Profitability Evaluation
Originated in the year 2000, ASOS has become one of the most popular online retailers of fashion and cosmetic products in the United Kingdom among the young adults. ASOS is headquartered in London and is publically listed on the London Stock Exchange. The company has a portfolio of 850 brands as well as their own line of product offerings shipping to a total of 196 nations worldwide. Further, international shipping is done with the help of fulfilment centers which are located in UK, USA and Europe. Some of the most popular product offerings which the company is known for are clothes, footwear, beauty and accessories (ASOS, 2022).
The main objective of this report is to conduct a thorough research into the annual financial statements of the company selected above for the past four years through 2018-2021 in order to interpret selected financial ratios which will help gain insights into the company’s overall performance of profitability, liquidity, efficiency and financial structure.
In order to evaluate the profitability performance of the company over the last few financial years, the return on capital employed ratio has been considered. In a nutshell, the return on capital employed (abbreviated as ROCE) is a metric which gauges the capital efficiency of an organization that is the efficiency with which an organization utilizes their total capital employed (Ainsworth and Deines 2019). This metric is quite common amongst potential investors who are looking to interpret the operational profits which a company is able to generate by making use of all its capital. The metric can be observed to reflect an inconsistent trend as it has deteriorated in 2021 to 9.39% from 12.52% in 2020. Further, results are not at par with the results in 2018 worth 22.72%. Although the operating profit absolute figures have increased in 2021 when compared to 2020 results owing to an increase in revenue, the actual operating profit margin has declined owing to an increase in costs such as cost of sales, distribution expenses and administrative expenses (Annualreports.com, 2022). Also, the total capital employed by the company has also increased in current year which has failed to translate a proportionate increase in operating profits resulting in a decline in this metric. The company needs to further improve their efficiency levels with respect to capital utilization and cost management in order to witness favourable results in future.
The efficiency ratios can be evaluated with the help of stock turnover ratio, debtor collection ratio and creditor’s payment ratio. The stock turnover ratio which is also referred to as the inventory turnover ratio is a financial ratio which helps determine the efficiency with which an organization manages its inventory. This aspect is crucial in working capital management as a situation of overstocking and understocking can adversely affect the company (Brewer, Garrison and Noreen 2015). The stock turnover percentage rate can be observed to have declined to 4.85% from 6.13% in previous year validates the inefficiency with respect to managing inventory. On an average the company is holding onto inventory levels for longer than average before it is sold. The debtor collection day’s ratio of the company has also been observed to have increase from 2.36 days in 2020 to 3.88 days in 2021 thus reflecting the least favourable results through 2018-2021. This can be interpreted as taking more time to collect debts from customers to whom credit sales are extended. This increases the likelihood of bad debts. However, this increase is also influenced by an increase in total net sales. Lastly, the creditor payment days have reduced from 39.5 days in 2020 to 36.81 days in current year. Although this is favourable as payments are being facilitated quickly, this does not do well for the overall cash conversion cycle. The cash conversion cycle will get compromised upon based on the evaluation of the above three ratios.
Efficiency Evaluation
The liquidity or short term solvency performance of the company can be interpreted by evaluating the current ratio and quick ratio. The current ratio of an organization can be interpreted as the availability of the total current assets in order to meet the total current liabilities of the company (Griffin and Mahajan 2019). In layman terms, it can be expressed as the sufficiency of the short term resources of an organization which are readily convertible into cash foe meeting supplier and other short term obligations (McLaney and Atrill 2016). The current ratio should ideally by greater than 1 which showcases the company to have enough current assets in hand. The quick ratio is a conservative measure of liquidity as it disregards inventories from current assets because of the time it takes to liquidate inventories for realizing cash. The notion is that if suppliers demand their dues, it is not possible to sell all inventories at once for meeting the obligations. However, it is not always possible for the quick ratio to be greater than equal to 1 especially for retail organization such as ASOS that have to keep funds invested in inventory for its customers. None the less, the liquidity position of the company has indeed improved. This is because of the conscious effort of the company in order to mitigate the liquidity risk exposure because of the Covid19 pandemic. The current ratio of the company has increased from 1.19 times in 2020 to 1.56 times in 2021 and is the most favourable in the last four years. A similar trend can be noticed for the quick ratio as well which has increased from 0.57 times in 2020 to 0.75 times in 2021 showcasing the most favourable result in the last four years. Such improvement is because of an increase in total current assets especially idle cash & cash equivalents and funds locked in inventories.
