How to perform Financial Analysis- Microchips PLC: Financial Report. (2013/14)

1.      Company Introduction:

Microchips PLC is electronic components manufacturing company and its products are usually marketed to audio and visual industries.  Some of the popular clients of Microchips PLC are Sony, Panasonic, and Samsung. In this document financial performance of the company is analyzed based on its past four year’s financial data. It also discusses about company’s future investment plans.

 

2.      Microchips PLC, analysis and comments upon its financial performance

 

In the field of business, company accounts and financial results conveys financial position and financial performance of the organisation. Understanding the financial data displayed in the financial statements might be in confusing for the users. In this chapter a financial performance report of Microchips PLC is generated based on the financial statements provided by the company. Performance of the organisation is analysed by considering various performance ratios such as profitability ratios, liquidity ratios, efficiency ratios, investment ratios and gearing ratios. Based on these values financial performance of the organisation is assessed for four consecutive years from 2010 to 2013 and is reported as follows:

2.1.            Profitability Ratios

Profitability ratios are totally related to the profit made by the company and by taking into consideration the capital employed and sales achieved. Profitability ratios are percentage return on capital employed, gross profit percentage, and net profit percentage or operating profit (Pamela Peterson Drake, 2014).

Return on capital Employed:

2010 2011 2012 2013
Return on Capital Employed 3.40% 3.20% 3.00% 2.70%

Table 2.1.1 Return on Capital Employed

According to financial data the return on capital employed values of Microchips is consistently decreased for the last for years. In general, it is stated that higher the return on capital employed higher the performance of the organisation is. Even though organisation is having positive return on capital employed its performance during the period 2010-2013 is low.

Gross Profit Percentage:

 

2010 2011 2012 2013
Gross Profit% 37.10% 34.80% 32.50% 29.00%

Table 2.1.2 Gross Profit Percentage

 Gross profit percentage is the percentage calculated between gross profits to the sales. Usually, gross profit percentage is highly influenced by industry percentage, but in general, higher the gross profit percentage of the organisation, then it could be mentioned that organisation is performing well. From the financial data provided for the period 2010-2013 value of gross profit percentage is higher, so organisation generally a price that as it is performing well If each year separately considered. But when total period is considered the gross profit percentage of the organisation is consistently decreased. According to the profitability ratios it is identified that profitability of the organisation was decreased and consistently, but it is still making profits.

2.2. Liquidity Ratios:

Liquidity ratios deals with assets and liabilities of the organisation and based on the values of such assets and liabilities performance of the organisation could be assessed (Investopedia.com). As a part of analysing liquidity ratios of the organisation, microchips, current ratio and quick ratio provided in the financial data is considered and following analysis was made

Current Ratio:

Current ratio is the ratio between current assets of the organisation to its current liabilities. From the table provided below. It could be identified that organisation is having more current assets than current liabilities.

 

2010 2011 2012 2013
Current Ratio 3.5 3.5 3.6 3.7

Table 2.2.1 current ratio

 

According to the studies, if the value of the current ratio is greater than one, then it indicates no problems for organisation. So, from the above results it could be stated that organisation is maintaining a healthy ratio between its current assets and liabilities and it has the greater ability to pay its liabilities.

Quick ratio:

Stock is current assets that take long time to get converted into cash. So, to calculate the liquidity of the organisation in a way other than current ratio quick ratio is calculated by removing stock from current assets. So, quick ratio is defined as the ratio between current assets without stock to current liabilities.

 

2010 2011 2012 2013
Quick Ratio 2.5 2.3 2 1.3

 Table 2.2.2 Quick Ratio

 

From the above financial data on quick ratio it could be stated that organisation still has the greater capability to pay its liabilities even stocks are not included in current assets category. But for the analysis period the value of quick ration is decreased consistently. Increase in stock could be the reason for its consistent decrease. Overall the liquidity of the organization is good and organization is maintaining healthy ratio between its assets and liabilities.

 

2.3.            Efficiency Ratios

Stock Turnover:

Stock turnover ratio between the costs of sales to the total stock. If stock moves slowly, it causes problem to the working capital. So usually researchers state that higher the stock turnover higher will be performance of the organisation (Pamela Peterson Drake, 2014) (Investopedia.com).

 

2010 2011 2012 2013
Stock Turnover 5.9 5.6 5 4.8

Table 2.3.1 Stock Turnover

 From the above financial details, it is stated that performance of the organisation related to stock turnover is good. But the value of staff turnover has flown down between 2010 and 2013. However, as value is higher and is positive. So, organisation is understood to be performing well

Stock Turnover in Days

 Staff turnover and this is the average stock holding time of an organisation. It is calculated by taking ratio between stocks to the cost of sales for total year (365 days).

