MASTERS IN BUSINESS ADMINISTRATION

Financial Modelling

Course Work

Financial Statement Analysis on

ESPRIT HOLDINGS LTD

By: Zahoor Soomro

INDEX

Sr No CONTENTS Page No.

1. Executive Summary 1
2. Company Profile 2
3. Introduction 3
4. A framework for Evaluating Company 3
Main Ratios (Table) 3
5. Profitability Ratios 4
5.1 Return on shareholders funds (ROSF) 4
5.2 Return On Capital Employed 5
5.3 Gross profit Margin Ratios 5
5.4 Net Profit Ratio 6
6. Efficiency Ratios 6
6.1 The average stock turnover 7
6.2 Average settlement period for receivables 7
6.3 The sales to capital employed 7
6.4 Average Payment Period 7
7. Liquidity Ratios 8
7.1 The current ratio 8
7.2 Quick Ratio 8
8. Gearing Ratios 9
9. Investment Ratio 9
9.1 Interest covering ratio 10
9.2 Dividend payout ratio 10
9.3 Earning per share 11
9.4 Price Earning Ratio (P/E) 11
10. Conclusion 12
11. References 13
12. Appendix 14
 Esprit Ratio Analysis

1. Executive Summary
Esprit has been performing excellent in overall operations, demonstrating sustainable
growth in turnover and earnings. The Group’s turnover reached HK$29.6 billion, an
increase of 26.9%. With improving efficiency, the Group’s operating profit grew
31.4% to HK$6,259 million. This is a big plus in the upward trend in the growth.

The ratio analysis is the effective and reliable evidence of the company’s success.
There are several ratios that are calculated in the report. The significant success
depicted in the profitability ratios which shows the gross profit margin has constant
trend line through out 3 consecutive financial years. the period. Where as ROSF
(Return on shareholder funds) is getting upward trend in the current financial year

The Esprits efficiency ratio clearly indicates the strength of the company to operate
the business effectively. Where as the receivable settlement period also indicates the
favourable results. The average stock turnover in year 2007 has gone down and
indicates more in and out of the business.
The company’s liquidity ratios depict the upward trend which is favourable trend.
This shows the excellent level of the liquidity available in the company.
The Esprit does not have any long term liabilities since 2005 therefore the Gearing
Ratio is not applicable over this period of time.

The investment ratio shows strongly favourable outcomes for the company. This
shows upward trend in the Earning per Share, the dividend payout ratios and price
earning ratios. These ratios attract the traders to invest in the business. More the
investor invest in the business more the liquidity rise and more the income for
operations become available.

The success of Esprit can be measured through significant financial information of the
company that is available in the financial reports. These numerical have, mostly the
positive trends in the business operations.

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2. Company Profile

ESPRIT is a youthful Lifestyle brand which offers fashion and new style apparels,
footwear, jewellery, house wares etc which was established in 1968 and has its
headquarters in Hong Kong. ESPRIT does the business under the group ESPRIT
HOLDINGS LIMITED. The group is engaged in production and distribution
(wholesale and retail) of high quality and affordable products under its globally
renowned ESPRIT brand and also cosmetics and other body care products under its
RED EARTH Brand. The group operates in more than 40 countries directly
controlling more than 660 retail stores and over 13,000 controlled space wholesale
point-of-sales internationally.(ESPRIT Annual report 06/07).

On April 2006, Forbes recognised ESPRIT as one of the World’s 2000 largest Public
companies. (DeCarlo, S.2006).

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3. Introduction

To gauge the performance of any company requires the careful understanding of the
financial information provided in the financial statements. This information can be a
matter of interest for the stakeholders in many ways. The most important is the buying
and selling of the company’s shares. The ratio analysis provide the careful numerical
to judge the profitability, efficiency, liquidity, gearing and success of financial
investment of the company.

4. A Frame work for Evaluating Company

Assessing the company creates unique modelling opportunities and challenges. When
deciding to acquire the company, one has to carefully analyse the strengths and
weaknesses of the company on the numerical backgrounds. To understand the
company’s risks is very crucial before the actual decision being made.

