Executive Summary
The following report is the financial analysis of BAT International Company in the form of ratio analysis for the three most recent financial years. In addition, an analysis of similar ratios has been done for two of BAT’s main competitors, Imperial Tobacco International and Philip Morris International. A critical analysis of the ratios shows that BAT has had a positive performance trend over the last three financial years and most of the ratios depict superior performance. Consequently, the report recommends to potential investors to purchase the company’s shares at any opportunity. To the existing shareholders, the report recommends that they maintain their shares as the trend in the financial performance of the company suggests future financial success which is likely to maximise their wealth.
Introduction
The main reason for the existence of companies is to create a stream of benefits to its shareholders throughout the life of the business. The investors expect the business to be operational for an indefinite period. The stakeholders of companies have varying interests in the business depending on the types of relationships they have with the business. For instance, ordinary shareholders invest their money in the business expecting to get returns in the form of dividends and appreciation of their share prices (Swart 2002). The lenders are interested in the liquidity position of the business to have confidence in the ability of the business to repay the amounts borrowed.
Every company is obliged to prepare its annual reports to communicate with its stakeholders about its operational progress (Grundy, Johnstone and Scholes 1998). The most common financial statements are the income statements, the statements of financial position and the statement of cash flows. These statements contain the various variables of operations such as the incomes and expenses as well as the assets, capital and liabilities of the business.
However, in their current form, the financial statements do not provide sufficient information to their users for purposes of making decisions regarding their future relationship with the company. It is due to these shortcomings that financial analysis of the financial statements becomes necessary (Crowther 2007). The most common analysis of the financial statements is ratio analysis.
This report explores some of the financial ratios for BAT Company, an international cigarette manufacturing company with headquarters in London, Great Britain. An interpretation of the ratios is given. The ratios are then compared with similar ratios for two of the company’s main competitors; Imperial Tobacco International and Philip Morris International, to give a comparative indication of the performance of the company. Based on these ratios, investment advice is then given to the current and potential investors of the company.
Ratio Analysis of BAT Company and its Competitors
Ratio analysis of financial statements of companies is important for purposes of enabling the company’s stakeholders to make informed decisions about their future engagements with the company (Besley & Brigham 2008). The stakeholders include the stockholders, creditors and lenders, the government as well as potential investors. Ratios are usually classified into several classes that include profitability, liquidity, financial leverage, investors and turnover ratios.
Profitability ratios are used to measure the effectiveness of management as is shown by the returns generated from sales and investment. Liquidity ratios show the company’s ability to pay its creditors on time. Leverage ratios show the proportion of the company’s resources that constitute debt. Turnover ratios show the firm’s effectiveness in using its assets to generate sales. Investors’ ratios are used to show the overall performance of the company (Peterson & Fabozzi 1999).
The ratios to be discussed in this report include the current ratio, return on equity, return on assets, net profit margin, debt to equity ratio, debt to asset ratio, times interest earned and earnings per share. The table below shows an analysis of these financial ratios for three competitor companies in the Tobacco industry; the British American Tobacco Company, Imperial Tobacco and Philip Morris International Company.
A critical interpretation of the ratios
The current ratio is used to show the ability of the company to pay amounts owing to its creditors on time (Peterson & Fabozzi 1999). A current ratio of above 1 is an indicator that the company can meet its creditor payment deadlines on time. The current ratios of BAT as calculated above are desirable and portray a positive trend. The return on equity ratio measures the financial returns of the company that emanate from using shareholders’ funds. The positive returns for BAT are an indicator that the company is profitable. The persistent increase in the ratio over the last three financial years is a positive trend that suggests superior performance in the foreseeable future.
The return on assets ratio is an indicator of the profitability of a company about the total assets of the company (Grundy, Johnstone and Scholes 1998). The persistent increase of this ratio for BAT for the three years is an indicator of the superior performance of the company. The net profit margin measures a company’s ability to effectively control its production, operating and financing expenses. In BAT Company, the persistent increase is positive for the shareholders of the company. The debt to equity ratio shows the number of funds supplied from outside the company expressed as a percentage of owners’ supplied funds. If this ratio exceeds 50%, the company is highly geared. In respect of this ratio, BAT Company is a highly geared company and the trend is adverse to the company.
