Financial ratio analysis involves the calculation and comparison of ratios derived from historical financial figures of a business undertaking. These financial figures can be obtained from the published financial statements of the firm. “The level and historical trends of these ratios can be used to make inferences about a company’s financial condition, its operations, and attractiveness as an investment.” (Finpipe.com, n.d.) A financial ratio will appear to be meaningless when considered in isolation. However, the financial ratios in context give the financial analyst and investors, valuable information on the financial strengths and weaknesses of a firm and the trend that is emerging in the financial performance of the organization. Thus a ratio gains utility and value when compared with other available data and information.
The concept of financial ratio analysis makes use of different financial ratios classified into various categories. These categories provide in-depth knowledge on various facets of a firm’s operations as well as the financial performance during the periods under review. There are different groups of ratios such as leverage ratios, liquidity ratios, operational ratios, profitability ratios, and solvency ratios. Leverage ratios show the proportion of debts used in the capital structure of a company. Liquidity ratios comment on the short-term financial strength of the company and comment on the ability of the company to meet the short-term financial obligations. Operational ratios measure and report on the efficiency of the firm in using the assets and other resources. Profitability ratios exhibit the ability of the company to generate earnings from the operations of the firm and solvency ratios indicate the ability of the company to generate sound cash flow and meet its financial obligations. This report presents an analytical report interpreting the financial ratios for ITV calculated from the information contained in the financial statements for the years 2007 and 2008
Return on capital employed
This ratio indicates the ability of the company to generate returns for the shareholders from the operations of the company. The company has charged off £ 2565 million as impairment of intangible assets and £ 66 million as amortization of intangible assets which has reduced the overall profitability and resulted in a net loss during 2008. This has resulted in a reduced return on capital employed for the year 2008 as compared to 2007.
Gross profit margin
The operating costs before amortization and impairment of intangible assets and exceptional items have increased in the year 2008 as compared to the year 2007. While the operating costs were 85% of the total revenue during 2007, the percentage increased to 89% in the year 2008 which resulted in a lower gross profit margin.
Net profit margin
The change in the accounting policies resulted in an additional charge to the income statement on account of impairment of intangible assets and amortization of intangible assets which reduced the net profit of the company to a large extent. This has affected the net profit margin and reduced the net profit margin in the year 2008 significantly.
Operating profit margin
The same reason for the change in accounting policies with respect to the treatment of intangible assets has affected the operating margin of the company and has resulted in a reduced operating margin during 2008 as against that of 2007. Without taking into account the impairment and amortization the operating margin would have been 5.6% for 2008 as against 13.2% for 2007. However, the operating margin has been affected by the increased operating costs in the year 2008.
Asset turnover
The total assets in the year 2007 included unimpaired and unamortized intangible assets which have increased the total asset value and therefore the number of times the assets were turned over is less in that year. However, after charging off impairment and amortization the value of the total assets has come down and this has increased the assets to turnover ratio indicating a higher utility of total assets in the year 2008.
Current ratio
The current ratio in the year 2008 has come down due to the fact that there is an increase in the current liabilities (borrowings) during 2008 as compared to 2007. The borrowing as at the end of 2007 was £ 33 million while it increased to £ 259 million in 2008 significantly affecting the current ratio.
Gearing ratio
There are two reasons for the higher gearing ratio in 2008. The merger and other reserves representing equity have come down from £ 2702 in 2007 to £ 273 during the year 2008. Similarly, due to operating loss, the retained earnings have declined from £ 14 million profit to a negative figure of £ 286 million during the year which has reduced the total equity from £ 3239 in 2007 to £ 534 in 2008. Because of this significant change in the total equity the gearing ratio for the year 2008 has increased considerably.
Interest cover
For the year 2007, the earnings of the company could cover interest payments by 5.82 times, whereas for the year 2008, since the company’s operations have resulted in operating loss, there was no means of covering the interest payments. Therefore the ratio for the year 2008 shows a negative figure.
