Financial Management and Control - Paper Example

Financial Management and Control

INTRODUCTION

Analysis of the performance of an entity is a significant practice in business as it helps in the assessment of the financial health and stability of a firm and additionally forecasting the financial position of a firm's future trends. This report will provide an evaluation of the performance of Tripplewood Plc using the liquidity, profitability, gearing and efficiency ratios. Ratio analysis is one of the tools used to analyze the financial statement of companies. Additionally, the report will give a critical evaluation of assumptions that underlie the breakeven analysis and also critically examine the viability of a project that Grey Goose Limited plans to implement. Further, the report will provide a comparison and contrast of the various techniques applied in long-term decision making. Lastly, the report will indicate the main overall conclusions as well as some recommendations on any exceptions.

TASK A

1. Tripplewood Plc Performance Presentation to the Board

Tripplewood Plc. Board

This report brings to your attention the analysis of the company's performance over the past two years. The assessment is based on various ratios with the results illustrated below.

Profitability Analysis

Profitability ratios measure the overall effectiveness of firms' performance by evaluating a firm's capacity to yield returns from the capital investment in a venture thus earn profits (Lee, Lee, and Lee, 2009).

Gross profit margin: The gross profit margin evaluates the ability of an entity to control the production costs or manage the margins from purchase and sale of products.

Table 1: Tripplewood Plc gross profit margin.

Particulars 2015 2016

Amount in 000 Amount in 000

Gross profit 14,030 14,135

Sales 23,400 26,500

Gross profit margin= (Gross profit/sales)*100 59.96% 53.34%

Tripplewood Plc.'s gross profit margin for the year 2015 was substantially high at 59.96% implying a gross profit earning of 5.9 per pound of net sales. Consequently, the firm had about 59.96% of its total revenue to meet the operating and non-operating costs. 2016 however recorded a ratio of 53.34% a 6.62% decline compared to 2015. The decrease indicates the firm is losing control in efficiently managing the cost of sales.

Net profit margin: The ratio is a measure of a firm's profitability that compares the after-tax profit to the sales revenue.

Table 2: Tripplewood Plc net profit margin.

Particulars 2015 2016

Amount in 000 Amount in 000

Net profit 4,355 1,910

Sales 23,400 26,500

Net profit margin= Net profit/sales)*100 18.61% 7.21%

The year 2016 recorded a significant decline in the net profit ratio from 18.61% in 2015 to 7.21% in 2016. The drop in the ratio is due to the decrease in the firm's net profit from 4.355million in 2015 to 1.91million in 2016 as a result of the increase in operating expenses mainly the bad debts and selling and distribution whose growth was more than double.

Operating margin: Is a profitability measure that gauge the sales return a business generates from its operations.

Table 3: Tripplewood Plc operating margin.

Particulars 2015 2016

Amount in 000 Amount in 000

Operating Profit 10,805 8,610

Sales 23,400 26,500

Operating margin= Operating profit/sales)*100 46.18% 32.49%

The operating margin was 46.18% in 2015 but significantly dropped to 32.49% in 2016. The decrease was due to an increase in operating expenses which indicate that managements control of these costs was deteriorating.

Return on equity: ROE evaluates the ability of a company to generate profits from the investment that shareholders have put in the firm hence it is an indicator of the rate of return that stockholders receive on their investment.

Table 4: Tripplewood Plc Return on equity.

Particulars 2015 2016

Amount in 000 Amount in 000

Net profit 4,355 1,910

Ordinary Shareholders funds 13,045 13,045

Return on equity= Net profit/Ordinary Shareholders funds)*100 33.38% 14.64%

The company recorded a return on equity of 33.38% in 2015, however, in 2016 there was a considerable drop to 14.64%. The decline shows that management was not efficient in utilizing the resources provided by the equity investors.

Return on capital employed: The ratio assess the effectiveness of a firms management in utilizing employed capital to generate profits.

Table 5: Tripplewood Plc Return capital employed.

Particulars 2015 2016

Amount in 000 Amount in 000

Operating profit 10,805 8,610

Working capital(Total assets-current liabilities) 37,160 42,510

Return on capital employed (Gross profit/sales)*100 29.07% 20.25%

Tripplewood Plc had a significantly high return on the capital employed high of 29.07% in 2015 implying that employed capital yielded a positive return. However, 2016 recorded a ratio of 20.25% which was a 10.92% decline from 2015. The drop shows that the firms earning power per pound of capital employed was declining.

