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Financial Analysis of BAE Systems

Financial Analysis of BAE Systems

Introduction

A financial report aims at showing the profitability and cash flow of the company. This information is used by the decision-maker of the organization to make an appropriate decision regarding the positioning and to distribute resources accordingto (Williams and Dobelman 2017). At a more advanced level, financial reports aim at targeting different aspects of financial statements. The income statement, which is a crucial part in determining the profitability of a company gives an idea about various sources through which a company is making a profit.

Moreover, it uncovers the number of sales made by the organization, and various types of expenses depending upon how expenses are affecting the profitability(Vogel 2016). This project aims at analyzing the financial statement of “BAE Systems”. The company is situated in London with its share open for any investor who wants to buy. BAE System has many subdivision or subsidiaries that have the same kind of work delegated throughout various division. BAE System is a giant producer of various defence and aircraft products such as avionics, missiles and other aerospace and defence related products(Schroeder, Clark and Cathey 2019). BAE Systems create and develop fighter aircraft with the association of several other American and European aerospace companies. The company at present is making a huge amount of profit by providing solutions in the field of defence and aerospace services.

Financial Analysis

The main objective of this project is to produce a financial analysis of BAE Systems Inc., a London based defence and aerospace solution company(Dewachter et al. 2015). This report would also show the market position and demand for the company's products through the applicable valuation method. The financial report focuses on assessing the financial stability of a company of on-going period and financial productivity for a speculated period(Post and Byron 2015). A financial report provides an assumption regarding the financial stability of a company after considering various aspects of industry knowledge. Financial analysis is a helpful method through which various financial operationsare thoroughly analyzed. Thisanalysis helps to retain the stability of a company for the long haul and thus helps in bridging the gap between implementation and execution(Grennan and Michaely 2018). By proper analysis and calculation of liabilities, assets and other elements of financial valuation, decision-makers and investors and predict the future phases of the company. BAE Systems produces annual financial reports on its website using which various financial calculations are done for the present to calculate its worthiness in the current market.

Profitability Ratios

There are various methods to conduct the financial analysis of a company. One of the methods is the profitability ratio. These are various sets of calculating methods to assess and evaluate the financial status of a company(Kallala et al. 2015). Through the calculation of profitability ratios, the investors get an idea about whether or not they should gamble their money on buying the company's share to obtain a high return on investment. The below-calculated ratios are some of the important calculations on which the investor's investing decision depend upon:

Gross Profit Margin:

It gives the analysis of how much profit a company is generating upon the cost incurred in the manufacturing of those products(de Assis et al. 2017). These costs are termed and prime cost which, to put in simple words in the amount of money that a company invests on building a product(Alexander et al. 2017). Gross Profit ratio entails the profit earned on every single unit that is sold. To calculate the gross profit margin, first, the entire profit for the company is calculated and then the amount is subtracted from the cost of goods sold. Then it is divided with the total sales, and a percentage of the obtain result is estimated. Gross profit margin of BAE Systems for the year ended in 2018 is as follows:

Gross Profit Margin(%)

Sales for the year

22452.67

Less: Cost of Goods Sold

7821.928

Gross Profit

14630.74

Gross Profit Margin(%)

65.16259

As it is observes that the Gross Profit Margin for BAE Systems is not competitive and is considered as average in terms of gaining profit. There are many other companies out there who provide the same kind of products to its target market, and thus the competition is huge when it comes to selling their products(Riley et al. 2016). Therefore, the G.P is higher than many of its competition that is providing similar services to a certain industry. BAE Systems will need to work even harder if it wants to increase the gross profit margin shortly.

Net Profit Margin Ratio:

Net gain or profit is obtained by subtracting all kinds of expenditure that are incurred during a certain period form the total or gross profit that a company makes in that stipulated period (Pierson et al. 2015). The amount thus obtained, is then divided from the total sales of the company to obtain the net Profit Margin Proportion.

Net Profit Margin

Net Profit for the year

1334.8

Sales

22452.67

Net Profit Margin

5.944949977

As observed from the above calculation, That NPM ratio is much lower than the GPM. This is because there are several operating expenses that BAE Systems has to sustain to keep the business running(Maina and Sakwa 2017). The higher the NPM of a company, the better it would have a chance of survival and expanding its potential. Therefore, if a BAE Systems wants to earn more profit, it would have to take measure to cut down the expenses which are required to run the business. The company's profitability would considerably increase as are plans to cut down on expenses.

Solvency or Liquidity Ratio:

Solvency ratio is used to estimate the stability and power of the company for a short period to repay its debt. It is calculated by dividing the current assets and current liabilities of the company(Nesticò and Pipolo 2015). The total amount of current asset is compared with the current liabilities, and a ratio is created. The higher the ratio. The more power a company will have in repaying its debt. Here we would be calculated the liquidity ratio of BAE Systems to assess its solvency in the short run.

