Introduction
Imperial Tobacco Company (ITC) is a renowned corporation that has been using its resources in producing quality products that suit users’ needs. It is credited for adopting an effective lean administrative system that ensures optimal utilization of resources and reduction of wastages. Indeed, the company that started its operations in 1901 has recorded tremendous growth due to its effective administration.
This is evident since it is administered under quality ideals that ensure holistic adoption of best practices. The company was started with a core mission to be the leading producer and distributor of cigarettes in the world. It was also started to provide the best solutions to consumers in terms of product quality. It has tried to achieve its mission through the development of clear-cut policies and operating strategies that are economically viable and socially relevant. In particular, the policies have enabled the company to create value for shareholders through cost optimization and effective resource utilization.
The company has also managed to develop unique product portfolios and brands to suit consumer needs. Key brands of cigarettes that it produces include Davidoff, west, Gauloises blondes and Montecristo. All the brands are in high demand since they meet customer needs and expectations. They have enabled the users to have a variety of products to choose from based on their taste and preference. As noted, the company was formed in 1901 through an amalgamation of 13 different British cigarette producing corporations.
The amalgamation was to enable the companies to form a strong unit of production that could facilitate the provision of quality services and products to consumers. It was also to pull up resources to facilitate the manufacturing of quality products and to counter competition from other emerging corporations, especially in the US. Since its inception, the company that is located in Britain has been able to transform its operations to match international standards. This has enabled it to gain international recognition and expand its market share.
Indeed, the company is currently the fourth largest corporation in the world in terms of market share. It has a wide network of customers who receive quality services through its dedicated staff members at various locations (Fernando, 2009, p, 114). Its strong distribution network has immensely contributed to its exemplary performance that has been increasing over the years. This is evident since the company remains a recognized corporation that manages to sell a huge number of products on daily basis. Its daily sales volume in terms of units stands at 320 billion cigarettes in a year. This large quantity of sales is due to its effective marketing strategy and promotional activities that are tailor made to influence consumer decisions towards buying its key products (Fernando, 2009, p, 114).
In terms of performance, the company that started its operations as an in-house service provider has now gained momentum in the cigarette industry. The company currently, records positive growth as evident in its financial statements. The statements report a positive growth trend and a higher performance projection. Its financial ratios also depict the vibrancy of the institution and its ability to sustain its operations effectively. Its good performance has seen the company get listed in the London stock exchange where it has a market capitalization of more than $24.3billion. This amount shows that the company is in the right direction in terms of performance. Further, the company has been able to record excellent performance since it has a good structural and management framework.
Financial Analysis
This section provides a comprehensive financial analysis of Imperial Tobacco Company. The analysis is carried out by employing or establishing the strength of key financial ratios based on the company’s performance. The ratios seek to give a clear indication of how the organization has been performing financially. Indeed, financial ratios are key performance indicators that various stakeholders in institutions assess to ascertain the performance position of an institution (Sinha, 2009, p, 430). For instance, it enables investors to establish the viability nature of an institution and whether their investments are secure. They also assess the ratios such as return on investment to establish the number of monetary resources that they may achieve since their interest is mainly based on the benefits that they are bound to receive.
Key ratios that are being analysed in this section include financial, working capital, cash flow, gearing and investment ratios. The main aim of the analysis is to provide credible information about Imperial company’s liquidity position, capital gearing management and profitability level. Information on working capital management, cash flow maintenance and investment ratio performance indicators are also bound to be provided (Sinha, 2009, p, 432).
These ratios are significant since they are instrumental in influencing the decision making of key institutional stakeholders such as investors. The ratios will give stakeholders a reason to get attached to the company and support its activities especially when they are positive. Therefore, the analysis will enable imperial tobacco company stakeholders to make credible and informed decisions that would steer the company to higher performance levels.
Liquidity Ratios
Liquidity or financial ratios are key performance indicators that enable stakeholders in an institution to establish the ability of a company to meet its short-term obligations with minimal complications. The performance level is established by assessing current and quick test ratios (Baker& Powell, 2005, p, 48).
