bae systems 2012assignment.doc

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A report evaluating and reviewing the financial and

non-financial Business performance of BAE

Systems Plc. and its competitor Rolls Royce Plc.

NAME : KUTAY OKTAY

STUDENT NUMBER : 77129140

COURSE : MA INTERNATIONAL BUSINESS

MODULE TITLE : MANAGING FINANCIAL RESOURCES

DATE : 14th DECEMBER, 2012

MODULE TUTOR : PAUL SMITH

WORD COUNT : 3,053


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Executive summary

BAE Systems is one of the biggest defence companies in the world. The company

has taken its new name as BAE Systems after merged with GECs MarconiElectronic Systems in November 1999. After these businesses merged, new

company became the largest arms dealer in the world.

BAE Systems focuses on the three main business areas as defence, aerospace and

security. The company continues to their operations all around the globe with

approximately 87000 employees worldwide and is managed in London, the UK.

It is a global company with operating subsidiaries in the United States, Australia, the

United Kingdom, Oman, Singapore, Poland, Sweden, Canada, Germany, South

Africa, Puerto Rico, New Zealand, Brazil, Malaysia, Israel, France, Saudi Arabia,Hong Kong, Panama, Venezuela, Nigeria, Brunei Darussalam, Italy, Mexico,

Honduras, Barbados, India, the Netherlands, and Colombia (FAME, 2012a).

Boeing, Lockheed Martin (US based) and EADS (EU Based) are the biggest rivals for

BAE in these industries. Otherwise considering the UK, Rolls Royce can be

comparable with BAE Systems in the defence industry. Thus for purpose of this

report, Rolls Royce will be used as a second company for the comparison.

There are some financial highlights of BAE Systems according to 2011 as follows:

- Sales (excluding intra-group sales) down 14% to 19.1bn

- Underlying EBITA (excluding HQ) down 8% to 2.02bn

- Slightly decrease on operating profit down 1% to 1.580bn

- Dividends per share increased by 7.4% to 18.8p

- Gained 5.9p per share from an agreement between BAE and UK Tax Government

- Earnings per share up 14% to 45.6p including R&D tax benefit (agreement)

- 0.8bn debt financing succeeded


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Table of Contents

Introduction............................................................................................................................................ 5

Financial accounting principles and concepts and their importance in considering business

performance.......................................................................................................................................... 5

Accounting Policies of BAE Systems................................................................................................ 6

Critical Accounting Concepts of BAE System effecting to business performance..................... 6

Ratio Analysis of BAE Systems.......................................................................................................... 7

Profitability Ratios............................................................................................................................. 7

Return on capital employed........................................................................................................ 7

Operating profit margin ratio....................................................................................................... 8

Return on shareholders funds ratio........................................................................................... 8

Efficiency Ratios............................................................................................................................... 9

Inventories turnover period......................................................................................................... 9

Receivables turnover period..................................................................................................... 10

Payables turnover period........................................................................................................... 10

Liquidity Ratios................................................................................................................................ 11

Current Ratio............................................................................................................................... 11

Financial Gearing............................................................................................................................ 11

Gearing Ratio.............................................................................................................................. 11

Global defence market position of BAE Systems.......................................................................... 12

Home Markets of BAE Systems................................................................................................... 12

Financial Performance Comparison of BAE Systems and Rolls Royce.................................... 13

ROCE............................................................................................................................................... 13

ROSF................................................................................................................................................ 14

Current Ratio................................................................................................................................... 15

Gearing Ratio.................................................................................................................................. 16

Limitations of ratio analysis............................................................................................................... 17

External factors............................................................................................................................... 17

Internal factors................................................................................................................................. 17

Issues when using consolidated accounts.................................................................................. 17


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Introduction

The main focus of this report is to explain the financial and non-financial results of

BAE Systems. While doing this, second company Rolls Royce will be used for

comparative purposes as and when appropriate.

The main target of BAE is to be the premier global defence, aerospace and security

group.The group delivers through its wholly-owned subsidiaries and equityaccounted investments, a full range of systems and services for air, land and naval

forces, as well as advanced electronics, security, information technology solutions

(FAME, 2012a).

The key strategic actions of BAE Systems are;

- To deliver sustainable growth in shareholder value

- To drive shareholder value by improving financial performance and competitive

positions across the business

- To increase international business

- To improve profit and cash generation

- To focus on improving customer satisfaction

Financial accounting principles and concepts and their importance in

considering business performance

Financial reports provide information about the financial position of a reporting entity,

the effects of transactions and other events that change a reporting entitys economic

resources and claims. This information is useful in making economic decision about

future and about how an entity has managed its resources and the claims on those

resources in the past.