Solvency Ratio

Current Asset

12784.04

Current Liabilities

12422.98

Solvency Ratio

1.02906388

As it is indicated that from the above calculation that the solvency ratio of BAE Systems is more than 1. According to some experts, if the ratio is more than 1, it indicates that the organization is abled enough to fulfill its short term debts or obligation and is working efficiently and productively(Afonso, Baxa and Slavík 2018). On the other hand, if the current ratio was too high, it would have indicated that the company is not utilizing its resourced properly. Therefore the solvency ratio shows that BAE Systems is working efficiently and is capable of meeting its debt. Thus it can be concluded that the solvency rate of BAE Systems is in a good position at the moment.

Acid Test

Acid Test id the advanced level of solvency ratio, which tends to exclude all the inventories from the total current asset to calculate the ratio(Karna, Richter and Riesenkampff 2016). This is because inventory cannot always be immediately sold to cash it out to repay its debt. Here, the Acid test of BAE Systems is conducted to find out its actual liquidity capability.

Current Assets

12784.04

Less : Inventory

1033.135

Net Current Asset

11750.91

Acid Test

Net Asset

11750.91

Divide : Current Liabilities

12422.98

Acid Test Value

0.945901

An Ideal Acid Value should be equal to or around 1. Therefore Acid Test would keep on reducing if BAE Systems adds on more inventory. Therefore, ifBAE Systems wants to increase its Acid Test Value, it needs to roll in more cash into the business to enable itself to meet its short term obligation more efficiently.

Equity Ratio

Equity proportionhighlight the amount of money that the business is utilizing from a borrowed source to run its business. Equity ratio should always be less as it would indicate a good financial

Stability and little use of borrowed money in the business(Chen, Duan and Zhang 2015). Here, the equity ratio of BAE Systems of BAE Systems will be assessed to indicate its stability without borrowed money.

Equity Ratio (%)

Long term debt

4690.487

Divide : long term debt+ equity

12189.39

Equity Ratio (%)

38.48007

Therefore from the above calculation, it can be estimated that BAE Systems uses 38% of its capital from borrowed sources and therefore becomes liable to repay the money. It needs to cut down the amount borrowed, as it would create the burden of repayment to the shareholders with interest, which would reduce the profit of the company(Chatterton et al. 2018).

Limitations of the ration Analysis conducted for BAE Systems

Although Ratio analysis is an important method to conduct financial analysis of the company, it is not free of demerits which are as follows:

  • The ratio analysis of BAE Systems would be an indication of a certain type of period, which is only for the year 2018. Therefore, in a new year, this analysis would be of no use, and the calculations would have to be done again(Weygandt, Kimmel and Kieso 2019).
  • The ratio analysis calculated for BAE System in this project has overlooked the changes in the price of the product due to inflation(Kenett 2015). Major of the calculation is based on figures of the past which might be changed the project would be read by readers. Therefore the information of this ratio analysis cannot be used for the practical purpose all for further accounting calculations.
  • The ratio analysis calculated is a mere indication of the quantitative measure of the company's assets and liabilities(Kenet 2015). Ratio analysis excludes the other aspect of financial analysis which is the qualitative measurement.
  • Lastly, this analysis will not affect and decide the financial stability BAE Systems have. It is just asuggestion of how a firm is operating, and well, they are using their resources(Chapuis et al. 2015).

Company Valuation -

Asset-Based Approach – The most commonly used valuation calculation is Asset Based method. In this method, the book value of all the various stock, inventory and debts and liabilities in the balance sheet of a company is compared and adjusted concerning its current value in the market(Wagner et al. 2015). Under this method, all the initial are updated as per the current market position of those liabilities and asset. The asset-based valuation of BAE System is calculated an under:

Assets based Valuations

2018

2017

2016

2015

Non-Current assets

15170

14738

15947

13751

Current Assets

9576

7715

7029

6332

Total Assets

24746

22453

22976

20083

Less: liabilities

Current Liabilities

9307

7106

7299

7153

Non-Current Liabilities

9821

10563

12213

9928

Total Liabilities

19128

17669

19512

17081

Net Worth of Company

5618

4784

3464

3002

Trend

17.4%

38.1%

15.4%

Dividend Valuation Method – Dividend Valuation Method helps to calculate the value of all the price of its current open share, and whether or not its worth is equal to all the dividend that needs to be paid shortly to all the shareholder when the price is discounted to the current value. It focuses on the assessment of the true and fair value of stock irrespective of its value in the current market scenario and considers the dividend payment element and expected return on investment. The Dividend Valuation Model of BAE Systems is calculated below.

Dividend Valuation Model

CAPM =
RF+BETA*( Market Risk Premium-Risk Free  rate of Return)

Beta:

0.49

Risk-Free rate

2.10%

market Risk Premium ( Return On equity)

23.98%

CAPM

0.128212

Here the CAPM value came to be 12.82% which is considered to be good concerning the returns on investment. Therefore a shareholder can choose to gamble by buying the shares of BEA Systems, which would yield a high dividend rate.

