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Finance, Funding and Legislative Frameworks for Success

Assignment 1 Ratio Analysis 11/24/2012


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Contents
Table of Figures ..................................................................................................................................... 3 Executive Summary .............................................................................................................................. 4 Introduction ........................................................................................................................................... 5 I. II. 1. 2. 3. 4. 5. III. IV. V. VI. VII. Comparison between the Latest year results and previous year results ........................................ 5 Ratio analysis of latest and previous years ................................................................................... 6 Liquidity........................................................................................................................................ 6 Solvency........................................................................................................................................ 6 Working capital management ....................................................................................................... 6 Profitability ................................................................................................................................... 7 Asset efficiency ............................................................................................................................. 7 Comparison with industry average figures ............................................................................... 8 Measurement against the organizations KPIs .......................................................................... 8 Evaluation of the uses of KPIs in assessing organization performance ........................................ 9 Discussion and explanation of your results............................................................................... 9 Limitations and advantages of method used ............................................................................. 9

Conclusion .......................................................................................................................................... 10 Appendix 1 .......................................................................................................................................... 11 Appendix 2 .......................................................................................................................................... 12 Appendix 3 .......................................................................................................................................... 15 References .......................................................................................................................................... 16

Table of Figures
Figure 1: NEXTs annual report and accounts ................................................................................. 5 Figure 2: current and quick ratios ................................................................................................... 6 Figure 3: Debt ratio and times interest earned .............................................................................. 6 Figure 4: Days sales outstanding and trade debtors collection period .......................................... 7 Figure 5: Profit margin and ROE ..................................................................................................... 7 Figure 6: Inventory turnover and total assets turnover ................................................................. 8 Figure 7: Yahoo.fianance.com ........................................................................................................ 8

Executive Summary NEXT Plc is an apparel retailer based in UK. During the studied period, NEXT Plc has presented to its shareholders and its creditors and to stock analysts an extraordinary performance through its results. Its ability to maintain growth over the recent years, and its capability of generating cash, has enabled it to be ranked as the second best performing FTSE 100 Company. The sluggish growth of the global economy, the soaring commodity prices and the negative impact of the increasing inflation on consumer spending were very challenging matters to NEXT. However, because of its highly qualified staff, it could overcome the challenges and make good results. Nothing can be perfect. NEXT has also its weakness. Some of them are due to its own choices of its strategies but others are just external and depend to the environment.

Introduction NEXT is a UK based retailer that is known of its neatly designed clothing, shoes, accessories, and home products. Covering not only UK market but also the international market, it distributes its products through its three essential channels: NEXT Retail, NEXT Directory, and NEXT International. In spite of the sluggish economy and the challenging environment, this giant retailer has had an excellent year and was capable of presenting good results to its shareholders. For the time range of 2011, NEXT has been ranked as the second best performing FTSE100 Company in regards of its stock price and dividend performance. This remarkable success is mainly due to the companys devotion to growth delivery and that is by investing in the brand, improving the products, and managing the business well. By the current report, we intend to analyze sustainability of these financial results using the necessary ratios and comparing them to industry averages and also measuring them against KPIs of the company. I. Comparison between the Latest year results and previous year results According to NEXTs annual report and accounts (January 2012), Earnings per share have increased by 15.1% to a peak level of 255.4p. Revenue has exceeded 4% to 3,441m from continuing business and 5% profit growth to 570m. Dividend per share for the year rose by 15% to 90p and remains covered 2.8 times. Cash generation remains strong. Next Plc continued its program of share buybacks, buying 12.5 million shares at an average cost of 2321p. During the year it returned 425 million to shareholders in share buybacks and dividends.

Figure 1: NEXTs annual report and accounts 5

II.

Ratio analysis of latest and previous years According to the data published in the official Next`s web site/ NEXTs annual report and accounts (January 2012) (Appendix 1) 1. Liquidity As shown in the table below (Appendix 2), it seems that the company still has low ratios even with the increase that it made over the past year. According to the quick ratio, the company did not have enough cash to cover its current liabilities during 2011, as the quick ratio was 0.84. That means it couldnt pay off its short term debts without having to liquidate its inventory. However, it could improve its liquidity during the last year. This improvement is mainly due to erasing the unsecured bank loans.
Ratio Current ratio Formula Current assets/current liabilities Quick ratio (Current assetsInventories)/current liabilities Figure 2: current and quick ratios 2011-2012 1.5:1.0 1.03:1.0 2010-2011 1.3:1.0 0.84:1.0 Difference Increase 0.26 Increase 0.19

2. Solvency Its formula is: Total assets/ Total liabilities (2112) = 1631.5/1854.2 = 88%. The ratio has slightly increased from the last years that was 87%. Creditors prefer low debt ratios because the lower the ratio, the greater the cushion against creditors losses in the event of liquidation which is not the case for NEXT. A debt ratio of 88% is very high and it means that a great deal of assets is financed by credit which might be an important burden for the company issuing more debt. However, when we take a look at TIE, it seems that the company can comfortably meet its obligations. TIE during 2011-2012 period of 20.8 is a very large number even if it has slightly decreased compared with the last periods which was 23.3. Ratio Debt ratio Times interest earned Formula 2011-2012 Total assets/ Total 88% liabilities Operating profit/interest 20.8 times charges. 2010-2011 87% 23.3 times Difference - --Decrease 2.5

