Financial Performance and Investment Recommendations for Healthcare Holdings - Report Example

• Executive Summary

The report is conducted to analyze the financial performance of Healthcare Holdings Plc and to evaluate the investment appraisal of the company in order to make suggestions and recommendations for the management for its business expansion in U.S. The financial performance analysis shows that the profitability of the company was improved in 2015 as compare to 2014 with the controlled expanses. However, the financial position and efficiency of the company was not good in 2015. The business expansion in U.S. and heavy investment are found as the major reasons for the negative financial performance. However, it is expected that with mature operations in U.S, the company would recover its profit margin, efficiency and cash cycle. The investment appraisal techniques used by the company showed that the investment is acceptable; however, the company did not consider risk factors into account while making heavy investment for long term in U.S. Therefore, it is suggested to the company that it is also required to consider risks analysis and risks management along with corporate governance. In addition to this, the company is suggested to make investment from its internal finance sources include retained earnings and cash from internal members.

• Business Financial Performance Analysis
  • Interpretation of the Statement of Profit and Loss

Sales

The profit and Loss Statement of Healthcare Holding Plc for 2014 and 2015 is reviewed that shows the good performance of the company. The net revenue had increased to £39,678,000 in 2015 from £36,918,000. As it is a service providing organization, therefore, there is no cost of goods sold but there is alternative cost of service that includes the employee expenses. The profit and loss statement also revealed that cost was also increased with the increase in sales as the expenses of employees had increased by 8.13%. The market development is one of the major reasons for the change in sales as the company has recently expanded in the market of U.S in the same fiscal year that made the company enable to have a new source of revenue and profit. The demand of the service of the company is expected to be further increased with its market expansion. The quality of service is another reason that could be further improved as the cost and expenses of employees are increasing. The quality of services could be improved by increasing both quantity and quality in the service of physicians. The service quality is very important for the satisfaction of the patients to attract the potential patients to increase the profitability. However, the net revenue is shorter than the sales of the company as the net revenue growth is 7.48%, it means that the company is failed to manage its doubtful debt that had increased in 2015 due to the US health reforms.

Expenses

It is revealed in the review of the expenses that the major proportion in the total expenses was hold by employee expense. More than 50% of the total expense is covered by salaries of staff, while, 20% is covered by suppliers and 20% by C&T. The salary expenses were increased by 2% in terms of their proportion in the total expenses as can be seen in the graphs.

The proportion of employees might be increased due to the focus and strategy of the company in line with the service quality improvement to be the leader in the market. This strategy could be attained by the increase in the number of qualified and skilled professionals with high salaries and payments. The research cost proportion is however declined from 22% in 2014 to 20% in 2015. It means that the rising cost of employee expense was controlled by reducing the research cost. The employees were considered as more responsible to maintain the performance and profitability of the company.

The company has made efforts to manage the expenses in order to have sustainable profit growth. The total expenses as can be seen in the graph have increased by 5% in 2015. The legal claims are the major cost that was increased by 219% in 2015 to £249000 from £78000. The legal costs might be increased due the new legal and regulatory system of U.S. as the company expanded in U.S market during 2014 and 2015. The company might be unfamiliar of the legal environment of the new market. Although, the total expenses were increased, however, the proportion in the total revenue is low. It may be caused by the decline in the expenses of research by 7.20% to cover the increased expenses of employee, suppliers and depreciation. These costs were increased in order to provide the excellent quality service in U.S market.

Profitability

The gross profit margin is declined by 0.58%. Although, the revenue of the company increased, however, the gross profit margin declined. One of the major reasons for this decline is the increase in the employee expanses to improve the quality of the service.

However, the overall profitability of Healthcare Holdings Plc was improved in the year 2015 due to the rise in demand on its expansion in the U.S market and the control of the overall expanses. The net profit margin of the company has increased by 1.27% from 2014 to 2015. The net profit margin is increased even with reducing gross margin as the other expenses were controlled and their proportion was reduced in relation to the revenue of the company and the overall demand of the quality service.

