Porters Five Analysis: Advantages and Disadvantages

Porters Five Analysis: Advantages and Disadvantages Usefulness of the strategic models Why are models commonly used in strategic management what model are, provides, usefulness, strategy making, Strategy Johnson et al. (2005, p. 9): Strategy is the direction and scope of an organisation over the long term which achieve advantage in a changing environment through its configuration of resources and competences with the aim of fulfilling stakeholder expectation. Uvod Strategic decisions are long term decision based on scope of companys activities made in order to obtain advantage over competition. Johnson et al (2005, p. 10) says that such decision have certain characteristics. They are complex in nature, are made in condition of uncertainty. These decisions have impact on operation decisions. They require integrated approach from managers to deal with strategic problems. Strategic decisions which are made without previous analysis but as some kind of individual notions or wishful thinking are consider to be vulnerable issue. Identifying the root of strategic analysis is difficult. It does not provide us with prescription of what strategy to implement. Companys strategic decisions are too complex for programming. Thus, author says that helping to understand issues is the aim of strategic analysis not to give answers. Model is the framework for recognizing, understanding and categorising factors applicable to strategic decisions (Grant, 2008, p. 27). Models were developed in order to solve usual problems and challenges in business. The general advantage of model is that they smooth differences between abstraction and real practise. They pose a new way of seeing a particular situation and resolving this situation. The common use of the model can be explained by their characteristic. They are projected to solve exact problems and increase efficiency. On the other hand no model can secure that by their implication solving the problem will be hundred percents successful. They are just framework which gives understanding and options for making right decision and diminish uncertainties (Assen et al, 2009). Theories, analytical tools were not made in order to replace inventiveness or experience. Their significance lies in managing discussion, processing information and opinions and supporting communication and agreements. Managers are more confident and effective in reacting on new circumstances and issues as they use models (Grant, 2008, p. 27). There are many models in strategic management which were developed on different bases in order to solve different needs. Every model focuses on various factors some are made to look at eternal surrounding of businesses as industry and market. Some models analyse inner capabilities or structure of organisation. Company chooses the models according its specific needs and what problem wants to solve. If the organisation wants to analyse its external environment it can use PESTE analysis. Industry analysis enables managers to understand how external issues influence companys performance and operations. When managers want to look better on companys product range in order to take right step to the future it can use the Boston Matrix for it. This model helps company in situation as decision making about investments to products portfolio. It guides the company what steps to take if the product is in particular stage e.g. if it star company should keep it and invest to its promotion (Keler-Si lver, 1997, p. 40). In the case of core competencies model it is advised that company should switch from portfolio planning and evaluation of individual businesses to exploring the collective capacity the whole company has. The model encourages company to stop doing activities which are not its core competencies. The confirmatory activities can be e.g. outsourced. By using this model an organisation can identify and improve the cross-company competencies. Thus it can bring new opportunities for success in the market (Keler-Silver, 1997, p. 50). Scenario planning is strategy model based on exposing various possibilities which might happen in the future. Thus it represents a context in which managers can make decisions. As they can see a scope of possibilities they are better informed and decision are more likely to be successful. The scenario planning is mostly used for understanding the dynamics of environment, identifying new openings, evaluating strategic alternatives and for taking long-term decisions. Managers can discover and consider the unsure aspects of future (Assen et al, 2009). One of the models which consider the root of competitive advantage in business is the Kays distinctive capabilities model. The model presents resource-based theory and sees a company as set of asses and capabilities. The model helps to identify distinctive capabilities which are the core of companys success. This model provides a useful tool when company make decision about redefining its strategy. It is used to widen awareness of the sources which made company competitive and to sustain these sources (Assen et al, 2009, p. 30). On the other hand Kare-Silver (1997) argues that the competitive environment has changed and the models are insufficient and shortcoming todays management. He says most of them are too theoretical, superficial and confusing and they are not enough helpful in todays environment. Further he gives the seventh criteria according to which models should be developed to meet current needs. The criteria are reflecting the business realities, starting with customers, rooted and immersed in market understanding, practical, specific, encouraging a long-term view and measurable. Author adds that it is crucial for organisation in current changing conditions to rediscover and redefine its strategy. Organisation needs to know direction in which to go and relying on strategy model is not a response. In conclusion we can say that decision making process is very challenging and requires complex view. Model provide useful tool for simplifying and mainly for making it more effective. However they do not