Financial Statements of Pearson PLC-Free-Samples for Students

Question: Discuss about the Financial analysis of the financial statements of Pearson PLC. Answer: Introduction This report contains a financial analysis of the financial statements of Pearson PLC. Various ratios are calculated in the first part of the report which reflects about the companys profitability liquidity and efficiency and also it financial condition in the market. A brief overview about the company is also provided in the report. The second part of the report contains an evaluation of the two investment proposals, on which the company is looking on for making investment. Capital budgeting techniques like NPV, IRR and payback period is used for the purpose of evaluation. The report ends with a conclusion containing the findings of the analysis. About Pearson PLC It is a British owned company and worlds leading corporation engaged in providing digitalize teaching and learning services. The company has expertise in educational assessment. It offers its services to the schools, corporations and also directly to the students. The media brands owned by the company are Peachpit, Longman, Addison-Wesley and many others. The company was founded in year 1844 by Samuel Pearson. It has its headquarters in London and is known as the largest book publisher and education company all over the world. The company is listed on London Stock Exchange with a ticker LSE: PSON and is a part of FTSE 100 index. The mission and vision of the company is to increase the quality of life of people through learning because it believes on the fact that, learning provides and open up many career opportunities and make peoples life better. It provides products like published newspapers, books, magazines and services like higher education, school management and assessment related to education. Ratio Analysis The technique which is most commonly used in the analysis of financial statements of a company is known as ratio analysis (Zainudin, Zainudin, Hashim Hashim, 2016). Various types of ratios are calculated with the help of financial data available in the annual reports, to measure the liquidity, profitability, efficiency and capital structure of the company. Ratio analysis reflects the trend going in the company regarding its profits, earning and various other factors (Vogel, 2014). A ratio analysis of Pearson is done for past four years, on the basis of financial data taken from its annual reports. Referring to the excel sheet, following ratios are calculated: 2016 2015 2014 2013 Profitability Ratios Net Profit Margin Net profit after tax/sales -51.3% 18.4% 9.6% 10.6% Return on Assets Net profit after tax/total assets -23.2% 7.1% 4.1% 4.9% One of the main purposes of doing this analysis is to determine profitability of the company by calculating ratios like NPR and ROA. Pearson had negative profit percentage of -51.3% in 2016, whereas the same was highest in 2015 at 18.4%. The reason for such a huge decline was the collapse of its higher education business functioning in US. The company faces many problems due to decline in sale of textbooks and change in digital learning (Warren Jones, 2018). Looking at ROA of the company, it has been increased from 4.9% to 7.1 % in 2013 to 2015. This implies that company was efficiently utilising its assets to generate profits. After facing a great fall in the profits, the ROA for 2016 was reported at -23.2%. Company incurred a huge loss which cannot be covered with its assets (Tracy, 2012). Efficiency (or Asset Management) Ratios 2016 2015 2014 2013 Days of Inventory Inventory/average daily cost of goods sold 40.98 38.88 37.13 35.36 Total Asset Turnover Ratio Sales/total assets 0.45 0.38 0.43 0.46 These ratios tell about how efficiently company is working on its goals and targets. The days of inventory ratio tell how long companies will take to make and sell its products (Lee, Lee Lee, 2009). The number has been increased in past 4 years from 35 days to 41 days. It means companys ITR is low and increase in inventory over the years cause high inventory days. Total asset turnover ratio show how capable an organization is in turning its assets into sales. Overall the ratio has been fall for Pearson but as compare to 2015 it has increased to 0.45 in 2016. This implies assets were been utilized better and its pre publications has also increased from 2015 (Higgins, 2012). Liquidity Ratios 2016 2015 2014 2013 Current Ratio Current assets/current liabilities 1.06 1.07 0.67 0.62 This ratio determines the liquidity of the company and shows its potential to pay off its short term liabilities. In 2016, the ratio was 1.06 as compare to that of in 2015. As the ideal ratio is 1:1, which means company has enough current assets to pay its current liabilities. Its current liabilities are almost 60% less than its current assets (Fraser, Ormiston Fraser, 2010). Financial Structure Ratios 2016 2015 2014 2013 Debt/Equity Ratio Debt/equity 131.5% 81.3% 90.4% 91.6% Equity Ratio Equity/total assets 43.2% 55.2% 52.5% 52.2% D/E shows what portion of companys fund is financed through debt and what are financed through equity. Pearson has 131.5% of D/E ratio, which is highest in the past 4 years. This is because companys total debt is more than its equity. Reason for this can be the US incident which makes the share price fall. Equity ratio has also decreased from 52.2% to 43.2% because less funds are invested by equity investors. The company is not performing well for the investors as a result the ratio has been fallen (Engle, 2010). Market Ratios 2016 2015 2014 2013 Earnings per Share (EPS) Net profit after tax/no. of issued ordinary shares (2.86) 1.01 0.58 0.67 Dividends per Share (DPS) Dividends/number of issued ordinary shares 0 0 0 0 Price Earnings Ratio Market price per share/earnings per share (316) 963 1,678 1,517 EPS, DPS and P/E ratio shows market condition of the company. EPS tells about the profit earned by each share. The earning per share was negative in 2016 due to the losses incurred by the company. Though Pearson has issued more number of ordinary shares in 2016 but their market