Main Ratios
Ratio Analysis

Efficiency Gearing Investment

Profitability Liquidity Cash Flow

Current Ratio Quick Ratio Earnings per share

Gross Profit Net Profit

Creditors Collection Period Price / Earnings

Return on Capital Employed

Creditors Period Dividend Cover

Stock Turnover Interest Cover

Debtors’ period Dividend Yield

Figure 1 Main Ratios

Source: (Adapted from Michael Jones 2006, second edition p220)

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5. Profitability Ratios

The financial metrics that used to assess business capability to generate revenue as
compare to revenue. (Michel Schlosser 2002)Profitability ratios are calculated to
measure the company’s performance to determine whether the company is performing
at satisfactory level i.e. the ability to generate profits. (Wood, F and Sangster, A,
1999, Berman.C, et al 2006)

Profitability Ratios

70

60

50
Percentage

ROSF
40 ROCE
30 Net Profit Margin
Gross Profit Margin
20

10

0
2005 2006 2007
Years

Figure 2 (Profitability Ratios FY 2005, 2006, 2007)

5.1 Return on shareholders funds (ROSF)

Return on Shareholders Funds is the ratio that depicts the level of investment by the
shareholders in the company and the returns that company pays off to its shareholders.
The profit that shareholder actually receives from the company’s total generated profit.
The Esprit according t pots financial statements paid highest percentage in 2005 as it
is 47% where as it is 41% in 2006 and it goes down as low as 43% in 2007. The year
2005 however was not that desirable but in the current trend of the company’s
financial performance it is visible that the trend going up which is good sign for the
company.

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 Esprit Ratio Analysis

5.2 Return on Capital Employed

These are the returns that company is getting back from its capital employed in the
business. Through this indicator company gauge the performance and asses whether
business process has generated the sufficient amount of return to pay for its cost of
capital. (Michel Schlosser 2002)

Esprit gained 60% of return on capitals in 2005. The return reduced as low as 50% in
2006 and the same percentage in 2007. There seems considerably drop in the financial
ratios of the company in year 2006 and 2007. This result indicates that the company is
paying more cost on the investment on company’s assets in the year 2006 and 2007 as
compare to the ratios depicted in 2005.

5.3 Gross profit Margin Ratios

This is very useful ratio specially where stock is purchased gained mark up and sold.
However this reflects the position of strength of the business profitability. According
to the company’s financial statements it can be analysed that the company is making
the best performances on its profitability side. It indicates that the trend goes around
the same thought pout the period from 54% in 2005 and a slight dip towards 53% and
recovery take to 54% in 2007, that reflects the company’s good financial position. The
gross profit margin remains at 54% and Net profit margins remain more likely to be
steady at 20% through out the period. (Esprit annual report FY 2005-06 and 2006-07)

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5.4 Net Profit Ratio

This ratio is very important for the company to retain the existing share hokders as
well as to make it attractive for the buyers in the stock market. This includes the profit
generated from trading activities.

Esprit generated around 16% in 2005 and trend goes to next year and then graph
moves up to 17% in the year 2007. This depicts the company’s profitability is
growing up at the tremendous level which is a good sign for the stakeholders.

6. Efficiency Ratios

The efficiency ratio depicts how effectively a business is operating. The main
objective in this ratio is to measure the efficient use of the assets. (Michael Jones
2006) These ratios measures the way in which certain resources are utilized or
managed within the business. Profitability of a business varies according to the way in
which the assets are used. (Atrill P. and McLaney, E. 2006)

Efficiency Ratios

80
Avg Stock turn over
60
40 Ave settlement
period for receivable
20 Avg payment period
0
2005 2006 2007 Sales to the capital
employed
Years

Figure 3 (Efficiency Ratios FY 2005, 2006, 2007)

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 Esprit Ratio Analysis

6.1 The avaerage stock turnover

time at Esprit is Average 49 Days in 2005 which increase 58 days in 2006 and
decreases in to 37 days in 2007. this depicts that the stock remained in the business for
more days in 2006 which is not considerably treated as desirable. But in the year 2007
this decreased to 37 which show the more business sales trend and more in and out
behaviour. The one of the reasons can be the new fashion items and seasonal impacts.
Some time out of season stock get stuck up and takes time to sale.

6.2 Average settlement period for receivables

The average settlement period is as higher as 38 days in 2007 as compare to the 28

days in 2005 and 32 days in 2006. It is because the sales have increased and so is the
customer base has increased. Higher the customer base in the business, likely to the
business transactions. Therefore there is increase in settlement period. This might be
one of the ways to boost the customer base by providing them a relaxation in
payments.

