Financial Analysis of the G4S Company The WritePass Journal

Financial Analysis of the G4S Company Executive summary: Financial Analysis of the G4S Company Executive summary:Financial adaptability:PROFITABILITY RATIOS:Return on capital employed (ROCE)2007Gross profit margin:Net profit margin:Short term liquidity ratios:Current ratio:Acid test ratio:Operating efficiency ratios:Inventory turnover period:Trade receivables collection period: Trade payables payment period:Capital structure ratios:Gearing ratio:Interest Cover Ratio:Solvency Ratio:Fair value accounting:Equity approach:Income Approach:Full fair values:Argument for fair value Accounting:Fair Value Accounting Advantages:  Comparability of financial information:  Argument against fait value accounting:Fair Value Accounting Disadvantages:ReferencesRelated Executive summary: The G4S Company is the largest security services provider in the United Kingdom  Ã‚  Ã‚   that specialises in all aspects of security, including the deployment of security officers, monitoring, crisis management, planning and training, and security advice. It is part of Group 4 Securicor PLC and was established from the merger between Securicor and Group 4 Flack’s security businesses. The company provides specialist security services to more than 5,000 customers across a range of sectors, including commercial services, events, facilities management, industrial, financial and professional services, public sector, retail and transport. It also manages the security for 41 companies in the FTSE 100 and provides real solutions to customers, including Woolwich Building Society, IBM, Virgin Atlantic, and Bridgnorth Aluminium.The company is a member of British Security Industry Association (BSIA), Security Industry Authority, National Security Inspectorate (NSI), SITO, IATA, AOA, Fi re Protection Association (FPA), Confederation of British Industry (CBI), British Quality Foundation, and European Aviation Security Association.   G4S plc collectively with its subsidiaries and joint venture companies primarily supplies range of business services that encompass secure solution and cash solutions to both government agencies and commercial businesses.   Though first joined the stock market in 2004, G4S plc currently floats in the London Stock Exchange as one of the top 100 companies listed in the London Stock Exchange in 2007 (G4S Company) Financial adaptability: G4S has strong operating activities; this is due to significantly increase in cash inflow generated from operating activities, from  £373m in 2008 to  £ 509m in 2009. The firm has also invested heavily on financing investment; consequently this has had a negative effect on the cash and cash equivalent, this may have contributed to the fall in the cash equivalent from  £56m to  £38m.   The firms have decided to spend less on investing activities; consequently the net cash inflow from investing activities has fallen down significantly from  £504m in 2007 to  £184m in 2009. Therefore since the firm can generate revenue from operating activities, this will enable the firm to adapt to any new business venture. PROFITABILITY RATIOS: Return on capital employed (ROCE) 2007 2008 2009 8.83 % 6.81 % 8.22% G4S ROCE is with the median range compare to other firm in the same sector. The ROCE slightly fell in 2008 from 8.83% to 6.81%. This was due to increase in capital employed from  £2148.3 million in 2007 to  £3402.6 million in 2008. Also contributing to the fall was the increase in profit before interest and tax from  £217m to  £264m However G4S ROCE slightly increased in 2009 to 8.22%. This was due to the fall of fixed asset from  £3402.6 million in 2008 to  £3316.5 million in 2009. This may contributed to the increase in ROCE. Furthermore PBIT has increased from  £264m to  £303m. Gross profit margin: 2007 2008 2009 22.38% 92.99 % 21.91% G4S gross profit margin plummeted in 2008 from 22.38% to 92.99%. This was due mainly to the increase of gross profit from  £ 1,005 m to  £ 5,527m, compare to the slightly increase in revenue from  £ 4,490.4m to 5,942.9m. This indicates the firm is relatively depended on cost of sales to generate profits. However G4S gross profit margin fell significantly in 2009 from 92.99% to 21.91%. This was due to the fall of gross profit from  £ 5,527m in 2008 to  £ 1,536m in 2009. Even though revenue increased from  £ 5,943m to 7,009m in 2009, this did not affect the fall in the gross profit margin. Since the firm is operating exceptionally in relation to generating profit through gross profit activities. This indicates the firm is profitable since it can generate profit from its own activities. Net profit margin: 2007 2008 2009 4.83 % 4.45 % 4.32 % G4S net profit margin has fallen in the last three years.G4S net profit margin slightly reduced in 2008 from 4.83% to 4.45% this was due to the increase in profit before tax the company had to pay compare to previous year. G4S paid interest in 2008 of  £ 264m compare to 2007 of  £ 217m. Also the revenue significantly increases in 2008 from  £ 4,490m to  £ 5,943m. The ratio fell again in 2009, once again contributing to the fall in net profit margin was due to increase in tax and interest G4S had to pay from  £264m to  £303m. The fall in the ratio may be due to the fall in cost of sales, since, despite the significant increase in revenue from  £5,943m to  £ 7,009m, this did not affect the fall in the ratio. This indicates the firm is profitable since the revenue has increased in the last 3 years. Short term liquidity ratios: Current ratio: 2007 2008 2009 1.25 1.28 1.25 G4S current ratios were lower in 2007 compare to 2008, this indicates the firm have financial problem in the short term. However G4S current ratio has slightly increased in 2008 from 1.25 to 1.28, this was due to increase in current assets from  £ 1,528m to  £ 2,174m, and current liabilities increased from  £ 1,220m to  £ 1,694m. Since current asset are higher than current liabilities, this implies the firm has no financial difficulties in the short time. However the ratio fell in 2009 from 1.28% to 1.24% this was due to decrease in current assets from  £ 2,174 m to  £ 1,847m; this was mainly due to fall in bank and deposits from  £562m to  £308m.   