Financial Accounting - Investment Opportunities

Chapter 1: Executive Summary
The cornerstone for investing in fact is through carrying out a financial analysis of the potential investment companies. This paper will be making financial analysis of EasyJet and Marks and Spencer using a circumspective comparative analysis on the financial statements of these two. Then based on the findings, a way forward will be given in form of practicable and realistic recommendation.
Having outlined the above, the financial analysis of EasyJet and Marks and Spencer will be done basing the argumentations on: profitability and liquidity, their capital Structure and gearing ratios, their relationship with investors as well as their trend of price per share and finally, their reporting of social responsibility methods. An intrinsic and expansive evaluation of these companies will be concurrently done to compare the similarities and difference accounting methods deployed as we later progress into their analysis to ascertain their worth and investment value. Finally, recommendations will be made to ascertain which investment will be most financially rewarding and practical. Chapter 2: Empirical Analysis of Retail & Airline Industries
Liquidity and profitability
For investor seeking financial vitality of a company, the liquidity and profitability indicators presage the most information of the financial capability of a potential investment company. According to Gitman and McDanie (2009), ratios are used to evaluate a company’s liquidity and profitability, also, important indicators that are used in identification of danger signals. Liquidity refers to the ability of a company quick access to cash to keep the operations going and meet its commitment on short-term basis. High liquidity instigated to an entity or an investor in a low-risk situation, but it also tends to diminish profitability.
The current ratio for the Airline industry in the current financial period was reported at 2:1. This is in accordance with the industrial regulation for the current ratio requirement and therefore its ease in the payment of its debts using the available cash. Its quick ratio was reported at 0.8:1 which was below the industrial requirement of 1:1. The reason for such lag was the increase in the accounts receivables for the Airline industry as most of its sales was based on credit. There is a close relation between the current liabilities and current assets of a firm. The current obligations should be paid with funds generated by proficient use of assets or internal cash. Meeting current obligations by acquiring long-term loans complicates further.
On the case of its profitability ratio implications, the Airline Industry’s profit margin had been increasing tremendously and this has been boosted by the increased market share in the economy. In the initial stages, the industrial profit margin of 35.7% was achieved and this showed the success it is experiencing. The return on capital for the firm was valued at 10.47% which denotes the amount in which the management earns from the shareholders equity. This was beyond the anticipated return on equity which was stipulated at 9.2%. This is according to the information on Airlines’ Financial Journal.
Masulis (1988), analyses that the retail Industry current ratio and quick ratio 2:1 and 1:1 respectively. This provides a relative stable base for the Retail industry and therefore meeting of its short term obligations is at ease. Current ratio is referring to the working capital of a firm; therefore, the higher it is the better the coverage of existing assets. If it is too high, this implies mishandling of stock, which may arise due to existence of unsold stock or unrealized debtors. Such a scenario affects a company’s profitability, volume of profitability and the working capital (International Monetary Fund, 2006).
In the case of profitability ratio, retail industry enjoys a profit margin of 22.5% unlike the industry requirement of 20.2%. This is attributed to the high market share the industry possesses. The Industry Return on equity is given at 4%, this is due to the overreliance to the debts for financing its operations. The retail industry is a significant contributor to the overall economic activity in the UK, however, the industry is facing challenging outlook as they are dealing with liquidity matters, condensed consumer spending and poor credit market conditions.
Capital Structure and Gearing
According to Mohanty (2005), Capital structure is illustrates how a company finances its assets through debt, equity hybrid securities or a combination of all. Hence, the company’s capital structure is the structure of its liabilities. Also, gearing ratio is used to determine the percentage or ratio of a firm’s capital outlay financed from outside sources. Financing incorporate sourcing, allotment, management, and profiling and control of inherent risks and monetary assets. The challenge in the case of financial manager is the determination of ideal funding sources mix for a given firm and its consequences (Garvey et al., 1999).
Pertaining to Bloomberg.com information on the Company’s gearing ratio, retail and airline industry gearing ratio is at 16.76% and 12.62% respectively as compared to the industry ratio of 15.2%. The higher gearing ratio in Retail Industry is due to the increased emphasis on the use of more debt than equity financing because of its easy accessibility. This has been due to the increased debts in the Company’s operations and therefore debt financing is of core importance unlike the use of equity financing.
