Sample Essay: COMPASS GROUP PLC

Part A: Forecast the financial statements
a) Discuss issues to consider when preparing projected financial statements (10 marks)

One of the major issues that the Compass group has to deal with is the currency exchange rates they have to deal with when reporting their consolidated financial statements. The company is currently using a fixed rate to be used as basis for the computation of the whole fiscal year. In order to shield to company from devastating currency losses, they have already engaged in currency swaps to protect the company’s interests.

There were also the exceptional items that happened several times throughout the last five years that the company has experienced. They are going to affect the financial analysis we have of the company’s previous performance as well as future prospects. This is the reason why the exceptional items are not included as part of the figures found in the financial statement. The items considered to be of exceptional nature were the sale of company’s assets as well as investing in new facilities of considerable amounts.

There are also different account principles being used by the company’s numerous subsidiaries throughout the world. The differences in the accounting rules are nevertheless reflected in the consolidated financial statements.
b) Forecast the consolidated income statement and the consolidated balance sheet for the year to 30 sep 2009 (40 marks)

Here are the forecasted financial statements of the company. The sales growth revenue percentage was determine first to be used as the basis for the computation of the rest of the items in the balance sheet.

The base year used was the year 2004 for calculations. Instead of growth rate, the company is expected to actually post a reduction in their sales. This is realistic since the current economy is already a dire situation plus the fact that the company has already been showing a reduction in their growth rates in the previous years. The first table above expresses the figures in actual numbers while the one below is shown in terms of the percentage that they are expected to be in the year 2009.

Note: The net income was taken from the net operating cash flow. The tax expense was taken from the balance sheet. The COGS was calculated by deduction as well as the net income. All other individual expenses were summarized in the COGS figure for simplicity.

The following figures are also forecast figures in the year 2009. The most conservative figures were chosen in order to reflect reality best in the dire economic situation that the rest of the world is in right now.

The following ratios were computed using the following set of data. They are derived from the balance sheet. The rest are assumed where needed.

The figures in pink are the ones that are forecasted to happen in the year 2009. The growth rate of the sales revenue was also used as the basis for the computation of the operating expenses. The rest of the items in the balance sheet are forecasted using the biggest possible expense or the lowest possible income. This is the manner by which the forecast is believed to be approximate to what the reality will hold since the economic situation is already dire. All percentages shown can then be used to derive the actual balance sheet items. They are not shown here as they are already part of the data computed in the cash flow analysis of the company to derive the amount needed for extra funding by other means.

Those figures that are expressed as percentage in relation to sales have been computed using a set of relevant data. There are some of them that are assumed to be the closest and most reasonable given the data by the company. The ratios expressed are naturally derived from the division of the indicated items directly.

From the forecasted financial data above, the following computation is done to arrive at the retained earnings of the company up to the forecasted year. The needed funding can then be ascertained from the above information. The amount needed to be borrowed is also determined by this analysis. The cash flow of the company can now be derived from the previous data to determine the future amount needed. Here is the derivation of the projected cash flow statements.

The cashflow derived is very simplified but it nevertheless includes all the essence in detailing the cash needed by the company in the year 2009 as derived from the data in the forecasted balance statements. The cash in the investing portion is assumed to be zero since it is not prudent for the company to continue making investments in these dire economic times. The cash from financing activities decreased by 10 since that is the amount of dividends paid regularly. There are no more cash raised through getting more debts as this might compromise the company’s positions. The projection however will tell us the amount of cash the company needs to raise through whatever means. The company will have an expected deficit of 8.942 million. This was derived by 944.942 from cash in operations minus 936 from cash needed in financing activities.

The company either needs to raise some stocks or negotiate a revolving credit line with their bank partner. This figure will be the basis on whether the public still has the appetite for buying bonds or stocks to this amount. This is also the amount that the bank has to consider whether the company still has the capability to pay despite the present economic conditions.
Part B: Write a report to the management of the compass group plc analyzing the predicted financial position and performance of the company and comment on the company’s financial strategy (50 marks)

The following financial statements are arranged to show the previous financial performance of the company as well as their future prospects. From the data displayed below, we can infer the right kind of strategy that the company needs to have in order to prosper in the future.

This is the income statement that will be used as basis for later analysis.

This is the balance sheet statement that will be used as the basis for later analysis.

This is the consolidated Cash Flow to be used as basis for later analysis.

The second 2008 figures are simply multiplied by 2 from the previous one since the company’s reports only includes six months figures. It is presumed that this will be the closest approximation of the financial performance of the company for the whole 2008 itself.

The following are the common size trends and time trends of the company. They will indicate the past performance as well as give us a clue as how the company will be faring in the future.