ensure the real effect will be same. Description of Porters Five Forces Model of Competitive Strategy Formulating competitive strategy necessarily needs to analyse the company within its environment. The model is based on analysis of companys external environment. However the relevant environment is wide, the model is focus on organisations surrounding as industry in which it operates. Industry structure has powerful impact on competitive direction thus it is inevitable to analyse it. Five basic competitive forces determine the competition in an industry. The strength of the forces is to drive profit in industry in way of long term return on invested capital (Porter, 1980 p.3, 4). Next Porter says: The goal of competitive strategy for a business unit in an industry is to find a position where it can best defend itself against these competitive forces or can influence them in its flavour. Johnson et al. (2005, p. 78) refer to five forces as sources of competition which evaluate the attractiveness of industry. Authors give several points which company should take into account when using this model. When organisation has varied activities the framework needs to be used at the level of strategic business unit as for each of unit can be the impact of forces different. Next, it is inevitable to understand relations between five forces as well as macro-environment factors. As forces are not separate changes within one force influence other forces. It is a dynamic process of shifting source of competition. According to Luffman et al. (1996) the power of Industry competitor is consider to be the most important force of the model. Industry is in permanent change as every firm wants to success and it looks for opportunities to achieve it. Obviously, not all decisions lead to getting advantages some remain failure. There are many issues which influence the competition between companies as size of the company, industry structure and concentration, product differentiation and variety of rivals. Competitive rivalry is also determined by numbers and qualities of competitors. In situation of many companies in the industry which sell nearly equal product, the firm has a low level of power. Conversely if companys product is unique, it is an enormous strength (Kilde, 2005). Buyer power poses the rate of influences of costumer on pushing price down. The size or number and concentration of buyers are the most significant determinants of buyer power. Other factors include the level of information or differentiation of competitors (Karagianno et al, 2005). There are situation in which buyer power tent to grow as a low switching cost for buyer to move to another seller, when the product is not differentiated or product failure to perform its primary function. In case of trading with small number of strong buyers they tend to dictate conditions to sellers (Luffman et al, 1996). The extent to which supplier drive price up, is reflected in Supplier power. The numbers of input suppliers, product specificity or switching cost determine supplier strength. When company has few suppliers or choice of suppliers is narrow, the supplier power is high. Question here is how easy company can change its suppliers. Grant (2005, p. 83) says that suppliers of raw materials or components are mostly small companies so their bargaining power is low while suppliers of commodities enhance their power through cartelization. Same it is with labour union. If there is a high percentage of a unionised employee within an industry their supplier power is high and companys profitability is lowered. Substitutes are alternatives of product so they decrease demand for product. According to the value they give to consumer their power can be higher or lover. Johnson et al. (2005, p. 78) indicate these forms of substitution; product-for-product substitution, substitution of need when new product or service make previous unneeded and generic substitution means that product competes among others for consumer income to be spent on it. It reduces companys power when its product can be easily substituted. An attractive industry tempts other companies to enter. Threat of new entry represents the capability of new companies to enter and be able to compete in industry. The process of entering is easier for new companies and consequently it becomes a greater threat for existing companies when there are no economies of scale, industry is not capital intensive, access to distribution channels is open or there is a little protection of technology. On the other hand when there are strong barriers existing companies can keep their position. Difference between new entrants and substitutes is that new entrants when successfully enter industry will offer nearly same product. Thus, it is a bigger threat to company (Luffman et al, 1996). Thompson et al (2007, p.54) describe the way of using the model for identifying the essence and strength of competitive pressures within an industry. They divided it into three steps. The first step is to recognise particular competitive strengths related to every force from the model. Secondly, evaluation of the pressures takes place. It is essential to find out how strong they are i.e. strong, moderate, and weak. The last step is to decide the contribution of strengths on achieving profits. Evaluation of strengths and weaknesses of the model Porter (2008, p.80) says this importance of the model: Understanding the competitive forces and their underlying causes reveals the roots of an industrys current profitability while providing a framework for anticipating and influencing competition over time. He adds that effective strategic positioning can not be made without knowing industry structures. To avoid a subjective position for evaluation of the model we look at other authors views. The most significant strength of Michael Porter Five Forces model is that it remains best known and commonly used model in strategic management even after twenty years of it introduction. The simplicity is also consider to be a strength of the Five Forces model as it is easy to use and provides understandable way of market