GHO PLC Analysis - Essay Example

Part III Liquidity Analysis The current ratio signifies the liquid position of the company and represents a safety net for the creditors of that particular company. GHO plc has maintained a fairly consistent current ratio over the two years and efficiently managed its resources. It current holds £2.42 of current assets for every £1 of current liabilities. The company is almost at par to the industry average of £2.5 of current assets for every £1 of current liabilities. However, insights into the company’s financial statements show that GHO plc holds much of current assets in terms of inventory. The quick ratio clarifies that the company holds £1 of current assets for every £1 of its near obligations which is below the industry standards. The company could run into liquidity problems and may be unable to meet it short term obligations. Efficiency Analysis GHO plc had a moderate collection period of 37 days in 2010 as compared to the industry average of 30 days. The company required to put in place measures to improve the collection period over the next few years. However, the collection period severely deteriorated over the following year to 46 days. Further analysis of the financial statements has shown that the sales of the company increased by only 20 percent whereas the debtors increased by 50 percent in the same period. The audit team needs to analyze the increasing debtors and their creditability in the market. Similarly, it needs to analyze the debtor policies of the company. GHO plc needs to revise its policy to improve its collection cycle in the long run and decrease the chances of bad debts. GHO plc has a poor inventory turnover as compared to industry average. In 2010, it took the company 91 days to convert the stock into a sale which worsened more in the following year. In 2011, it took the company 114 days to convert the stock into a sale as compared to average 75 days in the industry. This shows the inefficiency of the sales as well as the management team. Further analysis of the statements has shown that the inventory increased by 42 percent whereas the cost of goods sold increased by only 14 percent. The audit team needs to analyze the reason behind the higher closing stock. GHO has a moderate creditors’ payment period. The company takes 80 pays to pay for its credit purchases in 2011 as compared to 65 days in 2010. The company has discredited its worthiness in the market as the creditors are not being paid promptly. The audit team needs to inspect the credit condition of the company as well as work on a way to increase its worthiness. The total asset turnover ratio signifies the amount of sales generated by the efficient usage of the total assets invested in the company. GHO generated sales amounting to £1.5 for £1 invested in the assets in 2011 as compared to £1.7 for £1 invested in the assets in 2010. This shows that the efficiency of the assets has decreased over the year. Insights into the financial statements show that the assets increased by 29 percent whereas the sales increased by only 20 percent which has caused the decline. The audit team needs to identity the unnecessary points where the money is being held up without potential returns. The possible points could be the inventory and debtors. Profitability Analysis The gross profit margin is a critical measure from an investment’s point of view. It is a measurement of the efficiency of the company’s production facilities and the management. GHO plc maintains a moderate gross margin but still is still below the industry standards. This shows the marked inefficiency of the facilities as well as the production team. The company contributed only33 cents to the gross profit of the company for every £1 sale that was made. But at the same time, the net income has dramatically increased over the period. The net income increased by 106% in the year 2011. However, GHO plc still lags behind the industry with respect to the competitors in the profitability margin. In the year 2011, the company generated 7 cents for every dollar transaction that took place. It showed an increase as compared to the last year but below the industry average of 10 cents for every £1 sale that is made. The audit teams needs to inspect the expenses that have incurred during the year to analyze the low profit margin despite a 109 percent increase in the come. The operating profit margin signifies the efficiency of the company’s operations as well as pricing strategy. GHO plc showed a 100 percent increase in operating profit in 2011 as compared to 2010. The company contributed 12.5 cents to the profitability of the company in 2011 as compared to 7.5p in 2010 for every £1 sale that was transacted. The company has shown some efficiency in the operations which is depicted by the increase in operating profits. Capital Analysis The gearing ratio measures the financial leverage of the company and indicates the percentage of assets financed by the debt holders as compared to the equity holders. GHO’s financial leverage increased from 32 percent to 42 percent from 2010 to 2011. The company financed £2,000 worth of new assets by debt which has gravely increased the leverage. At the same time, the company plans on to issue debentures that will further increase the leverage to 50 percent. With more leverage and increasing risk, it