Profitability ratios
As per the prevailing scenario, Jupiter Holdings Plc is seeking an investment and is considering the acquisition of either Griffin Care Services Ltd or Midlands Commercials Ltd. Griffin operates through its lease hotels providing services for young people who are not cared for under the foster system. Midlands on the contrary makes use of their large storage space for storing and repairing commercial vehicles. The main purpose of this report is to analyse the financial performance of both the potential targets using financial ratios and recommend the best possible investment for Jupiter Holdings.
There are several metrics that are intended to analyse the profitability performance of both companies. The gross profit margin showcases the proportion of turnover left behind after meeting the cost of sales (Fridson and Alvarez 2022). The net profit margin ratio illustrates the margin of turnover left behind after meeting the total expenses incurred during the year (Williams and Dobelman 2017). The gross profit margin and the net profit margin ratio of Midlands are higher at 70.15% and 36.80% respectively when compared to Griffin whose results are 49.18% and 25.93% respectively. This is because of a comparatively higher turnover and lower expenses which have been incurred during the year. However, when it comes to the return ratios, the return on capital employed and the return on assets which illustrates the company’s ability to make use of their total capital invested in resources with efficiency for generating profits is better for Griffin at 94.85% when compared to 43.17% for Midlands. Furthermore, the asset turnover at 3.66 times is also higher for Griffin when compared to Midlands. This means that although Midlands have higher margins, Griffin are much more capital and resource efficient.
When it comes to overall efficiency, the cash cycle of Griffin at -78.00 days is much more favourable than 3.73 days of Midlands. This is because of better receivables management as the payable payment period for both companies are almost similar. This is interpreted as Griffin to be quicker in converting its working capital investments into cash when compared to the likes of Midlands. The liquidity position of the companies can be measured with the help of the current ratio. The current ratio means the reliance a company can place upon its total current assets for meeting the total current liabilities (Robinson 2020). At the very least, the current ratio must be 1. Griffin has an optimal current ratio of 2.01 times while Midlands although having a higher ratio at 7.95 times is required to make use of their current assets more efficiently. Lastly, when it comes to solvency ratios, the gearing of Griffin is 0 while that of Midlands is 27.68%. This means that the risk of default and financial leverage is low for Midlands but negligible for Griffin. Likewise, the interest coverage ratio tends to measure the total number of times an organisation may meet its interest expense from the available total operating profits (Griffin and Mahajan 2019). Since the long term debt and interest expense for Griffin is zero, the metric is also zero which in the case of Midlands is a high 12.03 times.
Return ratios
Conclusion and Recommendation:
Based on the financial analysis of both the companies, it can be concluded upon that both companies have a strong and favourable set of financials with a positive future outlook and a high growth potential. Jupiter Holdings should not go wrong either of the investment opportunity. However, if the company were to choose among the two, Griffin Care Services Ltd is recommended. This is because the company’s risk of default is negligible and the company tends to be capital efficient. Additionally, their liquidity position is optimal while they tend to manage their working capital with better efficiency levels.
Working capital management is the efficiency with which an organisation tends to manage their investments in current assets and current liabilities to ensure that they have enough short term liquidity for ensuring a smooth day to day operations of the business (Easton et al. 2018) In order to ensure that there is efficiency in working capital management, both the companies who are service providers needs to ensure that they have a minimum cash cycle. This means that these service providers (the companies provide service and has no inventory) must have a minimum and quick operating cycle. As seen from the ratios, the receivable collection period of Griffin at 18.50 days is quite quicker than 99.25 days of Midlands. The metric indicates the total time it takes for a company to collect debts from customers to whom services have been provided on credit. Likewise, the payables payment period measures the total time it takes for an organisation to pay off the suppliers during a financial period for supplies or materials purchased on credit. This is higher for Griffin at 96.50 days when compared to 95.52 days of Midlands. Therefore, the cash cycle for Griffin is shorter than that of Midlands which means that Griffin is better at managing their working capital.
|
Source |
Advantages |
Disadvantages |
|
Equity Shares |
No Fixed Dividend Obligations No Creation of Charge |
Sacrificing some amount of control Expensive based on return expectations |
|
Retained Earnings |
No requirement of giving up control Cost is bare minimum |
Shareholders may be dissatisfied. May not have equivalent cash flows |
|
Debt |
Interest is tax deductible Cheaper when compared to equity |
Covenants and Collaterals Statutory Payments |
(Source: Warren, Reeve and Duchac 2016).
