Financial position analysis of Northern Foods

Aims and Objectives

Our main aim as a group of three was to analyse the financial position of a public limited company through ratio analysis and cash flow analysis. We chose to analyse Northern Foods plc because we felt that choosing a manufacturing company with perishable goods would be more interesting, as opposed to a standard retail outlet.

From this analysis our objective was to construct a clear, reflective and detailed report of our chosen company's financial situation. From this we hoped to improve knowledge and understanding of cash flow and ratio analysis.

Research Methodology

The majority of our data was collected from a hard copy of the company's annual report 2008/2009. This was acquired through emailing the Northern Foods enquiries, requesting a copy to be delivered. From the annual report we studied the statement of financial position, consolidated income statement, statement of cash flow and the notes to the accounts for our analysis. Our secondary source of information was the Financial Reporting 2 Handbook, which we used to calculate and understand what the ratios showed. Another source of information we used was the company's website, From here we used the company's mission statement and main aims to determine what direction Northern Foods was looking to go. These aims were also used to analyse the performance of the company during the financial year of 2008/2009. The final source of information we used was the London Stock Exchange website ( From here we found the historical market price of the shares in Northern Foods so that we could calculate the Price Earnings Ratio at the year ended 28 March 2009.

Brief History and Introduction to Northern Foods

The company was established as small business in 1880 in the form of a dairy farm. In 1956 the business became a public limited company and changed its name to Northern Dairies. As the company expanded through the 1960s it diversified its products to that outside of a dairy, resulting in a name change to Northern Foods plc in 1972. The company then went on to acquire businesses such as Bachelor's and Fox's Biscuits. Over the decades the company has tried to stick with the trends of the food market. As a result of producing food for highly reputable companies, 75% of the customers are supermarkets, such as Asda, Tesco and Morrisons.

Business Aims

Northern Foods had a main aim to create the highest rate of sale in their chosen market. The fact that they want to become the biggest retailer in their market shows that they are an ambitious company, willing to spend time and money on their services. The secondary aim of the company was to invest heavily in growth to maintain a strong and balanced business.

In trying to achieve their aims and objectives, Northern Foods hope to minimise its impact on the environment and follow all legal obligations. They also wish to maintain good Health and Safety in the workplace to "become the best in class" for health and safety in their market. Board meetings are held daily, weekly and monthly in order to ensure that this high standard is maintained.

Ratio Analysis

Ratio analysis is used widely by many companies and businesses across the globe. It helps businesses make decisions on future policies and helps to determine aims and objectives for the future. Not only is it used by the business itself, ratio analysis helps the seven stakeholder groups, including investors, suppliers and the government, to make decisions outside of the business. For example, investors will be using the return on long-term capital to see if the business is a worthwhile investment.

There are three main categories that ratios fall into, these are; profitability, working capital & liquidity and gearing.

Advantages of Ratio Analysis

There are many different advantages to ratio analysis such as:

  • You can compare ratios to past years results for internal evaluation and act on that.
  • You can also compare competitor's ratios to see how the business is coping in its market and whether or not it is performing well.
  • Ratios are quick and easy to calculate so a business doesn't have to spend a long time writing them up. They can also be done by anybody with a bit of business knowledge, so fully trained accountants are not needed to calculate them.
  • Widely recognised as a way of analysing performance.

Disadvantages of Ratio Analysis

There are also many different disadvantages of ratio analysis:

  • One ratio on its own cannot be used as you need the full picture or something to compare them with to be able to analyse them properly.
  • The ratios can be easily manipulated or window dressed by spreading assets or liabilities to other businesses related to them, making the ratios performance seem better than it actually is.
  • Ratios are a snapshot and only reflect the moment in time that they are taken.
  • Ratios are calculated from a previous years accounts and are therefore historical and not a picture of the present.
  • Ratios also don't take into consideration the time value of money such as inflation and exchange rates if trading overseas.

Profitability Ratios

Gross Profit Margin

The gross profit margin is the first measure of profitability used in ratio analysis and only takes into account the trading activities. It is used to show how much gross profit the company earns for every £1 of turnover they take.

Gross Profit Margin % = (Gross Profit/Turnover) x 100

Net Profit Margin

The net profit margin is the same as the gross profit margin except it uses the net profit before tax and interest rather than the gross profit, so it takes into account the operating activities of the company. This ratio is used to show how much net profit the company earns for every £1 of turnover they take before paying interest and tax.

Net Profit Margin % = (Net Profit before Interest and Tax/Turnover) x 100

Return on Long-Term Capital

The return on long-term capital ratio is one of the three ratios that come under the bracket of return on capital employed. The ratio incorporates the long-term loans that the company has taken so that the return percentage reflects all of the long-term financing in the company. It is used to show how much net profit before tax and interest has been made for every £1 of the loans, share capital and reserves invested into the company.

