Rolls Royce is a multinational corporation that operates in four main global markets which include; defense aerospace, energy, civil aerospace and marine. The company values it’s and brand more than anything else. Strategic innovation has been essential to the organization’s corporate objectives for over ten years and currently the company is delivering outstanding performance across the globe. This paper endeavors to conduct a financial analysis on Rolls Royce by evaluating the information provided in the annual report.
Discuss the importance of comparing income from operations to cash flow from operations
One significant effect of comparing the income from operations to cash flow operations is due to the fact that both give different results, and there is a need to investigate whether there are huge discrepancies. Income from operations does not consider the working capital changes and any value obtained from this method do not give a true measure. On the other hand, cash flow from operations serves as a better metric since it considers the organization’s sources of capital as well as the working capital changes.
Cash flows from operations are difficult to manipulate under GAAP compared to the extent to which net income can be manipulated. This makes it important for the comparison of the net income and the cash flow operations in order to investigate any differences and in case there are any corrective actions taken.
Income from operations consider transactions that take place in one accounting period and does not consider any significant capital changes that took place in the past or the previous accounting period. On the hand, cash flow operations consider any capital acquisition or selling and any effect the transactions bring to the cash flows. Therefore, a comparison is required so as to make sure that a financial analyst does not rely on the net income and hence make a wrong decision.
2. 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
The current ratio measures the ability of a corporation when it comes to taking care of the short term obligations using the short term assets. The current ratio for Rolls Royce in year 2011 was 1.2. This is admirable as it shows that the company can be able to cater for the short term obligations when they become due.
Acid test ratio
The acid test ratio for Rolls Royce in year 2011 was 0.71. Generally, the ratio shows the liquidity position of an organization and a ratio of 1 is usually preferred. The 0.71 acid test ratio of Rolls Royce shows a weak liquidity position as the current liabilities exceed the current assets and any short term obligations arising may be met with difficulty.
Accounts Receivable Turnover ratio
This ratio indicates the how liquid the accounts receivable are. An organization is recommended to have a high receivable turnover ratio as possible. Rolls Royce receivable turnover ratio in year 2011 was 4.4. This implies that either Rolls Royce collection of accounts receivable and extension of credit is efficient.
Inventory Turnover ratio
Rolls Royce inventory turnover ratio is 1.8. This ratio indicates how many times the stock for the company has been sold and replaced in 2011. Usually, the higher the ratio the more preferable the ratio is for the company. The ratio for company 1.8 is low, and the company should endeavor to reduce the level of obsolete stock.
Days Sales of Inventory
This ratio determines an idea of how long it takes Rolls Royce to convert inventory into sales. Rolls Royce, therefore, takes 107 days to convert inventory into sales. Nevertheless, a shorter period is usually preferred.
Debt to Equity ratio
This ratio indicates the proportion of debt and equity used to form the capital structure of the company. A high debt to equity ratio is usually not preferred as it shows that the company is highly geared and is prone to insolvency or liquidation. Rolls Royce debt to equity in year 2011 was 2.4 which indicate that the company’s debt is two times more the equity.
Interest Coverage Ratio
This ratio measures the ability of Rolls Royce to cater for the interests and costs arising from the debt used by the company. Rolls Royce had an interest coverage ratio of 2.2 implying that Rolls Royce earnings are able to pay the interests resulting from debts. This is commendable for the company as it shows that it can be able to meet the interest costs without being liquidated.Gross Profit Margin
Rolls Royce gross profit margin ratio was 22 percent implying that after eliminating the cost of sales, the company makes 22 percent profit. This means that the variable cost take 78 percent of the company’s sales.
Operating Profit Margin
Rolls Royce operating profit margin in 2011 was 11 percent. This implies that only 11 percent of the sales remains after the prime costs and expenses have been paid for. It is evident that Rolls Royce does not have a commendable margin as 11 percent is weak and can lead to losses.
Return on Common Stockholders
The return on common shareholders in year 2011 was 2.8 which imply that for every share that each shareholder has he/she gets $ 2.8. This is commendable although the management still needs to improve more on the performance.
Return on Investment.
Rolls Royce had a return on investment of 5.2 percent in year 2011. This shows that investments in the year were not that profitable. It could be that the projects were not profitable, or they are long term and have not started generating huge cash inflows. How are segments identified under U.S. GAAP and International Financial Reporting Standards?
According to the U.S GAAP, the segments have disclosed according to their geographical locations whereby each segment’s location has been identified in the annual report. In addition, the GAAP does not require the disclosure of capital expenditures and liabilities something that Rolls Royce has adhered to.
According to the IFRS, Rolls Royce has disclosed the segment’s operating results clearly showing the sales, profits and assets contained in assets in each and every segment in each geographical location.Calculate Rolls-Royce. 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?
The return on investment is usually obtained by dividing the addition of long term liabilities and equity by the net income. The return on investment gives a measure of the efficiency of an investment. Rolls Royce has a Return of Investment which implies that the company’s investment are not very efficient and, as such the management needs to put a lot of effort in order to increase the efficiency of investments by relevant monitoring and evaluation tools.
Steps of Increasing Return on Investment in Rolls Royce
One strategic method of increasing the return on investment in Rolls Royce is by undertaking capital appraisal methods before undertaking projects. The capital appraisal methods usually investigate the viability of investments by evaluating the expected cash flows and the cost of investment.
Secondly, the return on investment can be increased by borrowing cash in order to boost the investments already undertaken. The funds borrowed can be used to purchase the latest technology which can increase the investment’s efficiency.
Thirdly, Return on investment can be increased by reducing the number of less profitable projects. An investment incurring losses for four years consecutively should not be undertaken. In this way, the overall return on investment will increase in the long run.
Residual Income of Rolls-Royce
Residual income is usually obtained using the formula below;
RI = Operating Income - (Operating Assets x Target Rate of Return)
1186 – (2561*10)
The major assumption when calculating the residual income is the target rate of return. It is assumed the target rate of return of Rolls Royce is 10 percent.
8. Based on the ratios that you calculated above, what is your overall assessment of the company?
Based on the ratios, it is evident that Rolls Royce has a weak liquidity position as shown by the acid test ratio. In terms of profitability, the company has weak management strategies of earning a profit. According to the solvency ratio, the company stands in a precarious situation of being insolvent as the gearing level is extremely high. In terms of efficiency, the company is unable to maintain profitable investments and hence the level of efficiency is still lacking some managerial input.
Daves, P. R., & Brigham, E. F. (2009). Intermediate Financial Management. London: Cengage Learning, .
Rodgers, P. (2007). Financial Analysis: Managerial Level (3, illustrated ed.). London: Butterworth-Heinemann.