The financial position of Kier Group Plc. - Free Essay Example

Introduction. This paper provides a discussion of the financial position, performance and cash flows for Kier Group Plc, a UK based construction company. The company is listed on the London Stock Exchange operates in the Industrials Sector and in the Engineering and Construction Industry. (Reuters, 2008). The discussion is based on the companyà ¢Ã¢â€š ¬Ã¢â€ž ¢s 2007 and 2008 financial statements as well as the notes to the financial statements. Part 1 Direct and Indirect Method of the Cash flow Statement. The direct method of preparing the cash flow statement shows the specific cash inflows and outflows that result in reported cash flow from operating activities. It shows each cash inflow and outflow related to a companyà ¢Ã¢â€š ¬Ã¢â€ž ¢s cash receipts and disbursements, adjusting income statement items to remove the effect of accruals. In other words, the direct method eliminates any impact of accruals and shows only cash receipts and cash payments. (Epstein and Jermacowicz, 2007; CFA, 2008). The indirect method on its part shows how cash flow from operations can be obtained from reported net income as a result of a series of adjustments. The indirect method begins with net income. To reconcile net income to operating cash flow, adjustments are made for noncash items, for non-operating items, and for the net changes in operating accruals. (Epstein and Jermacowicz, 2007; CFA, 2008). The cash flow statement is made up of three components. These include cash flows from operatin g activities, cash flows from investing activities and cash flows from financing activities. It should be noted that the use of the direct or indirect method has an impact only on the manner in which cash flows from operating activities are presented. Cash flows from investing activities and cash flows from financing activities are presented in the same manner under both methods. (Epstein and Jermacowicz, 2007; CFA, 2008). Under IFRS, IAS 7 Cash Flow Statements encourages the use of the direct method but permits the use of either method. (Epstein and Jermacowicz, 2007). Under U.S GAAP FAS 95 Statement of Cash Flows also encourages the use of the direct method although the indirect method can also be used. FAS No 95 requires that if a company uses the direct method, it should also present a footnote disclosure of the indirect method. Reformulation of Cash Flow Statement Kier Group Plc prepared its 2008 cash flow statement using the indirect method. In this section we reformulate the cash flow statement using the direct method. Appendix 2 shows the original cash flow statement of company for the year ended 2008. Kier Group Plc Cash Flow Statement 2008  £Ãƒ ¢Ã¢â€š ¬Ã¢â€ž ¢000 Cash received from Customers2,290.5 Cash paid to suppliers(2,056) Dividends received 0.8 Interest Received 9.6 Income taxes paid (18.4) Cash paid to employees (117.9) Net Cash Flows from operating Activities 48.6 Since the cash flows from investing and financing activities are the same under both methods we have presented only the cash flows from operating activities. The full cash flow statement is shown in appendix 2 and the calculations for the above figures are shown in appendix 1. Profitability, Liquidity and Gearing of Kier Group Plc. To better understand the profitability, liquidity and gearing of Kier Group Plc we need to calculate a number of ratios for the company. Profitability. The profitability ratios we use here include the gross profit margin, operating profit margin, net profit margin and the return on equity. Appendix 3 shows the profitability ratios calculated using the balance sheet and income statement over the period 2004 to 2008 inclusive. It can be observed that the gross profit margin has been fluctuating over the period under study. For example, the ratio declined from 8.93% in 2004 to 8.85% in 2005. It then increased to 8.94% in 2006. It witnessed a further increase to 9.24% in 2007 and then a decline to 9.02% in 2008. The operating profit margin on its part witnessed a constant upward trend over the period 2004 to 2007. It however dropped to a record low in 2008 when the figure dropped below its base period (2004) figure of 2.95% to 2.85%. Net profit margin too witnessed an improvement over the period 2004 to 2007. It however declined from 2.69% in 2007 to 2.02% in 2008. The return on equity (ROE) recorded its highest figure in 2004 and its lowest figure in 2008. The ROE has also been fluctuating over the period 2004 to 2008. Overall, the company has been profitable but its profitability ratios have not witnessed great improvements over the last five years. Liquidity The liquidity ratios show that Kier Group Plc is not in a good liquidity position. The current ratio shows that