SOP Assignment 2

MODULE ASSIGNMENT COVER SHEET
MATRICULATION NUMBER: 40190077_________________________________
Please ensure that you have removed your name from your assignment
– don’t forget to check both the header and the footer.
Please do include your Matriculation Number, though.
MODULE TITLE: SUSTAINING ORGANISATIONAL PERFORMANCE ________
MODULE NUMBER: SOE11728 2014-5 TR3 002__________________________
NAME OF MODULE LEADER: CLAIRE LINDSAY ________________________
DATE OF SUBMISSION: 24th August 2015 ______________________________
DECLARATION
I agree to work within Edinburgh Napier University’s Academic Conduct Regulations1 which require
that any work that I submit is entirely my own2. The regulations require me to use appropriate citations
and references in order to acknowledge where I have used any materials from any sources.
I am providing my student Matriculation Number (above) - in place of a signed declaration – in order
to comply with Edinburgh Napier University’s assessment procedures.
1 These form part of the Student Disciplinary Regulations - A useful website on Academic Conduct
requirements and how you can ensure that you meet them may
be accessed through the Student Portal, via the Plagiarism icon.
Please note that breaches of Student Disciplinary Regulations, such as Plagiarism and Collusion,
may be investigated and penalised.

1
Sustaining
Organizational
Performance
Coursework 2
40190077

2
Executive Summary
This report discussed on financial analysis, divided into three main parts which
includes financial ratio study and financing method for client/investor in funding MDM
plc. In the first part, investigation on which ratio to be reviewed in company profitability
(profitability ratio and all of its components) is executed, and in the second one all ratio
that contributes to company riskiness (Efficiency, Solvency, Liquidity and Solvency
ratio along with its element) is examined. These ratios is obtained by calculation
utilising a ratio equation provided in appendix A. On the first and second parts,
example from existing company (balance sheet and ratio calculations) is provided for
the purpose of easier explanation to client meaning of ratio number and these ratio
effect. Finally in third part financing methods for MDM plc project are suggested, it is
mainly divided into two, which is Debt and Equity. Both method advantages and
disadvantages are supplied in this essay, along with preferred method according to
company assumed situations. These method can only be chosen in real world once
client has obtain data on MDM ratio analysis, since these ratios are very useful in
determining company conditions, both its profitability and risk, before deciding on
which method to execute in funding MDM project and its operations.

3
Index
Page
1. Introduction 4
2. Financial Analysis 4
2.1 Ratio of Profitability 7
2.2 Risk Ratio Analysis 11
2.3 Financing Method 14
3. Conclusion 19
4. References 20
APPENDIX A 22
APPENDIX B 25

4
1. Introduction
It is financial consultant duty to monitors, analyse, and manage client
financially to achieve financial objective, through guidance and planning. In this report
as financial consultant, analysis on company investment has been requested, detail
discussion on company profitability and riskiness ratio will be discussed, and including
possible financing company project methodology will be examined.
2. Financial Analysis.
Example financial statement:
Table 1.1 Dell Balance sheet statement 2012 to 2013 (Assets) (Dell Inc., 2013)

5
Table 1.2 Dell Balance sheet statement 2012 to 2013 (Liabilities and Equity) (Dell Inc., 2013)

6
Table 1.3 Dell income statement 2012 and 2013 (Dell Inc., 2013)

7
Example Ratio:
Table 1.4 Dell Financial analysis ratio
2.1 Ratios of profitability
To define company profitability, Profitability ratios is used, providing company
degree of success in generating incomes/attaining profits, along with efficiency/risk
ratio, related to successfulness/profitability level in managing resources to generate
sales/business activity (McLaney and Atrill, 2013).
The ratio calculation is shown in table below (see Appendix A for equations
and Ratio definition in Appendix B):

8
Table 2.1 Dell Inc. Profitability ratio
1. Profitability ratio analysis:
 Return on equity: high percentage is better showing the company
successfulness. There are drop in 2013 (39.2% to 22.2%) indicating
that investment being employed ineffectively (escalation in equity but
lower net income), decreasing investor interest in Dell. Investor should
consider that unbalanced company debt will influence assets structure
(since most company assets are funded by equity and debt) causing
smaller stockholder equity (denominator), meaning with lower net
income (numerator) will still attain high ROE.
 Return on Assets: higher percentage express high company assets
profitability. In 2013 Dell ROA drop to 4.9% from 7.8% in 2012 pointing
an unfavourable position for investor due to less effective management
on assets (increase in assets but lower net income). ROA is correlated
to ROE as it reveals company successfulness before leverage
consideration. In company growth, ROA is used in deciding internal
growth rate and also for measuring sustainable growth rate.
 Return on capital employed: Higher ROCE illustrate more efficiency in
managing capital invested, considered as company long term
profitability indicator and more useful in determining company longevity