6.3 The sales to capital employed

Compare the sales of company with total assets employed. The Esprit has 2.9 times in
the 2005 as compare to 2.6 in 2006 and 2.5 times in 2007. This clearly indicate that
the company is constantly investing in assets buying and at the same time its sales
trend is going well stable by maintains the desirable ratio of times in the business
operations (Esprit annual report FY 2005-06 and 2006-07) Therefore after analysis on
financial reports of Esprit that can be stated that the company is efficiently managing
its resources effectively by efficient internal working capabalities.
6.4 Average Payment Period

The slower a business is to pay the longer the business has the money in the bank. The
Esprit average payment time period is 38 days in 2007 which has the same trend in
the following years. This shows that the company takes almost 38 day to off the debts.

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7. Liquidity Ratios

Liquidity ratios seek to test how easily a company can pay its debts. (Michael Jones
2006). this ratio determines a firm’s ability to meet its short term financial obligations.
(Atrill, P. and McLaney, E.2006)

Liquidity Ratio

3
2.5
2
Current Ratio
1.5
Acid Test Retio
1
0.5
0
2005 2006 2007
Years

Figure: 4 Liquidity Ratio FY 2005, 2006, 2007)

7.1 The current ratio

is the comparison of current assets with current liabilities. Esprit has current ratio of
2.50 in 2007 as compare to 2.25 in 2006 and 2.02 in 2005. Company has realised
highest level in the financial year 2007 which is strongly desirable. This shows the
excellent level of the liquidity of the company. (Esprit annual report FY 2005-06 and
2006-07

7.2 Quick Ratio

This ratio is the measure of extreme short-term liquidity. As more the stock the Esprit
sold more likely to increase debtors. More the debtors pay the cash more the business
gains cash. It is kind of immediate test of the company. The thinking is that if all debts
needed to be settled tomorrow or next week, could they be? Where as the Company
here got 2.02 in year 2007 as compared to the 1.63 in 2006 and 1.50 in 2005. This
ratio indicates that company has acquired strong ability to payoff the debts in short
notice that strongly reflects the company’s position to meet the short obligations.
(Esprit annual report FY 2005-06 and 2006-07

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8. Gearing Ratios

Gearing ratios are derived from the balance sheet. Gearing effectively represents the
ordinary shareholders funds and the debt capital of the company. Gearing refers to
relationship between the amount of finance provided by outside Parties to the
company.(Lunt.H, 2006).This ratio measures the contribution of long-term lenders to
the long-term capital structure of the company (Atrill, P. and McLaney 2006).

The Esprit does not have any long term liabilities since 2005 therefore the Gearing
Ratio is not applicable.

9. Investment Ratios

This ratio depicts the future position of the company and helpout the investor to make
investment decions accordingly. If it refledcts positive growth that likely to attract the
investor in the company. This ratio specifically deals with shareholder’s returns.
Investment Ratios are those ratios available and which are designed to help investors
to assess the returns on their investment. (Atrill, P. and McLaney 2006).

Investment Ratio

80

60 Dividend pay out

ratio
40
Earning per share
20
0 Price earnings
2005 2006 2007 ratio(p/E)

Years

Figure :5 Investment Ratio FY 2005, 2006, 2007)

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9.1 Interest covering ratio

This ratio calculates that how easily the company can pay off the debts. According to
the financial calculations of Esprit that can be analysed that the company has got
strong ability to pay off the long-term debts well in time in the financial year 2005
and year 2006 where as it seems there is no gearing available for the company in the
year 2007 the interest covering ratio can not be calculated for the period.

9.2 Dividend payout ratio

The Company has announced dividends and paid off to the share holders every year.
The graph above shows that the paid off dividend in the year 2005 was about 51 %
which rose to 65% in 2006 and again a slump of 5% realised by taking it to the 60 %
in the financial year 2007. This can be assume that the company has started investing
the different projects which will likely to generate higher returns in the future

9.3 Earning per share

This ratio is the important source of measuring the performance of the company. The
importance of this ratio can be gauged easily by the fact these ratios are published in
the accounts of listed companies unlike other ratios.

The Esprit financial reports show that company has been generating earning per share
on the continuous upwards trend. Each share earns HK $ 2.79 in 2005 and HK $ 3.09
in 2006 where as it is as much as HK $ 4 in 2007. This depicts the company’s
excellent earnings on per share.