the company has been in a good position to meet its short-term financial obligations (current liabilities) with short-term (current) assets. This can be seen from appendix 4 which shows the liquidity ratios. The current ratio has been above 1 throughout the period under study. The ratio has been slightly above 1 indicating that an instant request by short-term creditors for the company to repay its short-term financial obligations may render the company in a poor working capital position. The quick ratio is even worse as it indicates that the company can only cover approximately 50 percent of its short-term current assets excluding inventory. The cash ratio too indicates that the company is in a very difficult liquidity position. Gearing The gearing ratios are shown in appendix 5. The gearing ratios indicate that the company is a high gearing or leverage company. Its total debt-to-equity ratio is very high indicating that most of its short and long term operations are financed by debt. Long-term operations are also financed mostly by debt as the long-term debt-to-equity ratio has been above 50%. The ratio was 3.55 in 2005 and 1.42 in 2006. Debt-to-total assets also indicates that the company is financing most of its assets with too much debt. Assets are financed with more than 80% of debt. The gearing position of Kier Group Plc indicates that it may face significant financial risks, that is, the risk that it may be unable to meet both short and long-term financial obligations as the fall due. (Ross et al., 1999; Elliot and Elliot, 2005). This may result in the liquidation of assets to meet financial obligations. Part 2 Financial Statements The statement of financial position (balance sheet) measures the companyà ¢Ã¢â€š ¬Ã¢â€ž ¢s assets and liabilities as at a particular date. Assets occur as a result of past events and represent items from which probable economic benefits will flow to the company. For an item to be recognised as an asset three characteristics must be satisfied as follows (Epstein and Mirza, 2005: 29): The asset must provide probable future economic benefit that enables it to provide future net cash flows; The entity is able to receive the benefit and restrict other entitiesà ¢Ã¢â€š ¬Ã¢â€ž ¢ access to that benefit; and The event that provides the entity with the right to the benefit has occurred. Looking at Kier Group Plcà ¢Ã¢â€š ¬Ã¢â€ž ¢s balance sheet, one can observe that its assets are presented using the non-current and current format wherein non-current assets are presented first, the followed by current assets. This is in compliance with IAS 1 Presentation of Financial Statements. One can also observe that current assets form a significant portion of the companyà ¢Ã¢â€š ¬Ã¢â€ž ¢s total assets. For example, as at 2008, current assets totalled  £1054.6million and noncurrent assets totalled  £176.1million. Current assets therefore represent 85.7% of the total assets of the company. Maintaining more current assets indicates that the company is able to meet short-term financial obligations with little stress. The structure of the companyà ¢Ã¢â€š ¬Ã¢â€ž ¢s assets enable it to be able to capitalise on investment opportunities since it can easily convert a significant base of its assets to cash with little loss of value and with less time. Kier Group meas ures its assets at their historical cost except for derivative financial instruments which are measured at their fair market values. While this presentation provides a true and fair view of the companyà ¢Ã¢â€š ¬Ã¢â€ž ¢s assets, it provides little information about the current replacement cost of the assets. (CFA, 2008; Epstein and Jermacowicz, 2007). Investors may be interested in knowing how much the assets cost to replace at current market prices. Therefore the balance sheet may not serve as a true measure of value. Certain inventories have also been value at net realisable value. IAS 2 Inventories requires that inventories should be valued at lower of cost and net realisable value. (IASB, 2008; Epstein and Mirza, 2005; Epstein and Jermacowicz, 2007). We may therefore reasonably expect that the net realisable value of the certain items of inventory was lower than the cost and therefore in complying with IAS 2, the company valued them at net realisable value. à ¢Ã¢â€š ¬Ã…“Li abilities represent future probable sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions of eventsà ¢Ã¢â€š ¬Ã‚ . (IASB, 2008; Epstein and Mirza, 2005; Epstein and Jermacowicz, 2007). The income measures the financial performance of the company over a period of time. It shows the expenses that have been made to generate revenues. (Penman, 2003). The most important figure from the income statement is net income, which shows how much the companyà ¢Ã¢â€š ¬Ã¢â€ž ¢s