Manage financial about BT plc

To Board of Directors of Reed Elsevier Plc.

From Reporting Accountant

Date 11th November 2015

Subject: Corporate performance analysis 2010 - 2014

Introduction

The following report shows the financial appraisal of Reed Elsevier Plc. The financial analysis relates to five years financial period covering the periods 2010-2014. In order to have a full understanding of the figures computed I have attached a summary of five appendices. This appendix shows the vertical and horizontal trend analysis and the financial ratios covering the relevant period included in your financial statements.

Financial Ratio Analysis-Profitability

Reed Elsevier Plc. has maintained a high level of Return on Capital employed during the five year financial period. The Return on capital employed shows an upward trend over the years from 15.01% in 2010 to 19.61% in 2014. This shows that the company is performing above the industrial average benchmark of 8%-11% which indicates a favourable business performance and improvement in its profit margins. Further progress can be made if the business utilises its fixed assets more effectively and minimises its working capital.

The gross profit margin is viewed as gross profit expressed as a percentage of total revenues. A high Gross profit margin indicates increased profitability. As seen in our computation the gross profit margin from 2010-2014 was 63.52%, 64.58%, 65.03%, 64.90% and 65.25%. The result implies that Reed Elsevier Plc was able to generate £63.52, £64.58, £65.03, £64.90 and £65.25 of operating profit from every hundred pound of sales revenue in the corresponding financial years. These ratios above shows a moderate increase from 63.52% in 2010 to 65.25% in 2014. Despite slight decrease in 2013 to 64.90%, the gross profit margin improved marginally by 63.52% in 2010 to 65.25% in 2014. The decrease in gross profit margin in 2013 might be due to rise in inventory cost. Reed Elsevier Plc would be able to maintain a high profit margin by increasing revenue while decreasing its operating cost simultaneously. It may be plausible to increase selling price and reduce the cost of sales. More so, the company may choose to alter its product mix and sales mix in line with effective pricing policy.

Similarly, a review of the net profit margin shows a steady increase over the 5 years period from 18.00% in 2010 to 24.29% in 2014 providing evidence that the business is efficient in converting sales to profit.

There was a decrease in Return on Assets from 13.11% in 2013 to 12.65% in 2014. This occurred after an initial and steady increase from 9.77% in 2010. This suggests that the decrease in net income might have had a negative impact on the company’s earnings on investments. This may also suggest that the company did not utilise its assets efficiently during the period of decline.

The Asset Turnover fluctuated during the period showing a decline from 0.54 in 2010 to 0.52 in 2014. The low asset turnover can be attributed to ineffective use of the company’s assets.

More so, as seen in the horizontal trend analysis, operating profits increased steadily during the period. This might be attributed to the movement in sales which fluctuated over the years. Similarly, the costs of sales show a corresponding movement with sales during the period. This increase in cost of sales may be due to raw material prices and cost of labour. Other factors to consider are production costs, selling price and appropriate sales mix.

Financial Ratio Analysis - Liquidity

We can measure the short term solvency of Reed Elsevier Plc using liquidity ratios. Under this we can estimate the current ratio as the ratio of current assets to current liabilities. This measures the extent to which current assets cover current liabilities. When compared to the industrial benchmark of 1:1, the result suggests that Reed Elsevier Plc has a weak current ratio of 0.66:1 in 2010 that has deteriorated in subsequent years to 0.49:1 in 2014. This means the company might not be able to meet its current liabilities as they fall due. However the result might be due to the nature of its business as a publishing company requiring it to carry high inventory to meet fluctuating demand.

The acid test ratio measures the ability of a firm to cover its immediate liabilities using its short term assets. As shown in appendices 1 Reed Elsevier Plc have been operating on a low acid test ratio ranging from 0.60:1 in 2010 to 0.46:1 in 2014, this ratio is considered low when compared to the average benchmark of 0.75: 1.25. However it should be noted that the low acid test ratio does not suggest insolvency but reflect the need of carrying high inventory required for operations. The acid test ratio of competitors should be considered in order to make appropriate decision.

Financial Ratio Analysis- Efficiency

A close look at the inventory turnover shows that it has been decreasing steadily over the years (2010-2013) but increased marginally by 5.30% in 2014 which shows that the company might be making effort to manage its inventory efficiently. The implication of a high inventory turnover ratio shows that the firm is holding a low level of average inventory in relation to sales. The decrease in inventory turnover to 25.84 days in 2014 shows that the company may be holding inventory, this means money is tied up in stock, this money could have earned interest in the bank, items in inventory also carry storage cost, and risk of getting bad. It is recommended that the company adopts a stock policy that will save future costs and improve earnings.

