Accounting and Managerial Finance
JD Sports Fashion Plc., established in 1981, has shown great success since it’s an FTSE 250-listed sportswear retailer in the UK and Ireland (Rapley, 2017). The organization’s headquarters are in the UK. The company has developed an online platform for marketing activities where products are displayed and customers can make orders. JD Sports Fashion Plc. It is a world-class multinational retail sports fashion group specializing in supplying the best footwear, apparel, and accessories brands. The company is one of the leading retailers and distributors of sports and athletic products (Branch et al., 2017). It operates in nine countries and primarily in three segments: sports, fascia, and distribution. The company covers various brands such as JD Chausport, Scotts, Tito, Dealings, Gyms, Millets, Foot Patrols, Go outdoors, and Canterbury.
JD Sports Fashion PLC has a share price forecast of a median target of about 1150 with the highest estimate and 1420 and the lowest estimate at 800. This median estimate forecasts a decline of the share price by 0.09% within the next five years. Based on the earnings history and assessments, the company reported annual earnings would range at 32.19 per share. Based on revenues history and estimates, there is a likelihood of the organization’s revenues increasing for the next five years, with 2021 annual revenue being 6.17billion which was a 0.92% increase from 2019 due to its expansion by setting up new stores. The organization has more than one thousand and three hundred stores globally. The company issued a share capital of £2433 083 comprising of 973233160 ordinary shares each at 0.25p as of January 2021, which holds. Dividends and earnings per share are at 1.44p per common share. The basic earnings per ordinary share decreased to 23.05p from 25.29p in 2020. The company’s financial performance has been affected by COVID-19 pandemic, hence altering its operations, causing some employees to work from home and the rest of the workers to adapt to the changes of the set measures. However, the company did not record losses over the last three years.
Financial Ratios (all values are in £)
Profitability
The ratios selected for evaluation, in this case, include gross margin, return on assets, profit margin and return enquiry is evaluated below. The profitability ratios used have gross profit margin, operating profit margin, return on assets and return on equity.
Liquidity Ratios
These ratios assess the ability of JD Sports Fashion PLC to meet its short term financial obligations on time. The current ratio below shows the liquidity of JD Sports Fashion PLC by comparing current assets and current liabilities. The quick ratio compares the less liquid stock. The ratios applied include the current ratio, quick ratio, quick assets, current liabilities and current assets.
Efficiency Ratios
These ratios show the efficiency of the organization in utilizing assets to generate profits. The efficiency ratios used include assets turnover, inventory turnover, and day sales inventory.
Investment Ratios
The ratios are crucial in evaluating the current share price trends from the organization and providing forecasts on the share’s current and future market value. Ratios used include earnings per share ratio and price-earnings per ratio.
Gearing or leverage ratios
These ratios help determine the ability of the organization towards meeting its long term obligation. The percentages used include debt to equity ratio, equity ratio, and debt ratio.
Ratio analysis is an essential tool used by management in analyzing the position of an organization and guiding it towards making critical decisions. The profitability of a firm mainly focuses on the earnings attainable from a Firm’s revenue. Revenue increased from £6110 billion in 2020 to £6167 billion in 2021. The increase was as a result of increased sales in the respective years. The higher the revenue of an organization concerning its sales then the more profitable its general operations are.
Profitability ratios measure the capacity of a firm to generate profit from its operations (Husain & Sunardi, 2020). They are crucial to investors and creditors by helping in judging the firm’s returns. Gross margin compares gross profit of JD Sports Fashion PLC. to its net sales. The profit margin measures the organization’s net profit generated for each Euro sale. Return on Assets measures profit generated in Euros invested in assets. At the same time, return on Equity indicates JD Sports Fashion PLC capacity of generating profits from shareholders’ funds.
