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Financial Statement Analysis of Rolls Royce Holdings

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 Financial Statement Analysis of Rolls Royce Holdings

Fatima Alderei, Mohammed Alghfeli, Bashayer Alkhanbouli, Shamma Alramsi, Salem Almansouri,
Shamsa Alkarbi

Supervised by:
Professor Haitham Nobanee

Abstract:

The corporation Rolls Royce is the subject of this study, which included a ratio analysis. Rolls

Royce PLC, a significant British producer of aircraft and marine engines. The quantitative and

secondary data are derived from Rolls Royce's annual reports, which are available online. The time

span covered is from 2017 through 2020. The result has been presented in the table and graph

forms. After the analysis, it has been found that the company is facing loss and has extensive debt

financing. The overall performance of the company is deteriorating. At the end of the report, some

recommendations are provided for investors that they can use before investing in the company.

Key Words: Ratio Analysis, Liquidity Ratio, Debt Ratio, Activity Ratio, Profitability Ratio, Cash

Flow Ratios, Financial Statements

Introduction:

In this report, the ratio analysis will be carried out on the Rolls Royce company. Rolls Royce PLC,

a significant British producer of aircraft and marine engines. Upon its bankruptcy in 1971, the

corporation was separated from its automobile manufacturing business and nationalized. It went

private in 1987. The HQ is in London. This section of Rolls-Royce PLC produces commercial
and military aircraft engines alone and in collaborative ventures with corporations in Japan, Europe

and US.

The financial statement portrays the image of the company, and accounting ratios are a crucial

instrument in the study of financial statements. When two or more variables are analyzed using

fractions, proportions, percentages, and the number of times they occur, a mathematical calculation

known as a ratio is performed (Musallam, 2018). Using two numbers from the financial statement

to produce figures, an accounting ratio is created. This is referred to as accounting ratio calculation.

In order to properly analyses the data given by the financial statement, it is necessary to do a ratio

analysis of some sort. It provides useful information and identifies the points that are needed to be

investigated (Masdupi, Tasman, & Davista, 2018). Despite the fact that ratio analysis is a

complicated subject, it is an analytical approach that includes the regrouping of data through the

application of mathematical connections (Kadim, Sunardi, & Husain, 2020). It required a deep

understanding of the financial statements. In this report, we will be conducting the ratio analysis

from fours years from 2017 to 2020. This will help in knowing the performance of the Rolls Royce

in different areas.

Literature Review:

Many types of research conducted before related to the ratio analysis. Such as Alhosnai et al. has

conducted the ratio analysis on Johnson and Johnson (Alhosnai, et al., 2021). Similarly,

Almansoori et al. has conducted the ratio analysis on the ADNOC (Almansoori, et al., 2021). Johri

and Maheswari (2019) have explained that ratio analysis is the most basic and oldest approach of

analyzing a company's status for all stakeholders. This approach compares the actual ratio to an

ideal ratio ( Johri & Maheshwari, 2019). The importance of the ratio analysis is explained by Yun,
Lu, and Jian (2018) a financial statement and yearly review data are used to acquire a solid picture

of the company's progress over time and describe prospective performance trends as a key sign of

business success (Yun, Lu, & Xian , 2018). Ratio analysis is a way to get information about a

company's liquidity, efficiency, and profitability in a way that is based on numbers. This

company's information is found by looking at the company's financial statements over a long

period of time to get it. The company's income statement and balance sheet are two of the financial

statements used in ratio analysis, as are other financial statements (Ghanem, et al., 2021).

Ratio analysis is a way for people who look at financial statements, like investors, to see how well

a company can turn its assets into cash. According to the Kwak (2019) The main goal of ratio

analysis is to use the results of the analysis to help you make decisions (Kwak, 2019) Husain and

Sunardi (2020) also think that financial ratios are a good way to figure out and show where a

company is doing well and where it isn't ( Husain, Sarwani, Sunardi, & Lisdawati, 2020). Ratios

can help the management figure out where the company is strong and weak and where it needs to

make more effort or change how it runs (Tian & Yu, 2017). Managers and investors required a

technique and tools that help them figure out how the company will do in the future. A study helps

managers make the best decisions for the company by giving them the information they need to

make them quickly and effectively. There could be new investments, new ways of doing business,

or variations in the workforce that need to be made (Wadhwa, 2019).

Data Methodology:

The data required for the ratio analysis is quantitative data. The data type is secondary. The

quantitative and secondary statistics are derived from Rolls Royce's annual reports. The time frame

covered is from 2017 till 2020. Table 1 below is representing the financial data of Rolls Royce.
Table 1 Financial Data of Rolls Royce

2020 2019 2018 2017

Current Assets 14,331 16054 16,070 14,595
Current Liabilities 13,700 14,976 14,851 10,925
Inventories 3,690 4,320 4,287 3,660
Cash 3,452 4,443 4,974 2,953
Receivables 5,455 5,065 4,690 7,919
Total Assets 29,517 32,266 31,857 30,002
Total Liabilities 34,392 35,620 32,909 23,832
Total Equity 4,875 3,354 1,052 6,170
Sales 11,824 16587 15,729 16,307
Cost of Goods Sold 12,034 15645 14,531 13,134
EBIT -2,095 -713 -803 2,085
Interest 882 430 2,415 161
Net Income -3,169 -1311 -2,393 4,208
Operating Cash Flow -3,009 2,297 2,226 1,810
All the numbers in million, Source: Annual Report

Using the above data, we will calculate the following ratio explained below:

1. Liquidity Ratios:

A liquidity ratio shows how well a company can pay its short-term debt. The statistic shows

if a company's current assets can pay its current debts. (Alneyadi, et al., 2021). Cash,

Current and Quick is often calculated. The denominator of any liquidity ratio is current

obligations, while the numerator is liquid assets (Ahmed, 2020).