It is best recommended to Jupiter Holdings Plc to first consider their capital structure before raising the finances. If the company is highly geared, it must consider equity while on the contrary may consider raising debts (Martin, Keown and Titman 2020). Hence, finances are recommended to be raised in a way that the capital structure of the company is optimum.
| Calculation of Contribution of Each Product | ||||
| Particulars (£m) | Silver | Gold | Platinum | Total |
| Sales | 16,236.00 | 10,824.00 | 7,749.00 | 34,809.00 |
|
Less: Variable Costs |
||||
| Material | -5,166.00 | -3,444.00 | -3,444.00 | -12,054.00 |
| Labour | -5,065.20 | -5,115.60 | -5,216.40 | -15,397.20 |
| Contribution Margin: | 6,004.80 | 2,264.40 | -911.4 | 7,357.80 |
|
Less: Fixed Costs |
||||
| Overheads | -2,583.00 | -2,583.00 | -2,583.00 | -7,749.00 |
| Profit/(Loss): | 3,421.80 | -318.6 | -3,494.40 | -391.2 |
The company should consider making the product gold as it has a positive contribution margin and covers the total variable costs involved.
The company should stop making the product platinum as it has a negative contribution margin which means that the sales generated is not enough to cover the total variable costs.
The total contribution margin is calculated as the difference between the total sales generated from a product or multiple products and the total variable costs incurred in making the products (Brigham and Houston 2021). It is calculated for understanding how much of sales contributes to covering the fixed costs and the profits to be earned (Banerjee 2015). It is useful in evaluating product value for it can be used in breakeven calculations and cvp analysis which measures the interrelationship between costs and volume to maximise profits (Brewer, Garrison and Noreen 2015).
Efficiency ratios
There will be some amount of improvement in total profitability if the company ceases to manufacture platinum. Instead, the company should consider channelising their resources to making silver which is the most profitable product line and also happens to sell the most. Additionally, the company can also focus channelising the resources to Gold for making it profitable.
| Cash Flow Forecasts (£) | ||||
| Particulars | 0 | 1 | 2 | 3 |
| Land Investment | 105,000 | |||
| Building Costs | 150,000 | |||
| Fittings and Equipments | 82,050 | |||
|
Total Initial Investment |
337,050 | |||
|
Total Sales Revenue |
620,100 | 632,502 | 645,152 | |
|
(-) Cost of Cement Products Sold |
164,195 | 167,479 | 170,828 | |
|
(-) Cost of Metal Stock Sold |
113,614 | 115,886 | 118,204 | |
| (-) Staff Cost | 25,523 | 26,033 | 26,554 | |
|
(-) Light and Heat |
36,252 | 36,977 | 37,717 | |
|
(-) Other Overheads |
138,951 | 141,730 | 144,565 | |
|
Total Expected Cash Flows |
-337,050 | 141,565 | 144,396 | 147,284 |
| Calculation of Project Appraisal Techniques | |||||
| Year | Cash Flows | Cumulative Flows | PVIF (12%) | Discounted Cash Flow |
Cumulative DCF |
| 0 | -337,050 | -337,050 | 1 | -337,050.00 | -337,050.00 |
| 1 | 141,565 | -195,485 | 0.893 | 126,397.32 | -210,652.68 |
| 2 | 144,396 | -51,089 | 0.797 | 115,111.85 | -95,540.83 |
| 3 | 147,284 | 96,196 | 0.712 | 104,834.00 | 9,293.17 |
| PBP: | 2.35 | ||||
| DPBP: | 2.91 | ||||
| NPV: | 9,293.17 | ||||
| IRR: | 13.59% |
Based on the npv, this project is recommended as the value is positive. Additionally, the payback and discounted payback is also within 3 years which is favourable. However, the internal rate of return does not provide a cushion of 5% over the cost of capital but still exceeds the cost of capital. Therefore, considering the investment appraisal results, the project can be accepted theoretically since it has a positive npv which will create long term value for the company and its shareholders (Michelon, Lunkes and Bornia 2020).
