Company Audit

 

 

Background of the Company:

Go-Ahead group plc is considered to be one of the major bus and rail providers throughout the UK. It was founded in the late 1980’s and especially in 1987 where it was named Go-Ahead northern limited before expanding throughout the UK and becoming Go-Ahead group PLC ( Go Ahead website,2016). The chairman of the Company is Andrew Allner and the CEO is David Brown. (Go ahead Annual Report, 2015) Go Ahead group headquarters is in Newcastle and the employees exceeds 26,000 (Go ahead Annual Report, 2015).The firm was first listed in the London Stock exchange since 9, May,1994 as a FTSE 250 company ( London stock exchange,2016)

Structure of the Company

There is a wide range of bus and rail companies that are owned by Go-ahead, and they are listed in the company’s website. (2016)

Go-Ahead Bus Companies:

Brighton&Hove

Go-Ahead London

Go-East Anglia

Go- North East

Go- South Coast

Metro Bus

Oxford Bus Company

Plymouth City Bus

Go- Ahead Rail Companies:

GTR

London Midland

South Eastern

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Figure 1 shows the operations of Go-ahead group throughout the UK. (Go-Ahead Website, 2016)

 

 

 

 

The board committee In the Go-Ahead group is consisted from the Chairman and three non-executive directors and two executive directors and a secretary. (Go Ahead Annual Report, 2015)

ANDREW ALLNER	Chairman
DAVID BROWN	Group Chief executive
KEITH DOWN	Group Finance Director
KATHERINE INNES KER	Senior Independent director
NICK HORLER	Non-executive Director
ADRIAN EWER	Non-executive Director
CAROLYN FERGUSON	Group Company Secretary

 

 

Rationale for choosing the Company:

According to the London stock exchange, the transportation sector is large in the UK and many people daily uses either the Bus or rail for going to their work or to the university so I found it quite interesting to choose that type of industry and especially Go ahead group which owns many bus and rail companies alongside with their competitors who operate throughout the UK.

Regulations for the Go-Ahead group

Since Go-Ahead operates in three major divisions, the regional bus, London Bus, and UK rail services.  The regional bus in the UK outside London are required to meet the criteria of the Traffic commissioners in the UK law, which licences and register  the bus companies to operate regionally in the UK. Moreover they are also required by UK corporate governance companies act 2006 to comply with the regulations on health and safety, accessibility, driver training, and environmental performance. (Go ahead Annual report, 2015)

London Bus division in the Go Ahead group are regulated by Transport for London (TFL), and finally the UK rail services in the Go-Ahead group are regulated by Office Of rail Regulation (ORR). (Go ahead Annual report, 2015)

 

 

 

 

 

Top two competitors:

There were two main competitors to Go ahead group which were mentioned in the 2015 Annual report, Stage group and First group. Go ahead holds 7% of the market share in the regional bus industry, while Stage group and First Group holds 23% and 20% respectively. In the Rail Market industry, Go ahead holds 27%, while Stage group and First group holds 27% and 11%. (Go- Ahead annual report, 2015) Stage coach group is one of the major bus and rail providers throughout the UK buses and coaches in North America, and considered to be a competitor to the Go-Ahead group. Stagecoach was founded in 1980 and their head quarter is in Perth, Scotland. Their chairman is Brian Souter and the Chief Executive is Martin Griffiths. (Stage coach website, 2016). They entered the London stock exchange in 1998 as a FTSE 250 company. (London Stock exchange, 2016) Stagecoach operates various bus and rail companies all over the UK. There operations are:  South West Trains,  East Midlands Trains networks. Stagecoach and Virgin have also partnered to jointly run the East Coast and West Coast inter-city rail franchise. Stagecoach also runs the Megabus, which is a low coast coach service in the UK. (Stage coach Website, 2016)

 

 

 

 

 

 

 

 

 

 

 

 

The second top competitor to Go-Ahead group is First Group which operates Buses and Rail Services all over the UK and North America. First group was established in 1995 and their headquarter in Aberdeen, Scotland. The First group chairman is Wolfhart Hauser, and Tim O’Toole is the chief executive. (First group Website, 2016) First Group entered the London Stock Exchange in 1995 as a FTSE 250 company in the Travel and Transportation sector. (London Stock Exchange, 2016). First group operates both buses and rail services.  Their Bus services is considered one of the largest in the UK, beside Stage coach, Go- Ahead, and National Express.

 

 

 

 

On the other hand, First group plc also provides rail services through couple rail franchises.

