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Assessment of financial health of an organisation or a business is an important function of managers. A major resource that managers use to formulate the plans and formulae for financial allocation to the various departments is the financial data at their disposal. An accurate assessment of this data as pointed by Wood (2012a, p. 7) differentiates between effective and non-effective management in most organisations.
Financial ratios are important in the analysis of financial information in a company since they enable managers to make the most out of the financial information. According to Wood, ratios in an organisation’s financial analysis enable the “evaluation of relationships between component parts of financial statements to obtain a better understanding of a firm’s performance” (2012a, p. 7).
As a follow-up to a previous assignment, the essay will utilise data obtained from the ratio and financial analysis of Jackson Food Group, which is an example of a privately owned company. In the public company category, Marks and Spencer will be analysed.
A comparison between the two will then be made involving the assessment of other companies such as Tesco, which is another publicly owned company. The results will then be used to answer the question of how ratio analysis assists in determining the value of a private and public company.
Marks and Spencer Critical ratio analysis
Mark and Spencer is one of the leading retailers in the United Kingdom. It is involved in the sale of clothing and home products as well as foodstuffs (Smith 2012, p. 4). The company also boasts of a number of retail stores around the world with over 78,000 employees among its ranks.
According to Smith, the company has “703 stores across the UK in high streets and retail parks as well as stations, airports, and other locations” (2012, p. 4). The company is also highly profitable besides being the first retail company to surpass the one billion pound mark in the UK (Marks & Spencer Financial Services plc n.d).
The company has undergone a series of changes with the executives being changed over the years (Interim 2012/13 Marks and Spencer PLC Fixed Income Investor Conference Call – Final n.d.). The company is of interest in this essay because it is listed in the London Stock Exchange, is a constituent of FTSE 100 index, and thus a public company (Smith 2012, p. 4).
The ratio analysis for Mark and Spencer reveals a relationship between the share price and market value of the company over the last three years (Barker 2011, p. 32).
The revenue rose steadily from 8,567million in 2010, 8,733 million in 2011, to reach 8,868 in 2012 (From Marks & Spencer To X Holding: The Future Of Cross-Border Group Taxation 2011). The total operating profit has however been on the decline with 746 million pounds being received in 2010 from a high of 836 million and 853 million recorded in the preceding years (Barker 2011, p. 32).
The basic earnings per share in the three years were 33.5p, 38.8p, and 32.5p respectively (From Marks & Spencer To X Holding: The Future Of Cross-Border Group Taxation 2011). The calculated current ratio over the three years was 0.80 for the year 2010, 0.74 for the year 2011, and 0.78 for the year 2012 (Barker 2011, p. 32). The quick assets ratio was 2.98, 2.58, and 2.49 respectively for the three years (Barker 2011, p. 32).
This observed relationship between the shares and market value was remarkable. The shares seemed to change with the ratios. As Barker claims, the relationship can be expected for any public company of this magnitude (2011, p. 33).
The same can be seen in the credit crunch of the time around the year 2008 when the share prices dipped only to improve with the resolution of the financial problem (From Marks & Spencer To X Holding: The Future Of Cross-Border Group Taxation 2011). The share price dropped from the value obtained for the year 2011 to the value obtained for the year 2012 (Barker 2011, p. 34).
This case was however better than the value obtained for the year 2010, which recorded the lowest value over the three years (From Marks & Spencer To X Holding: The Future Of Cross-Border Group Taxation 2011). The market value reflected the share value the years with the highest being the year 2011 when the share price was relatively high (Barker 2011, p. 32).
The rate of change in the share price and earnings per share over the three years was proportionally related to the dividend cover. The earnings per share were highest in the year 2011 with the dividend cover being lowest in the same year for the three years (From Marks & Spencer To X Holding: The Future Of Cross-Border Group Taxation 2011). This relationship is apparent in many public companies listed in the stock exchange with Mark and Spencer not being any different (Barker 2011, p. 34).