forces analysis (Kare-Silver, 1997, p. 46). According to Brandenburger (2002), the Porters Five Forces model remains to affect the scope of business strategy both in the education field and also in practise of organisations. He emphasises that the model is certainly the most known and used from competitive strategies. The reason is that it provides an obvious picture of important activities of firms. The model describes all movements from suppliers of resources through company to consumer. The role of company is stressed as it is the unit where value is created. On the other hand, suppliers and customers are consider to be necessary in such chain. The model provides useful information for three issues of companys planning, according to Recklies (2001). Firstly, it enables to determine the attractiveness of an industry. Consequently the model helps to make decision about entering or leaving industry. Further, its usefulness lies in comparison the impact of the competitive forces on the organization with the impact on rivals. Secondly, when company knows about the power and intensity of models forces it is able to come up with possibilities for improving its competitive position e.g. differentiation, strategic partnership. Thirdly, the author says that the model with combination with PESTE analysis which influences changes in the industries, the Five Forces model can indicates the trends within the industry. Hill and Jones (2007, p. 66) also talk about importance of microenvironment. Forces in the model are not constant because they are determined by wider macro-environment as economic, politic, social and technological forces. These have evident impact on the model forces and consecutively on the whole industry. The role of macro environment is important but it is the subject of the PESTE analysis and we will not discuss it closer. According Lynch (2000, p.131) the model presents effective way of analysing the environment and it is recommended to use it as the firs step of company strategy development. He points out its real relevance as results are presented in logical and structured way. Hill and Jones (2001, p.97) see the model as very useful as it can be used to analyse character of competition within industry and for recognising opportunities and threats. Opportunities and treats represent the external part of SWOT analysis so we can see the clear connection of Five Forces model with another model. Another advantage of the model is that it looks on organization and industry through a wide range of aspects which are included in the models five forces. Thus, it is systematic approach for analysing the current situation of business and plan strategy (Oliva, 2002). For better picture of the model and to underline its strengths we look at an example of bank sector and examine the impact of launching the Internet banking in Five Forces model context (Siaw, Yu, 2004). In the terms of threat of entry force, the Internet banking enables small banks to enter the industry. Scale benefits are removed and network of branch is less important as there is direct access to customer in more suitable way. Bargaining power of buyers increases as they have more choices. Switching cost decrease because product has become more undifferentiated and standardised. As far as rivalry is concern, the differences between banks are smoothed as size of a bank is less important. Further providing services through the Internet is cheaper than using traditional distribution channels. Internet banking increased supplier power. Banks acted as supplier before. Now they pose intermediaries which enables access to range of products and delivery channels. Switching costs are high for bank if it is dealing with big customers. Such analysis helps manager to understand how the Internet influences five competitive forces. Existing banks using the analysis periodically can evaluate changes within the industry. Potential entrants can assess if the enter into industry will be profitable for them. Overall the analysis is useful in competitive strategy formulating (Siaw, Yu, 2004). Besides numbers of advantages the model is subject of many critiques. According Grant (2002, p. 89), the theoretical bases of the Porters Five Forces model are the most criticised by economists. Furthermore doubtful theoretical foundation, there are limitations because of static character of the model. Industry structures are considered to be stable and determinate by external forces. Grant (2002, p. 89) says that: Industry structure drives intensity of competition, which in returns determines the level of industry profitability. Therefore industry structures cannot remain unchanged in dynamic process of competition. Another issue which Grant points out is missing empirical evidence of importance of industry environment for company profitability. Faulkner and Campbell (2003, p. 249) also criticise static character of the Five Forces model saying that industry structures are continuously changing because of competition between firms and strategies adoped by companies within the indust ry. Static character of the model is also pointed out by Lynch (2000, p. 131), he says that forces are constantly changing and the moves could be more rapid than the model explain. Next critic which Lynch expresses is about the buyer power. The model assumes that this aspect is as equal as others factors while he argues that buyers should be got greater importance. According to the model, the environment is viewed as a threat to a company however some organisations see co-operation with others, especially with suppliers, very beneficial. Faulkner and Campbell (2003, p. 249) express their view to this question, too. They criticise Porters view on rivalry and competition between companies to be more essential than possible interaction as joint ventures or alliances. Lynch also questions the fact if it is sufficient for company to create its corporate strategy just after applying the Five Forces model. Further critics of model presented by Lynch consider its ignorance of human aspect o f strategy. The model overlooks features as country cultures