The International Accounting Standards (IAS) requires from companies to present

their financial information comprising of three main financial statements:

1. Balance sheet (A statement of financial situation)

2. Profit and loss account ( The statement of comprehensive income )

3. Cash flow statement

Balance sheet gives us information about companys financial position and shows

that how company manages its liquidity and its solvency. The statement of

comprehensive income measures the profitability performance of company.

Information about changes in financial position of an entity is useful to help assess


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the operating, investing and financing activities of the period. It is generally

mentioned in a statement of cash-flows (Weetman, 2011).

These statements will help us to understand deeply the performance of BAE Systems

and will give us a chance to have a comparison with Rolls Royce. In addition, this

financial information allows stakeholder to understand general position of thecompany in stock exchange.

Accounting Policies of BAE Systems

Firm procedure wants the managers to settle the group and parent company financial

statements for each financial year. Under that law they are required to prepare the

group financial statements in according to International Financial Reporting

Standards (IFRSs) as accepted by the European Union and applicable law, and haveelected to prepare the parent organization financial statements in according to UK

accounting standards and convenient law (UK Generally Accepted Accounting

Practice).

The directors are liable for keeping suitable accounting records that are admissible to

show and explain the parent companys transactions, and make public with

reasonable accuracy at any time the financial position of the parent company and

allow them to guarantee that its financial statements cooperate with the Companies

Act 2006 (BAE Systems Plc. 2011, pp. 54 ).

Critical Accounting Concepts of BAE System effecting to business

performance

The preparation of the financial statements in congruity with IFRS depends upon the

use of clear crucial accounting measurements and judgements. The company is

immune under the limitations of FRS 1, cash flow statements, from the requirement

to publish its own cash flow statement, as its cash flows are included within the

consolidated cash flow statement of the group.

The critical accounting policies of the group are listed as follows:

- Recognition of profit on long-term contracts (IAS 11, Construction Contracts)

Revenue on long-term contracts is recognised in the groups income statement when

performance stages have been finished. Revenue and cost estimates are considered

and updated at least quarterly, and more frequently as determined by events or

circumstances. The meaningful proportion revenue of the groups 17.8bn was

accounted for under IAS 11 in 2011.


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-Valuation of retirement benefit obligations for defined benefit pension schemes (IAS

19, Employee Benefits)

The retirement benefit obligation recognised in the groups balance sheet represents

the present value of the defined benefit obligations as adjusted for unrecognised past

service cost and as reduced by the fair value of scheme assets. The groups share ofthe IAS 19 pension loss was 4.6bn, excluding numbers distributed to equity

accounted investments and other participating employers on 31stof December in

2011.

-Valuation of acquired intangible assets (IFRS 3, Business Combinations) and on-

going impairment testing (IAS 36, Impairment of Assets)

Earned intangible assets without goodwill are valued in parallel with global used

models, which require the use of predictions that may be different from existing

outcomes. These intangible assets are depreciated at their guessed beneficial lives.Amortisation periods impact to future results and if there are some differences

between predicted and real circumstances related to individual intangible assets.

Goodwill is not depreciated, but is tested yearly for impairment and carried at cost

less accumulated impairment losses. The impairment review calculations need the

use of estimates related to the future profitability and cash-generating capability of

the acquired businesses. The group recognised intangible assets totalling 561m in

respect of acquisitions made during 2011, including 291m of goodwill. Total

intangible assets were 11.5bn, including 10.7bn of goodwill at the end of 2011.

Ratio Analysis of BAE Systems

Profitability Ratios

Return on capital employed

The Return on capital employed (ROCE) ratio is generally used by companies for

evidence of profitability. This ratio measures the amount of operating profit possible

to cover reserves, share capital and non-current liabilities.

BAE Systems Plc.s ROCE ratio for last 5 years

2007 2008 2009 2010 2011

11,54% 15,93% 2,15% 11,67% 11,43%

The ROCE ratio for company decreased sharply to 2,15% at the end of 2009.The

main reasons of this result are huge amortisation and impairment of intangible assets

and regulatory penalties of company. BAE Systems was alleged to have paid bribesto win overseas contracts, including the sale of Tornado jets to Saudi Arabia.


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Company has paid 278m for regulatory penalties and spent 1259m for

depreciation while group had spent 303m for amortisation in 2008.

Operating profit margin ratio

The operating profit margin is the most popular way to show the companies

operational performance. However, this ratio must not seem as a certain indicator ofthe operational performance because it changes in different business areas.

