Next PLC, Clothing Retail Company

Introduction

Next PLC is a clothing retail company listed on the London Stock Exchange. The company mainly operates in the United Kingdom. It has about 500 stores in the UK, and about 200 franchised stores overseas (Next PLC 2014: 6). Next PLC is considered among companies in the clothing retail industry with a high growth rate, and an increasing market share. Next’s market share increased from 6.96% in 2013 to 7.5% in 2014. Marks & Spenser market share declined from 11.36% in 2013 to 11.18% in 2014 (Butler 2014). Marks & Spenser is the market leader by size. Next PLC carries out its sales through three main channels, which include the Next Directory, UK retail stores, and international retail stores.

Company market share 2014 2013
1 Next PLC 7.5% 6.96%
2 Marks & Spenser 11.18% 11.36%

Source: Butler (2014).

Comparative analysis

The comparative analysis takes into account the performance of the firm in the years that ended January 2013 and January 2014. It examines the income statement and the balance sheet.

Horizontal analysis of income statement

The analysis compares the two by finding out the percentage change from 2013. The table below indicates the changes that have occurred in the income statement..

No Item 2014
£m
2013
£m
Difference
£m
%
1 Revenue 3,740.0 3,562.8 177.2 4.97
2 Cost of sales (2,499.9) 2,437.0 (4,936.9) (202.58)
3 Gross profit 1,240.1 1,125.8 114.3 10.15
4 Distribution costs (296.2) (269.5) (26.7) 9.91
5 Administrative expenses (217.7) (201.0) (16.7) 8.31
6 Share of results of associates 2.5 0.6 1.9 316.67
7 Operating profit 722.8 695.1 27.7 3.99
8 Finance income 0.7 0.4 0.3 75.00
9 Finance cost (28.3) (29.0) 0.7 (2.41)
10 Profit before tax 695.2 666.5 28.7 4.31
11 Taxation (142.0) (157.9) 15.9 (10.07)
12 Profit after tax 553.2 508.6 44.6 8.77

Source: Next PLC (2014: 72).

Horizontal analysis of balance sheet

The table below shows the changes that occurred on the firm’s balance sheet in the two years.

No Item 2014
£m
2013
£m
Difference
£m
%
1 Non-current assets 676.5 685.8 (9.3) (1.36)
2 Current assets 1468.1 1207.8 206.3 21.55
3 Total assets 2144.6 1893.6 251 13.26
4 Current liabilities (834.5) (816.0) (18.50) 2.27
5 Non-current liabilities (1,023.9) (792.0) (231.9) 29.28
6 Total liabilities (1,858.4) (1,608.0) (250.4) 15.57
7 Net assets 286.2 285.6 0.6 0.21
8 Total equity 286.2 285.6 0.6 0.21

Source: Next PLC (2014: 74).

Vertical analysis of income statement

In the vertical analysis, the entries are expressed as a percentage of revenues in the income statement (Gibson 2011: 189). The percentages are displayed in the table below.

No Item 2014 2013
1 Revenue 100% 100%
2 Cost of sales 66.84% 68.40%
3 Gross profit 33.16% 31.60%
4 Distribution costs 7.92% 7.56%
5 Administrative expenses 5.82% 5.64%
6 Share of results of associates 0.07% 0.02%
7 Operating profit 19.33% 19.51%
8 Finance income 0.02% 0.01%
9 Finance cost 0.76% 0.81%
10 Profit before tax 18.59% 18.71%
11 Taxation 3.80% 4.43%
12 Profit after tax 14.79% 14.28%

Source: Next PLC (2014: 72).

Vertical analysis of balance sheet

In the vertical analysis of the balance sheet, entries are expressed as a percentage of total assets (Gibson 2011: 189).

No Item 2014 2013
1 Non-current assets 31.54% 36.22%
2 Current assets 68.46% 63.78%
3 Total assets 100.00% 100.00%
4 Current liabilities 38.91% 43.09%
5 Non-current liabilities 47.74 41.83
6 Total liabilities 86.65% 84.92%
7 Net assets 13.3% 15.1%
8 Total equity 13.3% 15.1%

Source: Next PLC (2014: 74).

