Finance analysis of United Utilities and Bristol Water - Free Essay Example

Sample details Pages: 12 Words: 3452 Downloads: 5 Date added: 2017/06/26 Category Finance Essay Type Analytical essay Did you like this example? Title: A comparative financial analysis of United Utilities and Bristol Water to determine who is in the financially healthier position focusing on the interpretation of the figures (what they mean now and in the future) and interpretation (what they mean now and for the future) of key ratios applied. Financial Health Don’t waste time! Our writers will create an original "Finance analysis of United Utilities and Bristol Water" essay for you Create order A companyà ¢Ã¢â€š ¬Ã¢â€ž ¢s financial health is defined as the state of its finances at a particular time. It is measured by taking a snapshot of its assets and liabilities at one moment in time, usually at the end of a reporting period. . Financial statements ate the best indicators of financial health of a firm. Balance sheet is the financial summation of all activities performed by the company till date. Balance sheet analysis helps in understanding whether a company can wither durations of economic pressures. Balance sheet in conjunction with profit and loss statement gives a picture of how efficiently a firm is using its assets and how much returns it is generating for equity holders. Additionally, financial health relates not only to the past performance of the company but also to its ability to competitively sustain future profitability. Profit and loss statement shows how much a company earned in a period. Latest profit and loss statement indicates current profitability of operations. Assessing financial health is not just looking at absolute numbers. It is also about how much return a company generates on its capital, how efficiently it employs working capital. Cash statements are more of a confirmation of financial health signals obtained from above two analyses. It throws additional light on the quality of information in PL and balance sheet statements. Financial health of Bristol Water and United Utilities The first place to analyse financial health is a balance sheet of a company. Appendix I gives highlight of the Bristol Waterà ¢Ã¢â€š ¬Ã¢â€ž ¢s balance sheet. Its total fixed assets have increased significantly mainly due to  £47m investment in one of the group companies. The current assets have also increased by 39% leading to a 30% increasing in total assets. On the other hand, current liabilities have decreased and company had positive current assets as compared to negative current assets in the previous year. This shows that the liquidity of the company has increased and is a good sign of improving financial health. Long term liabilities have increased to finance investment in a group company. After paying dividends, the shareholders funds increased by  £3.8m. Increase in shareholders funds shows the healthy state of the company. In case of United Utilities, the total fixed assets have increased by more than 10% to  £7,958m. This growth is mainly driven by increase in tangible assets, an indicator of higher value of assets. Another sign of improvement in companyà ¢Ã¢â€š ¬Ã¢â€ž ¢s financial health is the increase in its current assets and decrease in current liabilities. This has increased the current net assets, a sign of improving liquidity. The increase in net debts is more than countered by increase in assets and this reflects in massive improvement in shareholders funds at over 21%, which is higher than growth in Bristol Waterà ¢Ã¢â€š ¬Ã¢â€ž ¢s shareholders funds. A higher shareholders fund indicates that United Utilities is in good financial health. Appendix II shows the highlight of last two profit and loss statements of Bristol Water and United Utilities. Bristol Water sales increased by just 1% to  £70.7m in 2004. The cost of sales also increased by 1% which means gross margin à ¢Ã¢â€š ¬Ã¢â‚¬Å" ratio of operating profit to sales has remained same. The earnings before tax decreased due to significant increase in interest in 2004. But this was countered by reduction in tax by about 60%. It resulted in profit after tax increased by 30% to  £11.5m in 2004. 