Northern Foods Profitability, Liquidity, Activity, Gearing and Investment - Case Study Example

Northern Foods Profitability, Liquidity, Activity, Gearing and Investment INTRODUCTION This essay provides an in depth analysis of financial position of Northern Foods for the years 2007 and 2006 ending on 31st March respectively by using Ratio Analysis of Financial Statements of the aforesaid years. It is involved in the business of making Ready meals, Sandwiches, Salads, Frozen, Biscuits and Puddings – operating across Chilled, Frozen and Bakery divisions – in both the retailer own brand (ROB) and branded arenas. The main competitors of Northern Foods Plc are Nestle, Uniq and United Biscuits whereas Nestle has global presence in most of the countries and has strong potential to compete in different brands of Northern Foods Plc. The essay covers major aspects of the Northern Foods plc’s financial position viz., profitability, liquidity, activity, gearing and investment. PROFITABILITY ANALYSIS Ratios Northern Foods Plc 2007 2006 % ∆ Gross profit turnover 20.75% 23.49% (13%) Operating profit turnover 5.92% 5.95% 1% Net profit margin 3.15% 1.87% 40.7% Return on capital employed 0.14 0.08 47% Return on equity 0.33 0.32 0.50% The above ratios depict the profitability position of Northern Foods plc for the last two years (2007-2006). K.S.Rao has pointed that “The profitability ratios measure the overall record of management in producing profits for long term survival or its survival will be threatened ” (223). These ratios reveal the comparison of two years 2007 and 2006 and shows corresponding change over the years. Northern Foods Plc gross profit ratio had a decline by about 13% in the year 2007 as compared to that in 2006. The company’s operating profit ratio for the year 2007 i.e., 5.92% is much lower than that in the previous year, which shows a 1% decline in the company’s operating profit. It has slumped by about 1% in 2007 as compared to the year 2006. Though the Company’s sales have increased but the cost of sales comparatively to the year 2006 has increased resulting lower gross profit for the year 2007 as compare to 2006, meanwhile the operating expenses shows a declining trend. Northern Foods plc Net profit ratio for the year 2007 displays substantial increase in profitability as compared to 2007 which is 40.7% higher than to year 2006. The difference in operating and net profit margin is due to the lower finance expenses and higher finance income for the year 2007 as compare to previous year 2006. Northern Foods plc ROCE ratio in 2007 exhibits a drastic increase in the company’s profitability by about 47% as when compared to 2006 which was 0.08 %. The ROCE calculation takes into account PBIT and Total assets less current liabilities. In Northern Plc case, the PBIT shows slight increase but due to substantial decrease in current liabilities that resulted better ROCE as compare to previous year 2006. The return on equity shows the extent to which a company generates profit on the funds invested by its shareholders. The company’s ROE ratio suggests a slight increase of profitability. As per the company’s financial statements for the year 2007 the returns generated on equity have increased by about 0.50% than 2006. For the calculations of ROE, net profit after long term interest and tax is divided by share capital and reserves. In Northern Foods Plc it comes to be 0.33 % for the year 2007 as compare to 0.32 % of the corresponding year 2006. The total equity is composed of (as classified in Northern Foods plc’s financial statements) Share capital, share premium account, capital redemption reserve, reserve for own shares, hedging and translation reserve, other reserves and retained earnings. The analysis of consolidated statement of changes in equity and notes to the accounts reveals that there is not much significant movement in equity from the start of the period till equity at the end of the period except few items such as premium arising on issue of equity shares, transfer to profit or loss on cash flow hedge and net loss for the period. It is notable that the net loss arising from discontinued operations has been offset with the current’s year 2007 profits resulting decline in total equity at the end of the period. The company has disposed off five non-efficient and requiring substantial investment businesses which resulted total overall group loss of £ 22.5 mln. However, the net income has been considerable better in 2007 as compare to previous year to boost the ROE to higher side comparatively for the current year 2007. The profitability analysis of Northern Foods Plc doesn’t shows a vivid picture for the year 2007 as its one of the criteria for any investor for investment decision, thought it has to compete with its competitors who have substantial business portfolio