An Analysis of Working Capital Management Results Across Industries - Term Paper Example

Table of Contents Particulars Page No 1.0 Introduction 2 2.0 Key Financial Ratios 3 3.0 Merits and Demerits of Depreciation 5 4.0 Analysis of Cash Flow Statement of Ted Baker 7 5.0 Business or Shareholder’s View and Discussion of the Key Financial Findings 8 and Ratios 1.0 Introduction Ted Baker PLC is a leading name in the global lifestyle brand with its presence in across five continents of the globe through its distribution channels which includes wholesale, retailing( inclusive of e-commerce) and licensing. The company operates 316 stores on a global basis with 180 stores in UK, 48 in Europe, 53 in North America and remaining in Middle East, Asia and Australia. Ted Baker was founded in 1988 in Glasgow and is a renowned name in apparel industry with its products ranging from men’s clothing, women’s clothing to men and women accessories. The company is listed in FTSE index with its shares trading at FTSE all-share, FTSE 350 Low Yield, FTSE 250, FTSE Mid 250 and FTSE 350. It lies in the personal goods sector of FTSE. Ted Baker PLC group has been successful in achieving strong results across all its business areas which has recently shown an increase in 18% increase in its group revenue in 2013 when compared with 2012. Furthermore all segments i.e. retail, wholesale and licensing has shown increasing trend and contributed equally for the growth of the group. This report has been drafted in a comprehensive manner to make a critical analysis of the financial statement of Ted Baker Annual Accounting results of the 52 weeks ended 26th January 2013,(attached is the annual report of Ted Baker Plc) by help of ratio analysis and making a financial analysis of the performance of the company from business perspective to highlight upon all major factors which influences the business decisions and also impacts investors in their investment decisions (Lyroudi & Lazaridis, 2000). 2.0 Key Financial Ratios Ratios play an important role in evaluating the performance of any organization as they act as unique accounting tool measuring the actual performance of the company and comparing the same with previous year’s data or within the same industry to come to a final conclusion which helps both company and investors in making strategic decisions. An analysis of the Ted Baker’s key financial ratios for the year ended 26th January has been calculated and presented as below.( Note : Attached herewith is an additional file showing all calculations of the financial ratios.) Profitability Ratios This ratios help to determine the profitability and growth of an organization, in terms of measuring its actual performance based on its profitability. Description 2013 2012 Net Profit Margin 8.49 8.14 Total Asset Turnover 1.55 1.62 Gross Profit Margin 62.38 61.31 Operating Income Margin 11.60 11.26 Operating Asset Turnover Ratio 1.73 1.83 Sales to Fixed Asset Ratio 5.60 6.04 Return on Capital Employed 25.00 26.47 Liquidity Ratios This ratio’s highlight the liquidity position of an organization and helps to determine how quickly a firm is able to convert its short term assets into liquidity. Description 2013 2012 Current Ratio 1.72 1.98 Acid Test Ratio 0.68 0.85 Efficiency Ratios This ratios measure the actual efficiency of the firms in utilizing their assets to generate business. Description 2013 2012 Working Capital 47105 45350 Sales to Working Capital 5.40 4.75 Day's Sales in Receivable 48.95 51.78 Accounts Receivable Turnover 7.46 7.05 Accounts Receivable Turnover in Days 48.93 51.77 Days Sales In Inventory 258.00 226.97 Inventory Turnover 1.41 1.61 Inventory Turnover In Days 258.87 226.71 Net Working Capital to Total Assets 28.61 34.07 Fixed Asset Turnover Ratio 2.11 2.34 Current Asset Turnover Ratio 0.85 0.91 Solvency and Gearing Ratios This ratio’s help to determine the long term debt paying ability of a firm and is a important tool to determine the optimal mix of debt and equity in the capital structure of the firm. Description 2013 2012 Debt Ratio 0.40 0.36 Debt/Equity 0.67 0.56 Debt to Tangible Net Worth 0.67 0.57 Cash Flow/ Total Debt 0.27 0.24 Interest Coverage Ratio 45.69 116.68 3.0 Merits and Demerits of Depreciation Depreciation has been commonly used by organizations all across the globe. The Generally Accepted Accounting Principles (GAAP), requires the non-current assets to be depreciated or appreciated as per the prevailing situation which acts as a means of adjusting the net worth of the assets of the financial disclosure. Generally depreciation is carried on using two different methods i.e. Straight Line Method and Written down Method. Discussed herewith are the merits and demerits of Depreciation in Financial Accounting. Merits Depreciation is of prime importance as it helps in reflecting the true and fair view of all depreciable assets as it reflects the current