Financial analysis of HMV

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INTRODUCTION

HMV is a prominent retailer in the business of entertainment products that has 243 stores in Singapore, Hong Kong, Ireland and UK. They also have 9 shops as a small entertainment chain in the United Kingdom and a website, hmv.com, that sells products which are physical and digital in nature such as books, video games, music and film. (HMV group,2012 )

The first excusive store of HMV was opened in London’s oxford street in the year 1921. They had a large variety of stock and dominated 25% of the UK music market. Despite facing a lot of difficulties now, HMV is making every possible effort to improve its reputation and sustain in the market against its competitors. (The times 100 , N.D.)

Accounting statements provides knowledge about the financial position and profitability of the company. They are facts which are recorded using accounting principles are expressed in money terms. As per the section 211 of the companies act, the companies should disclose all the relevant information and shouldn’t hide it so that the financial statements show correct result. These statements are income statement and statement of financial position. Income statement shows the net profit or net loss occurred by the company in a year and this statement is also known as statement of profit and loss. The statement of financial position indicates the assets, liabilities and the capital of the company on a specific date and is also known as balance sheet. (Goel et al, 2012)

RATIO ANALYSIS

PROFITABILITY RATIOS

Gross Profit Ratio

2011

4.82%

2012

3.40%

Comments:

After calculating the gross profit ratio and comparing the results of 2011 with 2012, it has been observed that there has been a slump from 4.82% in 2011 to 3.40% in 2012. This slump was because of decline in the revenue of the company which in 2011 was 1102.2 £m and fell to 873.1 £ million(HMV group,2012) .This shows that there is no improvement in the condition of the business and hence the operational performance of the HMV group has been very weak in this annual year. The company should focus on factors like revenue, which would directly affect the gross profit. Research and adopt new strategies to increase its revenue. As mentioned in the annual report, the company is planning to sustain by introducing new technology products, amending customer relationship management. (HMV group,2012)

Operating Profit Ratio

2011

0.88%

2012

-1.71%

Comments:

This ratio depicts the profitability of the trading operations of the company. The operating profit of the company in 2011 was 0.88% whereas in 2012 it was -1.71%. In 2011 there was a considerable margin ratio, signalling that enough proportion of revenue is being converted to operating income but in 2012 the company’s operating expenses exceeded its income indicating that the costs and expenses of the company went out of control because of which company has to carry forward operating losses to the next year or certain number of years. This portrays that the company is losing money instead of earning. Somewhere this is also positive for the company because it is reducing the company’s tax liability.

According to the report, there is a decrease in HMV Retail’s operating profit mainly because of decline in sales. The company is also taking measures to improve the operating profit by amending relationships with their music and film suppliers, etc. (HMV group,2012)

LONG TERM SOLVENCY RATIOS

Gearing Ratio

2011

11.90%

2012

118.45%

comments :

According to the data the gearing ratio at 28 April 2012 was 118.45% as compared to 11.90% in 2011 which signals us that the company has increased its long-term borrowings by 152.2 £ m and added only about 75.6 £ m to the total equity. Such high gearing ratio indicates that the company is almost entirely dependent on borrowed funds than its own funds, which signifies that the company will face difficulty in paying back its loans and might become bankrupt. Since the company has more liabilities and less equity, it will be very risky for potential investors to provide funds to the company because the company might not be able to repay the loans with interest. In order to reduce gearing ratio the company should start selling its shares to pay their debt or swap their debt by negotiating with the creditors to become shareholders.

Debt Ratio

2011

1.33%

2012

1.90%

comments :

Debt ratio is calculated to know how much of the firm’s assets are financed by creditors. Assets can be both tangible and intangible. Liabilities can be both short and long-term liabilities. The debt ratio in 2011 was 1.33%, which increased to 1.90% in 2012. Assets reduced by 137.1 £m while liabilities reduced only by 69.7 £m. Lower debt ratio is favourable because it shows that company is less dependent on outsider’s funds for financing their assets, but in this case the debt ratio has risen by 0.57% and became 1.90% in 2012, assets reduced by 137.1 £m while liabilities reduced only by 69.7 £m which points that company has more liabilities than assets. (Accounting explained, 2011)

HMV group will face difficulty in paying not only the interest but also the principal amount with such weak cash flow because the company is already having revenue generation crisis.

