Financial Analysis Decision Making

Analysis of the Financial Reports Brief description of the company Electrocomponents Public Company Limited is a high service distributor of electronic, electromechanical and wider industrial products. They supply products to worldwide engineering customers. The group operates in 27 countries, covering 82% of global GDP, and supplies to most of the remaining countries worldwide via third party distributors.

Electrical, automation and cables Electronic components, power and connectors Mechanical products and tools IT, test and safety equipment Main Customer Groups Total around 1. 5 million customers from all industrial sectors are typically research and development (R&D) or maintenance engineers in business. They also sell products to end customers. Currently they are focusing on 2 main customer groups refer to product groups.

1. Electronic and Electromechanical or EEM Primary customers are electronics design and pre and low volume electronics production.

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This has been seen as an attractive and growing segment because of strong electronics market growth, technology proliferation and R&D investment.

2. Maintenance, Repair and Operations or MRO Within MRO, their important customer is involved in factory automation that primarily uses process control and automation products (PCA). Main Markets are divided into 4 geographical areas: UK, continental Europe, North America and Asia Pacific. below. UK 40% Current market size (in sales) is shown Continental Europe 33% Asia Pacific 9% North America 18% Chutsana Na Nagara (0654258)

Trend analysis shows sales have increased by 13% from Y2005 as international sales increased (Business Review) due to a combination of strong revenue growth in continental Europe, North America (joint promotions programs), and Asia Pacific especially a successful customer acquisition program and contribution from new Thailand sales office.

However, cost of sales has increased by greater amount (by 20%). Generally speaking, cost of sales should not increase much more than increase in sales because this shows that all produced goods might not be sold (stolen, defected, etc. ) or raw Chutsana Na Nagara (0654258) FACS Page 8 material cost greatly rose due to inefficient procurement. Also, normally when sales increases, business will receive discounts from big batch purchases and even reduces cost of sales. By comparing cost of sales with sales: Y2005 was accounted for 47% but Y2006-7 was the same at 49% of sales.

So the problem for Electrocomponents might be, (Chief Executive’s and Business Review), that their strategy to expand product ranges, availability, and promotions to better satisfy and attracts customers in highly competitive markets. These led to increase in inventory holding and cost of sales. As a result, gross profit increased by only 4% from Y2006 or 8% from Y2005 (lesser amount than sales growth). directly affected. Gross profit and mark-up ratios are Gross Profit Ratio Gross Profit x 100 Sales Y2007

Gross profit derived from sales deducted by cost of sales. They normally change adversely; the more cost of sales, the less gross profit. Ratio also illustrates market situation; UK is their biggest but highest competitive market (Business Review) so increasing price to raise profit is prohibited. That is why business earned only.  They are measuring profitability at different levels. Although gross profit ratio decreased, net margin ratio increased.

This supports that business better managed operating expenses through achieving in Enterprise Business Systems or EBS and reorganization projects. In other words, It is justified that (13%increase) distribution and marketing expenses which seems to be variable costs (especially sales commissions) for Y2007 has changed in relation to sales (14%increase)—comparing to Y2006; these expenses increased 15% while sales only increased 7%. This was because strong field sales team in North America, EBS, and Japan’s e-commerce increased to 57% of its sales, (Business Review).

Moreover, administrative expenses (fixed costs) greatly decreased (78%) because reorganization project led to low infrastructure cost especially the removal of around 110 roles including the closure of the telemarketing department in the UK (Webpage1). So, total operating expenses decreased to 40% as a percentage of sales and led to increase in operating profit by 32% from Y2006. Regarding profitability, the business is doing well in terms of generating profits from worldwide sales growth which is supported by effective marketing activities, product strategies, and investment projects.

It is acceptable to use “ending” inventory as it was the most current inventory level business held and it shows that supply chain management truly helped improve stock turn from 2. 5 to 2. 7times (Business Review). Business tended to increase raw materials while decrease finished goods. In general, when sales increase, business should stock finished goods for availability to customers—not raw materials as they are not immediately ready for sale. However, ratio can mislead if business stocks too much and cost of sales are not well-managed, the ratio still increases and problems are hidden.

