FInancial analysis of Air-Engines plc

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Introduction to Accountancy

1. Introduction

Air-Engines plc is a British aeronautical engineering firm. For the current year of 2013, the company has 14,863 employees globally. There are two companies that are direct competitors for Air-Engines plc: Britech Engines (BE) and Capital Services (CS). The report will mainly analyze the financial situation of Air-Engines plc and its two competitors. The major analysis instruments will be the ratio analysis, including the liquidity ratios, profitability ratios as well as other important ratios for understanding the financial situations of Air-Engines plc. The ratios of previous two years are available and the financial data for the year of 2013 of the three companies are also available. Thus the report will be structured as follow: in the second session, the report will briefly introduce the calculation of different ratios as well as the indication that different ratios will bring to us. Then the report will calculate the financial ratios for the three companies for the year of 2013. In the third session, the report will analyze the performance of Air-Engines plc based on the ratios obtained form the previous session. In the fourth session, the report will compare the performance of Air-Engines plc to its two competitors.

2. Ratio Calculation Findings and Discussion

This Report will mainly use the Financial Data to analyze the Liquidity Ratio, profitability ratios as well as other turnovers. The report will now introduce the calculation of different ratios shown in the table.

The first ratio is Return on Equity (ROE), which is calculated by dividing the operating profit to the total equity. The second ratio is the Operating margin, which is calculated by dividing the operating profits to the total revenue. The third ratio is the Gross margin, which is calculated by dividing the gross profits to the total revenue. The fourth ratio is the current ratio. The Current Ratio is a popular financial ratio used to test a company's liquidity by deriving the propositions’ of current assets available to cover current liabilities. The concept behind this ratio is to ascertain whether a company's short-term assets are readily available to pay off its short-term liabilities. In theory, the higher the current ratio, the better.

Formula:

The fifth ratio is the acid-test ratio, which is a liquidity indicator that further refines the current ratio by measuring the amount of the most liquid current assets there are to cover current liabilities. The quick ratio is more conservative than the current ratio because it excludes inventory and other current assets, which are more difficult to turn into cash. Therefore, a higher ratio means a more liquid current position.

Formula:

The receivables settlement period is similar to the sales outstanding days, which is calculated by dividing the Receivables to the Total Revenue and then times 365. The Fixed assets turnover is calculated by dividing the total revenue to the total fixed assets. The last ratio is the sales revenue per employee, which is quite straight forward. The ratios for the three companies in the year of 2013 are listed in the table below.

Air-Engines

Britech Engines

Capital Services

2013

2013

2013

Return on Equity

38.41%

22.95%

38.87%

Operating margin

15.76%

10.94%

17.21%

Gross margin

40.63%

40.63%

62.00%

Current Ratio

1.39

1.97

0.50

Acid Test Ratio

0.78

1.06

0.50

Receivables Settlement period

25.66

28.52

7.60

Fixed Asset turnover

3.49

3.64

2.09

Sales Revenue per employee

25.84

31.99

23.22

Table1. The Ratios for the three companies in the year of 2013.

3. Findings and Discussion of Air-Engines

In order to better analyze the performance of Air-Engines, the ratios are compared with the results of the previous years, which can be seen from the table below.

Air-Engines

2011

2012

2013

Return on Equity

30.73%

33.80%

38.41%

Operating margin

12.50%

13.75%

15.76%

Gross margin

31.00%

36.13%

40.63%

Current Ratio

1.5: 1

1.46: 1

1.39:1

Acid Test Ratio

1.2: 1

1:1

0.78:1

Receivables Settlement period

40 days

42 days

26 days

Fixed Asset turnover

3.5 times

3.2 times

3.5 times

Sales Revenue per employee

£27,500

£26,800

£25,836

Table2. Financial Ratios for Air-Engines from 2011 to 2013.

The return on equity is increasing from 2011 to 2013, which means that the company has higher returns. It is a good news for the company’s shareholders because the higher the ROE, the better performance the company will have. The operating margin and the gross margin are also increasing from 2011 to 2013, which indicates that the company has a higher profitability in the year of 2013. It may because that the company has reduce the costs so that the cost of goods sold will be lower year by year, which will result in higher operating margin as well as gross margin. As in year 2011, the Current Ratio of Air-Engines PLC is 1.5:1, which means that the company has a good ability to cover its liabilities. The ratio of 2012 and 2013 is lower than that of 2011 mainly because the macroeconomic environment of the crisis. However, as we can see in year 2013, the Current Ratio is still 1.39:1, indicating that the company still has good ability to cover its short term liabilities. Now comes to the Acid Test Ratio. It is clear that the Acid Ratio of Air-Engines PLC is around 1 in 2011 and 2012, which implies for every 1 dollar of debt, the company has 1 dollar easy-to-liquidate asset to compensate. In year 2013, the Acid Test Ratio goes below 1, which is a signal that the company may suffer from liquidity risks. Thus, it is an indicator that the mangers of the company need to take measures so that the ratio comes back to the normal range in the next year. The receivable settlement period decreases dramatically, which indicates that the company has a better cash collection performance. The sales on credit can be paid in a shorter period, which also reduce the probability of bad debt in the future. The fixed asset does not change much during the three-year period mainly because the company does not invest too much in the fixed assets. The sales per employee decreases in 2013 mainly because the increasing number of employees for the company as a whole.

