Financial Performance Analysis Marks and Spencer PLC

Executive Summary

This report focuses on Analysis Marks and Spencer’s financial performance analysis. A brief explanation why the company was selected for this analysis is given. The report focuses on five major categories of ratios that include profitability ratios, liquidity ratios, working capital management ratios, capital structure ratios, and stock market performance ratios. After a thorough analysis, shortcomings of financial performance analysis are discussed to show the level of reliance on the analysis carried out. At the end of the report, recommendations are given to show how the company’s problems should be addressed.

Introduction

Businesses are created to enable the owners to make a profit. The path to profitability is characterized by difficulties, and this compromises the ability to create optimum profit for the owners. It is, therefore, necessary to evaluate business performance to determine the extent to which specific goals have been realized. The agency problem necessitates business analysis. The current business environment is characterized by a separation between the ownership and control.  In other words, those in control of business are hired by the owners to manage the business on their behalf. This relationship makes it necessary to implement performance evaluation mechanisms to ensure management activities are directed towards meeting the shareholder’s interests (Bertoneche & Knight 2001). The financial analysis provides one of the best approaches to evaluate business performance that help shareholders to know whether the business is being run properly. The existence of diverse business stakeholders increases the importance of financial performance analysis. Some of the key stakeholders that rely on the financial performance analysis data include the shareholders, financiers, investors, suppliers, government, strategic partner, and the employee (Rani, Yadav & Jain 2016). These stakeholders have specific interests in a business that necessitates ascertainment of business performance. For instance, the suppliers rely on financial performance analysis data to measure the ability of a business to pay for supplies. Investors need to know the profitability of a business to make informed investment decisions. The employees are interested in the company’s performance to assess their job security.  The going concern of a company that shows poor financial performance is at stake and this makes employees worried about job security. It is clear the different groups of stakeholders have specific interests in a business, and they use financial performance analysis to assess their interests.  This study involves analyzing Marks and Spencer plc’s financial performance.

The decision to choose Marks and Spencer as the company to analyze is influenced by some factors. Firstly, the company operates in the retail sector that is highly competitive. Businesses in this sector implement competitive strategies that affect financial performance. Also, the industry is influenced by complex environmental factors that make the financial performance of retailers to keep changing. Secondly, Marks and Spencer is a listed company whose shares are traded on London Stock Exchange. Public companies are required by the law to make their financial reports public (Pounder 2013). These financial reports are prepared in line with the international financial reporting standards (IFRS) and therefore meet the highest financial reporting standards, and this guarantees the availability of sufficient and accurate data in public domain. It is therefore easy to carry out a financial performance analysis on the company due to the availability of the relevant data. The company’s financial statements are published on its website. They are also found in financial analysis sites like MorningStar. Lastly, the company has been in existence since 1884, and this guarantees the existence of past data (Worth 2007). An effective financial performance analysis requires comparing past data with the aim of identifying whether the company is showing a positive or a negative trend.

Profitability Ratios

Profitability ratios provide a picture of business performance in generating profit for the owners. The main purpose of establishing a business is making profit for the owners. Other subsidiary goals arise in the course of pursuing the profit maximization objective. Computing profit ratios support the identification of trends that show whether the business is generating the right returns. The main profitability ratios include the return on assets, return on equity, the gross profit margin, and the net profit margin (Bertoneche & Knight 2001). Marks and Spencer’s financial statement provide the relevant data to support the calculation of these ratios.

Return on Assets

The return on assets(ROA) evaluates the efficiency in the utilization of the company’s assets in profit generation. This ratio is computed by dividing the net profit by total assets (Saleem & Rehman 2011). In other words, it expresses the net profit as a percentage of the total assets. A high return on asset implies that the company is efficient in using its assets to generate profit. Using this ratio in financial performance analysis requires comparing ratios of past years to show the company’s trend.

Table 1

Year 2013 2014 2015 2016 2017
Net income 454 524 487 406 117
Total assets 7,568 7,903 8,196 8,476 8,293
Return on assets (%) 6.29 6.78 6.04 4.88 1.4

The company’s return on assets was highest in the year 2014 where it stood at 6.78%. From this high, the ratio declined each year, and this was an indication of a declining efficiency in the use of assets to generate profit.  The ROA for the year 2017 was 1.4% that was substantially lower compared to that of the previous years. The decrease in the ROA was caused by a persistent decrease in the net profit.