Returns

ROE (Return on Equity) and ROCE (Return on Capital Employed) were reduced by 4.73% and 0.43% respectively. The decline in the returns is mainly occurred due to the heavy investment made by the company to expand its business in the market of U.S. Therefore, the company made less profit in 2015. Another reason could be the incomplete operations of the company in U.S. It means that with the fully operated investment and mature operations in U.S, the future returns would be expected to be increased. As the financial performance for now was only affected by the increase in employee expanses caused decline in the gross profit margin, therefore, the company can control its profitability by further controlling and reducing its expenses and to maintain the profitability. However, it is not possible for the companies to make the initial stage of the business expansion and growth profitable.

• • Statement of Financial Position

Liquidity and Gearing

The current ratio and acid test ratio in the graph below shows that the liquidity position of the company is very strong. The current ratio was increased from 1.37 in 2014 to 1.46 in 2015. It means that the ability of the company to cover its short term liabilities and loans has increased in 2015. The recovery of the debt could be a major reason for the improvement in the current ratio. The quick ratio also shows the improvement by 0.06 increases from 2014 to 2015 (See Appendix). The quick ratio was improved as the company’s sales were increased and the company paid its short term bills quickly.

The company is more dependent on the creditor financing and loan as the debt to equity ratio has increased from 48% to 60%. The investors owned more than 50% in the total assets of the company; however, it was declined to 40% in 2015. The improvement in the performance could be one of the major reasons for why banks and financial institutions provided more loans to the company. In addition to this, the heavy investment to expand the business in U.S could be another reason for the increase in debt to equity ratio as the company might be invested the finances of creditors. The increase in debt caused the decline in the interest coverage. The interest coverage in times was reduced to 2.83 in 2015 times from 3 times in 2014. The increase in loans means the rise in the interest cost, however, it is already mentioned earlier that the company was not profitable for its initial investment. It means that the future profitability could improve the interest coverage ability of the company.

Efficiency

The inventory turnover of the company was declined in 2015 by 0.29 from 2014 to 2015. One of the major reasons for the decline in the inventory turnover is the increase in the inventory holding period. The days of inventory were increased from 74.55 days to 79.13 days as can also be seen in the graph above. There could be two reasons for increase in days includes change in sales and change in inventory. As the sales were increased, it means the change in inventories was the major reason for the rise in days. It means that the company’s efficiency was reduced to recover its inventory as quickly as possible (See Appendix). As the company moved in the new market of U.S., it is not possible to control the inventories in its beginning .Therefore, the maturity of operations and rise in demand in U.S could improve the inventory turnover and reduce the inventory days in future. The receivable days also shows that the ability of the company was changed to collect cash from the customers in 2015 as compare to 2014. The Healthcare Holdings Plc received payments from private insurers and individuals; however, the expansion in U.S market also accounted the government as the federal insurer. This could be the reason for the increase in receivable days. The days of payable were declined from 112.78 to 106.45. The increase in days of receivable could be the major reason for the decline in the payable days as the company receiving cash late, therefore, paying late to its suppliers.

• • Statement of Cash Flows

Healthcare Holding Plc was remained the rich in cash firm in the previous years before 2015. However, the cash of the company decreased in the year 2015. It was the cash richness that helped the company in past years to pay dividends to its shareholders on their investments. It means that the company’s ability to pay dividends was declined in 2015. The source of cash inflows is the profit of the company, however, the cash outflows for many activities include heavy investments, purchase of property and plants and increase in inventory. The cash went down in 2015 due to the heavy investment in property, plant and equipment to expand business in U.S. In addition to this, the receivables were also accounted in one of the reasons for cash decline as the company was receiving cash late while paying for inventories earlier.