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Public companies have relatively different ratio analysis from private companies mainly due to things such as multiple owners and the issue of share price that have to be satisfied in any criteria used in the calculations (From Marks & Spencer To X Holding: The Future Of Cross-Border Group Taxation 2011). The ratios are similar in the calculation to the methods used for private companies (Barker 2011, p. 32).
Jackson Food Group Critical Ratio analysis
In the formative assessment, an evaluation of the ratio analysis for Jackson Food Group was made. The current ratio for the company was almost in the same range as that for Mark and Spencer with the year 2010 having the highest at 1.6 and 2011 having the lowest of the three at 1.5 (William Jackson Food Group acquires Abel & Cole: Deal In Brief 2012).
The year 2012 had a current ratio of 1.4. The quick ratio had the same trend. As Wood (2012b, p. 13) points, the trend observed in the public company was not evident here since the ratios were mot proportional to each other. Besides, the share prices were missing.
The gross and operating margins were reported to be on the rise over the three years used for comparison (William Jackson Food Group acquires Abel & Cole: Deal In Brief 2012). The same trend was apparent for the previous years since the year 2007. The trend can be used to predict the changes to be expected in a bid to make any interpretations from the data.
The trend observed in the private company was compatible to that of the public company with the exception of the under established share price (William Jackson Food Group acquires Abel & Cole: Deal In Brief 2012). Jackson Food Group is privately owned. The ratio analysis provides the owners with the best opportunity to evaluate their methods in an attempt to use the results to improve on output as confirmed by Wood (2012b, p. 13).
Ratio analysis is also important to them in that it predicts the performance in the period of years to come (Watson 2010, p. 28). For the public company on the other hand, the owners are diverse. The information is useful to managers in the implementation of the set out goals (Wood 2012b, p. 13).
The ownership is also by many members. As it is in the private company, the ratio analysis has a role to play in the prediction of future performance as in the Mark and Spencer case (Watson 2010, p. 22). The profitability ratios obtained from the company are important in the provision of “information on the amount of income from each dollar of sales” (Watson 2010, p. 28). Based on this exposition, Jackson Food Group improved in the returns over the five years analysed.
This was the same for the public company analysed. The shareholders’ ratio was also important in the analysis made on Jackson Food Group. It was also important in comparison with Mark and Spencer (William Jackson Food Group n.d.).According to Watson, a shareholder ratio describes the “company’s financial condition in terms of the amount per share of stock” (2010, p. 28).
Similarities and Differences
From the analysis of the two companies, differences emerge based on the ratio analysis carried out for each. The liquidity ratio for the public company showed a trend in the ability of Mark and Spencer to meet the immediate and short-term obligations (Arnold 2009, p. 93).
As Norton states, the ability of a company to meet these obligations can effectively be evaluated by the use of the liquidity ratio (2012, p. 10). The profitability ratios reflected differently for the two companies. However, the trends were similar and could accurately be used to assess the income from sales in both companies.
The shareholder ratio was effectively assessed for the private company. It revealed a positive trend in the share price (Arnold 2009, p. 93). A difference in the two companies based on this ratio is that, for the public company, there was a negative relationship between the share price recorded for a year and the dividend cover. The private company posted a positive relationship between the share price and the dividends with this relationship being expected for the same company (Arnold 2009, p. 93).
There are a number of significant differences in the ratios for the two companies, which reflect the known differences between a private and public company (Gareth 2012, p. 31). The financial leverage ratio for the different years for the two companies is similar. This ration may help in the provision of information “on the degree of a company’s fixed financing obligations and its ability satisfy these financing obligations” (Gareth 2012, p. 31).
The public company has multiple shareholders concerned with the running of the business. They may be more important to them as compared to a private company (Gareth 2012, p. 33). Another significant ratio that was assessed for the companies, though indirectly, was the return on investment ratio. For the three years used in the analysis, a trend was apparent for both companies with the public company having an increasing value (Arnold 2009, p. 93).
