Organisations Chosen and Their Industry
The organisation selected is Persimmon PLC, which will be compared to an organisation in the same industry, Redrow PLC. Both firms operate in the construction industry and a vertical/horizontal analysis will be conducted to determine which firm is the optimal investment. Presently such industry is operating in an extremely vulnerable external environment especially in light of the financial crises and economic recession that are afflicting England and the rest of Europe. Therefore particular attention should be devoted to the financial health of the firm before conducting any investment.
The financial analysis shall be divided into three main sections, being financial performance, financial position and financial stability. 1. 1 Financial Performance of Firms Selected During the years under consideration Persimmon managed to attain a higher profitability level denoted by an increase in net income of 4. 14%. This rise is substantiated by the increasing operating profit margin computed in the latter section of this paper, which outlined that the profit generated out of every ? 100 of sales increased (Randall 1999, p 464).
Despite a rise in profit level, the efficiency of management in resource utilisation diminished as portrayed by a decrease in the return on capital employed (Randall 1999, p 463). In
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In this respect the fall in the return on capital employed is arising from lower effectiveness in resource utilisation. Indeed management should be acclaimed for their improving expenditure efficiency outlined in the operating profit margin ratio. In 2006 Persimmon acquired a subsidiary undertaking for ? 508. 5 million as highlighted in the Cash Flow Statement. There is the possibility that management have not yet attained effectiveness in such firm leading to the aforesaid fall in return on capital employed and return on assets ratio. This may arise due to conflict, organising and controlling problems.
On the contrary Redrow encountered a fall both in the operating profit margin and return on capital employed. However, the return on assets increased. In this respect the financial problems of Redrow stem from cost efficiency rather than resource utilisation. This indicates the need of cost control measures to ensure a sound efficiency in the company’s operations. Both Persimmon and Redrow are encountering problems concerning profitability on different facets. However, all the profitability ratios of Persimmon are significantly higher than those of Redrow. Such prominence is also outlined in the higher profit figure for Persimmon.
This indicates that Persimmon is better both in efficiency, resource utilisation and holds a greater market share than Redrow. 1. 2 Financial Position of Persimmon and Redrow Both organisations are facing a falling trend in liquidity ratios. The current ratio, which outlines the ability of current assets to cover current liabilities, has decreased for both firms. However, a good ratio is noted for these corporations. This argument does not apply to the acid test ratio, which denotes the capability of the most liquid assets to cover the current liabilities (McKenzie 2003, p 205-206).
Redrow holds a higher percentage of inventory on total current assets as denoted in Table 1 above. In fact, the acid test ratio of this company is lower than that of Persimmon. A low acid test ratio is highly risk on a liquidity facet, because inventory is the least liquid in cash terms outlining the risk of cash problems. Such issue is further compounded by the fact that the percentage of inventory is at an increasing trend as outlined by the horizontal analysis above. This is particularly the case for Persimmon, which have a 16.
04% increase during the period under consideration. An examination of the cash flow also fails to provide positive results for both companies. Persimmon is capable to generate cash from operating activities, which is a good variable. However the net cash from operations diminished by 66. 83% from 2006 to 2007. This seriously hindered the cash and cash equivalents balance, which ended up in an overdraft of ? 48. 8 million in 2007. The cash flow picture of Redrow is even worse.
Both in 2006 and 2007 the company was not able to generate cash from operations after deducting interest and taxation (Blake 1997, p 13). Indeed a net cash outflow from operating activities occurred, which even increased by 280% during the time frame chosen. Indeed this company also holds a negative cash and cash equivalents. Such figures portray an increasing risk of cash flow problems for both companies. Cash is regarded as the life blood of the organisation. A company without profits can survive a year or two.
However, without cash it can perish in a few months. Therefore management ought to adopt hands on approach in order to mitigate such issue. Due to the considerable materiality of the inventory figure a particular ratio was adopted that examines the number of times stock is turned over. The higher this ratio the better the stock management, because it diminishes the risk of stock obsolescence and reduces the money tied up in stock, which is an important factor as noted in the previous paragraph (Wood et al. 2002, p 377).
Such figure is not positive for both companies because it is dropping, which also amalgamates with the cash problem noted above. Suggestions that can be provided to both firms to stimulate cash is to adopt sound credit control policies and reduce the inventory level, which is tying significant cash. Again the ratios of Persimmon are better than those of Redrow, with the exception of the current ratio. Persimmon also holds a better cash flow, even though weak as outlined in the previous paragraphs. This thus puts Persimmon above Redrow on the liquidity aspect.