Regarding shareholders’ view, they may be in high financial risk as borrowing interests must be paid before distributing dividend and, in liquidation; lenders will be repaid before shareholders receive any repayments, FACS1. The gearing ratio itself does not mean very much because it depends on type of business and investment stage. We compare it with interest cover Chutsana Na Nagara (0654258) FACS Page 15 which decreased due to interest charges increased by greater amount (74%) than profit (33%).

Since the business has been established in 1928, they are growing and expanding internationally rapidly (Webpage2 and Webpage3). At present, they are doing well in term of profitability, efficiency, and investment areas, or to say, they are succeeding in sustaining global sales growth across the group, grow margin stabilization and tight control of costs. Chutsana Na Nagara (0654258) FACS return on Capital Employed (ROCE) Operating Profit x 100 Capital Employed Y2007 91. 1 x 100 = 20. 2 % 450. Y2006 68. 5 x 100 = 12. 6 % 543. 5 ROCE is the combination of Net Margin and Net Assets Turnover.

As earlier mentioned both ratios increase and led to significantly increased ROCE. It suggests that overall performance is satisfied due to effective pricing and cost management as well as asset management were improved comparing to Y2006. This also illustrates overall success in EBS, product strategy, new technology launches, supplier relationships and low costs projects that are paying off. The number of times (1. 9) that net assets can generate sales is very important as one turn equals to 10. % that sales can generate profit. That is why ROCE = 20. 2% as it equals two turns.

This suggests that it may greatly increases sales very soon because business recently plans to accelerate sales growth in China which is a big potential market and if business can manage to utilize assets well, there will be increase in profit on capital employed even more. Furthermore, it is better if the ROCE rate of 20. 2% is less than the rate of cost (interest rate) that business pays for money borrowed to invest in these assets because it means assets are used for generating profit that can cover cost of acquiring them.

Regarding Corporate Governance, the business is subject to the provisions of the Combined Code on Corporate Governance published in July 2003 and appended to the Listing Rules of the UK Listing Authority. There are many practices company must follow. For example, the Audit Committee shall consist of not less than three members and be independent non-executive directors. Also, it is authorized by the Board and able to investigate any activity within its Terms of Reference which allows for full access to Company information and can seek that information from any employee of the business.

Employees are directed to co-operate with any request made by the Committee. If, at all time, company strictly follows the set rules, they can ensure operating properly. Chutsana Na Nagara (0654258) FACS Page 18 Moreover, regarding Ethical concerns (Business Review), they are focusing on many areas of responsibilities such as ethical trading and sets of KPI for environmental concerns. Along with their profitability, business is considered be on track of long term prosperous. However, there is one important area that needs to be immediately improved. This is liquidity. From the logic below;

Business acquires funds from borrowings/loans 54. 99% (21. 54% + 33. 45%) which exceeds equity (45. 01%). The proportion shows business is considered at high risk. This evidence is also strongly supported by earlier ratios and cash flow analysis. Suggestions aim to point out at major areas. Most of them involve the concern on liquidity which has been mentioned earlier. . Recently, there are many business activities going on to support their expansions that involve mostly in long term investments.

However, it seems that business finance their activities with short term liabilities as they increased significantly. This is not a proper means of investment because, normally, short term liabilities are at higher interest rate and the payment due is sooner, but business uses them for long term investments which take time to generate cash back.

Business may soon suffer from low liquidity and inability to pay day-to-day expenses and interests as business pays back the cost of using money even before they make profit from the money borrowed. Chutsana Na Nagara (0654258) FACS Page 19 The evidence was supported by increased in Gearing ratio; while, Current ratio, Acid test and Interest Cover ratio have significantly decreased. Although, interest expenses from borrowings reduce tax payable, business must ensure they have ability to pay interests and it is worth to do so.

Unless they restructure funding sources, they can go bankruptcy very soon because many long term projects will be implement next year. By doing so, business surely improves their liquidity and reduces financial risk for business itself as well as shareholders’. 2. It was very risky that the Board has announced to maintain the same amount of dividend paid for three years while business is under investments/expansions and these two activities consume huge amount of money. Dividend amount is greater than profits after tax and interests; business seemed to borrow current liabilities for cash dividend paid.