This is the common size analysis of the balance sheet. It is focusing on the assets with total assets used as basis for 100%. The rest are reflected according to their relative size.

We can see immediately that the company had a lot of significant intangible assets in the years 2004-2005 but drastically reduced in the following years. The drop is very sharp as you can see ranging from 69% to a sudden 2% in 2006. This must have meant a lot of conservative financing for the company later. The most interesting part is the 2004 which does not have any cash in their account except for the value of their physical properties, plant and equipments. The cash holdings of the company increased to a more comfortable level at the range of 30-33% after the year 2004.The current assets basically did not change drastically for four consecutive years.

This is the time trend analysis of the company’s assets. We can clearly see that the intangible assets of the company have dropped dramatically from the time of 2005. This can be seen already in the common size analysis but the time trend also confirms it. Aside from the year 2005, the year 2006 still has a considerable amount of assets as compared to the rest of the succeeding years after it. The asset size decreased from 120% to a sudden 106 % only in comparison relative to the year 2005 as basis. The years 2007 and 2008 have a fairly stable amount of assets indicating stable performances. On a more detailed analysis, the tangible investments of the company increased in 2007 and 2008. Their intangible investments are left alone as this does not have a marked effect on the company’s performance. The receivables of 2008 on the other suddenly went double that of the year 2006 indicating the increase of credit given to customers and an increase in sales.

This common size trend analysis was done using the equity as the basis for the computation.

The most obvious information you can get right away is the short term borrowings of the company in the year 2005. They are significantly huge since they have to practically start the company operating from scratch. It has since then dropped considerably to about 4-6 percent with the succeeding years. The same goes for long term borrowings. The company made a substantial borrowing in the year 2004 at the level of 187% compared to the 64% something that the company has since then maintained in the years 2007. This simply indicated that their previous investments have already been paid and that they have now stabilized the income for the company’s operations.

This time trend analysis used the year 2006 since it is the only one with a complete set of figures that are verifiable. The short term borrowings saw a small bump at the rate of 126% and then returned to state near that of 2006 in the form of 93%. This only meant that the company has encountered additional investment needs aside from the substantial amount that they have already borrowed in 2005. The operations have remained fairly stable after this. The equity of the company has also decreased noticeably from the year 2006 to around 75-83% only. This has either been because of stock issuance or the reduction in owner’s equity since the company has now shown to be fairly stable in its earnings.

The following financial ratios are computed and arranged by year to show the company’s financial position. This is also to gain an understanding of what will be the best strategy the company should take.

The most striking information that you can get in the financial ratios is the profit margin of the company. The company has already been in the negative zone when it comes to their profit margin. This was because of a substantial investment in the years 2004-2005. It did become gradually smaller as the years passed by but it is still negative in the year 2009. The company has to be careful with their finances if they want to survive the current depression affecting the whole world. Another indicator of poor performance is the return on assets by the company. They had never been able to post a rate of above 10%. The returns on the assets are all within 2-8% only. This is very small indeed considering that the company has to make substantial investments in order to run the operation. The small margin in the food industry leaves very little room for mistake. Even the net operating income of the company has a very sharp reduction in their figures in the year 2009. It is almost smaller by four times literally. Even if the company does not take into account the year 2009, the previous years are still showing a decrease in the NOI.

Another danger sing is the debt to equity ratio of the company. It has risen recently from an insignificant 08 to 2.0 level. This only means that the company is in dangerous grounds.

The rest of the other ratios like the current ratio and the cash ratios have remained more or less stable. These are only due to the varying conditions that a business can normally encounter. The rest of the details are better indicators of the company’s performance.

Naturally, there are no receivable ratios since the company sells the food on a cash basis. There are no items sold on credit. This is one thing that is advantageous for the company’s operation. It actually lessens the chances of being short on cash on their daily operation. In a long term sense, the company is also far away from danger since they don’t have to contend with the long waiting time needed to make use of the sale they had commenced. The company does not have to wait for the cash to be cleared in their names. The time trend and the commons size analysis confirm this also. The company has already made a substantial investment at the start. They are only slowly starting to regain their investments. This is no time to be extravagant.

The strategy that the company has to take this time is one of a very conservative and prudent type of actions. There should be no additional investments. The debt should be paid as little as possible to conserve cash. All expenses should be reduced. There should be no credit extended to customers as this might compromise the company’s own cash reserves. Considering there are numerous signs for danger to the company in combination with the adversarial economic conditions right now, the company should stay away from all kinds of speculative actions. There should be no expansion of the company’s operation whatsoever. If possible, the company should wait again until they have cleared all debts before thinking of expanding again. This is to ensure that the company will survive despite tough economic times.