Analysis of Financial Statements: Theoretical Framework

The accounting regulating organisations of various nations cast a duty of the management of an entity to prepare and present the financial statements of an entity, which represent a true and fair view of the affairs of the entity. The fair and transparent representation assists the stakeholders and experts to arrive at meaningful business and other decisions (Fabozzi and Drake, 2009). The following report is aimed at analysing the financial performance of the entity Royal Mail Plc. The company Royal Mail Plc. is engaged in the business of postal services and courier services in the UK. The shares of the entity are listed on the London Stock Exchange. The company belongs to the Integrated Shipping & Logistics industry. The company operates its business through a number of subsidiaries such as Royal Mail Group Limited and the General Logistics Systems. The report will make use of the various ratios to analyse the financial performance of the entity over the period of five years, i.e. the financial years starting from year 20145 to 2018. The report is further aimed at analysing the trends in the stock market of the share prices of the said entity. This would be followed by the conclusion as to whether it is vital to invest in the entity on the basis of the financial health of the company.

As prescribed in the US GAAP framework formulated by the regulators, financial statements are prepared with the intention to serve the various stakeholders. It must further be noted that these statements must be in the comparative format in order to evaluate the performances in a detailed manner. In addition, it is significant to note that, as there exist a number of stakeholders, there is no specific purpose for the preparation and presentation of the financial statements. This means that financial statement serves as the base for a number of decisions, such as lending, buying, and regulating and many more (Delen, Kuzey and Uyar, 2013). While the investors are keen to know the overall financial health of the company, the regulators have the prime objective of ensuring that the statements comply with the corporate governance requirements and applicable accounting framework (Robinson et. al, 2015). Thus, in order to make the decisions, stakeholders must analyse the statements according to their needs. Further, the statements provide a competitive analysis of the performance with respect to the performance of the competitors belonging to the same industry.

There have been prescribed a number of techniques for analysing the financial vitality of an enterprise. These techniques make use of the relevant and specific data from the financial statements and the market, about the enterprise (Stickney et al., 2009). One such technique is ratio analysis. A comparative ratio analysis aids an individual to gain an insight about the profitability, efficiency, liquidity, and solvency positions of an entity. The ratios are further useful when compared with the industry average and the relative data of the competitors (Bragg, 2012). In addition, the ratios aid in further trend analysis and thus overall financial vitality of a company can be assessed.

Analysis of Financial Statements: Practical Application

Another way of evaluating the current performance and the worth of an entity is by making use of the stock’s price, as derived from the live market or the stock exchange where the shares of a public company are traded. It is significant to note that the analysis of the stock price in the light of the historical performance of an enterprise would yield limited results (Hillier, Grinblatt and Titman, 2011). The said evaluation must be done in conjunction with the company’s future prospects and the current news in relation to recent agreements entered into by an entity. An industry analysis must also be combined. The evaluation on the above lines will give an overall insight at a macro level of the position of an enterprise. Accordingly, the stakeholders can make investment and regulatory decisions.

Ratio Analysis: Profitability

The profitability position of an entity can be primarily assessed with the help of three key ratios namely the return on equity, the gross profit margin, and the net margin (profit) ratio. While the net profit ratio is calculated as the percentage of profits to the revenues, the return on equity is computed as the percentage of profit on the total shareholder’s equity. The gross profit is calculated taking the percentage of gross profit on the revenue. These ratios aid in the evaluation of the company’s ability to generate income against the expenses and other incidental costs incurred towards the income generation (Gill, Biger and Mathur, 2010). The following graph depicts the net profit ratio in respect of the Royal Mail Plc. over the last five years.

As depicted in the graph above, the net margins have been consistently falling since the year 2015. While the net profit margin for the year 2015 was 3.48 percent, it fell down to 2.61 percent in the year 2016. The fall is again evident in the year, where the net profit margin was 2.55 percent. However, it is significant to note that the net margin in the year 2014 are extraordinary high due to the specific credit item namely the Royal Mail Pension Plan amendment (Royal Mail Plc., 2015). The amount for the same had accounted for about £ 1350 million in the year 2014. In addition, it is to be noted that the gross profit margin has been consistent, except in the financial year 2017, where the gross profits were slightly higher. The reason for the same was the lower people costs, distribution costs and the conveyance costs. 