Current ratio
The current ratio gives a clear indication of the company’s ability to convert its current assets into cash to facilitate payments. The ratio indicates the level at which the available current assets that accompany has can facilitate settlement of current liabilities. The ratio is calculated by dividing current assets by current liabilities (Baker& Powell, 2005, p, 49). Imperial Tobacco Company’s current ratio stood at 0.78:1 in 2012 as compared to 0.70:1 in the year 2011. This shows a positive growth of 0.8% that is attributable to the effective or increase of assets. The increase also shows that the company has a lot of assets in comparison to its liabilities. The assets can facilitate the settlement of the evident liabilities within the shortest time possible without complications. Indeed, the company has effectively managed its assets and current liabilities.
Quick Ratio or Acid Test
The quick ratio measures an institution’s capacity to cover its liability obligations using current assets with the omission of stock value. That indicates the ability of a company’s highly liquid assets in meeting current obligations (Platt, 2004, p, 94). The imperial company recorded appositive growth in its quick test ratio that stood at 44% in 2012. This shows that Imperial Corporation is liquid enough to enable it to meet its liability obligations with ease. The increase is due to the proper coordination of investment and asset acquisition processes. Positive growth is essential for its expansion and sustainability, especially in the current competitive environment.
Financial Risk/ Working Capital Management Ratios
The working capital management ratio remains a significant performance indicator that shows the ability of a company in managing its stock units, debt and payable obligations (Platt, 2004, p, 95). Effective management of working capital is what contributes to exemplary performance in most institutions. This is evident since the elements that constitute working capital define the level of revenue and profit that a company can realize. Effective working capital is attained when a company report high units of stock turnover, minimal stock days, reduced number of debt collection and payment days.
Stock Turnover/ Stock Days
Stock turnover that is calculated by dividing the cost of sales by average stock indicates the number of times a company can sell its inventory or products during the year. This enables managers to know the number of products that the market can absorb and plan effectively for proper flow of production (Platt, 2004, p, 98). Imperial company’s stock turnover stood at 5380 units in 2012 compared to 23773 units in 2011. The increase in the number of units that it sells gives a clear indication that the company is on the path to achieving excellent results. The increase is attributable to effective marketing, execution of promotional activities and quality of the products.
Stock Days
Stock days indicate the average number of days that stock is held in a company’s store before sales are made. The lesser the number of days’ stock is held the better for a company that aspires to record high performance (Megginson, Smart & Lucey, 2008, p, 79). That is corporations should ensure that they can sell their stock as early as possible to avoid holding dead stock. As noted, stock holding days of Imperial Company stood at 26 days in the year 2012. This is according to the last financial report that indicates that the company reduced its stock holding period to 26 days from 29 days in 2011. This shows that the company is executing its marketing strategies effectively. It also shows that the products are on high demand from customers.
Debt (Receivable) Collection Period
Debtor collection period that is derived at when trade debtors is divided by sales shows how long it takes a company to receive payments from customers especially those who are served on credit terms (Shah, 2005, p, 5). The period should be less than 30 days as recommended by various professionals. This is essential in facilitating the preparation of financial statements and ensuring that a company does not run out of cash to drive its daily activities. Debtor collection period for Imperial Company stood at 37 days as at 2012. This shows laxity in the management of debt collection despite the reduction in the number of days compared to the year 2011. The company should adopt viable modalities to ensure timely collection of debt to enable it to achieve its liquidity obligations.
Creditor (Payables) Payment Period
The creditor payment period indicates the number of days that a company takes to pay its suppliers and distributors. This influences the trading relationship between managers and suppliers (Shah, 2005, p, 6). This is because suppliers are always willing to work with institutions that pay them real-time or within a reasonable duration. The repayment period for Imperial Company stood at 47 days in 2012 compared to 49days in 2011.