First Rail Franchises ( First Group website,2015)

Great Western Railway

TransPennine Express

First Hull Trains

Tramlink

 

 

The availability and reliability of the information that is publicly available

It’s obvious that all the information needed information to perform the company analysis. There are a huge amount of articles and readings relating to the firm activities and those articles are useful to consider the consequences of the firm’s activities on the firm market value. As the company usually establish its financial results in its annual reports, these reports can be a useful tool to perform the analysis for the company and its competitors.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Introduction

Financial analysis has been academically viewed as the process of systematically studying the financial statements of an organization to determine the real value of its performance. The method uses ratios and comparisons of equity. The definition is, however, deficient since, in practice, there appear more interests by various stakeholders of an entity. (Martin S Fridson, 2011, pp. 45-47) (Keith N. Herist, 2011, pp. 40-56). Various participants of an on-going concern need accurate information about an organisation. Such information helps them understand the performance of business. The suspense is mainly the drive of analysis, financial statements thus the development of a logical system to answer all the pending queries (Kwok, 2008, p. 68).  The literature review herein enlightens on the broad issues of analysis, including various methods of conducting it.

Importance of Financial Analysis to Investors and Shareholders

1. Investors

Eric Osei‐Assibey et.al (2012) p. 14 argue that investors hold their entities closely as they have financed them painfully. In a research to investigate the factors that determine the financing alternatives in SMEs, the authors relate that new enterprises prefer low cost financing due to perceived risk. The primary interest of the investors in the business is mostly net revenue that flows from the operations invested in after a short period. Financial statements are not entirely reliable in analysing a business. There is, therefore, need to look into other aspects of the business to measure the quality of business, to understand the sustainability of the firm or to directly investigate the reliability of books of accounts filed periodically (Eric Osei‐Assibey, 2012, p. 14). Christian Nielsen et. al (2006) p.78 after investigating some rules that are suppossed to make analysis of  capital statements possible further state that there is no ideal way of predicting the future of a business entity.  However, using a model it is prudent to endeavour to take a sneak peak on the probability of continuing in business given the current economic surrounding. The analysis helps in making critical decisions such as whether to buy or to rent, to keep an asset or to dissolve it, to employ or to retrench, to diversify or to concentrate on the same line of doing business, to welcome new information from research or to postpone the action (Christian Nielsen, 2006, p. 78).

In a separate study , David B.H. Martin and Brandon K. Gay (2004) p.36 argue that investors are more concerned with a factor of money that makes it valuable. Using a lengthy approach in their technical paper, they describe money as the side production in the economy. The study reveals that investors continuously avail their creativity to make innovations in their products. Therefore, being familiar to the generation of different ideas makes it obvious that they eventually run out of ideas. There is thus need to purchase the knowledge of entrepreneurs progressively and finance them to set the ball rolling. The endless search for areas to invest in may bring more ideas than they can manage. A proper way to value individual investments is vital (David B.H. Martin, 2004, p. 36)

1. Shareholders

Lorne N. Switzer and Yu Cao (2011) p. 223 explain that to increase capital, directors invite the public to participate in the decision-making of the company. With the purpose to study the relationship between boards of directors’ alignment with shareholders’ interests, they find that directors sell shares to the public promising annual dividends. Beattie explains that the share capital the people buy makes them shareholders of the enterprise. The study that uses Rotman/Clarkson (CCBE2) Canadian Board Shareholder Confidence Index as the measure of the interests of shareholders reports that shareholders hold particular interest of the company. Therefore, they closely examine the quality of statements that are produced monthly and annualy. It is clearly stated that their main aim is to get higher dividends at the end of each accounting period. They thus follow the performance of the business closely regarding profits so that dividends are highly valued (Lorne N. Switzer, 2011, p. 223).

Beattie (2002) p. 40 tends to think differently about the issue of shareholder holding special intersts in the firm. The findings of a qualitative sudy that he conducted point out that the period in which to sell off their shares is vital to determine. He implies that in the real sense, shareholders intend to rip of the firm through making marginal revenues and the sale of shares. It’s widely known that the firms for the firm’s ability to make rewarding dividends, then time and patience become necessary values of investors and shareholders. Besides getting profits at regular intervals, shareholders like to make profit margins through trading shares in the stock market. Analysing financial statements are core thing that helps make that critical decision. However, one needs the clear advice from a stock broker who uses the methods of equity to project that returns of stock before it happens. The complexity of accurately verifying the financial statements available is a tricky business that uses techniques like net assets analysis, market capitalization and price earnings (Beattie, 2002, p. 40).