As evident from the graph above, the effect of the high net margin in the year is evident in the return on equity as well. Otherwise, the return on equity for the shareholders has remained more or less the same in the years 2015 to 2018. The flat trend depicts the no change in the equity structure as well as the operating framework of the entity.

Liquidity position of an enterprise is one of the most fundamental characteristics of a business. This gives an insight of the ability of the business to pay off its short term business debts (Saleem and Rehman, 2011). The current ratio and the quick ratios are regarded as the prime ratios to evaluate the liquidity position of an enterprise. The current ratio depicts the proportion of the current assets of the company to the current liabilities and thus is useful in the evaluation of the payment ability if the short term obligations. Quick ratio takes into account the most liquid assets of the company (i.e. excluding the inventories) as proportion to the current liabilities. A comparative position of the liquidity of the Royal Mail Plc. has been described as follows, with the aid of the graph and data belonging to the last five years.

Ratio Analysis: Profitability

The above graphs describe the comparatives for five years, the data of which is provided in the appendix below. The cash and cash equivalents, amounting to around £ 600 million (Yahoo Finance, 2018), own the major portion of the current assets of the year 2018 for the entity Royal Mail Plc. The cash and the cash equivalents of the year 2018 are almost double than that of the year 2017, depicting a better liquidity position of the enterprise. In addition, the other current assets are at a better place than the previous year, together leading to the increase in the overall current assets of the enterprise and the current ratio. Another major contributory towards the better current ratio in the year 2018 is the reduction in the amount of the short-term debt.

The quick ratio changes are at the same pace as that of the current ratio change because of the consistency in the amount of the inventories over the years, as depicted in the data in the appendix.

The efficiency ratio analyse the ability of an enterprise to make use of the various assets and resources. The efficiency ratios make use of the comparison of the assets owned by the entity with that of the revenues or the profit performances (Agha, 2014). Thus these category of ratios inform the investors about the company’s ability to utilise what it has owned in order to generate the most profit possible for owners and shareholders. There are a various kinds of efficiency ratios namely the asset turnover ratio, the inventory turnover ratio, the fixed asset turnover ratio, and others. Either the ratios are stated in number of times, or the number of days. The following two graphs give a glimpse of two prime efficiency ratios and the trend over the period of five years.

The inventory days refers to the average number of days, goods or the inventory remain before being sold by the enterprise. Thus, a low ratio indicates that a company is quickly converting its inventory into the sales. The entity Royal Mail Plc. has been depicting a consistent low inventory holding days, because of the nature of the inventory involved.

Similarly, accounts receivable days refers to the number of days a bill was outstanding before being collected form the debtors of the entity. The second graph in the efficiency as depicted above showed an increasing trend until the year 2017, with a slight decrease for the year 2018. The change is attributed to a marginal increase in sale with a more change in the receivable outstanding.

The accounts payable period refers to the days taken by the entity to pay off its accounts payables. Similarly, the accounts payable period is also on consistent rise over the five years period, which has risen from about 65 days in 2015 to 78 days in 2018.

The long term stakeholders such as the owners, government lenders, private lenders, regulators and even the society are keen to know the solvency aspect of business from long term vitality of the enterprise point of view. The two major ratios that shed the light on the debt structure and the impact of the same in the organisation are the debt equity ratio and Interest Times ratio. The debt equity ratio is used to evaluate a company’s financial leverage, and is also called the gearing ratio. The figures as stated in the appendix in respect of the entity in question show that there is a declining trend in the debt equity ratio for the enterprise since the year 2015. The decrease in the debt equity ratio is an evidence that the entity is reducing its dependence over the debt for the conduct of the business. The year 2018 shows a drastic reduction in the entity’s other liabilities, and hence the fall. On the lines of the same, it must be noted that the interest time’s ratio has significantly reduced from the financial year 2017 to the financial year 2018. The change is of almost 50 percent.

Liquidity

The market capitalisation of the entity as per the latest data is that of the £ 2.805 billion. This indicates that the entity is a large cap company. The following image shows the relative price trend of the shares of the company Royal Mail Plc. over the period of five years, as traded on the London Stock Exchange. Currently the enterprise is valued at £ 3.25 billion.