or management skills. The presumption that companys own interests are primary might not be correct for some charitable and government institutions. Hill and Jones (2001, p. 97) reveal two weaknesses of the five forces model. The first is, as the other authors say, about its static character however they enhance their critique to disregarding the role of innovation. Innovations represent driven force of competition within the industry. As any company comes up with new product, technology or process it can gain great competitive advantage and earn profit. Another function of innovation lies in converting industry competition. As the production costs could be cut down due to e.g. new technologies, the barriers to entering the industry are removed and small companies can also access the competition. They provide example of the steel industry where after introducing technology as electric arc furnaces, the characteristic oligop oly industry became more price competitive and fragmented industry and smaller companies can also compete. Porter (2008, p.86) does not see innovation itself as a strong factor which can make industry profitable. He argues that often industries with low technology, high switching costs or price intensive buyers are more profitably than attractive software or information technologies ones. Because the model is static, all changes, which arise in the industry, cannot be recorded. Hill and Jones (2007, p. 66) conclude: The Five Forces model is of limited value because it represents no more than snapshots of a constantly changing situation. Thus, managers must constantly repeat industry analysis and pay attention to changes in the forces of competition. As far as the second critic is consider, same as Grant (2002, p. 89), Hill and Jones (2001, p. 97) talk about overrating the role of industry. Industry is given too much importance as the determinant of organisation profit while the differences between individual companies are neglected. Companies profit within industry varies and it has been detected that only 10% to 20% of differences is explained by industry structure. Consequently, we can say that companys own capacity and resources are more significant for profitability than industry in which it operates. None of company will be successful just because it is in the at tractive industry. Companys strategic resources as intangible assets, brand name are critical for analysis and strategy making (Crook at all, 2003). Other authors who agree that the Porters model is completely focus on external environment rather than internal resources of a company are Faulkner and Campbell (2003, p. 249). They criticise Porters view on outside environment as a root of firms success. Their another critique consider the application of industry analysis to individual company. This might not be as successful as first thought. In spite of critics authors admit that the Porters model of industry analysis stays as one of the most significant model of strategic management even though it has been introduced twenty years ago. Further shortcoming of the Porters model is that it was meant for industrial companies g.e. Coca-Cola, Ford Motors or Dell, not for knowledge based firms in field of advertising, consulting or legal. Manager of these companies bear some risk by using this tool and it is recommended to alter the model according to needs of such firms (Sheehan, 2005). Recklies in her article Porters 5 Forces (2001) indicates various criticisms. Besides acknowledgement that the model is static and it does not take into account co-operation between companies, the author gives also other critiques. As the model supposes perfect market, it has limited application in more regulated industries. The model fits the best to analyse simple market structures. In the case of complex industries with numbers of interrelations it is very complicated to analyse all five forces. On the other hand the author alerts that too narrow look on one segment in such industry can cause oversight of important factors. She concludes, as well as others authors, that the Five Forces model present a tool for managers to view the current situation of the industry in easy and understandable way and it is a good beginning for additional analysis. Recklies in her another article (2001) says that one of the reason for critics are todays changed economic circumstances. The model is found on the situation in the eighties. Cyclical developments, steady market structures and strong competition are typical for this time. Nowadays, technologies, the Internet and e-business application are seen in all industries and it transforms industry structures. This is the reason why the model cannot be used to explicate today dynamic changes and she adds: It is not advisable, if not to say impossible, to develop strategy solely on basis of Porters model. Downes realised the same trend and in the article Beyond Porter (1997) he introduces three new forces digitalization, globalization and deregulation as current issues which influence businesses. The new forces are seen in business activities as they are moving from physical world to computerised networks. According to Downes new strategic framework and analytical tools are essential to apply. Digitalization enables firms to gain access to greatly more information than before on the other hand it pose the treat of unfamiliar and unpredictable competition. Due to Globalization even local companies are able to become global as logistic and communication improved. Deregulation also opens up new possibility for company e.g. restructuring, more open international market. More others authors argue that the model should be extended about another force. They have various views on what it should be. Hill and Jones (2007, p. 57) see the sixth force as complementors. Complements are considered to be determinant of demand for products thus having a satisfactory supplier affects companys profit. Attractive complementary products create value and opportunity for company within an industry. On the other hand inefficient complementors pose threat and they are cause of slow industry