The financial structure ratios provide an insight into the solvency position of an organization. This can be validated by the help of the gearing ratio which is one of the most common indicators of the exposure to financial leverage. The gearing ratio of the company has increased significantly over the past four financial years with results in 2021 at 85.13% when compared to 42.86% in last year. This is indicative that the company has raised long term debt financing and is making more use of debt financing as opposed to equity financing for its overall operations (Warren, Jonick and Schneider 2020). Further, the capital structure of the company is therefore highly geared which increases the exposure to financial leverage and thus the risk of default. In order to optimize the capital structure, the company should consider repaying their long term debts and rely upon equity sources of finance equally.
Conclusion
It can be concluded based on the discussions of this report that accounting ratios are quite effective when it comes to gauge the financial performance of an entity for a particular financial period. The company’s performance of profitability, efficiency and financial structure has deteriorated in the current financial year when compared against prior years thus requiring an urgent attention of the management. Lastly, the company was able to showcase a favourable performance when it came to maintaining sufficient liquidity.
Liquidity Evaluation
(a) Prepaid Expenses: As the name suggests, these expenses are incurred in advance for a benefit which flows into the company over the short term future. As a result, these expenses are deducted from the relevant expense charged in the profit & loss account and treated as a current asset in the balance sheet (Kieso et al. 2019).
(b) Accrued Expenses: Accrued expenses are also referred to as outstanding expenses. These are expenses which are not settled and paid for by the business but have been incurred by the business. As a result, these are charged to the profit and loss account as an expense by adding it to the relevant expense during the period it is incurred. Further, it is shown as a current liability in the balance sheet (Robinson 2020).
(c) Prepaid Income: This is also referred to as income which is received by the business in advance before providing the goods or service to the customers. As income is recorded in the profit and loss account when it is earned and not when cash is received, these are deducted from the relevant income stream in the profit and loss account. Further, since the company has an obligation to provide the goods/services in future, it is shown as a current liability.
(d) Accrued Income: Accrued income can be interpreted as the income which the company has earned but are still awaiting the receipt of consideration. Hence, this is added to the relevant income line item in the profit and loss account. Also, it is shown as a current asset in the balance sheet as it represents a future benefit to be received through cash payouts.
(a) Depreciation: This line item should be added to the net income under cash flow from operations since it is a non cash expense which needs to be adjusted for in order to compute the actual cash flows from operating activities (Weygandt et al. 2019).
(b) Disposal of non-current asset: Disposing off any non-current asset will result in cash flowing into the business for which the line item is added under investing activities.
(c) An increase in inventories: This will be deduced under the cash flow from operating activities as changes in working capital accounts. This is because an increase in closing inventory balance indicates additional inventory purchased which translates to cash outflows for which these are adjusted.
References
Ainsworth, P. and Deines, D., 2019. Introduction to accounting: An integrated approach. John Wiley & Sons.
Annualreports.com, 2022. [online] Annualreports.com. Available at: <https://www.annualreports.com/Company/asos-plc> [Accessed 15 March 2022].
ASOS, 2022. ASOS | Online Shopping for the Latest Clothes & Fashion. [online] ASOS. Available at: <https://www.asos.com/> [Accessed 15 March 2022].
Brewer, P.C., Garrison, R.H. and Noreen, E.W., 2015. Introduction to managerial accounting. McGraw-Hill Education.
Griffin, P.A. and Mahajan, S., 2019. Financial Statement Analysis. Finding Alphas: A Quantitative Approach to Building Trading Strategies, pp.141-148.
Kieso, D.E., Weygandt, J.J., Warfield, T.D., Wiecek, I.M. and McConomy, B.J., 2019. Intermediate Accounting, Volume 2. John Wiley & Sons.
McLaney, E. and Atrill, P., 2016. Accounting and finance: an introduction. Prentice Hill.
Robinson, T.R., 2020. International financial statement analysis. John Wiley & Sons.
Warren, C.S., Jonick, C. and Schneider, J., 2020. Financial accounting. Cengage Learning.
Weygandt, J.J., Kieso, D.E., Kimmel, P.D., Trenholm, B., Warren, V. and Novak, L., 2019. Accounting Principles, Volume 2. John Wiley & Sons.
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