The Financial Outlook of Burke Company - Coursework Example

?Executive Summary Prime Bank Limited has been approached by Burke plc, a restaurant chain managing company, for a long term loan in order to expand its operations. The financial outlook of the company looks stable. Although the net profit and gross profit margin of the company has decreased during the year, the asset base of the company has significantly increased. The Bank should sanction the loan, after consultation with the management of the company and evaluating the financial feasibility of the expansion plan. Introduction The report (a consultancy service to Prime Bank Limited) evaluates the financial outlook of Burke plc in order to determine whether it would be in the position to repay the loan facility sanctioned by the Prime Bank Limited. Burke plc is a renowned name in the mid-priced dining restaurant industry. The company, since its inception, has flourished by leaps and bounds and has been able to establish a chain of restaurants operating in various towns all across the UK. The company had been enjoying strengthen financial outlook in the prior years, but due to the increased competition and repercussions of the recession, the management is of the view that the company requires substantial funds in order to reform its operational strategy and further increase its market share. The management plans to refurbish few old restaurants in order to attract new customers and restore its profitability. With the availability of funds, Burke plc would also be able to manage its working capital requirement in the most appropriate manner. The company can hire new workforce, acquire state of the art machine and open up new restaurants in order to enhance its market share in the industry. The closest competitor of the company is Hare plc which also holds a substantial market share of the industry. In order to acquire competitive advantage, Burke plc can utilize the funds in countering the forces of competition which are the bargaining power of customer and supplier, threats of new entrants and substitute and the rivalry among the companies. With the sanctioned loan, the company can implement and align Information Systems into its overall corporate strategy, which is likely to give an edge over the other players in the market. In addition, product and service differentiation can also be created when a company has substantial pool of funds available. Promotion is considered to be the corner stone in the marketing mix of any organization, and it is an established fact that a company always requires a substantial amount of capital in order to finance the promotional activities. Company Analysis Ratio analysis is a very accurate and reliable tool when it comes to analyzing the financial outlook of an entity. The primary reason to conduct a ratio analysis is to quantify the results of the operations of a company and compare them with that of the prior year(s) in order to assess different aspects of the financial feasibility. The ratios can be divided into various categories such as profitability, gearing and liquidity, each focusing on a different area of the financial outlook of the organization and highlighting the company’s performance. These analyses form an integral part of the financial statement analysis, especially from the investors point of view, who always strive to invest in companies having strengthen and stabilizing financial ratios and representing an upward trend. It is of great significance that the ratios must be benchmarked against a standard in order for them to possess a meaning. Keeping that into account, the comparison is usually conducted between companies portraying same business and financial risks, between industries and between different time periods of the same company. The analysis is divided into three main categorize namely Profitability, Liquidity and Gearing. Profitability ratios identify how efficiently and effectively a company is utilizing its resources and how successful it has been in generating a desired rate of return for its shareholders and investors. Liquidity ratios measure the ability of the company to quickly convert its asset into liquid cash to settle its short term liabilities. Whereas, the Gearing ratios identifies the extent to which the company is financed through debt and to what degree the operations are being conducted from the finance raised through raising equity capital or otherwise. Profitability Ratios Burke Plc Hare Plc   2011 2010 2011 2010   Profitability Ratios Gross profit margin 22.00% 24.00% 26.00% 24.00% Operating profit margin 9.18% 10.62% 15.00% 13.00% ROCE 7.20% 7.25% 6.90% 5.40% Cash generated from operations per share 54p 60p 65p 62p Gross profit margin is an analyzing tool which assists in identifying how effectively and efficiently the company is utilizing its raw materials [1], variable cost related to labor and fixed costs such as rent and depreciation of property plant and equipment. The ratio is calculated by dividing the sales revenue by the gross profit. Analyzing the trend of gross profit margin, in the financial year 2011 the gross profit margin decreased as compared to the financial year 2000. Although the sales in the year 2011 has increased by ?730 thousand, but this was offset by an increase of ?657 million in the cost of sales. This could be an indication that the company, through better marketing, was able to increase its revenue, but it was not able to able to curtail its cost of production. The increase in the sales as compared to the previous one was 16% whereas the cost of sales increased by 20%. Net profit margin, on the other hand analyzes the profitability of the company before deducting the taxation and finance charges from the earnings [2]. The ratio is calculated by dividing the profit before interest and tax with the sales revenue of the current financial period. The ratio highlights how well the company is managing its selling and administrative expenses it also highlights the other income generated by the company during the course of its operations. Following the same trend as the gross profit margin, the operating profit margin also decreased during the current year. The decrease in the gross profit margin can be analyzed by considering the fact that the selling and admin expenses of Burke plc increased by 10% and 12% respectively during the current year. Considering the financial performance of Hare plc, it can be observed that the company was able to uplift its gross and operating profit margin. This clarifies the fact that the adverse effect on the operations on the company is primarily due to the lack of managing its operations prudently. Return on capital employed (ROCE) is, according to the analyst, is considered to be the most significant ratio in order to evaluate a company’s performance from an investor’s point of view. ROCE measures a company’s ability to earn a return on all of the capital that is being employed by the company [3]. The ratio is calculated as net income upon total capital employed, which is the sum of debt and equity financings. The ROCE of the company has marginally decreased owing to the decrease in the operating profit margin and gross profit margin. Cash generated from operations per share (EPS) are considered one of the most important financial ratios from the