FINANCE FOR MANAGERS SEMESTER 1 2011/12

ASSIGNMENT 1

Part A.
The primary financial statements produced by a wide range of entities are the balance sheet, the income statement and the cash flow statement. These statements taken together provide the essential data required to analyse the financial position and performance of a business. The balance sheet, also known as the statement of financial position, presents the accumulated wealth of a business at a particular point in time, as well as the form in which this wealth is held (Atrill and McLaney). It also shows how finance has been raised and how it has been deployed. The income statement – or profit and loss account, as it is sometimes called – presents how much profit (or loss) a business has generated during a period of time (Atrill and McLaney). The income statement links to the balance sheet at the beginning and end of an accounting period. Finally, the cash flow statement shows the sources and uses of cash during a particular period (Weetman). It explains changes in the cash position caused by operating, investing and financing cash flows. These three financial statements will have to be used in conjunction one with another to provide a grater picture of the financial health of the business. The ‘current assets’ is one of the most meaningful items to be analysed in the balance sheet for a company like Marks and Spencer. It includes ‘all the resources that are reasonably expected to be converted into cash within one year in the normal course of the business’ (Weetman). It is important to look at the current assets in relation to the current liabilities to get a feel for the company’s liquidity. This is, the company’s ability to meet its short‐term obligations, such as its working capital needs and its debt obligations. The two most common used ratios when assessing an entity’s liquidity are the ‘current ratio’ and the ‘quick ratio’ or ‘acid test’.

�������������� ���������� =

�������������� ������������ 1,641.7 �� = = ��. ���� �������������� ���������������������� 2,210.2 ��

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�������������� ������������ − ���������������������� 1,641.7 �� − 685.3 �� = = ��. ���� �������������� ���������������������� 2,210.2 ��

Although a 2:1 current ratio and 1:1 quick ratio tend to be considered ’ideal’, lower ratios can be understandable for retail companies due to the nature of their business. Nevertheless, 0.74:1 current ratio and 0.43:1 quick ratio that M&S reported suggest that the firm may have difficulty meeting current obligations. Low values, however, are not always fatal. As suggested in the academic article “Zero income survival times for ten fashion retailers”, if the company

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has good long‐term prospects, it may be able to enter the capital market and borrow against those prospects to meet current obligations. The nature of the business itself might also allow M&S to operate with these low ratios. Since its inventory turns over much more rapidly than the accounts payable become due, there is a timing difference that can allow the firm to operate with current ratio less than one. The Director’s report points out that 28.6% of the current assets are held in cash or cash equivalents, which includes ‘short‐term deposits with banks and other financial institutions, with and initial maturity of three months or less and credit card payment received within 48 hours’. When analysing the income statement, it is important to look at the ‘Profit for the year’ figure. The profit for the year, also called ‘Net profit’, is ‘the income that is attributable to the owner(s) of the business and which will be added to the equity figure in the balance sheet’ (Atrill and McLaney). This figure is calculated by deducting all the expenses incurred in generating the sales revenue for the period and taking account of non‐operating income. As part of his research for “Marketing Metrics”, P. Farrys conducted a survey of nearly 200 senior marketing managers on the importance of this figure. 91 per cent responded that they found the ‘net profit metric’ very useful, as it is one of the most important aspect of a for‐profit organization. For Marks and Spencer, one can see that in 2011 the net profit totalled £598.6 million. This means and increase compared to the £523.0 million net profit obtained the previous year. To gain perspective on this figure we can work a horizontal analysis. When expressed as a percentage, one can gain a feel for the significance of the changes that took place in the last year.

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������ ������������ 2011 − ������ ������������ (2010) ∗ 100 ������ ������������ (2010) 598.6 �� − 523.0 �� = ∗ 100 = ����. ����% 523.0 ��

At first sight it looks like an excellent rate of growth, but we would need to see it in relation to the sector to get a better idea of the real performance of the company. In the Director’s report this is considered as a brilliant performance ‘driven by growth in like‐ for like sales in the UK and a good achievement in the International business’. Moreover, this report points out that, in November 2010, the company set out plans to invest additional £850m. to £900m. over the next three years. These expenditures are the reason for the growth rate not to be as high as in previous years. However, they are confident that this investment will deliver future benefits.

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Another important figure to analyse is the ‘Capital expenditures’ (CAPEX), found on the cash flow statement under ‘Purchase of property, plant and equipment’. This figure includes the founds used by the company to acquire or upgrade physical in order to maintain or increase the scope of its operations. Capital expenditure decision represents one of the most important decisions taken by a company, as it is directed towards expansion of the level of operations. The capital expenditures figure on £327.3 million in 2011 for Marks and Spencer is an important sign of the continuing developing of the business. Although these expenditures translate into a reduction of the profit for the year, the investment decision provides a better framework for future activities. As pointed in the Director’s report, these expenditures are part of a three‐year plan to ‘enhance the company’s UK business and develop a multi‐channel and international capabilities’. The Chief finance officer emphasizes that “we continue to invest in our supply chain and technology in line with our plan to build an infrastructure fit to support the future growth of the business”, and he added: “we are targeting an internal rate of return of between 12% and 15%”.

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