The graph below shows the Operating Cash Cycle where it can be seen that the days were increased to 33.39 in 2015 from 18.07 in 2014. The cost of supplies is needed to be controlled to control the OCC of the company. The cost of supplies is selected to analyze the cash in respect to the analysis of inventory. It could be expected that the improvement in operations in U.S would help the company to pay high dividends to the shareholders with the recovery of the investment and cash.

It is important to mention in this case that the oeprating cash cycle that uses efficiency ratios specifically relies on the cost of sales and inventory levels. Being service industry the specific cost of sales is not present; hence, it was suggested using employee expenses in place of the cost of sales. However, for the inventory ratios, in place of cost of sales, the information related to the supplies was used for analysis. Considering employee expenses in place of cost of sales has a limitation employees in a busines incur both direct and indirect cost, for example, the administration related employees who are not directly associated with the production of service should not be technically included in the cost of sales. However, companies do not provide such extended information about each employees which limits the ability in clearly using exact cost of employees associated with the service.

• • Market Segment Analysis

Segment Analysis in Respect to Global Market

There are three segments of Healthcare holdings include UK, US and Scandinavia. The graphs below shows that the proportion of U.S in global market revenue, operating expenses and operating profit has increased in 2015, while the proportions of other segments were declined. It means that though U.S is the inferior market due to lowest revenue but the segment performance has been improved in 2015. The demand of the service of Healthcare Holdings in the U.S market could be one of the reasons for the rise in the proportion of U.S.

Segment Ratios

Reviewing the segmental financials of the company, it is revealed that the performance of the company in all three segments is good. However, due to the rise in revenue of U.S. the gross profit margin of U.S market has increased in 2015 while, gross margin of Scandinavia was declined. On the other hand, the net profit margin and operating margin of U.S has declined while increased for other two markets. The increase in the expenses in U.S market to improve quality and quantity could be the major reason for the decline in the net profitability. However, the improvement in the operations and demand in future will give rise to the net profitability of U.S. segment and it is expected to be the superior segment in future.

• 2. Investment Appraisal
  • Management Forecast

The management of Healthcare Holdings Plc used 10 years forecasting for investment appraisal to expand business in U.S. The purpose of the forecast was to review of the investment. For this purpose, the management forecasted revenue and cost (including employee expenses) in the U.S market for 10 years. Although, the forecast of the management is telling that what is going to be happened in U.S. with the investment, however, the forecast period is very long and the management did not consider any change and uncertainty. Who sees that what will be the conditions in the next 10 years?

• • Investment Appraisal Techniques
    • 2.2.1 Payback Period

The management of the company used payback period for the investment appraisal to evaluate that when the company would recover its initial investment in U.S. The management forecasted that the investment would be recovered in 4 years 3 months. It means that the company is expecting to make profitability from the fifth year of operations. The investment of the company is justifiable as the payback period of the investment is reasonable. The investments with rapid period are acceptable as compare to the longer payback period in order to avoid risks to the investments. It means that the investment in U.S is acceptable. However, the payback period technique has some drawbacks to use to appraise the investment such as it is not significant to analyze the cash inflows that could impact the overall profitability of the investment.

• • • 2.2.2 Accounting Rate of Return

Another technique of investment appraisal is Accounting Rate of Return to forecast the profit and returns on the investments made. The accounting rate of return in exhibit 3 shows that the company forecasted 99% returns on 10 years investment in U.S. For the long term investments, the rate of return must be above 80%. It means that the investment to expand business in U.S. is acceptable with 99% rate of returns. However, the complete reliance on rate of return could be threatened as it excluded all the uncertainties, external impacts and systematic errors that could impact the entire operations performance of the company. The risks chances are high for the long term projects that are not taken into account in the accounting rate of return.

