Introduction
This paper seeks to conduct an analysis for the financial performance of Lexus in relation to other industry competitors; Jaguar, Mercedes, Porshe and BMW. In order to arrive at objective results, the analysis will compare various financial and performance metrics for the businesses. It is a purely objective analysis that will be based on the figures obtained from the annual reports of the companies.
Return on capital employed (ROCE)
Return on capital employed is a metric for a company’s profitability and the effectiveness of its capital employment.
ROCE = Profits before interest and tax/Capital employed.
A significantly huge amount of ROCE is a clear indicator of efficiency in the appropriation of the capital employed to the business operations. If a company is to generate sufficient shareholder value, it must achieve a ROCE which is higher than the total capital invested in the entity. The metric is further applicable in intercompany profitability comparisons in relation to the amount of capital used. Lexus in this analysis has the lowest ROCE at 4.4% against 305% for Jaguar, 17% for Porshe, 8.14% for Mercedes and 12.8% for BMW.
This low ROCE for the business could be an indication Lexus is not making full employment of the capital employed and so it’s missing on profitable business opportunities.
Gross profit Margin
This is a profitability ratio that compares the total gross profits earned in a business with the total sales. GP margin is a financial metric for the company’s cost effectiveness and the management’s prowess to manage its stocks and operations, and the skilful application of the total costs to the output. It represents the total profits generated from the total sales before charging the selling and administrative expenses. A big percentage of GP margin means that the business management is running the business operations smoothly and efficiently in terms of costs application to the end products. It also shows the existing opportunities for the business to maximize net profits on the sales as long as overhead costs are properly managed. A diminishing GP margin for the business can be interpreted to illustrate dismal business performance in regards to profitability. This lower margin in relation to the industry averages indicates a possibility that the business could be under pricing its products. The 18.8 % margin for Lexus over the five years shows that the entity has continuously generated some profits from its sales. (G.P of $18.8 out of every $100 sales). However, compared to the industry averages, other competitors have higher gross profit margins (Jaguar 37.7%, Porshe 29.9%, Mercedes 22.1% and BMW 20.3%) an indication that Lexus could be under pricing.
According on the discrepancy between the industry figures and the company’s figures for the G.P ratio, it’s evident that Lexus has an opportunity to review its prices upwards so as to step up its gross profits to match the industry averages. Such a price increase should however be consistent with the market forces of demand and supply for their brands. The presumption that the demand in the automobile market is elastic can guarantee safety of profits upon an upward price review. (Tracy, 2012.)
Inventory turnover
This is a representation and metric for the ability of a business to efficiently manage the available stock and derive reasonable sales out of it. It is a simple illustration of how many times the inventory of an entity has been sold out over a specific accounting period. It’s a very relevant metric for success in any business that holds inventory like the automobile industry businesses. If a business has high inventory turnover, it means that such a business is operating on the favourable side. This is founded on the premise that inventory is the least liquid asset held by the company at any particular time. A relatively low inventory turnover is an indication of massive overproduction or overstocking or is deficient in marketing effort in the entire business processes. It thus becomes a sign of ineffectiveness in the entity’s inventory management systems backed by the facts that inventory does not earn any rate of return to the business but it’s holding and storage costs are usually too high.
Lexus has an inventory turnover average of 34 for the past five years, and this performance is slightly below the industry averages. For instance, Jaguar has a turnover of 67, Porshe 66, Mercedes 73 and BMW 7. The industry averages imply that Lexus are missing on a great opportunity in the market due to their low inventory turnover. This performance can be due to a deficient product line or marketing function in Lexus. There could also be a mismatch in the demand and supply for their products and so the management needs to understand the demand for their product in specific markets and control their production. Otherwise, holding high inventories for automobiles is to costly in terms of storage and security in the short run and depreciation alongside changing tastes and preferences in the long run. These costs have the direct effect of reducing the total profits for the company every time they are incurred. (Vandyck, 2006).
Receivable Turnover
The receivable turnover is a financial metric that shows the average length of time taken by any business to receive cash from its credit sales customers. The ratio represents the total efficiency of the business marketing function to solicit for liquid cash out of their credit customers. It is a key performance indicator for the business’ debt collection department because it shows how soon credit sales are converted to actual cash. If the receivable turnover is high for any business, it implies that there exists a strong credit control function in the entity and its super efficient in debt collection. A lower or diminishing turnover achieved in any implies a weakness in the ability to collect cash from its credit customers. It further serves as a sign of high opportunity costs incurred for the unpaid accounts receivables. For the purposes of liquidity, the receivable turnover can be used to understand how soon a company receives cash out of credit sales. It can thus serve as a good basis for planning.
The receivable turnover for Lexus is 33 which is relatively higher than for Jaguar (23), Porshe (19) and Mercedes (24). This is an indication for increased efficiency in credit control policies at Lexus than the three competitors. This is however not a guarantee for maximum efficiency because BMW have a high turnover of 406. This therefore means that Lexus still have a greater opportunity to beef up their credit management in order to match the industry market average.
Payable Turnover
This ratio illustrates the total number of times a business pays its credit suppliers for all such purchases sourced in a specific accounting period. It forms an objective metric for the company’s effectiveness in handling the settlement of its bills. Favourable business conditions are indicated by a high amount of turnover since it shows that the bills are being settled more quickly. On the contrary, a lower accounts payable turnover means that the company is taking relatively longer periods to settle its bills from credit purchases.
