This report initially
illustrates a brief discussion in the real estate industry in which the two
firms operate in and the competitive risk that comes with it. Firstly it provides an evaluation of the
changes to the capital structure using each company’s annual reports and the
financial risk associated using gearing ratios. Finally the methods of Altman and Beaver have
been used to assessing bankruptcy risk.
The concept of capital
structure shows how the long-term capital of a firm is split between equity and
debt.” The financing decision” is the way a firm decides the value of equity
and debt (Appendix 1) and this has an effect on the value of a firm and the
financial risk as well. The Gearing Ratio which is usually calculated us debt
over equity measures the financial risk of an entity and where the gearing
ratio is high is better to avoid new financial debts since the company may not
be able to meet the financial obligations.
Securities Group Plc
Securities has large amounts of debts but they keep reduce throughout the years
and as a real estate company it usually invest in whole properties and such
transactions cost large amount of debts which is usually the reason why such
companies have those amounts of debts. Also, long term debt is bigger than
short term and this a positive fact for an entity because long term debt is
cheap and shareholders have to invest lower amounts. As far as the gearing
ratio is consider is always been pretty consistent, ranging from 53%
percent to 31% percent which is a good result as a healthy company usually has
a ratio of 25%-50. Also, they manage to always have a bigger amount of equity
the chart (Appendix C), we can assume a surprisingly reduction in the result of
gearing ratio from 142% in 2013 to only 5% in 2017. However although the gearing
was incredibly high the first four years the bankruptcy risk was also high
because the higher the firms debt ratio the higher the probability of bankruptcy
(a gearing ratio of more than 50% is consider high). The fact that in 2017 the
figure fall to 5% is neither not positive because although the amount of long
term debt decreased the amount of short term debt is increased and as trade-off
theory illustrates a high debt may result to bankruptcy despite the tax
benefit. (Arnold,2007) The current
liabilities has keep rising the last years and from 209.0 on 2013 they became
895.4 the 2017 and this may be due to short-term mortgages which is common in
the real estate industry(reference). Despite this the equity number is keep
rising smoothly probably by issuing more shares.
Accounting data in forms of
financial ratios can predict whether companies are going to bankruptcy at least
five years prior to the failure. The six main ratios of Beavers approach are
investigated. (Beaver, 1966)
Cash flow ratio is a
measure of a company’s liquidity and is the ability of a firm to cover its
liabilities with the operating cash flows. A higher level of cash flow
indicates a better ability to afford declines and better ability to pay
dividends to investors. The cash flow to total debt
ratio of the failed entities is weaker than those of the non-failed entities.
The cash flow ratio for
both the two companies is dramatically low for the five years. The highest
percentage for Land Securities Group PLC is 0.3% and for Grainger PLC 1% .This
is due the nature of real estate industry (cash-flow poor industry) where is
usual for developers to struggle in cash flow because a property will only
incur expenses until it is completely finished.
The current ratio is
commonly used to measure how many times a company cover its current liabilities
with its current assets. The higher the
percentage, the most likely for a company to pay the creditors back.
Land Securities Group Plc
has a current ratio lower than 1 for 2013 and 2014 which means that the company
was unable to covers its current liabilities because they were more than the
current assets. The following two years the entity manage to have a current
ratio which is consider ideal because is between 1:1 and 2:1. Lastly the
company didn’t manage to keep the good figures and the result fell again below
1 in 2017.
Grainger Plc on the other
side, has a current ratio above 2:1 for 4 year 2013-2016 meaning that the
entity didn’t manage to use its current assets efficiently and this can cause
problems in the working capital management.
The final year the company has an ideal ratio of 1.19: 1 because of the
increase in current liabilities.
profit after tax/ total assets ratio is an indicator on how an entity uses its
assets to achieve earnings. A higher percentage indicates a better use.
Securities Group has a constant low percentage of PAT throughout the years with
the only exception of 2015 the ratio increased to 13.6% but it decreased again
in the following year. This reflect that the company used the recourses
efficiently only in 2016.
Grainger results also shows a constant very low
percentage that time 50% less than Land Securities average. The company have to
consider the use of capital resources.
The working capital formula shows how an entity covers its
The working capital ratio for Land Securities Group Plc was
stable for the most years between (2%) – 6% which is consider very risky. The
only difference was in
The Grainger Plc also manage to keep a stable for the first
four year 52%-57% which illustrates that
the entity is able to pay its debt on time. This dramatically change in 2017
when the figure falls to 10% which is very low.
The turnover ratio illustrates
provides us with information on the amount of time an entity can continue to
pay its bills.
Debt/ Total Assets ratio identify
how a firms assets are financed by debt and is a measure of financial risk.
Land Securities ratio had
decreased during the five years by 14% meaning that it possibly started to
issue more shares to finance its assets.
Grainger Plc had a figure of
0.73-0, 71 in 2013-2015 which is near 1 which means that the entity has a good
amount of leverage. Unfortunately this
change in 2016 and 2017 when the ratio fall to 0.58 and 0.57 respectively.
Bankruptcy Risk – Altman
Edward Altman (1968) combined together five ratios in order
to determine how likely a company is to bankrupt one year prior to the event.
Generally a lower Z score means a higher odds of bankruptcy.
The firm has been in the bankrupt zones for the last five
years with only the exception of 2016 when the score was 2.11 and in that time
the entity was considered safe. Although the score in 2016 was great they
didn’t manage to keep it and in 2017 it fell again 1.62. The fact that the
average Z score for the five years is 1.74 and is below the lower limit makes
the risk for bankruptcy very high.
Land securities Plc
Land on the other side has an
overall Z score of 2.65 and although this suggest that they have a probability
to going bankrupt in the next two years in the last years they reached high Z
scores reaching its peak in 2014 with 3.03 suggesting that the entity is safe
from bankruptcy with a strong financial