FINANCIAL ANALYSIS AND MANAGEMENT

Table of Contents1. Introduction:31.1 Purpose of assignment31.2 Key highlights31.3 Methodology31.4 Source of data (FAME)42. Justification43. Performance Analysis:53.1 Profitability Ratios53.1.1 Return on equity (ROE)53.1.2 Return on assets (ROA)63.1.3 Return on capital employed (ROCE):73.2 Liquidity Ratio:93.2.1 Quick ratio93.2.2 Current ratio103.3 Gearing ratio123.4 Investment ratio133.4.1 Earnings per share (EPS)133.4.2 Dividend payout ratio144. Summary of Analysis155. Weaknesses of ratio analysis166. Conclusion and Recommendation16Recommendation16

1. Introduction:The pricing hike in the energy products in the country has raised alarms. The consumers expenditure is increasing day by day (Wahlen and Brown, 2010). Recent news shows that the consumers expenses have risen by about 1.23 per day due to the rapid rise in the prices of the electricity and gas (www.npower.com, 2013). The governmental additional cost of green production has burdened the energy companies with additional production costs. Thus this has compelled the companies to raise the prices (Yogo, and Campbell, 2010). In the following assignment the focus will be to evaluate the financial performance of the energy company RWE Npower Plc operating in UK. 1.1 Purpose of assignmentThe purpose of the assignment is to evaluate the financial performance of the company for consecutive five years. The tool of financial ratio is implemented to understand the change in the financial health of company over a given period (Puxty, 2010). The comparative study of the year on year financial figures will help to understand the reasons for rising production cost and the prices of the energy products. The financial ratios are beneficial for both the mangers of the company as well as the stakeholders to understand the worth of the company (Wachter, 2011). 1.2 Key highlightsThe company Npower has a customer base of 3 million households for 14.6 terawatt hours (TWh) of electric supply (www.npower.com, 2013). Npower also provides electricity distribution services for 350000 business houses in Britain with an addition 33.4 TWh of electricity (www.npower.com, 2013). The company also provides gas supply with approximately 163.4 million capacities (www.npower.com, 2013). Npower is a subsidiary of RWE which is into the business of generation of power and exploration of gas in UK and Europe. 1.3 MethodologyFor the purpose of financial analysis of Npower, the tools of financial ratio are applied to carry out the evaluation. Financial ratio is an effective method to critically evaluate the performance of the company (OBryan, 2010). The comparison of the present performance with the historical figures will indicate the development of the company in financial as well as economical values. The company analysis is an effective tool as these ratio analyses are made for the managers of the company to make the decisions pertaining to different areas of business (Lewellen, 2010). The financial statements form the basis of the financial ratio analysis. For this purpose the financial statements are sources through valid sources like Fame or the annual reports from the websites of the company (Michael, 2011). The ratio analysis is calculated to identify the profitability ratio, liquidity ratio, gearing ratio and the investment ratio. Apart from this the analysis drawbacks are also discussed to highlight the weaknesses of the methodology (Kinney and Trezevant, 2010). 1.4 Source of data (FAME)Fame (Forecasting Analysis and Modelling Environment) is a platform to avail the financial statements and reports of the companies operating in UK and Ireland. This is the most valid and reliable source of information as the files are available in an achieved forms and comes with a particular login ID (Libby, 2010). Apart from this the software also helps the viewer to access the value of the shares and debentures of the company along with the asset value of the company. Financial ratios are also made available at these sites which give the insight of the company to the non-financial viewers for their easy understanding (Frankel et al. 2010). 2. Justification Fame software is used as this is a prevalent source of information. As this framework has a record of almost all the companies functioning in UK, this source has been selected for the purpose of collecting the financial statements of the past 5 years of Npower (Chapman, 2012). The financial statements are valid and reliable as the login of these sites requires the discloser of the details of the user and hence it is secured. Mintel is another data base which shows similar reports but it is not used as this data base shows jumbled figures which include a number of irrelevant data (Soumaya, 2012). Financial ratio analysis model is used as this model shows a comparative study on year on year basis and so it helps the mangers of the company to understand the flaws in the present operation and evaluate the success of new plans incorporated (Mathuva, 2012). The managers of the company can use these ratios to understand the financial performance of the company without considering all the financial reports which saves time. 3. Performance Analysis:Performance analysis is the determination of the change in the financial performance of the company in the given external economic condition (Soleimani and Salehfar, 2012). These ratios show the ability of the company to perform strategically within the prevailing financial condition. 3.1 Profitability RatiosProfitability ratio is the indicative of the earnings that the company has been able to earn through the deployment of the capital invested. This ratio shows the earnings in comparison to the cost of the company (Khan and Rehman, 2012). 3.1.1 Return on equity (ROE)ROE = Net income/ Shareholders equity*100