Also the current liabilities fell down from  £ 1,694m to 1,482m. This was mainly due to reduce of bank overdraft from  £283m to  £183m. Acid test ratio: 2007 2008 2009 1.19 1.23 1.21 G4S acid test slightly increased in 2008 from 1.19 to 1.23, this was due to the increase of inventory from  £57.1m to  £85.5m. The actuality that the differences between the current and acid test ratios is not too high this indicates that G4S stocks are not that high. The stocks are worth around  £85.5m; but since current assets are  £ 1527.5, that’s not a huge level of stock holdings. Also the increase in current asses and current liabilities contributed to the increase in current ratio. However the ratio fell down in 2009 from 1.23 to 1.21, this was due to descend of inventory the firm holds from  £85.5m to  £ 77.8 m. also contributing to the fall was the reduction of current assets from  £ 2,174 m to  £ 1,847m.   Additional this indicates that G4S has good financial situation that it had before. Operating efficiency ratios: Inventory turnover period: 2007 2008 2009 78.64 69.51 90.08 G4S inventory turnover ratio has fallen in 2008 by 9 days. This indicates efficient management of inventory because the inventories are frequently sold. Moreover, revenue significantly increases in 2008 from  £ 4,490m to  £ 5,943m. Furthermore this indicates the firm requires high level on inventory in order to operate the business. Since the inventory has increased from  £57m to  £86m. The ratio increased significantly in 2009 by 20 days.   This was due to the high increase of revenue from  £ 5,943 m to  £ 7,009m, also the inventory fell down from  £86m to  £78m, and this was due to reduction on holding stock from  £23m to  £16m. Trade receivables collection period: 2007 2008 2009 62 72 59 In 2009, the trade receivable increased from 62 days to 75 days. This was mainly due to significant increase in trade debtors from  £ 763 m to  £1,171m. This may indicate the firm policy is to allow more credit in order to generate more sales. This contributed in fall in cost of sales from  £ 3,485m to  £416 m. However G4S trade receivable collection fell down in the year 2009 from 72 days to 59 days this shows the firm policy of efficient management to reduce debt. The increase could be due to slightly increase in trade debtor collection from  £ 1,171 m to  £1,127 m Trade payables payment period: G4S trade payable payment period fallen down in 2008 from 11 days to 12 days, this was due to the increase in payment period form  £137.m to  £197m this resulted in the increase of 1 day payment period. This indicates the firm policy is to collect the creditors too quickly. Since the firm revenue increased in 2008 from  £ 4,490m to  £ 5,943m, the firm should allow more time for collection from creditors.Trade payables payment period: However in 2009 the firm reduced the trade payables payment period from 12 to 10 days, this resulted in reducing the payment to creditors from  £197m to  £192 m. is clear that G4S has efficient control of its creditors. Although G4S may miss out on extra cash discounts from the creditors for paying late. Although the revenue increased from  £ 5,943m to 7,009m, this did not affect the ratio to fall down. Capital structure ratios: Gearing ratio: 2007 2008 2009 144.98% 193.48% 176.43% G4S gearing ratio has a higher gearing ratio compare to other industry. The gearing ratio dramatically increases in 2008 from 133.98% to 193.48%. This was due to significant increase in long term loan from  £ 1,369m to  £ 2.455m, which affected the increase in creditors in order to finance the business. However the ratio fell down in 2009 to 176.43%, this was due to reduction in long term borrowing, also contributed in fall of gearing was due to reduction in   current liabilities from  £ 1,694m to  £ 1,482m. This indicate the firm is too dependent on borrowing in order to finance the business, since the firm has high gearing ratio, therefore the firm could enter liquidation if they don’t solve its debts. Interest Cover Ratio: 2007 2008 2009 2.48 2.40 2.54 In 2008 the interest cover was slightly reduced from 2.48 to 2.40, this was due to a dramatic increase in interest charge from  £ 217 m to  £264 m. However the interest cover ratio reduced slightly in 2009 from 2.40 to 2.54, this was due to the increase in PBIT from  £264m to  £303 m, which the business incurred. However the interest cover slightly increased from 2.40 to 2.54, this was due to profit before interest slightly increased from  £ 454m to  £499m. G4S has a low interest cover which may not be enough to pay off its interest in difficult economical times and could consequence face bankruptcy. Solvency Ratio: 2007 2008 2009 29.57% 25.59% 27.24% G4S solvency ratio reduced in 2008 from 29.75% to 25.59%. This was