investor’s point of view. The ratio is calculated by dividing the profit generated from the operations, as mentioned in the cash flow statement, and dividing it by the number of equity shares outstanding during the year. CGPS has also shows a downward trend for the Burke plc, where as for the Hare plc, it is showing an inclining trend. Liquidity and efficiency Ratios Burke Plc Hare Plc   2011 2010 2011 2010   Liquidity and Efficiency Ratios Current ratio 0.94 : 1 0.87: 1 0.6:1 0.6:1 Acid test ratio 0.81:1 0.76:1 0.5:1 0.5:1 Debtors turnover period 20 days 17 days 27 days 25 days Inventory turnover 36 days 31 days 9 days 10 days The liquidity ratio measures the company’s ability to pay its short term liabilities. The ratio illustrates that how quickly a company can convert its assets into cash and cash equivalent in order to pay off its short term liabilities [3]. The most commonly used liquidity ratio, the current ratio, which is calculated by comparing the current assets and current liabilities. The strengthened the current ratio the more ability the company has to pay its debts and short term obligations over the next 12 months. The current assets ratio of the company has improved which portray that the management is working towards stabilizing the asset base of the company. Considering the prior year financial data of the company, the company had a perfect current ratio in the financial year 2009, but due to increased competition, the ratio took a downward plunge in the year 2010. The company’s asset base is substantially greater than its competitor. The asset test, which is also regarded as the quick ratio, is calculated by subtracting the inventory balance from the total current assert balance. . Out of the current assets mentioned, inventories are regarded as the one which takes comparatively more time to be converted into cash or cash equivalent. The acid test ratio has followed the same trend as the current ratio. Inventory turnover represents how quickly a company’s inventory is sold, which can be calculated by dividing the sales revenue by the average inventory balance as at the year end. High inventory level is not beneficial for the company as it represents that the company’s investment is tied in inventory and currently it is not generating any income. A lower inventory turnover period represents that the sales are poor and there is excess inventory in the storage. Whereas a higher turnover period might represents that sales are comparatively higher. Burke plc’s inventory turnover has increased during the current year which could be due to the fact the since the company wanted to increase its sales, it might have overbought the inventory. If comparing the trend with that of the company’s competitor, it can be observed that the inventory turnover period of Hare plc has also increased. Thus it could be concluded that due to the bleak economic environment, the market in general was stagnant and the companies could not be able to sell their products and services within the anticipated period of time. The trend of debtor turnover is closely linked with the inventory turnover period. It can be observed from the financial analysis of Burke plc that the debtor turnover has increased by 5 days, due to the delay in collection of the receipts. Hare plc, however, was able to manage its debtors which could be done by availing the services of factoring. Gearing Ratios Burke Plc Hare Plc 2011 2010 2011 2010 Gearing Ratios Equity ratio 66% 69% - - Debt ratio 34% 31% 45% 44% The gearing ratios and indicate the level of risk taken by a company as a result of its capital structure [4]. These ratios are a great source of determining the level of financial risk to which the company is exposed and thus helps in reducing it to the optimum [4]. The equity ratio indicates how much of the entity’s assets are financed through the finances generated through the revenue from the operations of the entity and raising financing through equity issue rather than acquiring debts or other financial institution. The company’s equity ratio has decreased during the current year, which means that the company has shifted its focus from financing its operations to financing it’s through debt financing. The fact can be corroborated through the fact that the company’s non-current liabilities has increased by 25% to ?2.5 million. The increase in the debt financing is also reflected from the increase in the debt ratio of the company. Although raising financing through debt equity is considerably a quicker way of acquiring pool of funds, but it is liable to decrease the profitability of the company as the finance charges increases. Burke plc has been facing certain financial difficulties for the past years. An analysis of the income statement of the company will reveal that although the sales of the company has increased during the current financial year, but the net profit for the year has decreased by 12%. This is due to the fact that operational and financial cost of the company has increased majorly during the current period. Analyzing the balance sheet of the company, it can be analyzed that the asset base of the company has significantly increase. Increase in the non-current asset might be related to the acquisition of new buildings for the setting up of new restaurants, as the depreciation expense in the current year has increased by? 26 thousand. The company is also adhered toward maintaining liquidity as the cash and bank balances have also increased during the current year as compared to priors. The short term payables of the company has decreased by 2% during the current year which represents that the company is managing is working capital prudently and is keeping the liability side as under control as possible. Recommendation and Conclusion The financial outlook of the company, as presented by the ratio analysis of the company, is stabilized. The company is expected to have enough liquidity (as presented by the current and acid test ratio) in the future and thus would be able to pay the loan installment, along with the markup in the future. Prime Bank Limited should consider sanctioning a long term loan with floating markup rate to the Burke plc. The initial markup rate should be set lower as it is apparent from the company’s profit and loss analysis that the company would be not able to sustain the burden of higher finance charges. In addition, feasibility report pertaining to the opening of new restaurant should be made available by the management of the company to the bank. If the report mentions a significant uncertainty relating to the operations of these new restaurants, the bank should reassess its decision of sanctioning the loan. In order to further discuss the terms and conditions, a meeting should be set with the management of Burke plc. Reference [1] Richard Loth “Profitability Indicator Ratios: Profit Margin Analysis.” investopedia.com. Investopedia, n.d. Web. 16th June 2011. [2] Rosemary Peavler “Use profitability ratios in financial ratio analysis”Bizfinance.about.com” About.com – a part of the New York Times company, n.d. Web. . 17th June 2011. [3] Jim Mueller “Diving into financial liquidity” investopedia.com. Investopedia, n.d. Web. 17th June 2011. [4] “Gearing ratios” qfinance.com. Bloomsbury information limited, n.d. Web. 18th June 2011. Read More