development and low profitability. Also Grant (2005, p. 103) see complementors as significant impact on companies competitiveness and refer to them as to the sixth force. In the case of close complements of products, products have low value separately as consumer wants the whole. Question is how the value is divided between producers. The most common the supplier with stronger market position who is able to lower the value of other complements, gets much of profits. Karen-Silver (1997, p. 46) argues while current competitive environment calls for new forces to be consider, the original core i.e. five forces stays the most powerful. Porter (2008, p. 86) agrees that there are other important issue within an industry but he refers to them as to factors not forces. He presents factors like industry growth rate, technology and innovation, Government, complementary products and services. In addition he says: It is especially important to avoid the common pitfall of mistaking certain visible attributes of an industry for its underlying structure. In summary, Michael Porters models do not have the influence they used to have any more. New economic laws came up and other drivers stared to transform markets. Nevertheless, that does not mean that Porters theories became invalid. All we have to do is to apply them with the knowledge of their limitations in mind and to use them as a part of a larger framework of management tools, techniques and theories. This approach, however, is advisable for the application of every business model brand-new or old, from Porter or from somebody else, and in every economy Bibliography Assen, M., Berg, G., Pietersma, P., (2009) Key Management Models: The 60+ models every manager needs to know. Essex: Pearson Education, UK 2nd ed. Brandenburger, A., (2002) Crook, T.R., Ketchen, D.J., Snow, C.C., (2003) Competitive Edge: A Strategic Mnagement Model, .pp. 44-53 Downes, L., (1997) Beyond Porter, The Context Magazine. Available at: http://www.contextmag.com/setFrameRedirect.asp?src=/current/archive.asp Faulkner, D., Campbell, A., (2003) The Oxford Handbook of Strategy: Strategy overview and competitive strategy. Oxford (New York): Oxford University Press, USA, pp. 248-250 Grant M, R., (2002) Contemporary Strategy Analysis: concepts, techniques, application. Oxford: Blackwell Publishers, UK, pp. 89 Grant (2005) p. 83 Hill, C.W.L, Jones, G.R., (2007) Strategic Management: An Integrated Approach. 7th ed. Boston: Houghton Mifflin, USA pp. 46-67 Hill, C.W.L, Jones, G.R., (2001) Strategic Management: An Integrated Approach. 5th ed. Boston: Houghton Mifflin, USA pp. 97-98 Johnson, G., Scholes, K., Whittington, R., (2005) Exploring Corporate Strategy: Text and cases. 7th ed. Essex: Pearson Education, UK Kare-Silver, M., (1997) Strategy in Crisis: Why business urgently needs a completely new approach. London: Macmillan Press, UK pp.45-47 Karragiannopoulos, Luffman, G., Lea, E., Sanderson, S., Kenny, B., (1996) Strategic Management: An Analytical Introduction. Oxford: Blackwell Publishers UK, pp. 48-55 Lynch, R., (2000) Corporate Strategy. 2nd ed. Essex: Pearson Education, UK, pp. 124-132 Oliva, A.R., (2002) A Framework for Success, Marketing Management jan/feb. pp.39 42 Porter, M., (2008) the Five Competitive Forces that Shape Strategy, Harvard Business Review. Recklies, D. (2001) Porter 5 forces, Recklies Management Project GmbH, Available at: http://www.techba.com/training/course2/LinkedDocuments/Porters%205f.pdf Recklies, D. (2001) Beyond Porter ACritique of the Critique of Porter, Recklies Management Project GmbH, Available at: http://www.themanager.org/Strategy/BeyondPorter.htm Sheehan, N.T., (2005) Why old tools wont work in the new knowledge economy, .. . 26 (4), pp. 53 60 Available at: Siaw, Yu Thompson The Introduction and History of Dabur Nepal Pvt Ltd: The Introduction and History of Dabur Nepal Pvt Ltd: Dr. S.K. Burman set up Dabur in 1884 to produce and dispense Ayurvedic medicines reaching out to a wide mass of people who had no access to proper treatment. Dr. S.K. Burmans commitment and ceaseless efforts resulted in the company growing from a fledgling medicine manufacturing in a small Calcutta house, to household name that at once evokes trust and reliability. There are many stores in different region and country. As a reflection of its constant efforts at achieving superior quality standards, Dabur became the first Ayurvedic products company to get ISO 9002 certification. Reinforcing its commitment to nature and its conservation, Dabur Nepal, a subsidiary of Dabur India, has set up fully automated greenhouses in Nepal. This scientific landmark helps to produce saplings of rare medicinal plants that are under threat of extinction due to ecological degradation. There are various product manufactured by this company in Nepal. Daburs Health care range brings for you a wide selection of Ayurvedic and natural products that offer complete care for varying individual needs. Our product are derived from the time-tested heritage of Ayurveda and backed by the most modern scientific test and trials that ensure no failing quality and safety in anything you pick. The guiding force behind Daburs growth and success has been the wealth of nature and its limitless capacity to support life. And we have constantly taken care to preserve and protect this natural bounty with this overall vision of and to eco-sustenance, expand Daburs resource and production base, Dabur Nepal Private Limited was set up as an independent Group company in 1992. This new company, set amidst the verdant greens and towering mountains of the Himalayan kingdom of Nepal, has established a unique bond of technology and preservation. 