There have been a number of ups and downs in the share prices of the entity. A number of factors contribute to the said fluctuations. The recent being the when the entity was in the top the FTSE 100 fallers list, thereby hitting a new low in the market. The reason for the same was the disappointing figures from US mail delivery peer FedEx Corp (Proactive Investors, 2018).

While the EPS refers to the earning fetched by a shareholder in terms of net attributable to them in terms of per share, the dividend per share refers to the dividend earned on a single share, as declared by the company.

The EPS, DPS and other ratios have been depicted in the appendix, which are in line with the earnings of the entity. The company’s EPS were highest in the year 2014 to due to the high earnings. The EPS has fallen on the lines of decline in the net profit margin. The same is the trend for the DPS.

However, the market value of shares is on consistent rise and that is a positive sign. The price earnings ratio refers to the ratio of market price of a company’s share to its earning per share. Accordingly, the price earnings ratio of the company has improved over the five years. The increasing trend in the price earnings ratio indicates that the investors are bullish on the stock and are expecting from the company to post higher earnings. The dividend yield is the ratio of a company’s annual dividend compared to its share price. The high dividend yields are stated to be attractive. Lower dividend in the year 2018 has dragged down the dividend yield as well, as compared to the year 2017. 

Conclusion

As per the discussions conducted in the previous parts, it can be concluded that the preparation and the presentation of the financial statements forms the integral part of the businesses. These are essential not only in terms of the fair representation of the transactions and events to the various stakeholders, but also make the entities accountable towards the regulators of the accounting and the compliance provisions. It must further be noted that the analysis of such financial statements assist the stakeholders in gaining the useful information about the business enterprise on the lines of investment, financial wellness and the overall competitiveness in the industry to which an entity relates. The report was an attempt to analyse the financial data of the entity Royal Mail Plc, which is a popular name in the courier and postal service industry. The ratio analysis technique was adopted for the analysis and the same was presented with the aid of the graphical representations. The various ratios gave an insight of the various facets such as the capital structure, the effectiveness of the utilisation of the assets, the ability to pay off the debts and many more.

It has been recommended to the company to manage its short term liabilities and assets in a better way, as the accounts receivable and payable periods are on rising trends, as shown by the ratio analysis. The increasing trend in these ratios is an alarming trend for the entity.

 In addition, a brief evaluation of the market vitals was done. Thus, it can be stated that financial analysis serves a number of purposes for various stakeholders.

References

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Bragg, S. M. (2012) Financial analysis: a controller’s guide. UK: John Wiley & Sons.

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Fabozzi, F. J. and Drake, P. P. (2009) Finance: Capital Markets, Financial Management, and Investment Management. UK: John Wiley & Sons.

Fridson, M. S. and Alvarez, F. (2011) Financial statement analysis: a practitioner’s guide (Vol. 597). UK: John Wiley & Sons.

Gill, A., Biger, N. and Mathur, N. (2010) The relationship between working capital management and profitability: Evidence from the United States. Business and economics journal, 10(1), pp. 1-9.

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Proactive Investors (2018) Royal Mail shares hit new record low as investors react to disappointing numbers from FedEx. [online] Available from: https://www.proactiveinvestors.co.uk/companies/news/211485/royal-mail-shares-hit-new-record-low-as-investors-react-to-disappointing-numbers-from-fedex-211485.html [Accessed on 24 December 2018].

Robinson, T. R., Henry, E., Pirie, W. L., and Broihahn, M. A. (2015) International Financial Statement Analysis Workbook. UK: John Wiley & Sons.

Saleem, Q. and Rehman, R. U. (2011) Impacts of liquidity ratios on profitability. Interdisciplinary Journal of Research in Business, 1(7), pp. 95-98.

Stickney, C. P., Weil, R. L., Schipper, K., Francis, J. (2009) Financial Accounting: An Introduction to Concepts, Methods and Uses. Boston MA: Cengage Learning.

Yahoo Finance (2018a) Royal Mail plc (RMG.L). [online] Available from: https://uk.finance.yahoo.com/quote/RMG.L/balance-sheet?p=RMG.L [Accessed on 24 December 2018].

Yahoo Finance (2018b) Royal Mail plc (RMG.L). [online] Available from: https://uk.finance.yahoo.com/quote/RMG.L/history?period1=1396117800&period2=1522348200&interval=1mo&filter=history&frequency=1mo [Accessed on 27 December 2018].