The tables show that the total non-current assets decreased in value. In the year that ended 25th Jan 2014, total current assets increased by 21.6% from the value in the previous year. Total assets increased by 13.3%. It shows that the increase in the balance sheet size is driven by an increase in current assets. Current liabilities increased by 2.3% and total liabilities by 15.8%. It shows that long-term debts are used to finance the increase in current assets. Equity changed positively by a small margin.

The income statement shows that cost of sales became a smaller proportion of sales in the year that ended January 2014 compared with the one that ended January 2013. It shows that the firm’s control has become more effective compared with the previous year.

Ratio analysis

The ratio analysis considers five groups of ratios that check the firm’s financial condition.

Liquidity

Liquidity ratio Next PLC 2014 2013 Difference
Current ratio 1.76: 1 1.48: 1 0.28
Acid test ratio 1.30: 1 1.07: 1 0.23
Cash flow liquidity ratio 1.07: 1 1.00: 1 0.07

(Appendix 1)

Solvency

Solvency ratio Next PLC 2014 2013 Difference
Gearing (%) 78.2% 71.9% 6.3
Interest coverage (x) 25.5 24.0 1.5
Debt ratio 86.7% 84.9% 1.8

(Appendix 2)

Working capital management

Working capital ratios Next PLC 2014 2013 Difference (days)
Stock turnover ratio (days) 56.3 49.7 6.6
Debtor collection period (days) 78.9 73.9 5.0
Credit payment (days) 84.9 80.0 4.9

(Appendix 3)

Cash operating cycle

Next PLC cash operating cycle Days
2014
Days
2013
Difference
Holding time for stock 15 15 0
STOCK TURNOVER 56.3 49.7 6.6
Add:
Credit time allowed to trade customers
30 30 0
TRADE DEBTORS COLLECTION PERIOD 78.9 73.9 5.0
Total 180.2 168.6 8.9
Less:
Credit time taken from suppliers 40 40 0
TRADE CREDITORS PAYMENT PERIOD 80.3 73.6 6.7
Cash operating cycle (days) 59.9 55.0 4.9

Profitability.

Next PLC profitability ratios 2014 2013 Difference
Gross margin (%) 33.2 31.6 1.6
Operating profit margin (%) 19.3 19.5 (0.2)
ROCE (%) 55.2 68.5 (13.3)

(Appendix 4)

Asset utilization

Next PLC asset utilization 2014 2013 Difference
Asset utilization (x) 13.07 12.47 0.6
Capital utilization (x) 2.85 3.51 (0.66)
Fixed asset turnover (x) 7.34 6.63 0.71
Net assets turnover (x) 13.07 12.47 0.6

(Appendix 5)

Shareholder measures

Next PLC 2014 2013 Difference
Total Earnings Per Share (EPS) 347.1p 301.9p 15.0%
Dividend 164.8p 147.7p 11.6%
Price 6160.30p 3946.95p 2213.35
Price/ Earnings ratio 17.75 13.07 4.67
Dividend yield = dividend per share/ price 0.027 0.037 (0.011)
Dividend cover = EPS/ dividend per share 2.11 2.04 0.06

Sources: Next PLC (2014: 89), Yahoo Finance (2014).

Industry averages

The following table presents industry averages in comparison to Next PLC.

Next PLC Industry averages
Gross margin 33.16% 36.25%
Pre-tax margin 18.59% 12.37%
Net profit margin 14.79% 7.74%
Current ratio 1.76: 1 1.74: 1
Acid ratio 1.18: 1 0.86: 1
Interest coverage 28.48x 21.01x
Debt/equity ratio 2.8x 0.56x

Source: MSN (2014).