operations have contributed to the total returns to shareholders. The income statement may therefore be considered a very important statement than the balance sheet because it provides an indication of how the assets and liabilities in the balance sheet come about and how the increase in shareholder value has occurred. Kier Group Plc had net income of  £47.2million in 2008. Thi s indicates that the company contributed a total of  £47.2million to shareholder value from its operating activities. The income statement and balance sheet are usually based on accrual accounting and provide little information about the movement of cash. As a result the cash flow statement which is to a certain extent similar to the income statement except for the fact that it eliminates accrual items provides a better picture of the sources and uses of cash by the company. The cash flow statement constitutes both operating, investing and financing cash flows. The cash flows from financing indicates that companyà ¢Ã¢â€š ¬Ã¢â€ž ¢s ability to generate cash from its operations. Kier Group Plc generated cash flows from operations of  £48.6million in 2008, used cash in investing activities totalling  £30.8million and used cash in financing activities totalling  £22.3million. (Kier Group Plc Annual Report and Accounts, 2008). this indicates that the compan y generates more cash from operating activities and spends cash in investing and financing activities. Accounting Policies Adopted by Kier Group Plc. Kier Group Plc prepares its consolidated accounts following international accounting standards (IFRS/IAS). The companyà ¢Ã¢â€š ¬Ã¢â€ž ¢s financial statements are prepared following U.K Generally Accepted Accounting Principles (GAAP). In preparing its 2008 financial statements the company disclosed a number of significant accounting policies. It adopted a number of international financial reporting standards and interpretations for the first time. (Kier Group Plc Annual Report and Accounts, 2008). For example the company adopted IFRIC 10 Interim Financial Reporting and Impairmentà ¢Ã¢â€š ¬Ã‚ . The annual report (2008) states that the adoption of IFRIC 10 had no significant impact on the timing and recognition of impairment losses because as the group already accounted for such amounts using principles consistent with IFRIC 10. The company also adopted IFRS 7 Financial Instruments: Discloses and related amendments to IAS 1. Adoption of these standards also had no impact on the com panyà ¢Ã¢â€š ¬Ã¢â€ž ¢s profit/loss. The company measures assets using historical cost. The company consolidates all subsidiaries from the date that control transfers to the Group to the date that control ceases. The purchase method is used to account for the acquisition of subsidiaries. This is in accordance with IFRS 3 Business combinations. Interests in joint ventures are accounted for using the equity method of accounting. This is in accordance with IAS 31 Financial Reporting Interests in Joint Ventures. Only goodwill arising from business combinations is recognised as an asset in the balance sheet. In accordance with IAS 36 Impairment of Assets, the Group does not amortise goodwill. Rather, it tests goodwill annually for impairment and writes down the value of goodwill by the impairment loss if there is significant evidence that the value of goodwill has reduced. (Kier Group Plc Annual Report and Accounts, 2008). Other intangible assets which comprise contract rights are stated at cost less accumulated amortisations and impairment losses. The company uses the straight-line method to amortise intangible assets over their useful life. Revenue from contracts is recognised using the percentage of completion method which is in compliance with IAS 11 Construction Contracts. (Kier Group Plc Annual Report and Accounts, 2008). Inventories including land held for sale are valued at lower of cost and net realisable value in accordance with IAS 2 Inventories. The company charges operating lease rental charges to the income statement on a straight-line basis over the life of each lease. Borrowing costs on qualifying self constructed assets is capitalised in accordance with IAS 23 Borrowing Costs. (Kier Group Plc Annual Report and Accounts, 2008). Amendments to IAS 1. The amendments of IAS 1 include two issues. These include the preparation of a separate statement of comprehensive income or an inclusion of a portion under the income statement for comprehensive income and the disclosure of information on non-controlling interest in the statement of shareholders equity. (ACCA, 2008). These amendments, which are expected to be effective as from 1st January 2009 are not expected to have any impact on the results of companies adopting these changes. Consequently, Kier Group Plc will