Price to Earnings Ratio:Price to earnings ratio helps in determining the price of a share based on the profit that a firm is earning per unit of that share. The price to earnings share is also called the earnings multiples or price multiple (Shahbaz et al. 2017). A high P/E ratio suggests that the shares of a firm are highly underrated or the shareholders are expecting a high return on investment. Companies who do not have sufficient earning or are running at a loss do not have this ratio. This ratio of BAE Systems is as follows:

Price to Earnings Ratio

2018

2017

2016

2015

Price

493.7

554.4

599

499.6

Earnings per Share

0.31

0.27

0.29

0.29

Price to Earnings Ratio

1592.580645

2053.333333

2065.517241

1722.758621

From the above table, it can be assessed that the earning that the P/E ratio has significantly decreased as compared to the previous years. This indicated that the price of the share of BAE Systems is decreasing over time, and as a result, the value of the share is also decreasing.

Methodology:

The techniques and method used while doing this project are an indication of how well or bad BAE System is operating as far as the financial stability of the company is concerned. The project entails at showcasing the various aspect of financial research and calculation to bring out the worthiness the company. The methods for the financial analysis of BAE Systems Includes calculation of various elements of ratio analysis and determining various aspects of company valuation for the calculation of net worth of the company (Chang et al. 2016). The various determinants used while the calculation of the financial statement can be used to estimate the net worth of the company, which should be more than 10 Billion Dollars, given the financial stability the company has constantly maintained and the total assets and inventory that the company owns. BAE Systems has been one of the dominant suppliers of products relating to defence and aerospace. With the above estimated financial analysis of the company in this project, it can be assumed that the BAE System will operate for a long time with stable profitability.

Capital Structure:

Amount of liabilities for Absolute PLC – Cost of debt implies the amount of interest that a company has to repay on its various borrowed capital such as loans, bonds and mortgages. The cost of debt is a type of expense that is an additional liability that comes when they decide to borrow money for their business(Kostyukova 2017). As interest expenditure is deducted from the book value, it is essential to deduct it after charging the taxes. Cost of debt, together with the equity makes firm's cost of capital.

Cost of debt can imply the overall financial stability and health of the company and can calculate the overall credit score or the strength of the firm to repay its loan. The amount of liability for Absolute PLC is calculated as under:

Cost of Debt

Interest rate

8%

tax rate

19%

COST OF DEBT =
r*(1-t)

6.48%

Cost of Debt for Absolute PLC

Cost of Equity:

It represents interest, an investor expects from the investment to be pursued by the company. It is the rate of interest that is paid by a firm to its investors. The cost of equity is an expense of the firm which needs to be paid when the company makes a profit using the shareholder's money or just profit in general. All the shareholders become eligible to get a certain part of the profit of the organization, which is decided by calculating the Equity cost. The Equity Cost for Absolute PLC is calculated as under:

Calculation of Cost of Equity

Dividend Growth Model

Proposed DIVIDEND (D1)

0.315

Current Price (p0)

3.2

Growth (G)

5%

KE =
(D1/P0)+g

14.8%

Cost of Equity

Weighted Average Cost of Capital:

This is the method of calculating the average rate of interest that a firm needs to pay to its shareholder or who have invested in the shares of the company. It is also known as the company's Capital Cost. This essentially represents the minimum return that a company should be earning on its asset to satisfy its shareholder, The WACC of Average Plc is estimated below:

WACC

Finance

Amount

Rate

percentage

WACC

Equity

300

14.8%

24%

3.6%

Reserve

150

14.8%

12%

1.8%

Bond

800

6.48%

64%

4.1%

Total

1250

100%

9.5%

Difficulties while Calculated the WACC: There are various useful ways of assessing the WACC and planning the rate of profitability accordingly. But there are various limitations to it as well. Some of the limitation that is generally faced while calculating the WACC such as It is very difficult to maintain the same capital structure throughout the year as market inflation keeps on changing. For the calculation of WACC, the rate of the cost of current capital is required, which is very difficult to evaluate. The WACC includes elements such as equity and debt to get calculated(Chan and Chong 2017). The rate of interest in the cost of debt keeps on changing depending on the market situation. Hence it becomes extremely difficult to calculate the WACC. While WACC considers only the essential elements such as debt, equity and preference shares to calculate the average Capital Cost to avoid complex procedure for the calculation, if other elements of capital budgeting such as extendable bonds, warrants etc., it would make the calculation technique much more difficult.  And if a calculating method has too much complexity and difficulty along the way, the probability of making a mistake or producing. An error-free project becomes much more difficult.  Limitations are part of every single aspect that exists in the world and WACC is no exception. Nevertheless, it is still one of the best method out there for estimating and calculating theCapital Cost.

Conclusion:

Therefore, the preparation of this project has was immensely helpful in getting sufficient knowledge regarding the financial analysis of BAE Systems. The company’s specialty remains in the production of defence and dominant aerospace products. Through the financial analysis, it is noticeable that the company is financially strong and would continue to dominate the market for a very long period. The ratio analysis has also indicated that the solvency capability of the company is very high, that suggests that BAE System is capable to dissolve also the debts through the liquidation of the current asset.

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