30% increase in profits is a good signal of increasing profitability and value of the company. In case of United Utilities, its sales increased by 10% to  £2,115m in 2004. This increase is much more significant when we compare to 1% increase in case of Bristol Water and indicates that United Utilities growth is top driven. On the other hand, the cost of sales increased by just 8.9%, which is a good indicator of increasing profitability. Lower percent increase in costs as compared to sales means that additional sales were achieved at higher profits. The above two scenarios should have led to even higher % increase in earnings before interest had there not been a significant profit from the sale of operations in 2003. Also lower per cent increase in earnings before tax means percent increase in interest was higher than percent increase in earnings before interest and taxation. The profit after tax was  £361m in 2004. It increased by 30% due to exceptional  £85m tax charge in 2003. Overall both Bristol Water and United Utilities are profitable businesses. Profit after tax is what investors are looking for and both the companies increased it by 30%. While the increase in case of Bristol Waters was due to massive reduction in taxation, the growth was more sales driven in case of United Utilities. This indicates that profit after tax growth pattern is more sustainable in case of United Utilities as compared to Bristol Waters. Cash flow statements are the third part of financial health analysis. Appendix III gives the highlight of cash flow statements of the two companies. Both companies had positive net cash inflows from operations. The primary earnings of a company comes from its operations and if cash flows from operations itself are negative than a company has got very less chances of survival unless it turns the operation cash flows into positive. Cash flows from investment and financing are only secondary. A company that finances its operations and investments without external financing is in very strong financial health. Business performance measures Business performance is best measured by analyzing various financial ratios. Ratios allow companies to be compared on current versus past performance and also with different companies. By comparing its ratios to those of other businesses of the same size within the same industry, firms can better determine areas in which they are competitively advantaged or disadvantaged. Ratios present both the strengths and weaknesses of a business, but they are only indicators targeting areas that require further research. Operating profit margin Operating profit margin is the first and most primary indicator of companyà ¢Ã¢â€š ¬Ã¢â€ž ¢s performance. All other indicators are dependent on other things which could be separated from basic business. Operating Profit Margin = Operating profit / Sales Appendix IV shows operating margin calculations. Both Bristol Water and United Utilitiesà ¢Ã¢â€š ¬Ã¢â€ž ¢ operating profits margins have remained same over both the years and it is 27 % in both the cases. This is because both businesses are regulated by government and can only charge a certain amount for their services and products. It is clear from above that profits increase can mainly be achieved by increase in sales rather than by reduction in costs. The chances of higher organic growth are limited due to inelastic nature of water consumption. Companies can achieve substantial growth either by acquisitions or by diversifying into other businesses. Fixed asset turnover Higher fixed asset turnover indicates that a firm is making better use of its assets. Fixed asset turnover = Turnover / Fixed Asset Appendix V shows fixed asset turnover ratio of the two companies. Bristol Water is able to better employ its fixed assets by generating higher sales per unit of fixed assets. While United Utilitiesà ¢Ã¢â€š ¬Ã¢â€ž ¢ fixed asset turnover has remained same, Bristol Waterà ¢Ã¢â€š ¬Ã¢â€ž ¢s ratio has come down due to significant increase in investment in group companies. On the