The profitability ratio analyzes the efficiency of the current pricing and the effectiveness of cost management strategies. The gross profit margin for JD Sports Fashion PLC slightly increased from 0.47 in 2020 to 0.48 in 2021. This slight increase is explainable by the fact that revenue grew by a higher proportion than sales. An increase in revenue is explainable by external factors which are exogenous to the organization. An increase in the ratio indicates that profits increased. The operating profit margin of the company deteriorated from 0.063 in 2020 to 0.9 in 2021. The impact of COVID 19 on businesses could be due to this factor. A decrease in operating profit indicates shows decreased ability of the company in managing its operating expenses. It also shows a decrease inability of the company to generate earnings from non-operating areas.
Return on assets also declined from 21% in 2020 to 9% in 2021. Return on investment shows that the company’s ability to develop an income from its assets declined hence low profitability levels. Furthermore, return on equity ratios showed a slight decrease from 36% in 2020 to 31% in 2021. This decrease indicted reduced returns from shareholders equity hence lower profitability levels. Tie decreases could be due to COVID 19 market evolutions which slowed demand and increased expenses of operation.
Since the profitability ratios evaluate the ability of an organization to generate profits and revenues from its resources, with the net operating profits, return on assets and returns on Equity decreasing, JD Sports Fashion PLC shows a downward trend except for Gross profit margin which is increasing.
Gearing ratios provide information regarding the proportion of debt to Equity of JD Sports Fashion PLC. These ratios influence an organization’s ability to raise funds for an optimal capital structure (Bintara, 2020). The ratios primarily focus on the capital structure of an organization. These ratios are vital in that too much debt can reduce the amount of profit contributed by an organization’s equity holders, affecting the solvency of an organization (Mohammed et al., 2020). Every firm thus has an obligation of balancing the two funding sources. The debt to equity ratio of JD Sports Fashion PLC increased from 7.33% in 2020 to 24.3% in 2021. The ratio shows the debt amount used by the company expanded. The increase was due to borrowing for refinancing during the pandemic recession period.
Investment ratios help in creating an understanding regarding organizations capable of developing financial stability. Equity to shareholders is only receivable at the end after all payments on taxes and interests. EPS is the net profit that can accrue concerning one outstanding share of common stock, which is distributable as dividends after all deductions. The earnings per share decreased from 25.29 pence in 2020 to 23.05 pence in 2021. The earnings per share thus deteriorated hence indicating reduced profitability. The earnings per share calculation take place through allocating profits to shares. A higher ratio is better than a lower percentage. The earnings per share ratios help evaluate the share price and dividend rates (Markonah et al., 2020). They determine prospects on current and future market ratios.
Efficiency ratios provide information regarding how an organization utilizes its resources and makes sales and income. Efficiency is critical for JD Sports Fashion PLC since it directly impacts revenues, profits, working capital, and liquidity.
The average inventory turnover period measures the efficiency in handling the inventory of an organization. Average inventory turnover is the rate at which a company can restock. Daily sales determine the duration at which a firm can collect trade receivables. A higher inventory turnover period is better than a lower one. A higher rate indicates higher efficiency since the conversion of inventory to sales is fast hence increasing profitability levels. The average inventory turnover period for JD Sports Fashion PLC risen from 84 days in 2020 to 93days in 2021. Therefore, the ratio shows that the company’s efficiency was declined based on the rate of replenishing the stock. Therefore, JD Sports Fashion PLC had higher efficiency in level in stock management in 2021.
The quick ratio helps to analyze the liquidity of the company. The quick ratio declined from 0.24 in 2020 to -1.03 in 2021 due to increased current liabilities. These rates define the creditworthiness of a firm. The quick ratio helps determine an organization’s ability to cover or settle liabilities through the use of current assets (Pattiruhu & Paais, 2020). The decline in 2021 signifies decreased liquidity position of the company. The organization might be undergoing financial challenges due to the harsh economic conditions relating to the pandemic. Within the two years, the quick ratio is below one. Thus, the organization was unable to meet its obligations using quick assets. External factors influence the quick ratio.
