Introduction
The financial analysis for a company is done using the historical data. They mostly tell us what happened in past or recent past. However most of the financial analysts and their clients are mostly concerned about what would happen in future. The shareholders of the company are concerned with the prospective future earnings and dividend payment. Creditors are mostly concerned with the company’s ability to meet the future debt payments; while the managers are mostly concerned about company’s ability to meet the need of finance in future expansion. Although the analysis is done by using the historical data, still it can provide significant information to get an insight to resolve these concerns.
Financial analysis is mostly done using the data collected from the annual reports of the company to forecast the company’s financial health. This can be done through a cautious examination of the trends in key financial data, comparison of financial numbers across companies and analysis of significant financial ratios.
The process and methodology
This essay is mainly aim to assess the financial as well as operational state of the target firm against the comparable as well as the market portfolios. Data for five years have been taken to formulate the financial ratios and hence the profitability ratios on excel with help of excel template. With this information, a trend analysis has been carried out for both the companies while having a comparison between them.The companies are also compared against their respective market portfolios and even the market portfolios are compared against each other, so that the markets can be analysed, in which these companies are operating in. The trends in the financials would give an idea how the companies are managing their financial activities. This would also give an idea about the efficiency of the respective managements. Looking at its profitability sometimes can be misleading. Situations can be different in the back stage. That is why one must look at the return on capital investment, return on net assets, financial and operational leverage. Some companies can attain a higher profit with the help of high debt component on its balance sheet, but at the same time the company is exposing itself to the financial risk which can even be more dangerous for the company if not managed in a proper manner.
Financial Leverage
Financial leverage is an assessment of the financial risk which may arise from the debt amount existed in the capital structure of the company (Shim & Siegel, 2000). Usually the financial leverage varies across industries.
Financial Leverage can affect the return on capital employed in the following way.
Return on Capital employed (ROCE) = Return on Net Assets (RONA) + [Financial Leverage * (Return on Net Assets – Net Borrowing Cost (NBC)]
=RONA + [Financial Leverage * Spread].
So it is quite apparent the calculation of ROCE comprises of three components, named as return on net assets, financial leverage and net borrowing cost.
Operating leverage
Operating leverage is known as the amount of short term liabilities generated by the net operating assets. This ratio is an assessment of operating liabilities against the net operating assets.
Operating Liability Leverage = Operating Liabilities (OL)/ Net Operating Assets (NOA).
Overview: The companies
Unilever UK: The target company
Unilever is one of the renowned names in the world of fast moving consumer goods. The company has been able to make its strong presence in the market of food, home and personal care products. The company has its presence in around 100 countries with some 174000 employees around the globe. At the heart of its success are its research and development division who innovate to excel. The company has invested some € 927 m in the R&D worldwide. These must be the reason that that the company has been the sector leader for 10 years on the Dow Jones sustainability index (Unilever, 2010).
P&G: The comparable company
This company is one of the leading organisations operating in the world of consumer goods. The company has been in Dow Jones 100 sustainable companies list worldwide. Since 1837 the company has build up brands which can touch the consumer lives in their daily activities. The company has pioneered in a profit sharing program where the employees are enabled to have an ownership stake in the companies; hence the employees can relate their work with the organisation in a much better way. As per Barron’s the company has been ranked third in ‘World’s most respected companies’ list (P&G, 2010).
Comparison between the two companies: Profitability and Trend analysis
The below pictures are the graphical representation of various ratios for both the companies, Unilever and Procter & Gamble.
ROCE
In the above graph, the return on capital employed (ROCE) is quite higher for Unilever than that of P&G. Shareholders are concerned about this ratio as a higher ratio encourages the equity holders more to invest in the particular company. From that sense surely Unilever is able to satisfy the investors more than P&G. However this can result in a risky affair if attained at a cost of higher financial leverage.
Trend:
Unilever reported a very high return on capital employed in 2005; then the ratio has seen a slowdown in 2006 and 2007 and again an increase in 2008. The company has been able to attain such high ratio at a cost of similar change in the trend of financial leverage. P&G has seen a decline in the year 2006 and from there on the company has seen almost a stable return on capital employed.