The debt to asset ratio shows the proportion of a company’s assets financed by outside sources (Gibson 2009). For BAT Company, this ratio indicates that a large proportion of the company’s assets are financed by debt, and the trend is deteriorating. The time’s interest earned ratio measures how many times the profits from operations can be used to meet future interest charges, or the company’s ability to honour its debts in the form of finance costs. The ratio is positive for BAT and the trend is still promising. The earnings per share is a measure of the returns from each ordinary share in the company. A higher figure is an indicator of superior performance. The earnings per share for BAT indicate good performance and the trend is also positive.
Comparison of the ratios with those of competitors and industry averages
Compared with its two main competitors, that is, Imperial Tobacco and Philip Morris International, British American Tobacco seems to be exhibiting superior performance. In terms of the current ratio, only BAT has a positive ratio, the rest are insolvent. The return on equity and the net profit margin of BAT is also superior to that of the two competitors. The return on asset ratio is also strong, but less than that of Philip Morris International. The debt to equity ratio is adverse compared to the industry average of 50%, but it is still superior to that of its competitors.
The company is also highly geared as indicated by the debt to asset ratio, which is negative from the eyes of the lenders. The ratio is, however, better than that of its competitors. The times interest earned ratio for BAT is also superior, although Philip Morris International has better ratios. The earnings per share of the company are also superior to those of the Imperial Tobacco Company over the three years. However, Philip Morris International achieved better performance (its figures are in US Dollars).
From this analysis, it is clear that for most of these ratios, BAT International Company elicited positive outcomes and trends compared to its competitors. For potential investors seeking to commit their resources to purchase shares in a profitable company, BAT is a good choice. For the current shareholders, it is recommendable to maintain their ownership in the company as there is a trend towards superior performance.
Consideration of ethical and corporate social responsibility issues
The tobacco industry has had a large share of challenges and is highly regulated because of the many ethical concerns involved. Tobacco intake is regarded as a health concern as the products have direct health implications for the consumers as well as those around them. BAT Company shows responsibility towards the consumer by giving them information about all the possible negative effects of using the products on the packaged cigarettes. Furthermore, consistent research and development in the company geared towards harm reduction have been employed leading to the production of e-cigarettes.
References
Besley, S. & Brigham, E. F., 2008. Essentials of managerial finance. 14 ed. Mason: Thomson/South-western.
Crowther, D., 2007. Managing Finance. 2 ed. Oxford: Elsevier Butterworth-Heinemann.
Gibson, C. H., 2009. Financial reporting & analysis: using financial accounting information. 11 ed. Mason: South-Western Cengage Learning.
Grundy, T., Johnson, G. & Scholes, K., 1998. Exploring strategic financial management. New York: Prentice Hall.
Peterson, P. P. & Fabozzi, F. J., 1999. Analysis of financial statements. New Hope: Fabozzi.
Swart, N., 2002. Personal financial management. 2 ed. Lansdowne: Juta.
Appendices
Appendix 1: British American Tobacco’s Income Statement extracts for the three years ended 31st December 2011, 2012 and 2013
Appendix 2: British American Tobacco’s Statement of Financial Position extracts as of 31st December 2011, 2012 and 2013
Appendix 3: Imperial Tobacco’s Income Statement extracts for the three years ended 30th September 2011, 2012 and 2013
Appendix 4: Imperial Tobacco’s Statement of Financial Position extracts as of 30th September 2011, 2012 and 2013
Appendix 5: Philip Morris International’s statement of income extracts for the three years ended 31st December 2011, 2012 and 2013
Appendix 6: Philip Morris International’s statements of financial position extracts as of 31st December 2011, 2012 and 2013