This could be a good strategic idea to retain shareholders’ confidence on the successful implementation of EBS, execution of the strategy and cost reduction initiatives will significantly improve financial performance over the next three years. However, it could turn to be the worst idea especially when liquidity is now in concern. The alternative solutions can be that business issues more shares so they use cash received to pay dividend or pay shareholders with stock dividends (dividend reinvestment plan) so they still retain cash in the business.

These two alternatives will increase number of shares so, refer to Gearing ratio, financial risks can be reduced. Point above suggest that business rearrange sources of funding by seeking for long term sources and bewares of “overtrading”. They are expanding, stocking more inventories, having more debtors but lack of cash to pay for creditors—not only from normal trading but also interests from borrowing/loans.

Although the Board seems to be sure that after all these investments come alive under well-managed plan for implementations they will urely benefit and guarantee long term prosperous to business, business may go bankruptcy even before reaching the goal.

Business’s strategy to satisfy customers with around 350,000 products stocked globally, this can hardly do so efficiently. Although inventory turnover seems satisfied, acid test shows inventory greatly affects business’s liquidity. Business is suggested reconsider inventory policy to rearrange classes and only stock fast moving, high volume but low value items.

For slow moving, low volume but high value items, business may decide to use pooled strategy by stocking them in one warehouse in location that can easily transport products to anywhere needed, Chopra and Sodhi (2004). Business is expanding very much. Their performance on receivables collection period is slightly weaker because trading worldwide interfaces with many parties and increases procedures complexity.

Business must ensure activities are in control and they have sufficient cash to pay creditors. Regarding risks assessment (Business Review); it is wise to include isks from suppliers into consideration as they are trading in competitive markets with enormous competitors and high penalties. Satisfying customers is vitally important; therefore, this requires reliable suppliers as well as effective supply chain management for inventory management and reduce cost of sales.

It is suggested business focus on international markets especially North America and Asia which have higher revenue growth. Currently, North American’s e-commerce is account for only 10% of total sales. This is elatively low comparing to other regions. This may be a great opportunity to increase profits because sales can be increased through e-commerce; while, costs are reduced from, for example, reduction in sales teams. The significance of cash management in managing a business. Cash is one of the most important resources in running a business as Pizzey (1998) put that it is the life-blood of the business.

However, cash is not profit. Highly profitable businesses cease to exist just simply because they do not maintain sufficient cash to allow proper level of liquidity; for example, paying for routine business’ expenses. While too much idle cash means inefficiency as it does not generate any added value to business. To avoid falling into either ends, business needs cash management. This can be done through preparing cash flow statement to examine past performance and include corrective actions/improvements in cash budget for future directions/guidelines.

To illustrate, business can recognize transaction flows with initial factors; identify risk because it allows for regular monitoring and control; plan their money ahead such as acquiring funds from proper sources at reasonable price rather than rushing into lenders when problems surprisingly happen, etc. We can; therefore, say that ultimate significances of cash management are that business runs smoothly, stably; is safe from insolvency and increases confidences for shareholders.

Routing : At fist stage, Wolfs were produced from Mark-I which had most expensive unit cost of $m(5). This increased cost of sales and while price was fixed, business received less profit.

Capacity : Business has already invested in Engineering&Quality and bought new factory. However, using Mark-I led to insufficient capacity; decreased opportunity to win big contracts; and limited sales volume. Business ended up with insufficient products to generates enough sales to cover all costs especially capital expenditure. Three issues above affected cash out-flows which led to extremely high negative cash position.

One possible solution is to replace Mark-I with Mark-III to efficiently increase capacity. So leadtime is decreased; stocks are reduced; business tends to decrease debtors, increase profit, reduce loans and interest paid; hence, cash position gets better.

Preparation: Business critically analyses internal and external environments/factors to formulate strategic plans that must be in line with business objectives. Business then sets up operational plans with properly identifying resource requirements to support strategies. This resource plans are finally translated into financial plans to complete a budget preparation.

