Introduction To Accounting 1Financial Ratio Analysis

Heriot-watt University- Dubai Campus24th November 2008

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DEBENHAMS

AIM and COVERAGE

The aim of this presentation is : to look at some financial data from

Debenhams. to use ratio analysis to evaluate their

performance. assess the value of using ratios in

drawing conclusions about their performance.

Debenhams Plc is one of the United Kingdom's longest continuously operating clothing and goods retailers.

The company owns and operates nearly 100 department stores, primarily in England.

…INTRODUCING…

Founded in 1778, Debenhams operated independently until its hostile takeover in the 1980s.

Debenhams reported rising profits and revenues in its first year of independence.

…HISTORY…

The following ratios have been covered in this presentation:– Gross Profit Margin – Net Profit Margin – Return on capital employed – Gearing Ratio – Asset Turnover – Stock Turnover – Debtor Days – Current Ratio – Acid Test

Ratio Analysis

Ratio analysis helps us check how a business is doing as compared to any of the previous years.

We can use ratio analysis to try to tell us whether the business: is profitable has enough money to pay its bills could be paying its employees higher

wages is paying its share of tax is using its assets efficiently has a gearing problem is a candidate for being bought by another

company or investor

Table With Profit Report – Annual Report 2007

Table With Financial Information on Income

Statement – Annual Report 2007

Gross-profit Margin

The gross profit margin ratio tells us the profit a business makes on its net sales before we take off any administration costs, selling costs, etc.

We should have a much higher gross profit margin than net profit margin.

G.P.M = Gross Profit x 100 Turnover

Net Profit Margin

The net profit margin ratio tells us the amount of net profit per £1 of turnover a business has earned.

N.P.M = Net Profit x 100 Turnover

= Profit before Interest and Taxation x 100

Turnover

(net profit = gross profit – expenses)

Return on capital employed (ROCE)

The Return on Capital Employed ratio (ROCE) tells us how much profit we earn from the investments the shareholders have made in their company.

ROCE = Profit of the year x 100 Share holders fund

Profitability

G.P.M N.P.M ROCE

0

10

20

30

40

50

60

70

80

90

20062007

AnalysisGross-Profit Margin Net-Profit Margin Return On Capital

Invested

2006 2007 2006 2007 2006 2007

19.4% 15% 3.63% 6.4% 82% 48.5%

Findings(s) Increase in sales of 3.76% and a higher increase in cost of sales of 8.75% has resulted in a decrease in G.P.M

NPM increased by around 3% and all administration costs have decreased.

ROCE has fallen by 40%

Reason(s) - Acquisition and reorganization of stores in Ireland- Closure of the Jervis street store

- Decrease in distribution costs- Although interest receivable fell by £3.1m, interest payable has fallen drastically by £98m

- There was a 205% increase in equity, but Turnover increase of only 4%. - Redundancy costs and other expenses of £3.7m were incurred

Comment(s) Increase Selling Price (low price strategy).

With all the decrease, sales have also increased. Debenhams manages to control their admin costs very well.

Next year will be more promising with the introduction of stores in Ireland.

Gearing

Gearing is concerned with the relationship between the long terms liabilities that a business has and its capital employed.

Gearing = Long Term Liabilities Equity Shareholders Fund

Gearing2006

Long Term LiabilitiesEquity

2007

Long Term LiabilitiesEquity

Analysis

Findings(s) The gearing (i.e. dependence on long term borrowings) has decreased by 70%.The gearing ratio has decreased from 20.58 : 1 in 2006 to 6.08 : 1 in 2007.

Reason(s) Long term liabilities (i.e. bank O/Ds and borrowings) have fallen by around 9.6% from £1,097m in 2006 to £992.1m in 2007.

Comment(s) This is a good indicator of the company’s choice of raising funds. Debenhams has cut down on long term liabilities and has increased hedge and other reserves.Gives Shareholders the confidence that their investments are secure.

Table With Financial Information on Balance Sheets – Annual Report

2007

Total asset turnover

The asset turnover ratio simply compares the turnover with the assets that the business has used to generate that turnover.

Total Assets Turnover = Turnover Total Assets

Stock turnover: stock control

The lower the investment in stocks the better. Modern stock control theory tells us to minimize

our investment in stocks.

Stock Turnover = Average Stocks (Cost of Sales/365)

Debtors turnover Ratio

An accounting measure used to quantify a firm's effectiveness in extending credit as well as collecting debts. 

Debtors' Turnover =    Average Debtors    

Credit Sales/365

Turnover ratios

Asset T.O RatioStock T.O Ratio

Drs. T.O Ratio

0.91

13.613.5

0.850000000000001

13.3 13.7

2006 2007

AnalysisAsset Turnover Ratio

Stock Turnover Ratio

Debtors Turnover Ratio

Findings(s) The ratio has fallen by 6.6%

Stock turnover ratio has decreased since the previous year.

DTR is well balanced with not much of a difference, but it has increased by 1.45%

Reason(s) Total assets have increased by 11.9%, but revenue has increased by only 3.9%

Not much of a difference.

Comment(s) With an increase in total assets, there is a slower increase in total revenue. Turnover is expected to increase next year and make up for the decrease in turnover this year.

Stocks of Debenhams are much more liquid than those of any other retailer in the region. Debenhams = 13.3 daysWoolworths = 67 daysBurberry = 166 days

Debenhams debtors pay their accounts within 13-14 days on an average. Woolworths take around 40 days to repay. Debenhams has good and punctual debtors.

Current ratio

The current ratio is also known as the working capital ratio and is normally presented as a real ratio.

Current Ratio = Current Assets Current

Liabilities

Acid test ratio The acid test ratio is also known as the liquid or the

quick ratio. The idea behind this ratio is that stocks are sometimes a problem because they can be difficult to sell or use.

Acid Test Ratio = (Current Assets - Stocks) Current Liabilities

Liquidity ratios

Acid-Test Ratio

Current Ratio

0 0.1 0.2 0.3 0.4 0.5 0.6 0.7

0.24

0.64

0.21

0.66

2006 2007

Analysis

Current Ratio Acid – Test Ratio

Findings(s) There is a 3% decrease in the current ratio

Quick ratio has increased by 14.2%

Reason(s) - Current Assets have increased (with an increase in cash deposits from £34m to £80.4m)- Current liabilities have also increased (Bank O/D by £68.2m and Trade Payables by £12.8m)

- Current assets have increased by 19% and current liabilities have increased by 31%-If the inventories were to be ignored, then the short term stability would be better.

Comment(s) This shows that short term liquidity situation of Debenhams is not very solid. To pay off its bills will be difficult. Its current liabilities are 1.5 time more than its current assets.

With increase in price to increase revenue, Debenhams should at the same time concentrate on increasing their stock turnover ratio which would help them in cost reduction.

Profitability

Ratio

Gearing Ratio

Turnover

Ratio

Liquidity

Ratio

GPM (23.2) 70.5 Asset T.O

(6.6) Current Ratio

(3)

NPM 76 Stock T.O

(2.2)

ROCE

(41) Drs. T.O

1.5 Quick Ratio

14.2

Total 11.8 70.5 (7.3) 11.2 100.8

DEBENHAMS Final Overview

Conclusion : Revenue increase led by good performance from

new stores and modernizations (including the website rebuild; The website is expected to result in a huge turnover in the next five years).

Although revenue increased, it was offset by a low pricing strategy and a low stock turnover ratio which led to higher costs of purchases.

Its net debt position has decreased in the course of the year by £79.6m which makes it more stable in the long run and less dependent on borrowings.