Return on Net Operating Assets
As expected Unilever has a higher return on net asset than P&G. This is an assessment of company’s productivity from its assets. It is mainly important how effective these assets are, considering the acquiring and holding cost of those assets.
Trend:
Unilever has seen almost stable values from 2005 to 2007. However the company has seen a higher growth in 2008.The reason has been that the company has sold off some of its assets in that particular year. P&G has to enhance its efficiency of its assets. Throughout this period, the value of RONA has varied slightly and has been quite low for the company.
Financial Leverage
Financial Leverage is much higher for Unilever; hence it has higher financial risk compared to P&G. The company is holding more debt in its portfolio which in turn enhances its return on capital employed ratio. It is quite apparent from the ROCE equation that this return has a positive relationship with the financial leverage of the company. Unilever has been able to mark a higher ROCE at a cost of high financial leverage.
Throughout these four years, P&G has managed to have almost stable financial leverage ratio, which is quite good for the company’s financial health. The creditors of the company would be happy to see that the company maintains its financial leverage around 0.5 to 0.6 which means P&G has enough assets to repay its debt amount, if needed. Unilever needs to control the amount of debt on its portfolio. However the amount of leverage for Unilever has decreased drastically in 2006; from there it has shown another slowdown in 2007 and a slight increase in 2008.
Unilever has generated more short term liabilities through their net operating assets than that of P&G. P&G has maintained quite a stable operating leverage throughout this period which is quite a good for the company’s financial health.
Trend:
Unilever maintains quite a higher ratio of operational leverage, which can result in a risky exposure for the company. Compared to this P&G has maintained a low and stable ratio throughout this period.
Profitability Margin
The profitability is quite higher for P&G. The reason could be that the company has been low sales and has been able to maintain a high profit a minimum cost, which increased its profitability.
Unilever has shown a gradual growth in profitability margin; however in 2008, the company has been able to set a high growth rate in the profitability margin. P&G has been able to attain a continual growth in the profit margin till the year 2007, but in 2008 the profit margin has seemed to see a slight decline in value. In that, P&G has been able to increase its sales and the profit; but the proportion of increment in the sales was more than the change in profit. This is the reason that the company has seen a lower profit margin in that particular year.
The asset turnover ratio has been quite high for Unilever. As mentioned earlier Unilever posses a higher productivity on its assets.
In this ratio both the companies have shown almost a similar trend; both have seen a slowdown in their efficiency ratio. The reason could be that as days have passed on, both the companies have increased on the asset amount; however there were no proportionate change in the profit amount.
Common Size Analysis of the Balance sheet
In this analysis the target firm Unilever has been compared with the comparable firm, Procter & Gamble.
Apart from the miscellaneous assets, similar to P&G, Unilever has most of its contribution to the net operating assets have come from the property, plant and equipment it has held. In 2009, the contribution of these assets to Unilever’s total operating assets has been 18.6 %, while that for P&G was 14.96 %. The least contribution has come from the receivables amount; although the percentage is quite higher compared to P&G.
Unilever
The receivables amount is quite higher for Unilever. The company must look at this fact and take proper action to minimise the receivables level. Within the operating liabilities, apart from other liabilities, the contribution from the accounts payable is much higher for both the companies.
It seems that Unilever has a long receivable collection cycle as well as a long payable cycle. P&G has also a large payable cycle. It is quite apparent that the company believes in collecting the receivables at a much faster rate and prefers to pay the creditors in a much slower rate.
Both the companies have debt and preferred stocks at their financial asset portfolio. The financial asset structures for both the companies are quite similar. The most of the financial assets consist of long term debt components and this is quite true for both the companies. As the companies operate in fast moving consumable goods, it is quite obvious that they would need a good amount of capital for the same. So the companies prefer to collect a good chunk of money from the creditors.
Overall Unilever has a moderate debt level on its portfolio. However it should take care of its receivable and payable cycles. The company must accelerate its collections from the debtors; hence it should review and reformulate its credit policy.
Common Size Analysis of the Income statement
The below images present the amount of Unilever’s cost of sales, growth margin, operating expenses, operating income as percentage of sales in comparison with the company, P&G. Unilever’s cost of sales as a percentage of its sales amount is much higher than that of P&G.
