Any firm in the present market is required to maintain a balance between liquidity and profitability and at the same time conducting its day to day operations. Liquidity is a condition to ensure that firms are able to meet its short term obligations effectively and its smooth flow can be guaranteed from a profitable venture. The importance of cash or liquid assets as an indicator of financial health should not be surprising while keeping in view its role in the business. Business must be run both efficiently as well as profitably. In this process, an asset liability may occur which increases the firm’s profitability in the short run but at a risk of it losing its solvency. On the other hand, focusing on liquidity will be at the expense of profitability.

A large number of business failures have been attributed to inability of financial managers to plan and control properly the current assets and current liabilities of their respective firms (Smith, 1973).

In this assignment I will focus on the finance and ratios of the UK based firm D S smith Plc.

DS Smith plc is an international packaging supplier and office products wholesaler. The company has operations in approximately 18 countries. Segments The company has two distinct activities, Packaging and Office Products Wholesaling. In total, annually it sources 1.7 million tonnes of waste paper by means of collections through its 16 U.K. depots and open-market purchases from supermarkets and third-party waste merchants. It has operations in the U.K. Ireland, France and the Benelux region, with development businesses in Germany, Spain, and Italy. Its network of distribution centres comprises: the U.K. (9), Ireland (1), France (6), Benelux (1), Germany (2), Spain (2), and Italy (1) (Bloomberg).

Financial ratios quantify many aspects of a business and are an integral part of financial statement analysis. Financial ratios are categorized according to the financial aspect of the business which the ratio measures. Financial ratios allow for comparisons

between companies

between industries

between different time periods for one company

between a single company and its industry average

Ratios generally hold no meaning unless they’re benchmarked against something else, like past performance or another company. Thus, the ratios of firms in different industries, which face different risks, capital requirements, and competition, are usually hard to compare.

Financial ratios are used to analyze companies. As financial ratios are percentages, companies of different size can be accurately assessed and compared.

A company’s long-term solvency depends in part on its ability to pay its long-term bills. Long-term solvency ratios are also called financial leverage ratios and leverage ratios.

Long-term solvency ratios measure how a company can meet its long-term financial leverage obligations. Long-term solvency ratios include the total debt ratio, the debt-equity ratio, the equity multiplier, the times interest earned ratio, and the cash coverage ratio.

Financial ratios are useful indicators of a firm’s performance and financial situation. Most ratios can be calculated from information provided by the financial statements. Financial ratios can be used to analyze trends and to compare the firm’s financials to those of other firms. In some cases, ratio analysis can predict future bankruptcy.

Financial ratios can be classified according to the information they provide. The following types of ratios frequently are used:

Liquidity ratios

Asset turnover ratios

Financial leverage ratios

Profitability ratios

Dividend policy ratios

Liquidity ratios provide information about a firm’s ability to meet its short-term financial obligations. They are of particular interest to those extending short-term credit to the firm. Two frequently-used liquidity ratios are the current ratio (or working capital ratio) and the quick ratio. the cash ratio is the most conservative liquidity ratio. It excludes all current assets except the most liquid: cash and cash equivalents.

Asset turnover ratios indicate of how efficiently the firm utilizes its assets. They sometimes are referred to as efficiency ratios, asset utilization ratios, or asset management ratios. Two commonly used asset turnover ratios are receivables turnover and inventory turnover.

Receivables turnover is an indication of how quickly the firm collects its accounts.

The debt ratio is defined as total debt divided by total assets The debt-to-equity ratio is total debt divided by total equity Debt ratios depend on the classification of long-term leases and on the classification of some items as long-term debt or equity.

The times interest earned ratio indicates how well the firm’s earnings can cover the interest payments on its debt.

Profitability ratios offer several different measures of the success of the firm at generating profits. The gross profit margin is a measure of the gross profit earned on sales. The gross profit margin considers the firm’s cost of goods sold, but does not include other costs.

The above is the explanation of the many financial ratios calculated in the making of this assignment. Below I will list out the results from the financial analysis and ratios meanings.

EBITDA(Earnings before interest, tax depreciation and amortization) during the fiscal year of 2008/09 was 163.9 while in 2009/10, it was 166.0. This is a change of 2.1 and which corresponds to a ratio of 0.98.