Figure 3: Debt ratio and times interest earned

3. Working capital management DSO represents the average length of time that the company has to wait after making sales before receiving cash which has to be kept as short as possible. NEXT has not improved it much
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as there is only 2 days difference between the 2 periods. DSO remains fairly high figure and NEXT might want to take action to cut it down. Trade debtors collection period is also high number which means that it took NEXT almost 2 months and a half in average to pay its suppliers compared to 68.5 days last period. Ratio Formula 2011-2012 Days sales Receivables x 83.3 days 365 / Annual outstanding sales Trade debtors Trade debtors x 74.2 days 365 / Annual collection sales period 2010-2011 85.2 days Difference Decrease 1.9

68.5 days

Increase 5.7

Figure 4: Days sales outstanding and trade debtors collection period

4. Profitability NEXT has improved its Profit margin on sales ratio by 16% from the last period. It was 14% compared to 12% last period. Shareholders invest to get a return on their money, and Return on Common Equity ratio reveals to what extent their investments are successful. This soaring number has reached 213% from 169% last period is a very high percentage and that is due to the high level of debt in the companys balance sheet. Ratio Profit margin ROE Formula 2011-2012 Profit for the 14% year/sales Profit for the 213% year/common equity 2010-2011 12% 169% Difference Increase 16% Increase 26%

Figure 5: Profit margin and ROE

5. Asset efficiency Two asset efficiency ratios are to be discussed here: Inventory turnover ratio and total assets turnover. These ratios measure how effectively the firm is managing its assets. Inventory turnover was 9.25 which roughly means each item of NEXTs inventory is sold out and restocked 9.25 times per year. NEXT was able to expedite its turnover over the last period as it was only 8.95 times. Total assets turnover has almost remained unchanged over the two periods. It was 1.86 times. Ratio Formula Sales/ Inventories Inventory turnover Total assets Sales/ Total assets 2011-2012 8.95 1.86
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2010-2011 8.95 1.84

Difference Increase 3% - ---

turnover
Figure 6: Inventory turnover and total assets turnover

III.

Comparison with industry average figures Industry average figures were not easy to be found except if we had access to the two most popular sources of industry averages: RMAs Annual Statement Studies and Dun & Bradstreets Key Business Ratios. However, Yahoo.fianance.com has ranked NEXT as the leader of the apparel industry among its 68 competitors in regards of some ratios: Market Capitalization, P/E Ratio, and Return on Equity. Statistic Market Capitalization P/E Ratio (ttm) PEG Ratio (ttm, 5 yr expected) Revenue Growth (Qtrly YoY) EPS Growth (Qtrly YoY) Long-Term Growth Rate (5 yr) Return on Equity (ttm) Long-Term Debt/Equity (mrq) Dividend Yield (annual)
Figure 7: Yahoo.fianance.com

Industry Leader NXT.L 5.76B NXT.L 1,403.10 CHRS KORS 74.40% HOTT 42.90% LLL.TO 34.03% NXT.L 336.86% CBK N/A

NXT.L 1.22 4.80% -5.50% 10.70% 431.338 N/A

NXT.L Rank 1 / 68 1 / 68 30 / 68 40 / 68 13 / 68 38 / 68 1 / 68 N/A N/A

IV.

Measurement against the organizations KPIs According to the chief executive`s review and NEXTs annual report 2012, the company use different KPIs (appendix 3): Brand sales: Our budget for the first half is for Brand sales to be up between 1% and 4%, with Retail sales between 0% and -3% and Directory between +9% and +12%. (chief executive`s review, p 15). During the year Next`s has exceeded 4% to 3,441m Group cash flows: We intend to use up to this amount- 200m- to buy back shares and at a price of 28.00 that sum would buy around 4% of the shares in issue (chief executive`s review, p 15). At the end of year 2012 cash generation, combined with buybacks, increased earnings per share by 6%. Margins and Costs: However we believe that we can offset at least 28m of this increase with cost saving initiatives. (chief executive`s review, p 15). Next plc passed on some of this cost inflation in the form of 7% higher selling prices. Stocks well managed. Other KPIs are details in the appendix 3: Selling space, like to like sales, Operating margin, Average active customers and Share buybacks

V.

Evaluation of the uses of KPIs in assessing organization performance KPIs are quantifiable measurements, agreed at the outset, that reflect the critical success factors of a business or organization. They differ from business to business and from department to department. Challenges of using KPIs 1. The KPIs are usually difficult to be adapted to the recent changes, especially after been designed 2. The KPIs do not demonstrate the exactness of the business performance 3. KPIs usually companies ask for an external expert to give a good understanding and recommendations of KPIs analysis. Despite the limitation associated with the use of the KPIS, still remain a much better means to determine its actual work output in the context of performance management. Advantages of using KPIs 1. KPIs allow managers to determine potential profit areas and ways to reduce cost in the business. 2. KPIs allow managers to negotiate competitively contracts, which can affect positively the Companies competitive advantage. 3. The KPIs help managers to find gap areas in its Operation which needed improvement.

