Rolls Royse is a global leader in the provision of power systems and services at sea, on land and also in the air. Over the years, the company has established a very strong position in defense aerospace, energy and nuclear production and also civil airspace. The company is headquartered at Buckingham Gate in England but has operations in the regional offices in the US, Europe, Middle east, Asia and recently, Australia.
In evaluating the performance of Rolls Royse, we shall gather both qualitative and quantitative information regarding the company and carry out a number of operations to gauge the company’s performance. The company’s financial data will be evaluated for an in-depth analysis of the financial ratios and interpretations thereof given.
This intention of this paper is to attempt to carry out an evaluation of Rolls Royse with particular emphasis on the financial ratios. These ratios will include the profitability, Liquidity, solvency and other measurements and ratios. Other aspects of management accounting will also be analyzed and evaluated. This is with particular bias to cash flow statements and their comparison with operating income, the identification and reporting of operating segments among others
Lastly, the paper will give an overall opinion on the performance of Rolls Royse, based on the financial ratio analysis with the aim of obtaining the global picture of the business performance.
It is very important that a company compares its operating cash flows from operating profits. This is because these two terms are not synonymous with one another. Operating income is net of expenses while cash flows are all the net moneys that are received by the company. It’s the net of all cash inflows and outflows. Comparison of cash flows and the operating income is therefore useful in the identification of non cash items in the computation of income. This is because, these non cash items are charged to the profit and loss accounts yet they do not involve any cash in their transactions. Such items include provisions for depreciation, provisions for bad and doubtful debts etc. Cash flows also identify those items of income that form part of other incomes and are not charged to the operating income.
Comparison of these two sets of financials is usually important in assessing the company’s efficiency in the generation of cash from the various sources. It also shows how this money has been applied in the business for the generation of returns to the shareholders.
Comparing cash flows with income clearly shows the company’s sources and uses of funds, this is useful in explaining how much money the company has that can be utilized in the settlement of its debt obligations. Generally, this comparison gives the company a glimpse of its financial capacity to meet its obligations. A company that is apparently profitable and stable in terms of assets base may not be in a position to generate enough cash to be able to sort out its short term cash requirements and that’s why it’s imperative that the company has a clear understanding of its cash position regardless of its profits.
Calculate and interpret the following short-term liquidity ratios: Current Ratio, Quick Ratio or Acid Test ratio, Accounts Receivable Turnover ratio, Inventory Turnover ratio and Days Sale in Inventory ratio.
This ratio measures the ability of the company to meet its current financial obligations as and when they fall due, using the most liquid assets.
According to the above calculations, Rolls Royce current assets are 1.2 times her current liabilities and thus she is in a position to able to meet her current liabilities using the current assets. A current ratio of 1 and above is considered safe as the company can comfortably meet her obligations. A very high ratio may not however be beneficial as the company is likely to be holding a lot of its assets in current form.
Quick ratio/acid test ratio
This ratio is used to measure the company’s ability to meet its short term financial obligations as and when they fall due, using the most liquid assets. It’s assumed that stocks may take a longer than one year time to be realized thus its omitted in the computation. For Rolls Royse, the ratio will be as follows;
Based on the ratios above, Rolls Royce is not able to meet all her short term financial obligations using the most liquid assets as they cover only 83 % for the year 2011.
Accounts Receivable Turnover ratio
This ratio is computed as sales divided by average accounts receivable
The average accounts receivable will be computed as opening and closing accounts receivables divided by 2
This ratio indicates the number of days on average, which a customer takes to pay their debts.
Inventory turn over
This ratio shows measures the number of days that the company takes to covert stocks into sales for the company. It’s mathematically computed as
Cost of goods sold divided by the average stock, For Rolls Royce, the ratio will be as follows:
= 3.477 times
Days of sales in inventory
This ratio shows how many days it takes to turn inventory, including work in progress into a sale. The formulae used to compute this ratio is as follows.
= (2,561/8676)* 365 days
= 107.74 days.
This is the length of time that Rolls Royce takes to convert its stocks into a sale. It looks reasonable looking at the nature of Rolls Royse business which is the construction and sale of heavy equipment for use in the aerial and marine waterways among others.
Calculate and interpret the following long-term solvency ratios: Debt to Equity ratio and the Interest Coverage ratio.
Debt to equity ratio
This ratio relates the debt that is borrowed from financiers and employed in the business to the equity that has been contributed by the shareholders for investment in the company. Companies select a proper mix of debt and equity so as to leverage on the two for maximum returns. This is because, interest charged on debt is usually tax deductible.
It’s calculated as
In this scenario, the company is financing most of its assets using debts obtained from financiers. This is because there is more debt than equity in the company;
Interest coverage ratios
This ratio indicates the ability of the company to pay its interest and principle for its debt obligations. It’s calculated by dividing the company’s EBIT by the interest expensed during the year as appears in the profit and loss account
= EBIT/ Interest expense
This shows that Rolls Royse is in a position to service its loans without any notable difficulties. Here, EBIT is a lot, many times than the interest expense.
Calculate and interpret the following profitability ratios: Gross Profit Margin, Operating Profit Margin, Return on Common Stockholders' Equity, and Return on Investment.