Return on Equity

The return on equity (ROE) compares the net income with the shareholders’ equity. Equity is the sum of common stock and the retained earnings. The equity shows the monetary value of the shareholders’ wealth in the company(Bertoneche & Knight 2001). This ratio is computed by expressing the net income as a percentage of equity. An increase in ROE shows improved performance.

Table 2

Year 2013 2014 2015 2016 2017
Net income 454 524 487 406 117
Total equity 2,505 2,707 3,200 3,445 3,156
Return on equity (%) 17.63 20.14 16.47 12.25 3.55

Marks and Spencer’s ROE has been decreasing since the year 2014. This decline is caused by a declining net income registered in years 2015, 2016, and 2017. The poor performance in the year 2017 was also influenced by a reduction of equity.

Gross Profit Margin

The gross profit margin compares the gross profit with sales. It involves expressing the gross profit as a percentage of the total sales (Niresh, 2012) Changes in gross profit and sales influence the margin. A high gross profit margin shows a good performance.

Table 3

year 2013 2014 2015 2016 2017
sales 10,026 10,310 10,311 10,555 10,622
gross profit 3800 3866 3990 4127 4089
gross margin=gross profit/sales 37.90% 37.50% 38.70% 39.10% 38.50%

The company’s gross profit margin has been relatively stable ranging between 37.90% and 39.10%.  This stability emanates from the fact that the cost of sales and sales have been changing at almost the same rate.

Net profit margin

The net profit margin is a ratio comparing the net profit and the sales. Computing this ratio involves dividing the net profit by the total sales and converting it into a percentage. This ratio provides an objective approach to assessing the company’s sales and costs.  An increase in the net profit margin implies an increase in efficiency.  On the other hand, a decline in the net profit margin implies that costs are on the rise and this is a sign of inefficiency.

Figure 4

Year 2013 2014 2015 2016 2017
Sales 10,026 10,310 10,311 10,555 10,622
Net income after tax 454 524 487 406 117
Net profit margin 4.53% 5.08% 4.72% 3.85% 1.10%

The company’s net profit margin has been on the decline since the year 2014. The net profit margin for the year 2014 was 5.08% while that of the year 2017 was a mere 1.10%. This trend raises serious concerns since it is an indication that the company’s expenses have been increasing disproportionately compared to the sales.

Liquidity ratios

Liquidity ratios assess the company’s liquidity position. Liquidity refers to the company’s ability to meet short term liabilities as they fall due. It is important to maintain favourable liquidity to enable a business to finance its daily operations. A cash flow problem can paralyse operations since it can compromise the ability to meet crucial short term obligations such as salary and essential input elements such as raw materials (Saleem & Rehman 2011). The most important liquidity ratios are the quick ratio and current ratio.

Current Ratio

The current ratio compares the current assets with the current liabilities. This ratio is calculated by dividing the current assets by current liabilities. A business is said to have a favourable liquidity position when the quick ratio is 1and above (Saleem & Rehman 2011). Such a ratio implies that the current assets are equal or more than the current liabilities.

Table 5

year 2013 2014 2015 2016 2017
current asset 1,268 1,369 1,455 1,461 1,723
current liabilities 2,238 2,349 2,112 2,105 2,368
current ratio 0.57 0.58 0.69 0.69 0.73

The company’s liquidity position has been improving although it is far below 1. The lowest current ratio was registered in the year 2013 at 0.57.  This shows that the company can experience difficulties when meeting short term obligations.  The increase of the quick ratio to 0.73 is an indication that the company is implementing sound measures to improve the liquidity position.

Quick Ratio

The quick ratio provides another perspective to evaluating the liquidity position of a firm. This ratio recognizes that inventory forms a substantial part of the current assets. It, therefore, seeks to evaluate the liquidity position in the absence of the inventory.  To compute the quick ratio, current assets less the inventory is divided by the current liabilities (Saleem & Rehman 2011). Sometimes items in the inventory are slow moving, and it is, therefore, difficult to raise cash from inventory items.

