Financial Performance of BAE Systems - Research Paper Example

Executive Summary: Strengths: BAE Systems Plc (BAE) operates in the market of defense systems. It was established in 1999 upon the merger of Marconi Electronic Systems and British Aerospace to be the third largest global defense company. BAE has better market status than Cobham. BAE improved its market status from 2004 to 2005 and became more capable of selling its inventory. Both companies were good at managing their debtors. Weaknesses: Cobham is better than BAE in using their assets to generate sales. Cobham is more profitable than BAE and it generated more income from its investment capital than BAE. This is because Cobham has better control over its costs than BAE. Both Cobham and BAE have difficulty paying short term debts. Furthermore, BAE must borrow long term or issue more shares to cover it current liabilities because its current assets are not sufficient. BAE used debt more than Cobham to fund its operations and acquire assets. However both Cobham and BAE have adequate values of Interest covers. Even though BAE had higher risk of not paying its debt more than Cobham, but Investors' expectations for BAE Systems were slightly higher than Cobham as evident in P/E ratios. 1.0. Introduction Performance of a business is often demonstrated in the good quantitative results at the end of the fiscal year. In addition, historical figures are also reviewed to assess the change and strength of the current results. This paper will review and summarize the financial performance of one of the world's renowned manufacturer of defense systems BAE Systems Plc by making use of financial ratio analysis. To better evaluate the financial performance of BAE, its financial ratios are compared with another competitor within the same industry. Cobham Plc was chosen to be compared with BAE. Finally, outlook in the future of BAE will forecasted based on available information. 1.1. The Market for Defense System The threats of terrorism have significantly boost defense systems spending especially for countries like United States. After the September 11 tragedy which shocked the global business environment becomes a grim reminder for nations to improve their defense systems. 1.2. BAE Systems Plc: Company Profile BAE Systems Plc (BAE) traces its origin to the 7.7 billion merger of Marconi Electronic Systems which is the defense electronics and naval shipbuilding subsidiary of the General Electric Company Plc and British Aerospace which specializes in the manufacture of aircraft, ammunition, and naval systems. Out of these prestigious business organizations, its establishment in 1999 equipped with a unique competitive advantage which enables it to position itself as the third largest global defence company and sixth largest US defense company employing 97, 500 highly skilled people. 2. Financial Ratio Analysis Financial ratio analysis is an essential tool to assess the financial health of a business entity. It enables a financial analyst to highlight specific measures and compare it with the performance of similar business enterprises within the same industry. This tool is currently utilized by business managers, investors, creditors, suppliers, and other decision makers in order to determine the financial performance and well being of a business organisation. Financial ratios are grouped into four broad categories, each showing a different aspect of a company's financial performance. These are profitability ratios, financial leverage ratios, liquidity/solvency ratios, and efficiency ratios. In order to get a deeper insight of BAE's financial performance, its computed financial ratios will be benchmarked with its competitor's Cobham Plc. The rationale of choosing these two business organizations is simple. It should be noted that both of them are regarded as important players in the global defense industry. Being in the same line of business and the same industry, it is right to assume that BAE and Cobham Plc both face the same challenges and opportunities in the sector under consideration. This assumption justifies the comparability of their financial performance during the fiscal years. 2.1 Profitability Ratios Profitability ratios measure the ability of the company to generate income from its investments less the costs incurred (Fraser & Ormiston 2004). The ratios computed for this category are return on capital employed, sales profit margin, and return on equity. These ratios were computed for BAE Systems and Cobham Plc. for 2004 and 2004 as shown in table 1. Table 1: Profitability Ratios of BAE and Cobham during 2004-2005 Return on capital employed is a variant of return on investment which measures how well the company is utilizing its capital. Even though ROCE declined for Cobham from 2004 to 2005, but it is still higher than both values of ROCE for BAE in both years. Profit margin measures earnings from every poundof sales. It is used to compare companies that operate within the same industry. Even though Cobham profit margin has decreased from 17% in 2004 to 14% n 2005, but it is still higher than BAE's profit margin which averaged about 8% during 2004 and 2005. In 2005, Cobham retained 0.14 as profit from every pound of sales while BAE retained 0.08 for every pound of sales it generated. This indicates that Cobham has better control over its costs and is more profitable than BAE. As for ROE, return on equity measures how much wealth is created for the company's stockholders for every share that they have on hand (Fraser and Ormiston 2006). Logically, higher performance ratios indicate a healthier financial condition. Thus, Cobham exhibited a higher average of ROE than BAE. This indicates that Cobham is more profitable than BAE. To sum up, By comparing the three profitability ratios of both companies, it is easily detected that Cobham is more profitable than BAE. Cobham management employs better cost saving techniques and provides better return on invested capital. 2.2 Liquidity Ratios Liquidity or solvency ratios are used to measures the company's ability to finance its short-term obligations by its cash and near cash items. To put it another way, it is concerning how fast a company turn their assets into cash. Included in these ratios are current and acid test or quick ratios. Table 2: Liquidity Ratios of BAE and Cobham during 2004-2005 Current ratio expresses the "working capital' relationship of current assets available to meet the company's current obligations" (Horngren 2000, p.153). If current assets exceed current liabilities then the ratio will be greater than 1 and indicates that a business has sufficient current assets to cover demands from creditors. According to this information, BAE Systems wasn't under good conditions in indicated period. Because, they weren't able to cover current liabilities with their current asset (0.68) and provided that there had been any problems with receivables, BAE would have to need to borrow more long term loan or issue more shares. On the other hand their rival COBHAM covered its short-term borrowings. Besides, the figures (1,24-1,34) indicates that they were really good at controlling their short-term debts The acid test is more indicative as it shows the company's ability to pay its current obligations without relying on the sale of its inventory. Higher ratios indicate more liquidity. If this ratio is 1:1 or more, then clearly the company is unlikely to have liquidity problems. If the ratio is less than 1:1 we would need to analyse the structure of the current liabilities. As for our companies' results, whereas BAE systems's situation (0.63-0.61) made them borrow more loans, COBHAM's position almost covered all current liabilities. Furthermore, as far as we are concerned, working capital and liquidity test suggest that Cobham was more capable than BAE in meeting its short term liabilities in 2004 and 2005. 