Other UK companies supporting findings
Based on the need to compare the findings of Mark and Spencer to another public company, other public companies were also assessed. They showed the same trends obtained in the Mark and Spencer case (Tesco Corporation SWOT Analysis 2012). One of the public companies that showed a significant relationship to Mark and Spencer is Tesco (Wood 2012a, p. 7), which had similar ratios to those obtained for Mark and Spencer with an inverse relationship being identified on the share price and the market value.
Tesco had ratios that closely resembled those obtained for Jackson Food Group that represented the private companies. The current ratios for the three years were 2.5, 2.48, and 2.58 respectively thus representing a higher value than for the private company though with a similar trend (Tesco n.d).
The ratios obtained for Tesco were related to the trend expected for a public company. They were in a close relationship to those for Mark and Spencer (Wood 2012a, p. 7). This finding proves that there is little difference between the ratios for privately and publicly owned companies since the use of these ratios is however similar for both sets of companies (Canada 2012, p. 13).
Usefulness of Ratio Analysis Established
From the ratio analysis for both the private and public companies, there are a number of uses of the ratios for instance in improving the performance of the business and or assisting in informed decision making in matters business (McLaney 2011, p. 13). According to McLaney, financial ratios are important in any business and that managers should adapt a culture of analysing them regularly (2011, p. 13).
A number of uses and advantages of carrying out a ratio analysis in a company from the two companies is the efficiency in the evaluation of the ability of a firm to meet its obligations (McLaney 2011, p. 13). For the above companies, the analysis of the ratios could inform the managers and executive members in administration on whether their companies would be able to meet the goals set in their strategies.
Another use of financial ratios is to “interpret the performance of the firm over the period covered by the financial statements” (McLaney 2011, p. 15).
In the cases above, the managers could interpret the results of their respective companies for the past three years as a guide in decision-making. Managers also need tools to predict the performance of their companies in the future. Financial ratios present them with a reasonable way of doing this task as supported by Norton who states that financial ratios are important in “predicting future performance of the firm” (2013, p. 18).
Another use of these ratios is also stated as enabling business owners to “establish the extent, which the assets of the firm have been financed by a fixed charge capital” (Norton 2013, p. 18). This extend can be interpreted from the ratios such as those provided for the public and private companies above.
Another use of the ratios is in comparison making (Norton 2013, p. 18). Comparisons can be made on different areas of a company with the performance of other companies in the same industry. As McLaney states, “Cross sectional analysis can be made where the performance of the firm in question is compared with that of individual competitive firms in the same industry” (2011, p. 13).
Apart from cross-sectional analysis, a manager also needs to know how different parts of the organisation are performing. This case involves comparing them with other branches of the company elsewhere. Another comparison that can be made using the data obtained is a time series analysis (Jagupilla, Vaccari, & Hires 2010). According to McLaney, “the firm’s performance is evaluated over time” (2011, p. 17).
Limitations and Solutions
There are several limitations in the use of ratios in financial analysis. One is that the ratios are computed at a specific point in time. They may therefore not be reliable in making an impression of the whole financial year (Introduction to Management Accounting 2012).
They also ignore the effect of inflation and its relationship with business performance, “which is a vital part in the daily business management” (Arnold 2006, p. 41). As in the cases above, comparisons are made for firms, which have different levels of utilisation of technology and the size of their turnover (Norton 2013, p. 18). According to McLaney, “the different accounting policies applied by firms in similar industries say in depreciation calculation are a hindrance to comparison” (2011, p. 16).
These problems can easily be overcome by using current ratios and regularly making the calculations to avoid misleading results. Comparison of similar sized firms may not be possible. However, comparisons may be made in companies having close profit margins.
In conclusion, ratio analysis is an important function of managers. It may be used to determine the value of both private and public companies. The case above features the comparison of a private and a public company with few differences in the ratios being demonstrated. A comparison with other public companies reveals a similar trend. Some of the limitations to the use of these ratios have emerged. However, they are countered by the wide use that the ratios can present.
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