2010 2011 2012 2013
Stock Turnover in Days 65 69 80 89

Table 2.3.2 Stock Turnover in Days

 In general organisation should try to keep stock turnover in days as low as possible. Because, if stock is hold for long time it ties up working capital and results in performance issues. From the above financial data it is found that stock turnover in days has increased for the given duration 2010-2013. According to the statistics efficiency of the organization has gone down. Reason could be increase in stock.

 Debtors Collection Period and Creditors Payment Period

 Debtors collection period is the time duration that speaks about how quickly business collects is debts. Creditors payment period is a duration, which speaks about how quickly business space to its creditors.

2010 2011 2012 2013
Debtors Collection Period 80 88 92 96
Creditors Payment Period 45 48 49 40

Table 2.3.3 Debtors Collection Period and Creditors Payment Period

Usually Debtors collection Period should be low and Creditors Payment Period should be optimally high. From the above graph it could be noticed that Debtors Collection Period is high and it is still increase and on the other hand Creditors Payment Period is decreasing. But observing company value itself does not provide and understanding for these values they should be compared with industry values.

Working Capital Turnover:

 Working capital turnover presents how efficiently working capital of the organisation is generating sales. Working capital is the difference between current assets and liabilities. It is calculated by using a relation between sales to working capital.

 

2010 2011 2012 2013
Working Capital Turnover 2.8 2.6 2.4 2.3

Table 2.3.4 Working Capital Turnover

From the financial data it is observed that working capital turnover of the organisation is been positive for the selected duration and proper working capital turnover presented by the organisation. So, working capital of the Microchips is generating good sales for the organisation.

Figure 2.3.4 Working Capital Turnover

 

2.4.            Investment ratios

Investment ratios analyses performance of the organisation according to the benefited provided to the shareholders.

Dividend Yield:

 

2010 2011 2012 2013
Dividend Yield 5.30% 3.22% 2.64% 2.09%

Table 2.4.1 Dividend Yield

Dividend yield is the true ROI achieved by the shareholder who invested in the organisation. Usually investors wants that companies to grow its capital as well as its dividend yield (Pamela Peterson Drake, 2014) (Investopedia.com).

Dividend Cover

Dividend cover explains how much profit of the company are transformed into ordinary dividends up the organisation. Usually organisations try to transform more profits into ordinary dividends to retain them for future purposes.

 

2010 2011 2012 2013
Dividend Cover 1.5 2.4 2.7 3

 

Table 2.4.2 Dividend Cover

 From the above information it could be stated that company distributing their profits in the form of ordinary dividends has increased consistently from 2010 to 2013. So, it is possible for the organisation to ensure capital growth.

Earnings per share:

Earnings per share is the ratio calculated between profit after interest and tax to number of ordinary shares issued by the organisation.

2010 2011 2012 2013
Earnings  Per Share ( €1) 0.9 0.98 1.04 0.95

Table 2.4.3 Earnings  Per Share ( €1)

 P/E Ratio:

P/E Ratio is the ratio calculated between market share value of the ordinary shares issued by the organisation to its earnings per share.

 

2010 2011 2012 2013
P/E Ratio 13 13 14 16

Table 2.4.4 P/E Ratio

Earnings per Share and the P/E ratio provide knowledge on organisation’s anticipated future earnings. As it is shown in the above picture P/E ratio was high during the given period. Reason for increased in the P/E ratio is higher market share price. Increase market price of the ordinary shares has reduced the influence of the EPS in 2012.  Higher P/E ratio generates positive future of the Microchips.

2.5.            Gearing

 

2010 2011 2012 2013
Gearing 45% 50% 55% 74%

Table 2.5.1 Gearing Ratio

 

From the gearing ratios provided in the financial data it could be assessed that long term borrowings of the organization and preferential shares for the organizations are increasing its ratio when compared to its total capital employed. It is better to maintain some equilibrium to that will lead to the performance of the organization (Pamela Peterson Drake, 2014) (Investopedia.com). As total borrowings are still maintaining lower than total capital it could be stated that performance of the organization is good according to gearing ratio.

Summary:

From the analysis of profitability ratios, liquidity ratios, efficiency ratios, investment ratio and gearing ratios it is concluded that the Microchips PLC’s financial performance is good according to the results. Over the course of time organization is striving hard to improve its performance. Increase in stocks and decrease in stock turnover in days could be one reason that slowed down its performance.