For example, luxury cars are sold less than cheap cars. Thus they bring huge

operating profit and small sales volume.

BAE Systems Plc.s Operating Profit Margin for past 5 years

2007 2008 2009 2010 2011

8,23% 10,31% 4,82% 7,13% 8,89%

Operating profit margin increased from 8,23% to 10,31% because rising of other total

income and interest received from 1257m in 2007 to 3380m in 2008.Then there

was a significant fall in 2009 due to 33% increase in administration expenses and

207% increase in net interest. Another interesting point is that when ROCE ratio was

slightly decreasing from 11,67% to 11,43%, operating profit margin increased from

7,13% to 8,89% between 2010 and 2011.It was due to 17% decrease in

administration expenses in 2011 despite 16% decrease in sales revenue in the same

period.

Return on shareholders funds ratio

The return on shareholders funds (ROSF) ratio is a measure of the profit for the

period that is available to the ordinary shareholders with the ordinary shareholders

stake in a business. This ratio is the indicator for investors who may invest to the

company. If company has a high percentage of ROSF, it means that company is

more profitable.

BAE Systems Plc.s ROSF ratio for last 5 years

2007 2008 2009 2010 2011

20,70% 32,77% 6,05% 27,08% 34,57%

There is a significant increase in ROSF ratio by 60% between 2007 and 2008

because of high amount of interest received in 2008.The reason of sharp fall

between 2008 and 2009 is that group had to pay huge numbers of amortisation costs

and other interest paid. In addition, BAE was fined 256million by the U.S.

department of justice after pleading guilty to conspiring to make false statements toits government (Dailymail, 2010).


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By comparing 2010 against 2009, there was less impairment and interest payments

while revenues were approximately the same. Thus ratio increased from 6,05% to

27,08% in 2010 compared to 2009.Between 2010 and 2011, ratio increased by

27,66% because of 20,83% reduction in the total reserves.

When we have looked the evolution of the stock market prices, outlined below, wecan easily recognise that ROSF ratio and prices are going parallel by the years.

Especially decreasing of ROSF ratio between 2008 and 2009 affected market prices

negatively.

Evolution of Stock Market Prices between 2005 and 2012 (FAME, 2012a)

Efficiency Ratios

Inventories turnover period

Inventories turnover period is an efficiency ratio which shows frequencies of stockchanges. And a company prefers short time turnover for inventories because

holdings stocks have a cost for companies.

BAE Systems Plc.s inventories turnover days

2007 2008 2009 2010 2011

74,50 65,70 83,84 119,57 90,59


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There is a negative trend between 2008 and 2010 in inventory turnover periods

despite the positive situation from 2007 to 2008 because when cost of sales was

increasing, it reflected negatively to turnover period and when cost of sales was

decreasing, inventories turnover period was becoming lower and reducing stock

costs.

Receivables turnover period

Receivables turnover period shows that how often company collects money from its

customers. So it will be a good benefit for company if customers pay money to

company more frequently.

BAE Systems Plc.s receivables turnover days

2007 2008 2009 2010 2011

55,91 64,41 54,23 47,35 53,82

Despite the increasing from 2007 to 2008, group was successful on risk and credit

management those receivables turnover days had been falling from 64,41 days in

2008 to 47,35 days at the end of 2010.After that there is a slightly increase from

47,35 days in 2010 to 53,82 days in 2011.

Payables turnover period

Payables turnover period could be analysed by two different ways. Firstly, if the

company make payments in short days to suppliers, it will be a good prestige for

company. On the other hand, if there is a chance for company to delay its payments

and put these payments into long terms, company are not going to face with cash

problems.

BAE Systems Plc.s payables turnover days

2007 2008 2009 2010 2011

23,29 21,98 19,04 19,27 19,84

BAE Systems Plc. is a global company so directors of company have to protect

groups goodwill against competitors and should show this discipline to their

suppliers. Between 2007 and 2009, turnover days were deducted by 4 days. After

2009, there were some slight increases from 19,04 days to 19,84 days in 2011.


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Liquidity Ratios

Current Ratio

Most researchers agree that optimum current ratio for business is 2 (2 times or 2:1)

but different types of business have current ratios under the 2:1 and it does not mean

that their business go for a bankrupt. Manufacturing companies have to keep more

raw materials in the stocks and they sell products on credit, because of this

increasing possible on trade receivables that causes high ratio.

On the other hand, supermarkets do not need to keep all things in stock and most of

their sales are made for cash that causes low ratio.

BAE Systems Plc.s current ratiofor past 5 years

2007 2008 2009 2010 2011

0,74 0,75 0,73 0,65 0,62

Between 2007 and 2009, current ratio hasnt changed so much and stayed stable.