net value of the assets and not future or historical cost of the assets. Depreciation helps in setting aside a cumulative fund from the reserves which is later used to replace the asset thereby lowering the burden of finance during the purchase of a new asset. It is useful and helpful for income tax purposes as the same is recognized by income tax authority as an expense which is later adjusted through deferred tax liability or asset as the case may be. Depreciation further acts as a matching expense, as it helps organizations to fairly state the amount of expense incurred as a result of the use of assets during an accounting period to match with the revenue generated from the use of such assets. Depreciation is further a non-cash expenditure which allows company to fairly reflect their assets at net value with added advantage of cost recovery and tax benefits. Demerits Depreciation can be calculated using different methods for the same assets which gives varying results making it complex for stakeholders to understand the real and exact rate of depreciation (Finance. 2011). Organizations in order to reduce the current year profits may charge a higher rate of depreciation thereby reflecting an unfair and untrue financial statement to its investors. The straight line method of depreciation does not reflect the difference in usage of an asset from one period to another on a correct basis. Depreciation at times due to its complexity may not reflect the necessary matching cost with revenues generated in various types of long-term assets. 4.0 Analysis of Cash Flow Statement of Ted Baker PLC The cash flow statement is an important financial tool as it helps to determine the inflows and outflows of cash for a particular period and further helps to determine where the cash from business has been generated and utilized during a particular period. It helps in proper cash management and highlights the efficiency of the firm in generating cash from its daily business operations. It also helps in determining the various capital investment programmes to determine their viability and profitability in the long run. The cash flow statement of Ted Baker Plc Group highlights that the net decrease in cash and cash equivalents to be same as those of 2012(£11.9 m) however there is an increase in cash generated from operating activities of £6.2m showing efficiency in its working which has been offset by an equal increase in its financing and investing activities showing signs of the company expanding its business and market area (Filbeck, & Krueger, 2005). There has been an increase in inventory £6.4m which is a threat for the company as the same indicates large stock compilations and increase in working capital with threat of dead stock which is common in apparel industry and swipes away a large portion of the profitability of the company. The working capital has increased from £47.2m in 2012 to £61.0m in 2013 showing an increase of £13.8m which is an area of concern for the company and has a direct impact on the liquidity position of the company forcing Ted Baker to introduce more liquid cash so as to ensure smooth flow of its daily operations (Antony, 2004). There has been an increase in the capital expenditure of the company by £4.8m which is mainly on account of new stores to be opened in 2013 and continuous investment in infrastructure and business showing signs of business growth and market expansion. However, liquidity is a concern for the company and the company need to make a pro-active planning to reduce its buffer stock and introduce a JIT system for maintenance of better liquidity. 5.0 Business or Shareholder’s View and Discussion of the Key Financial Findings and Ratios This is one the most important aspect of the entire report as this portion reflects the complete analysis of the entire ratio being calculated and discussed in the aforesaid report. The report looks to present the analysis from the Company Ted Baker PLC Group point of view as the financial report attached with the report provides an understanding of the investor’s view point and so as to ensure more information and knowledge to the readers this segment draw inferences from the Company viewpoint (Saleem & Rehman, 2011). Furthermore a discussion from the company’s perspective shall also enable to target an investor’s analysis viewpoint and provide better understanding and meaning to the entire discussion of the study. Profitability ratios are important tool in measuring the firm’s ability to generate revenue relative to sales, assets and equity and indicate how effectively and efficiently the profits generated by the company are managed. The profitability ratio of Ted Baker Plc Group highlights increasing trend in both gross margin and net margin which has increased by 61.31% in 2012 to 62.38% in 2013 and 8.14% in 2012 to 8.49% in 2013 respectively indicating growing trend for the