Measurement against key performance indicators (KPI)

KPI Next PLC 2014 2013 Annual change
Store numbers 541 540 1
Square feet (000’s) 7,008 6,728 4.20%
Total like for like (sales) -1.80% -3.80% 2
Net operating margin (retail) 15.60% 15.10% 0.5
Net operating margin (directory) 26.70% 25.30% 1.4
Next Directory active customers (total) 3,699,000 3,338,000 10.60%
Directory average sales per customer (GBP) 363 357 1.70%
Number of shares purchased (000’s) 6,202 7,510 -17.42%
Average cost per share (GBP) 47.7 32.13 48.46%

Source: Next PLC (2014: 19).

Assessment of Next’s KPI and evaluation of the KPI approach

Number of stores and square feet

Next has set an objective to increase the utilization of profitable space. The number of stores increased by one, and utilization of space by 4.20%.

Like-for-like sales

Like-for-like sales measures the annual change in sales figures. The value improved by a margin of two, which shows improvement in sales.

Net operating margin (retail)

Net operating margin shows the percentage of operating profit attributed to the retail division. Generation of profit increased for the retail division by a margin of 0.5.

Net operating margin (Directory)

Net operating margin (Directory) considers the profitability of the Directory division in isolation from the retail stores. The profitability of the Directory division increased from 25.3% to 26.7%.

Next Directory active customers

Next PLC recognizes that the Directory division creates a great opportunity to increase sales. The Next Directory revenue relies on customers who are active. The number of customers increased by 10.6% between the two years.

Directory average sales per customer

Directory average sales measure the level at which active customers purchase products. The average sales per customer increased by 1.07%. It shows that more customers are purchasing goods of a higher value.

Number of shares purchased

The firm prefers to purchase its own shares to strengthen their market value. The number of shares purchased decreased by 17.42%. It is the only indicator that declined.

Average cost per share

The firm purchased fewer shares at a higher price than the previous year. It shows that the firm has been effective in reducing share dilution.

Evaluation of the use of KPI

The KPI approach offers managers with a timely feedback to improve their performance before the year comes to an end. Firms can continuously improve their performance targets. It allows firms to set realistic and measurable goals. It is more effective because it applies both qualitative and quantitative measures for performance improvement (UAS n.d.). In a top down approach, KPI measures managers’ performance using governance and accountability benchmarks. On the other hand, from the ground upwards, KPI measures the effectiveness of workers in carrying out functions and activities that are completed routinely (Public Record Office Victoria 2010: 15). KPIs offer more space for continuous improvement than ratio analysis.

Discussion and explanation of results

The firm’s liquidity ratio improved between the two years. The firm has maintained an adequate proportion of current assets, enough to cover current liabilities. However, a higher level of current ratio may indicate larger amounts of assets that do not earn interest (Gitman and McDaniel 2008: 392). The acid ratio of the firm follows the same trend as the current ratio. The firm has increased ability to meet short-term debt requirements without relying on inventory (RMA 2011: 14).

The firm’s cash flow liquidity ratio increased in 2014 compared with 2013. It shows less pressure on the firm’s assets to finance operations (Hermanson, Edwards and Ivancevich 2006: 335). It also shows the reduced need for short-term external financing (Drake and Fabozzi 2012: 199).

The firm utilized more debt in 2014 compared with 2013. Gearing as a percentage of the utilization of debt has increased in 2014. The firm has more risk in 2014 than it had in 2013. Risk refers to the firm-specific risk to investors as a result of increased leverage (Clayman, Fridson and Troughton 2011: 286). The firm has to generate higher returns to cover debt, and pay dividends.

Usually, firms do not present the figure of the products they sell on credit. For the calculations, the total sales have been used to show the maximum limit that the debtor collection period cannot exceed. The debtor collection period is increasing, which may indicate more time given to debtors. A firm has to balance between increasing sales through credit and reducing the need for more working capital (Gill and Mathur 2010: 1).