2. Introduction to Financial Ratio: A financial ratio is a relative magnitude of two selected numerical values taken from an enterprises financial statements. Often used in accounting there are many standard ratios used to try to evaluate the overall financial condition of a corporation or other organization. Ratio may be expressed as a decimal value, such as 0.10 or given as an equivalent percent value such as 30%. Some ratio is usually quoted as percentages. Different ratio measures different thing Liquidity ratios measure the availability of cash to pay debt. Active ratios measures how quickly a firm converts non cash assets to cash assets. Debt ratios measure the firms ability to repay long-term debt. Profitability ratios measure the firms use of its assets and control of its expenses to generate an acceptable rate of return. Liquid Ratios: Liquidity reflects the ability of a company to meet its short-term obligations using assets that are most readily converted into cash. Assets that may be converted into cash in a short period of time are referred to as liquid assets; they are listed in financial statement as current assets. Current assets are used to satisfy short-term obligations, or current liabilities. The amount by which current assets exceed current liabilities is referred to as the net working capital. Current Ratio: It is used to calculate that how many short term assets a company has to meet its short term obligations. Current ratio= current assets / current liabilities a) 1.6:1 for year 2005 b) 1.8:1 for year 2004 As we know that higher the ratio better the company has more liquid assets to meet its short term liabilities. There were sufficient amounts of assets available to meet short term liabilities in the year 2005 which was 1.6:1 so there were 1.6 current assets available to meet its short term liabilities and in the year 2004 the ratio was increased to 1.8:1 which was much better than in the year 2005. So the company had good financial status in the year 2004 than in the year 2005. Acid Test Ratio: The acid test ratio is also known as the liquid or quick ratio. The idea behind this ratio is that stocks are sometimes a problem because they can be difficult to sell or use. Acid Test Ratio: Current assets- closing stock/ current liabilities 0.8:1 for year 2005 1.1:1 for year 2004 As we know that higher the acid ratio, is comparatively better. So the acid test ratio in 2005 was not sufficient to meet its current liabilities but the ratio was about 1.1:1 in the year 2004 which was sufficient to meet its liabilities and hence the liquid ratio in year 2004 was much better than 2005. 2.2. Profitability Ratios: profitability ratio compares components of income with sales. They gives us an idea of what makes up a companys income and are usually expressed as a portion of each unit of sales. Primary Ratio Return on Capital Employed: It is used in finance as a measure of the returns that a company is realising from its capital employed. It is commonly used as a reassure for comparing the performance between businesses and for assessing whether a business generates enough returns to pay for its cost of capital. ROCE compares earning with capital invested in the company. ROCE= [PBIT/ Capital Employed]*100% a)14.58% for year 2005 b) 18.79% for year 2004 This shows that ROCE in the year 2004 has more profit gained than in the year 2005. Return on Total Assets (ROTA): A ratio that measures a companys profit before interest and taxes (PBIT) against its total net assets. The ratio is considered an indicator of how effectively a company is using its assets to generate earning before contractual obligations must be paid. Return on Total Assets (ROTA) = PBIT/ Total Assets a)0.097 for year 2005 b) 0.14 for year 2004 The rate of return on total assets was better in the year 2004 in comparison with the ratio 0.097 in the year 2005 because there was more profit before interest and tax with total assets. Secondary Ratio: Gross Profit Margin: this ratio is the percentage of sales left after subtracting the cost of goods sold from net sales. It measures the percentage of sales remaining available to pay the overhead expenses of the company. Gross profit margin=Gross profit/ Net sales a) 22.1% for year 2005 b) 23.9% for year 2004 It was seen form the above data that the gross profit margin in the year 2004 was better than in the year 2005 so the company had better profit margin in the year 2004. Net Profit Margin: This ratio is the percentage of sales dollars left after subtracting the cost if goods sold and all expenses, except income taxes. It provides a good opportunity to compare your companys return on sales with the performance of other companies in your industry. It is calculated before income taxes because tax rates and tax liabilities vary from company to company for a wide variety of reasons. Net profit margin: Net profit Before Tax/ Net sales 4.7% for year 2005 6.5% for year 2004 The ratio measure average profit on sales. The percentage net profit to sales for Dabur Nepal Pvt. Ltd was 6.5% in 2004 and 4.7% in 2005 which mean that each Rs1 sales made an average profit of 6.5 Rs in 2004 and 4.7 Rs in 2005. This shows the Net Profit margin was better in the year 2004. Assets Turnover: It is used to calculate revenue generated per amount of long term capital invested in the business. It is used to see how effectively the long term assets are being utilized to generate the revenue. It is given by Assets Turnover= Turnover/ Capital Employed 3.87 times for 2005 3.68 times for 2004 We see the result of 3.68 times for 2004 this means that turnover is 3.68 times bigger than total assets. For the year 2005, it was even higher at 3.87 times. So the total asset turnover ratio was better in 2005 than in 2004. Activity Ratio Inventory Turnover: Inventory turnover is a measure of the number of times is sold or used in a time period such as a year. The equation for inventory turnover is equals the cost of goods sold divided by the average inventory, inventory turnover is also known as an inventory turns, stock turns, turns. A lower turnover ratio defines overstocking a company and a higher turnover ratio indicates inadequate inventory level or less in business. A lower turnover of inventory is somehow beneficial for a production company like Dabur Nepal Pvt. Ltd. Inventory Turnover=cost of goods sold/ average Inventory a)3.51 for year 2005 b) 7.65 for year 2004 Unit inventory turnover is better for the company, which excludes the over stocking and under stocking/ deficiency. It can be possible when cost of goods