company along with increase in customer base though increasing revenue. However, the asset turnover ratio of the company has declined from 1.62 to 1.55 in 2013 which is an area of concern as it implies that Ted Baker is generating less revenue per dollar of the asset and its assets are either underutilized or not utilized as per the optimal level due to constraints in demand of the products offered by the company which is again evident from the decreasing trend in the sales to fixed asset ratio. The biggest concern for Ted Baker in terms of its profitability is its decrease in Return on Capital Employed which is a key ratio eyed upon both by company and investors. The return on capital employed has decreased from 26.47% in 2012 to 25% in 2013 which is a minor decrease but may well indicate lowering real profits for Ted Baker (Deloof, 2003). The decrease in mainly on account of increase in its working capital and increase in stock which might result in dead stock and effect the profitability of the company in coming future years. Liquidity ratios play an important role in determining the ability of a firm to meet its short term obligations and liabilities. Ted Baker current ratio has slightly decreased from 1.98 in 2012 to 1.72 in 2013 which is a bit concern for the company however, the company has a strong liquidity position as any current ratio above 1 indicates strong financial position and ability of the company to meet its short term obligations with short term assets( like cash, inventory and receivables). Furthermore the quick or acid test ratio has shown a decreasing trend from 0.85 in 2012 to 0.68 in 2013 which is an area of great concern as the company has already been experiencing a quick ratio of below 1(Industry Standard) which has further declined mainly on account of large increase in stock which is mainly on account of changing fashion style in apparel industry and large stock piling. Ted Baker in order to ensure better acid test ratio should look to install a JIT system and scan market demands in a more comprehensive manner with lower buffer and emergency stock to meet contingency situations. Efficiency Ratios are of great significance as it reflects how long a business takes to revert back the money which it holds. They directly highlight the effective performance of the management in collection of its debts and business operations. The sales to working capital ratio of Ted Baker has increased from 4.75 in 2012 to 5.40 in 2013 which indicates that the firm has a better ability to finance additional sales without incurring an additional amount of debt which may be on account of Ted Baker relaxing the credit requirements to its potential customers to enhance sales, increase in the inventory level to reduce the order fulfillment time cycle or slow payments to its vendors and suppliers so as to hold on cash. The biggest threat here for Ted Baker is its ever increasing days sales in inventory which has increased from 227 days to 258 days indicating huge piling of inventory and large maintenance of inventory level to reduce the order fulfillment time cycle which has lead to an increase in the working capital requirement and has a direct impact on the quick ratio of the company to meet its short term cash obligations (Eljelly, 2004). However, the Accounts receivable turnover in days has slightly reduced from 52 days in 2012 to 49 days in 2013 which indicates that the management is taking crucial efforts to tighten its credit terms and generate cash faster from its debtors. Ted baker should further look to reduce the same and bring it to 40 days which is the industry standard in Apparel Industry in UK. Furthermore the fixed asset turnover ratio and current asset turnover ratio has decreased from previous years which are again areas of concern as the company has been not able to effectively use its investments in fixed assets and current assets to generate revenue (Padachi, 2006). The solvency and gearing ratio highlights the firm’s ability to meet its long term obligations. The debt ratio of Ted Baker has increased from 0.36 in 2012 to 0.40 in 2013 which indicates an increase in debts in relative to its assets however the same is not a big concern for Ted Baker as the same is below industry average of 0.5 and show signs that the company still has ample opportunity to introduce more debts for easy running of its business. The debt equity ratio has increased from 0.56 times in 2012 to 0.67 times in 2013 which indicates that Ted Baker is using less leverage in its capital structure and has a stronger equity position. Furthermore a decrease in debt-equity ratio indicates investing in Ted Baker Plc Group shares as less risky in times of rising interest rates as a ratio below 1 itself indicate that majority of its assets are primarily financed through equity. The cash flow to total debt ratio has also increased slightly from 0.24 