LIQUIDITY RATIOS

Current ratio

2011

0.45

2012

0.71

Comments :

This ratio indicates whether the firm is able to pay back its short-term liabilities within a year. The ideal current ratio should be 2:1 that says the current assets should be double of the current liabilities. If the ratio is higher, it is better for the firm since it shows that the company is able to pay its current liabilities more simply. (Goel et al, 2012)

Even though the HMV company is in debts and lacks liquidity, its current ratio is more in 2012 as compared to 2011.It is seen that the sales of the company has been reduced from £1102.2 million to £ 873.1 million. This decline of the sales of the products that HMV produces has in turn led to the inventory not getting used and lying idle since there is less demand for their product in 2012 than 2011. It can also be seen that current ratio of both the years is far away from the ideal ration which says that it is difficult for the company to pay its current liabilities on time. (HMV group,2012)

Quick ratio

2011

0.13

2012

0.22

Comments :

This ratio indicates whether the firm is in a position to pay its current liabilities within a month or immediately. The ideal quick ratio is 1:1, which says that for every single current liability, there should be at least one current asset. Quick ratio is considered better test of liquidity than the current ratio as it includes those assets, which are highly liquid in nature. (Goel et al, 2012)

In HMV, the quick ratio of 2012 is higher than the quick ratio of 2011. The company is investing its funds and resources where the profitability is low as compared to other places because the company is in loss and yet has a higher ratio in 2012 than 2011. The lenders will not be able to provide their support to HMV because their ability to pay them back is very less since the quick ratio of the company is too low in comparison to the ideal quick ratio.

PERFORMANCE RATIOS

Earning per share

2011

(29.3)P

2012

(19.3)p

Comments:

Earning per share is calculated to find out the overall profitability of the firm.it is calculated by dividing profit after tax and preference dividend by number of ordinary shares issued. It is better if the ratio is higher since it shows good performance of the firm but a lower ratio shows unfavourable performance of the firm.

Earning per share ratio of 2012 is 29.3p and of 2011 is 19.3p, which says that earning per share is higher in 2011 than 2012. It shows that the earning power of the firm has reduced in 2012. The investors would not want to invest in this company since due to the less earning of the company; the chances of payment of dividend to them would be less and hence there would be less investment in ordinary shares. The company will have to rely on loans from banks or financial institutions since the investors will not be willing to invest in HMV.

Dividend per share

2011

6.49 pence

2012

0 pence

Comments:

The company uses dividend per share to regulate the amount of dividend payable on each share. The shareholders will prefer if the amount of dividends keep increasing each year, which will only happen when the company makes huge profit. When the dividend rises, the market value of shares increases. Dividend per share is obtained by dividing total ordinary dividend by number of ordinary shares issued. (Scott, 2011)

As from the above calculations, we can see that the dividend per share of 2011 is more than the dividend per share of 2012. Due to this, the stockholders will receive no dividend in the year 2012 and the goodwill of the company goes down since its not performing as per the expectations of the shareholders. The value of shares will go down because the shareholders will not invest in the company in the future. The dividend in 2012 is 0 because there is an operating loss of (-) 0.71%. (HMV group,2012)

THE GOING CONCERN CONCEPT AND ITS PROBLEMS

The going concern concept states that the business shall go on forever, and that the company has no plans for closure. A company following going concern concept accounts its non-current assets in the balance sheet instead of writing it off as cost.The going concern concept considers the company’s legal and social aspects, management and the financial policies and the expectations of the owner. When all such aspects are in favor of the company, the business might run for a long period of time unless the proprietor himself wants to liquidate the company or there is an indication of a going concern problem. (Schindler, 1959)

The indicators of a going concern problem are financial indicators such as net liability position, negative cash flow, liquidity deficiency, equity deficiency, no financial support and inability to pay back the creditors. There are some operating indicators like loss of market, difficulties of labour, continuation of operating losses and use of obsolete technology. (Nsoa, 2011)

The evidences in the 2012 annual report and financial statements of HMV that suggests that the company is facing going concern problems are:

a) Liquidity deficiency

This problem occurs when the amount of current liabilities surpasses the amount of current assets of the company. In the case of HMV Company, the current assets are