price has reduced and each share was earning losses. However, in 2013-2015, the EPS has increased (Christian Ldenbach, 2013). DPS is zero because the company has not declared any dividend in the past 4 years. Price earnings ratio was negative because EPS was below zero. The value has been reduced in 2015 as compare to 2014 and 2013. This means investor has to pay fewer amounts for each dollar of earnings made by the company. A low P/E is considered desirable (Anderson, 2012). Ratios Based on Reformulated Financial Statements 2016 2015 2014 2013 Return on Equity (ROE) Comprehensive Income/shareholders' equity -53.70% 12.82% 7.85% 9.45% Return on Net Operating Assets (RNOA) Operating income after tax (OI)/net operating assets (NOA) -33.43% 9.82% 6.75% 7.93% Net Borrowing Cost (NBC) Net fin. expenses after tax/net financial obligations 3.90% 4.52% 6.67% 5.41% Profit Margin (PM) Operating income after tax (OI)/sales -50.20% 18.97% 11.21% 11.91% Asset Turnover (ATO) Sales/net operating assets (NOA) 0.67 0.52 0.60 0.67 Economic profit (RNOA - cost of capital) x net operating assets (NOA) (2,431) 513 76 152 ROE shows how well an organization is using its owners equity to generate income. According to the table, in 2016 company was giving negative returns because of lack in profits. It does not have sufficient earnings to generate returns to its shareholders. In 2015, ROE was highest due to the highest profits. RNOA measures the financial performance as well as the efficiency is utilizing the assets. The ratio was highest in 2015 which means company was properly using its assets in making income. NBC ratio has been reduced in 2016 because of the reduction in the finance cost of the company. Profit margin, as usual it is negative in 2016 and highest in 2015. The reason is same as discussed above. ATR of 2016 and 2013 is same and also more than 2015 and 2014. This is because the net operating assets were lower in these years as compare to the latter ones. Moreover they are been utilized to generate more sales in 2016 and 2013. Economic profits measure the opportunity cost. As it can be clearly seen that company has economic loss in 2016 because the company had a huge loss and its assets had also decreased. It made an economic profit in 2015, which was more than all 3 years, due to highest profits and increased operating assets (Damodaran, 2012). Capital budgeting analysis Bunnings Coles Original cost 77 million 135 million Estimated Life 10 Years 10 Years Residual Value 2 million -1.5 million Estimated Future Cash Flows 31 March 2018 -4 million -5 million 31 March 2019 5 million -1 million 31 March 2020 15 million 10 million 31 March 2021 20 million 15 million 31 March 2022 20 million 15 million 31 March 2023 20 million 20 million 31 March 2024 25 million 20 million 31 March 2025 25 million 20 million 31 March 2026 10 million 25million 31 March 2027 13 million 13.5million Bunnings Coles NPV 5.88 million -66.61 million IRR 11.4% -0.3% Payback Period 6 years more than 10 years Pearson PLC has decided to invest in two new projects, one is purchasing a Bunnings warehouse and other is investing in a Coles supermarket for selling its products and services. In order to choose a better investment, Pearson choose to use the capital budgeting techniques like NPV, IRR and payback period. These techniques are used for choosing an appropriate investment proposal (Atrill McLaney, 2009). Net Present Value It is determined to know about the profitability of the proposal. If NPV is positive, then accept the proposal. If it is negative, reject the project and if it is equal to zero, select on the basis of other criteria. The NPV of Bunnings is positive and also the project requires low initial outlay as compare to Coles. The latter proposal has negative NPV and its initial investment is also more than the former one. So from NPV standpoint, proposal first should be accepted (Baker English, 2011). Internal Rate of Return It is that rate where PV of cash inflow is equal to PV of cash outflow. Discount rate of 10% is been taken for the evaluation and the proposal having high IRR is considered to be more desirable. Bunning project has high and positive IRR of 11.4% whereas Coles has a negative rate of -0.3%. It is better to go for Bunnings warehouses (BiermanJr Smidt, 2012). Payback Period It shows the time period taken by a project to recoup the initial investment. Generally, proposals having longer payback period are not advisable for making investment. As it is clearly seen from the above table that Bunnings will take 6 years to recover its initial outlay which is within its life period. On the other hand, Coles will require more than 10 years recovering the same as the project is not capable of doing it within its life period. So proposal one should be accepted (Ahmed, 2013). As per all three techniques used, investment should be made in Bunnings project as it is profitable, require less investment and also has a shorter payback period. Conclusion From the first part of the report, it can be concluded that ratio analysis is a best method to evaluate companys financial position. From this analysis, it can be said that Pearson has not performed effectively and efficiently in year 2016. On the contrary of this, its financial performance in 2015 was best with highest profits and highest market price per share. The second part concluded that company should go for Bunning project as it is the most profitable as compare to the other option available. Pearson should choose first option for making investment. References Ahmed, I.E., (2013). Factors determining the selection of capital budgeting techniques.Journal of Finance and Investment Analysis,2(2), pp.77-88. Anderson, K. (2012).The Essential P/E: Understanding the Stockmarket Through the Price Earnings Ratio. Harriman House Limited. Atrill, P. McLaney, E., (2009).Management accounting for decision makers. Pearson Education. Baker, H.K. English, P., (2011).Capital budgeting valuation: Financial analysis for today's investment projects(Vol. 13). John Wiley Sons. BiermanJr, H. 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