Two profitability ratios, out of the three, declined in 2014 compared with 2013. Return on capital employed (ROCE) shows that there was a decline from 68.5% to 55.2%. The efficiency in utilizing capital declined in the two years. The year 2013 appears to have been a more productive year for the firm in its use of capital. Gross margin increased from 31.6% to 33.2%. It indicates the firm has been more effective in managing costs of sales.

Advantages and limitations of ratio analysis, and KPI

One of the advantages is that ratio analysis allows outsiders to evaluate the performance of a firm (Alrafadi and Md-Yusuf 2011: 620). It provides a common method to be used by most people. It can be used to evaluate separate areas of a firm’s performance, such as profitability, and solvency.

One of the limitations is that ratio analysis is limited by the differences in firms derived from differences in sectors, accounting standards, and countries, among other things (Alrafadi and Md-Yusuf 2011: 620). Another limitation is that ratio analysis does not indicate the causes of the changes in performance. Ratio analysis is considered weak for its reliance on historical data. Ratio analysis has a weakness that financial statements may not present some of the figures required for ratio analysis, such as products sold on credit. Ratio analysis uses annual data, which may be less usual for managers who want to take corrective action before the financial year comes to an end (Alrafadi and Md-Yusuf 2011: 620). Ratio analysis has a weakness that half of the firms will always be below the median or mean performance, based on a normal distribution (Lesakova 2007: 262). A firm has to compare itself with the best performers in the industry.

KPI provides firms with a dynamic measure of performance compared with ratio analysis, which is usually calculated using annual data. KPI has a weakness that they can only be used internally by the firm. The KPI may also allow some form of subjectivity on the analysis, which may also occur in ratio analysis (Lesakova 2007 263).

Conclusion

The shareholder measures have a positive change, which indicates improved performance, and higher expectations from investors. All the KPI indicators have a positive change, except for the purchase of its own shares. Next PLC shows improvement in most of the financial ratios. The firm is more profitable, and has more liquid assets than current liabilities. Next PLC has a better quick ratio than the industry average. The current ratio is at the same level as the industry average. The firm has a better interest coverage ratio than the industry’s average. When profitability and gearing are considered, the firm is not in a better financial position that it was a year ago.

List of References

Alfaradi, K., and Md-Yusuf, M. (2011) ‘Comparison between Financial Ratio Analysis and Balanced Scorecard’. American Journal of Economics and Business Administration 3 (4) 618-622.

Butler, Sarah (2014) ‘Marks & Spenser Losing Clothing Market Share Faster Than Rivals’ The Guardian. Web.

Clayman, M., Fridson, M., and Troughton, G. (2011) Corporate Finance: A Practical Approach. Hoboken: John Wiley & Sons.

Drake, P., and Fabozzi, F. (2012) Analysis of Financial Statements. 3rd edn. Hoboken: John Wiley & Sons.

Gibson, C. (2011) Financial Reporting and Analysis: Using Financial Accounting Information. 12th edn. Mason: South-Western Cengage Learning.

Gill, A., Biger, N., and Mathur, N. (2010) ‘The Relationship between Working Capital Management and Profitability: Evidence from the United States’. Business & Economics Journal [online] 10 (1), 1-9. Web.

Gitman, L., and McDaniel C. (2008) The Future of Business: The Essentials. Mason : Cengage Learning.

Hermanson, H., Edwards, J., and Ivancevich, S. (2006) Managerial Accounting. 8th edn. Saint Paul: Freeload Press.

Lesakova, L. (2007) Uses and Limitations of Profitability Ratio Analysis in Managerial Practice. ‘The 5th International Conference on Management and Benchmarking’. held 1-2 June 2007 in Budapest. Banska Bystrica: Matej Bel University Press.

MSN (2014) Next Plc. Web.

Next PLC (2014) Annual Report and Account: January 2014. Web.

Public Record Office Victoria (2010) Strategic Management Guideline 3: Key Performance Indicators. Web.

RMA (2011) Annual Statement Studies: Financial Ratio Benchmarks 2011-2012. Philadelphia: The Risk Management Association.