At over 55.1%, the increase in ROI between 2009 and 2010 is remarkable and shows that DS smith increased its sales while increasing the utilization of its assets used to generate these sales. And to achieve these results sales, operating income and average total assets had to all increase proportionately. This would be a good trend in the short term, but if it continues, it could be a sign that D S smith is not keeping a big investment in assets, because not that as the denominator in this ROI calculation, a low asset figure can be used to help drive up the overall result. Meaning that if this trend continues, it may indicate increased operations rather than improvement in efficiency.

Activity of D S smith

The activity ratios measure the company’s management of asset levels and sales (Marshall, 2002). Between 2009 and 2010, D S smith showed positive performance with its average day sales by over 25%. Together, these ratios show us the efficiency of collections relative to the average time span of receivables. The inventory fell by 5.9% and the fixed asset turnover increased by 18.8%. These turnover figures overall would suggest that assets are being used efficiently to produce sales.

Liquidity of D S smith

The liquidity of a company is the ability to meet its loan obligations as it relates to its current assets and its current liabilities (Marshall, 2002). The data in the Appendix shows that i have analyzed the three important liquidity ratios: 1) Current Ration, 2) Acid Test, and 3) Working Capital. Of these three, the best indicators of liquidity, when trying to show trends, are the Acid test and the Current Ratio. A current ratio of 2 and an acid test of 1.0 are considered “adequate liquidity” (Marshall, 2002). D S smith’s Acid Test numbers for 2009 and 2010 were .84 and .79, and its Current Ratio numbers for 2009 and 2010 were 1.45 and 1.54. Each sets of these ratio figures indicate that D S smith could possibility have some difficulties in meeting its financial obligations, so these numbers will be important to watch closely in the future.

Agency problem:

Jensen and Meckling (1976) define the agency relationship as a contract under which one party (the principal) engages another party (the agent) to perform some service on their behalf. As part of this, the principal will delegate some decision-making authority to the agent. Applied to finance theory, the agency problem refers to the conflict of interest arising between creditors, shareholders and management because of differing goals.

Agency theory is the branch of financial economics that looks at conflicts of interest between people with different interests in the same assets. This most importantly means the conflicts between:

shareholders and managers of companies

Shareholders and bond holders.

One particularly important agency issue is the conflict between the interests of shareholders and debt holders. In particular, following a more riskier but higher return strategy benefits the shareholders to the detriment of the debt holders.

In order to avoid the conflicts of interest posed by the agency problem, The Company D S smith has a procedure of providing the persons involved in making strategic decisions with stock options in which case, it will be in the best interest of the people concerned with the proper running of the company.

This step has many favorable outcomes, the least of which being that the people in the senior management will have a vested interest in seeing the share price of the company increase. This will allow for ensuring that the strategic decisions taken by superiors will not have selfish interests but rather the interest of the organization as a whole. These steps ensure that even at the managing level employees will take interest in seeing the company prosper.

Another step that is taken by the D S smith co. is to include the stakeholders in the company talks and steps to be taken in the Board of directors meeting also keep in mind the views of the stakeholders. This ensures that any decision taken will be made with the consent of the parties involved and affected by the decisions. This step also ensures that the decisions made will be made keeping the best interests of the company at heart.

One important tool in the mechanism of avoidance of the agency problem is to ensure that the company is audited by an external agent with no interest in the company. This ensures impartiality and lends a relief to the stakeholders that their stocks are tended to by someone not in the remotely manner influenced by the state. This is something that must be done in every stock listed company. As far as DS smith I concerned, the auditing is done by a professional that is truly impartial in the dealings of the company and this person is elected by the stakeholders and not by the board of directors. This ensures that the person is not motivated on the part of the board of directors about this matter. Many examples of agency problems leading to major company debacles are present and with a little research, we will find that these are a common occurrence. A recent example being the ENRON case where the mechanisms for avoiding the agency problem were circumvented and this led to a major fraud in the company listing.

Reflective Journal:

This assignment dealt with the financial analysis of a company’s health and we were instructed to complete a critical analysis of the companies performance with respect to the performance of the past year. All in all these entailed carrying out the fiscal ratios that had a meaning attached to each ratio. And this became a tool that makes me more capable of analytic thinking of what the figures on a companies balance sheet really mean. This enables me to have a tacit understanding as well as better place me in a position to explain the emerging financial trends of the company and reveal the hidden data. Information is correlated with the many ratios that we find out using the relations between them and put them to use in order for us to make up our mind and summarise the overall company performance in the market.

Also from this assignment, I have learnt the dynamics of the various concepts that comprise business analysis. Detrimental factors such as agency problem is studied in detail and the mechanisms and steps that the companies have in store for them to avoid these problems are examined and understood.