Introduction as a part of financial statement analysis”.

Introduction

This
report will examine and critically evaluate the financial performance of the
Merchant Hotel in the financial year ending 30th June 2013. Key
findings from the profit and loss account and balance sheet will be explained
throughout this report, as well as the discussion of external factors which may
have had an impact on the business. New terminology will used throughout this
report and calculations can be located in the appendices at the end of the
report.

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Background of the Hotel

The Merchant Hotel based in Warning Street Belfast, was
formerly known as the headquarters of the Ulster Bank in 1877 when it was
built. However, it has since been developed into an AA5 Red Star Hotel, the
only hotel to achieve this status in Belfast. According to the (Merchant Hotel,
2017) the hotel is situated in “the heart of
Belfast’s mercantile and commercial centre”, an excellent location as it is
based right in the centre of the Cathedral Quarter, where guests will travel
from far to visit and stay. The exterior of the building is Italianate in style,
which derives from high Victorian architecture, thus portraying an image of
luxury. The hotel is owned by the Beannchor
Group and was first developed in 2006 by Bill Wolsey. According to (Discover
Northern Ireland, 2017), The Merchant
Hotel was awarded Hotel Accommodation of the Year at the Northern Ireland
Tourism Awards 2012. Moreover, it also achieved the award of Best UK Hotel in
the prestigious International Hotel Awards, thus highlighting its excellent
success achieved.  In addition, the
Merchant Hotel Limited is a private limited company which means that the
company’s shares can only be sold to friends and family.  

 

The Academic Importance of
Ratio Analysis

Williamson et al. (2005, p.85) depicts that “Ratio analysis is used for various purposes and by
organizations as a part of financial statement analysis”.  Ratio analysis
highlights a business’s financial performance through quantitative data.

According to (Atrill and McLaney, 2008), calculating ratios
can give you an insight into the performance and position of a particular
business thus are extremely beneficial.  Moreover,
ratios are not hard to calculate however they
may be difficult to interpret; therefore further analysis must also be carried
out. For example, ratios can highlight the financial strengths and weaknesses
of a business; however they cannot offer an explanation. Singh and Schmidgall
(2002) agree with (Atrill and McLaney, 2008) highlighting
that financial ratios are essential to industry managers as they enable the
analysis of data in order to come to a decision. There is a variety of performance
indicators which will be discussed throughout this report with regards to The
Merchant Hotel accounts.  

These
include namely:

 

·        
Profitability

·        
Efficiency

·        
Liquidity

·        
Financial
gearing

 

Justification of the choice
of Performance Indicators

“A performance indicator is a selection, or combination, of
action variables that aims to define some or all aspects of a performance.
Clearly, to be useful, performance indicators should relate to successful
performance or outcome.” (Hughes and Bartlett, 2002). Moreover, (Graham and Harris, 1999) share similar views depicting that performance
indicators aid in the evaluation of past performances and enable the planning
of future decisions. The particular performance indicators mentioned previously
were chosen as they were the ones that were available for the author to examine
and interpret. Moreover, they also give a vast insight in the Merchants
accounts and allow for in depth analysis with regards to statistics.

 

Commentary on the findings

According to Beatham et al. (2004),
businesses measure their performance in financial terms, profit, and turnover.
This is also the case with regards to the Merchant Hotel. However,
Brander-Brown and McDonnell (1995) place emphasis on both the financial and non
financial performance indicators which give a more detailed picture of the
business. Therefore both internal and external factors which affect the
Merchant Hotel must be considered in order to reflect a true picture of the
hotels financial situation.

 

Profitability Ratios

Adedeji (2014) highlights that, the use of profitability
ratios aids in the determination of a company’s profitability. This information
allows managers to analyse and evaluate their business with regards to their
finances.

 

Gross Profit

Gross profit can be calculated by subtracting cost of sales
from sales revenue (Atrill and McLaney, 2008). This ratio allows a business to
see how much profit they are making for every £1 of turnover. As calculated in
Appendix 1, the Gross Profit% in 2012 was 80.73%.
This increased to 81.09% in 2013 with an overall increase of 0.36%. Sales
revenue increased by £757,616 from 2012 to 2013 meaning an increase of 7.4%.
Therefore, overall Gross Profit increased by £650.000 between 2012 and 2013. These
figures show that the Merchant Hotel maintains a high gross profit margin
indicating that they are in good financial health. According to (Novy-Marx,
2013), businesses with a high gross profit margin tend to be the most
successful in the industry. This therefore emphasises the Merchants efficiency
and ability to increases its sales.

 

Net profit

Net profit is calculated by subtracting the total revenue from the total expenses.