UAS (n.d.) The Key Performance Indicator Evaluation Process (KPI Process). Web.

Yahoo Finance (2014) Next Plc (NXT.L) – LSE. Web.

Appendices

Appendix 1

LIQUIDITY RATIOS GBP millions
Year ended 26th Jan 25th Jan
Current ratio 2013 2014
Current assets 1,207.8 1,468.1
Current liabilities 816.0 834.5
Current ratio 1.48 1.76
Year ended 26th Jan 25th Jan
Liquid ratio 2013 2014
Current assets 1,207.8 1,468.1
Stock (inventory) 331.8 385.6
Current liabilities 816.0 834.5
Liquid ratio 1.07 1.30
Year ended 26th Jan 25th Jan
Cash flow liquidity ratio 2013 2014
Cash & cash equivalents 136.3 273.3
Marketable securities 21.6 1.2
Cash flow from operating activities 659.0 614.8
Current liabilities 816.0 834.5
Cash flow liquidity ratio 1.00 1.07

Source: Next PLC (2014: 74-76).

Appendix 2

SOLVENCY RATIOS GBP millions
Year ended 26th Jan 25th Jan
Gearing 2013 2014
Loan capital (long-term debt) 729.0 1,023.9
Shareholder capital + reserves 285.6 286.2
Loan capital (long-term debt) 729.0 1,023.9
Gearing 71.9% 78.2%
Year ended 26th Jan 25th Jan
Interest coverage 2013 2014
Operating profit 695.1 722.8
Interest payable (finance costs) 29.0 28.3
Interest coverage ratio 24.0 25.5
Year ended 26th Jan 25th Jan
Debt ratio 2013 2014
Total liabilities 1,608.0 1,858.4
Total assets 1,893.6 2,144.6
Debt ratio 84.9% 86.7%

Appendix 3

GBP millions
Year ended 26th Jan 25th Jan
Stock turnover ratio 2013 2014
Year-end stock 331.8 385.6
Annual cost of sales 2,437.0 2,499.9
Stock turnover ratio (days) 49.7 56.3
Year ended 26th Jan 25th Jan
Debtor collection period 2013 2014
Year-end debtors 718.1 808.0
Sales (instead of credit sales) 3,547.8 3,740.0
Debtor collection period (days) 73.9 78.9
Year ended 26th Jan 25th Jan
Credit payment period 2013 2014
Trade payables 537.2 594.0
Cost of sales 2,437.0 2,499.9
Closing stock 331.8 385.6
Opening stock 317.9 331.8
Credit payment period (days) 80.0 84.9

Appendix 4

PROFITABILITY RATIOS GBP millions
Gross profit margin 2013 2014
Gross profit 1,125.8 1,240.1
Sales revenue 3,562.8 3,740.0
Gross margin 31.6% 33.2%
Operating profit 2013 2014
Operating profit 695.1 722.8
Sales revenue 3,562.8 3,740.0
Profit margin 19.5% 19.3%
ROCE 2013 2014
operating profit 695.1 722.8
Capital employed:
Shareholder capital + reserves 285.6 286.2
Loan capital (long-term debt) 729.0 1,023.9
ROCE 68.5% 55.2%

Appendix 5

ASSET UTILIZATION RATIOS
Asset utilization 2013 2014
Sales revenue 3,562.8 3,740.0
Net total assets 285.6 286.2
Asset utilization (x) 12.47 13.07
Capital utilization 2013 2014
Sales revenue 3,562.8 3,740.0
Capital employed:
Shareholder capital + reserves 285.6 286.2
Loan capital (long-term debt) 729.0 1,023.9
Capital utilization 3.51 2.85
Fixed asset turnover ratio
2014 2013
Revenue 3,740.0 3,562.8
Net property, plant, equipment 509.2 537.3
Fixed asset turnover 7.34 6.63
Net assets turnover ratio 2014 2013
Revenue 3,740.0 3,562.8
net assets 286.2 285.6
Net assets turnover 13.07 12.47

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