4. Comparison to its competitors

The performance and the ratios for all the three companies can be found in the table below. In addition, the financial data of the three companies in the year of 2013 are also listed in the Table3 below. The financial data may provide information about the basic information about the companies, such as the phases of life circle, the size of the company, etc.

Income Statement

£’000

£’000

£’000

Air-Engines

Britech Engines

Capital Services

Turnover

384,000

320,000

480,000

Cost of sales

228,000

190,000

182,400

Gross profit

156,000

130,000

297,600

Wages and salaries

55,000

50,000

165,000

Sundry expenses

40,500

45,000

50,000

Operating profit

60,500

35,000

82,600

Tax

12,100

7,000

16,520

Profit after Tax

48,400

28,000

66,080

Non-Current Assets

Buildings and equipment

95,000

70,000

190,000

Vehicles

15,000

18,000

40,000

110,000

88,000

230,000

Current Assets

Inventories

25,000

32,000

0

Receivables

27,000

25,000

10,000

Cash at bank

5,000

12,000

50,000

57,000

69,000

60,000

Total Assets

167,000

157000

290000

Current Liabilities

Payables

40,000

30,000

80,000

Accruals

1,000

5,000

40,000

Total Liabilities

41,000

35,000

120,000

Equity

Share capital

77,600

94,000

103,920

Retained profit

48,400

28,000

66,080

Total Equity

126,000

122,000

170,000

Total Equity & Liabilities

167,000

157,000

290,000

Employee

14863

10002

20670

Table3. Financial information of the three companies in 2013

From the table above, it can be seen that the Capital Service is the largest in size. It has the most employees as well as the most fixed assets. However, it can also be seen that Capital Service does not have inventory, which is quite uncommon. In addition, the most important information is that the Capital Service has the lowest costs, compared with other two companies, which indicates that the company will have the highest gross margin.

Air-Engines

Britech Engines

Capital Services

2011

2012

2013

2011

2012

2013

2011

2012

2013

Return on Equity

30.73%

33.80%

38.41%

24.21%

35.00%

22.95%

35.08%

36.93%

38.87%

Operating margin

12.50%

13.75%

15.76%

12.12%

18.65%

10.94%

15.53%

16.35%

17.21%

Gross margin

31.00%

36.13%

40.63%

39.00%

45.64%

40.63%

55.96%

58.90%

62%

Current Ratio

1.5: 1

1.46: 1

1.39:1

1.9: 1

2.1: 1

1.97:1

0.7: 1

0.95: 1

0.5:1

Acid Test Ratio

1.2: 1

1:1

0.78:1

1.2: 1

1.5: 1

1.06:1

0.6: 1

0.8: 1

0.5:1

Receivables Settlement period

40 days

42 days

26 days

30 days

31 days

29 days

25 days

28 days

8 days

Fixed Asset turnover

3.5 times

3.2 times

3.5 times

3.5 times

4.12 times

3.63 times

1.87 times

1.95 times

2.08 times

Sales Revenue per employee

£27,500

£26,800

£25,836

£30,250

£40,075

£31,994

£19,000

£22,140

£22,222

Table4. Ratios for the three companies from 2011 to 2013

From this table, it can be seen that the Capital Service has the lowest current ratio as well as the acid test ratio, which indicates that the company has the highest probability of suffering from the liquidity shock. In common situation, it is said that the Current Ratio of a company will be better around 2. However, while easy to understand, it can be misleading in both a positive and negative sense. A high current ratio is not necessarily good, and a low current ratio is not necessarily bad. From the table above, the liquidity ratios of Capital Service are too low that may trigger liquidity shock. However, the liquidity ratios for Britech Engines are much higher, which is a little bit conservative. The liquidity ratios of Air-Engines are just with in the acceptable range. Profitability ratio offers a useful means of highlighting the strengths and weaknesses of a business. As a result they provide useful signposts for further analysis. Although the calculation of profitability ratio is fairly straightforward, skill and judgment are required in interpreting the results. The ROE of Air-Engines is increasing and quite similar to the ROE of Capital Service. While the operating margin is a little bit lower than that of the Capital Service.

Conclusion

The financial performance of Air-Engines is increasing in the year of 2013 compared with its performance in the previous year. If compared with its major competitors, it can be seen that Air-Engines still can make com improvement. Reducing the costs of the products may help Air-Engines to increase the operating as well as the gross margin in the future. In addition, the liquidity radio indicates that there is not enough short term liquidity for the Air-Engines, thus it needs to take measures to keep the acid test ratio within the normal range. Collectively, Air-Engines is outperformed in several aspects than its competitors and it could have better performance if appropriate measures are taken.

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