and product lines such as Nestle and United biscuits. It is expected that the disposal of non–efficient business would ultimately help the Company in the coming years to restructure it and improve overall profitability performance which would appeal to investors and satisfy its shareholders. LIQUIDITY ANALYSIS Ratios Northern Foods Plc 2007 2006 Current ratio 0.95 1.15 Quick assets ratio 0.92 1.11 K.S.Rao has pointed out “Short term solvency or liquidity ratios measure a firm’s ability to meet its short term obligations. They focus on the extent to which a firm has enough cash or assets readily available convertible into cash to pay its current liabilities” (218). The above chart displays current and quick ratios that are most widely used as indicators by lenders and bankers. Northern Foods plc current ratio for the year 2007 shows a decrease in its ability to meet its short-term obligations by about 21% from that of 2006. The current ratio shows a decline due to decrease in current assets namely “Inventories, Trading investments and Trade and other receivables” as presented in Balance sheet of Northern Foods Plc Financial statements. The Company has been able to decrease its current liabilities from £ 257.4 mln to £ 225.7 mln in the year 2007. It shows that the company is able to pay off only 0.95% of its short term liabilities even after utilising all of its current assets. Usually a ratio of plus 1 is consider favourable which is not the case for Northern Foods plc. Quick ratio is more stringent measure of liquidity as it excludes inventories and prepaid expenses for calculating. Quick ratio for the company indicates a decrease in the company’s capacity to pay off its short term debts and liabilities in the year 2007 by about 20% when compared to the years 2006 respectively after keeping aside stock from Northern Foods plc current assets. The company, therefore, can only pay off 92% of its short term debt out of its very liquid assets. It reveals that Northern Foods plc has kept a substantial level of cash i.e. £ 48.3 mln in the year 2007 as compare to £ 40.7 mln of previous year 2006. The quick ratio also reveals that the Company has not tied a high level of cash in inventories, which is a good sign of management. Overall it can be stated that Northern Foods Plc ratios has declined for the current year 2007 as compare to the previous year 2006, but still its still noteworthy. The Company has been able to reduce it short term obligations by making payments to its creditors and thus has been able to generate free cash flow of £ 83 mln in the year 2007. This indicates a good sign of management; however idle cash yields no return, therefore its better that the Company should invest in high yielding investments. ACTIVITY ANALYSIS Ratios Northern Foods Plc 2007 2006 Net asset turnover 2.42 1.29 Stock turnover 24 39 Debtor collection period 36 65 Creditor payment period 54 71 (Weston, Besleyt and Brigham) have pointed out that “These ratios measure how effectively the firm is managing its assets. These ratios are designed to answer this question: Does the total amount of each type of asset as reported on the balance sheet seem reasonable, too high, or too low in view of current and projected sales levels?.(97) The above ratios portray the efficiency of these companies in performing business operations and generating sales on assets. The net asset turnover for Northern Foods Plc shows a growth in the company’s efficiency to generate sales after utilisation of its assets in the year 2007 by 47% as compared to 2006. This shows that Northern Foods Plc has been able to efficiently utilize its assets to generate sales although the assets and current liabilities were low in the year 2007 as compare to year 2006, but still the sales figure for the year 2007 are comparatively better. Stock turnover ratio for 2007 reveals that the company efficiently turned out its inventory in 24 days showing significant improvement by 20% as compared to 2007. Northern Foods Plc has been successfully able to reduce its stock held as evident from increased sales in 2007, but they have not been able to curtail cost of sales which has increased comparatively on year to year basis (2007-2006). The Company collected all its receivables for the year 2005 in 36 days again showing an impressive improvement of 79% when compared to previous year of 65 days. This shows that Northern Foods Plc has been efficiently able to improve its credit management by collecting its credit sales without losing its customers. However it should also be noted that it still takes the company more than a month to collect all its receivables. Northern Foods Plc paid all its trade payables in 54 days in the year 2007 which is 32% greater than that of year 2006. The ratio tells us that Company is sufficiently meeting its short