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Ratio analysis (Profitability analysis)

Financial statements can be analyzed by shareholders, the financial press, and others to check how well a company is performing.

Operating profit

Ratios are determined from a company's financial information and used for comparison purposes, e.g. operating profit to sales. This can be set out in the form: Operating Profit : Revenue. Alternatively, it can be set out as a percentage.

This is very helpful because it shows how much profit is made for each £1 of sales made. An improvement in Operating Profit margin would see this figure rising over time - showing that Cadbury Schweppes' customers are prepared to pay more for their purchases and/or that the company has made savings by improving the way it makes or ships its products. The operating profit margin of Cadbury Schweppes can be compared from year to year e.g. comparing 2005, 2006 etc., with 2004. Cadbury Schweppes' profit margin can also be compared with that of other companies.

If you refer back to the Profit and Loss Account, you can see the operating profit margin shown in the chart. This figure is crucial to Cadbury Schweppes as it relates to the second performance goal.

Current ratio

Here is another ratio you will find in your current course. This ratio shows whether the company owes more money to its suppliers and bankers than the assets it holds in the form of stocks, debtors and cash. If this number is less than 1, then the company's short-term or liquid assets are greater then its short-term liabilities.

If you refer back to the Balance Sheet, you can see that the current ratio for Cadbury Schweppes is as shown in this diagram.

This ratio is used in different ways for small and large companies. Businessmen and women considering whether to trade with a new small company would prefer to see this figure at 1.5 or above - as an indication that the company is solvent and will be able to pay its debts. For large established companies with good credit ratings, a lower ratio indicates an efficient use of capital.

Cash flow statement

In addition to the Balance Sheet and Income Statement, Cadbury Schweppes values the information provided in its Cash Flow Statement. This statement simply sets out the incomings and outgoings of cash in a business during a particular period of time e.g. one year. It shows how the main categories of cash flow have changed the cash balance in particular periods.

In 2004, Cadbury Schweppes achieved free cash flow generation of £265 million. Cash flow is very important to the company because cash enables the business to pay its bills, pay dividends to its shareholders and, in addition, to make acquisitions.

In recent times Cadbury Schweppes has focused on acquiring new businesses, increasing sales and innovation, cutting costs, and integrating existing businesses to achieve its aims of:

- higher sales growth

- improved operating profit margins

- higher levels of free cash flow.

Through efficient financial management Cadbury Schweppes is able to continually invest in making sure that customers are supplied with the brands that they enjoy.

Conclusion

Cadbury Schweppes prepares financial statements because:

- As a listed company, it is legally required to do so.

- Cadbury Schweppes wants to communicate a true and fair picture of the financial state of the company to its shareowners and external analysts.

- The company values transparency and honesty and aims to reflect this is all its communications, both internally and externally.

Cadbury Schweppes won the Communication of Corporate Strategy Award at the PricewaterhouseCoopers 'Building Public Trust' awards in 2005. This publicly recognized the high standards of the company's reporting: 'a highly accessible overview of its short-term strategy, major markets and measurable targets.'


 

A Nestlé case study
SUSTAINABILITY AND WATER

Introduction

Intelligent businesses in the 21st century operate with an awareness of their responsibilities to all of their stakeholders, not just responsibilities to directors and shareholders, but also to customers and, perhaps most importantly, the environment. For Nestlé, this is nothing new. From its founding in 1867 by Henri Nestlé who developed the first cereal-milk food for infants Nestlé has built its business on the basis of sound principles. The business is committed to creating value for all stakeholders and recognises that different stakeholders see different values as important.

The major stakeholders in Nestlé are:

- shareholders, who want a dividend from profits

- employees, who want job security and the necessary training and development to allow them to further their careers with Nestlé

- consumers, who want products that better meet their needs, that are available in the right places and at the right price

- business partners, who want long-term and trusted relationships

- local and national economies within which Nestlé operates.

This Case Study examines Nestlés policies on eco-efficiency and sustainability, and, in particular, how it has developed a responsible policy towards the use of water. This is covered in its first water review Nestlé and Water: Sustainability, Protection, Stewardship published in 2003.

Background

Nestlé is the worlds largest food and beverage company and employs over a quarter of a million workers. It is in the secondary sector at the center of the supply chain that starts with producers of agricultural products in the primary sector and ends with distribution and retailing in the tertiary sector.

Ownership

Nestlé SA acts as a holding company. SA is the Swiss equivalent of a UK public limited company (plc). Like all companies it has a duty to provide returns to its shareholders in the form of dividends. Nestlé balances this against the need for growth whilst continuously improving and being true to its principles of sustainability. Nestlé UK is a private limited company (Ltd), wholly owned by Nestlé SA. However, Nestlé UK has its own directors and can make many of its own decisions; this is because Nestlé strives to be as decentralized as possible - local decisions are made locally.