VI.

Discussion and explanation of your results Next Plc keep a quick growth -through NEXT directory- of its online business in the UK and internationally. NEXT Directory represents now 32% of group sales and 44% of operating profits. This success is due to its Retail store network. Moreover, this success is related to the high ability of the 2 businesses to work in the same line and cooperate. The strong cash generation is due to the company program of share buybacks. It bought 12.5 million shares at an average cost of 23.21. It paid back 425 million to shareholders in share buybacks and dividends. The Group remains well financed for coming periods, because of the renewing of its medium term bank facilities the key ingredient of our success is the stability and effectiveness of our management teams across the Group.

VII.

Limitations and advantages of method used Ratio analyses can be used by managers, creditors and stock analysts. This kind of analyses can provide useful information concerning a companys operations and financial conditions. However, it does have its limitations and we recite the most important of them (Ambrish Gupta,
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p131): Different accounting practices can spoil comparisons. Ratio Analysis techniques provide only numbers but not a deep understanding of the causes behind. Moreover, Inflation destroys the Companies' Balance Sheets. Companies can use Window Dressing to Manipulate Their Financial Statements, which will mislead the results. A firm might have good and bad ratios and that can be contradictory which makes analyses difficult. Seasonal factors can distort a ratio analysis. Interpretation of result is not a science. The analysis we have conducted here in this report has been based upon accurate data from next`s official website and credible academic use of ratios. It would have been better if we have found more useful data related to the industry average as to deepen the study of the companys performance. Conclusion In spite of the sluggish economy and the difficult environment, Next Plc has had an excellent year and was capable of presenting good results to its shareholders. Different financial analysis ratios techniques have been used for this report. We approached the real financial statement of the company, however some limits and lack of some information stand obstacle for a deep understanding.

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Appendix 1

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Appendix 2

Calculations of ratios a. Liquidity Current ratio = current assets/current liabilities 1,139.9/742.4 = 1.5:1.0 1,067.3/832.9 = 1.3:1.0 Increase 0.26 Quick ratio = (Current assets Inventories)/ current liabilities (1,139.9-371.9)/742.4 = 1.03:1.0 (1,067.3-368.3)/832.9 = 0.84:1.0 Increase 0.19

b. Solvency Debt ratio= Total assets/ Total liabilities (2012) = 1631.5/1854.2 = 88%. Debt ratio 2011= 1,559.9/ 1,792.3= 87% 2011-2012(m) Total assets 1,792.3 Total liabilities 1,559.9 Times interest earned Operating profit/interest charges Operating profit 566.8 Interest charges 24.3 601.8 2010-2011(m) 1854.2

1631.5

28.9

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601.8/28.9=20.8 times 566.8/24.3=23.3 times c. Working capital Days sales outstanding Receivables x 365 / Annual sales= 699.1*365/ 3,441.1 = 83.3 2011-2012 Annual sales Trade and other receivables Trade and other payables Trade debtors collection period Trade debtors x 365 / Annual sales= 545.0*365/ 3,441.1= 74.4 3,441.1 699.1 (545.0) 2010-2011 3,297.7 645.6 (544.6)

d. Profitability Profit margin = Profit for the year/sales Profit for the year Sales 474.8/3,441.1=14% 400.9/ 3,297.7=12% ROE= Profit for the year/common equity 474.8 3,441.1 400.9 3,297.7

Profit for the year Common equity 474.8/ 222.7= 213% 400.9/ 232.4= 169%%

474.8 222.7

400.9 232.4

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e. Efficiency Inventory turnover Sales/ Inventories 2011-2012(m) Inventories Sales 3,441.1/ 371.9= 9.25 3,297.7/ 368.8= 8.95 371.9 3,441.1 2010-2011(m) 368.3 3,297.7

Total assets turnover Sales/ Total assets Sales Total assets 3,441.1/ 1,854.2= 1.86 3,297.7/ 1,792.3= 1.84 3,441.1 1,854.2 3,297.7 1,792.3

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Appendix 3

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References Ambrish gupta ; financial accounting for management: an analytical perspective; dorlina kinderslev ; 2009; 131-135p Nexts annual report and accounts (january2012) Http://www.nextplc.co.uk/~/media/files/n/next-plc/pdfs/latest news/2012/ar2012.pdf Proctor. (2010) managerial accounting for business decision. London: prentice hall. Quinn. (2011) management and financial accounting: working capital ratio htt://martiniquinn.com/2011/12/01/working-capital-management-ratios-4-in-series-of-06on-financial-ratio-analysis>[16 august 2012 Results for the year ending january 2012: chief executive`s review, p15

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