit is also growing. So the breakeven point helps a company to understand the number of the unit that they must produce in order to continue the business. It gives a bird eye view of the profitability and the other affairs of the product (Drs. Sugijanto, 2013). Workings Note 1 Statement showing the contribution and PV ratio Particulars Amount ($) Sales 400000 Less : variable cost 240000 Contribution 160000 Less : fixed cost 80000 Profit 80000 Note 2 PV ratio = (contribution / sales) Contribution 160000 Sales 400000 PV ratio 40% Section 3 criterion 3 Investment appraisal techniques Investment appraisal technique is nothing but the capital investment decision. The techniques are used to evaluate the investment proposals in fixed assets or any other expansion activities. There are several appraisal techniques which either incorporate the time value of money or does not consider that factor. With the help of those techniques it is possible for the company to judge the feasibility of the investment make (Eun and Resnick, 2007). Following Illustration can help to understand how different investment techniques can help in decision making: IC Company has $ 200000 to invest. The following proposals are under consideration. The cost of capital for the company is estimated to be 15%. Project Initial outlay($) Annual cash flow($) Life of the project(Years) A 100000 25000 10 B 70000 20000 8 C 30000 6000 20 D 50000 15000 10 E 50000 12000 20 Present Value of annuity received is as follows: 8 years 4.6586 10 years 5.179 20 Years 6.3345 Now the above investment proposals can be analyzed by the following techniques Net Present value PI Projects life of the project( years) PV factor (15%) Annual cash inflow (constant)($) PV cash inflow ($) Initial outlay ($) NPV ($) PI A 10 5.179 25000 129475 100000 29475 1.29475 B 8 4.6586 20000 93172 70000 23172 1.331029 C 20 6.3345 6000 38007 30000 8007 1.2669 D 10 5.179 15000 77685 50000 27685 1.5537 E 20 6.3345 12000 76014 50000 26014 1.52028 Here Net present value of proposals= PV of cash inflow- Initial investment Profitability index (PI) = PV of cash inflow/ Initial investment Post payback profitability Project Initial outlay ($) Annual cash inflow (constant)($) Payback period (years) life of the project (years) post payback period (years) post pay back profitability ( $) A 100000 25000 4 10 6 150000 B 70000 20000 3.5 8 4.5 90000 C 30000 6000 5 20 15 90000 D 50000 15000 3.33 10 6.67 100000 E 50000 12000 4.17 20 15.83 190000 Here payback period = (Initial investment / Constant annual cash flow) Post payback period = life of the project PB period Post payback profitability = Constant annual cash inflow * post payback period Decision making In investment appraisal process each and every techniques has its own decision making criteria. It may be happened the most viable project under one technique gets second or third rank under another technique. For example in case of above proposals the ranking of the projects are Rank NPV PI Post payback Profitability 1 A D E 2 D E A 3 E B D 4 B A B C 5 C C - Under the NPV method the total cash flow from the project is discounted at its present value and then the initial investment of the project is deducted from that present value. If the result is positive then the project will be accepted and if it is negative then the project will be rejected. In the above example all the projects are having positive value so they are ranked according to the highest NPV as it will give highest surplus. As the company is having $ 200000 to invest so it can select project A, D and E (Granlund, Mouritsen and Vaassen, 2013). The profitability index technique is actually the benefit cost ratio derived from a project. If the PI is more than 1 then the project is accepted. If the proposals are mutually exclusive then the highest positive PI will be given highest rank. In the above example with $ 200000 in hand the company can invest in project D, E, B and a part of project A if the project is divisible (Peterson, Fabozzi and Habegger, 2004). The post payback profitability is the measurement through which it can be known that what would be the amount of profit earned from a project after recovering its initial outlay. The payback period indicate the time within which the initial investment will be recovered. The more post payback period the more will be the profit. So as per the post payback profitability the company should invest in project E, A and D (RIEDL and SRINIVASAN, 2010). There are other techniques also which can be used for the measurement, but here the commonly used techniques are considered. As the decision criteria may differ under different techniques a company should fixed one or two standard technique as per the industry standard in order to get a proper result and to avoid confusion (Danthine and Donaldson, 2005). Criterion 3 Accounting ratios are the mathematical measurement through which the financial stability, profitability and the solvency position of the company is ascertained. The ratios are calculated from the information available in the annual report (Hubbard, 2008). Here two companies from the retail sector of UK is taken into consideration and some useful ratios are calculated for three consecutive