Financial Analysis and Decision Making: Techniques to Solve Financial Problems and Make Effective Business Decisions

2021-06-02 18:07:40
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University of California, Santa Barbara
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Essay
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Financial ratios are useful as they indicators of the performance and financial situation of a firm. The current paper will compare and contrast the performance of Premier Legal Services (PLS) and Frederic & Ferdinand Solicitors (FFS).

Profitability

Profitability ratios are useful in evaluating the ability of the company to generate profit.

Return on Capital Employed

ROCE measures the efficiency a firm can make profits from its capital employed. ROCE is calculated as follows;

R.O.C.E=(EBIT)(Capital Employed) R.O.C.E of PLS and FFS for the years 2015 and 2016 is calculated as follows;

2015 2016

PLS 112,580/223,103

0.50

109,494/224,522

0.49

FFS 195,497/240,912

0.81

184,032/201,859

0.91

A higher ratio is favorable for a company since it means that more profit is generated by capital employed. Therefore, FFS makes more profit for every dollar of capital employed compared to PLS. It could be because FFS has more staff than PLS hence more productivity.

Return on sales

Return on sales determines how efficiently a company is generating profits from its revenue. R.O.S is calculated as follows;

R.O.S=(EBIT)(Sales) .

Return on sales of PLS and FFS for the years 2015 and 2016 is calculated as follows;

2015 2016

PLS 112,580/404,035

0.28

109,494/401,363

0.27

FFS 195,497/605,410

0.32

184,032/592,043

0.31

A higher ratio means that the management is efficient in cutting expenses. Hence, FSS is more efficient than PLS. It could be because EFS has more professional staff compared to PLS.

Operational Efficiency

Asset utilization ratio

The asset utilization ratio determines the total revenue earned by every dollar of the assets owned by a company. Asset utilization ratio is calculated as follows;

Asset utilization=(sales )(capital employed) The asset utilization ratio of PLS and FFS for the years 2015 and 2016 is calculated as follows;

2015 2016

PLS 404,035/223,103

1.81

401,363/224,522

1.79

FFS 605,410/240,912

2.51

592,043/201,859

2.93

R.O.E=(Net profit)(Equity) The figures from the table above show that FFS utilized its assets to generate more revenue compared to PLS. Therefore, FFS is more productive than PLS. The reason could be that FFS has more staff and hence more human resources.

Investors

Return on equity

Return on equity determines the ability of a company to make profits from the investments of the shareholders. R.O.E is calculated as follows;

The return on equity ratio of PLS and FFS for the years 2015 and 2016 is calculated as follows;

2015 2016

PLS 103,781/223,103

0.45

105,511/224,522

0.47

FFS 159,029/240,912

0.66

147,444/201,859

0.73

A higher return on equity indicates that a company is using the funds invested by its shareholders efficiently. Hence, FFS manages its investors funds more efficiently than PLS. The reason could be that FFS has more professional staff than PLS.

Solvency and Liquidity

Current ratio

The current ratio is an efficiency ratio that determines the ability of a company to pay off its short-term debts with its current liabilities. The current ratio is calculated as follows;

current ratio=(current assets)(current liabilities) The current ratio of PLS and FFS for the years 2015 and 2016 is calculated as follows;

2015 2016

PLS 288,731/189,101

1.52

309,357/191,568

1.61

FFS 384,402/224,725

1.71

344,993/183,708

1.88

A higher current ratio determines if a company can easily pay its current debts. Hence, FFS has a more favorable current ratio. The reason could be that FFS has more professional staff who manage the company well as opposed to PLS which has fewer professional staff.

Debtors days

The debtors days determines the average number of days that the customers of business take to pay debts. The debtors days is calculated as follows;

debtor days=(debtors)(sales) *3652015 2016

PLS (232,063/404035)365

209.64

(256,303/401,363)365

233.08

FFS (311,848/605,410)365

188.01

(321,252/592,043)365

198.05

A business is more stable when customers take less time to pay debts. Therefore, FFS has a more favorable debtor days ratio. The reason could be that FFS has professional employees who offer better services than PLS.

From the calculations, PLS is underperforming compared to FFS. First, FFS generates more profit for every dollar of capital employed compared to PLS. Secondly, FFS is more efficient in cutting expenses more than PLS. Thirdly, FFS has utilized its assets more than PLS. Fourthly, the customers of EFF pay debts quicker than PLS. Additionally, FFS manages its investors funds more efficiently than PLS

Issue 4

Organic business growth as an approach to grow and expand a business involves building the business from within the organization. For instance, Premier Legal Services may venture into the newly opened markets in China as a business growth strategy (Gielnik, Zacher, and Schmitt, 2016). The approach offers the company a commercial edge of growing with speed and implementing new growth models as opposed to when they merge domestically with local firms. Although a merger may bring in new additional skills and a capital base, it is also a deterrent to making quick and efficient decisions (Hauser). A merger has the risk of slowing PLS because it pumps a fresh pack of ideas to how PLS operate and implements its decisions. Mergers will only help create a domestic dominance which is unfavorable in the long-run. Local markets mostly fluctuate and may be affected by shocks in the industry.