Table 6

year 2013 2014 2015 2016 2017
Cash, marketable securities, accounts and receivables 380 399 507 505 781
current liabilities 2,238 2,349 2,112 2,105 2,368
quick ratio 0.17 0.17 0.24 0.24 0.33

The company’s quick ratio ranges between 0.17 and 0.33 which is an indication of a poor liquidity position. Although the company’s liquidity has been improving, there is a liquidity problem that can limit the company’s ability to meet short term obligations.

Working Capital Management Ratios

Just like the liquidity ratio, the working capital management ratios serve the help to identify the company’s liquidity. However, working capital management also helps to identify whether a firm is investing its current assets properly. Current ratio also serves as a working capital management ratio. The most desirable current ratio ranges between 1 and 2. A ratio exceeding 2 indicates that the firm is not utilizing its current assets optimally (Lartey, Antwi, S. & Boadi, 2013).

Inventory Turn0ver

Inventory turnover ratio measures the rate at which the inventory is sold and replaced. This ratio helps to assess the liquidity of the inventory since the rate at which inventory items are sold varies.

Table 6

Year 2013 2014 2015 2016 2017
inventory turnover ratio 8.6 7.98 7.69 8.05 8.39

The company inventory turnover rate ranges from 8.6 to 7.69 times per year. The turnover is relatively stable. It implies that it takes around 45 days to sell the company’s inventory.

Capital Structure Ratios

The capital structure ratios evaluate the fitness of the financing operations of a company.  A company is financed by shares, debt, and retained earnings.  Managing the capital structure seeks to realize the optimal combination of the three elements (Gill, Biger & Mathur, 2010). Retained earnings are the cheapest form of financing business as it involves reinvesting profits. However, this source of financing provides limited resources due to profitability limitations. The main capital stricture ratios include the debt to equity ratio and the long term debt to capitalization ratio.

Debt to Equity Ratio

This ratio compares total debt to equity. The ratio is obtained by dividing the total debt by shareholder’s equity.  Debt is good as it enables a firm to make more profit. However, a debt level that is too high can increase the cost of capital to the extent of eroding the shareholders’ equity.

Table 7

year 2013 2014 2015 2016 2017
short-term debt 552 446 279 297 518
long-term debt 1,677 1,606 1,698 1,727 1,663
total debt 2229 2052 1977 2024 2181
equity 2,505 2,707 3,200 3,445 3,156
debt-equity ratio 0.69 0.61 0.55 0.52 0.54

The company’s debt to equity ratio for the year 2017 was 0.54 compared to 2013’s 0.67. This is an indication that the company has been reducing reliance on debt. The company’s debt to equity ratio is reasonable as the concerned cost of capital is manageable.

Long Term Debt to Capitalization

Long term debt to capitalization ratio compares the long term debt and equity. The ratio is obtained by dividing the long term debt and equity. It shows the extent to which a company has exploited debt financing.

Table 8

year 2013 2014 2015 2016 2017
long term debt 1,677 1,606 1,698 1,727 1,663
equity 2,505 2,707 3,200 3,445 3,156
long term debt + equity 4,182 4,313 4,898 5,172 4,819
Long term debt to capitalization 40.10% 37.24% 34.67% 33.39% 34.51%

The company’s long term debt to equity ratio was highest in the year 2013.  It decreased consistently to the year 2016 after which it increased by over 10%.

Stock Market Performance Ratios

Stock market performance ratios are used to analyze the performance of shares. They provide an insight to potential and actual investors regarding the performance of shares in the market. A portion of the profit is distributed to the shareholders in the form of dividends while the other portion is retained to support operations.  Earnings per share and dividend payout ratio are the main stock market performance ratios.

Earnings per Share (EPS)

This ratio shows the amount of profit attributed to every share. EPS is computed by dividing the net profit by the number of outstanding common shares. It enables the shareholders to know the exact yield of their investment in the company (Niresh 2012).

Table 9

year 2013 2014 2015 2016 2017
total earnings 454 524 487 406 117
outstanding shares 805 815 823 821 816
earnings per share 0.56 0.64 0.59 0.49 0.14

The company’s EPS has been declining in the past three years. This negative trend is due to declining net profit.

Dividend Payout Ratio

Dividend payout ratio compares the amount of dividends distributed to the shareholders with the net income. In other words, it is a ratio between the dividends paid per share and the earnings per share (Bertoneche& Knight 2001). It shows the extent to which the income has been distributed to the shareholders as dividends.