Budgetary control: Budget is compared with actual figures. If variances occur, timely corrective actions are required; involving sending feedbacks back for reviews and formulated plans and/or forecasts may be revised. These re continuous processes and required management contributions/commitments at all time so that intended benefits are surely achieved. The technique can apply to WinningMarginTM. Our objective is to lead Wolf markets and strategy is ensuring products are adequate for sales. We prepare production and sales budgets  showing maximum productions are 14 Terriers and 8 Wolfs with total sales $116. 6. From this point, purchasing manager knows how many exactly materials to order and when to prevent material shortage. Production manager can effectively manage shift allocations.

Financial manager can see how much money to borrow more as we plan to invest in engineering and quality next year. Moreover, commercial manager can evaluate market share correctly. All Chutsana Na Nagara (0654258) functions know their responsibilities and control areas which help achieve the objective. In real business, all processes are much more complex and involve enormous factors such as competitors, substitute products, technologies, government legislations, as well as funding/borrowings which are not easy or fast as in the game. Also, business is legally committed to pay tax and interests which can be very high.

More importantly, suppliers and customers are not always reliable. Late payments from customers or late delivers from suppliers can severely interrupt whole business plan/process.

Marginal costing is a costing technique that helps business making decisions. We must understand cost behaviors to properly classify and, more importantly, control them. Total costs roughly comprised of variable costs, which changes with activity Dyson3 (2007) and fixed or “time-based” costs, which remain unchanged within a period of time regardless of how many products produced.

The difference between price and variable cost can be used to cover fixed costs and this is known as “contribution”. Business makes profit from any contribution amount exceeds fixed costs; or loss, if insufficient contribution. Regarding WinningMarginTM, this technique would have helped our decision in choosing market.

References

1. Electrocomponents plc’s annual report and accounts 2007, p. 8-13
2. Chairman Statement : Electrocomponents plc’s annual report and accounts 2007,
3. Chief Executive’s Review : Electrocomponents plc’s annual report and accounts 2007, p. 7
4. Chopra and Sodhi (2004): Managing risk to avoid supply-chain breakdown, MIT Sloan Management Review, Fall 2004, p. 53-61
5. Dyson1 J R (2007) : Profitability Ratios, Accounting for Non-Accounting Students, Pearson Education Limited, England, 7th Edition, p. 230
6. Dyson2 J R (2007) : Profitability Ratios, Accounting for Non-Accounting Students, Pearson Education Limited, England, 7th Edition, p. 230
7. Dyson3 (2007) : Direct costs, Accounting for Non-Accounting Students, Pearson Education Limited, England, 7th Edition, p. 293
8. Financial Analysis and control systems module pack, WMG, Winning MarginTM, p. 14 (2007)
9. FACS2 : Financial Analysis and control systems module pack, WMG, Budget and Budgetary Control, 2007
10. FACS3 : Financial Analysis and control systems module pack, WMG, Marginal Costing, 2007
11. Group Balance Sheet : Electrocomponents plc’s annual report and accounts 2007, p. 25 Chutsana Na Nagara (0654258)
12. FACS Page 35 Group Cash Flow Statement : Electrocomponents plc’s annual report and accounts 2007, p. 26
13. Group Income Statement : Electrocomponents plc’s annual report and accounts 2007, p. 24
14. Notes 1 – 30 : Please refer to Notes to the Group Accounts, Electrocomponents plc’s annual report and accounts 2007, p. 29-45
15. Pizzey A (1998) : Cash: the life-blood of the business, Finance and Accounting for Non-Specialist Students, Financial Times, Pitman Publishing, England, p. 83

Webpage1: About Us, Low Cost Infrastructure, Electrocomponents plc webpage, [online], http://www. lectrocomponents. com/ecm/about/strategy/infrastructure/

Webpage2 : About Us, Our History, Electrocomponents plc webpage, [online], http://www. electrocomponents. com/ecm/about/history/

Webpage3 : Investor Center, Historic Trends, Electrocomponents plc webpage, [online], http://www. electrocomponents. com/ecm/ir/finperformance/trends

Webpage4 : Our Responsibilities, Corporate Governance, Electrocomponents plc webpage, [online], http://www. electrocomponents. com/ecm/responsibilities/corpgov/

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