Payables payment period measures the number of days Reed Elsevier Plc takes to settle account payables. The ratios computed are well above the industrial average benchmark of 45 – 60 days. The payables payment period as at 2014 is 479.63 days, suggesting that Reed Elsevier has been inefficient in managing its account payables. However this figure should not be considered in isolation but should be compared to that of Reed Elsevier competitors in order to make effective decisions.

Trade receivable period is the number of days through which the company receives cash from its debtors. As shown in our calculation, the Trade receivable period is 94.02 days in 2014. A lower number of days signify that the company is managing account receivables effectively. It should be noted that a stiff policy on trade payables which is not favourable to suppliers may lead to loss of suppliers’ goodwill and ultimately cause business failure. Furthermore, it can be deduced that both the trade payables and receivable collection days are above the benchmark of (45-60 days) and 55 days. However the management of Reed Elsevier Plc need to compare results with that of similar sized competitors in order to make adequate financial decisions.

Cash cycle is the length of time, in days, that it takes for a company to convert purchased inventory into cash flows. Reed Elsevier has had a high negative cash cycle of (324.63) to (359.77) days during the five years period. This suggest that they do not pay for their inventory or materials until after they have sold the final product associated with them. It means that working capital is being used as efficiently as possible and have available cash for other things. Negative cash cycle has the following disadvantages; unsatisfied creditors, Loss of revenue, Loss of market share, Deprive entity from growing in new markets as receivables period is short and payment period is long. Customers won’t be happy as they do not have facility of reasonable credit term and creditors won’t trust because of long payment time.

Financial Ratio Analysis- Gearing

The gearing ratio of Reed Elsevier Plc shows the proportion of debt to equity. This figure shows a fluctuating trend over the 5 year period. In 2010 the gearing ratio was 59.25%, this increased to 60.49% in 2011 and decreased within the subsequent years to 54.85% and 49.39% respectively. In the final year of analysis, it increased to 53.49%.

Generally, the gearing of Reed Elsevier Plc is higher than the industrial benchmark of 33-47% which suggests that the company is highly geared and is relying heavily on debt. The effect of this is a default risk which may affect its operations and high interest rate attached to borrowing.

The decrease in gearing ratios in 2011 and 2012 may have been as a result of Reed Elsevier repaying some of its debt as seen in the statement of financial position. This might be a step to improving its gearing position.

Elsevier Plc adopts a hedging technique that minimises price fluctuations and losses.

Conclusion and Recommendations

Based on the results of our analysis, the acid test ratio and current ratio suggests that the liquidity position of Reed Elsevier Plc is too low, implying that it may have difficulty in meeting its financial obligations. In order to resolve this, it is recommended that the companies increase their level of current assets by increasing equity. There is also a high need for costs control and cash flow improvement. As shown in the profit statement, revenue fluctuated over the years and decreased by 4.54% in 2014 to £5,775m. One major area of concern is the management policy regarding trade payables periods and receivables collection period. For instance the payable payment days in the final year of analysis was 479.63 days while the receivable collection days for corresponding period was 94.02 days. Long payable payment days will lead to a strain in suppliers’ relationship. This indicates that Reed Elsevier Plc maintains a strict cash flow policy that allows a lengthy period of time before creditors are settled. While this might be suitable for Reed Elsevier business in the short run, it may need to be reviewed to improve relationships with stakeholders and ensure continued loyalty. However this figure should be compared with the activities of competitors to make the best financial decision.

Overall, as a publicly quoted company Reed Elsevier has performed well in boosting its earnings and this may result in increased investors’ confidence and customers’ loyalty.

A close look at the statement of financial position reveals that Reed Elsevier Plc has a trend of negative reserve balances; this might have resulted from the accounting method adopted in posting the balances. It could also be as a result of severe depreciation in currency position or significant adjustments to intangible assets. Whatever the case may be, the management must ensure these reserves are carefully investigated and appropriate actions taken to remedy the situation.

Furthermore, it is important to cut down on operating costs to ensure continued profitability. Also, the inventory management policy needs to be reviewed to check inefficiency and reduce wastes. Working capital should also be managed properly to avoid supplier relationship being strained.

Other points to note is the control of finance costs and other long term liabilities, this may be having an adverse effect on Reed Elsevier Plc operations if not properly monitored and hedged. Overall the business need attention regarding price fluctuations and operating costs and need to consider managing its current liabilities efficiently to enable it meet its obligations.

However, it should be noted that ratio analysis is not the only tool of measurement on which financial decisions is based, other qualitative factors should be considered to make effective decisions.

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Appendix 1 – Financial Ratio