Financial Accounting - Shepherd Neame Ltd - Essay Example

Performance Review of Shepherd Neame Ltd. Introduction Shepherd Neame are Britain’s oldest brewers. It is a pub retailer company with a sense of responsibilities towards community. They are family of brewers and believe that pub is the hub of the community. Shepherd Neame Ltd. is not only a champion in pub culture across South East, but also owns and maintains a number of hotels and other accommodation facilities. The company is also in food business in partnership with Kent Supplier under the style of “Local Food from Local People”. The company has also introduced Fairtrade Coffee and tea through its pubs. The business strategy of the company is to remain focused on building its brands and improve upon its estate. “The company’s strategy is to be a modern, high quality, highly efficient brewer, wholesaler and retailer of premium specialty beers, wines, spirits, and minerals.” (J.B.Neame, Chief Executive in 2007 Annual Report). The company is admitting in its report that turnover of the company is increasing year by year, but it fails to mention anything about liquidity position of the company. Keeping in view such shortcomings in the material issued by the company as well as based on above background about company; and also as per available terms of references, the financial and overall performance of the company has been analyzed in this write-up as under. Terms of Reference The task is to analyze the performances over a period from 2005 to 2007 in respect of following aspects of Shepherd Neame Ltd.: Behavior of Sales turnover over a period of time. Assessment of Profit before and after tax Comment on profitability, liquidity, efficiency, gearing, and investment potential using ratio analysis. To analyze whether company’s annual report, financial results, and other information are achieving the objectives of the company, and finally To judge the impact of market developments over the objectives of the company in short as well as long terms Procedures 1. For financial analysis the following documents were used for three years 2005, 2006, and 2007. Shepherd Annual Return 2007 Shepherd Annual Return 2006 Shepherd Annual Return 2005 Announcement of Preliminary results published on 3 October 2007, by the company 2. Financial ratios calculated from financial statements of Shepherd Neame Ltd. have been made as base to analyze the performance of the company over the financial periods from 2005 to 2007. 3. In order to evaluate the impact of market developments, the situation has been analyzed based on earning per share and the posture of low capital gearing adopted by the company, in absence any data available about the company from active markets. Findings 1. Behaviour of Sales Turnover In respect of analyzing the sales behavior over period from 2005 to2007, the sales in absolute figures have grown from £91,354,000 in 2005 to £95,343,000 in 2006 and to £100,047,000 in 2007. Relatively sales in 2007 have grown 4.9% over 2006 and 9.51% over 2005. The sales behavior is very positive and encouraging despite smoking ban. The basic reason for such tremendous growth in absolute sales is growth in company’s infrastructural facilities providing a real push to the business. By the end of 2007 the company owned 376 pubs; and out of these338 pubs are freehold. Further the adherence to basic strategy of brand building is in fact paying dividends in the growth of gross turnover of the company. On this issue the chairman of the company emphasized in his statement in company’s annual report 2007, “Our business strategy remains to build our brands, invest to improve our pub estate, remain focused on our strength and to improve our overall efficiency of our operations.”(M H Tampleman) To judge sales activity in detail it is essential to observe the speed with which inventory is being converted into sales, and for this ‘Inventory Turnover’ is a common measure. If the behavior of ‘Inventory ratio’ as calculated in Appendix ‘A’ is observed, we fill find the following trends: Inventory rotated in 8.11 times during 2006 in comparison to 7.59 times in 2007 and 8.03 time in 2005. Because of high inventory turnover in 2006, the sales increased by 9.51% over 2005 as compared to only 4.9% during 2007 over the sale of 2006. According so far gross turnover is concerned 2006 was the best year out of three years under consideration. 2. Assessment of Profitability before and after tax The company’s earnings (profitability) before and after tax during the period under consideration are detailed as under: Figures in £ ‘000 Year 2005 2006 2007 Operating Profits (EBIT) 12109 12951 12073 Profit before taxation 9869 11205 11572 Profit after taxation 7356 8116 9292 The profitability of firm can be better analyzed with the help of ‘Operating profit margins’, Net Profit Margins’ & Return on Assets (ROA), which ratios have been calculated in the Annexure A. Operating Profit Margin Operating Profit margin will illustrate how efficiently the managers of the firm are using business operations to generate profits.”