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9.4 Price Earning Ratio (P/E)

This is another key stock market measure. This depicts the company’s current price
in relation to the strength of the share to earn in future times. This ratio encourages the
investor to buy the share if the ratio is higher. The higher ratio depicts the popularity
of the company.

The Esprit has very strong P/E ratio. It is as favourable as 22.51 in 2007. The lowest
trend can be depicted through the figures in 2005 as low as 19.27 as compare to 20.51
in 2006. The company in 2007 has generally enjoyed the market confidence.

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10. Conclusion

After having careful analysis on the company’s financial statements we are can build
an opinion that the Esprit has got the factors of success in various parts of the business.
The trends in financial flows are stable through out the year. Which is a strongly good
sign for the company. The company has high level of availability of funds to pay of
its short term liabilities on a very short notice which will keep the operations of the
company very smooth. However the company has realized the slumps in the indices
of ROCE, the obvious reason of this can be the more investment being made in the
business then rate of return on it.

The numerical analysis on the financial numbers indicates the success of the company
and the continuous growth in the profitability, earning per share and price per share,
which even makes company lucrative for the stakeholders.

The present trend in the growth of the company clearly indicates that the company
will geographically expand more and will realize more profits that will certainly
attract investor to invest in the business and will give a boost to the company image in
the eyes of its target market.

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11. References:

Atrill P. and McLaney, E. (2006) p. 180

Atrill P. and McLaney, E. (2006) p. 187
Atrill, P. and McLaney, E.2006 pg-195
Atrill, P. and McLaney, E. (2006) pg-192

Berman, K.et al (2006), Financial Intelligence: A Manager’s guide to Knowing what

the numbers Really Mean, Harvard Business School Press,pg-151

DeCarlo, S. (2006), Forbes magazine, Special Report ,The Worlds Largest Public
Companies, Published on 03.30.06.
http://www.forbes.com/lists/2006/18/06f2000_The-Forbes-2000_Rank_13.html
(Accessed on 11th May,2008)

Esprit annual report FY 2005-06 and 2006-07

http://www.esprit.com/index.php?command=Display&page_id=5
(Accessed on 11th May,2008)

Lunt.H,(2006),Fundamentals of financial accounting ,CIMA publishing ,pg-520

Michel Schlosser (2002), Business Finance Application, models and cases, first
edition, ch: 8 p.144.145

Michael Jones (2006), Accounting, second edition, ch: 9, p.225-226

Michael Jones (2006), Accounting, second edition, ch: 9, p.226-227

Wood, F and Sangster. (1999), Business Accounting 2, Financial Times Pitman

Publishing, 8th Edition.p.410

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12. Appendix

In MN HK$ millions

Items in the Statement 2005 2006 2007

Profit attributable to share holders(Net profit after tax & preferred
dividends) 3338 3737 5180
(Ordinary) Share Capital 120 122 123
Reserves 6919 8985 11958
Long Term (non-current) Liabilities 0 0 0
Operating profit (Net profit before interest & taxation) 4201 4765 6259
Turnover (Sales Revenue) 20632 23349 29640
Gross profit 11219 12298 15885
Cost of sales(assume as credit purchases) 9413 11051 13755
Trade debtors (receivables) 1604 2137 3090
Trade Creditors (credit payable) 918 1057 1438
Current assets 5393 7624 11463
Current liabilities 2664 3387 4570
Inventory 1387 2101 2192
dividend announced for the year 1713 2421 3086
Number of shares in issue 1199 1220 1231
Market value per share 53.75 63.40 95
Earning per share 2.79 3.09 4.22
Number of employees (In normal number) 7720 8400 9617
Number of equity shares 120 122 123
A. Items in the Statement

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B. SUMMARY OF RATIOS CALCULATION

1. PROFITABILITY RATIOS:

Ratio 2005 2006 2007

Return on Ordinary 47% 41% 43%
shareholders Fund
Return on Capital 60% 52% 52%
Employed (ROCE)
Net Profit Margin 16% 16% 17%

Gross Profit Margin 54% 53% 54%

2. EFFICIENCY RATIOS:

Ratio 2005 2006 2007

Average stock 49 Days 58 Days 37 Days
Turnover
Average settlement 28 Days 33 Days 38 Days
period for Receivable
Average payment 36 Days 35 Days 38 Days
period
Sales to capital 2.9 Times 2.6 Times 2.5 Times
employed