• • • 2.2.3 Net Present Value

The net present value (NPV) is another technique of investment appraisal to assess and justify the investment by evaluating the profit on the invested money. The net present value in exhibit 3 shows that the Net Present Value of investment made in U.S. is positive. It means that the investment in 10 years would be profitable. The company considered 15% cost of capital that is considerably high. It means some risks factors are also taken into consideration while forecasting profitability using NPV as many external forces could be emerged such as inflation, currency impacts, volatility and pricing war etc. In addition to the discount rate, the management of the company also determined the percentage of NPV per initial cash outlay of 100% in making investment decision of business expansion in U.S. The forecasted results of NPV show that the investment is feasible and viable as the calculated percentage of 128% is higher than the expected percentage of 100%. It means that the results are more exceptional and above the set target of the company. However, the techniques used is more dependent on the heavy estimations and assumptions and therefore, there could be many errors occurred in the appraisal.

• • 2.3 Non Financial Factors

of the investment appraisal techniques that the company did not take the risk factors into account. Therefore, the management of the company is also needed to identify, assess and evaluate the existing and potential risks to the heavy investment and business expansion in U.S. The risks identification would help the company to address the potential challenges and uncertainties ahead in the U.S operations.

In addition to the risks management, another important non financial factor is corporate governance. Keeping the regulatory and social environment of U.S in mind, it is important for the management to align its corporate governance with this environment. Regardless of generating revenue, making profitable investment and generating outstanding returns, it is also important for the company to ensure good governance. All the rules, regulations and codes of conduct must be followed and the business must ensure the sustainability. The business must have positive impacts on the environment, society and economy of U.S. It would be helpful to develop a good reputation and image of the company in the market.

• • 2.4 Source of Internal Finance

There are two alternative finance sources that could be used by the company to finance its investment. These two internal sources include retained earnings and members’ contribution. The retained earnings is one of the most significant alternative options for Healthcare Holdings to invest in the U.S as it is the savings of the company after paying dividends and taxes to make further investment in the business. Taking investment from the retained earnings has multiple benefits. First and most important one is it saves a cost, for example, the cost associated with the developing a feasibility and costs associated with marketing the proposal to the potential investors. Furthermore, the cost of debt or the interest rate is saved in case of debt while in case of equity dividend cost is also saved. Second, it also saves the further dilution of control that increases in case of equity financing and solvency risk that usually increases with debt financing. However, the use of retained earnings can impact on the stock value of the business as the shareholders and investor might consider the business as risky due to the low and no payments in terms of dividends to their investments. Therefore, it can influence the stock value of the business. Furthermore, the retained earnings are kept with the business for unexpected events; therefore, using retained earnings can reduce the firm’s strength in dealing with any unforeseen challenge.

The contribution from the members of the board is another alternative option for internal financing to the investment. It is significant for the company to have funds from the internal members as they have more information and trust about the company and its investment assumptions. However, the contribution from the internal members can give rise to the conflicts and lack of control due to the high involvement of each member contributed. However, these two alternative options of internal finance could be used by the company to finance its investment in U.S by controlling their side effects and drawbacks.

• Appendix

Expenses

Total expenses growth

5.0%

Clinical research

-7.2%

Supplies:

6.0%

Employee expenses

8.13%

Legal claims costs

219.21%

Depreciation

4.67%

Interest cost

24.2%

Individual Expenses

2014

2015

Change

C&T

19.42%

16.75%

-1.15

Supplies

16.96%

16.73%

-2.3

Employee

45.07

45.65

0.58

Legal claim

0.21

0.62

0.41

Depreciation

4.93

4.80

-0.13

Efficiency

2015

2014

Change

Inventory turnover

4.61

4.90

0.29

Inventory days

79.13

74.55

4.76

Receivable days

60.61

56.30

4.31

Payable days

106.45

112.78

6.33

OCC

33.29

18.07

15.85

Operating Cash Cycle

Liquidity & Gearing

2015

2014

Change

Current Ratio

1.46

1.37

0.09

Acid test/quick ratio

1.20

1.14

0.06

Debt/equity Ratio

60.0%

48.76%

0.11

Capital Gearing

62.46%

67.22%

4.76

Interest cover(times)

2.83

3.00

0.17