A vertical analysis is used for the consolidated balance sheet to help develop and understand decisions that management needs to make on capital structure. The study utilizes a vertical analysis for the years 2020 and 2021. The comparison for the current assets is made with that of non-current assets and total assets while that of current liabilities compares with non-current liabilities and Equity with total assets.
Over the last three years, the company has achieved significant growth in assets. There is no consistent liability increase or decrease trend due to external factors influencing the firm’s operations. Liability increased during the year 2020and decreased in the year 2021. The inventory levels of the organization have increased. As shown in the analysis, there is a significant increase in the organization’s current assets from 2019 to 2021. Assets increases are observable from£ 700.5 to £813 in 2020 and further to 1093.1 in 2021.
Similarly, there is also an increase in the growth of total assets from the year 2019 to 2021. The development is due to the rise in the value of inventories and growth in prepaid expenses. The increase implies that JD Sports Fashion PLC is purchasing more merchandise. With expansion into various markets and countries, there is an increased need for buying stocks to serve new locations.
Total Cash at hand for the company has also significantly increased, indicating that the organization has reduced its investment in PPE. The increase in liabilities growth in the year 2020 is due to the increase in capital leases. Leases generate income for the firm without labor; hence it’s an excellent opportunity for all organizations. However, an increase in the shareholder’s equity is positive towards the organization’s retained earnings. High dividends increase the organization’s attractiveness to shareholders and empower the organization by establishing a source of funds.
JD Sports is using lease financing, especially in the year 2020 is influencing its income levels during the year 2020. The COVID 19 changes also influence the increase in its liabilities during this period. The organization analysis also shows an increase in equity and a decrease in long-term borrowing and loans—the company inputs on acquisitions of new plants due to expansion strategies and implementations of new projects. The new plants and machinery require human capital and inventory to begin operations hence necessitating an additional source of funding.
From the vertical analysis, it is also clear that the company is not making enough debt financing. Instead, it relies more on equity to raise funds. The company thus requires to balance its capital structure through restructuring to take advantage of any possible opportunities. JD Sports Fashion PLC will need to establish alternative modes of raising capital to sustain and promote its growth. The organization could utilize the advantage of capital deductibility, which can generate profit in the future.
Financial notes of the organization show that the company can use lease liabilities which is generating more revenues. The company is also expanding its operating profit through increased income since the rent gained is replaced using leaf liabilities with less deprecation charge.
The most prominent figure for loans and liabilities in 2020 for JD Sports Fashion PLC is nine hundred million for loans and borrowings. The high value of lending is dependent on increased changes and variations in the capital market due to the COVID 19 impact for the year. The challenges of forecasting, adjusting, and making sales have impacted the higher value of debts for financing. Furthermore, there has been an increase in-store expansion into various markets. The development of new stores in other countries is consuming has necessitated sourcing capital to facilitate start-up.
Project Analysis
Executive Summary
JD Sports Fashion PLC is a multichannel retailer whose performance is stable and positive depending on the director’s overview reports. According to the previous analysis, the company’s market performance shows a positive trend. However, through the computation of financial ratios and financial analysis, the company still has some areas to address. The company plans to invest in a new project-facing evaluation using capital budgeting techniques to predict the most suitable evaluation method. The team will then forward the best approach to the investment committee.
The Rationale for the Project
Capital budgeting techniques are crucial for any organization when making investment decisions. The company needs to evaluate the potential of the project they hope to invest in to make the right decisions.
Net Present Value
The company will use debt financing of 60% for the new project and a 5% interest rate. Thus the NPV discount rate will be 5%. However, we don’t have the free cash flows, and therefore they have to be calculated.
Free cash flows = Cash from operations –Capex
Furthermore, the Cash from operations presentations in the earnings before interest, taxes, and depreciation (EBITDA) are shown.
Since the initial cash outlay was £20m and the NPV is calculated by subtracting the initial outlay amount from the present value of cash flows.