question of which of these two companies is able to generate higher operating margin per unit of fixed assets, we multiply fixed asset turnover and operating margin. Since operating margins of both companies are same and Bristol Water has higher fixed asset turnover ratio, Bristol Water has higher operating margin per unit of fixed assets. Bristol Water is in better financial health and will remain so because of its ability to generate higher operating margin per unit of fixed assets. Return on capital employed The most important ratio describing financial health of a firm is return on capital employed. Capital employed is the finance provided either as equity or debt net of cash. The income used for measuring is earning before interest and tax to take care of the funds provided by net debt. Return on capital employed = EBIT / (Shareholders funds + Net debt) Appendix VI shows return on capital for both the companies. Bristol Waterà ¢Ã¢â€š ¬Ã¢â€ž ¢s ROCE has decreased from 13.5% in 2003 to 9.3% in 2004. Unitedà ¢Ã¢â€š ¬Ã¢â€ž ¢s ROCE has also decreased but only marginally from 9.4% to 9.0%. Significant drop in Bristolà ¢Ã¢â€š ¬Ã¢â€ž ¢s ROCE is because of massive increase in denominator. Net debts increased to  £140m from  £74m. The increase in net debt was not matched by the corresponding increase in earnings and hence ROCE decreased. Bristol Water is a more efficient user of capital even though the gap in ROCEs of Bristol Water and United Utilities is quite less now. Higher ROCE means that Bristol Waterà ¢Ã¢â€š ¬Ã¢â€ž ¢s financial health is better than that of United Utilities. If Bristol Water is able to generate higher earnings from its investments made in the last year, its ROCE will increase. Return on equity While return on capital employed shows how much firm earned, return on equity shows what is left for ordinary shareholders. Return on equity = Net income after minority and preference dividends / Average book equity, excluding minority and preference shares Appendix VI shows return on equity calculations. Preference shareholders are more like debt than ordinary shareholders. They have higher ranking than ordinary shareholders and get a fixed return. So we have excluded preference dividend from total earnings to obtain amount available to ordinary shareholders. Similarly we have also excluded minority interest from total shareholders to obtain equity shareholders funds. Bristol Waterà ¢Ã¢â€š ¬Ã¢â€ž ¢s return on equity at 17.6% is much higher than United Utilitiesà ¢Ã¢â€š ¬Ã¢â€ž ¢ return on equity at 11.7%. Also Bristol Waterà ¢Ã¢â€š ¬Ã¢â€ž ¢s ROE increased significantly from 14.0% over the year. The use of lower interest rate preference shares has increased returns to ordinary shareholders. Dividend cover Dividend cover is expressed as ratio of profit after tax to dividend. Dividend Cover = Profit after tax / dividend Appendix VII shows dividend cover calculations. A company with higher dividend cover ratio is in better financial health as it can safely keep up dividend payments even if there is downward movement in income in future. Bristol Waterà ¢Ã¢â€š ¬Ã¢â€ž ¢s financial health, when viewed with respect to dividend cover has improved in the last year. In 2003, it paid dividend higher than its profit after tax meaning dividend was funded from previous profits. A company canà ¢Ã¢â€š ¬Ã¢â€ž ¢t sustain that for long. Latest dividend cover of 1.52 means that Bristol Waterà ¢Ã¢â€š ¬Ã¢â€ž ¢s can easily pay dividends from its current earnings and hence it is better financial shape. United Utilityà ¢Ã¢â€š ¬Ã¢â€ž ¢s dividend cover ratio has also increased to 1.14. Though it is not as high as Bristol Waterà ¢Ã¢â€š ¬Ã¢â€ž ¢s dividend cover ratio, it still indicates stable financial condition. Interest cover Interest cover is useful in assessing the survival of a business. Many business fail because of their inability to pay interests and debts. A higher interest cover means a business can easily meet its interest payments without facing financial distress. Interest cover = EBIT / Interest payable A ratio of less than 1 would mean that company is having problems in generating