term obligation of payables which is a positive sign of good management. The difference between debtors’ collection and creditors’ payment shows that the company takes more time to pay its creditors than to collect its receivables. It shows a positive sign of the efficiency of the company’s management. Activity analysis for Northern Foods Plc is very impressive for the year 2007 as compare to year 2006. All of the Activity ratios reinforces that Management has done exceptionally good in year 2007 as compare to year 2006, it shows that Management has been able to implement its strategic decisions for achieving results as the Company generated more sales by utilizing its assets more efficiently which were low in the current year 2007. Similarly, it has been able to maintain a balance between receivable and payable policy by minimizing its credit cycle and similarly making payment to its short term creditors on time. This shows that management is vigilant of the fact that too strict credit management may lose its customers. Similarly, the Management has been able to pay off its short term obligations which shows that it has strengthen its credit relationship with its creditors. The improved ratios of Debtors collection period and Creditor payment period shows that management has been able to minimize its trade cycle which resulting in improving liquidity position of the Company. Gearing Analysis Ratios Northern Foods Plc 2007 2006 Debt to equity 1.44 2.39 Interest Cover 2.68 1.49 Long term lenders of a company are generally interested in examining the solvency position of a company in order to gauge its ability pay off the borrowed amount and periodic interest payments K.S.Rao says that gearing ratios are “used to assess the long-term commitments to the creditors” (219). The above ratios measure’s a firm degree of indebtness. This ratio is of critical importance as analysts and lenders are likely to observe it in recommending a share of the Company or lending a loan to the Company. The debt to equity ratio is calculated by dividing Net debt from Total equity (Shares plus reserves). The net debt is defined in Notes to the Accounts of Northern Foods Plc Financial Statement as total borrowings of the group, including both short term and long term bank loans, bonds, loan notes and finance leases, after offsetting the cash and cash equivalents of the business and short term investments. Net debt will also include the proportion of the fair value of the currency swaps hedging the balance sheet value of the group’s dollar denominated loan notes”. The debt to equity ratio reveals that it has 16% from 59% in the year 2007 whereas it was 70% in the year 2006. Ideally a ratio of 60:40 is considered ideal, whereas in the case of Northern Foods Plc it has improved significantly. The ratio shows that the Company is 59% leverage through debt and remaining is through equity financed. The interest cover for Northern Foods Plc is 2.68 times for the year 2007 as compare to 1.49 in the year 2006. The interest cover is calculated by dividing PBIT from finance expense. Interest cover is a pointer that the Company is earning sufficient enough before Interest and Tax to pay its interest expense easily, or the Company is burdened by finance expense. Ideally, an interest cover of above 2 is considered good, an interest cover of 2 times or less would be ranked as low. The interest cover of Northern Foods Plc has increased 44% in the year 2007 from the previous year 2006 of 1.49 times. Although the interest cover has shown an impressive improvement but if after scrutinizing, we come to know that PBIT (Profit before interest and tax) are not much not sufficiently high enough to comfortably pay finance expense, whilst finance expense are comparatively quite low in the current year 2007. It is also observable that PBIT is low due to increases cost of sales although administrative, distribution and other expenses were comparatively low in the current year 2007. INVESTMENT ANALYSIS Ratios Northern Foods Plc 2007 2006 Earnings Per Share 5.73 3.30 Dividend yield 0.04 - Dividend cover 2.43 0.36 (Weston, Besley and Brigham) have pointed out “These ratios give management an indication of what investors think of the company’s past performance and prospectus. If the firm’s liquidity asset management, debt management and profitability ratios are good, then its market value ratios will be high and its stock price will probably be high as can be expected”. (104). The investment analysis ratios are the ratios which help equity shareholders and other investors to assess the value and quality of an investment in the ordinary shares of the Company. The earning per share ratio is a measure of the amount profit earned by a Company during the financial year that can be attributed to each ordinary share. It is calculated as