Analysis of the Financial Strengths and Weaknesses Revealed by the Financial Statements

3. Analysis of the financial strengths and weaknesses revealed by the financial statements.

To make more sense of Centrica’s financial statements, five categories of ratios will be used so as to examine the financial performance of the company and thereby concluding about its financial strengths and weaknesses. The categories of ratios cover profitability, efficiency, liquidity, capital structure and return to investors. A copy of the ratios has been attached in the appendix.

PROFITABILITY

The profitability of a company is important and a key measure of its success. Three major ratios will be used: return on capital employed, net profit margin and gross profit margin. Return on capital employed will first be looked at. According to the figures for the past five years, there is an upward trend showing that the company has achieved a great success in ensuring that those resources invested in the business have been used more efficiently than the previous year, and hence it is likely that there will be a high percentage of profit being earned on the total capital employed.

With respect to net profit margin, it indicates how much of the total revenue remains to provide for taxation and to pay the providers of capital, both interest and dividends. This return to sales can be directly affected by the management’s ability to control costs and determine the most profitable sales mix. There is also an upward trend but a decline in 2001. It can be said that, in general, costs have been efficiently controlled in the generation of profit from sales.

Gross profit margin is also an important indicator for profitability of a company. It indicates for every £100 of sales how much gross profit has been made. According to the ratios for the past five years, it shows an upward trend but decreases in 2000 and 2001. This implies that cost of sales has not been controlled very well in these two years, or alternatively there may have been greater competition in the British utility industry and therefore lower selling prices and a lower gross profit.

EFFICIENCY

Efficiency ratios show how efficiently a company has controlled its current assets and liabilities. Stock turnover, debtors’ ratio and creditors’ ratio will be used for analysing the company’s management efficiency.

Calculating stock turnover, an upward trend has been illustrated over the past five years. This indicates that Centrica has taken long period of time to turn its stocks into sales. For this reason the costs of holding stocks have correspondingly increased.

As for debtors’ ratios, an upward trend has been shown over the past five years. This implies an increase in the debtor collection period. It is important, therefore, to reinforce the debtor administration of Centrica and thereby improving the effectiveness of the company’s credit