A companys short term and long term goal determine whether or not merger and acquisitions generate advantages or disadvantages considering key factors like market trends and policies, operational culture variance, acquisition costs and financial trends changes in the sector. One of the benefits of mergers is the added economic power that increases the value efficiencies of the new model of business formed by mergers and acquisitions. Also, there is the formation of economies of scale due to the additional resources a merger provides. The cost of production goes down while total output increases.

However, Mergers & acquisitions have several disadvantages especially due to the frictions and conflicts among the employee absorbed in the mergers and the proposed 10% of workers to be imported from the UK may conflict with other employees to be acquired from China and the rest from PLS (Wertheimer, 1971). Also, the employee may need a whole new re-training processes to adapt to the changes indicated in the new business outfit. Due to duplication of skills in mergers, a lot of staff may need to be cut off. In the case of delays in the implementation, the merger may skyrocket the general cost of management operations (Vance, 2003). Finally, mergers and acquisitions have high uncertainties of returns due to lack of proper forms of assurance.

Additionally, the history of mergers shows that about two-thirds of bid mergers do not go well with their terms (History of Mergers, 2012). In fact, both companies end up losing their stock in the market (Giraldo, 2011). Using the example above it is evident that PLS should not consider the merger option with any of its competitors because it may result in a poor performance of the organization.

Mergers and acquisitions of many American companies especially for foreign markets are meant to expand their capital market base. Foreign market acquisitions deals are increasingly becoming popular (Aufderheide, 2002). The Chinese new market is a good example and a good opportunity for PLS but not with a merger option. FFS and PLS share a similar resemblance, and hence a merger is not advisable. I would advise PLS to open a new office in the foreign market as opposed to a merger.

Net Present Value

Net present value combines two essential concepts. First, it determines the amount of cash flow that will result from the investment. Secondly, it compares the cash flows to inflows that must be met to make the investment. It is considered the best techniques to evaluate a project. NPV is calculated as follows;

NPV=(net cash flow/(1+R^T

Where R is the rate of return

T is the number of periods

Rate of return = 40%

T= 5years

Therefore,

Year Cash flow PV factor @40% Present value

0 (1000) 1 (1000)

1 1500 1.4 1071.43

2 1750 1.96 892.86

3 2200 2.74 802.92

4 2650 3.84 690.10

5 2900 5.38 539.0

NPV 2996.34

NPV=(15001+0.4^1+1750(1+0.4)^2+2200(1+0.4)^3+2650(1+0.4)^4+2900(1+0.4)^5)NPV=1071.43+892.86+802.92+690.10+539.03NPV=3996.34-1000NPV=2996.34

I would advise Samantha to implement the project. From calculations, the company could realize an NPV of $2996.34. It, therefore, means that the project would be beneficial. However, there are risks associated with the project. For instance, NPV is sensitive to future variations in cash flows, the cost of capital and salvage value (NET PRESENT VALUE (NPV n.d.). Also, it does not consider the size of a project. Hence, it is difficult to predict the financial viability of the project.

References

Aufderheide, P. (2002). Competition and Commons: The Public Interest In and After the AOL-Time Warner Merger. Journal of Broadcasting & Electronic Media, 46(4), pp.515-531

Giraldo, M. (2011). Dynamics of analysts' coverage and the firms' information environment. International Review of Financial Analysis, 20(5), 345-354. doi:10.1016/j.irfa.2011.06.003

Gielnik, Michael M., Hannes Zacher, and Antje Schmitt. "How Small Business Managers Age And Focus On Opportunities Affect Business Growth: A Mediated Moderation Growth Model". Journal of Small Business Management (2016): n. pag. Web.

Hauser, Philip M. "Business Implications Of Population Growth". Business Horizons 3.2 (1960): 87-96. Web.

History of Mergers. (2012). Mergers, Acquisitions, and Corporate Restructurings, 35-73. doi:10.1002/9781118269077.ch2

NET PRESENT VALUE (NPV). (n.d.). SpringerReference. doi:10.1007/springerreference_6962

Vance, D. E. (2003). Financial analysis & decision making: Tools and techniques to solve financial problems and make effective business decisions. New York: McGraw-Hill.

Wertheimer, H. W. (1971). The International Firm and International Aspects of Policies on Mergers*. Netherlands International Law Review, 18(02), 145. doi:10.1017/s0165070x00027492

 

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