Reliability of Financial Analysis

Seitz (1984) p. 99  writes that financial analysis is reliable. To evaluate the quality of assets and the extents of liability in business records analysis has to be done. There are many ways to find out how the business is doing against competition especially in the oligopoly markets (Seitz, 1984, p. 99).  However, Helfert ( 2003) p. 58 argues that the mathematical methods applied in analysis are too much for an ordinary investor who has little interst in analysis. He finds it annoying and complex to keep an analytical view and instead proposes emotional feeling as the best and most reliable way to invest (Helfert, 2003, p. 58). The methods of finanacial analysis that this report will review include: profitability ratios, efficiency ratios, liquidity ratios, gearing ratios, cash flow ratios, and investor ratios.

1. Profitability Ratio

Using a sample of 75 companies from china and japan,  Chunhui (Maggie) Liu et. al (2013) p. 183 seek to find the challenges in comparing ratios between the two nations. They describe profitability ratio as a category of financial measurements that are used to evaluate an entity’s ability to make profits as compared to its overall expenses and possible costs incurred in a period of time. As the ratio increases the company is said to be doing well against competition. However, the study finds difficulty in comparing liquidity, solvency and activity ratios. It is a clear implication that profitability ratios are inefficient methods of business analysis across countries despite adopting international standards. Therefore the ratios according to these two authors are not efficient in financial analysis. (Chunhui (Maggie) Liu, 2013, p. 183).

Another analyst, Courtis (1996) p.146-149, finds that profitability ratios are somewhat inconsistent across time as opposed to across space. In a study involving 101 listed companies in Hong Kong from 1988-1992, Courtis (1996) 146-149 avails information that one is likely to get constant results while comparing financial data within an industry as opposed to across industries. Much to the advantage of academic front, ten research questions were formed from this study. Therefore, the two studies highlighted here deliver that profitability ratios are not adequate in financial analysis (Courtis, 1996, pp. 146-149).

2. Efficiency Ratio

To conduct a research on the interrelationships among failure to pay risk, capital ratio, and efficiecy Thanh Pham and Thien Nguyen (2015) p. 520-521 identify the efficiency ratio measures the company’s ability to take care of its assets and manage its liabilities. They use inventory turnover ratio, receivables turnover ratio and asset turnover ratio on a scale referred to as Data Envelopment Analysis (DEA) Windows Analysis. It is important to individually reassess the effectiveness of these ratios so that an establishment of their contribution to research can be made (Thanh Pham Thien Nguyen, 2015, pp. 520-521).

Inventory turnover ratio is currently effective is determining how fast the inventory is being sold annually. Procter (1994) p. 41-42follows to explain that the method is less spread across UK due to its inhibitive nature to hinder manufacturing (Procter, 1994, pp. 41-42). On the other hand, empirical evidence exists that the Inventory turnover ratio is significant way of financial analysis (Mohammed Omran, 2004, pp. 84-89).

 

In the findings of a study that uses mathematical expansions to determine the relationship between marketing policies and profitability, receivable turnover ratio is found a significant method of financial analysis. Data of credit sales and accounts receivables was used from a set of UK companies to substantiate this claim (Yoram C. Peles, 1982, pp. 20-21).  Britney (1980) p. 200 agrees that the ratio within the context of a sizable company is useful. He describes it a reasonable way for managers to measure the value of working asset. However, she warns that entrepreneurs must interpret comparisons safely. (Britney, 1980, p. 200).

Britney (1980) p. 200 further credits yet another efficiency ratio. She says that there is no better way for managers to understand the producutvity of their other than through using th asset turnover ratio. However, Manuel J. Rocha Armada (2012) p. 70  tries to assess the efficiency of wealth to income ratio. He identifies that first the turn over ratio is a failed mission, especially in forecasting risk premium (Manuel J. Rocha Armada, 2012, p. 70). Unlike profitability ratios, efficiency ratios have proven their importance in financial analysis.

3. Liquidity Ratios

According to Francis (1999) p. 210  liquidity ratios helps to calculate the ability of a firm to pay short-term loans. The higher the value of the ratio the safer the company is in clearing its current liabilities. The ratios include the current ratios, quick ratios and the operating cash flow ratio (Francis, 1999, p. 210). However, Mohammed Omran (2004) p. 89 observes that some analysts prefer to use the current assets in calculating the liquidity ratio of a company, arguing that such property would be quickly turned to pay up the existing liabilities. Bankruptcy analysts and mortgage analysts like to use liquidity ratios to determine if a company can pay its loans. The report mortgage analysts give crucial as it stamps whether the firm can be a going concern or not (Mohammed Omran, 2004, p. 89). In addition, management needs to check the liquidity of the entity continuously. Failure to do this may make them fall into the trap of making huge profits yet not be able to pay their creditors. Liquidity ratios are therefore one of the most important key forms of ratios used in financial analysis. The whole process of analysing statements cannot be succesful without liquidity ratios.