Return on Long-Term Capital % = (Net Profit before Interest and Tax/Loans, Share Capital and Reserves) x 100

Return on Shareholders' Capital

The return on shareholders' capital ratio is another of the three return on capital employed ratios. This ratio only takes into account the share capital and reserves of a company, and discards the loans as they aren't share capital. This ratio is used to show how much net profit has been made for every £1 of share capital and reserves the company has.

Return on Shareholders' Capital % = (Net Profit after Tax/ Share Capital and Reserves) x 100

Return on Equity Capital

The return on equity capital ratio is third and final of the return on capital employed ratios. This ratio is used to calculate the return on investment for ordinary shareholders only, rather than all shareholders. This is only feasible when there are preference shares in the company, which in the case of Northern Foods, means this ratio is the same as the return on share capital as there are no preference shares.

Return on Equity Capital % = (Net Profit before after Tax and Preference Dividend/Ordinary Share Capital and Reserves) x 100

Return on Gross Assets

The return on gross assets ratio is used as an alternative to the various return on capital employed ratios. It shows how much net profit before interest and tax has been made per every £1 of assets that the company owns.

Return on Gross Assets % = (Net Profit before Interest and Tax/Total Assets) x 100

Gross Profit Margin

As is evident from the summary of ratios, the gross profit margin has dipped by 2.9% from 2008 due to a declining gross profit and increase in turnover. This is mainly due to the restructuring of company production lines that would be classed as direct costs, which has a negative effect on the cost of sales. This is evident because the gross profit margin before exceptional items (restructuring) for 2009 is 0.04% larger than the corresponding margin from 2008. Therefore, the £31.3m of restructuring is the only reason for the decrease in the margin.

In relation to the rest of the industry, even after restructuring, Northern Foods seems to have a healthy gross profit margin. Cranswick plc also offers a wide range of food products and their gross profit margin for the same period was at 14.07%. So a gross profit margin of 17.85%, although in comparison to 2008's figure is poor, is still above that of a competitor in the same market, which reflects good profitability.

Net Profit Margin

The net profit margin for Northern Foods for 2009 had a severe decrease of almost 3% in comparison to that of 2008. However, as with the gross profit margin, restructuring of the company is the major factor for this drop as it was equivalent to the value of approximately 60% of the net profit before tax and interest. Before restructuring, the net profit margin for 2009 had actually increased by 0.21% on 2008's value to 5.4% (see appendix 2) which shows improving profitability had the directors decided not to restructure.

In comparison to Cranswick plc, the net profit margin is 0.93% lower for the corresponding year before restructuring, and a very concerning 4.56% lower after restructuring, although this is because Cranswick plc did no restructuring during the financial year ended 30 March 2009.

Return on Long-Term Capital

The return on long-term capital for 2009, like the profit margins, has also suffered from poorer performance in comparison to 2008. There was a decrease of exactly 5% to 5.23% for 2009, which is because of the lower profit for the year. As with all of the profitability ratios, restructuring has affected the ratio drastically, with 2009 having a better return by 4.59% (see appendix 3).

This increase has come about because the net profits before restructuring, interest and tax for both years are only £4.3m apart but the total long-term capital for 2009 was down by £95.9m, mainly due to the massive increase in accumulated deficit which is because of a £103m loss on benefit schemes. This means that the return would be much worse had the company broken even and the accumulated deficit not changed.

Return on Shareholders' Capital (Return on Equity Capital)

From all of the profitability ratios, the return on shareholders' capital was the one that changed the most. For 2009, the return on shareholders' capital was 4.62%, compared to 20.86% in 2008 which is a drastic change of 16.24%. There were two reasons for this drop rather than just one in previous profitability ratios. The first is the restructuring of the company, because before any restructuring in 2009 the return was at 52.5% compared to 23.22% which is more than double the return (see appendix 4).

The other reason is the taxation that the company received. In 2009 there was a one-off payment of £12.5m due to the changes in legislation of the industrial buildings allowance regime. Ignoring this movement on deferred tax, the result for 2009 would be a return of 27.73% (see appendix 4), which is an increase of 4.51% from 2008. This actually shows an improvement in this area, mainly due to the huge deficit change explained in the return on long-term capital analysis above.

The return on equity capital is the same as the return on shareholders' capital for Northern Foods plc because they have no preference shares in their capital structure.

Return on Gross Assets

The final profitability ratio is the return on gross assets. Northern Foods suffered a decrease of 3.6% which again shows that they performed poorly in 2009 compared to 2008. The restructuring of the company has had an effect on this ratio though, as it has done with all of the profitability ratios. Before restructuring, Northern Foods had a return on gross assets of 8.28% for 2009 compared to 7.08% in 2008 (see appendix 5) so the return improved if the restructuring is ignored as a one-off payment.

