Financial statements serve the main purpose of providing information to the stakeholders of companies about their financial performance. However, not much can be derived from the information in the financial statements in their current form. Financial analysis is necessary in order to derive figures that can be interpreted and used for purposes of making investment decisions (Peterson and Fabozzi 117). Ratio analysis is one such form of financial analysis that has been applied in this report in the case of Rolls-Royce plc, a British multinational company that distributes power systems in different industries.
Ratios are classified into several categories depending on what they measure about the company (Palepu and Healy 1-13). Rolls-Royce plc is a profitable company as seen by the positive profitability ratios in 2015 that include return on sales, return on assets and return on equity. However, the company’s profitability has deteriorated from that of 2014 as depicted from the declining trend of the profitability ratios (See appendix). This decline was as a result of a negative sales growth during the two financial periods, whose revenue growth rates were -5.3% and -3.7% respectively. The asset turnover also reduced slightly from 0.62 to 0.60, an indication that the efficiency of the company’s assets in generating revenue also decreased (Delen, Kuzey and Uyar 3977).
The financial leverage ratio of Rolls-Royce plc increased from 3.48 to 4.45, an indication that the proportion of the company’s assets financed by debt increased during the period. An increase in financial leverage is not a positive signal to investors and lenders who view the company to be at risk of insolvency (Ho 30). However, the short term liquidity position of the company improved as deduced from the slight increase in the current ratio from 1.46 to 1.48. This reflects the increasing ability of the company to settle its maturing short term debts without violating payment deadlines (Palepu and Healy 1-15). While the inventory turnover remained relatively unchanged at about 4 times a year, the debt collection period increased from 145 days to 171 days, which is likely to increase the cash operating cycle of the company.
The declining financial performance of Rolls-Royce plc is further reflected by the earnings per share, which decreased from 65.42p in 2014 to 58.73p in 2015. Dividend per share also decreased from 23.10p in 2014 to 16.37p in 2015. The dividend payout ratio was 35.3% in 2014, but was reduced to 27.9% in 2015. The earnings per share, dividend per share and the dividend payout ratio are important ratios for the investors when making investment decisions, and their negative trend in the case of Rolls-Royce plc is likely to discourage the investors from committing their funds in the company.
However, there seem to be systems in place in Rolls-Royce plc in order to overturn the negative trend in financial performance. A larger proportion of the company’s revenue was committed in year 2015 for purposes of research and development than in 2014 as shown by the research and development ratio, which was 5.3% and 5.7% in 2014 and 2015, respectively.
It is evident from the analysis of ratios of Rolls-Royce plc that ratios provide information that can be used by the stakeholders of a company to make decisions by studying the trends in the financial performance and planning their future engagement with the company based on the trends.
Delen, Dursun, Cemil Kuzey and Ali Uyar. “Measuring firm performance using financial ratios: A decision tree approach.” Expert Systems with Applications 40.10 (2013): 3970-3983. Print.
Ho, Chien-Ta Bruce. “Performance measurement using data envelopment analysis and financial statement analysis.” International Journal of Operational Research 2.1 (2006): 26-38. Print.
Palepu, Krishna G and Paul M Healy. Business analysis & valuation : using financial statements. Mason: South-Western, Cencage Learning, 2012. Print.
Peterson, Pamela P. and Frank J. Fabozzi. Analysis of Financial Statements. Hoboken: John Wiley & Sons, 2012. Print.
Appendix: Ratio analysis of Rolls-Royce plc
| ||Net income/net sales × 100||1081/13354 × 100 |
|1232/13864 × 100 |
| ||Net sales/average total assets||13354/22324 |
= 0.60 times
= 0.62 times
| ||Net income/average total assets × 100||1081/22324 × 100 |
|1232/22224 × 100 |
| ||Average total assets/ Average equity||22324/5016 |
| ||Net income/average owners’ equity × 100||1081/5016 × 100 |
|1232/6387 × 100 |
| ||Total current assets/ total current liabilities||12116/8173 |
| ||Cost of sales/ average inventory||10172/2637 |
= 3.86 (4 times)
= 3.74 (4 times)
| ||Average account receivable/ (Net sales/365)||6244÷(13354/365) |
= 171 days
= 145 days
| ||(This year’s net sales – last year’s net sales) / last year’s net sales × 100||((13354-13864) ÷ 13864) × 100 |
|((13864-14642) ÷ 14642) × 100 |
| ||Gross profit/ net sales × 100||3182/13354 × 100 |
|3523/13864 × 100 |
| ||Net income/ number of ordinary shares||58.73p||65.42p|
| ||Dividends paid/ number of ordinary shares||16.37p||23.10p|
| ||Dividend per share/ earnings per share × 100||16.37/58.73 × 100 |
| ||R&D expense/ net sales × 100||765/13354 × 100 |
|730/13864 × 100 |