4. Gearing Ratios

The gearing ratios compare the owners’ capital with the borrowed money (Higson, 2000, p. 14). In the text, the author emphasizes that to show a firm’s strength is equally important as it would give the directors the moral authority to compete strongly in the market. Beattie (2002) p. 7 starts her argument by recognizing that capital is inclusive of ordinary shares and the balance in the current account. She recognizes that gearing ratios are simple but give the health status of financials in a company. The investment part combines both long-term loans and overdrafts. However, a firm is barely able to measure up in the market if most of its financing is generated from loans. On the other hand, if the investors ensure that their operations come from own pocket only, they stand a greater chance against the competition. (Beattie, 2002, p. 7). Higson ( 2000) p. 14 and Beattie (2002) p. 7 quite agree on the fact that inspite of gearing ratios not being popular with scholars, evidenced from few scholary materials about the ratio, the method of financial analysis is reliable for financial analysis. In a nut shell, gearing ratios are useful ways of analysing financial information.

5. Cash Flow Ratios

The cash flow ratios indicate how well liabilities are covered in the cash flow statement. Andreea (2014) p. 55 identifies weaknesses in cash flow ratios arguing that the cash flow in itself is not a complete and reliable source of finacial informaton. Cash flowing from operations is preferred while calculating cash flow ratios as it hits the cashbook on a daily basis for some entities. For the institutions that have a lower frequency of cash flowing in, then it almost as always is in massive amounts (Andreea, 2014, p. 55). However, Thanh Pham and Thien Nguyen, (2015) p. 518  further state that a contradicting approach proving that if the cash is not as much as expected, then the ideal situations prove that the business cannot pay up its current loans from the part of cash flow that has the highest turnover (Thanh Pham Thien Nguyen, 2015, p. 518). The implication of the study is that the cash flow ratios are inadequate methods of financial analysis.

6. Investor Ratios

A simple method described by Alice C. Lee (2009) p. 16 states that Investors need an indicator to help them invest in one stock and not in another. The aim is to know the earnings per share. The total profits divided by the number of ordinary shares gives a figure of earnings per share. Therefore, price to earnings ratio shows the price of each share based on the future valuation of the share. The investor then pays more for a share anticipating that the stock will fetch more money in the future (Alice C. Lee, 2009, p. 16).

Nevertheless, in a study to investigate different investor proxies, Gianluca Mattarocci, (2013) p. 326 notes that online search frequency for company’s information is more reliable than the over-emphasized investor ratios. The ratio only determines how much an investor is paying for every unit of money sold in as sales of a company. Again the ratio is merely an indicator. More ratios include debt to equity ratio, dividend yield, and price to book ratio, payout ratio, and current ratio (Gianluca Mattarocci, 2013, p. 326). Therefore, investor ratios are only useful to the extent of stock and capital evaluation. They require other methods of financial analysis, like the gearing ratios for a comprehensive report in analysis of financial information.

Pros and Cons of Financial Analysis

Jae K. Shim (2007) p. 125 strongly believes that at face value the process of distributing financial statements to get meaningful information is all through advantageous. However, he notes that a keener look at the issue reveals that the process as a whole has some downsides. These negatives are necessary to discovering if there is going to be a fair evaluation of financial analysis (Jae K. Shim, 2007, p. 125). In the text, he identifies the following advantages

Pros

1. Economic analysis places most interest on relevant data in simple form at a glance. An observer can evaluate a company by looking at computed numbers instead of going through all financial statements
2. Evaluating financial statements assist in analysing the trends of business. The process constitutes comparing one company to another over a period. Comparisons are vital because they create a competitive environment especially among enterprises in the industry.
3. Ratios break down the financial statements. Financial statements in their raw state can seem like single figures in the eyes of the public. However, taken through analysis, the public can appreciate the field of finance and accounting.
4. Finally, financial analysis helps in comparing companies of different sizes. The trends of large organisations are dissimilar to those of smaller ones. Comparing the two kinds of entities is practically impossible if one is using only the financial statements. However, if done on the platform of ratios, the accurate picture of individual companies is seen. It is common to find that small and medium term enterprises perform better financially than the large organisations.

However, Gill (1992) p. 116 argues that there are hidden disadvantages that an entity finds when relying on analysing financial statements using various rates.