3. LIQUIDITY RATIOS:

Ratio 2005 2006 2007

Current Ratio 2.02:1 2.25:1 2.50:1

Acid Test ratio (Quick 1.50:1 1.63:1 2.02.1

Ratio)

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4. GEARING RATIOS:

Gearing Ratio is not applicable as the company has no Long-Term (Non-Current)

Liabilities

5. INVESTMENT RATIOS:

Ratio 2005 2006 2007

Dividend payout ratio 51% 65% 60%

Dividend per share HK $ 14.99 HK $ 18.10 HK $ 24.83

Earning per share HK $ 2.79 HK $ 3.09 HK $ 4.22

Price Earning Ratio 19.27 Times 20.51 Times 22.51 Times

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C. Calculation of ratios

Profitability Ratio
1. Return on shareholders funds
(ROSF) = Net profit after tax & preference dividend * 100
Ordinary Share Capital + Reserves

2005 2006 2007

3338* 100 3737 * 100 5180* 100

120+6919 122+8985 123+11958

=47% = 41% =43%

2. Return on Capital Employed (ROCE) = Net profit before interest and tax * 100
Share Capital + Reserves+ Long term liabilities

2005 2006 2007

4202 *100 4765 * 100 6259 * 100

120+6919 122+8985 123+11958

=60% = 52% =52%

3. Net Profit margin = Net profit before interest and tax * 100
Sales Revenue

2005 2006 2007

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3338*100 3737 * 100 5180*100

20632 23349 29640

= 16% = 16% = 17%

4. Gross Profit margin = Gross Profit * 100

Sales Revenue

2005 2006 2007

11219 *100 12298 * 100 15885*100

20632 23349 29640

= 54% = 53% = 54%

Efficiency ratios:

1. Average Stock turnover period = Average inventories held* 365

Cost of Sales

2005 2006 2007

(1137+1387)/2 *365 (1387+2101)/2 *365 (2101+2192) /2 * 365

9413 11051 13755
=49 Days = 58 Days =57 Days

2. Average Settlement period for receivables= Trade Receivables * 365

Credit Sales

2005 2006 2007

1604*365 2137* 365 3090*365

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20632 23349 29640

=28 Days =33 Days = 38 Days

3. Average payment period = Average creditors * 365

Credit purchases

2005 2006 2007

918 *365 1057 * 365 1438* 365

9413 11051 13755

=36 Days = 35 Days = 38 Days

4. Sales to Capital Employed = Sales Revenue

Share capital +reserves+ non current liabilities

2005 2006 2007

20632 23349 29640

120+6919 122+8985 123+11958

= 2.9 times =2.6 times = 2.5 times

Liquidity ratios

1. Current Ratio = Current Assets

Current Liabilities

2005 2006 2007

5393 7624 11463

2664 3387 4570

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= 2.02:1 = 2.25:1 = 2.50:1

2. Acid Test Ratio = Current Assets - Stock

Current Liability

2005 2006 2007

5393-1387 7624-2101 11463-2192

2664 3387 4570

= 1.50:1 =1.63:1 = 2.02:1

Gearing Ratio

1. Gearing Ratio = Long term liability*100%

Share Capital+Reserves+long term Liabilities

2005 2006 2007

nil *100 nil * 100 nil * 100

120+6919+0 122+8985+0 123+11958+0

Since they don’t have a long term liability (no borrowings) gearing won’t occur.

2. Interest Cover Ratio = Profit before interest and tax

Interest payable

2005 2006 2007

4202 4765 6259

2 1 nil

= 2101 times =4765times = 00times

Note: Gearing Ratio is not applicable as the company has no LT (long Term) liabilities

Investment ratios
1. Dividend payout ratio = Dividend announced for the year *100
Earning for the year available for dividends

2005 2006 2007

1713 *100 2421*100 3086*100

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3338 3737 5180

= 51 % = 65% = 60 %

2. Earning per share = Earnings available to ordinary shareholders

No of ordinary shares in issue

2005 2006 2007

3338 3737 5180

1196 1209 1226

=HK $ 2.79 =HK $ 3.09 =HK $ 4.22

3. Price Earning Ratio = Market value per share

Earnings per share

2005 2006 2007

53.75 63.40 95
2.79 3.09 4.22

=19.27 Times =20.51 Times =22.51 Times

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