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A food producer and an engineering company

Tables 7.2 and 7.3 show how the top three ratios are calculated for Heinz and IMI, companies whose accounts were examined in Chapter 6.

TABLE 7.2 The ROI analysis for Heinz

The ROI analysis for Heinz

TABLE 7.3 ROI for IMI

ROI for IMI

Heinz makes a classic Anglo-Saxon 20 per cent ROI and has excellent margins or operating profit percentage. Asset turnover is well below the textbook 2:1 but there are explanations:

- A ratio of 2:1 is not appropriate for all sectors.

- The capital employed figure may include non-productive assets; for example, there is 734m cash at the year-end in question.

IMI has an even better ROI, with excellent profitability but again assets utilization below 2:1. However, once again the caveats as for Heinz apply.

The top ratios taken from published accounts give an overall picture, but in-depth analysis is required if you are to reach reliable conclusions.

The pyramid of ratios

The top three ratios are often described as a pyramid of ratios, with ROI being the apex. If you accept that the ultimate objective of strategies is to make a return, this is delivered through strategies that ensure profitability, good margins and cost control on one side and through strategies that ensure asset utilization or efficiency on the other (Table 7.4).

The 'classic' accountants' ratios are costs as percentages of sales spreading down or out on the left-hand side of the pyramid and sales to the amount of assets on the right-hand side. That is, sales to fixed assets, sales to inventories, sales to receivables and so on to an appropriate split of the capital employed component - assets and liabilities. These ratios are normally multiples; for example, 12:1 for a year's sales to the year-end receivables indicates that the entity has one month's receivables outstanding, but with the proviso that sales are evenly spread throughout the year.

Now let us look at BT's accounts and calculate classic ratios (Tables 7.5-7.14).

TABLE 7.4 Profitability and efficiency analysis

Profitability and efficiency analysis

TABLE 7.5 BT pic - group income statement (Page 102)

BT pic - group income statement

SOURCE: BT (2013)

The income statement gives us the sales figure: revenue = 18,017 and operating profit of 2,986. In published accounts there are few detailed cost figures, but there may be many in the notes; thus from the BT account notes we can find total staff costs of 4,747 and average number of employees 89,100.

The balance sheet (Table 7.6) gives us the capital employed figure of 17,537 and such individual asset or liability amounts that we wish to use to analyse asset utilization or efficiency. The word 'efficiency' is used here in the sense of making fixed assets/plant and equipment work hard and also in the sense of managing to keep down levels of inventory and receivables while not paying suppliers before you ought to.

TABLE 7.6 BT pic - group balance sheet

Page 104

BT pic - group balance sheet

SOURCE: BT (2013)

Table 7.7 shows a good ROI but not the 20 per cent textbook figure. Why? Well, one reason is that BT is a utility with guaranteed and regulated revenues, thus apparently less risk. A regulator of any utility will soon pick up that there is less risk from revenue streams suddenly evaporating. For example, they may well demand limited profit margins or force asset investment.

TABLE 7.7 BT pic - ROI, profit % and asset turnover

BT pic - ROI, profit % and asset turnover

Not at all surprisingly for an asset-heavy, infrastructure-heavy company sales to fixed assets, property, plant and equipment is low (Table 7.8).

TABLE 7.8 BT pic - asset turnover - asset utilization

BT pic - asset turnover - asset utilization

In spite of commercial customers being billed monthly and many consumers paying by direct debit customers are (or have to be?) given credit, in this case nearly two months' worth (Table 7.9).

TABLE 7.9 BT pic - debtor turnover - debtor days

BT pic - debtor turnover - debtor days

Apart from spare parts for exchanges and stock in any retail outlets inventories will be low and in any case a small fraction of sales. If the stock were mostly trading stock then unless margins were constant across product lines it would be better to analyse inventories against the cost of sales numbers (Table 7.10).

TABLE 7.10 BT pic - turnover - inventory days (to sales)

BT pic - turnover - inventory days (to sales)

With BT there is no significant difference and using sales is acceptable for an overall view of the business (Table 7.11).

TABLE 7.11 BT pic turnover - inventory days

BT pic turnover - inventory days

Is it the power of the purchaser? Or maybe the type of purchases? The picture from the published accounts and the overall ratio is one of suppliers being paid on average after 115 days (Table 7.12).

TABLE 7.12 BT pic - payables to sales - days payables

BT pic - payables to sales - days payables

As for inventory, a more accurate figure is given by relating payables to COS (Table 7.13). Which means suppliers have to wait even longer to be paid!

TABLE 7.13 Payables or creditor days

Payables or creditor days

 
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