Quoted from a distinguished review article, Garvey (1999) came up with three distinct and important theories on the firm’s capital structure that tries to articulate the strategies a company can use. The main intrinsic theory that has a major implication on the entity’s capital structure is the trade-off theory. The theory provides that corporations should inquire for debts levels which will poise with the advantages of tax incase of additional debt with the cost of potential financial anguish. Tax advantages occur since the interests’ payments these firms make when the companies utilize debt capital which is set to be against firm’s tax liabilities (McCaffrey at al., 1997). This factor is well endowed in retailing businesses. As Ian Coull, the former UK food retailers’ Director, Sainsbury’s (Masulis, 1988) however, also states that tax advantages are worn out by the costs which are articulated to the financial distress (Hunsaker et al., 1995).
In the analysis of capital structure in UK retailing, Drummond (2002) observed that operators are able to retain financial assistance in order to safeguard it from the imperative effects of adverse business operations conditions. For instance, very low gearing ratio and moderate performances leads to low return on equity. Saflas (2003) notes that a company should not have a very high gearing which will minimize the risk the company faces when it indulges in a very high interest payment. Similarly, the figure is not too high which could sound as an assurance that the company is not missing out on investment opportunities and new markets
Investor Relations & Share Price
According to Saftlas (2003), news or information plays a major role in stock pricing. The impact of positive news in the economy is that the stock prices are affected positively unlike in the case where negative news brings about adverse effects to the stock price. In a more volatile market, financial decision makers take time and analyses the trend in the economy. As a matter of fact, the investor relations and share price trends, according to Heath, (2010) are related factors, in that the performance of listed companies is dependent on the investor relations the company has formed. Therefore, if the relations are good, the same will be for the share prices, hence the trends and vice versa (Bragg, 2010).
According to the financial report published, the share price of the Aviation and retail industry is highly affected by the global financial crisis that affected the economy in 2008. For instance, in the year 2008 to 2009 the economy experienced a bear crisis and therefore the company’s price per share deteriorated over that time. This was also articulated by the market crashes which forced individuals to dispose their share investments in exchange for cash. Later on, the price per share has been increasing steadily over the past decades, this was after the global effect experienced was solved and returned to norm.
Investor Relation is a calculated management task which incorporates communication, finance, securities law compliance and marketing to enable an effect communication that is two way between a company and business constituent. The IR officers provide information to the investors in order for them to decide if they can invest in the company. Some of the investment strategies may not be available to the general public and in so doing provides them with broad field of analysis. The IR provides the general trust to the investors and the public at large and therefore the good relationship between the firm and the auditors enhances transparency and in the long run increases the firm’s liquidity, share price and fair value of the company.
Corporate Social Responsibility
EC Newsdesk (2002) noted the intensifying globalization has encouraged companies to take responsibility for the society beyond the legal and profit generating force with a more efficient communication on environmental and social issues. Therefore, for companies to succeed in the new market environment, they have to be socially responsible and be seen as such (Perrini et al, 2006).
According to Ross (2002), the airline industry participates in CSR worldwide. This enables the company to market its services offered to the society and in so doing attracts major investors and also clients. CSR also encourages the Industry to build a good rapport with the citizens of the UK and this facilitates large market share in the economy. Moreover the government regulation provides that a Company registered in its geographical region should undertake Corporate Social responsibility and its statements. As the economy is involving an increasing competition, the company’s involvement will be entirely on Corporate Social responsibility as these will make consumers to be able to know the Company better hence maximizing their profits in the long run.
Contrary to this, the retail industry also participates in corporate social responsibility in order to realize the strategic goals. In essence, this is the requirement by the government for the company to report the information on the financial statement. The CSR enhances the retail industry to be highly competitive in the economy and as such increase its revenue outlay in the long run.