(Finance Scholar.com). Shepherd’s operating profits are best again during 2006. The mangers of the company performed really well during 2006.During 2006 the ratio was 0.14 as compared 0.12 in 2007 and 0.13 in 2005. This may be the result of high sales during 2006. But certainly the company did not performed well operationally during 2007 as compared to other two years. Net Profit Margins Net profit margin is “an indication of how effective the company is at converting revenue into actual profits.” (InvestorWords.com). This ratio measures the percentage of each dollar of sale reaming after all expenses including interest and taxes. The higher the net profit margin, the better it is. Accordingly the company has done equally well during 2007 and 2006 with ratio of 0.9 as compared to 0.8 during 2005. Inter company comparison will in fact the real rate of success for Shepherds. Return on total Assets (ROA) This ratio is also called the return on investments. ROA “gives an indication of the effectiveness of your business in generating a profit. The higher the ratio, the greater the return on assets. However this has to be balanced against such factors as risk, sustainability, and reinvestment in the business through development costs.” (ANZ) Generally speaking Shepherds is performing well on this count as its ROA is near 0.44 during all the three years except that during 2006 ROA was 0.45 but that hardly makes any difference. The management is very effectively utilizing its total assets to bring profitability at a reasonable higher rate. The important thing is that uniformity has been maintained with regard to use of assets. It appears that one of the assets of the Shepherds is idle. The investment on assets is producing its worth for the Shepherds. Considering profitability an aggressive factor in the performance of Shepherds during three years, it can safely be said that the year 2006 outclassed both 2007 and 2005, and perhaps 2006 has created a sort of profitability benchmark for future years. 3. Liquidity Current Ratio is the best measure to assess liquidity depth of a company. In fact Current Ratio is most used ratio in the financial analysis for determining liquid position of a company. It determines the company’s ability to meet its short term obligations. “The current ratio is an excellent diagnostic tool as it measures whether or not your business has enough resources to pay its bills over next 12 months.” (Susan Ward). As per current ratios calculated in Annexure A for three years of the company under consideration, the situation is not at all that bright so far liquidity is concerned. Generally a current ratio of 2.0 is cited as acceptable, but again every thing depends upon the industry the company is operating into. But the position of Shepherds has never been bright on this count in all the years. The ratios are as dismal as 0.72, 0.48, and 0.95 during 2007, 2006, and 2005 respectively. Only during the year 2005 it was some what near the ratio of 1.0. It worsened even in the year 2006, a year of great turnover and profitability. It shows that company is finding it very difficult to meet short term liabilities since long and the liquid position has been tight all along. 4. Efficiency Inventory turnover ratio considered above along with Total Asset Turnover indicate the efficiencies with which firm is operating. These ratios as calculated in Annexure A indicate that total assets were used to potentially best in 2006. But the total assets have not been utilized as per their full potential as ratio in all the three years is less than one. The ratio is 0.53, 0.59, and 0.58 respectively during 2007, 2006, and 2005. The real reason for under utilization of assets is company’s huge investments in estates. During 2006 inventory turnover was the highest 8.11 among the three years, and so is the total asset turnover at 0.59. That does not means other years’ performances were not good. In fact the difference was marginal but the results of efficiency of assets and inventory was great in 2006. 5. Gearing Gearing of capital structure means the ratio of mix of long term debts and equity maintained by the company. Gearing can significantly affect its value by affecting return and risk. Gearing is also called leverage. Debt ratio measures the degree of indebtedness and accordingly the degree of gearing. The higher the debt ratio, the higher is firm’s leverage or gearing and vice versa. Simply speaking a company that has raised funds mostly through equity capital is low geared and when funds are raised mostly through preference capital, bonds, and debentures, the company is high geared. In case of Shepherds there are no loan or debt capitals beside capital belonging to equities. Also long term liabilities constitute only creditors and pension liability. Debt ratio as calculated indicate that the company is very low geared during all the three years under consideration. The debt ratio for 2007, 2006, and 2005 respectively is 0.28, 0.14, and 0.27. In fact the capital structure of the company s not at all geared to take advantage of leverage or gearing. It is wrong to assume that by bringing loan or preferred capital, the company may not remain an attractive proposal for equity investors. In fact gearing bring in a situation whereby after meeting the fixed amount obligations, the company can turn its entire profitability to equities, and thus in turn increasing EPS and its market prices. 