Return on equity

20102011201220132014

NET INCOME3,719.0025,212.0011,017.0023,451.0022,451.00

TOTAL EQUITY8,996.009,069.009,246.0010,234.0011,919.00

Return on equity 0.412.781.192.291.88

Figure 1: ROE of Npower(Source: Created by the author)ROE is the profit earned by the company by employment of the equity of the shareholders. These show the rational investment which has earned favourable return for the company. The ROE of Npower has shown a down fall from that of 2013 as the company has not been unable to earn returns from the equity investments (Saeidi and Jorjani, 2012). This is also indicative of the fact taht the company has not been able to make a rational investment decision which has resulted in the drop of the ROE. The shareholders of the company will be depressed by the performance of the company.

3.1.2 Return on assets (ROA)ROA = Net income/ Total assets *100

Return on assets

20102011201220132014

NET INCOME2,079.002,159.001,917.002,153.002,476.00

Total assets44,607.0046,400.0047,335.0054,705.0052,384.00

Return on Assets 0.050.050.040.040.05

Figure 2: ROA of Npower(Source: Created by the author)3.1.3 Return on capital employed (ROCE):ROA indicates the ability of the company to utilise the assets of the company to generate income. More is the value of ROA, more is the efficiency of the company to generate sales through the operational activities. The employment of capital into a business is for the purpose of earning profit. ROCE is the indicative of the income earned through the total investment in a certain project (Kheradyar and Ibrahim, 2011). The capital employment comprises of the debentures of the company and the net assets which may be infused. The assets of the company is not fully explored to meet the actual efficiency of the company. ROCE = Profit after tax / Capital employed*100Capital employed = Debt + EquityReturn on capital employed (ROCE)

20102011201220132014

NET INCOME2,069.002,148.001,971.002,153.0022,451.00

Equity8,996.009,069.009,246.0010,234.0011,919.00

Debt35,313.0037,331.0038,089.0044,471.0040,465.00

ROCE0.230.240.210.211.88

Figure

Figure 3: ROCE of Npower(Source: Created by the author)3.2 Liquidity Ratio:Liquidity ratio is the availability of the short term assets of the company which can be converted to liquid cash with minimum depreciation value (Krishnan, 2012). This source of liquid assets is required to meet the short term fund requirements of the company like working capital and other short term liabilities (OBryan, 2010). 3.2.1 Quick ratioQuick ratio = (Current assets inventories) / current liabilities

Quick ratio

20102011201220132014

TOTAL CASH AND SHORT TERM INVESTMENTS346384332671354

TOTAL RECEIVABLES

1,397.001,179.001,143.001,547.001,723.00

TOTAL CURRENT LIABILITIES

6,693.006,936.006,091.007,445.007,431.00

Quick ratio

0.260.230.240.300.28

Figure 4: Quick ratio of Npower(Source: Created by the author)Quick ratio is a more useful means to determine the liquidity condition of the company as this ratio does not includes the stock into consideration of this ratio and hence it is helps to determine the actual liquidity condition of the company (Krishnan, 2012). The quick ratio of Npower has started improving. This can be attributed to the fact that the company has improved the receivables of the company. The conversion period has reduced and so the company is able to convert the products to cash equivalent to pay the creditors of the company (www.rwe.com, 2014). The quick ratio in the year 2013 has shown the highest result. This can be attributed to the fact that the company was able to earn better through the production process in the past year. 3.2.2 Current ratioCurrent ratio = Current assets/ Current liabilities

Current ratio

20102011201220132014

TOTAL CURRENT ASSETS5,736.006,233.005,691.009,576.007,489.00

TOTAL CURRENT LIABILITIES6,359.006,396.006,097.007,445.007,331.00

Current ratio0.900.970.931.291.02

Figure 5: Current ratio of Npower(Source: Created by the author)

Current ratio is the indication of the current assets as compared to current liabilities. The operational activities of the company determine the ideal current ratio and this ratio is different for different companies (Krishnan, 2012). The ideal current ratio is considered to be 2:1 but it depends on the company to company. For Npower it is evident that the company as maintained a constant current ratio which shows that the company has shown stagnant approach has not undergone any change in the production capacity as well as the increase in the demand of the company(Krishnan, 2012). This ratio shows that the company has financial crisis as the demand of the products have stagnated. 3.3 Gearing ratioGearing ratio signifies the gearing up of the activities of the company which results through the use of liabilities of the company. 3.3.1 Interest coverage ratioInterest coverage ratio = EBIT / InterestEBIT = Earnings before interest and tax Interest coverage ratio

