By: Tracy Porter
Copyright 2007
By law, the annual report must contain a minimum of four basic components, which are the directors’ report, profit and loss account, balance sheet, and an auditors’ report. Financial Reporting Standard (FRS) 1 requires all companies, other than small companies, to include a cash flow statement in their annual report (Holmes et al, 2005).
The Directors’ Report
The directors’ report provides information about the company and its operations, to include its principal activities and likely future developments (University of Leicester, 2006). The principal activity of Napier University Ventures Limited is to provide and assist in providing research consultancy, training, and general education services. In 2004 the company increased its revenue by 7.6% to £3,129,052. The 2005 directors’ report, however, lists a decrease in revenue by 7.5% to £4,062,163 from £4,391,536. There appears to be a distinct variance of revenue in 2004 of £1,024,645, so the writer of this paper felt it necessary to ring Napier University Ventures Limited and point out the discrepancy in the annual reports. After the management accountant satisfied himself that the writer was not a qualified accountant, he said that the figures varied because the company had been restructured. It is important to note, however, that there was no mention of a company restructure in the 2004 or 2005 annual reports, and this writer feels that an event as significant as that surely should have been noted.
The Auditors’ Report
The accounts for 2004 and 2005 were audited by RSM Robson Rhodes LLP. It is interesting to note that they made no mention whatsoever of the fact that the figures in the 2004 annual report for the year 2004 were completely different from the figures in the 2005 annual report for the year 2004. Surely, one would have thought the auditors would have felt the need to explain why the accounts they audited had such a variance of amounts, but this writer could find no mention on it in either the 2004 or the 2005 annual reports.
Because of the significant variance in the accounts in 2004 and 2005, this writer discovered that the previous auditors for Napier University Ventured Limited were Ernst and Young, a highly respected global accounting firm. On 22 August 2003, however, Ernst and Young resigned as auditors, but the reasons for their decision not to work for Napier University Ventures Limited were not stated. On 1 October 2003 Henderson Loggie were appointed as auditors for Napier University Ventures Limited, and they audited the company’s 2002/2003 annual accounts. The following year, however, on 1 April 2004, RSM Robson Rhodes were appointed as auditors, and they audited the company’s financial accounts for 2004 and 2005.
The Profit and Loss Account
The profit and loss account is a document that reflects how the company performed in the period reported on, which is normally the previous year. Napier University Ventures Limited chose to use a format that is more provincial in layout, and this layout made it easy for the writer to note the apparent inconsistencies in the figures for 2004, as those figures appeared on both the 2004 and 2005 annual reports. To avoid confusion, the figures recorded in the 2005 annual report and accounts will be used in this paper.
The top of the profit and loss account is known as the trading account, and it is for this reason that the profit and loss account is sometimes referred to as the trading and profit and loss account (The Financial Training Company, 2005). The profit and loss account begins with the turnover and ends with the gross profit. The turnover reflects how much the company sold after deducting trade discounts and before adding tax (Holmes et al, 2005). Napier University Venture’s Limited’s turnover in 2004 was £4,391,536 and in 2005 it was £4,062,163, which reveals it had a decrease in revenue of 7.5%. The consultancy expenses would be identified as the cost of sales, and were £3,341,332 in 2004 and £3,036,966 in 2005. The gross profit therefore was £1,050,204 in 2004 and £1,025,197 in 2005.
The next section of the profit and loss account is known as the profit and loss account proper, and it begins with the gross profit and then shows the deduction of expenses to arrive at the net profit (The Financial Training Company, 2005). This section lists other expenses and income to include administrative expenses, other operating income, gift aid donation, and interest receivable to come up with a net loss on activities before taxation of £7,685 in 2004 and £40,269 in 2005. What is of concern, however, is the fact that the administrative expenses were not deducted from the gross profit, but were instead added to it, yet there were no notes to indicate why this was so.
The final section of the profit and loss account indicates what has happened to the profit or loss that was left after taxation (Holmes et al, 2005). Napier University Ventures Limited merely added the balance brought forward from the previous year and a transfer from the revaluation reserve to come up with a balance carried forward at a loss of £221,305 in 2004 and £259,952 in 2005.
