Peyton Financial Analysis

Financial Accounting, first assignment

Question 1:

In order to assess Peyton’s recent financial performance, we had to consider that 2015’s revenue will be equally spanned over the year in order to compare periods of uniform length.

We can observe that Peyton’s net sales massively declined over the last two years with a drop of 19% between 2013 and 2014, and 13% between the projected year 2015 and 2014. With this decrease in sales, the negative impact in the gross profit is even stronger, which is common considering a classical cost curve. Those figures could be justified by the decrease in use of coal-fired power plants in the United States.

Moreover, SG&A has increased of about 7% since 2015, which has worsened Peyton’s low performance.

The company has a small amount of liabilities compared to their assets and equity, telling us that the company still owns a good amount of their own assets. A big percentage of their income in 2013 also went into their retained earnings for 2014. With retained earnings far bigger then the common stock, which is positive sign regarding Peyton’s health.

In order to complete our commentary on Peyton’s financial performance, we computed a few ratios. However, we could only measure them for 2014 since we couldn’t obtain 2012’s and 2015’s balance sheet. This analyze would have been more complete if we had a benchmark in order to compare Peyton’s ratios with its competitors.

Firstly, the activity ratios. We could expect inventories to be quite high in such industry. Peyton’s inventory turnover is 7.15. In other words, this means that Peyton sells its entire inventory every 51 days. It is as expected, and this is a good performance for Peyton. Moving on to the working capital turnover. This time Peyton’s performance is poor since they made only 3,32 $ of revenue for each $ of working capital they had.

Peyton’s liquidity ratios show that this corporate doesn’t face any problem of liquidity. In effect, both current ratio and acid test ratio are way above 1. They are easily able to reimburse their short-term liabilities.

And finally, the profitability ratios. The operating margin profit is equal to 0,28. This indicates that they are not able to charge a high price for their product, meaning that the competition could be quite intense in this market. Their profit margin ratio is about 4.5%, which means that only 4.5% of Peyton’s sales convert into net income. This number seems low but without a comparison within this sector we can’t say more.

Peyton’s ROA is 10%. It tells us about the satisfactory use of assets by the company in order to generate net income. This is quite a good performance.

And finally, the company’s ROE is 68%. It means the use of the equity invested in the firm by the common shareholders to generate earnings is very satisfying.

Question 2:

To start off, McNeilly suggests to raise the percentage of ‘allowance for doubtful accounts’ from 2.5% to 4.5%. Historically the Peyton’s range lies between 2-5%, but in the current economical outline of the company, 4.5% seems more prudent and realistic and will have as a consequence a provisional decline in the net income and thus increase the tax gain for the company by lowering corporate tax. If we suppose that the figures for the FY 2015 will be similar to the FY 2014, this would lower the EBIT by approximately 6.75 million USD and as a consequence proportionally reduce corporate tax by 2.35 million USD for a 35% tax rate.

Concerning inventories, no decision has yet been made, since there’s a disagreement between McNeilly who doesn’t want to face a supply risk for the following financial year, whereas Berry is protesting and stressing out the fact that there were important savings to be made by lowering the inventory. As a conclusion they decided that the policy will be reviewed by the end of the year.

For the 100 million USD assets purchased in 2015, McNeilly proposes to reduce the useful-life of those assets, and those assets only, from 7 to 5 years and to apply the double-declining depreciation in accordance with the productivity of the assets over the years. Consequently, charges will rise sharply in the short term and again net income will decrease, raising the tax gain as an advantage. In the long run though, charges will decrease, and Peyton will end up with the same salvage or resale value. Thus, depreciation charges will rise by 40 million USD in the first year (with the double declining rate of 2 x (1/5) x 100 = 40% applied on the 100 million), which is 25.7 million more than if the company would have used the straight-line depreciation over 7 years (40 - (100/7)). Depending on how this capital expenditure is financed, debt or equity, financial expenses might raise as well in the case of an external financing and may ultimately reduce the net income.

Finally, it is estimated that approximately 10 million one-time out of pocket costs, 80 million equipment impairment as well as 15 million inventory write downs might be incurred, but there’s no certainty when those figures should be incurred, which suggests that we should not worry about them in the near future. But again, those operations are prudent, preventive and non-aggressive policies reducing the net income of Peyton enterprises.  

Question 3

Overall, in our opinion, ‘conservative’ accounting is something viewed positively by investors, since it respects the principle of prudence and gives a true and loyal image of the company’s financial figures. Furthermore, it gives a signal about the seriousness and the long-term perspective of the company’s management. However, the answer may depend on when the IPO will take place and how many years of financial statements the company will have to disclose. In our eyes, it seems very important that the company’s financial figures should be comparable and regular over time and to avoid huge gaps from year to year. Because, in that case, it may seem as the company’s business activity is not regular, sensitive and volatile, which may scare away investors. In the current economical outline, we wouldn’t change the accounting policies, since it will increase the gap between the FY figures from 2014 (already strongly declining) to 2015 and increase the losses that seem to lie ahead for Peyton, when looking to the Q1 2015. Moreover, Peyton would only be coherent with its current accounting methods, that it has been applying over the last years and we don’t see any rush for a change when looking at the outline. We think it might be better to apply the ‘conservative’ policies from FY 2016 on, as Peyton forecasts an ‘uptick in demand’ around the beginning of FY 2016 which might ultimately smoothen its profits compared to 2015 and show more prudence and solid financial footing for the coming years. By applying these new policies, incurring the impairments and write downs and introducing depreciation methods that will lower the bottom line considerably in the short term from 2016 on, the company will have more margin for growth in the years coming and thus more optimistic perspectives on estimated future earnings and financials, more likely to materialize, which will affect the company positively during the IPO and afterwards. In a nutshell, we are approving the ‘conservative’ approach, but we would rather postpone the suggested policies to FY 2016 and we would also suggest reviewing the depreciation method not only for the new assets, but for all the assets, in order to be more coherent and comprehensive.