Lastly, it is recommended that companies do not resort only to financial factors which are revealed from investment appraisal considerations (Alles et al. 2021). Additionally, entities must also consider non-financial factors which are equally important when it comes to project appraisal (Jiambalvo 2019). The limitations of all the investment appraisal techniques are presented in a tabular format as follows:
|
Technique |
Limitation |
|
NPV |
1. It is sensitive to the choice of discount rate. 2. It does not consider the size of the investment and is biased towards large projects. |
|
PBP |
1. It does not consider time value of money. 2. It does not consider all streams of cash flows. |
|
DPBP |
1. The technique does not account for all cash flow streams. 2. It does not provide the profitability and value addition of an investment |
|
IRR |
1. It does not quantify the value addition to the wealth of shareholders. 2. It is not reliable in case of mutually exclusive investment opportunities (Siziba and Hall 2021). |
Liquidity ratios
| Bifuraction of Overheads Using High Low Method | ||||||
| Premium | Standard | Budget | ||||
| 2021 | 2020 | 2021 | 2020 | 2021 | 2020 | |
| Total Overheads (£) | 85,000 | 60,000 | 92,500 | 80,000 | 78,000 | 60,000 |
| Activity Level (Units) | 800 | 400 | 1,201 | 939 | 1,100 | 600 |
| Per Unit Variable Overhead | 62.5 | 47.71 | 36 | |||
| Total Variable Overhead (£) | 50,000 | 25,000 | 57,300 | 44,800 | 39,600 | 21,600 |
| Total Fixed Overhead (£) | 35,000 | 35,000 | 35,200 | 35,200 | 38,400 | 38,400 |
| Marginal Cost Card | ||||||||||||
| 2021 | 2020 | |||||||||||
| Premium | Standard | Budget | Premium | Standard | Budget | |||||||
| Cost | Per Unit | Cost | Per Unit | Cost | Per Unit | Cost | Per Unit | Cost | Per Unit | Cost | Per Unit | |
| Sales Units | 800 |
412.5 |
1,201 |
209.83 |
1,100 |
190.91 |
400 |
750 |
939 |
335.46 |
600 |
466.67 |
| Total Sales Revenue | 330,000 | 252,000 | 210,000 | 300,000 | 315,000 | 280,000 | ||||||
|
Less: Variable Costs |
||||||||||||
| Raw materials | 90,000 | 112.5 | 80,000 | 66.61 | 90,000 | 81.82 | 80,000 | 200 | 110,000 | 117.15 | 130,000 | 216.67 |
| Direct labour | 40,000 | 50 | 34,000 | 28.31 | 39,500 | 35.91 | 30,000 | 75 | 45,000 | 47.92 | 50,000 | 83.33 |
|
Variable Overhead |
50,000 | 62.5 | 57,300 | 47.71 | 39,600 | 36 | 25,000 | 62.5 | 44,800 | 47.71 | 21,600 | 36 |
| Total Contrbution Margin: | 150,000 | 187.5 | 80,700 | 67.19 | 40,900 | 37.18 | 165,000 | 412.5 | 115,200 | 122.68 | 78,400 | 130.67 |
| (2.1.4) Contribution per unit of Scarce Resource and Decision Ranking | ||||||
| 2021 | 2020 | |||||
| Premium | Standard | Budget | Premium | Standard | Budget | |
| Unit Heat Resistant Material | 90 | 70 | 10 | 90 | 70 | 10 |
| Total Sales Units | 800 | 1,201 | 1,100 | 400 | 939 | 600 |
| Total Heat Resistant Material | 72,000 | 84,070 | 11,000 | 36,000 | 65,730 | 6,000 |
| Total Contribution Margin | 150,000 | 80,700 | 40,900 | 165,000 | 115,200 | 78,400 |
| Contribution Per Unit of Material | 2.08 | 0.96 | 3.72 | 4.58 | 1.75 | 13.07 |
| Production Ranking | 2 | 3 | 1 | 2 | 3 | 1 |
| Budget Production Schedule if Contract is Honoured | |||
| Premium | Standard | Budget | |
| Maximum Demand | 2,000 | 1,500 | 1,000 |
| Unit Heat Resistant Material | 90 | 70 | 10 |
| Total Resource Requirements | 180,000 | 105,000 | 10,000 |
| Production Ranking | 2 | 3 | 1 |
| Units that can be Produced | 2,000 | 871.43 | 1,000 |
| Actual Production | 1,900 | 1,000 | 1,000 |
| Marginal Cost Income Statement | ||||
| Premium | Standard | Budget | Total | |
| Total Resources | 171,000 | 70,000 | 10,000 | 251,000 |
| Contribution Per Unit of Material | 2.08 | 0.96 | 3.72 | |
| Total Contrbution Margin | 356,250 | 67,194 | 37,182 | 460,626 |
| Less: Fixed Overheads | 35,000 | 35,200 | 38,400 | 108,600 |
| 321,250 | 31,994 | -1,218 | 352,026 |
| Budget Production Schedule if Contract is Not Honoured | |||
| Premium | Standard | Budget | |
| Maximum Demand | 2,000 | 1,500 | 1,000 |
| Unit Heat Resistant Material | 90 | 70 | 10 |
| Total Resource Requirements | 180,000 | 105,000 | 10,000 |
| Production Ranking | 2 | 3 | 1 |
| Units that can be Produced | 2,000 | 871.43 | 1,000 |
| Actual Production | 2,000 | 871.43 | 1,000 |
| Marginal Cost Income Statement | ||||
| Premium | Standard | Budget | Total | |
| Sales Units | 2,000 | 871.43 | 1,000 | 3,871 |
| Unit Heat Resistant Material | 90 | 70 | 10 | |
| Total Resources | 180,000 | 61,000 | 10,000 | 251,000 |
| Contribution Per Unit of Material | 2.08 | 0.96 | 3.72 | |
| Total Contrbution Margin | 375,000 | 58,555 | 37,182 | 470,737 |
| Less: Fixed Overheads | 35,000 | 35,200 | 38,400 | 108,600 |
| Less: Financial Penalty | – | 30,000 | – | 30,000 |
| Profit/(Loss) | 340,000 | 23,355 | -1,218 | 332,136 |
It is recommended that Global Tyres Limited should honour the Standard Tyres Contract as it would result in ultimately a higher total profit for the business when compared to not honouring the contract and facing a financial penalty.
References
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