Make your own free website on Tripod.com

Ratio Analysis


The Body Shop is a group engaged in the origination, production and sale of naturally based skin and hair care products and related items through its own shops and franchise outlets.  Their financial statements for the years 1990 to 1994 are interpreted as following.

The ROE of the company has deteriorated significantly since 1990, and has varied between 17% and 22% over the last four years (Figure 1).  It indicates that the company is not efficient to use those resources invested in achieving the profits compared to 1990. 

In general, the ROE is greater than ROA except in 1991, which means that the company was able to earn more from borrowed funds.  It is shown by its high loan gearing of 72-76% in 1990, 1993-1994.  Hence the earnings of the company is more sensitive to profit changes as the interest in respect of the LMS loans must be paid regardless of profit level.  In contrast, the company has significant reduced their trade gearing from 33% in 1990 to 8% in 1994 by repaying to creditors in shorter period.  This implies that the company adopts a policy of maintaining high proportion of LMS funding, while reduces their rely on trade creditors for possible reputation reason.

In 1990, the ROE is higher than ROA (33% compared to 26%).  The coverage shows that the company was left with 51 pence per £1 of profit once interest and tax were charged.  The gearing multiplier of 2.52 shows that the shareholders had £2.52 of assets under management for every £1 of shareholders funds.  In 1991, with ROE lower than ROA (19% compared to 22%), the coverage had increased, taxes had fallen so the shareholders were left with 55 pence per £1 of profit pre interest and tax.  Gearing had decreased by 40% to 1.51 times.  In the next three years from 1992-1994, the coverage and gearing had been increased but it did not help to improve the ROE due to a significant decrease in ROA.  Hence, in 1994, the company is left with 60 pence per £1 of profit once interest and tax is charged.  The gearing shows the shareholders have £2.09 of assets under management of every £1 of shareholders funds.  A comparison of the 1990 and 1994 is shown as below figures:

 

1990

1994

% Increase/Decrease

ROE

0.33

0.20

-39%

ROA

0.26

0.16

-38%

Coverage

0.51

0.60

+17.6%

Gearing

2.52

2.09

+17.1%

There is a downward trend of ROA for the company over the five years.  In 1994, the company has produced a rate of return on total assets of 16%, which is decreased by 10% comparing with 1990 though it has picked up 2% from 1993 (Figure 2).  During 1994, management through its operating activities has produced 16 pence in profit before tax and interest for every pound invested in resources, compared with 26 pence in 1990. 

The decrease in rates of ROA over the years is significant and results from the decrease of ROS and Asset Turnover.  The ROS has varied between 15-20% over the years.  For 1994, each pound of sales revenue has produced 17 pence in profits, which has decreased by 3 pence in 1990.  In addition, it is interesting to find that the operating leverage is 0.  It is likely these costs are treated as variable costs by the management of the company.  Although sales has increased to 131% in 1994 comparing to 1990, the increasing variable costs has reduced gross profit margin due to its significant proportion to sales.  The decrease of profit margin might be due to increase in the sales of lower profit margin product or increase of purchase and production cost that cannot be passed onto customers.  However, the company is still able to maintain a 10% net profit in 1994 as 1990 because of the reduction of tax and interest.  The analysis is set out below: 

 

1990

1991

1992

1993

1994

% Increase in Sales comparing to 1990

100

+36.8%

+74.5%

+99.2%

+131%

Variable costs to sales

80%

81%

81%

85%

83%

Profit margin

20%

19%

19%

15%

17%

Net profit to sales

10.1%

10.5%

11.2%

8.3%

10%

The asset turnover has also decreased significantly from 1.29 times in 1990 to 0.97 times in 1994.  It seems that the company is not effective in utilizing its total assets to generate sales revenues.  However, the asset turnover might be affected by several reasons.  First, there was no cash and other assets in 1990-1 for some reasons.  Second, there is a significant increase in fixed assets and debtors as shown in below figures:

 

1990

1994

% Increase

Fixed assets

£32,799

£76,400

133

Debtors

£9,358

£24,700

164

The cash days have increased significantly to 46 days in 1994 and it indicates that the company needs a longer time to realise the sales revenues as cash flow from operations.  The debtor days were increased in 1991-3 and this is usually a bad sign as it suggests that the company is lack of proper credit control, poor liquidity and higher risk of bad debts.  The company has tried to reduce the days of collection to 46 days though it is still 6 days more compared to 1990.  Stock days have been improved significantly by 36 days and this helps to reduce capital employed and risk of stock obsolescence.  The fixed asset turnover is only able to maintain at 0.39 times in 1994 as 1990.

As a conclusion, the Body Shop appears to be experiencing decrease in return on equity due to a decrease of return on assets.  Although their sales are increasing, the profit margin is decreasing possibly due to the intensive competition in the industry.  The firm is seeking these sales increases by retaining profits in the firm, increasing borrowing, reducing low working capital and current assets.  


Back to Accounting and Finance Article List