3.         Capital Investment Appraisal

 

The three popular methods that are used for appraising a capital investment include Return on Investment, Payback Period and calculating Net Present Value (NPV). Important factors that usually considered before making a decision about the investment appraisal are the cost of capital, duration of the project and time value of cash flows. Based on these values following appraisal were made.

3.1. Return on Investment:

According to the details provided (all values in millions):

 

Project X Project Y
 

Initial capital expenditure:

Cash Inflows : Year  1

2

3

4

Estimated resale value end of year 4

€m

75

20

35

30

25

10

€m

90

30

35

25

30

10

Table 3.1.1. Basic Information about the projects

Calculating total cash flow for both projects

Cumulative Cash flow for Project X = (20+35+30+25) = 110

Cumulative Cash flow for Project Y = (30+35+20+30) = 120

Formulae used for further calculations:

Incremental Profit       = Cumulative Cash Flow – Incremental Profit

Average Profit                        = Incremental Profit/ total number of years (i.e, 4 here)

Return investment is calculated and tabulated as follows:

 

Return on investment
Project X Project Y
Cumulative Cash Flow 110 120
Initial Expenditure 75 90
Incremental Profit 35 30
Average Profit 8.75 7.5
Return on investment 11.66666667 8.333333333

Table 3.1.2 Return on Investment

 Interpretation: Based on the information provided about two projects as it is found that both project X and Y are yielding good return on investment made. But when a comparison is made project X is yielding more returns than Project Y (Arjen Siegmann, 2003) (Holger Kraft and Eduardo S. Schwartz, 2010).

Drawback of ROI based appraisal: calculating return on investment is simple and it is also seems to be simple to understand the project. As it does not take time of the cash flow into account its validity could be questioned (Y O Lam, 2014) (dosen.narotama.ac.id, 2014).

3.2. Payback period

Payback period is the duration that organizations take to recover its investment completely from their business operations. Based on the cashflow information provided in table 3.1.1 following calculations related to the payback period is calculated.

 

  Payback Period
Year Cass Flow for X Cumulative Cashflow of X Cass Flow for y Cumulative Cashflow of Y
1 20 20 30 30
2 35 55 35 65
3 30 85 25 90
4 25 110 30 120

Table3.2.1 Calculations related to Pay Back Period

 

Formula for Payback period:

                                                                                                Unrecovered cost at start of the year

Payback period = Year before full recover +  ———————————-                                                                                                         Cash flow during the year

Therefore,

Payback period of Project X = 2 years + ((75-55)/35)X12) months

= 2years 8 months

Payback period of Project Y = 3 years

Interpretation: Based on the information provided about two projects as it is found that both project X and Y are taking not more than 3 years period of time to recover its investment. But when a comparison is made project X (2year 8months) is recovering its investment more quickly than Project Y (3 years).

Drawback of payback period based appraisal: It is also easy to understand but it cannot assess value of the organization based on time value of the cash flows (Y O Lam, 2014) (Sascha Rudolf, 2008) (dosen.narotama.ac.id, 2014).

3.3.            Net Present Value

Net Present Value is one form dynamic investment appraisal method used and it also depends on the cash flow. When compared to IRR net present value provided meaningful interpretation for the investment planned. Based on the cashflow information provided in table 3.1.1 following calculations related to the net present value is calculated.

Net present value for Project X and Project Y are calculated at various discount rates (8%, 10%, 15%, 20% and 25%). Tables related such calculations can be seen in Appendix 2. As net present value for both Project X and Project Y are high for discount rate 8%  they are provided below.

Formulae for NPV:

NPV = CF0 + CF1/(1+K)1 + CF2/(1+K)2 +…………

Project X
Year Discount Factor @ 8% Cash Flow Discounted Cashflow
0 1 75 75
1 0.926 20 18.52
2 0.857 35 29.995
3 0.794 30 23.82
4 0.735 25 18.375
 NPV 15.71

Table 3.3.1 NPV of Project X

Project Y
Year Discount Factor @ 8% Cash Flow Discounted Cashflow
0 1 90 90
1 0.926 30 27.78
2 0.857 35 29.995
3 0.794 25 19.85
4 0.735 30 22.05
 NPV 9.675

Table 3.3.3 NPV of Project Y

Therefore,

NPV of Project X = 15.71

NPV of Project Y = 9.675

Total NPV of the Project is: 15.71 (as optimal project will be selected)

Interpretation: Based on the information provided about two projects, it is found that both project X and Y are having good net present value. But when a comparison is made project X (15.71) is having more net present value than Project Y (9.675).