Unilever
Apart from that, the percentage of other expenses like operating expenses is quite high for Unilever. As a consequence, the gross profit margin and operating profit percentage is quite low for Unilever, while compared to the company, P&G.
The percentage of cost has been much higher for Unilever; this has been the reason that the company’s after tax operating profit percentage and the percentage of comprehensive income available to the shareholders has been much lower, in alignment with those of P&G. Unilever needs to reduce its expenses to enhance its profit margin.
Trends analysis
In this section we try to explore trends analysis of Unilever PLc for both income statement and balance sheet during the period 2005-2008. We use the year 2004 as base with index of 100.
Balance sheet trend
Appendix 5 shows as that most of items in balance sheet were increased during the period 2007-2008. In contrast, there is a decrease in the year 2006. For example, in year 2005 inventory was 106.11% and declined to 95.90% in 2006 and grew again to 107.60% and 143.07% in year 2007& 2008 respectively.
Income statement trend
We can see also in appendix 5 that, there is a growth in gross margin during the last five years. This could be explained by the increase in sales during these years. For instance, in 2008 sales were increased by 117.23% leads to increase gross margin by 114.47%. Moreover, Comprehensive income has increased highly during the last five years.
Comparison of profitability between Unilever and UK portfolio
The stakeholders of Unilever must be happy with the below mentioned graphical representation of the profitability comparison between Unilever and average of a set of companies in UK. The UK portfolio consists of the following companies.
- Unilever PLc
- Associated B. FOODS
- Cranswick Plc
- Northern Foods Plc
- Premier Foods Plc
- Ropert Wiseman Dairies Plc
- TATE & LYLE
Comparison of profitability between P&G and USA portfolio
The USA portfolio consists of ten significant companies from USA. They are as follows.
- P&G Plc
- Energizer Holdings Inc
- Clorox
- Hein celestia
- Imperial
- Scottes Miracle
- Spectrum
P&G has shown comparatively superior performance than the overall USA portfolio. However in 2008, USA companies have been able to attain a steep growth in profitability compared to 2007.
Comparison of probability between UK and USA portfolios.
USA portfolio has seen a sharp growth in profitability in 2007-08 period. There may be some tactical and financial improvement happened in that time which led to a step growth for the USA market. Apart from that for the fast moving product industry, UK has been doing well almost through out the years.
Strengths of the companies
Strengths of Unilever
- Unilever has mostly found its strength by expanding its business in the developing and emerging markets around the globe.
- Unilever has been paying dividend to their shareholders throughout the years, which raised the shareholders’ belief for this company.
- Unilever has gone through a five year long organisational restructuring process. This has been the growth strategy of the company, which has surely paid off adding to its profitability margin.
- As the company has used quite a good amount of debt on its portfolio, it gets quite a large amount of tax shield on the same. The company has been able to reduce their tax burden by a certain good amount which has been helpful in enhancing the profit margin for the company.
Strengths of P&G
- The strong cash generation and its confidence on its business have enabled the company to mark higher profit throughout the years.
- The market risk of the company is quite low; which have enabled the company to be a good choice to make investment in.
- Similar to the Unilever, this company is also a constant dividend payer, which is surely good news for the shareholders of the company.
Conclusion
Unilever and P&G, both are renowned names in the world of consumer goods. Both the companies are making profits and are in a better position compared to the other companies in the same industry operating in the respective countries. However Unilever has attained this profitability with the debt amount it has on its balance sheet. The advantage is that Unilever is getting more tax shield which would lessen their tax burden; and hence enhance their net profit margin. Still there is also s disadvantage attached to it. The company can fall in distress if the debt holders want their money in one go. To reduce the risk of financial distress the company must enhance its liquidity position, so that in need it can lay its hands on the readily available cash and cash like liquid assets. The company must hedge their financial risks with the help of financial instruments. Through these activities the company would be able to fetch the full advantage of having more debt component on balance sheet. Another important fact is that compared to P&G, Unilever has much higher percentage of receivables and payables amount. Unilever must try to reduce the amount and enhance their liquidity position. The company has gone through a five years long restructuring process. Hopefully both the companies will maintain its sustainable growth in coming years