Gearing Ratios

Debt Equity Ratio

The Debt/Equity ratio of 530.3% for 2009 suggests that the company is highly geared. The large change from the 2008 ratio of 158.3% is representative of a rise in loans, up from £261.9m in 2008 to £286.9m in 2009. The change in the ratio is also explained by a drop in equity, down from £165.4m in 2008, to £54.1m in 2009. The main change in equity comes from Accumulated Deficit, which has dropped to minus £151.7m, compared with the minus £30.7m of 2008.

Proprietorship Ratio

The Proprietorship ratio of 8.5% in 2009 suggests that the company's shareholders are financing only 8.5% of its assets, with the rest being financed by loans and trade payables. The change in the ratio from the figure for 2008, 24.2%, shows that either the total assets have grown, or the amount of share capital has lowered. As with the last ratio, the main reason for the difference is the large change in the Accumulated Deficit, with total assets also falling slightly from £682.4m in 2008, to £636.8m in 2009.

Interest Cover Ratio

The Interest Cover ratio of 0.29 times in 2009 suggests that the company does not have enough profit to cover its interest charges. The ratio is very low, which could affect the company's chance of getting loans in the future. The change in the ratio, from 0.76 times in 2008, is mainly caused by a drop in profit before interest, from £43.7m in 2008, to £17.3m in 2009.

Earnings per Share

The earnings per share ratio of 0.54p per share in 2009 suggests that each share has earned a profit of 0.54p in the year. Compared with the 2008 figure of 7.08p per share, this shows that the profit each share will provide has dropped significantly. This is due to the drop in profits for the year, as there has been no change in the share capital since in the year.

Cash Flow Analysis

The Statement of Cash Flow is a financial statement that shows the cash inflows and outflows of a business. It will show the business whether or not they have enough cash at the end of the year to invest in growth or other parts of the company. It is more important than a consolidated income statement because if a company doesn't have cash it cannot survive.

Advantages of Cash Flow Analysis

There are a number of advantages to cash flow analysis including:

  • As it is dealing with pure cash and not things like depreciation it is easy to understand to a non-accounting minded person.
  • Shows the liquidity of a company showing if it has enough money to pay off debts.
  • Because it only deals with cash, the statement of cash flow is an up to date analysis of the position of the business.

Disadvantages of Cash Flow Analysis

There are also a number of disadvantages of cash flow analysis:

  • Cash Flow is historical and therefore can't be used as a forecast.
  • By the time it is published many more cash transactions will have taken place throughout the business, resulting in the data being misleading.
  • Two different methods to producing a statement of cash flow. This makes them harder to compare with previous or other companies.

Northern Foods Plc Cash Flow

Net cash from operating activities

Profit from operations was down from £43.7m in 2008 to £17.3m in 2009. The company's impairment in property, plant and equipment increased by £22.5m from 2008 to 2009. This is a result of the amount spent on restructuring the business, making the facilities better. The operating cash flow before movement in working capital and special pension contributions was down by £3.3m over the two years also due to the restructuring of the business.

In 2008 Northern Foods paid out £22m on its pension scheme. However in 2009 it didn't pay any sort of pensions, this resulted in the cash flow from operating before movement in working capital increasing by £18.7m over the two years. The movement in trade receivables decreased by £6.5m to a loss of £2.8 and movement in trade payables was almost halved to £8.5m from £16.8m. This shows that they have paid £8.5m of their debts off. This led to a net cash from operating activities of £54.1m in 2009, compared to £32.5m in 2008.

Investing Activities

Northern Foods spent £9.5m more on fixed assets and equipment in 2009 as part of the restructuring programme. In 2008, the company expanded by acquiring Baxters Food Group for £22m. The company received cash of £15.9m in 2008 through proceeds of sale of property, plant & equipment, disposal of trading investments and receipt of deferred consideration, whereas in 2009 the company didn't receive any of this cash inflow. These transactions resulted in Northern Foods having a net cash used in investing activities of £29.9m, £3.9m more than that in 2008.

Financing Activities

In 2008 the company gained £45m in revolving credit facility from 2007, meaning that they borrowed more. In 2009, however, the company paid off £15m of this credit facility from the year before. This resulted in a £60m difference in cash between the two years, contributing to the low net cash used in financing activities. Another factor that led to this low figure was the purchase of more than double the treasury shares bought in 2008, in preparation for future investment. Dividends for 2009 were consistent with those for 2008, with the company paying £20.7m for the year, only £0.3m less than in 2008 despite the heavy spending on restructuring. This could be to keep the shareholders interested in the company.

Cash and Equivalents

The net cash and equivalents at the start of the period for 2009 was £72.9m, which was an increase of £24.7m on 2008's figure. Taking all of the transactions into account, the net cash equivalents at the end of the financial period for 2009 was £50.9m, compared to £72.6m in 2008. A major influence on this difference came from the payment of bank loans, overdrafts and loan notes which increased from £0.3m in 2008 to £9.9m in 2009.

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