A payables turnover of 42 days for Lexus is favourable against the industry values for Jaguar (147 days), porshe (61 days), and Lexus (43 days). The shorter period of settling bills protects the business against unfavourable economic waves such as inflation. It also keeps the total liabilities for the Lexus Company relatively low an aspect that is closely and keenly evaluated by potential investors. The turnover for Mercedes is however lower (36) than that of Lexus. This is an implication that Lexus has not exploited all opportunities available to minimize the same. (Vandyck, 2006).
Gearing ratio
The gearing ratio is a financial measurement for the exact proportion of the total equity that can be applied to settle all the debts owed by a business entity at a particular point in time. It is a metric for the total amount of financial risk that is inevitable to the business. A higher level of gearing ratio shows that a significant amount of the total equity held in the company would be used up if the company was to settle all its debts. This would in turn mean that the degree of the financial risk facing the company portfolio is high. The ability of the business to meet all its financial obligations out of the existing equity is limited. Lenders and creditors will always examine the levels of gearing for all their clients so as to ascertain the level of risk that would accompany the funds lend out. High gearing serves as a proof for the lender that the borrower could face challenges in servicing the new debt. A lower gearing ratio to the contrary implies an increased ability for the borrower to repay the borrowed funds and thus a reduced financial peril for the business due to its ability to easily meet its debt obligations from its equity.
Lexus has the highest gearing ratio of 75% among the businesses evaluated in this paper. Jaguar has 23.3%, Porshe has 24.9% Mercedes has 73.9% and BMW has 67.6%. Since the automobile industry is neither a monopoly nor a regulated industry, Lexus faces an increased financial peril. In order to maximize its survival chances and continuity into perpetuity, the company needs to evaluate and minimize its debt financing so as to reduce the risks associated with high gearing ratios. (Robinson, 2009).
Interest cover ratio
The interest cover ratio is an indicator of an entity’s ability to service its interest on debt payments in a timely manner. It is basically an objective measure of the entity’s financial muscle to afford the interest on the debt. A lower interest cover ratio means that the company can readily afford interest on the debt owed. The focus of investors on this metric is to evaluate the business’ ability to settle its interest bills in good time without eating into its profits or operations. Creditors also examine the ratio in a deliberate attempt to assess the business’ ability to afford an additional debt.
An interest cover of 65.2 is relatively high compared to the industry averages despite the fact that the company Lexus can still afford its debts. Compared to a 12.2 interest cover ratio for Mercedes and 20.8 for BMW, Lexus’ ability to service its interest obligations is limited. As a potential investor, this situation is a discouraging factor because of the risk created by the high interest cover ratio. The company could in the near future be compelled to sacrifice its profits to repay interest.
Current Ratio
The current ratio is a relative liquidity metric that compares the total current assets with the total current liabilities held by an entity. Below is the formula for calculating the ratio:
Current assetsCurrent liabilities
Current ratio parallels the amounts of current liabilities and current assets held by a business entity at a specific time. It forms a rational basis for business owners and investors to ascertain whether the business is able or unable to service all its current liabilities by liquidating all or a portion of the total current assets held. This ease of converting such current assets into cash enables the current ratio to act as an indication of the extent of liquidity for the company. The liquidity of a company increases with an increasing current ratio.
The preference for a lower current ratio by any aspiring investor is founded on the belief that the total assets held by the entity will be utilized in the expansion of its operations. It reliability for decision making is also boosted by the fact that it takes into account the total sum of all current assets held by the company. However, it is not a firm base for sound and reliable decision making for purposes of investment and thus individual current ratios are compared to the industry averages. Lexus has a very high current ratio of 1,076 compared to the same ratios of other competitors; jaguar 1.03, Porshe 0.71, Mercedes 1.16, and BMW 0.98. This huge deviation from the industry trend makes Lexus an inappropriate investment opportunity.
Net profit Margin
This ratio is a direct comparison of the net income earned by the business entity and total sales and calculated as follows:
Net incomeTotal sales
It is a metric that shows how each dollar derived from every sale is reflected in the net profits. It is a metric for the total percentage benefit that the company/ entity earns from a unit sale. Critically analyzed, the NP margin is an illustration of the business’ cost controls in an attempt to achieve maximum profitability. Higher proportions of the net profit margin can be interpreted as indications for an entity’s conversion of its revenues to net profits.
The usefulness of the ratio to potential investors is to evaluate the ability of the entity to generate profits from the sales achieved in any accounting period.
Lexus has a positive net profit margin of 5.8% which shows that the business is earning some reasonable profit from the sales revenues generated- it’s not operating in losses. However, a further comparison with the rest of her competitors in the same industry, the Lexus Company is performing below par and should adopt measures that increase the net profits such as cutting down the overhead costs incurred in all business operations.
Net currents assets
This is a metric for the company’s financial health in the short run. It’s an illustration of the amount of capital being created or consumed by the business operations on a daily basis. A positive figure for net current assets has the implication that the business is in a good position to finance its day to day activities. A negative net current assets figure on the contrary means that the company is unable to meet the financial needs for its daily operations.
The five year average current assets for Lexus is high (998,534.4), and it implies that it is in a good position to continue operating efficiently. It has a higher amount of current ratio compared to the industry averages for other competitors. A high amount of current assets also implies a degree of financial stability for the business. This financial stability acts as a competitive advantage for the Lexus Company to attract more investors because of the guaranteed safety of their investments and the belief that the company can comfortably fund its daily operations without eating into the profits or having to borrow external funds. (Robinson, 2009).
References
Robinson, T. (2009). International financial statement analysis. Hoboken, N.J.: John Wiley & Sons.
Tracy, A. (2012). Ratio analysis fundamentals.
Vandyck, C. (2006). Financial ratio analysis. Victoria, BC [u.a.]: Trafford Publ.