£135.2 million and the current liabilities are £189.9 million in the year 2012. This can even be seen from the current ratio of the company in 2012, which is low. This indicates that the company will face difficulties in paying off its debts. The potential investors will be repelled to invest in a company, which is not even able to pay off its current liabilities. We can even see that the current liabilities are£393.3 million and current assets are £179.2 million of the company in 2011. It can be concluded that the liabilities of the company is more than the assets it holds in both the years which in turn testifies that the company will face crisis of paying its debts from a long period of time and might be liquidated in the future. (Altman and McGough, 1974)

b) Shortage of funds

From the balance sheet in the annual report of the company, we get to know that the companies long-term borrowings has increased tremendously by £152.2 million and total equity increased by £75.6 million which signifies that the company mostly relies on outsiders fund instead of owners funds. There is less flow of equity in the organisation because the company has not earned enough profit in the past and this diverts the investors from investing in other potential company instead of HMV. Since there will be a shortage of investment, the company will struggle to pay the interest as well as the principal amount of the loan taken from banks and other financial institutions. In order to pay off its existing loans, the company will have to take more loans and will eventually fall into a debt trap. (Altman and McGough, 1974)

CONCLUSION

The annual report of the company shows the overall health of the company. It is important for stakeholders because they want to know if the company is earning more income than its expenditure. It contains the activities company undertook during the year and views of directors and auditors about the company’s profitability. It is also important as it tells whether the assets grew this year more than the previous year and if the liabilities reduced this year as compared to the previous year.

The accounting statements are very beneficial in evaluation and study of a company’s performance. They help in giving a fair opinion of the profit and loss of the company and the assets and liabilities a company holds. The users of the financial statements such as creditors, shareholders and government are interested in the financial statement of the company. It assists the managers in recognising the current situation of the business and developing strategies and plan of action accordingly. The shareholders would like to know whether their funds are getting invested efficiently or not. The Government of the country is interested in the accounting statements to check if the tax paid to them by the company is correct or not. Financial statements are also suitable in knowing as to how funds should be invested and resources to be used potentially.

REFRENCE LIST

Accounting explained, (2011), debt ratio, available from http://accountingexplained.com/financial/ratios/debt-ratio

[Date accessed: 30 January 2014].

Altman, E. and McGough, T., (1974) evaluation of a company as a going concern.138 (6).

Goel, DK., Goel, R., Goel, S., (2012) analysis of financial statements.Sirmour (H.P.): Arya publications. 10th edition

HMV group, (2012), ‘annual report and accounting 2012’ hmv group plc. Y, radley:Britain

Nsoa, (2011), indicators of a going concern and mitigation factors.Available from http://files.nsoa.co.za/uploads/ISA_570_Indicators_of_Going_Concern_and_Mitigating_factors_1318.pdf [Date accessed: 30 January 2014].

Schlinder, J.S., (1959) the going concern concept in accounting. 34(4).

Scott,P.(2011) accounting for business. Oxford university press:oxford.

The times 100(N.D.) ‘building on a brand’ a HMV UK case study. Available from http://businesscasestudies.co.uk/hmv-uk/building-on-a-brand/#axzz2rrI6Jey3 [date accessed: 30th January, 2014]

APPENDICES

Profitability Ratios

Gross Profit Ratio

Gross profit

--------------------- X 100

Revenue

2011

53.2 = 4.82 %

-------------- X 100

1102.2

2012

29.7 = 3.40 %

------------- X 100

873.1

Operating Profit Ratio

Operating profit

------------------------ X 100

Revenue

2011

9.8 = 0.88 %

------------- X 100

1102.2

2012

(-)15.0 = (-)1.71 %

----------- X 100

873.1

Liquidity ratios

Current ratio

Current assets

---------------------

Current liabilities

2011

179.2 = 0.45:1

--------------

393.3

2012

135.2 = 0.71:1

--------------

189.9

Quick ratio

Current assets (-) stock (-) prepaid expenses

------------------------------------------------------------

Current liabilities

2011

179.2 (-) 106.2 (-) 19.7 = 0.13:1

--------------------------------------

393.3

2012

135.2 (-) 79.1 (-)14.3 = 0.22:1

--------------------------------

189.9

Performance ratios

Earning per share

Profit after tax (-) preference dividends

-------------------------------------------------------

number of equity shares

2011

= (29.3)pence

2012

=(19.3)pence

Dividend per share

Total ordinary dividends

-------------------------------------------------------

Number of ordinary shares issued

2011

27500000 =6.49 pence

---------------------- X 100

423,587,657

2012

0 = 0 pence

-------------------- X 100

423,587,657

Long Term Solvency Ratios

Gearing Ratio

Long Term borrowings

------------------------------------------------- X 100

Equity and preference share capital

2011

7.0 = 11.90 %

-------------- X 100

58.8

2012

159.2 = 118.45 %

-------------- X 100

134.4

Debt Ratio

Total Liabilities

------------------------

Total Assets

2011

440.9 = 1.32:1

---------------

332.1

2012

371.2 = 1.90:1

-------------

195

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