sold and turnover inventory are equal. As the year 2005 shows 3.51 times turnover inventories which were better because less amount of stock was there in this year but in the year 2004 the inventory turnover was more which was 7.65. As form definition we know less the turnover ratio better the profit gain by the company. So the companys financial status was better in 2005. Debtors Turnover: It indicates the velocity of debt collection of a firm. In simple words it indicates the number of times average debtors are turned over during a year. Debtors Turnover= [Debtors/ Sales]*365 The two basic components of accounts receivable turnover ratio are net credit annual sales and average trade debtors. The trade debtors for the purpose of this ratio include the amount of Trade debtors Bill Receivables. The average receivables are found by adding the opening receivables and closing balance of receivable and dividing the total by two. a)20.50 days for year 2005 b) 22.17 days for year 2004 Accounts receivable turnover ratio or debtors turnover ratio indicates the number of times the debtors are turned over a year. The higher the value of debtors turnover the more efficient is the management of debtors. In the year The debtors turnover was 22.17 days in the year 2004 in comparison with this there was 20.50 days in the year 2005 so, the company took less days to collect its debt in the year 2005 than in the year 2004. As a result the company had better financial state in 2005. Conclusion: The turnover of the company has increased by 4.69% over the previous year. The net profit after tax has reduced by 2.28% over the previous year due to lower contribution margin. During the year company has invested Rs 24.65 crore on account of fixed assets. Out of which, major amount is spent towards installing a new packing machine in juice plant in flex pack and increasing cold store capacity. It has deposited off its fixed assets amounting Rs 4.51 crore during the year. Hence as a whole Dabur Nepal Pvt. Ltd has well financial status in year 2004 but all the ratios were affected by the political instability of politic in Nepal as well as by other effect of the company. References: http://www.dabur.com/EN/Investors1/Annual_reports/2004-05/Dabur-Nepal-fina-05.pdf http://www.bized.co.uk/compfact/ratios/ Course Work Managing Financial Principles and Techniques Level 7 Advanced Professional Diploma in Management Studies Submitted to: Course Tutor/ Assessor Muhammad Atif Majeed Submitted by: Kabindra Simkhada Id: 201093 London College of Business Information Technology Contents Net present Value 1 Pay Back Period 1 Internal Rate of Return 1 Post completion Audit 1 Methods of finance available for company A 2 Scatter diagram 3 Advantage of Scatter Diagram 4 Disadvantage of Scatter Diagram 4 Appendix 5 Forecasting total cost Net present value: Both incoming and outgoing of a time series of cash flows is defined as the sum of the present values of the initial investment. The NPV is similar to PV of future cash flows minus the purchase price. This is a central tool for discounted cash flow analysis and is a standard method for using the time value of money to appraise long term project. It is used for capital budgeting, economics, finance and accounting. It measures the excess or shortfall of cash flows. The net present value of the company A is $76,990. this means in an initial investment of $260,000 in a project for 5 years of period the profit gain in the project is $76,990. Pay Back Period In capital budgeting refers to the period of time required for the return on an investment to repay the sum of the original investment is payback period. The time value of money is not taken in account. It measures how long something takes to pay for itself. This term is also widely used in other types of investment areas, often with respect to energy efficiency technologies, maintenance, upgrades, or other change. Payback period is a tool of analysis is often used because it is easy to apply and easy to understand for mist individuals. It is useful for comparing similar investment. According to the project A we earn or get back our initial investment in 3 years 6 month of period and after that period all the money gained is profit. Internal Rate of Return (IRR) It is also called discount cash flow rate of return or simply the rate of return. The internal rate of return on an investment or project is the annualized effective compounded return rate of discount rate that makes the net present value of all cash flow form a particular investment equal to zero. It is commonly used to evaluate the desirability of investment or projects. The higher a projects IRR the more desirable it is to undertake the project. Assuming all other factors are equal among the various projects, the project with the higher IRR would probably be considered the best and undertaken first. At the discount rate of 7.10% the NPV of project is equal to 0. Post Completion Audit Post completion audit is a key example of an internal audit. In this process technical details are discussed briefly. The purpose of post-auditing is to examine how well or badly a project has performed after it has been implemented. This process may be taken at any stage after a project has been started and need not wait until after the project has been completed. It is important for the project to perform post completion audit. Following are the benefit of post completion audit. Improved quality of decision making: after feedback and suggesting changes that need to be made to the process of decision making Improved realism of project appraisals: this is to attempt to prevent biasing upward of cash flow in proposals. Identification of key variables: This after the event knowledge can help to identify what the actual key variables were compared with the ones that were thought to be the case before implementation More frequent project termination: although firms are often unwilling to stop unsuccessfully projects, it may be the logical thing to do. Performing post audit actually gives the information to make that decision. Following things are checked in post