times in 2012 to 0.27 times in 2013 indicating a slow but steady progress by Ted Baker in its ability to carry its total debt which the company again need to make efforts to increase the same and come to the industry standards (Gandy, 2011). Thus in a nutshell Ted Baker PLC Group has been performing well in terms of its overall performance. The biggest threat for the company has been the rising stock piling which has a direct impact on its liquidity ratios and increase in working capital requirements (The same has been reflected in the Annual Report of Ted Baker as attached with the assignment.) Furthermore Ted Baker shall need to make the fashion environment scanning on a regular basis to lower upon its buffer stock and inventory piling. The company still has scope to increase leverage in terms of more debts however, the company has been strong in its equity position and shall look to build upon the same (Ray Kelvin CBE, Founder and Chief Executive, Ted Baker Plc Group). The group revenue has increased by 18% along with increase in sales of wholesale, retail and licensing segment of the business( Annual Report, Ted Baker, 2012). Furthermore on the investor side the company has been showing promising signs of dividend payouts and its EPS has increased 42.2p in 2012 to 51.5 p in 2013 as reflected by the Annual Accounts of Ted Baker, 2012 and is a steady deal for investors to invest in the shares of the company. References Antony, T. 2004. Thin Capitalization: Issues on the Gearing Ratio. Journal on Australian Taxation, 7 (1), 39-57 Deloof, M. 2003. Does Working Capital Management Affect Profitability of Belgian Firms? Journal of Business Finance & Accounting, 30(3&4), 573-587. Eljelly, A. 2004. “Liquidity-Profitability Tradeoff: An empirical Investigation in an Emerging Market”, International Journal of Commerce & Management, 14(2), 48 - 61 Finance. 2011. Why business needs finance. Retrieved on May 21, 2014 from http://tutor2u.net/business/gcse/finance_why_needed.htm Filbeck, G., & Krueger, T. M. 2005. An analysis of working capital management results across industries. Mid-American Journal of Business, 20(2), 10-17. Gandy, M. 2011. Is a low current ratio bad? Retrieved on May 21, 2014 from http://www.markgandycfo.com/2011/03/is-a-low-current-ratio-bad/ Lyroudi, K., & Lazaridis, Y. 2000. The Cash Conversion Cycle and Liquidity Analysis of the Food Industry in Greece [Electronic Version]. EFMA 2000 Athens Padachi, K. 2006. Trends in working capital management and its impact on firms’ performance: an analysis of Mauritian small manufacturing firms. International Review of Business Research Papers, 2(2), 45-58. Saleem, Q. & Rehman, R. 2011. Impacts of Liquidity Ratios on Profitability. Interdisciplinary Journal of Research in Business, 1 (7), 95-98 Appendix Calculation of Ratios Profitability Ratios   Year Year Description Formula 2013 2012 Net Profit Margin (Net Profit/ sales)*100 8.49 8.14 Total Asset Turnover (Net Sales/Average Total Assets) 1.55 1.62 Gross Profit Margin (Gross Profit/ Sales)*100 62.38 61.31 Operating Income Margin (Operating Income/Net Sales)*100 11.60 11.26 Operating Asset Turnover Ratio (Net Sales/ Operating Assets) 1.73 1.83 Sales to Fixed Asset Ratio (Net Sales/Average Fixed Assets) 5.60 6.04 Return on Capital Employed (Earning Before Interest and Tax/ Capital Employed) 25.00 26.47         Liquidity Ratios       Description Formula 2013 2012 Current Ratio (Total Current Assets/ Total Current Liablities) 1.72 1.98 Acid Test Ratio (Cash+Marketable Securities+ Net Trade Receivable)/ Total Current Liablities 0.68 0.85         Efficiency Ratios       Description Formula 2013 2012 Working Capital Total current Assets- Total Current Liablities 47105 45350 Sales to Working Capital Net Sales/ Average Working Capital 5.40 4.75 Day's Sales in Receivable Gross Receiveables/(Net Sales/365) 48.95 51.78 Accounts Receivable Turnover Net sales/Average(Gross) Receivables 7.46 7.05 Accounts Receivable Turnover in Days 365/ Accounts Receivable Turnover 48.93 51.77 Days Sales In Inventory Closing Inventory/( Cost of Goods sold/365) 258.00 226.97 Inventory Turnover Cost of Goods Sold/Average Inventory 1.41 1.61 Inventory Turnover In Days 365/Inventory Turnover 258.87 226.71 Net Working Capital to Total Assets (Net Working Capital/ Total Assets)*100 28.61 34.07 Fixed Asset Turnover Ratio Cost of goods sold/ Net Fixed Assets 2.11 2.34 Current Asset Turnover Ratio Cost of Goods Sold/ Current Assets 0.85 0.91         Solvency Ratios & Gearing Ratios       Description Formula 2013 2012 Debt Ratio Total Liablities/ Total Assets 0.40 0.36 Debt/Equity Total Liablities/ Total Equity 0.67 0.56 Debt to Tangible Net Worth Total Liablities/ (Total Equity- Intangible Assets) 0.67 0.57 Cash Flow/ Total Debt Cash Flow From Operations/ Total Liablities 0.27 0.24 Interst Coverage Ratio Earning Before Interest and Taxes/ Interest Expenses 2.68 2.90 Read More