Investment ratio
Earnings per share
Since the operations of the company have resulted in a net loss during 2008 the earnings per share show negative earnings per share of 65.9p during that year as compared to 2007 (3.5p)
Earnings yield
The earnings yield for the year 2008 has drastically been reduced due to the loss per share reported by the company. Earnings yield is arrived at by dividing the earnings per share by the current market price per share. Since the company had negative earnings per share due to the net loss for the year 2008, the dividend yield for the year 2008 is negative and different from that of the year 2007.
Dividend per share
Dividend per share has come down due to the loss reported for the year 2008 as compared to the net earnings for the year 2007. With the available reserves, the company has declared an interim dividend of 0.675 per share.
Dividend yield
The dividend yield is calculated by dividing the dividend per share paid during the year by the current market price. Since the company has paid a dividend of 0.675p only per year during 2008 as compared to 3.15p for the year 2007, the dividend yield for the year 2008 is much lower during the year 2008.
Dividend Cover
The dividend cover for the company is arrived at by dividing the net income attributable to the equity holders by the total dividend paid by the company. Working out this ratio based on the loss for the year 2008 gives a negative dividend cover of 98.31 times. Whereas for the year 2007 the net profits earned by the company were adequate to cover the payment of dividends by 1.12 times.
Cash flow ratio
Cash flow from operations to current liabilities Cash flow from operations for the year 2007 has covered up to 30% of the current liabilities while for the year the cash flow could cover only 13.17%. This is due to increased current liabilities in 2008 resulting from increased short-term borrowings.
Cash cover rate
The cash cover rate indicates the ability of the company to meet all of its cash obligations including liabilities and dividends. Due to poor operating results the company was unable to generate adequate cash during the year 2008. This was due to increased operating expenses resulting in lower gross profit and net income. The poor cash generation in 2008 as compared to the year 2007 has resulted in a lower cash cover rate for the year 2008 as against the previous year.
(16) Cash flow per share
Cash flow per share for the year 2008 was at 0.039p per share as against 0.074p per share during the year 2007. The low cash flow per share is due to the inability of the company to general cash on account of reduced profitability of the company during 2008.
(17) Capital expenditure per share
There is no significant change in the capital expenditure per share between both the years 2007 and 2008 as the company has not made any substantial capital expenditure during the periods under review.
Debt service coverage ratio
The low debt service coverage ratio for the year 2008 is due to the fact that the company has ended with a poor operating cash generation during 2008 and in addition, the total debt has also increased during the year as compared to the year 2007.
Working investment ratio
The net current assets representing the working capital for the year 2008 have shown an increase from the year 2007. This has affected the working investment ratio for the year.
In general, the financial performance of ITV for the year 2008 based on the analysis of the financial ratios worked out from the information contained in the financial statement for that year and compared with the financial performance during 2007 indicate that the company has incurred more operating expenses during 2008 as compared to the previous year and this has significantly affected the gross profit of the company. In addition, the company has made accounting adjustments on account of impairment of intangible expenses and amortization of intangible expenses to a large extent. This exercise has affected the net income of the company and resulted in a net loss during the year 2008. However, the company has paid a dividend of 0.675p per share using the retained earnings and reserves.
The lower operating profits have resulted in poor cash generation from the operating activities. The net loss and lower cash generation have significantly affected the performance of the company as shown by the ratio analysis. The market price of the shares of the company has also drastically come down from 85.4p as of 31st December 2007 to 39.75p as of 31st December 2008. The drop in the share price may be attributed to the poor financial performance of the company during the year 2008. The lower dividend paid by the company for the year 2008 as compared to the year 2007 has significantly affected the investment ratios. The poor cash generation has affected the cash flow ratios and the increased operating expenses and reduced operating margin has affected the profitability ratios of the company for the year 2008. Increased borrowings during 2008 have increased the current liabilities and this has had a significant impact on the current ratio of the company. The accounting adjustments in respect of intangible assets have resulted in reduced total assets as shown in the balance sheet and the reduction in the value of the asset has affected the assets turnover ratio for the year 2008. There has been a significant change in the total equity of the company during 2008 as compared to the year 2007 which has affected the gearing ratio for the year 2008.
Reference List
Finpipe.com, n.d. Financial Ratio Analysis. Web.