Financial Decision Making in assessing company growth - Free Essay Example

b) Performance appraisal of Capello Designs PLC Return of Capital Employed (ROCE) is often considered to be the best measure of profitability in order to assess the overall performance of the business (McLaney Atrill, 2009). The year 2009/10 has seen a decrease of 4.5% from 24.6% to 20.1% in the ROCE ratio compared to the previous year, operating profit between the two years are similar, the difference in ROCE is due to the large change in capital employed. The decrease in ROCE suggests a poor efficiency and profitability of the companys investments. Capello Designs ROCE is significantly lower than the typical ROCE of 27% of other companies in the hair care products sector. Capello Designs should strive to maximise the return of capital employed by finding the optimum mix between mix of unit profitability and capital utilisation. The decrease in Return of Shareholders funds suggests management is less efficient in utilizing its equity base and giving a better return to its investors than it was in the previous year. Gross profit from the year 2008/09 to 2009/10 has declined by 2.4% from 30.8% to 28.4%, this suggests an increase in costs without any corresponding increase in selling price, or/and selling prices have declined due to competition, or the range of goods may have changed to include more products with lower margins. The facts show that the sales revenue has increased by 7% compared to the cost of sales that has increased by 11%; the divergence of figures has contributed significantly to the decline in gross profit. T he decrease in net profit by only 0.5% suggests that overheads have been tightly controlled during 2009/2010. Capello Designs profitability margin figures are falling below the typical profitability gross margin figure of 35% and net margin of 13%. The company can however increase its profitability by reducing costs, increasing turnover, productivity and increasing efficiency, to increase the overall performance of the company. Working capital cycle days has decreased from 81 days to 77 days, trade receivables have decreased by 13 days, while inventory have increased by 13 days which means there has been a reduction in the time taken to collect amounts owed by credit customers, but there has also been a raise in the time inventory is held for, this could also suggest the reason for the difference in current ratio of liquidity in comparison to acid test ratio of liquidity. Trade payables are taking longer to settle in 2009/10 compared with the previous year and has increased for a period of 4 days from 71 days to 75 days. Net Asset Turnover is a measure of the effectiveness with which assets are being used to generate sales and a company would ideally expect to see an increasing trend. However the ratio has actually declined as the growth in sales (7%) has not kept pace with the growth in assets (26%), with particular references to the increases in non-current assets, inventory and trade receivables. The current ratio measures liquidity and solvency, essentially a measure of the businesss ability to meet its current obligations. A generally acceptable current ratio of current assets to current liabilities is 2:1 (Gill Chatton, 2003). The current ratio of Capello Designs has fallen from 1.9:1 to 1.7:1. A lower ratio means that the company may not be able to readily pay off its short-term liabilities or take advantage of any discounts available, overall a weaker liquidity position than the previous year. Current ratios tend to overstate the current liquidi ty position of a company, therefore the acid-test ratios need to be compared. TheÂÂ  acid-test ratio is also a liquidity indicator that further refines the current ratio with the exclusion of inventory (Loth, 2010), a more conservative ratio than the current ratio because of its exclusion of inventory which is more difficult to turn into cash. Therefore, a higher ratio means a higher liquidity position. The acid-test ratio has declined by 25% from 1.2:1 to 0.9:1, the ratio is now less than one, which would suggest that the company cannot meet its current liabilities and that the liquidity of the business is now cause for concern. Furthermore, the acid-test ratio is much lower than the current ratio, which would suggest that current assets are highly dependent on inventory. The combination of ratios would suggest that the liquidity position of the company needs to improve. Various methods in which Capello Designs could do so is by increasing the current assets from loans o r other borrowings with a maturity of more than one year, converting non-current assets into current assets as well as increasing current assets from new equity contribution, or perhaps investing profits back into the business. Gearing Ratio (1) has increased quite considerably from 38.9% to 59.2%. The gearing ratio has increased by over a third, this is a consequence of the significant additional loan taken out during the year. The increase in gearing (leverage) means the company is considered to be more risky than before; because it is more vulnerable to downturns in the business cycle asÂÂ  the companyÂÂ  must continue to serviceÂÂ  its debt regardless of how bad sales are. Interest cover has decreased from 11.3 times to 6.6 times, a reduction of 4.7, which amounts to almost 40%, the gearing of this company needs to be closely reviewed going forward. Capello Designs could consider reducing its loan and maximise the use of its overdraft facility which would help its short term liquidity problem without unduly increasing its gearing ratio. The earnings per share have decreased by 1.1 pence from 27.7 to 26.6 pence which is discouraging. The dividend per share and dividend payout rate has remained constant throughout both years. The dividend yield has reduced by 1.1 however the P/E ratio has increased by 2.6 times from 14.1 to 16.7, giving Capello Designs a greater price/earnings ratio than its main UK competitor. A high P/E ratio is one that has a high price compared with its recent earnings (McLaney, 2009), this implies that investors are more confident this year in the growth of future earnings. However the dividend yield has decreased by 0.5% to 3.6% compared to its main UK competitor with a dividend yield of 4.9%, which is more than a third of an increase of Capello Designs. This comparison suggests that the shareholders of Capello Designs main UK competitor can be more confident that dividends will be maintained as opposed to Capello Designs. Overall the companys performance seems to be deteriorating, in comparison to the typical figures of other companies in the same sector, Capello Designs is not performing as well as it should be, in comparison to the previous year, this year has taken a turn for the worst. Profitability as a whole has declined and there is cause for concern when it comes to the liquidity of the business, gearing, activity and investment. This company needs to be closely monitored over the next few years. Appendix Profitability Ratios Return on Capital Employed Profit before interest and tax x 100 Total assets less current liabilities Return on Shareholders Funds Profit after taxation x 100 Shareholders funds Gross Profit Margin Gross Profit x 100 Turnover Net Profit Margin Operating Profit x 100 Turnover Activity Ratios Trade Receivable Days Trade receivables x 365 Turnover Inventory Days Inventory held x 365 Inventory used (cost of sales) Trade Payables Trade payable days x 365 Credit purchases (cost of sales) Net Asset Turnover Turnover x 365 Total assets less current liabilities Working Capital Cycle Trade receivables plus Inventory days less Trade receivable days Capital Gearing Ratios Gearing Ratio (1) Long term debt x 100 Shareholders funds Gearing Ratio (2) Long term debt x 100 Shareholders funds plus long term debt Gearing Ratio (3) Net Debt x 100 Shareholders funds Interest Cover Profit before interest and tax Net interest payable Liquidity Ratios Current Ratio Current assets___ Current liabilities Acid Test Ratio Current assets less inventory Current liabilities Investor Ratios Earnings per share Profit after tax Number of ordinary shares issued Dividend per share Total ordinary dividend Number of ordinary shares in issue Price/Earnings Ratio Current market share price Earnings per share Dividend Cover Profit after tax Number of ordinary shares issued Dividend Yield Net dividend per share x 100/90 Current market price Dividend Payout Ratio Dividend per share Earnings per share