due to increase in total asset from 3,676m to 5,577m. Also the increase of share holders’ funds from  £1,087m to  £1,427m contributed to fall in the ratio. This indicates the firm is too dependent on borrowing in order to finance their business. However the ratio fell down in 2009 to 27.24%, this was due to slightly fall in total assets from  £ 5,577m to  £ 5,164m; this was due to reduction of current assets from  £2,174m to  £1,847m and also the fall in shareholders’ funds, from  £1,427m to  £1,407m, may have   contributed to increase in solvency ratio. This indicates the firm is solvent, since it has higher total assets compare to total liabilities. Fair value accounting: â€Å"Fair value is the amount for which an asset could be exchanged or a liability settled between knowledgeable, willing parties in an arm’s length transaction†. (IAS 39)   Starting out from the idea that the best estimation of the fair value is the market price of the asset or liability in quires, and attitude in mind that this price does not exist for all items, or if it does exist it may not always be reliable, it is essential to lay down some ordered procedure that institution can follow when making their estimates. Based on IAS 39. The continuation of published prices in a dynamic market is the best indication of fair value and when it exists, should be used to value the financial asset or liability. A financial instrument is deemed to be quoted on an dynamic market if the listed prices are regularly and easily available If the market for a financial instrument is not active, the financial institutions should find out the fair value using a valuation technique incorporate all the factors that participant in the market would consider when establish the price and which is familiar with accepted economic way used to set the prices of financial instruments. In a perfect market, fair value equals practical market price. If there is no active market, fair value is an estimate of value in use. The IASB differentiates between three levels for estimating fair values: Using quoted prices for identical assets or liabilities in active markets whenever that information is available (market values); If quoted prices are not available for similar assets or liabilities, fair value should be approximated using quoted prices of similar assets or liabilities with market equivalents. If quoted prices of identical or similar assets or liabilities are not available or not objectively determinable, fair value should be estimated using valuation methods based on present value techniques of future earnings, or cash flows and valuation techniques. Fair value of an asset usually is based on the judgment of future cash flows of the entity, which means that the same asset can be measured differently for two companies because of different borrowing rates and managerial appraisals. Thus, the reliability of fair value estimates declines with the shift from liquid markets to non-traded items. Botosan et al. (2005) provided a concise summary of the extant academic literature on The relevance and reliability of fair value estimates in financial statements. They suggest (Citing Barth, 1994, Petroni Wahlen, 1995, and Nelson, 1996, amongst others, in Support) that: â€Å"The evidence generally shows that fair values obtained from actively traded markets are more reliably associated with share prices than those derived from thinly traded markets or internal estimation models .Supporters of fair value accounting argue that, the fair value accounting measurement is relevant than the historical cost accounting as it provides up to date information in line with market and it takes in to account to economic adjustments to the acquired cost. Many accounting academics’ argue that the fair value method shows the economic realities that are avoided by the historical cost accounting†. Calculating fair value of an asset or liability Equity approach Mixed approached Income approach Full fair value approach Equity approach: All unrealized fair value changes are admitted in a revaluation reserve when transaction is realized. According to IAS 116 realized holding gains do not affect the income statement. Mixed approach: Changes on unrealized fair values are transferred into revaluation reserve however; changes on realized fair values are reflected in income statement instead of equity according to IAS 39. Income Approach: Gains or losses resulting from changes in fair values are usually reflected in the income statement. Full fair values: Changes made in every fair value are recorded in the income statement including internally generated goodwill. Self produced goodwill is the difference between the equity values of the firm and book value of the firm. Argument for fair value Accounting: Supporters of the market value accounting argue that the fair value accounting measurement is relevant than historical cost accounting as provides as up to date information constant which market with market and it takes in to account economic adjustment to the acquired cost. Many accounting academics argue that is method shows the economics reality that is avoided by historical cost accounting. Valuing all financial instruments by their fair value will allow stakeholders of the financial statements to gain a fair and true view of the companys true financial conditions as only fair value shows the economic situation and the changes in them. However, historical cost-based accounting indicates the conditions that happened when