Profitability Ratios
Profitability ratios are significant performance indicators that enable corporation stakeholders to establish the state of a company in terms of financial strength. The ratios show the state of a company in terms of profitability, asset turnover; profit earned and returns on investment (Megginson, Smart & Lucey, 2008, p, 43).
Gross Profit Margin
Gross profit margin provides information about the amount of income that an institution can generate. The ratio should read a positive figure if an institution is managing its core business well (Megginson, Smart & Lucey, 2008, p, 61).
This is important since corporations drive their daily activities with the profit or surplus amount realized out of sales. Due to this it can be said the imperial company is on the right track since it has a positive growth in its profit margin value. Its profit margin stood at 19% in 2012 as compared to 20.5% in the year 2011. The growth is attributable to its high sales and effective management of liability obligations including allocation of resources. If the company maintains this trend, it will be able to emerge as atop and the largest company by revenue or market share in the world.
Return on Capital Employed
Return on investment indicates the returns or proceeds realized from long term investments. The ratio is used mostly by investors in making investment decisions. This is because it sends a positive massage to investors that their investment may be able to attract substantial returns. The ratio is essential for them since their interest in any institution is the returns that they would receive from their investments. Imperial company’s return on capital employed stood at 16% in the year 2012 that shows how well the company can reward its stakeholders.
Asset Turnover
Asset turnover ratio indicates the volume of sales generated from long term capital used. Imperial company has a turnover rate of 1.58: 1 as indicated in its 2012 financial report. The exemplary turnover rate depicts how well the company is utilizing its assets in generating more income.
Long-term Capital
Capital Gearing
Capital gearing indicates the amount of capital that is sourced from prior charged capital. It is found by dividing non-current liabilities by the total sum of share capital, reserves and non-current liabilities (Shah, 2005, p, 9). The higher the ratio the better for a company that seeks to leverage its performance. In 2012 Imperial Company recorded a high capital gearing ratio that stood at 69%. This was a significant increase from the figure that was realized in the previous year. The percentage growth shows that the company has been able to source its capital from prior resources effectively.
Interest cover
Interest cover is calculated by dividing profit before interest and tax by interest charges. It indicates the extent to which proceeds or profit amount that companies realize are absorbed by interest charges. Imperial company has an interest cover of 51.4%. This figure shows that the rate at which profits are absorbed by interest charges is in the increase. This may be as a result of low interest charges or expenditure that the company incurs.
Investment Ratios
Divided Yield
Divided yield is a significant ratio that investors evaluate in most institutions. It indicates the percentage return that investors would get from their investments. The higher the rate of divided yield the better for a company since such an institution would be in apposition to attract more stakeholders. Divided yield for Imperial Corporation stood at 2% as indicated in its 2012 report. This increase depicts that for every shares held investors would receive 2% return.
Divided Cover
Divided cover shows the number of times a company can pay divided to investors out of the available proceeds. Divided cover for Imperial Company stood at 0.5% in 2012 that shows a positive growth of 0.05% as compared to the figure realized in the year 2011. This shows that the company’s income levels or profit margin is expanding effectively (Bhat, S 2008, p, 2).
Earnings per Share (EPS)
Earning per share value is arrived at by dividing the sum of profit after tax and preference divided by the number of ordinary shares. It gives investors snippet knowledge of the amount that they are likely to receive as their income (Bhat, S 2008, p, 2). This is evident since it measures the amount of profit that is earned for issued ordinary shares The company’s EPS stood at 0.68 % in the year 2012 that shows a remarkable improvement. The earnings per share increased due to effective management resources and reduction of wastages within its production chain.
Cash Flow Ratios
Operating cash flow to maturing obligation ratio measures the extent to which cash flow that is generated from normal business activities can cover short term liabilities (Porter & Norton, 2011, p, 717). It is calculated by dividing current liabilities by cash flow from operating activities. It gives a clear indication of how liabilities are being covered in most institutions. Imperial Company recorded 431% in its cash flow to maturity obligation ratio in 2012. The imbalanced ratio shows that the company’s liabilities cannot be covered effectively by the cash flow that it generates. This requires the company to adopt a favourable strategy to ensure that it mitigate the evident imbalance appropriately.