The Balance Sheet
The balance sheet is a list of all the assets owned and all the liabilities owed by a business at one particular point in time (University of Leicester, 2006).
The first section of the balance sheet lists the fixed assets, which are items the business owns and for which a value can be placed. They are not for resale, but for use by the business (Holmes et al, 2005). Napier University Ventures Limited listed their tangible fixed assets and investments as £69,035 in 2004 and £81,590 in 2005.
The second section of the balance sheet lists current assets, which are items owned by the business with the intention of turning them into cash within one year, or cash, including money in the bank (University of Leicester, 2006). In 2004, Napier University Ventures Limited had debtors amounting to £410,868 and cash at £2,726,923. In 2005 the business had debtors amounting to £845,308 and cash at £1,827,304. This indicates that from one year to the next the business’s debtors had more than doubled, but their cash had decreased by a third.
The third section of the balance sheet is the creditors, which are monies the business owes that fall due within one year. Napier University Limited’s creditors in 2004 were £3,363,271 and in 2005 were £2,950,916.
It is important to note that this company’s current liabilities outweigh their current assets, with net current liabilities being £225,480 in 2004 and £278,304 in 2005. The total assets were less than the current liabilities with a total net liability of £156,445 in 2004 and £196,714 in 2005.
The final part of the balance sheet lists the capital and reserves, which is comprised of the business’s revaluation reserve and the total loss from the profit and loss account. Napier University Ventures Limited had a loss of £156,445 in 2004 and £196,714 in 2005.
Company Performance
The performance of Napier University Ventures Limited can be analysed through the use of several ratios that are used to determine the creditworthiness or investment potential of a company.
The current ratio is a common method of analyzing the working capital, or net capital assets, of a company, and is used to determine a company’s short-term solvency. (The Financial Training Company, 2006). The standard value of the current ratio of any company should be anywhere between 1 and 1.5. If it is too low then the company may have difficulty paying its short-term debts, but if it is too high then this indicates the company is not making the most efficient use of its assets. The current ratio is calculated as:-
Current ratio = Current assets -------------------- Current liabilities
In the case of Napier University Ventures Limited, the current ratio is calculated as:-
2004
Current ratio = £3,137,791 =.93
--------------------
£3,363,271
2005
Current ratio = £2,672,612 = .91
--------------------
£2,950,916
In the past two years the current ratio has been less than 1, and in 2005 the current ratio was less than the current ratio of the previous year. Because the current ratio is less than 1, this reveals that the company may have difficulty meeting its short-term obligations.
The debtors ratio is an important ratio that is used to determine the length of time it takes a company to receive payment for goods and services (The Financial Training Company, 2006). The debtors ratio is calculated as:-
Average collection period = Debtors * 365 -------------------- Sales
In Napier University Ventures Limited’s case, it is calculated as:-
2004
Average collection period = £410,868 * 365 = 34 days -------------------- £4,391,5362005
Average collection period = £845,308 * 365 = 76 days -------------------- £4,062,163
The debtor days, therefore, have increased by over a month from 2004 to 2005, and this trend is worrying indeed.
The creditors ratio is an important ratio when considering whether or not to grant credit to a business because it indicates the general time scale over which a company tends to pays its current credit suppliers (The Financial Training Company, 2006). The creditors ratio is calculated as follows:-
Average payment period = Creditors * 365 -------------------- Cost of sales
In the case of Napier University Ventures Limited, the creditors ratio would be calculated as:-
2004
Average payment period = £3,363,271 * 365 = 367 days -------------------- £3,341,3322005
Average payment period = £2,950,916 * 365 = 355 days -------------------- £3,036,966
The creditors days have improved by 12 days from 2004 to 2005, but considering the fact that any creditor would have to wait 11½ months to receive payment on an invoice, it does not appear that this company is too concerned about its credit standing within the business community.