the transaction took place and any possible changes in the price do not appear until the asset is realized. Although, the well-known application of fair value offers a more as good as and consistent valuation Framework, as financial instruments are valued at the same time and according to the same standard. The Traditional model, on the other hand, does not allow comparisons easily made. Companies similarly financial instruments, with the same cash flows and risks, can show different values on their Financial statements according to the moment in time when they purchased the Justification of the full fair value model is draws upon the criticism that may be leveled against the mixed valuation model, where some instruments are recorded at historical cost and others according To their fair value. In the mixed model the criterion for valuing an instrument at its cost or market value Do not depend on the character of the instrument but on whether the companies intends to hold it Long term or trade it; this is strictly related to the difference between the instruments to old banking activity and the asset trading portfolio. Thus, if the mixed model is applied, similar instruments may be valued differently and have a Different result on the financial position and the income statement. Moreover, the difference between, the credit portfolio and the trading portfolio may vary from one company to the next, and therefore Make it difficult to compare financial statements. Lastly, the mixed model creates advantages for a degree of accounting principles that, The categ orization rules might be interpreted so as to categories assets and liabilities so that it is possible to apply the most advantageous valuation criterion, in detriment to the quality of the information And, in short, the ability of financial statements to show the economic reality of the company Reliably and objectively, Fair Value Accounting Advantages: Market value measurement is more important to stake holders are it reflects market price of the asset and the liabilities It provides more transparency for the users if all financial instruments can be measured at fair value stake holders can achieve grade advantages (Jackson 2000) Reliability of fair value accounting Financial information’s must be   reliable when it   must show faithful   economic reality of the transactions, regardless of its legal form, as well as being prudent, free and complete   from errors. For this reason fair value should not be applied to all financial instruments as it is not possible to get reliable values for some as important as loans   and deposits acquired, as there are no active markets for most of them, nor are there adequate valuation techniques allowing them to be estimated reliably.   Comparability of financial information: Stakeholders of the financial information should able to investigate a companys financial statements timely basis and compare them with similar industry to analyses the companys financial position, Changes in its financial position and performance in similar terms. Familiar situations and events must therefore be treated in a similar way. Whereas the mixed model may head to conditions in which similar instruments are given different Valuations because they were bought at different times, the results obtainable by this method are parallel and similarity comparable with one another. However, applying fair value would, in many cases, involve a degree of bias in the preparation of these financial statements which would make assessment more difficult. Given that companies may use different models with considerably different assumption to find out the fair value of different financial instruments, both the fair Value and the implication for the income statements of different companies coul d be very difficult to compare. Although, users of financial information are familiarized to the mixed model and understand it Perfectly well, having developed technique that use the historical cost information to assess the Company’s situation and estimate future cash flows.   Argument against fait value accounting: There are wildly held views on fair value accounting that the suitability of applying the criteria of fair value to instruments held in asset management. However, this method is vigorously rejects for the valuation of the non current asset and financial liabilities. In order to be useful as the basis for rational economic decision-making, financial information must be reliable, comparable and relevant. The criticism mainly on these features and the force obtaining the advantages of the fair value process would have constancy of the system as a whole Fair Value Accounting Disadvantages: Fair values and invaluable it is subjective of managers and directors and agency theory indicates that managers and directors usually keep their advantages of un very volubility to the manage financial report ( Ramanna Watts 2007)   when fair value on asset liability is not available fair value is measured based estimated by using best   available   information and technique available in the circumstances however most oven difficult occur when choosing estimated of fair value by using in appropriate models. E.g Cash in hand or using assumptions that is not reflect the risk of asset (Jackson 2000) References cemla.org/pdf/acp/dp-0607-bde-eng.pdf. accessesed 5th of may 2011, time. 23:43 Melville, A international financial reporting practical guide. ACCA global   reviews Fame G4S financial analysises.