Free Cash Flow Ratio
Imperial company’s cash exhaustion ratio stood at a standard number of days of 25 in 2012. This shows that the company can manage its normal operating costs effectively (Porter & Norton, 2011, p, 719). This is evident since cash in hand can cover the company’s liabilities without resorting to borrowings.
Conclusion/ Summary of the Financial Ratios
Indeed, Imperial Company has been recording exemplary performance financially since its inception. This is depicted by the company’s financial ratios that have been reporting positive growth over the years. The ratios indicates how well the company is managed and how various activities are executed. Key ratios that have been reviewed include profitability, cash flow, investment, working capital and long term gearing ratios. In particular, the company reported 78% growth in its current ratio in the year 2012. This indicates that the company has been able to manage its resources well. It also shows that the company has been able to acquire more assets and that the assets available at its disposal can settle its liabilities with minimal complications.
The company’s liquidity capacity and strength is also exemplary. This is shown by its positive liquidity ratio that stood at 15.1% in the year 2012. That is the company can be able to finance its activities effectively since the available cash can facilitate the settlement of its current liabilities. Consequently, the company has a strong asset base that guarantees its sustainability and growth. This is significant since institutions are mostly measured by their asset capacity.
A company that has a strong asset base is more likely to attract more investors than corporations that operate under inferior asset platform (Leitner, 2007, p, 2). This is a major issue that investors evaluate before investing in any company to ensure that their investments are secure. Further, the company recorded a strong working capital, return on investment and gearing levels in terms of value.
Activity Based Cost (ABC) Approach and key components
Activity based costing (ABC) is an accounting concept that ensures effective management of resources (Chellasamy & Ligy, 2011, p, 1). The concept provides requisite incentives that managers can apply in ensuring proportional allocation of resources. Indeed, the concept has been instrumental in enabling most institutions to record exemplary performance. This is evident since it has enabled managers in various institutions such as Imperial Company to identify and eliminate non viable activities. As noted by Chellasamy & Ligy (2011, p, 1), activity based costing facilitates priority based funding of projects in institutions. That is the concept helps in cost management through effective budgeting. This ensures that resources that are required to drive the execution of various activities are availed based on standardised requirements.
It ensures that cost estimation for an activity is determined once the activity has been identified. The viability of the activity must also be ascertained to ensure that any resource that is injected yield optimal returns (Leitner, 2007, p, 6). This promotes effective management of fixed, variable and overhead costs that define the successful nature of a venture. ABC also aids decision making on issues on pricing of products, outsourcing, project evaluation and measurement of process improvement. Firstly, the concept enables managers to make strategic decisions especially when levying prices of various items. It also enables them to ascertain the actual cost of executing an identified activity or a venture. This helps in ensuring that the prices are levied proportionately to curb possible loses and over payments by customers.
Thirdly, the concept enables managers to execute consistent evaluation of process improvement in all business units. This is essential since it promotes the adoption of innovative ideas and concepts of production (Mayes & Shank, 2012, p, 6). Indeed, the concept would be of great relevance to Imperial Tobacco Company that operates various business units. It would ensure that the company manages its resources effectively and receive optimal results. It will also see the company eliminate some of the wastages that it has been occurring in some of its business units. Further, the concept would enable the company to manage its fixed and variable costs effectively. This will see it expand its profit base and productivity levels that are vital for its sustainability.
The Rise and Impact of ABC Approach
Indeed, the use of activity based costing is increasingly gaining momentum in most settings. It is used as a performance measure and a strategy for attaining exemplary performance. It is also used as a strategy for achieving effective utilization of resources and balancing of overheads. That is it ensures effective distribution of resources between the evident cost centres in institutions (Mayes & Shank, 2012, p, 67. Managers affirm that ABC is an instrumental concept since it has enabled them to identify key projects that are viable and the projects that are not performing well.