Capital employed is measured as capital and reserves plus long-term liabilities, or alternatively, fixed assets plus current assets less current liabilities, and it represents the long-term investment of the business. Return on capital employed (ROCE) is regarded as one of the best measures of a company’s profitability, which indicates how successful it is in utilizing its assets. The higher the percentage of ROCE, the more efficient the company is believed to be. (The Financial Training Company, 2006). ROCE is calculated as:-
ROCE = Net profit before interest and tax * 100 -------------------- Capital employed
In the case of Napier University Ventures Limited, ROCE is calculated as:-
2004
ROCE = (£7,685) * 100 = 4.9
--------------------
(£156,445)
2005
ROCE = (£40,269) * 100 = 20.5 -------------------- (£196,714)Although the ROCE was higher in 2005 than it was in 2004, since the company has consistently been operating at a loss, the figures arrived at are not particularly relevant in this instance.
Gearing, or leverage, is defined as the ratio of the total market value of a company’s debt capital to the total market value of its equity capital. The formula for gearing is often called the debt to equity ratio and is used to calculate a company’s financial leverage. If a company has a high debt to equity ratio then it means that it has been aggressive in financing growth through debt (Investopedia, 2006). The gearing ratio is calculated as:-
Gearing ratio = Long-term loan capital * 100 -------------------- Capital employed
In the case of Napier University Ventures Limited, the gearing ratio is calculated as:-
2004
Gearing ratio = £0 * 100 = 0 -------------------- (£156,445)2005
Gearing ratio = £0 * 100 = 0 -------------------- (£196,714)
Napier University Ventures Limited does not have any long-term liabilities falling due after more than one year so, technically speaking, it is not a geared company.
Conclusion
After having carefully considered all of the information contained in the Annual Report and Accounts for 2004 and 2005 for Napier University Ventures Limited, this writer does not feel the company would be a suitable company to invest in.
One major cause of concern is the fact that the figures for 2004 in the 2004 annual report differs from the figures for 2004 in the 2005 annual report. Although the management accountant of that company has explained that the variance is due to a restructuring of the company, this writer is simply not satisfied with that explanation. There is also cause for concern because there is no mention of any company restructure in the 2005 annual report.
Another area of concern is the fact that Napier University Ventures Limited has had three auditors since 2003, and the reasons for this need to be explored further before any investment is made into this company.
The fact that Napier University Ventures Limited has consistently operated at an ever-increasing loss is another factor in the decision not to invest any money into this company. Since the company is losing money, the likelihood of getting a return on the investment will be slim.
Every single one of the ratios used to determine the company’s credit worthiness or investment potential has come back with worrying results. The current ratio, which measures a company’s short-term solvency, was less than 1 in both 2004 and 2005. The debtor days for 2005 was 76 days, as opposed to 34 days in 2004, and this indicates that company is not very aggressive in recovering funds from debtors. The creditor days in both 2004 and 2005 approximately a year, and this reveals the company is not very proactive in paying its debts.
The only positive thing that can be said about Napier University Ventures Limited is the fact that it is not a geared company, which means it is not financed by debt capital. There are so many other detractors, however, it would be impossible for this writer to recommend any kind of potential investment opportunity concerning this company.
References
The Financial Training Company (2005). Unit 5: Maintaining Financial Records and Preparing Accounts: Pocket Notes, FTC Foulks Lynch Ltd: Wokingham, England
The Financial Training Company (2006). Unit 15: Cash Management and Credit Control, Foulks Lynch Publishing: Wokingham, England
Holmes, G. et al (2005). Interpreting Company Reports and Accounts, 9th Edition, FT Prentice Hall: London, England
Investopedia (2006). Debt to Equity Ratio
URL: http://www.investopedia.com/terms/d/debtequityratio.asp
[26 August 2006]
Napier University Ventures Limited (2003). Annual Report and Accounts 2003.
URL:http//www.napier.ac.uk/depts./finance/nuvl03.doc.
[ 30 October 2006]
Napier University Ventures Limited (2004). Annual Report and Accounts 2004.
URL:http//www.napier.ac.uk/depts./finance/documents/nuvl_annual_accounts_2004.doc.
[ 27 October 2006]
Napier University Ventures Limited (2005). Annual Report and Accounts for the Year Ended 2005.
URL: http//www.napier.ac.uk/depts./finance/acc_nulv/2004_05.doc.
[ 27 October 2006]
University of Leicester (2006). Accounting and Financial Statement Analysis, 11th Edition, Learning Resources: Cheltenham, England