However there is a 10% fall from 2009 to 2010 because of decreasing current assets

from 8788m to 7616m. When we look for 2010 and 2011, this trend continues from

65% to 62% in terms of declining current assets from 7616m to 6381m while

liabilities reduced from 11658m to 10275m.

Financial Gearing

As Atrill and McLaney so eloquently phrased it, Financial gearing occurs when a

business is financed, at least in part, by borrowing instead of by finance provided by

the owners as equity (2008, p. 204).

Gearing Ratio

BAE Systems Plc.s gearing ratio for past 5 years

2007 2008 2009 2010 2011

84,46% 128,56% 197,89% 149,29% 214,71%

The gearing ratio measures the contribution of long-term liabilities to the long-term

capital structure of a business. There was a straight increasing on gearing ratio

between 2007 and 2012 despite a 24% fall from 197,89% to 149,29% in 2010.High

gearing ratio means that company operates its activities by long term borrowings. In

addition, highly geared business is risky for shareholders because a small reduction


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in operating profit will cause much more negative change in the returns to

shareholders.

Global defence market position of BAE Systems

In 2010, BAE Systems was second the second largest global defence supplier. This

presented sustainability of the groups strong position in its global and domestic

markets overall. On the other hand Rolls Royce, competitor of BAE Systems, needs

to improve its revenue for challenging its rivals.

Home Markets of BAE Systems

BAE Systems is a major supplier to the US Department of Defence, offering a

balanced portfolio of products and services across defence and security domains,including the operational support of equipment used around the world by US forcesand their allies. Also the group plays an important role in the UKs defencecapabilities across air, maritime and land platforms, including military and technicalservice contracts.

BAE Systems is a leading in-country defence supplier, supporting the operationalcapability of the Saudi air, land and naval forces, and investing in the development ofSaudi indigenous defence capabilities. In addition, India continues to develop as ahome market. BAE Systems is investing in its presence through technology sharingand inward investment in this growing defence and security market (BAE Systems

Plc. 2011, pp.15).

0

5

10

15

20

25

30

35

40

45

DefenceRevenuein2010($

Bn)

Top ten global defence companies (Source:Defence News)


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Financial Performance Comparison of BAE Systems and Rolls Royce

Graph 1

ROCE

2007 2008 2009 2010 2011BAE 11,54% 15,93% 2,1% 11,67% 11,43%

ROLLS ROYCE 12,27% -28,32% 31,45% 7,9% 11,44%

(FAME, 2012a,b)

Graph 1 clearly indicates that one of the two companies achieved better results in

every year. BAE Systems performed more stable than Rolls Royce in five years

period. Thus Rolls Royce results has been seemed unexpected during the 5 years.

This occurred risk for stakeholders.

-40

-30

-20

-10

0

10

20

30

40

2007 2008 2009 2010 2011ROCE(%)

Return on Capital Employed between 2007-2011

ROLLS ROYCE

BAE


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Graph 2

ROSF

2007 2008 2009 2010 2011

BAE 20,7% 32,77% 6,05% 27,08% 34,57%

ROLLS ROYCE 24,51% -80,21% 76,53% 18,42% 23,65%

(FAME, 2012a,b)

BAE Systems generated considerable return to their shareholders balanced while

Rolls Royce had shown changes in every year. Thus investing Rolls Royce is more

risky for shareholders than investing BAE Systems. On the other hand, an investor,

who can make good future predictions, will have a chance to gain more returns from

Rolls Royce.

-100

-80

-60

-40

-20

0

20

40

60

80

100

2007 2008 2009 2010 2011ROSF(%)

Return on shareholders funds between 2007-2011

ROLLS ROYCE

BAE


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Graph 3

Current Ratio

2007 2008 2009 2010 2011

BAE 0,74% 0,75% 0,73% 0,65% 0,62%

ROLLS ROYCE 1,41% 1,10% 1,55% 1,34% 1,22%

(FAME, 2012a,b)

Based on the above, Rolls Royces results were much better than BAE. It means that

Rolls Royce managed their current assets and liabilities effectively. The reason why

BAE Systems results were going down is increasing long-term liabilities

continuously.