Cons

1. Different companies are established in various industries which translate to having an array of environmental factors, thus making the comparison a difficult task. In fact, there are different approaches to approaching financial preparations. The difference in nature of business and accounting policy and principle applying to each form of business makes it cumbersome to access data of the same type in one business form (Gill, 1992, p. 116).
2. Estimates and assumptions affect financial information unpleasantly. Important decisions are made based entirely on the interpretation of the financial statements. Estimates are not the best figures to place one’s hope on. The average values used in computing numbers to use in the ratios have the effect of increasing the standard error of data. The further from the mean figure an item is the more misleading it becomes in the application.
3. Ratio analysis is primarily historical while commercial users are more interested in the future and current situations. The main aim of conducting analysis is to predict the future trends of the company. As much as studying the historical background of a company’s financial position plays a dynamic role in predicting the future it is insufficient just to rely solely on it. Surprises may occur, as they often do due to the unpredictability of economic situation.
4. Viscion ( 1977) p. 7 adds that the data are based on the market at a point which variable depends on the market (Viscione, 1977, p. 27). As a result, the management should not be quick to think that the analysis for one year will reflect in the future.

Discussion of Business Valuation Methods

From a wide range of literature, there are three business valuation methods, namely net assets or equity, market capitalization and price earnings method. Each of these methods carries their advantages and limitations described by various authors.

Equity Method

Harrington (2004) p. 101-103 defines the equity method as the process of determining the net worth of a company is mostly done by looking at the company’s net assets after liquidating all assets and paying off all debts. The values of assets and liabilities are extracted from the most recent financial statements. Therefore, most of the setbacks of financial statement analysis are transferred to this method of valuation (Harrington, 2004, pp. 101-103). Britney (1980) p. 196  also discusses financial analysis, equity method stating that unlike in other methods of valuation, it is impossible to present the value of loyal customers, intellectual workforce, and strength of the brand and the capability of research in the financial statements. In his book, Corporate Financial Analysis: In a Global Environment, the author explains that significant factors cannot be put in monetary terms, yet they hold any entity together if progressive revenue is going to be achieved (Britney, 1980, p. 196). In conclusion, the advantage of using equity method of valuing a company is that it is straight forward. However, the shortcoming in using this method is that it only values the equity side of the investment thus becoming a biased level.

Market Capitalization Method

An alternative way of valuing an institution that Harrington (2004) p. 101-103 described is that of determining the value of a company’s share at the stock exchange. This is an active approach as it looks at the investor’s willingness to buy the stock at the current price being offered. The underlying assumption here is preceding one use of money to buy shares. The implication is that the share value is at its best according to the investor’s judgement. The investor is thought to be rational, basing his decision to buy the stock upon assuming that the business will increase the value of that share.

Abdolmohammadi (2005) p. 42 identifies that the only setback here is that this kind of valuation only favours the investors, failing to consider other parties interested in the same information. In the study where the analyst seeks to find out the effect of intellectual capital on market capitalisation, also mentions that the market value of business mostly stays on one aspect of assessment. It is therefore important to provide an overall review template of the company’s value (Abdolmohammadi, 2005, p. 42). In a nut shell, the advantage of market capitalization is that it is the simplest method of determining the worth of the market in the market. However the downside is that market capitalization only covers the shareholders’ interests leaving out the debt holders.

Enterprise Value Method

In his book, Harrington (2004) p. 101-103 continues to describe a method that incorporates debt holders of the firm as well as the shareholders. This is the business value method of the firm. The underlying assumption in this one is that the total value of a business is the value relating to the equity holders and debt holders. The formula applied is:

 

Directly from the formula, if investors want to buy the company, they will do so with full knowledge of the commitment that they are going to carry.  However, in the methods described earlier, the investors only hold partial knowledge of the firm. The enterprise worth formula includes both the shareholder’s personal interest as well as the debt holders’ personal interest.

Free Cash Flow Model

Tudor Spencer (2005) p.63 describes the free cash flow model that assumes a company should pay all its debts using money coming from operations. The formula can be used to determine free cash flow in an entity (Tudor Spencer, 2005, p. 63). One can apply either of them depending on the information available.  However, as described earlier by Andreea (2014) p. 55, cash flows are inherently weak in determining ratios. In that case, they are also weak in determining the value of a company in the market.

In conclusion, financial analysis is relevant in more ways than one in evaluating the value of a company. The financial statements are inadequate while it comes to gauging the performance of a firm. The most important thing is to understand how the invested capital is doing regarding revenues collected (Gibson, 2012, p. 145). The methods of financial analysis are so useful that they reveal which department heads are not playing their roles as it ought to be. The operations of a business should tend to converge to perfection if maximum profits are to be made.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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