enough earnings to meet its interest payments. Appendix VIII shows interest cover calculations. Bristol Waterà ¢Ã¢â€š ¬Ã¢â€ž ¢s interest cover has decreased from 3.7 to 3.1 due to significant increase in interest costs. The company took  £70m of additional loans in the last year and this has increased interest costs. Bristolà ¢Ã¢â€š ¬Ã¢â€ž ¢s interest cover is higher than 2.4 interest cover in case of United Utilities. Bristolà ¢Ã¢â€š ¬Ã¢â€ž ¢s interest payments would probably increase next year when it will have to pay one year full interest on additional loan. Nonetheless both companies appear in good financial health with respect to their ability to pay interests in future. Cash flow interest cover Cash is the king. Lenders are interested in cash generating capacity of the business. Though earnings are a good measure of strength of a business, it is ultimately cash that counts during financial distress. Cash flow interest cover = Net cash inflow from operating activities / Interest payable Appendix VIII shows cash flow interest cover ratio. Bristol Waterà ¢Ã¢â€š ¬Ã¢â€ž ¢s ash flow interest cover ratio at 5.2 is much higher than 3.7 in case of United Utilities. Though both companies generate high amount of cash to repay interest, Bristol Water is in superior financial health due to higher cover. Due to higher safety of margin, lenders would feel more comfortable in giving Bristol Water debt as compared to United Utilities. Cash from operations to net income ratio A companyà ¢Ã¢â€š ¬Ã¢â€ž ¢s quality of earnings can be judged from the ratio of its operating cash flow to net income. Higher cash flow to net income ratio means indicates higher quality of earnings as accrual earnings carry a risk, howsoever insignificant. It also shows less use of accounting gimmicks in manipulation of earnings. Appendix IX shows net cash flow from operations to net income ratio. Both companies have high net cash flow from operations to net income ratio indicating the solid nature of earnings. Bristol Waterà ¢Ã¢â€š ¬Ã¢â€ž ¢s higher ratio at 2.96 means that it is in better financial health than United Utilities. Financing measures Trade debtor days It reflects how much of a companyà ¢Ã¢â€š ¬Ã¢â€ž ¢s capital is blocked in running its operation. Clients take time to pay and the higher time they take, the more capital is required to finance operations. The company with lower trade debtor days is more efficiently using its working capital. Trade debtor days = Trade debtors / Sales * 365 Appendix X shows the trade debtor days for both companies. If we look at individual levels first, Bristol Waterà ¢Ã¢â€š ¬Ã¢â€ž ¢s trade debtors days have increased by 27% while that of United Utilities have decreased by 8%. This means that Unitedà ¢Ã¢â€š ¬Ã¢â€ž ¢s management has reduced the capital required to run operations and it is a sign of improving financial health. But when we compare two companies, we find that United Utilitiesà ¢Ã¢â€š ¬Ã¢â€ž ¢ trade debtor days are still higher than those of Bristol Waters. So though Bristol Waterà ¢Ã¢â€š ¬Ã¢â€ž ¢s efficiency in working capital management has slipped in the last year, it is still better than that of United Utilities. Trade creditor days Trade creditor days represent on average how much time the company takes to pay its creditors. The higher the time a company takes the lesser capital it would need from its investors and would use creditorsà ¢Ã¢â€š ¬Ã¢â€ž ¢ capital to finance its operations. Trade creditor days = Trade creditors / Sales * 365 Appendix X shows trade creditor calculations. Bristolà ¢Ã¢â€š ¬Ã¢â€ž ¢s trade creditor days have decreased whereas Unitedà ¢Ã¢â€š ¬Ã¢â€ž ¢s trade creditor days have increased. This means that now United is funding more of its operations form the money owed to its creditors whereas Bristol is funding operations with more of shareholders money. When we look at both trade debtors and creditors, United has improved the efficiency of its working capital management whereas it has slipped in case of Bristol Water. Additionally, comparing absolute trade creditor and trade debtor days, it appears that the companies are