 

Drawback of payback period based appraisal: Identifying appropriate discount rate is big task for this kind of discounted cash flow techniques (Sascha Rudolf, 2008) (dosen.narotama.ac.id, 2014).

Summary:

Overall, from all three capital investment appraisal methods it is observed Project X is the most appropriate project for the organization among the two project proposals made for future investments. Reasons for choosing Project X are: it is more return on investment, better payback period and more net present value.

4.         Optimal Investment Policy and Resultant NPV

 

Optimal investment policy could be realised by calculating cost to benefit ratios and is calculated as follows:

Cost/Benefit  Ratio = NPV/Investment Cost

Based on the cost/benefit ration ranks are assigned as shown in the table below:

 

Optimal Investment Policy
Project Investment Costing NPV @ 8% Cost/Benefit Ratio Ranking
X 75 15.71 0.209466667 1
Y 90 9.675 0.1075 2

Table 4.1.1 Optimal Investment Policy calculations

As Project X is identified to be having better position that Project Y among bank loan total investment cost of the project X is assigned and remaining amount is assigned to project y as shown in initial outlay of the table provided below.

Resulting NPV from optimal investment policy
Project Rank Cost/Benefit Ratio Initial outlay resultant NPV
X 1 0.209466667 75 15.71
Y 2 0.1075 45 4.8375
120 20.5475

Table 4.2.1 Optimal Investment Policy and resultant NPV

Therefore,

            Resultant NPV of the total project is: 20.5475

Chances of taking up Project Y: (45/90) X100 = 50%

 

Interpretation:

The optimal investment policy provided above has increased the resultant NPV value from 15.71 to 20.5475. In the early case when two projects are appraised, according to the capital investment results only Project X could be chosen for the investment so NPV of the investing project is calculated to be 15.71. But in this scenario an optimal solution for investing 120 million loan effectively such that no risk is caused. As a result of the optimal investment policy provided above resulted NPV is greater than previous case. So, optimal investment solution is better option for the organization.

 

5.         Reflection Critique

The structure this assignment has provided me a great opportunity learns about interesting concepts about appraising an organizational performance and their investment plans. When this assignment work is started few concepts that I have come across in this project are broadly known but after finishing this assessment I feel comfortable with concepts such as calculating NPV, payback period, and interpreting them to understanding organizational capital investment plans. While working on capital investment appraisal at initial stages it found difficult to calculate values from cumulative values and original cash flow. Course materials provided in the moodle and few example documents helped a lot to understand the concepts. Then on it become easy passage for me to complete this assignment. This assignment made me confident that even a non finance person like me can do investment appraisal.

Bibliography

  1. Alan Pizzey, 1989, Cost and Management Accounting: An Introduction for Students, PCP Accounting and Finance Series
  2. Arjen Siegmann, 2003, Optimal Investment Policies For Defined Benefit Pension Funds, Research Memorandum WO no 728/0308
  3. Boyd, G, 2013, Capital investment: a guide to making better decisions, CAI,
  4. narotama.ac.id, A Textbook of Financial Cost and Management Accounting: Ratio Analysis, http://dosen.narotama.ac.id/wp-content/uploads/2013/02/Chapter-9-Ratio-Analysis1.pdf
  5. Holger Kraft and Eduardo S. Schwartz, 2010, Cash Flow Multipliers And Optimal Investment Decisions, NATIONAL BUREAU OF ECONOMIC RESEARCH
  6. Koen Milis, Monique Snoeck and Raf Haesen, Evaluation of the applicability of investment appraisal techniques for assessing the business value of IS services, katholieke universiteit leuven
  7. Malcolm, 2007, Accounting and Business Valuation Methods : how to interpret IFRS accounts Howard, Elsevier Science & Technology, 2007
  8. Pamela Peterson Drake, 2014, Financial Ratio analysis, http://educ.jmu.edu/~drakepp/principles/module2/fin_rat.pdf
  9. Sascha Rudolf, 2008, The Net Present Value Rule in Comparison to the Payback and Internal Rate of Return Methods, http://university.akelius.de/library/pdf/the_net_present_sascha_rudolf.pdf
  10. Vernimmen, Pierre, 2005, Corporate finance: Theory and practice, Wiley
  11. Watson, D, 2013, Corporate finance- principles and practice, Financial Times Prentice Hall
  12. Y O Lam, 2014, The Diagnosis of Traditional Capital Investment Appraisal Techniques, http://www.hkiaat.org/images/uploads/articles/AAT4%20-%20Capital%20Investment%20Appraisal%20techiques.pdf
  13. com