Gross Profit Margin
This is a financial metric that shows the amount of revenue that is the net of the expenses that go directly into the cost of production of the particular goods or services. It’s usually calculated as shown
(Gross Profit /sales)*100%
Operating profit margin
Also called the net profit margin, this ratio measures the net return to the investors relative to the sales revenues. This ratio is calculated as follows;
Return on equity
This ratio measures the net return or profit on the money that the share holders have invested in the business of the company. All business owners aim for a higher return and therefore a higher return is good for investors. It’s calculated as follows;
Net Income/ equity for the shareholders
This shows the earnings that is attributable to the shareholders of Rolls Royce.
Return on investments.
This ratio is a metric that measures the returns to the investor’s money in a company.
It’s computed as
Net profit/ total assets,
This means that any moneys invested in the company earned about 5% for the year 2011.
This essentially means that each dollar invested in the company earns a return of about 5% each year
How are segments identified under U.S. GAAP and International Financial Reporting Standards?
Identification of an operating segment is important in ensuring that proper accounting is done on all business segments. This is because, segment reporting helps management in decision making on whether a segment is profitable or a loss making entity in the enterprise for proper planning and resource allocation.
Under GAAP, the management has unfettered discretion in deciding what makes a segment. This is because segment reporting is majorly for internal use. There is however a few issued guidelines on how GAAPs should be identified. Segments are generally identified based on some preselected criteria such as geographical regions, customer base, or even product based classification.
GAAPs also state that a segment will also be identified if there is a service, product or even a class of customers who are expected to be the major consumers of the commodity.
Lastly, a segment will be recognized and reported if it has over ten percent in terms of revenue, total assets and also profits in relation to the business of the company
Under IFRS 8, Segments are recognized where; the internal management is involved in and regularly reviews the performance of the segment (http:// www.iasplus.com)
The said segment runs a separate business from which revenue is earned and also the expenses will be covered. This includes incomes and expenses that relate to the inter company operations.
The financial information for the segments must first of all be made available for the segment to be regarded as so. In fact, the company must prepare separate accounts for the segment that can be made available for all to see
Just like GAAP, any unit that accounts for more than10% of the total revenues, total assets etc.
Calculate Rolls-Royce's Return on Investment by breaking it down into the margin and turnover components. What steps can Rolls-Royce take to increase its Return on Investment?Calculate the Residual Income of Rolls-Royce. What assumptions did you make to obtain your answer?
The return on investment can be broken down into its components by employing the DuPont system that is as follows
NET Return on assets= (Net income/sales)*(sales/ total assets)
Operating return on assets
= operating income * sales/Total assets
= (1186/11,124) *(11,124/16,423)
= (1186/ 16,423)*100%
= 7.2% her investment,
In order for Rolls Royce to increase her return on investment, she must first of all identify the components of this metric and see how each metric can be manipulated for a larger return. The returns on investment can therefore be increased if the revenues are increased and at the same time the costs kept at the minimum.
This will increase the profitability and by extension the net profit is increased with reduced expenses. To increase the return on investment in the current situation, it can be assumed that the company is not operating at full employment and has extra capacity for both production and markets.
The following formulae is used to compute the residual income
RI = Operating Income - (Operating Assets x Minimum Required Rate of Return) Equals a $ amount
= 1186- 845.78
Based on the ratios that you calculated above, what is your overall assessment of the company?"
Looking at the analysis above, the company’s performance is way above average in all aspects. The liquidity ratios show a company with robust ability to settle its due debts as and when they fall due. The company has attained a more than average ratios for both quick and current ratios, meaning that the company is able to meet its obligations with the available current assets. The quick ratio however is less than one, meaning that the company will have some difficulties were it to settle its debts using the most current assets less stocks.
The efficiency ratios paint a picture of a very efficient company in the handling of its accounts receivables and the turnover of stocks. This means that the company is able to manage the current assets very efficiently to generate revenues.
The solvency ratios also indicate that the company is in a net debt position, as shown by the positive debt equity ratio. While the above ratio is not considered ‘risky’ in finance circles, its evident that the company is financing most of its assets using more of debt as compared to equity.
In terms of profitability, the company has a gross profit margin of 22% and net profit margin of 11%. A comparison with the industry performance indicates that this return is moderate as the current operating environment is not very good, considering that the company is coming from the turmoil’s of the global financial crisis that had almost brought the company to its knees.
Lastly, the company reported a return on investment of 5%. This figure is relatively low due to the reasons advanced above which include the global recession and its effects on the business of the company. We have however made a few suggestions to the company on what needs to be done to guarantee a better return to the company’s shareholders (Wilbert et al ,2004)
In summary, the company’s financial performance is ok, considering the industry performance indices and operating climate. However, the business of the company is expected to continue to improve in the coming days as has been the trend for the past few years. The management of the company has pledged their commitment to ensuring that the company stays ahead of the pack and delivers value for the investor, this is evidenced by the great projections of company’s expected performance in the next five years.
IFRS 8. Adopted from http:// www.iasplus.com
Rolls Royce annual report (2011). Adopted from .
Wilbert,S et al (2004) Financial ratio analysis: An effective management tool. University of Michigan