NPV = Present value of cash flows- initial outlay
NPV=48.99-20 = 28.99
The project has a positive NPV. Thus the committee should choose this project. The potential to gain profits in the new project is high, amounting to above the initial outlay within the first three years. Thus based on NPV evaluation, the investment committee should select the project.
Ratio Analysis (financial and non-financial)
Adjusted Present Value
The adjusted present value is an adjustment of the net present worth and is highly useful in making capital budget decisions, especially with debt financing. Since JD sports fashion considers using 60% debt financing for the project, it is necessary to determine using the adjusted present value method the impact of the debt on company adaptability due to the interest arising from debt financing.
Adjusted Present Value derivation formula uses unlevered firm value to sum to the net effect of the debt. Unlevered firm value is the amount an organization uses through reinforcing sources of funds from the use of equity without debt financing (Comeig Ramírez, 2020). Thus APV helps identify the impacts on unleveraged firm value after using debts to finance company operations. The company will employ £twenty million to invest in the new project, and 60% will be from debt financing. 60% f £20m is 14m. Therefore fourteen million will be from debentures or loans and borrowings. With the county’s tax rate at 19% and debt financing at 5%, there is an excellent likelihood of having an expensive share capital.
Furthermore, debt financing enables benefits through interest deductibility. It also reduces tax liability, thus increasing the overall profit of the organization. The use of debt financing, therefore, promotes the need for the APV method of evaluation. The 1.77 beta in table 2 of the unlevered firm capital represents the risk that a firm faces through share capital instead of debt financing.
Project Financials (Investment valuation methods)
Weighted Average Cost of Capital
WACC is a method used to evaluate the proportion between the number of sources of funds to the costs of raising funds (Harvey, 2020). According to the table, the JD Sports Fashion PLC has decided to use 40%, which implies 8M from the issuing of share capital and 12M from issuing of debentures, which are short-term loans and borrowings. The organization has chosen a path to promote debt financing and utilize the interest deductible. In the income statement, interest deductible is an expense.
WACC= (E/V *cost of equity) +(E/V *cost of debt)*1-tax rate.
E represents the market value of equity in the firm
V represents the market value of the dent in the firm
The WACC considers both debt and equity for financing a firm’s projects. From the table, the WACC of the project is 19% with the consideration of the tax rate.
Project Risks
Projects risks may include poor forecasting of the current economic conditions, which are likely to impact future project returns. Economic recessions can externally affect the performance of the new project leading to failure.
The project may also face the risk of poor debt management, which may lead to the project’s returns failing to cover the debt on time, leading to losses. The finance team should ensure proper debt management to ensure that the company can recoup its investments on time to meet its goals.
Critical Discussion
The net present value considers the time valuation from a project but does not consider the opportunity costs that arise as the project is carried out (Knoke et al., 2020). Furthermore, it fails to consider taxes and depreciation while calculating the free cash-flows. The Adjusted Present value, on the other hand, thinks of the impact of using debt for investment. The WACC, on the other hand, evaluates the use of debt and equity in raising funds. It considers taxes and also utilizes different weights for the sources of funds.
The WACC could be the most recommended rate of return for the investment committee to use since it can calculate the NPV.
Conclusions and Recommendations
By analyzing the financial statements, the company should engage further in expanding to new markets to expand its scope and create new customers. JD Sports can open up new retail stores and invest heavily in digital advertisement to reach its clients efficiently and increase efficiency. Online marketing should also receive attention since, due to the COVID 19 pandemic, people have shifted to online purchases instead of visiting retail stores.
The company should restructure its capital structure by increasing the use of debt financing. Since the company highly concentrates on using equity as its primary source of capital, it loses all possible benefits from using debt financings, such as interest deductibles and tax liabilities. It also needs to establish strategies for building its cash reserves to attend to emergencies and develop strategically due to the highly evolving markets.
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