6. Investment Potential The best way to judge the investment potential of a company is the market ratios, i.e., Price/ earning ratio and Market/Boo ratio. In absence of information about market price per share of common stock, these ratios cannot be calculated. However, information available for Earning per share (EPS) is generally of interest to present and prospective stockholders. EPS represents the amount earned on behalf of each share of common stock. As per annual reports of Shepherd Neame Ltd., EPS for the three years under consideration are 73.4p, 64.2p, and 58.1p respectively for 2007, 2006, and 2005. These figures indicate that the EPS is increasing year after year. This is mainly because there are no preferred stocks or loan capital invested in the company. Naturally investing public can have an attraction in the company with consistently increasing EPS and absence of loan capital to share the earnings. 7. Objective achievements The annual reports of the company indicate the following trends of the company: a) The company has strengthening its portfolio of brands with the latest addition of the Asahi Sales and marketing license. b) The company has won Queen’s award for sustainable development for 2006. It has also been notices above that the year 2006 was an exceptionally good year as per financial statements of the company. c) The company is making huge investments in developing existing estate as well as acquiring new estate to further strengthen the immoveable properties of the company. d) Retail business of the company is performing exceptionally well as we have noticed above in profitability analysis. All above factors indicate that the coming is progressing effectively and surely in achieving its objectivity. The factors that are putting impediments on its way to achieving its strategic objectives are the company’s precarious liquidity positions, and the investments in estates. There is every doubt that the company will not be able to reap immediate profits on such investments; and this will further worsen its liquidity position. 8. Impact of market developments The company is not very active so far stock exchange markets are corned as quotations of its shares are not readily available. However major market fluctuation can impact the company in a major way because the company is very low geared. The company is not having long term loan capital like bonds or debenture investments into it. Also there are no preference capital investments in the company. In a situation like this, in case of its shares touching lower ebb of prices, the company will not have capital to depend upon as fresh investments into the company would be highly doubtful when bears will rule the market. Conclusion Apparently the turnover has touched 100m fissure in 2007, the increase of 4.9% in sales is less than half of increase of 9.51% in 2006. Also liquidity wise the company is always at in a tight spot in order to meet its short term obligations. It is true company is strengthening its capital base by investing into estates to be used for business purposes; the rate of profitability growth is static. The net margins are not growing beyond 0.9, or at the most one can say profitability growth is slow and negligible. The asset turnover ratio is very low. The assets of the company are not being effectively utilized to their full potential. Such a situation may worsen the already precarious liquidity situation any time. The only good point is that despite all these factors EPS is showing an increasing trend; and that is because company is not geared as absence of any loan or preferred capital. Recommendations The company should improve its liquidity position as it is very precarious at present and bring trouble any time into the working of the company. Secondly, the company should introduce some cost cutting solutions in order to maintain net margins at present level. This is so because funds that are being utilized for investments in estates will not an immediately impact on operating activities till those estates are ready for regular use for business purposes only. Appendix A Bibliography ANZ, Benchmark Your Business, viewed on March 4, 2008, http://www.anz.com/australia/business/calculator/businessbenchmark/return.asp M H Tampleman, Shepherd Neame Annual Report & Accounts 2007, page 3. Finance Scholar.com, Operating Profit Margin, viewed on March 4, 2008, http://www.financescholar.com/profit-margin-analysis.html InvestorWords.com, Net Profit Margin, viewed on March 4, 2008, http://www.investorwords.com/3260/net_profit_margin.html J.B.Neame, Chief Executive, Annual Report 2007, page 11 Susan Ward, Is your business sick?, About.com, viewed on March 4, 2008, http://sbinfocanada.about.com/od/management/a/3ratios.htm Shepherd Annual Return 2007 http://www.shepherdneame.co.uk/company/Final2007/annual2007_colour.pdf Shepherd Annual Return 2006 http://www.shepherdneame.co.uk/company/Final2006/annual2006_colour.pdf Announcement of Preliminary results published on 3 October 2007, by the company http://www.shepherdneame.co.uk/company/values_and_standards.html Read More