converging. This is not unexpected given the regulatory control and mature state of the business. Structure of assets and claims Analysis of funding structure is almost equally important as analysis of performance. Funding structure will impact how much shareholders will obtain for each pound of total assets. Book gearing Book gearing measures how a firm funds itself or how much of each pound worth of asset is financed through debt or equity. Book gearing = Net debt / capital employed Appendix XI shows book gearing calculations. Almost two-thirds of Bristol Waterà ¢Ã¢â€š ¬Ã¢â€ž ¢s assets are funded from debts whereas the figure is about half in case of United Utilities. Cost of debt is lower than cost of equity. The advantage of high gearing is that the company can obtain cheaper sources of capital and use financial leverage to increase share holders returns. The disadvantages occur when debt levels are very high and it may lead to bankruptcy due to a company not meeting debt covenants. It is difficult to judge what is the dangerous level of debt for a business. Looking at the characteristics of Bristol Water and United Utilitiesà ¢Ã¢â€š ¬Ã¢â€ž ¢ business and there strong profit and cash generation ability, these companies can sustain higher levels of debt than normal businesses. Higher return on equity in case of Bristol Water is because of increase in profit and higher debt levels. So Bristol water is not only in financially good state, but also efficiently employing various sources of capital to generate higher returns for its shareholders. Current ratio A large factor determining a companyà ¢Ã¢â€š ¬Ã¢â€ž ¢s financial health is its liquidity. Liquidity is best measured by current ratio. Current liabilities are the immediate concern of any company and the higher liquidity of current assets makes it a perfect candidate to satisfy current liabilities. Current ratio = Current assets / current liabilities Appendix XII shows the current ratio. It is almost same in both the companies and also moved in tandem over the last year. Also increase in current ratio signifies better financial health of the companies. Any ratio more than 1 means that company can easily meet it current obligations without having to liquidate anything more than current assets. Acid or Quick ratio Acid test or quick ratio is a conservative approach towards current ratio. Inventory sale would normally be at lower than cost price and may not be as liquid as cash or short term investments. Acid test or quick ratio = (current assets à ¢Ã¢â€š ¬Ã¢â‚¬Å" inventory)/current liabilities Appendix XII shows acid ratio calculations. Because of the nature of business of Bristol Water and United Utilities, inventory is very less. So there is almost no difference between current ratio and acid ratio. Conclusion Both Bristol Water and United Utilities are in strong financial health. Their have good mix of assets and liabilities. United Utilities is better when it comes to sheer size of numbers. Bristol Water on the other hand is more efficient user of capital. Both companies are earning a good return on their assets and have high chances of survival in the long run. Appendix I à ¢Ã¢â€š ¬Ã¢â‚¬Å" Balance Sheets of Bristol Water and United Utilities Bristol Water United Utilities  £m 2004 2003 % change 2004 2003 % change Tangible Assets 193.8 184.6 5.0% 7,769.4 7,087.3 9.6% Intangible Assets 0.0 0.0 116.1 69.2 Investments 47.0 0.0 73.0 59.6 Total Fixed Assets 240.8 184.6 30.4% 7,958.5 7,216.1 10.3% Current Assets 37.7 27.1 39.1% 1,560.9 1,174.9 32.9% Total Assets 278.5 211.7 31.6% 9,519.4 8,391.0 13.4% Current Liabilities -31.2 -40.8 -23.5% -1,374.8 -1,424.1 -3.5% Net current assets/(liabilities) 6.5 -13.7 -147.4% 186.1 -249.2 -174.7% Long term liabilities -150.8 -77.7 94.1% -4,702.0 -4,070.6 15.5% Deferred Income -8.4 -8.4 0.0% 0.0 0.0 Provision for liabilities -18.7 -19.2 -2.6% -339.7 -345.0 -1.5% Total long term liabilities -177.9 -105.3 68.9% -5,041.7 -4,415.6 14.2% Total shareholders fund 69.4 65.6 5.8% 3,102.9 2,551.3 21.6% Source: Bristol Water Annual Report 2004 (www.bristolwater.co.uk) and United Utilities Annual Report 