not be significantly affected by these changes. Rather, these amendments will result in disclosure of more information about comprehensive income and non-controlling interests. Bibliography Elliot, B., Elliot, J., 2005. Financial Accounting and Reporting, 9ed. FT Prentice Hall. Epstein, B. J., Jermakowicz, E. (2007). Interpretation and application of International Financial Reporting Standards, Wiley and Sons Inc. Epstein, B. J., Mirza A. A. (2005). Interpreta tion and application of International Financial Reporting Standards, Wiley and Sons Inc. IASB (2008) International Financial Reporting Standards (IFRS). Available online at: www.iasb.org. MSN Money (2008) Kier Group PLC: Financial Statement Available online at: https://moneycentral.msn.com/investor/invsub/results/statemnt.aspx?Symbol=KIERFlstStatement=CashFlowstmtView=Ann Penman, S. (2003) Financial Statements Analysis and Securities Valuation. 2nd Edition. McGraw-Hill. Ross, S.A., Westerfield, R.W., Jaffe, J. (1999). Corporate Finance. 5th Edition. McGraw-Hill International Edition Finance Series. Reuters (2008). Kier Group PLC (London Stock Exchange). Available online at: https://www.reuters.com/finance/stocks/companyOfficers?symbol=KIE.LWTmodLOC=C4-Officers-5 Appendix Appendix 1. Calculation of Cash Flow Items Cash collected from customers (CC) = Revenue à ¢Ã¢â€š ¬Ã¢â‚¬Å" Change in Accounts Receivables = 2332.4 à ¢Ã¢â€š ¬Ã¢â‚¬Å" (361.3- 319.4) = 2,290.5 Cash paid to suppliers = Cost of Sales + Change in inventories à ¢Ã¢â€š ¬Ã¢â‚¬Å" Change in Accounts payables = 2122.1 + (516.4-460.1) à ¢Ã¢â€š ¬Ã¢â‚¬Å" (914.2-791.8) = 2,090.5 Cash paid to employees is a balancing figure calculated based on the original cash flow from operations and the cash flows calculated based on our calculations. Dividends received, interest received, and income taxes paid remain the same as in the original cash flow statement. Appendix 2 Cash flow Statement Kier Group Plc 2008 2007 2006 2005 2004 Period End Date 06/30/2008 06/30/2007 06/30/2006 06/30/2005 06/30/2004 Period Length 12 Months 12 Months 12 Months 12 Months 12 Months Stmt Source ARS ARS ARS ARS ARS Stmt Source Date 10/16/2008 10/15/2007 10/15/2007 10/11/2006 09/15/2004 Stmt Update Type Updated Updated Reclassified Reclassified Updated Net Income/Starting Line 63.4 77.6 59.1 54.5 39.4 Depreciation/Depletion 16.4 15.0 13.5 12.3 8.1 Amortization 2.1 2.0 1.9 1.9 2.6 Non-Cash Items 7.5 -13.4 -34.8 -18.4 -1.0 Unusual Items 21.3 -0.7 -1.1 -7.2 -1.3 Equity in Net Earnings (Loss) -0.9 -3.0 -3.2 -0.9 0.3 Other Non-Cash Items -12.9 -9.7 -30.5 -10.3 0.0 Changes in Working Capital -40.8 24.1 52.2 27.0 -63.4 Accounts Receivable -48.7 -54.4 -26.7 -16.7 -26.2 Inventories -84.3 -20.1 -49.3 19.7 -52.1 Accounts Payable 97.8 104.9 131.8 31.3 27.9 Other Liabilities 2.4 3.2 1.1 1.8 -2.1 Other Operating Cash Flow -8.0 -9.5 -4.7 -9.1 -10.9 Cash from Operating Activities 48.6 105.3 91.9 77.3 -14.3 Capital Expenditures -27.5 -19.7 -23.2 -19.9 -21.5 Purchase of Fixed Assets -27.5 -19.7 -23.2 -19.9 -21.5 Other Investing Cash Flow Items, Total -3.3 -34.2 -4.7 2.3 6.3 Acquisition of Business -16.5 -28.0 -10.1 -16.5 0.0 Sale of Fixed Assets 2.5 1.5 4.6 6.0 2.8 Sale/Maturity of Investment 0.0 0.0 1.4 5.8 0.0 Investment, Net 0.0 0.0 0.0 0.0 20.7 Purchase of Investments -2.9 -7.7 -0.6 -1.5 -17.2 Other Investing Cash Flow 13.6 0.0 0.0 8.5 0.0 Cash from Investing Activities -30.8 -53.9 -27.9 -17.6 -15.2 Financing Cash Flow Items -3.2 -2.6 -2.7 -2.6 0.0 Other Financing Cash Flow -3.2 -2.6 -2.7 -2.6 0.0 Total Cash Dividends Paid -13.6 -5.9 -6.2 -6.4 -5.5 Issuance (Retirement) of Stock, Net -5.5 -5.6 -2.0 -0.2 1.3 Issuance (Retirement) of Debt, Net 0.0 0.0 0.0 0.0 0.0 Cash from Financing Activities -22.3 -14.1 -10.9 -9.2 -4.2 Foreign Exchange Effects 0.0 0.0 0.0 0.0 0.0 Net Change in Cash -4.5 37.3 53.1 50.5 -33.7 Appendix 3: Profitability Ratios Kier Group Plc Ratio Formula 2008 2007 2006 2005 2004 Gross Profit Margin (Gross profit/Revenue)x 100% 9.02% 9.24% 8.94% 8.85% 8.93% Operating Profit Margin (Operating income/Revenue) x 100% 2.58% 3.77% 3.32% 3.12% 2.95% Net Profit Margin (Net income/Revenue) x 100% 2.02% 2.69% 2.41% 2.33% 1.98% Return on Equity (Net income/Average Equity) x 100% 25.91% 38.18% 53.19% 43.26% 24.57% Appendix 4: Liquidity Ratios, Kier Group Plc Ratio Formula 2008 2007 2006 2005 2004 Current ratio Current assets/current liabilities 1.14 1.20 1.15 1.12 1.13 Quick ratio (current assets-inventories)/current liabilities 0.58 0.62 0.59 0.56 0.51 Cash Ratio (cash + short term investments)/current liabilities 0.19 0.22 0.21 0.16 0.08 Appendix 5: Gearing Ratios, Kier Group Plc Ratio Total Debt-to-equity Ratio 5.75 5.16 7.63 14.58 5.19 Long-term Debt-to-equity Ratio 0.66 0.78 1.42 3.55 0.63 Debt-to-total Assets ratio 0.85 0.84 0.88 0.94 0.84