20102011201220132014

EBIT3,809.003,980.003,667.003,504.003,536.00

Tax expenses981.001,118.001,046.009751,000.00

Interest coverage ratio3.883.563.513.593.54

Figure 6: Interest coverage ratio of Npower(Source: Created by the author)

Interest coverage ratio justifies the use of the liabilities. If the ratio is low this means that the company is not able to earn profit to pay the interest payable for the liabilities and hence the company may soon turn out to be insolvent (Krishnan, 2012). For Npower the ratio is decreasing and this is matter of concern as the company is finding it difficult to meet the cost or the interest of the liabilities. The earnings of the company have fallen in the recent years. If the condition continues Npower will find it difficult to survive in the competitive market and will soon windup. The interest coverage ratio can also influence the profit margin of the company as most of the profit earned will be drained away to pay the interest of the liabilities (Krishnan, 2012).

3.4 Investment ratioInvestment ratio is used by the shareholders of the company (OBryan, 2010). Investment ratio indicates the enterprise value of the company in the market which lures the investors to invest in the company. 3.4.1 Earnings per share (EPS)EPS = Net income / Number of shares outstanding

Earnings per Share

20102011201220132014

NET INCOME2,069.002,148.001,971.002,153.002,451.00

Preferred dividend 8388861,006.008101,059.00

TOTAL EQUITY8,996.009,039.009,264.0010,342.0011,919.00

EPS0.140.140.100.130.12

Figure 7: EPS of Npower(Source: Created by the author)

This ratio is useful for the investors of the company (OBryan, 2010). The investors make decision related to the investment in the company if these ratios are impressive. The ratio shows the ability of company to create wealth for the shareholders. In case of Npower the EPS has dipped lower than that of the previous years figures which means that the company has not been able to earn the expected returns from the projects (OBryan, 2010). This can be due to the reason that the economic condition of the energy sector has declined in the recent years.

3.4.2 Dividend payout ratioDividend payout ratio = (Equity dividend/ PAT + Preference dividend)*100 Dividend payout ratio

20102011201220132014

TOTAL DIVIDEND PAID8388861,006.008101,059.00

NET INCOME2,069.002,148.001,971.002,153.002,451.00

Dividend payout ratio 0.410.410.510.380.43

Figure 8: Dividend payout ratio of Npower(Source: Created by the author)Dividend payout ratio is the indicative of the company policy to reward the ordinary shareholders of the company (OBryan, 2010). This ratio shows the part of the earnings which the company declared to share with the shareholders of the company (Krishnan, 2012). Npower has shown improvements in the dividend payout ratio. Through the company is earning unsatisfactory profit in-spite of that the company has been able to maintain a good ratio of dividend payout ratio (OBryan, 2010). 4. Summary of AnalysisThe analysis of Npower shows that the company is having huge financial crisis. The demand of the products has declined as a result the operational cost of the company have not been rationalised. The profitability ratios of the company show that the company is bound to increase the prices of the energy products. The financial performance evaluates that the company has shown no improvement in the earnings of the company or the demand of the company. The return from the projects has also not been able to improve the financial health of the company. Npower has earned profit but that is not enough to overcome the interest payable by the company. 5. Weaknesses of ratio analysis Weaknesses of the ratio analysis are that the ratio cannot give the real picture relating to the financial performance of the company (Krishnan, 2012). Some of the strategies carried out by the company may lead to abrupt change in the financial statements and this will be reflected in the ratio analysis. The justification for such change cannot be determined without understanding the strategies of the company (Krishnan, 2012). The investment decision may also show apparent decrease in the cash flows which can change the ratios to give adverse results related to the performance of the company. The inflation factor is not considered in the processes of calculation of the ratio for historical data which also is a weakness as the actual value comparison is not considered. 6. Conclusion and RecommendationThrough the financial analysis conducted on the financial statements of Npower, the performance of the company is evaluated. The ratios indicated the areas of deficiency and inefficiency on the part of the company. The company has declined to earn profit which would help the company to suffice the burden of the liabilities. The dividend payout is the only satisfactory ratio which indicates that the company has been able to distribute the part of the small earnings with the shareholders. RecommendationDecrease in the operational cost: The operational cost should be decreased to increase the profit margins of the company. To achieve this company should decrease the waste of the resources and involve new technologies to increase the efficiency of Npower. Cost of resources: The resources incurs for the large amount of production cost. Npower should encourage the use of cheap raw material like renewable energy to produce electricity using green technologies. Improvement of collection period: The collection period of the company should be decreased so that the company can avail liquid cash to infuse into the operational activities. These strategies can help the company to improve the availability of resources to prevent lag in time of production process. Decrease in the ideal time will result in increase in the efficiency.

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