Financial Statement Analysis at IHG
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Table of Contents
Financial statements are not to be taken on their face value. Often, it is not enough for a shareholder, and other stakeholders, to simply look at the financial statement figures provided by the management in making the decision whether a company is worth investing in (Prentice-Hall, Inc., 2001). For instance, while a company might post higher than normal profits, these returns could be driven by the purchase of more assets. Therefore, an investor needs to ask himself whether the company is efficient in its use of assets implying the need to query what the management is doing with the resources available. To achieve this goal, an analysis of financial statements is a prerequisite. This is because it links items from different financial statements to come up with a complete illustration of how well the firm has performed over the current period as compared to previous years. The aim of this paper is to conduct a financial ratio analysis on the financial statements provided to the shareholders of Intercontinental Hotels Group (IHG) over the 2012/2013 period. Performance over this period will be compared to the 2011/2012 financial year so as to arrive at a conclusion on how well the group has performed over the two periods.
The IHG is a high-end hotel group and one of the largest hotel groups in the world. Launched as a single hotel in Brazil in 1946, the group has grown to over 4,700 hotels spread across the globe (Intercontinental Hotel Group, 2014, p. 5). These establishments are spread across one hundred countries under nine different brands that include the intercontinental and Crown Plaza brands. Currently, IHG operates on a management and ownership model where it manages most of the hotels operating under its brand, while owning very few of these establishments. Currently, the company is listed on both the New York Stock Exchange as well as the London Stock Exchange. Over the most recent reporting period, IHG posted gross revenues amounting to $1.9 billion dollars, making a gross operating profit of $668 million (Intercontinental Hotel Group, 2014).
The table below illustrates the ratios calculated in the course of a financial analysis of the accounting reports filed by IHG over a two year period.
IHG has divided its operations into different segments for reporting purposes. Geographically, the group has divided its operations into, Asia, Middle East and Africa segment, Americas segment, Europe, and Greater China segments. For operational purposes, these geographical segments are further divided along with the ownership structure of the group’s operations. Therefore, the arising operational segments are franchise, managed and owned and leased segments. Such a segmentation makes it easier to account for the various types of shareholders to whom the management is answerable. The tables under Appendices illustrates segmental information for each geographical and its respective operational segment.
Segmental information shows that the Americas region continues to show strong growth in terms of total revenue as it accounted for nearly half of IHG’s total revenue. However, Europe had a decline in revenue of $36 million while all other segments showed strong revenue growth. In terms of operational segments, hotels owned and leased by IHG had the highest revenue of all segments in greater china region. However, the AMEA region had hotels managed but not owned by IHG positing the highest revenues. Europe showed that ownership was not significant enough a difference to affect revenues while franchises had strong growth in the Americas region.
From these two tables, a number of deductions can be made. Over the 2012/2013, IHG saw a 3% increase of revenues as they rose from $1.8 billion reported in the 2011/2012 to reach $1.9 billion in the most recent year. At the same time, cost of sales increased by $12 million in 2012/2013 above the $772 million reported as cost of sales in 2011/202 financial period. These changes had a number of impacts on the profitability of the company. First, the gross profit margin increased from 57.93% reported in 2011/2012 to reach 58.8% achieved in 2012/2013 financial period. As a company that is heavily reliant of the intellectual and service capability of its employees, IHG has had to cut expenses incurred in developing physical facilities and the utilities that come with such developments (Liu, et al., 2013, p. 186). These cuts have seen the company’s operating profits increase from $551 million over the 2011/2012 period to $595 million in the 2012/2013 year. While these profits exclude exceptional items, the all-inclusive net profit before interest and tax rose from $547 million in 2011/2012 to $600 million in 2012/2013. This increase in profit led to an increase in the operating profit margin ratio that increased from 29% in 2011/2012 to 31% in 2012/2013 financial year. On an overall, the return on capital employed increased from 22% in 2011/2012 to 26% in 2012/2013 financial year.
As a result of increased profitability over the two reporting periods, IH reported increased efficiency in the use of its assets (Ahrendsen & Katchova, 2012, p. 262). Its asset turnover ratio was 0.19 in 2011/2012 year, while in 2012/2013, it rose to 0.22. This means that for every dollar of assets owned by the company, the management was able to derive sales of 22 cents in the latest financial period. Owing to increased profitability, IHG reported higher returns on the assets owned. This is denoted by the fact that the return on assets ratio increased from 16.89% in 201/2012 to 19.14% in 2012/2013. This means that for every dollar of assets owned by the company, the management was able to make three more cents in 2013 than it did in 2012 (Kaminski, et al., 2004, p. 21). This further illustrates the fact that the management at IHG is doing more in improving the company’s profitability using the scarce resources at its disposal. As a services company, IHG is not expected to turn over its inventory as many times as a company in the retail industry (Chadwick, 1984, p. 35). Over the 2012/2013 period, IHG was able to turnover its inventory at least once every two days. This is denoted by the fact that the inventory turnover period ratio was 1.86 over the latest period. In comparison, the same ratio was 1.89 in 2011/2012. This means that the company was not able to turnover its inventory as many times in 2013 as it did in 2012 (Drury, 1981, p. 24). This could lead to higher inventory storage. However, this was not reflected in the income statement, leading to the deduction that the increase was not significant enough to affect overall profitability.