This has facilitated a systematic termination of non viable projects and strengthening of potential ones through increased allocation of resources. They have been able to achieve this by diverting funds from non-viable projects to viable activities that hold the capacity of contributing positively to the company’s overall performance.
The concept also provides managers with pertinent incentives that enable them to classify various activities and to identify their output levels. This enables them to focus only on productive activities or ventures that can elevate the competitiveness of their institutions. As noted, by scholars ABC is a concept that appears to be a promising decision support tool that managers should not ignore. It seeks to present several answers or solutions to major complications that affects business operations in most institutions. This is because it provides clear-cut cost management strategies that are vital for ensuring optimal utilization of resources (Shim & Siegel, 2007, p, 39). It also provides proper guidelines that facilitate effective matching of cost elements with activities.
In recent days, practicing accountants put more emphasis on activity based costing. The professionals affirm that the concept remains relevant for institutions that aspire to achieve high returns. This is because it will enable them to maximize the resources that they have. They indicate that ABC provides the most convenient ways or techniques of cost management. The techniques hold the capacity of enabling most institutions to break even especially in the current business environment where institutions are facing several internal and external challenges. They affirm that the use of the technique is in the increase due to strategic, policy and structural reasons. Firstly, the concept is used predominantly since it facilitates effective preliminary evaluation of projects.
That is it enables managers and accountants to perform an intensive assessment of each activity to ascertain their productivity levels. This information helps them in making strategic decisions about resource allocation (Shim & Siegel, 2007, p, 39)). The information ensures that they allocate resources to performing activity units and review the causes of failure in other projects that may not be reporting good performance levels. Secondly, the ABC enables managers to execute effective cost implementation.
This is evident since it ensures that cost implementation is done in order of priority after proper identification of key and deserving cost centres. Thirdly, the use of the concept is gaining momentum since it promotes effective budgeting. It facilitates proper budgeting since it allows managers to plan and budget for the actual cost of various activities effectively (Goektuerk, 2007, p, 2).
This reduces cases of cash misappropriation that may present serious complications to a project’s execution. Budgeting is an integral part of any venture that is initiated with a strong growth orientation. This is because it gives a clear account of the resources that are required to aid the implementation of a project and how the resources are utilized. Indeed, poor budgeting and resource management is a recipe for failure. Projects that are not properly managed cannot report good performance as evident in most settings. Such projects can easily collapse if faced with economic externalities.
Why ABC Approach is Necessary for Imperial Tobacco Company
Indeed, ABC is a performance strategy that any company with strong aspirations to high productivity such as imperial tobacco corporation should embrace. This is because it supports strategic decision making on key elements that affect performance (Goektuerk, 2007, p, 9). This is evident since it fosters proper determination of product pricing, outsourcing process and identification of key activities. Consequently, it focuses on cost allocation and resource maximization that contributes to the elimination of unwarranted wastages.
The concept also helps in the segregation of fixed, overhead and variable costs elements. Imperatively, imperial tobacco companies should adopt the use of the ABC concept to facilitate its effective cost management. The concept would enable the company to manage its business units effectively. It will also ensure that its expansion plans are well coordinated and that they are undertaken under quality operating ideals (Hicks, 2002, p, 3).
It will enable Imperial Company to identify key activities that are yielding good returns within its value chain and support the activities optimally. For instance, the concept may enable the company to refocus its resource allocation strategy that currently favours all operating units to the Davidoff cigarette production unit. The production unit has recorded tremendous growth over the years and it still shows growth potential if the high demand for the product is adopted as its performance benchmark.
The concept would also be instrumental for Imperial Company since it would enable the company’s management to segregate the cost elements appropriately. That is the management would ensure effective segregation of fixed, variable and overhead costs that define the status of a project (Hicks, 2002, p, 6). The company will also be able to execute a systematic preliminary evaluation of projects to establish their performance level. The evaluation is to ensure that every activity that the company is executing can yield better results. Further, the concept will equip officials in the company with the knowledge on how to match cost with activities that are executed and proper identification of key areas of performance.
