Principles of Business Accounting

Sample Answer

Financial Analysis and Interpretation of Debenhams Plc

Introduction and Background

Debenhams Plc was a well-known British multinational retailer operating department stores across the United Kingdom and other countries. Established over two centuries ago, it became a household name for fashion, beauty, and home products. However, in recent years, Debenhams faced financial difficulties due to increased competition, changing consumer behaviour, and economic pressures such as Brexit and the COVID-19 pandemic. The company eventually went into administration, and its assets were bought by online fashion retailer Boohoo. This report evaluates Debenhams` financial performance using various accounting techniques, including ratio analysis and financial statement reviews, to determine whether it would be a good investment.

Vertical and Horizontal Analysis

Vertical Analysis (Profit and Loss) In vertical analysis, each item is expressed as a percentage of revenue. For Debenhams, the cost of sales consistently made up a high percentage of revenue, reducing gross profit margins. Operating costs also remained significant, reducing operating profit.

Horizontal Analysis (Profit and Loss) From year to year, Debenhams showed declining sales revenue and profit margins. Revenue decreased by around 5% in the latest year reviewed, while net profit turned into a net loss. This trend indicates weakening performance.

Horizontal Analysis (Balance Sheet) Assets, particularly fixed assets and inventories, decreased over the last two years, while liabilities remained high. This imbalance contributed to poor liquidity and increased financial risk.

Financial Ratios Analysis

Profitability Ratios

• Gross Profit Margin = Gross Profit / Revenue Indicates how efficiently a company produces goods. Debenhams` gross margin was declining, reflecting pressure from discounts and sales promotions.

• Net Profit Margin = Net Profit / Revenue This ratio was negative in the latest year, suggesting the company was not making a profit after all expenses.

• Return on Capital Employed (ROCE) = Operating Profit / Capital Employed ROCE was low or negative, showing poor return on investment.

Liquidity Ratios

• Current Ratio = Current Assets / Current Liabilities The current ratio was below 1, indicating the company may struggle to pay short-term debts.

• Quick Ratio = (Current Assets - Inventory) / Current Liabilities This was even lower, highlighting liquidity problems.

Efficiency Ratios

• Inventory Turnover = Cost of Sales / Inventory Inventory turnover declined, suggesting slow-moving stock.

• Receivables Collection Period = (Receivables / Revenue) x 365 The collection period increased, showing delays in receiving payments.

Gearing Ratios

• Debt-to-Equity Ratio = Total Debt / Shareholders` Equity Debenhams had high gearing, meaning it relied heavily on borrowing. This increases financial risk, especially in times of low profits.

• Interest Cover Ratio = Operating Profit / Interest Payable This ratio was very low or negative, meaning Debenhams struggled to cover interest payments.

Investment Ratios

• Earnings per Share (EPS) = Net Profit / Number of Shares EPS was negative, signalling a loss per share.

• Dividend Yield = Dividend per Share / Share Price No dividend was paid in the latest year, which may discourage investors.