 

Appendices:

Appendix 1: Financial data of Microchip PLC

 

 

  2010 2011 2012 2013
Current Ratio 3.5 3.5 3.6 3.7
Gross Profit% 37.10% 34.80% 32.50% 29.00%
Stock Turnover in Days 65 69 80 89
Net Profit % 2.00% 3.80% 4.40% 3.30%
Fixed Asset Productivity 1.46 1.43 1.39 1.27
Working Capital Turnover 2.8 2.6 2.4 2.3
Quick Ratio 2.5 2.3 2 1.3
Stock Turnover 5.9 5.6 5 4.8
Return on Capital Employed 3.40% 3.20% 3.00% 2.70%
Gearing 45% 50% 55% 74%
Debtors Collection Period 80 88 92 96
Creditors Payment Period 45 48 49 40
Return on Equity (i.e. Shareholder’s Funds) 4.80% 5.20% 5.50% 5.00%
Interest Cover 2.5 2.2 2 1.4
Dividend Cover 1.5 2.4 2.7 3
Dividend Yield 5.30% 3.22% 2.64% 2.09%
Average Share Price 11.7 12.74 14.56 15.2
Earnings  Per Share ( €1) 0.9 0.98 1.04 0.95
P/E Ratio 13 13 14 16
% Overheads / Cost of Sales 43.50% 40.00% 37.00% 33.00%
 %Materials/ Cost of Sales 40% 43% 45% 48%
% Wages/ Cost of Sales 16.50% 17.00% 18.00% 19.00%
Cash Operating Cycle 100 days 109 days 123 days 145 days

 

App Table 1. Financial Data

 

 

 

 

 

 

 

 

 

 

Appendix 2: Discounted Cash Flow

Discounted Cash flows Project X:

 

Year Discount Factor @ 8% Cash Flow Discounted Cashflow
0 1 75 75
1 0.926 20 18.52
2 0.857 35 29.995
3 0.794 30 23.82
4 0.735 25 18.375
 NPV 15.71

 

Year Discount Factor @ 10% Cash Flow Discounted Cashflow
0 1 75 75
1 0.909 20 18.18
2 0.826 35 28.91
3 0.753 30 22.59
4 0.683 25 17.075
 NPV 11.755

 

Year Discount Factor @ 15% Cash Flow Discounted Cashflow
0 1 75 75
1 0.87 20 17.4
2 0.756 35 26.46
3 0.658 30 19.74
4 0.572 25 14.3
 NPV 2.9

 

Year Discount Factor @ 20% Cash Flow Discounted Cashflow
0 1 75 75
1 0.833 20 16.66
2 0.694 35 24.29
3 0.579 30 17.37
4 0.482 25 12.05
 NPV -4.63

 

 

 

 

 

 

 

 

Year Discount Factor @ 25% Cash Flow Discounted Cashflow
0 1 75 75
1 0.8 20 16
2 0.64 35 22.4
3 0.512 30 15.36
4 0.409 25 10.225
 NPV -11.015

 

Discounted Cash flows Project Y:

 

Year Discount Factor @ 8% Cash Flow Discounted Cashflow
0 1 90 90
1 0.926 30 27.78
2 0.857 35 29.995
3 0.794 25 19.85
4 0.735 30 22.05
 NPV 9.675

 

Year Discount Factor @ 10% Cash Flow Discounted Cashflow
0 1 90 90
1 0.909 30 27.27
2 0.826 35 28.91
3 0.753 25 18.825
4 0.683 30 20.49
 NPV 5.495

 

Year Discount Factor @ 15% Cash Flow Discounted Cashflow
0 1 90 90
1 0.87 30 26.1
2 0.756 35 26.46
3 0.658 25 16.45
4 0.572 30 17.16
 NPV -3.83

 

 

 

 

 

 

 

 

 

Year Discount Factor @ 20% Cash Flow Discounted Cashflow
0 1 90 90
1 0.833 30 24.99
2 0.694 35 24.29
3 0.579 25 14.475
4 0.482 30 14.46
 NPV -11.785

 

 

Year Discount Factor @ 25% Cash Flow Discounted Cashflow
0 1 90 90
1 0.8 30 24
2 0.64 35 22.4
3 0.512 25 12.8
4 0.409 30 12.27
 NPV -18.53

 

 

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