Table 10

year 2013 2014 2015 2016 2017
net income 454 524 487 406 117
divided 84 271 254 278 132
Payout ratio (%) 18.4 51.7 52.2 68.5 112.6

Marks and Spencer’s dividend payout ratio has been on the rise in the past five years. The rise has been influenced by the company’s policy of maintaining the dividend per share despite the falling net income.

Shortcomings of Ratio Analysis

Although the financial analysis is one of the most objective approaches to evaluating business performance, it has some weaknesses that hinder absolute reliance when ascertaining business performance. Over-reliance on historical data is one of the greatest shortcomings of financial performance analysis.  Ratio analysis involves using the past data to compute key ratios that are used as a basis for understanding the future environment. Past data cannot accurately depict the future environment considering that business environment is dynamic (Saleem & Rehman 2011). The environment is made unstable by the intense competition and other factors of the environment such as technological, social, technological and social factors.  The unstable environment influence financial performance and this makes it difficult to predict the future using the past data.  Another shortcoming of the ratio analysis is the varying accounting environment.  Key elements if the accounting environment includes the national accounting policies, the international accounting and financial reporting standards, and the accountant’s values system and judgment. Accounting regulations vary from one country to the other in line with the local accounting needs.  There are also international standards that govern accounting operations. It implies that multinational companies are required to comply with diverse local accounting regulations in the host countries as well as the international regulations. In addition to accounting policy diversity, ethics influence the usefulness of ratio analysis. Accounting malpractices are common in today’s business environment as managers strive to paint a positive performance of their companies (Saleem & Rehman 2011). Accountants governed by weak value systems doctor financial statements to mislead stakeholders. Lack of financial statements’ integrity compromises the effectiveness of ratio analysis.

Conclusion

Financial performance analysis is the most objective business performance analysis approach. It involves the computation of ratios aimed at showing different aspects of financial performance.  The common categories of ratios used include profitability ratios, liquidity ratios, working capital management ratios, capital structure ratios, and stock market performance ratios.  These ratios provide a holistic assessment of business performance. Marks and Spencer’s shows mixed performances. Its profitability is declining based on the profitability ratios. The company’s liquidity position is weak, and this compromises the ability to pay short term liabilities. Although ratio analysis has many strengths, it has major weaknesses that prevent stakeholders from relying on it exclusively when measuring performance.

Recommendations

  • Improve liquidity-the company’s liquidity position should be improved in some ways. Firstly, dividend payout ratio needs to be reduced to increase the level of retained earnings, and this will improve the company’s liquidity position. Secondly, the company should substitute short term borrowing with long term debt.
  • Cost cutting strategy-the company’s escalating expenses are to blame for the declining profit. Marks and Spencer need to examine the expenses with the aim of identifying unnecessary costs. Every department should be involved in reducing costs.

List of References

Bertoneche, M., & Knight, R., 2001. Financial Performance, Financial Performance. Elsevier.vol.4no.3, pp. 74–105.

Gill, A., Biger, N. &  Mathur, N., 2010. The relationship between working capital management and profitability: Evidence from the United States. Business and Economics Journal, 10(1), pp.1-9.

Lartey, V.C., Antwi, S. & Boadi, E.K., 2013. The relationship between liquidity and profitability of listed banks in Ghana. International Journal of Business and Social Science, 4(3).

Niresh, J.A., 2012. Trade-off between liquidity & profitability: A study of selected manufacturing firms in Sri Lanka. Researchers World, 3(4), p.34.

Pounder, B. 2013. Convergence guidebook for corporate financial reporting. Hoboken, N.J., Wiley.

Rani, N., Yadav, S.S.,&  Jain, P.K., 2016. Financial Performance Analysis of Mergers and Acquisitions, in: Mergers and Acquisitions: A Study of Financial Performance, Motives and Corporate Governance. Springer Science, pp. 109–132.

Saleem, Q. & Rehman, R.U., 2011. Impacts of liquidity ratios on profitability. Interdisciplinary Journal of Research in Business, 1(7), pp.95-98.

Uotila, J., Maula, M., Keil, T. &  Zahra, S.A., 2009. Exploration, exploitation, and financial performance: analysis of S&P 500 corporations. Strategic Management Journal, 30(2), pp.221-231.

Worth, R. 2007. Fashion for the people: a history of clothing at Marks & Spencer. Oxford, Berg.

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