completion audit. Check whether the required quality has been achieved. The efficiency of the solution during operation compared with the agreed performance and standards. The actual cost of the project compared with the budgeted expenditure and the reasons for over or under expenditure identified The time taken to develop the solution compared with the targeted date for completion and reasons for a variance identified The effectiveness of any problems encountered and the effectiveness of the solutions generated to deal with them. If the project objectives have been stated in terms of learning outcomes, the extent to which these have been achieved would also be investigated. The audit would lead to the production of a report to the management, structured around the above points. Post completion is one of the important part of the project with the help of which we can verify whether the project meet the requirements, whether the project is completed or not. This is the basic requirements of the project now a days. Methods of finance available for company A Public limited Company is the company which gives services to the public. This company is non profitable organisation whose goal is to provide better and efficient services to the customer or public. A plc is a company that is able to offer its shares to the public which means it share its profit and public also take part or public are also the owner of the company. For long term sustain of the company finance are those that are needed over a longer period of time generally over a year. This company should give services to the public for long time. The methods of finance available for this company are as follows Shares: Shares relate to companies set up as plc. If a company want to expand the business then they can sell shares to the general public. This means any one can buy the shares in the business. Venture capital: Venture capital is becoming an increasingly source of finance for growing companies. Venture capitals are on the lookout for companies with potential. They are prepared to offer capital to help the business grow. In return the venture capital gets some say in the running of the company as well as a share in the profit made. Bank loan: as with short term finance, banks are an important source of longer term finance. Banks may lend sums over long period of time possibly up to 25 years or even more in some cases. The loans have a rate of interest attached to them. Using bank loan might be relatively easy but the cost of servicing the loan can be high. If interest rates rise then it can add to a business costs and this has to be taken into account in the planning stage before the loan is taken out. Government grant: some of the company get funds from the government. This could be medical sector, security sector etc which get its most of the funds from the government. Retained profit Owners Capital: some people are in a fortunate position of having some money which they can use to help set up their business. The money may be the result of savings, money left to them by a relative in a will or money received as the result of a redundancy payment. This is not enough sums to finance the business fully but will be one of the contributions to the overall finance of the business. Selling assets: By selling the assets like property, machine, equipment, other companies or even logos. In some cases it may be appropriate for a business to sell off some of these assets to finance other projects. Lottery funding: in UK the National Lottery might be a possible source of funds for some types of business. These businesses will mostly be charities or charitable trusts. The company that are not for profit business so any surplus they make is put back into the business to help develop and improve it. Scatter diagram A scatter diagram or scatter graph is a type of mathematical diagram using Cartesian coordinates to display values for two variable for a set of data. The data is displayed as a collection of points, each having the value of on variable determining the position on the horizontal axis and the value of the other variable determining the vertical axis. This kind of graph is called scatter diagram. This diagram mostly used for the experimental purpose. Different data collected from the experiment is plotted in the graph. If data exist that is systematically incremented or decremented by other, it is called the control parameter or independent variable and is customarily plotted along the horizontal axis. The measured or dependent variable is customarily plotted along the vertical axis. If no dependent variable exists, either type of variable can be plotted on both axis and a scatter plot will illustrate only the degree of correlation between tow variables. A scatter plot can suggest various kinds of correlation between variables with a certain confidence interval. Correlations may be positive, negative, of null. If the pattern of dots slopes form lover left to upper right, it suggests a positive correlation between the variables being studied. If the pattern of dot slopes form lower left to upper right. It suggests a negative correlation. A line of best fit can be drawn in order to study the correlation between the variable. An equation for the correlation between the variable can be determined by established best fit procedures. For a linear correlation, the best fit procedure is known as linear regression and is guaranteed to generate a correct solution for arbitrary relationships. The scatter diagram is one of the basic tools of quality control. Benefits of scatter plot are as follows The diagram shows the relationship between two variables where one variable is drawn at horizontal axis and other is plotted at vertical axis. This scatter plot is best method to illustrate the non linear pattern. This is the best method used for finding results in experiment. Disadvantages of scatter plot It is difficult to find exact value of the variables. To get the exact value we need more experimental values because of which this method is time consuming. It is difficult to get accurate result from more scattered data.