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

2007 2008 2009 2010 2011

CurrentRatio(%)

Years

BAE

ROLLS ROYCE


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Graph 4

Gearing Ratio

2007 2008 2009 2010 2011

BAE 84,46% 128,56% 197,89% 149,29% 214,71%

ROLLS ROYCE 122,46% 207,01% 146,58% 163,61% 114,84%

(FAME, 2012a,b)

Both of the companies gearing ratios were seen high but there was reflection

difference that sharp changes in Rolls Royce affected their investors as high financial

risk. Because when we have looked graph 2, there were significant changes on

ROSF in related to gearing ratio of Rolls Royce. Despite the high gearing ratio of

BAE, the group showed good performance for its shareholders and investors.

0

50

100

150

200

250

2007 2008 2009 2010 2011

GearingRatio(%)

Years

BAE

ROLLS ROYCE


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Limitations of ratio analysis

Ratios are necessary indicators but there may be limitations that shareholders and

managers have to bear in mind relating to external factors, internal factors and issues

specific to consolidated accounts.

They are a beginning point for further investigations and should be used together

with other analytical techniques. Ratios give information about one company but on

the other hand international, national and industrial statistics and projections, trade

association reports are necessary resources for giving the true picture of whole

companys present position and its future.

External factors

-Ratios need to be illustrated bearing in mind the political framework within which acompany has been operating as, for instance, when governments change the

measurements protectively that can affect on the sales of company.(Elliot and Elliot,

2012)

-Sudden economic changes such a global crisis could impact on:

-non-current assets, e.g. tax incentives to invest;

-inflated prices of raw materials that causes increasing costs

-costs affecting the profit before tax because of increasing bad debts and interest

rate

Internal factors

-Ratios might be distorted because they are based on period-end figures:

-when a business is seasonal, ending year figures are stable and might be an

unfair reflection to ratios

-On the impairment review of intangible and tangible non-current assets

Issues when using consolidated accounts

-The consolidated statement of financial situation aggregates the assets and

liabilities of the parent company and its subsidiaries. So consolidated accounts are

prepared for the stakeholders of the parent company and that they may be irrelevant

to the needs of creditors. Because creditors need to seek payment from the individual

group company to which it allowed the credit.

-Consolidated profit and loss account does not give a clear view of profits availablefor distribution by the holding company to its shareholders.


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The importance of cost and management accounting in terms of business

performance

The challenges of the competitive environment should cause companies to re-

examine their traditional cost accounting and management control systems. Despitethe significant change in the nature of organizations and differentiation of

competition, there has been little improvement in the style and implementation of cost

accounting and management control systems. Thus it is necessary to understand the

sources of todays practices reflect on the new demands for planning and control

information and develop a research strategy to meet these demands (Kaplan, 1984).

Management accounting is a supporting element for BAE Systems by collecting and

processing information that helps planning, controlling and budgeting strategies of

company.

Corporate Responsibility Review

Creating a successful and sustainable business requires more than financial results.The group places great importance not just on what we do, but how we do it.Responsible business is embedded within the groups strategy. The CorporateResponsibility (CR) objectives support the group in progressing towards recognisedleading positions in ethics and safety. The group also has programmes in place toprogress diversity and inclusion, and environmental sustainability (BAE Systems Plc.2011, pp.55)

Conclusion

Dick Oliver, chief executive of BAE, said that In the current challenging businessenvironment, the group continues to take the actions the board believes arenecessary to remain competitive and to deliver value for shareholders. In addition toits well established positions on priority programmes, providing key capabilities tosupport the needs of defence and security customers, the group has strong positions

in electronic systems and cyber security, together with significant internationalpresence. These strengths provide a good base of activity which, with a continuedfocus on cost, is expected to result in a resilient business performance (BAESystems Plc. 2011, pp.9).


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Bibliography

Atril, P., & McLaney, E. (2008) Accounting and Finance for Non-Specialists.6thed.

Essex: FT Prentice Hall, Pearson Education

BAE Systems (2011) Annual Report 2011 [Online]. Available from:

[Accessed 11 November 2012]

Elliott, B. and Elliot, J. (2012) Financial Accounting and Reporting. 15th edition. FT

Prentice Hall, Pearson Education

FAME (2012a) BAE Systems PLC: standard report [Online]. Available from: [Accessed 11 November 2012]

FAME (2012b) Rolls Royce PLC: standard report [Online]. Available from:

[Accessed 11 November 2012]

Kaplan, R.S. (1984) The Accounting Review: The Evolution of Management

Accounting. American Accounting Association, 59(3), pp. 390-418.

Weetman, P. (2011) Financial accounting [electronic resource] : an introduction.5th

ed. Harlow: FT Prentice Hall, Pearson Education

West, K. (2010) Campaigners' fury at 286m deal to end corruption probe after BAE

Systems admits using cash to win contracts. Dailymail[Online], 6 February.

Available from: [Accessed 7 December 2012].


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