total earnings for the year divided by the total number of equity shares. If we compare the EPS of Northern Foods Plc of year 2007 which is 5.73 with the year 2006 we would come to know that it has increased by 42% which was 3.30. The EPS is of significant importance as it helps any investor to compare with the previous earnings and to make a rationale decision by comparing against other companies. The EPS of Northern Foods Plc shows that it has increased due to better profits amounting to £ 28 in the year 2007. The dividend yield for Northern Foods Plc is 0.04 for the year 2007, whereas the dividend yield for the year 2006 cannot be calculated due to unavailability of share price. The dividend yield is the return a shareholder is expecting on the share of the company. Any investor makes a decision for buying a share by considering dividend yield and capital growth, hence dividend yield is critical is of a share’s performance. The dividend per share for Northern Foods Plc has remained the same in year 2007 and 2006 and this may have disappointed the shareholders, provided the retained profits have been invested in the business to earn profitable returns. The dividend cover for Northern Foods Plc for the year 2007 is 2.43 times whereas it was 0.36 for the year 2006. The dividend cover is calculated by dividing profit after interest and tax from total dividend. Dividend cover is an indicator how secure shareholders can expect to be in terms of their dividend paid. It measures the number of times the current dividend could have been paid from available current earnings. For Northern Foods Plc PAIT was £ 28 mln in year 2007 as compare to year 2006 which was £ 16.1 mln, whereas the total dividend paid was £11.5 mln in the year 2007 as compare to year 2006 which was £ 44.2 mln. The dividend cover for Northern Foods Plc has increased substantially by 85% in the year 2007 from previous year of 2006. This has resulted on increased profit in the year 2007 which was £ 28 mln as compare to profits of £16.1 mln in the year 2006, although the total dividend amount £ 11.5 mln was comparatively low to £ 44.2 mln of year 2006. Overall the investment analysis for Northern Foods Plc suggests a stronger position for the year 2007 as compared to year 2006. All of the ratios have shown improvement but the Company has not been generous enough to maintain a healthy dividend payout ratio to satisfy its shareholders. The Company have opted to retain its profits to offset its net loss amounting to Rs22.5 mln for the current period, although, the earnings for the year 2007 have increased. This analysis indicates that Northern Foods Plc must do better than its current performance to lure more investment or otherwise investors would look for other alternatives such as its competitors. An investor looks for dividend and capital growth in the stock when considering a buy for the share; therefore Northern Foods needs to perform exceptionally better than its competitors in order to satisfy its shareholders and investors. Cash flow Analysis: (Weston, Besley and Brigham) has pointed out “The statement of cash flow is designed to show how the firm’s operation have affected its cash position by examining the investment (uses of cash) and financing decisions (sources of cash) of the firm. The statement of cash flow helps to gauge whether the firm has sufficient cash for purchase of new assets, excess cash available for financing and investment decisions, repay its debt or invest in new products” (90.) The cash flow Analysis reveals that Cash and cash equivalents have increased by 22 % in the year 2007 which is £ 47.9 mln whereas as compare to the year 2006 which was 39.3 mln. The net cash from operating activities has gone down by (11%) from £ 57 mln in the year 2006 to £ 50.6 mln in the current year 2007. The detail of net cash from operating activities has not been included in the consolidated cash flow statement 2007. However, the net cash from/ (used in) investing activities has improved drastically from £ (46.2) of year 2006 to £ 155.1 mln of year 2007. It has increased by 235 % in the current year 2007 on account of disposal of discontinued operations (net of disposal costs, working capital and debt adjusters) amounting to £171 mln and is one of the main contributor in improving net cash from/(used in) investing activities. The other major item in investing activities is proceeds from settlement of insurance claim which amounts to £ 30 mln in the year 2007. The net cash (used in)/ from financing activities has been drastically reduced to £ (196.7) mln of year 2007 from £ 4 mln which was in the year 2006. It has been reduced by 4817 % in the current year 2007. This has resulted due to substantial amount of decrease in amounts drawn on revolving credit facility 2010 which amounts to £ 185 mln for the