Nestlé produces over 100 brands, including many household names such as Nescafé, KitKat and Nesquik. Other brands are also well known, but you might not have realized that they were Nestlé products - such as Golden Grahams, Buitoni, Friskies and Perrier. In 2002 Nestlé had a sales turnover of over £38.3 billion on which it made a net profit of over £3.2 billion. The majority of this profit (63%) was re-invested in the business whilst the remainder was paid out to shareholders in dividends. Its attitude to growth is that it, too, should be sustainable, and this usually means organic growth. However, its water business - known as Nestlé Waters since 2002 - has grown both organically and by acquisition. Nestlé acquired Vittel in 1969, Perrier in 1992 and San Pellegrino in 1998. Today, Nestlé Waters is established in 130 countries and is the worlds leading bottled water business.

Acting responsibly

Nestlé feels that it has a real role to show a lead in acting responsibly with its business partners, suppliers and customers around the world. Responsible business practices dont just make moral sense; they make good business sense. The company has therefore developed policies and principles to help it meet its general aims of fairness, honesty and concern for people. Its Corporate Business Principles includes all nine principles of the United Nations Global Compact referring to labor standards, human rights, and the environment which are applied throughout the company.

Some of the basic Nestlé values and principles are to:

- prefer long term development over short term profit

- develop long term commitments and relationships with suppliers and customers

- show respect for diverse cultures and ensure operations integrate with them

- recognize that consumers deserve information about the products they buy and the company behind the brand

- encourage all employees, led by senior management, to follow these principles by integrating them into Nestlés business processes.

Nestlé and sustainable development

Nestlé defines sustainable development as the process of increasing the worlds access to higher quality food, while contributing to long-term social and economic development, and preserving the environment for future generations. Nestlé tries to be a genuine partner in sustainable development. The rise in the worlds population means there is an increased demand for food. This in turn places pressure on water and raw materials produced by the primary sector. If Nestlé wants its business to continue growing it must encourage more production of better quality raw materials from its suppliers. Recognising that others face this issue, Nestlé created the Sustainable Agricultural Initiative with other food manufacturers. The group defines sustainable agriculture as a productive, competitive and efficient way to produce agricultural raw materials, while at the same time protecting and improving the natural environment and social/economic conditions of local communities. They recognise that this will take time, but by co-operating these competitors are better placed to make an impact on a global scale.

The basic economic problem

Economists distinguish between wants and needs; needs are those things which people require to survive. These comprise food, water and protection from the elements in the form of shelter and clothing. Nestlé products fall into two of these categories (food and water). However they can only be described as wants because it is possible to survive without consuming any Nestlé products at all.

All resources are considered scarce because the wants for them (the demand) outstrip the various uses for them (the supply). This means that they have to be shared out (distributed) by a mechanism such as price. There are numerous ways in which a resource may be used, an opportunity cost is therefore created whenever one use is preferred over another. If water is used for industrial production, it is not available for agriculture or domestic consumption. Water is a classic example of the distribution problem of scarce resources. There is actually enough water in the world for everyones needs, and it is not a resource that is ever used up in the way that other resources can be consumed. The amount of water in the earths water cycle evaporating from the sea, then falling as precipitation over land is constant, the problem is one of distribution - it is not always located where it is needed.

Factors of production

The factors of production are:

- land - natural resources including water and the proportion of the planet given over to agriculture producing raw materials

- labor - the human effort involved in production

- capital - the money invested in business including equipment purchases

- enterprise - the process of bringing the above factors together to make a profit.

Any production process involves the use of all factors of production. The efficient and sustainable use of factors of production has long been tackled by Nestlé working with its agricultural suppliers. Nestlé helps suppliers in developing countries to increase their output. For example, in Pakistan sales of milk per farmer have doubled in the last three years as a result of the support from Nestlé Agricultural Services provided to more than 115,000 farmers.

Despite consuming only a tiny proportion of water, (see table) Nestlé still seeks to minimize water use. 70% of water usage is by agriculture, and agricultural raw materials provide the basis of Nestlés finished products. It is important that the environment in which raw materials are grown is safeguarded and protected in a sustainable manner. Nestlé does not own farms but encourages sustainable agricultural practices amongst its suppliers. The company invests over £45 million per year in environmental protection, amounting to 3% of total capital expenditure on top of regular capital-investment projects that incorporate environmental components and factory environmental operating costs. Also, in certain parts of the world, Nestlé has invested in water education programs and community initiatives to develop sustainable and safe water supplies. It partners EcoLink - a non-profit-making, non-government environmental education trust - in a water tank project to provide a reliable source of clean water to many South African communities. For example, in the Nkomazi and Nsikazi areas 20 water tanks have been provided at various women's groups and schools reaching over 10,600 people. For more information see www.nestle.co.uk/studentissues and follow the links to Nestlé in the Community and the Ecolink page.

Nestlé uses water in manufacturing (for example to wash raw materials). It limits the use of water in its various operations and, where this is not possible, re-uses or re-cycles waste water.

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