9
over ROE. Showed in Dell case there is ROCE drop from 19.7% to
12.5% (assets increment but lower EBIT and higher current liabilities)
which is disadvantageous since investor prefer rising or at least stable
ROCE percentage in a company.
 Gross profit margin: Higher percentage exhibit better cost control,
which excess capital can be used to pay other expenses. In 2012 Dell
margin was at 22.3% falling to 21.4% which does not fluctuate much,
showing reasonable financial conditions, due to Dell capability in
decreasing cost of sales and using the excess capital to cover other
expenses (shown in drop of total operating expenses) although net
sales is the main decrement cause in gross profit margin.
 Operating margin: High percentage display company capability in
earning more per sales, low cost operations and sales progress faster
than operating cost. Dell operating margin drop from 7.1% to 5.3%
(because of sales reduction although operating expenses is lower than
previous year) which show company minor instability and non-
sustainability.
 Net Profit margin: Higher number means the company has been
executing effective expenses control, correct product pricing, and
attaining high profit on sales. Dell Net margin decline slightly from 5.6%
to 4.2% affected by drop in sales (affected possibly by inclination in
pricing) triggering lower net income although there are small decrease
in total sales cost and operating expenses. To increase net profit
margin cutting expenses is more reasonable as it is more controllable
factor than sales (what dell possibly trying to execute).

10
Table 2.2 Efficiency/Activity Dell Inc. ratio
2. Activity/Efficiency ratio:
 Account Receivable turnover: In dell case account receivable are
selling product by credit and credit collection. High number signify good
credit policy and collection function. Dell number drop from 9.585 to
8.589, reflected on the accounts receivable collections day increased
from 38.080 to 42.496 days, mainly caused by neither collection
department nor credit regulations but sales reduction since account
receivable shown growth in value.
 Inventory turnover: High ratio imply more inventory being sold and
replaced with new stock. Dell inventory turnover declines from 28.269
to 26.543, correlated to the turnover days increasing from 12.912 to
13.751 days, caused by inventories asset drop despite the reduction in
cost of goods sold. This ratio directly related to company production
and sales department, higher sales/demand on product require higher
production capacity.

11
 Fixed Assets turnover: High turnover number means company is more
effective in handling its fixed assets to generate sales. In Dell case it
decrease from 29.224 to 26.782, due to the less efficient fixed assets
management in 2013, proven with similar fixed assets in 2012 Dell
generate less sales in 2013. Possible solution is to use fixed assets
creating new product to stimulate sales growth.
 Assets turnover: Higher ratio demonstrate company efficiency utilising
its assets to produce sales. Dell shown less sales generated despite
inclining number of assets in 2013, revealed on its ratio falling from
1.394 to 1,198. The ideal ratio for all turnover should be more than 1 as
it means that invested assets or other factors is equal to sales
generated.
2.2 Risk Ratio Analysis
In case for risk analysis, leverage/solvency, efficiency/activity and liquidity
ratio are examined. Solvency is capability to pay off all debt if the business were
liquidated (Hachfeld et al., 2011), and liquidity ratio concerns on ability of business to
meet its short term responsibilities (Atrill and McLaney, 2006). The ratio calculations
are shown in table below (See Appendix A for equations and Ratio definition in
Appendix B):
Discussion:
Table 3.1 Dell Inc. Liquidity Ratio
1. Liquidity ratio:
 Current ratio: Higher ratio demonstrate company current assets is more
liquid/capable in compensating its current liabilities. Although Dell
manage to decrease its current liabilities but disproportionate current
assets drop causing current ratio falling from 1.338 to 1.193. It is still

12
reasonably good results provided Dell could keep the ratio above 1,
signifying Dell current assets can cover its current liabilities. Higher
ratio liquidity is favourable for creditors showing that the company can
pay its debt.
 Quick Ratio: Inventory is omitted in quick assets, considering it as the
least liquid company assets (hardly converted to cash without
depreciation and occasionally sold on credit). High ratio express
company quick assets (fast cash conversion) high availability to pay
current liabilities, without sacrificing long term assets. Dell ratio drop
slightly from 1.275 to 1.134, this decreases is cushioned by reduction
in current liabilities despite loss in current assets, inventory small
fluctuation does not affect much. Dell position is considerably good as
the ratio is above 1 (its quick assets almost similar to current assets
and can be used to cover its current liabilities).
Table 3.2 Dell Inc. Solvency/Leverage Ratio
2. Leverage/Solvency Ratio:
 Debt-to-total Assets: High ratio implies company possess high leverage
and financial risk. In 2013 Dell ratio shrink lightly from 0.799 to 0.775,
suggesting reduction in financial risk, and it is below 1 which express
Dell Assets are majorly funded by company profit and equity (there are
reasonable cash flow). It is correlated to liquidity ratio in Dell debt
payment capability from assets, since it is mostly not made from debt.