2.3 Activity Ratios Activity ratios are operating efficiency measures, which determine the ability of a company to maximise its output given a certain level of resources (Fraser and Ormiston 2004). These ratios significantly gauge the asset, investment, and cost management performance of the business entity. Ratios under this category are stock turnover, debtors' and asset utilization ratio. The stock turnover ratio measures the number of days the inventories stay in the company's distribution center or warehouses. In other words, it measures how well a company coverts their stock into sales. Thus, we can easily say that BAE was more capable than Cobham at finishing their stock. In our minds, it signifies that BAE was better in the market. If we talk about numbers, it can be said that this ratio fell from 76 days to 52 days from 2004 to 2005 for BAE sytems and that is probably a good thing. If there's less stock to worry about, lower investment in stocks meaning that the money they used to have tied up in the stock room was free to spend somewhere else. On the other hand, Cobham plc fell from 113 days to 94 days from 2004 to 2005 and that is probably a good thing. The debtors' ratio reveals the efficiency of a business organisation in collecting its account receivables. Lower numbers are typically preferred in this ratio classification as they signify speed and efficiency of the business organisation in dealing with its different transactions (Fraser and Ormiston 2004). According to numbers, both companies' debtor days are proportional to their stock turnover days. Therefore, it can be said that both companies were good at managing their debtors. As for asset utilization, asset turnover measures the amount of sales generated by every pound in the company's assets. In this case, Cobham plc 's asset usage was better than BAE Systems. Because, Cobham could earn 66 pence from ever one pound expenditure on the assets, whereas BAE could only make 54 pence. 1.3. Financial Leverage (status) Ratios Financial leverage ratios provide an indication of the long-term solvency of the firm. They indicate the extent of non-owner claims on the firm's profits as well as the firm's operating capability to meet its obligation. Gearing is the long-term debt to equity ratio which assesses the balance between liabilities and equity in the firm's long term resource structure. Another one is the interest coverage ratio which measures the extent to which earnings cover the interest obligation of the company (Thomson 2002, p. C-6). It should be noted that both of the ratios in this category are related to each other. If the company relies more on its creditor than its stockholders, it is more likely to incur interest obligations. By comparing Cobham and BAE capital gearing ratios, it was found that BAE used debt much more than Cobham to fund its operations and acquire assets. In addition to this, both Cobham and BAE show adequate values of Interest cover. However Cobham was less burdened by debt expenses and more capable to meet interest expenses other than BAE. Especially in 2004, Cobham's interest cover performance is outstanding. As a summary of financial leverage ratios, we can say that interest cover and capital gearing ratios proved that BAE uses more debt than Cobham to operate its business. The risk of BAE not being able to pay its debt is certainly higher than Cobham's. 1.4. Investor Ratios Investor ratio analysis helps us to make right investor decisions. These ratios can provide us to understand and compare from one company to another. It is an important way of judging. With these methods we can judge, if their shares are good value or not and their share price will rise or fall. Price earnings ratio gives us a clue about share of company faster and growing satiation. If the company price earnings ratio is higher, it means that it has a good value. On the other hand, if the price ratio is very high, the share can be called overvalued by competitors in the same sector's market.Then the investor can get an idea by looking at past year's earning and guess future share price and shares are worth buying or not. Between these two companies Cobham share price was rising 5.8 between 2004 and 2005 but BAE has a huge gap between those two years. Finally, in 2005, BAE has a higher (17.13) price earnings ratio rate. 2.0. Future Outlook 3.0. Conclusion: This paper analyzed the financial performance of BAE Systems Plc. Different financial ratios were computed and analyzed and then compared with Cobham Plc, who is a competitor within the same industry. Future performance of BAE Systems is predicted from events occurring after the financial analysis and industry outlook. Analysis of profitability ratios showed that Cobham is more profitable and more capable of generating income from its investment capital than BAE. Profit margins of Cobham were twice as much as profit margins of BAE and average return on shareholders equity for Cobham was higher than that of BAE during the period of the analysis. Profitability ratio comparison showed that Cobham has better control over its costs and is more profitable than BAE. BAE current ratio was less than one (0.68) indicating that it can not cover its current liabilities using their current asset. BAE must borrow long term or issue more shares. Both Cobham and BAE have difficulty paying short term debts; however Cobham liquidity is better than BAE. BAE has better market status than Cobham as demonstrated by their respective activity ratios. BAE improved its market status from 2004 to 2005 as its stock turnover days fell from 76 days to 52 days, which is better than Cobham market states with stock turnover of 95 days. Both companies were good at managing their debtors as indicated by their debtor days. However, Cobham is better at using its assets to generate sales as demonstrated by the asset utilization ratio. By comparing gearing ratios, BAE was evident to use debt more than Cobham to fund its operations and acquire assets. Both Cobham and BAE show adequate values of Interest cover as indicated by interest cover times. However, BAE has higher risk at not paying its debt more than Cobham. Investors' expectations for BAE Systems were slightly higher than Cobham as evident in P/E ratios. 4.0. Appendixes 5.0. Bibliography Read More