Liquidity Analysis

Liquidity ratios are used to assess the financial stability of a firm. The current and quick ratios are the fundamental means of evaluating liquidity.

Current Ratio: It measures the ability of a business to transform its assets into cash hence meet near-term obligations in due time.

Table 6: Tripplewood Plc current ratio.

Particulars 2015 2016

Amount in 000 Amount in 000

Current assets 8,680 10,760

Current liabilities 3,480 5,980

Current ratio=Current assets/current liabilities 2.49 1.80

In 2015, the current ratio was 2.49 which is above the ideal threshold of 2. However, the ratio reveals a serious concern as it has significantly dropped to 1.8 in 2016. The decline in current ratio shows that the firm's capability of paying its near-term obligations is worsening. The deterioration is due to the current liabilities rising at a faster rate than the current assets.

Quick ratio: This ratio evaluates the ability to pay off current obligations from quick assets such as cash and equivalent.

Table 7: Tripplewood Plc quick ratio.

Particulars 2015 2016

Amount in 000 Amount in 000

Current assets -stock 4,000 4,220

Current liabilities 3,480 5,980

Quick ratio=(Current assets-Inventory) /current liabilities 1.15 0.71

Quick ratio was better in 2015 than it was in 2016 since there was a substantial decline from 1.15 to 0.71. The low quick ratio in 2016 implies that Tripplewood Plc. has tied up a substantial portion of inventory in the current assets. Kuppapally (2007, p.210) suggests that a quick ratio of 1:1 is considered to be satisfactory, hence since it was less than 1 in 2016, it means that the firm's quick assets are less and will not meet all its current obligations. Overall the declining trend in the liquidity ratios indicates a deterioration of the firm's liquidity for the two years. As a result, the company may experience problems in covering its near-term obligations on time when they become due. Also, the company's suppliers may review the credit terms available. A firm's liquidity is crucial as it affects its aspect of going concern hence it is essential for the firm's management to devise measures of improving liquidity levels without impairing the levels of profitability.

Gearing Analysis

Gearing ratio: This ratio reveals the extent of borrowings a firm uses to finance its assets relative to the stockholders' equity (Epstein, 2012).

Table 8: Tripplewood Plc gearing ratios.

Particulars 2015 2016

Amount in 000 Amount in 000

Total debt 11,260 17,200

Total equity 29,380 31,290

Gearing ratio= Total debt/total equity)*100 38.33% 54.97%

There was an increase in the firm's gearing from 38.33% in 2015 to 54.97% in 2016 implying the firm has added more debt to finance its operations. Therefore, Tripplewood Plc. is now funding 55% of its activities through debt and 45% through equity. Largely, there has been a significant change in the firm's capital structure over the two years since the firm has increased its financial leverage through the use of more debt in financing its activities.

Debt to capital employed: The ratio gauges the extent of reliance on debt to finance a firms activities compared to the total capital hence gives an estimate of the risk level to the shareholders.

Table 9: Tripplewood Plc debt to capital employed.

Particulars 2015 2016

Amount in 000 Amount in 000

Total debt 11,260 17,200

Capital employed(total debt + total equity) 40,640 48,490

Debt to capital employed= Total debt/(total equity + total debt)*100 27.71% 35.47%

The debt to capital ratio was 27.71% in 2015 but significantly deteriorated in 2015 by rising to 35.47%. An increasing trend in the ratio indicates a higher risk to both the stockholders and the lenders.

Interest cover: The ratio gauges a firm's capacity to pay interest expense from its earnings hence determines a company's ability to meet interest obligations from profits.

Interest cover: The ratio gauges a firms capacity to pay interest from its earnings hence determines a companys ability to meet interest obligations from profits.

Table 10: Tripplewood Plc interest coverage ratios

Particulars 2015 2016

Amount in 000 Amount in 000

Earnings before interest and tax 10,805 8,610

Interest expense 1,650 2,680

Interest cover= Earnings before interest and tax/interest expense 6.55 times 3.21 times

Tripplewood Plc had a better interest coverage of 6.55 times 2015 than 2016 whose coverage was 3.21 times hence there was a substantial decline. Consequently, there was a deterioration of the firm's ability to cover the interest expense.

Efficiency Analysis

Inventory turnover period: This ratio is an indicator of management's efficiency in managing stocks. If the turnover is high, it saves a company costs of holding inventory.

Table 11: Tripplewood Plc inventory turnover ratios

Particulars 2015 2016

Amount in 000 Amount in 000

Inventory 4,680 6,540

Cost of sale...