13
 Debt-to-equity: High ratio reveal high risk since it shows that the
company is relying more on loan than shares. Higher shares indicate
more investment on company, means it is in great financial position
(low risk) attracting more investor to purchase its shares. Dell ratio fall
from 3.994 to 3.449, expressing Dell effort in trying to finance its
business more from equity than debt. In some cases having debt is
good, as it gets tax benefits and cheaper cost than equity, some
investors demand high dividend payment for the risk taken.
 Equity multiplier: High ratio referring to equity contribution to company
assets less than debt, company is deemed as high risk since company
has to increase cash flow for debt compensation, and it could also
mean investor own less of company assets than creditors. It is parallel
with debt-to-equity ratio if one decrease the other will follow, as seen in
Dell case equity multiplier drop from 4.994 to 4.451 as the debt-to-
equity ratio decline. This number provide insight on investor and
creditor on financing methodology the company able to utilise in funding
future assets (debt or equity).

14
Table 3.3 Dell Inc. Coverage ratio
 Time interest earned: High ratio dictates company ability in paying
interest and preventing bankruptcy, creditors prefer high ratio as it
means company able to pay interest punctually. In 2013 Dell earns
17.614 times of payable interest a reduction from 23.198 times
previously, due to decrease in operating income, but it is noticeably
good for Dell since it manage to keep the ratio above 1 (interest <
operating income). In some cases high ratio is not encouraging, it
may represent company earning is mostly used for interest payment
than new/ current project financing which potentially be more
beneficial.
2.3 Financing Project Method
After reviewing business profitability and riskiness using financial ratio and
balance sheet analysis, choosing the correct method financing a project is then
possible. Financing is project funding by sponsors as separate legal body, with project
cash flows isolated for financing intent from its sponsor, thus allowing assessment
independent of participant direct support in any form. It involves benefactors giving
equity and project management including nonrecourse debt issuance to benefactors
(Shah and Thakor, 1987). Generally both method has its own risk, for equity it may be
bought by rival to gain control of project by method of stockholders voting, so
prevention alternative would be non-voting security such as debt. However debt also
may reduce the management benefits control value since it poses bankruptcy threats,
including restraining contracts which leads to monitoring by debtholders (Chemmanur
and John, 1996). More details on equity and debt method benefits and threats for
investor is presented below:

15
Equity:
 Common Stock: security form that represent company equity
ownership (Financial Web, no date). Common stockholders are last
paid by company after bonds and preferred stocks.
Table 4.1 Common stock Advantages and Disadvantages (Financial Web, no date).
 Preferred stock: carry common stock equity and debt features,
unlike common stockholders although preferred stockholders does
hold some kind of ownership, excluding voting rights in company,
but they have greater claims on company assets and earnings.
Used by company which require funding but does not want to
increase debt, it is not counted as common stock and not treated as
debt too, hence not added as company debt and does not affect
earnings per share (Gitman et al., 2008).

16
Table 4.2 Preferred Stock Advantages and Disadvantages (Gitman et al., 2008).
 Bonds: a type of debt security, issued by corporate in raising funds,
it compensate regular interest and investors obtained. Lower rated
(by credit rating agencies) provide higher interest rate since
investor is at higher risk (Basu, no date).
Table 4.3 Bonds Advantages and Disadvantages (Basu, No date).

17
Debt financing method: investor become creditors and lending funds to
company and in return loan payment assurance by business owners with interest at
arranged rate and time (Admin, 2012).
Table 5 Debt Advantages and Disadvantages (Admin, 2012).

18
Equity financing for MDM plc is preferred for investor under these conditions:
Table 6 Equity financing as preference, assumptions made and expected results.
As for Debt method for MDM plc, is favoured assumed under these conditions:
Table 7 Debt Financing as preference, assumptions made and expected results.
In choosing which investment method employed, financial ratio review is
required, as these ratio is a quick way to determine company performance and
understanding its financial statements in simplified approach, showing company
strengths and weaknesses, making investment decision-making easier. For example

19
should investors prefer equity common stock financing, equity based ratio which
specifically considered alongside with other ratio of risk and profitability. Return on
equity can gives investor general idea on how invested capital is used for business
operation and profit margin offers insight on company net profit which may converted
to dividends, another substantial ratio is debt-to-equity ratio if the ratio is heavier on
debt, it could be potentially riskier for stockholders as there may not be enough excess
money for dividends payment after compensating company debt. The review and
analysis for all financing method are not limited to these ratio, others are needed to be
examined too before deciding on which investment method to execute.
3. Conclusion
Both company profitability and riskiness level are reflected in financial ratio
analysis which derived from balance sheet using equations, these ratio is more useful,
faster and simpler method in understanding company annual performance compared
to financial statement, hence it is essential for investors to understand financial ratio
analysis before choosing any type of investment. Both debt or equity method has its
own benefits and threats, utilising these financial ratio investors can make efficient and
logical decision-making which will provide higher gain.