years from the data collected from their annual reports. Ratio analysis Next Plc Debenhams Plc 2014 2013 2012 2014 2013 2012 Liquidity Ratios Current assets 1468.1 1207.8 1139.9 486.3 470.5 459.5 Current liabilities 834.5 816 742.4 758 741.9 727 Current Ratio 1.75925704 1.480147 1.5354256 0.6416 0.6342 0.63205 Quick assets 1082.5 876 768 140.6 112.6 127.2 Quick Liabilities 831.9 810.6 734.8 534.2 506 563.6 Quick Ratio 1.30123813 1.080681 1.0451824 0.2632 0.2225 0.225692 Efficiency ratio Total asset 2144.6 1893.6 1854.2 2148.4 2132.8 2091.2 Revenue 3740 3562 3441.1 2312.7 2282.2 2229.8 Asset Turnover Ratio 1.74391495 1.881073 1.8558408 1.0765 1.07 1.066278 Receivables 808 718.1 699.1 74.7 78.3 75.4 Revenue 3740 3562 3441.1 2312.7 2282.2 2229.8 Receivable turnover 4.62871287 4.960312 4.9221857 30.96 29.147 29.57294 Receivable collection period 78.855615 73.58408 74.15405 11.789 12.523 12.34236 payables 594 537.2 545 529.3 545.8 525.4 Cost of goods sold 2499.9 2437 2395.8 2033.4 1982.6 1927.5 Payable payment turnover 4.20858586 4.536485 4.3959633 3.8417 3.6325 3.668633 Payable payment period 86.7274691 80.45876 83.03072 95.011 100.48 99.49209 Inventories 385.6 331.8 371.9 345.7 357.9 332.3 Cost of goods sold 2499.9 2437 2395.8 2033.4 1982.6 1927.5 Inventory turnover 6.48314315 7.344786 6.4420543 5.882 5.5395 5.800481 Inventory Turnover period 56.299852 49.69512 56.658945 62.054 65.89 62.92581 EBIT 720.5 690.9 604.7 118.8 149.9 170.1 Interest 25.3 24.4 25.2 13 10.9 11.8 Interest Coverage Ratio 28.4782609 28.31557 23.996032 9.1385 13.752 14.41525 Debt 1023.9 792 889.1 623 646.5 703.2 Equity 286.2 285.6 16623 767.4 744.4 661 Financial Gearing ratio 3.57756813 2.773109 0.0534861 0.8118 0.8685 1.063843 Equity 286.2 285.6 222.7 764.4 744.4 661 Total asset 2144.6 1893.6 1854.2 2148.4 2132.8 2091.2 Equity Gearing ratio 0.13345146 0.150824 0.1201057 0.3558 0.349 0.316086 Profitability Ratios Gross Profit 1240 1125 1045.3 279.3 299.6 302.3 Revenue 3740 3562.8 3441.1 2312.7 2282.2 2229.8 Gross profit ratio 33.2% 31.6% 30.4% 12.1% 13.1% 13.6% Operating profit 722.8 695.1 601.8 128.6 155.4 175 Revenue 3740 3562.8 3441.1 2312.7 2282.2 2229.8 Operating Profit Ratio 19.3% 19.5% 17.5% 5.6% 6.8% 7.8% Net Profit 553.2 508.6 474.8 87.2 115.9 125.3 Revenue 3740 3562.8 3441.1 2312.7 2282.2 2229.8 Net Profit Ratio 14.79% 14.28% 13.80% 3.8% 5.1% 5.6% (Nextplc.co.uk, 2014) From the above ratio analysis following points can be discussed Liquidity ratio indicates the liquidity position of a firm. Liquidity means the ability to pay cash and cash equivalents when it is required. Liquidity is necessary for smooth running of a business. Poor liquidity position hampers the credit policy of the firm as they may not be able to pay their creditors due in time. On the other side the firm may able to capture new market opportunities if its liquidity position is high. Current ratio and quick ratio are the two important ratios measure the liquidity position (Magiera, 2010). In next plc the current asset ratio is more than 1 but not as much as it should be. It is also in the increasing trend from which it may be predicted that very soon they may reach to the ideal form. In case of current ratio also the Debenhams Company produces a negative image as the current ratio fall below 1. It means the company has more current liabilities to pay than its available current assets (CHEN, MITTENDORF and ZHANG, 2010). Quick ratio as the name indicates is the proportion between the quick assets and quick liabilities. Next plc has moderate quick ratio which is also more than 1. In Debenhams the quick ratio is too low almost 0.22. This clearly indicates that the company is suffering by liquidity crunch (Nextplc.co.uk, 2012). Debenhams Company has a good receivable and payable management policy (Annualreports.com, 2014). The overall condition of the Debenhams is deteriorating as all the ratios are below the standard (Annualreports.com, 2012). The quick ratio of both companies are very low because they have blocked a large amount in inventories they have bank overdraft balances which is also a financial burden (Annualreports.com, 2013). The liquidity, solvency and profitability position of the Next Plc is better than the other one (Nextplc.co.uk, 2013). So from the total discussion made it can be concluded that Next plc is a consistent performer in the market but the Debenhams is gradually losing their position, So they need to focus more on their activities. Lastly it should be remembered that ratio is one of the tools of performance analysis but it is not the only tool, so the other factors should also be considered before giving any final decision. References Annual report. (2014). [online] Available at: https://www.tescoplc.com/files/pdf/reports/ar14/download_annual_repor [Accessed 18 Aug. 2015]. Annualreports.com, (2012).Debenhams plc - AnnualReports.com. [online] Available at: https://www.annualreports.com/Company/debenhams-plc [Accessed 18 Aug. 2015]. Annualreports.com, (2013).Debenhams plc - AnnualReports.com. [online] Available at: https://www.annualreports.com/Company/debenhams-plc [Accessed 18 Aug. 2015]. Annualreports.com, (2014).Debenhams plc - AnnualReports.com. 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