To improve profitability, it would be expected that IHG would risk to have more receivables as well as payables in its balance sheet. This would lead to higher liquidity ratios that would be an indicator of higher risk of facing a liquidity crisis. This was the case over the last two financial periods at IHG. In 2011/2012, the company had a current ratio of 0.85 that means that its current assets only accounted for 85% of its current liabilities. During the 2012/2013 period, the current ratio was 0.75 which means that current assets accounted for 75% of current liabilities. It can be deduced that IHG had higher receivables over the most recent period, but they were not enough to cover for the increase in payables over the same period. The acid test ratio shows a complementary movement as it reduced from 84% in 2012 to 71% in 2013. As the acid test ratio is net of inventory, a decline points to higher risk of liquidity as company can only cover 71% of its current liabilities using its most liquid assets that are mainly made up of cash.
Higher risk of liquidity was also accompanied by higher gearing. In 2012, IHG had a gearing ratio of 41.22%, while in 2013, the company posted a gearing of 49.56%. This shows that its capital structure was made up of 41% debt and 49.56% debt in 2012 and 2013 respectively. Therefore, in 2013 IHG had a higher risk of liquidity and financial problems owing to its higher financial obligations in that year. Its debt to total assets ratio also increased from 90% in 2012 to 97% in 2013 showing that in the last financial period, debt made up 97% of total assets owned by the company. Higher gearing is often accompanied by higher interest obligations. As such, the interest cover ratio increased from 9.6 times in 2012 to 7.63 in 2013. This decline further proves that the company is more burdened with debt in 2013 than it was in 2012. It would be expected that higher interest commitments would lead to lower dividends thus the lower dividend coverage ratio (Estrada, 2005, p. 193). Therefore, IHG had a lower dividend coverage ratio in 2013 than it did in 2012 denoting that it would not pay as much dividends in the near future as it had over the previous years.
Accounting reports should be an accurate and faithful representation of the company’s performance over the reporting period (Deloitte Global Services Limited, 2014). While accuracy is a desirable quality of financial statements, one hundred percent accuracy is almost unachievable. This is because of the many small items that cannot be fully accounted for in full in a group’s financial reports. As such, the conceptual framework incorporates the materiality concept that states that those items that are large enough to have an impact on the decision made by stakeholders should be included in the financial statements (International Accounting Standards Board, 2014). As such, materiality is entity specific as what might be material for a multi-billion dollar company is not material to a company worth thousands of dollars.
Faithful representation serves to underline the importance of having an error-free reports (Deloitte Global Services Limited, 2014). As such, it is important that the management discloses information in a neutral manner that is complete as it is free of error (Deloitte Global Services Limited, 2014). As such, consideration must be given to those who can interpret financial numbers as well as those who need these numbers translated into words. Therefore, financial reports should be a representation of the economic status of the company in numbers as well as words to explain the numbers (Deloitte Global Services Limited, 2014).
In drawing up its financial statements, IHG has met the desired qualitative characteristics of faithful representation and accuracy. This is denoted by the fact that the company discloses in full all exceptional items that have been incurred in normal operations. Exceptional items such as audit fees have been shown in the notes to the accounts. The company’s management has also disclosed factors such as risk and any changes in the accounting policies adopted by the company. This is not only in compliance with accounting standards, but also a way of letting users of financial know about how different the current financial statements differ from those of the previous year.
Often, financial statements include items such as deferred tax that are not easy to understand for the general user of the statements. For these users, the company has made full explanations on how the figure has been arrived at matching the words to the numbers. This makes financial statements relevant to both the analysts and the average stakeholder who has not had a tight grasp of accounting concepts. Moreover, the management discussions and analysis section of the report gives all users how the management views the company’s performance in the future. This gives the accounting reports a predictive value as well as a confirmatory value useful to decision makers.
An in-depth analysis of financial statements is often a prerequisite before one judges the financial soundness of a company. Dividing the analysis along the lines of profitability, liquidity, gearing and investment gives the decision maker a sound background check on how well the company has performed over the desired financial period. This is taken a step further by comparing two financial periods. As one of the largest hotel groups in the world, an analysis of IHG provides a look into the health of the hospitality industry over the 2013 financial period. An overall profitability analysis shows that the company performed well as it kept its operational costs low while increasing its revenues. Efficiency ratios show that IHG was able to derive more use of its assets in the s2013 period compared to the previous financial year. This is shown by the fact that its asset turnover ratio, and return on assets ratio increased in the current period as compared to the previous financial year. However, increased profitability meant that the company had to borrow more to finance the growth. This is reflected in the gearing and liquidity ratios. The effect of more borrowing is that it placed more pressure on the returns to shareholders, as denoted by a reduction in dividend and interest covers.
In meeting the qualitative expectations of accounting standards, IHG has ensured that its financial statements are easy to read for the general public. The management matches numbers to words in a bid to explain exceptional items. Though these items are incurred in the normal course of business, deeper explanations of the largest and most material items enables decision makers arrive at that right conclusions as to the general direction of the company. It can be concluded that the financial statements from IHG meet the qualitative expectations as stated in accounting conceptual frameworks.
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Source: (Intercontinental Hotel Group, 2014)
Appendix 2: Segmental operations
|Owned and leased||141||138|
|Owned and leased||44||48|
|Owned and leased||140||198|
|Owned and leased||212||199|
Source: (Intercontinental Hotel Group, 2014)