List of References
Baker, H & Powell, G 2005, Understanding Financial Management a Practical Guide, Blackwell Pub, Oxford.
Bhat, S 2008, Financial Management: Principles and Practice, Excel Books, New Delhi.
Chellasamy, P & Ligy, V. 2011. Activity Based Costing – a Tool for Decision Making. Web.
Fernando, A. C. 2009. Corporate Governance: Principles, Policies and Practices. Pearson Education, New Delhi.
Goektuerk, H. 2007. Activity-Based Costing (ABC) – Advantages and Disadvantages How ABC can be applied to institutions of higher education, Grin Verlag GmbH, München.
Hicks, D. 2002. Activity-Based Costing: Making it Work for Small and Mid-sized Companies, Wiley & Sons, New York.
Leitner, A. 2007. Activity Based Costing, Grin Verlag GmbH, München.
Mayes, T & Shank. 2012. Financial Analysis with Microsoft Excel, South-Western Press, Australia.
Megginson, W., Smart, S & Lucey, B. 2008. Introduction to Corporate Finance, Cengage Learning, London.
Platt, H 2004.Principles of corporate renewal, University of Michigan Press, Ann Arbor.
Porter, G & Norton, C. 2011. Using Financial Accounting Information: The Alternative to Debits and Credits, Centgage Learning, Mason, OH.
Shah, A 2005. Fiscal Management., World Bank, Washington, D.C.
Shim, J & Siegel, J 2007. Handbook of Financial Analysis, Forecasting, and Modeling, Wolters Kluwer/CCH, Chicago.
Sinha, G 2009. Financial Statement Analysis, PHI Learning Pvt Ltd, New Delhi.
Appendix 1
Ratios
Financial ratios
Current ratio
Calculated as Current assets: Current liabilities
7113/9142 = 0.78
Quick Ratio or Acid Test
Calculated as Current assets less stock: Current liabilities
7113-3132/9142 = 0.44
Financial Risk/Working Capital Management Ratios
Stock turnover/stock days/(Inventory turnover/inventory days)
Stock turnover Cost of sales
Average stock
23080/1566 * 365 = 5380 days
Stock days Average stock x 365
Cost of sales
1566/23080 * 365 = 26day
Debtor (Receivables) collection period
Calculated as Trade debtors x 365 or Trade receivables x 365
Sales
Turnover
2852/28574*365 = 37 days
Creditor (Payables) payment period.
Calculated as Trade creditors x 365 or Trade payables x 365
Purchases
Purchases
1036/7980*365 = 47 days
Profitability ratios
Gross Profit Margin.
Calculated as Gross profit x 100%
Sales
5494/28574*100 = 19%
Return on Capital Employed
Calculated as Profit before interest and tax x 100%
Capital, reserves and long-term liabilities
1081/18096*100 = 6%
Asset Turnover.
Calculated as Sales
(x 100%)
Capital, reserves and long-term liabilities
28574/5833+-150+12413 = 1.58
Cash flow ratios
Operating cash flow to maturing obligations ratio
Current Liabilities x 100
Cash Flow from Operating Activities
9142/2119*100 = 431%
Free cash flow ratio
Cash Flow from operating activities
Capital expenditures
2119/300 = 7.06
Cash exhaustion ratio
Cash in hand x 365 = days
Short term liabilities
631/9142*365 = 25 days
Long term capital
Capital gearing
Calculated as: Non-current Liabilities x 100
Share Capital + Reserves +Non-current liabilities
12413/5833+-150+12413 = 69%
Interest cover
Calculated as Profit before interest and tax (x 100%)
Interest charges
1081/21*100 = 51.4%
Investor ratios
Dividend yield
Calculated as Dividend per share x 100%
Market price per share
0.7/31.6*100 = 2%
Dividend Cover (Inverse is Dividend Payout)
Calculated as Profit after interest and tax (x 100%)
Dividend (in income statement)
1081/6090*100 = 18%