Chapter 3 – Case Studies
3.1 Easy Jet PLC
3.1.0 Background
EasyJet (EZJ) is a British airline with its headquarters in London. It transports more passengers than any other airliner within the UK. Although founded in 1995, with only two rented airbus aircrafts, the company has been able to restructure its operations and expand its services to operations of over 180 aircrafts as of 2010. In essence, EasyJet operates cheap flights with use of large aircrafts. Nonetheless, its relative success has made it listed in the London Stock Exchange as well as being a part of the FTSE 250 index (Jones, 2005).
3.1.1 Liquidity and Profitability
According to Rothwell (2011), despite EasyJet being in a very competitive environment in the airline industry, it still maintains the best position and has minimal cost and with high profits in the airline industry. He provides that the market share keeps on increasing, this is instigated by the fact that its competitors are struggling with their investment strategy. This information was based on the financial report of Septembers 2010. The price per share for the company has increased by 34% since listed on the IPO articulated to the good company image it portrays.
It is evident, according to Bloomberg.com; Easy jet is in a better financial position to be able to meet the short-term liabilities as they fall due unlike in the case of its competitors. Its gearing ratio is at 16.46% as compared to the industrial and sector average of 20.2%. This implies that the firm can always be able to meet its short-term obligations with the available current assets. High liquidity ratio will denote that the shareholders would fear that the Company’s available resources are not put into proper use in order to facilitate the its growth, and also low liquidity ratio can easily drive away creditors as they fear that their obligation cannot be met with ease. Therefore, for preference in the economy, the liquidity ratio should not have high magnitude from the industrial one. Profitability in general is slightly lower than the industry and has compromised growth during the last years.
The net profit margin is remarkably lower at 4.57 as compared to the sector at 5.93. As Hunsaker (1999), puts it that the Airline industry has recorded notably poor performance, which is attributable to the recent upsurge of the overhead costs of aviation at large. This has been attributed to the increased oil prices in UK and also in the world at larger.
3.1.2 Capital Structure and Gearing
Easy jet Company enjoyed a gearing ratio of 18.46% which is consistent with the industry gearing ratio of 22.4%. This implies that Easy Jet involves itself in conservatism and therefore does not indulge in debt financing but focuses more on financing its obligations using the available assets. The company’s liquidity budget is at 4 million dollars with an adjusted debt financing at 10 million dollars. The debt financing for the company is stipulated at 50% of the net gearing and therefore showing its reliability in the use of asset financing method. As such it enjoys the indulgence in new markets and also where need be investments in the economy (appendix 1).
The graph analyzes the concept of market index over the last six months. The market index for Easy Jet Ltd increased gradually until the end of the year. This was facilitated by the influence of new information to the market which later on deteriorated paving way for downward slope of the market index.



3.1.3 Investor relation and Share Price trend
The case of Easy Jet, although a low budget airline when first incepted to the UK competitive airline market, the company managed to increase its share price and hence its profitability, because the consistent message resonated clearly and well with its clients (Groucutt et al 2004). On September 2010’s financial statement, Easy Jet’s chairman, Sir Michael Rake, asserts that ever since their IPO; Easy Jet’s share price has expectedly increased by 34%—something which he describes as “ superior performance to its European airline peers” (Pilling, 2010).This has been achieved despite the initial capital outlay after inception into the UK competitive market.
The investor relation in the case of Easy Jet has seen some improvement as in comparison to the rival companies in the field. This, in conjunction with the marketing strategies and policies deployed, has ensured that their investments progress tremendously. The company’s plan to form a partnership with strong suppliers will ensure that success on the supplier’s side will be achieved in the future. Easy Jet has also experienced a stable price per share over the last decades since the inception of IPO in comparison to that of its competitors in the industry.
The graph below gives a flow of price trend for easy jet PLC. The graph shows that the prices had initially risen steadily but towards 2007, it sharply deteriorates only to pick up later at a slower rate. The dramatically change poised by the graph can be inclined to the global financial predicament in which the economy faced as from the start of 2008. The Company did not fully recover from that impact and therefore the essence of gradual increase in the slope of the graph.


Corporate Social Responsibility
The goal of the Company is to ensure that current business operation is efficient in both on land and air, and to endeavor to find ways to reduce its ecological effect in future. For instance, Easy Jet PLC has focused its undertakings in ensuring that the environment is maintained without...