2004 (www.unitedutilities.com) Appendix II à ¢Ã¢â€š ¬Ã¢â‚¬Å" Profit Loss statement of Bristol Water and United Utility  £m Bristol Waters United Utilities 2004 2003 % change 2004 2003 % change Sales 70.7 70.0 1.00% 2,115.5 1,920.5 10.15% Cost of Sales 51.1 50.6 0.99% 1,489.9 1,368.8 8.85% Operating Profit 19.6 19.4 1.03% 583.7 524.9 11.20% EBIT 19.4 19.0 2.00% 585.6 558.9 4.78% EBT 13.5 14.6 -7.53% 337.5 327.5 3.05% PAT 11.1 8.5 30.59% 361.0 277.8 29.95% Source: Bristol Water Annual Report 2004 (www.bristolwater.co.uk) and United Utilities Annual Report 2004 (www.unitedutilities.com) Appendix III à ¢Ã¢â€š ¬Ã¢â‚¬Å" Cash flow statement Bristol Water United Utilities  £m 2004 2003 % change 2004 2003 % change Net cash flow from operating activities 32.9 29.7 10.8% 923.5 851.5 8.5% Return on investment servicing of finance -7.1 -6.7 -151.8 -218.9 Capital expenditure -71.2 -16.1 342.2% -1018 -697.9 45.9% Financing 72 -3.4 922.9 613.8 50.4% (Decrease)/Increase in cash -1.6 2.4 -166.7% 9.6 10.3 -6.8% Source: Bristol Water Annual Report 2004 (www.bristolwater.co.uk) and United Utilities Annual Report 2004 (www.unitedutilities.com) Appendix IV à ¢Ã¢â€š ¬Ã¢â‚¬Å" Operating Margin  £m Bristol Waters United Utilities 2004 2003 % change 2004 2003 % change Sales 70.7 70.0 1.00% 2,115.5 1,920.5 10.15% Cost of Sales 51.1 50.6 0.99% 1,489.9 1,368.8 8.85% Operating Profit 19.6 19.4 1.03% 583.7 524.9 11.20% Operating Margin 27.7% 27.7% 27.6% 27.3% Appendix V à ¢Ã¢â€š ¬Ã¢â‚¬Å" Fixed Asset Turnover Bristol Water United Utility 2004 2003 2004 2003 Sales 70.7 70 2115.5 1920.5 Fixed Assets 240.8 184.6 7958.5 7216.1 Fixed Asset Turnover 0.29 0.38 0.27 0.27 Appendix VI à ¢Ã¢â€š ¬Ã¢â‚¬Å" Return on Capital Employed and Return on Equity Bristol Water United Utility 2004 2003 2004 2003 Return on capital employed EBIT 19.4 19.0 585.6 558.9 Net debt 140.3 74.8 3,438.4 3,373.9 Shareholders funds 69.4 65.6 3,102.9 2,551.3 Total capital employed 209.7 140.4 6,541.3 5,925.2 Return on capital employed 9.3% 13.5% 9.0% 9.4% Return on equity Profit after tax 11.1 8.5 361.0 277.8 Preference Dividend -1.1 -1.1 0.0 0.0 Net income to ordinary shareholders 10.01 7.41 361 277.8 Total shareholders funds 69.4 65.6 3,102.9 2,551.3 Minority interest -19.6 -17.7 Preference shares -12.5 -12.5 Equity shareholders funds 56.9 53.1 3,083.3 2,533.6 Return on equity 17.6% 14.0% 11.7% 11.0% Appendix VII à ¢Ã¢â€š ¬Ã¢â‚¬Å" Dividend Cover Bristol Water United Utility 2004 2003 2004 2003 Profit after tax,  £m 11.1 8.5 361.0 277.8 Dividend,  £m 7.3 16.9 315.3 264.8 Dividend cover 1.52 0.50 1.14 1.05 Appendix VIII à ¢Ã¢â€š ¬Ã¢â‚¬Å" Interest cover and cash flow interest cover Bristol Water United Utility 2004 2003 2004 2003 EBIT,  £m 19.4 19.0 585.6 558.9 Interest payable,  £m 6.3 5.2 248.1 231.4 Interest cover 3.1 3.7 2.4 2.4 Net cash inflow from op. activities,  £m 32.9 29.7 923.5 851.5 Interest payable,  £m 6.3 5.2 248.1 231.4 Cash flow interest cover 5.2 5.7 3.7 3.7 Appendix IX Net cash flow from operations to net income ratio Bristol Water United Utility 2004 2003 2004 2003 Net cash inflow from op. activities 32.9 29.7 923.5 851.5 Net income 11.1 8.5 361.0 277.8 Cash flow to net income ratio 2.96 3.49 2.56 3.07 Appendix X à ¢Ã¢â€š ¬Ã¢â‚¬Å" Trade debtor and trade creditor Bristol Water United Utility 2004 2003 % 2004 2003 % Sales 70.7 70.0 2,115.5 1,920.5 Trade debtors,  £m 8.6 6.7 317.4 313.6 Trade debtors days 44.4 34.9 27.09% 54.8 59.6 -8.12% Trade creditors,  £m 2.6 3.5 72.6 61.2 Trade creditors days 13.4 18.3 -26.45% 12.5 11.6 7.69% Appendix XI à ¢Ã¢â€š ¬Ã¢â‚¬Å" Book gearing Bristol Water United Utility 2004 2003 2004 2003 Net debt 140.3 74.8 3,438.4 3,373.9 Shareholders funds 69.4 65.6 3,102.9 2,551.3 Total capital employed 209.7 140.4 6,541.3 5,925.2 Book gearing 66.9% 53.3% 52.6% 56.9% Appendix XII à ¢Ã¢â€š ¬Ã¢â‚¬Å" Current and Acid Ratios Bristol Water United Utility 2004 2003 2004 2003 Current Assets,  £m 37.7 27.1 1,560.9 1,174.9 Current Liabilities,  £m 31.2 40.8 1,374.8 1,424.1 Current Ratio 1.21 0.66 1.14 0.83 Stocks,  £m 0.7 0.6 17.1 20.6 Current Assets Stocks,  £m 37.1 26.5 1,543.8 1,154.3 Acid Ratio 1.19 0.65 1.12 0.81