Shropshire Hills Water plc 1.) Using relevant ratios in support of your answer, analyse the financial efficiency of Shropshire Hills Water plc (SHW) over the past two years. Financial efficiency ratios measure the efficiency with which a business manages specific assets and liabilities. This allows the business to scrutinise the effectiveness of certain areas of its operations. Looking at the data given, it could be supposed that SHW’s financial efficiency is weak. For example, their asset turnover for the year 2009 is:

1.3. While, previously in 2008 the asset turnover was:

1.4. This shows that the efficiency in which SHW uses their assets to generate sales revenue is decreasing. This could be one of the reasons why revenue has dropped, and therefore produced lower profits. It is important that SHW uses their fixed assets such as machinery, to produce as many products as it can (to its admissible capacity) because SHW needs to turnover as much stock as possible in order to pay their current liabilities which have risen by £388 million, in order to avoid debt and liquidation. It would be fair to point out that SHW’s financial team may have spotted this falling trend in asset turnover, hence why they decided to implement the latest technology on production lines the following year. In theory, this could increase productive efficiency because the new machines will be able to produce more stock, faster. Therefore lowering unit costs which will help to increase profit and improving asset turnover which in turn will better the financial efficiency of SHW. On the other hand, analysing the same data could also prove that SHW’s financial efficiency has improved over the two years. In the previous year of 2008, SHW’s receivables were:

47 days. While during the next year the receivables were:

16 days less, at 31 days. This decrease in the number of days taken to receive credit payments from debtors shows that SHW has improved on this area of financial efficiency. This is because 31 days is also the general amount of payables days. This may help SHW in terms of cash flow because; they would be in possession of the most liquid current assets (cash) from debtors to pay their creditors. As well as a smooth cash flow SHW will also be in TheBeautyInTheGeek.blogspot.co.uk

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possession of more cash overall, thus securing its place as market leader because more cash enables SHW to become equipped against unexpected exceptional items which could threaten their position against competitors. Yet, even though a shorter receivables period may improve cash flow, this may not have much effect on SHW since their payables days in 2008 were:

74 days. And in the next year (2009),

the payables increased by 3 days to 77 days. This means that the 31 days may not be as useful as predicted and as long as SHW’s payables are within the 70 day limit they may still be able to execute a smooth cash flow and run efficiently. To conclude, although there is one financial efficiency ratio (receivables) which shows an increase in financial efficiency, it is outweighed by the other ratios (such as asset turnover) which have decreased over the past two years. This is because the calculated number of receivables days (31) may be good for the industry average, but for SHW in particular, receiving all their money in a shorter period may lead to reckless spending during the 31 days. This could then mean that at the end of the 74 payables days there may be no cash left to pay for goods, which could compromise stock levels and effect SHW’s performance in the market because water is a product of high and quick demand which SHW need to be able to cater to if they wish to remain market leader. SHW is aware of this and in order to improve they have implemented new strategies which may help improve figures for the upcoming year. To increase weak ratios such as asset turnover they have implemented the latest technology in production lines, in an attempt to increase turn over but to also decrease unit costs, along with expenditure. This will widen profit margins as well as increase financial efficiency. R.M

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