With regards to Net Profit in 2012, the Merchant had a
negative figure of -108.20% as highlighted in
Appendix 2. This then increased in 2013 to 2.96%, thus depicting a Net Profit
difference of 111.16%. From 2012 to 2013 Net Profit increased by £11,314,859
which is a dramatic increase in just one year. This may have been due to the
recession which occurred in 2012 which had a major impact on businesses
throughout Belfast. This resulted in a loss of value in its tangible assets
accounting for 11,702,245. Moreover in 2013 hotel’s alcohol licence also
decreased in value to 140,000 as a result of depreciation.

                            Additionally, the
reasoning behind this negative net profit figure in 2012 may be due to the flag
protests which occurred in Belfast City Centre in December. This protest will have had a negative impact on The
Merchant Hotel’s net profit as its location is a short eight minute walk from
Belfast City Hall. Moreover, according to the (BBC, 2013) this flag
protest cost businesses between £10 million and
£15million, with potential to cause even more damage to businesses financially
in the future as a result of the discouragement by potential investors and
tourists.

 

Return on Capital Employed
(ROCE)

This
ratio measures the amount of profit generated by a business efficiently as a
result of its capital employed (Atrill and McLaney, 2008). Due to external factors affecting the profitability
in 2012 the return on capital employed was very low averaging at -514.44%.
However, the Merchant improved this dramatically in 2013 as figures rose to
21.39% as shown in Appendix 3. Although this is not a great amount of ROCE,
information from 2013 highlights that shareholders are receiving some form of
return on their investment. This increase in ROCE from 2012 to 2013 may
be due to the Merchant Hotel reducing its costs
or increasing its sales. As a result of their substantial loss of net profit in
2012 as a result of the Flag Protest etc, the hotel may have made the executive
decision to advertise special offers in order to attract customs and increase
its revenue income to make up for the loss made previously.

 

Efficiency ratios

Efficiency ratios measure how well a company can use its assets and
manage its liabilities effectively. The ratios which will be discussed in this
report include stock turnover, trade receivables, trade payables, sales revenue
per employee and also the average staff salary.

Stock turnover

This ratio is calculated by dividing the cost of sales by the
average stock held.

When comparing the stock turnover of the Merchant Hotel in
2012 and 2013, it can be seen from Appendix 4 that the turnover was quicker in
2012 by one day. In 2012 the stock turnover took a total of 35.2 days whereas
in 2013 it took 36 days.

Atrill and McLaney (2006) highlight the importance of stock
and the time taken to turn it over in order to make a profit. Therefore the
quicker the Merchant turn their stock over the better. In order to improve
their stock turnover they could offer discounts in order to aid in the selling
of stock which is not as popular. This would then result in the increase of
their gross profit.

 

Trade receivables (Debtor
Payment Period)

This financial ratio measures the length of time it takes for
money owed to the business to be collected from its debtors. As shown in
Appendix 5, with regards to the Merchant Hotel in 2012 it took an average of 74
days in order to collect money owed to the business. This is a disadvantage to
the Merchant as it is such a long period of time and the longer it takes
someone to pay their debts, the less likely it is that they will pay it. Moreover,
the company which owes the Merchant money could go into administration which
would result in the Merchant losing out on capital. However in 2013 the hotel
were able to collect the money owed to them in a much shorter period of time
averaging out at 47 days. This is a great improvement for the Merchant as it
minimises the risk of them not receiving the money owed to them.

 

Sales revenue per employee

This ratio highlights how much each employee contributes to
the business on average. From the calculation carried out in Appendix 6, it can
be seen that in 2012 each employee contributed £33,637. In 2013 this increased
to £35,790. This is advantageous to the Merchant as high revenue per employee is
a positive sign suggesting that they are finding ways to gain more revenue from
their staff. Jafri (2010) depicts that innovative behaviour of employees and
independent thinking is the key to many successful organisations. Therefore it
would be beneficial to the Merchant Hotel to take time to train their staff particularly
focusing on up selling, in order to make more profitable sales per employee.

 

Average staff salary

From the directors’ report it can be seen that in 2012 there
were 302 employees working within The Merchant Hotel. In 2013 this increased to
305 employees. The overall average that each employee received in 2012 totalled
to £15,194.5 where as in 2013 the average was
£14,876. However, the directors’ report did not disclose if the employee’s were
paid on an hourly basis or if the employees were part or full time staff. This
undisclosed information may have gave an explanation as to why the average
salary was higher in 2013 compared to 2012, even though there were more members
of staff working within The Merchant Hotel in 2013. Moreover, this reduction in
staff salary may be due to the management being more efficient in that they
sent employees home during quieter periods or by reducing the number of staff
in work during the week when it tends to be less busy.