20
4. References:
1. Admin (2012). Advantages and Disadvantages of Debt Financing. Ascent
Capital. [online]. Available at: http://www.ascentcapital.net/hello-world/
[Accessed on 3 August 2015].
2. Atrill, P., & McLaney, E. J. (2006). Analysing and Interpreting Financial
Statement. Accounting and Finance for Non-specialists, pp. 167-214 Pearson
Education.
3. Basu, C. (no date). Advantages and Disadvantages of bonds. Finance by
Demand Media. ZACKS. [online]. Available at:
http://finance.zacks.com/advantages-disadvantages-bonds-2350.html
[Accessed on 3 August 2015].
4. Chemmanur, T. J., & John, K. (1996). Optimal incorporation, structure of debt
contracts, and limited-recourse project financing. Journal of Financial
Intermediation, 5(4), pp. 372-408.
5. Dell Inc. (2013). ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934. United States Securities
and Exchange Commission, Washington D.C.
6. Financial Web (no date). Common Stock- Advantages and Disadvantages. The
Independent Financial Portal. [online]. Available at:
http://info.finweb.com/investing/common-stock.html#axzz3hkki9elJ [Accessed
on 3 August 2015].
7. FSA Formulas. (no date). FSA Note: Summary of Financial Ratio Calculations.
8. Gitman, L. J., Joehnk, M. D., Smart, S., Juchau, R. H., Ross, D. G., & Wright,
S. (2008).Web Chapter 16 Investing in Preferred Stock. Fundamentals of
investing. Pearson Higher Education AU. [online]. Available at:

21
http://wps.aw.com/wps/media/objects/3853/3945845/webchapters/webchapter
16.pdf [Accessed on 1 August 2015].
9. Hachfeld, G. A., Bau, D.B. & Holcomb, C. R. (2011). Ratios & Measurement
Agricultural business management. Financial Managementseries, 5. University
of Minnesota.
10.McLaney, E. J., & Atrill, P. (2013). Analysing and Interpreting Financial
Statements. Accounting: an introduction, pp. 240-298 Jean Morton.
11.Shah, S., & Thakor, A. V. (1987). Optimal capital structure and project
financing. Journal of Economic Theory, 42(2), pp. 209-243.

22
Appendix A
Table 8. Profitability ratios formula (FSA Formulas, no date)

23
Table 9. Efficiency/Activity Ratios Formulas (FSA Formulas, no date)
Table 10. Liquidity ratios Formulas (FSA Formulas, no date)

24
Table 11. Liquidity/Solvency and coverage ratio formulas (FSA Formulas, no date)

25
APPENDIX B (Atrill and McLaney, 2006).
Profitability Ratio:
Return on equity: how much stockholders gained from the investment on the
company.
Return on Assets: capability of company in managing assets to create profit.
Return on capital employed: comparison on how well average invested capital
(difference between total assets and current liabilities) can generate operating
income.
Gross profit margin: profitability percentage of the remains after paying the cost of
sales.
Operating margin: showing percentage of how much revenues left after taking
account all the operating expenses.
Efficiency/Activity Ratio:
Account Receivable turnover company potency evaluation in collecting debts and
giving loan.
Inventory turnover: measurement on company inventory flow annually.
Fixed Assets turnover: capacity of company fixed assets productivity in creating
revenue.
Assets turnover: ratio calculation on firm ability in making revenue from its assets.
Liquidity ratio:
Current ratio: ratio signifying company ability in paying its current labilities with
current assets.
Quick Ratio: company indication on its ability paying the current liabilities with the
most liquid assets (excluding inventory).

26
Leverage/Solvency ratio:
Debt to total Assets: company assets quantity which are being funded by debt
Debt to equity: ratio that point out the amount of debt for each dollar of equity made.
Equity multiplier: Evaluation on company assets which are finance by its
shareholders.
Time interest earned: ratio to calculate company ability in paying the debt interest

SOP Assignment 2

More Related Content

What's hot (20)

Viewers also liked (17)

Similar to SOP Assignment 2 (20)

SOP Assignment 2