year 2007, whereas it was nil in the year 2006. The other items are not of much significant which have contributed in decrease in net cash (used in)/from financing activities. ACCOUNTING POLICIES: The main accounting policies as refereed to page 60 of Northern Foods Plc Annual Report are that “financial statements have been prepared in accordance with International Financial Reporting Standards (IFRS). These financial statements have also been prepared in accordance with IFRS adopted by the European Union and therefore the group financial statements comply with Article 4 of the EU International Accounting Standards (IAS) Regulations. The financial statements have been prepared on the historical cost basis, except for the revaluation of certain financial instruments. Northern Foods’ management considers the following to be the most important accounting policies for the group. In applying these accounting policies, management makes certain judgments and estimates that affect the reported amounts of assets and liabilities at the period end date and the reported revenues and expenses during the financial year”. Basis of preparation This financial information has been prepared in accordance with IFRS. The comparative information for 2005/06 has been restated to reflect the impact of the business disposals in 2006/07 Disposal groups Disposal groups classified as held for sale are measured at the lower of carrying value and fair value less costs to sell. Revenue recognition Revenue is measured at the fair value of the consideration received or receivable and represents amounts receivable for goods and services provided in the normal course of business, net of discounts, VAT and other sales related taxes. (a) Sales of goods Sales of goods are recognized when goods are delivered and title has passed. (b) Sales of services Sales of services are recognized on completion of the service. (c) Finance income Interest income is accrued on a time basis, by reference to the principal outstanding and at the effective interest rate applicable, which is the rate that exactly discounts estimated future cash receipts through the expected life of the financial asset to that asset’s net carrying amount. Financing and treasury management The group has a centralized treasury function, which operates within a policy framework approved by the Board. The policy was reviewed by the Board in 2006/07 and the Board receives a monthly update on compliance. The principal areas of treasury management and respective policies cover the management of liquidity risk, interest rate risk and currency risk. Property, plant and equipment Property, plant and equipment held for use in the production or supply of goods, or for administrative purposes are stated in the balance sheet at historical cost or deemed cost less depreciation. Historical cost includes the expenditure that is directly attributable to the acquisition of the items. Deemed cost includes surpluses arising on the revaluation of certain properties to their fair values prior to the date of transition to IFRS. Land is not depreciated. Subsequent costs are included in the asset’s carrying amount or recognised as a separate asset, as appropriate, only when it is probable that future economic benefits associated with the item will flow to the group and the cost of the item can be measured reliably. All other repairs and maintenance costs are charged to the income statement during the financial period in which they are incurred. CONCLUSION The above analysis of financial position and performance of Northern Foods plc shows that overall performance of the Company is not satisfactory, although the Company has taken some strategic decision by disposing non-efficient business but however still the cost of sales is major contributor in lowering gross profits for the current year. The results of profitability, liquidity and cash flow analysis reveals that the Company has not posted good results comparatively (2007-2006) whereas the results of activity, gearing and investment analysis are noteworthy. The grey areas for Northern Foods Plc are cost of sales, net cash flow from operating activities, dividend payout ratio and PBIT (Profit before interest and tax) which needs immediate attention and focus so as to improve Company’s performance to better levels. The nature of the business of Northern Foods Plc has good demand in its market and it needs to understand the needs and wants of the customers so as to maximize customer’s satisfaction and profits for the Company. Appendix References K.S.Rao, Ramesh. Fundamental of Financial Management International ed. Macmillan Publishing Company: New York, 1989. Weston, J.Fred, Besley, Scott and Brigham, Eugene F. Essentials of Managerial Finance Eleventh Edition. The Dryden Press: Harcourt Brace College Publishers Read More