is believed that the company might run into slight financial problems. The interest coverage ratio indicates the ability of the company to pay interest payments when they become due. A ratio of less than 1 signifies that the company is unable to generate enough revenues to pay back to its creditors. GHO plc has a good interest coverage ratio both in 2010 and 2011. However, as compared to the industry standards, the company lags behind its competitors by a huge margin. This will gravely impact the credit worthiness of the company in the long run. With the issue of debentures around the corner, the audit needs to analyze the problem behind the lagging interest coverage ratio. Investment Analysis The return on equity indicates the level of profitability for the shareholders. It measures the income earned on the money invested by the owners of the company. GHO plc showed a drastic increase in return on equity from 13 percent in 2010 to 25 percent in 2011; showing a growth of 92 percent in one year. The dividend cover indicates the ability of the company to pay our dividends from the earnings: the higher the ratio, the better it is. GHO plc has a moderate dividend cover of 1.41 in 2011. The company could retain the dividends for future growth; however it continues to pay huge dividends. The audit team needs to inspect the presence of any financial conflicts of directors as well as the reason behind high payout ratio. Part IV The primary role of the auditors is to critically examine the reports of the company and to report on them to the company as well as other stakeholders. Historically, the auditors-internal as well as external were bent upon the examination of all the transactions that took place in the company. This independent verification of the financial records helped the company to reduce on record-keeping errors, asset misappropriation, and fraud within the organizations. However with changing times, changing stakeholder expectations and a new dimension of risk management, the role of the auditors is fast changing in the contemporary organizations. In this new environment, the leaders want the auditors to play a larger role and bring more value to the businesses. This has paved way for a broader role for the auditors. (KPMG, 2007) Therefore, the role of the auditors is fast expanding; and so are skills required for the audit. The auditor has moved from his traditional repetitive transaction check to a wider array of functions. (KPMG, 2007) The modern auditors frequently use the analytical review and the system analysis to perform a high quality audit. Analytical review is an audit procedure that involves the examination of the important ratios as well as significant trends of the corporation compared to past years. The auditor will then inspect any unusual trends and fluctuations in these financial statements. This helps the auditor to plan on the audit work as well as an overall review of the financial statements of the concerned company. (Chow, 2009) In the contemporary world, all organizations have an internal control system to monitor their operations as well as transactions occurring all over the year. The internal control includes all systems and procedures that are required to maintain a sound operational organization free from errors and frauds. Therefore, a modern auditor has changed his role based on the development of this system. The auditor analyzes the strength of the internal control system of the company, and based on his findings, assesses the quality of the accounting system as well as integrity of the financial records. Conclusion The auditors need to perform an analytical review of the GHO plc which will allow them to highlight the unusual trends and fluctuations in the financial statements. Based on these finding, the auditors will make quality recommendations to GHO plc which allow the organization to improve on its shortcomings. Similarly, using the system control, the auditors could analyze the strength of the internal control system at GHO plc and also make necessary recommendations to improve on it. A stronger internal control system will drastically help to improve the condition of the organization. Bibliography Bringham, E. F. Houston, J. F.(2007) Fundamentals of Financial Management. Cengag Learning. Brealey, R. (2007) Principles of Corporate Finance. Tata McGraw-Hill Education. Levy, H. and Alderson, M. (1998) Principles of corporate finance. South Western College Pub. McNamee, D., and Selim, G.M. 1998. Risk Management: Changing the Internal Auditor’s Paradigm. Altamonte Springs, FL: The Institute of Internal Auditors Research Foundation. Moeller, R., and Witt, H.N. 1999. Brink’s Modern Internal Auditing, 5th Ed. New York: John Wiley & Sons, Inc., Warren, C. S. Reeve, J. M. (2006) Financial and Managerial Accounting. Cengage Learning Williams, J. Haka, S. Bettner, and M. S. Meigs, R. , 2002.Financial & Managerial Accounting: A Basis for Business Decisions. McGraw-Hill Chow, D. 2009. Analytical Procedures – A Powerful Tool for Auditors. [online] Available at: http://www.hkiaat.org/images/uploads/articles/Analytical.pdf [Accessed 21st April 2012]. KPMG, 2007. The Evolving Role of the Internal Auditor. [online] Available at: http://www.kpmg.com/CN/en/IssuesAndInsights/ArticlesPublications/Documents/role_ia_O_0707.pdf. [Accessed 21st April 2012]. Read More