2. Activity Ratios:

The financial indicators that are used to assess a company's efficiency are activity ratios

(Xia, 2020) . The word refers to numerous ratios that measure a company's capital or asset

efficiency (Shreeda & Shah, 2018).

3. Debt Ratio:
 A high ratio shows a corporation is either exceptionally efficient with its assets or has little

assets, to begin with (BARAN, PASTÝR, & BARANOVÁ, 2016). A low ratio shows that

the company failed to use the assets efficiently to generate income. It is one of the important

ratios to determine the financial risk of the company. A value below 1 is indicating less

default risk and the company is safe (Keerthi & Eswari, 2020).

4. Profitability Ratio:

5. Analysts and investors use profitability ratios to figure out how well a company can make

money (profit) based on assets of balance sheets, sales, cost of operations and shareholders'

equity over time. They show how well a company can make money and make money for

its shareholders. (Srinivasan, 2019).

6. Cash Flow Ratio:

Cash flow ratios relate cash flows to other financial statement variables. A greater level of

cash flow signifies a stronger ability to endure operational downturns and pay dividends to

investors (SUTHAR, 2018).

Results and Discussion:

Table 2 Liquidity Ratios of Rolls Royce

Ratio/Years 2020 2019 2018 2017

Current Ratio 1.05 1.07 1.08 1.34
Quick Ratio 0.78 0.78 0.79 1.00
Cash Ratio 0.25 0.30 0.33 0.27

Figure 1 Current Ratio of Rolls Royce

 Current Ratio
1.60

1.40

1.20

1.00

0.80

0.60

0.40

0.20

0.00
2020 2019 2018 2017

Figure 2 Quick Ratio of Rolls Royce

Quick Ratio
1.20

1.00

0.80

0.60

0.40

0.20

0.00
2020 2019 2018 2017

Figure 3 Cash Ratio of Rolls Royce

 Cash Ratio
0.40

0.35

0.30

0.25

0.20

0.15

0.10

0.05

0.00
2020 2019 2018 2017

According to the above analysis, the liquidity ratio is representing decreasing trend from the year

2017 till 2020. The current ratio still after the decline is at the favorable position as it is above 1.

The current ratio and quick ratio are highest in 2017 while the cash ratio is highest in the year

2018.

Table 3 Activity Ratios of Rolls Royce

Ratio/Years 2020 2019 2018 2017

Receivable Turnover 2.25 3.40 2.49 2.19
Total Asset Turnover 0.38 0.52 0.51 0.59

Figure 4 Receivable Turnover of Rolls Royce

 Receivable Turnover
4.00

3.50

3.00

2.50

2.00

1.50

1.00

0.50

0.00
2020 2019 2018 2017

Figure 5 Total Asset Turnover of Rolls Royce

Total Asset Turnover

0.70

0.60

0.50

0.40

0.30

0.20

0.10

0.00
2020 2019 2018 2017

The trend of receivable turnover ratio was improving from the year 2017 to 2019 while in 2020

again it has shown decreasing trend. The high ratio is good as it indicates the company is collecting

its receivables quickly. The trend of assets turnover ratio is declining which indicates that the

company is not effectively using its assets to make revenue.

Table 4 Debt Ratio of Rolls Royce

 Ratio/Years 2020 2019 2018 2017
Debt Ratio 1.17 1.10 1.03 0.79
Times Interest Earned Ratio -2.38 -1.66 -0.33 12.95

Debt Ratio
1.40

1.20

1.00

0.80

0.60

0.40

0.20

0.00
2020 2019 2018 2017

Times Interest Earned Ratio

14.00

12.00

10.00

8.00

6.00

4.00

2.00

0.00
2020 2019 2018 2017
-2.00

-4.00

The trend of debt ratio is increased from the year 2017 to 2020. The value is greater than 1

indicating that the corporation is heavily reliant on debt to fund its assets. As discussed above that
the value of a debt ratio greater than 1 means high default risk. The time interest earned ratio is

negative means the company is not able to pay interest as it facing loss from operations.

Table 5 Profitability of Rolls Royce

Ratio/Years 2020 2019 2018 2017

Return on Equity -0.65 -0.39 -2.27 0.68
Return on Assets -0.11 -0.04 -0.08 0.14
Profit Margin -0.27 -0.08 -0.15 0.26

All three profitability ratios are showing a declining trend. Not only ratios are negative. The

negative ratios are due to the loss faced by the company from 2018 to 2020.

Figure 6 Return on Equity of Rolls Royce

Return on Equity
1.00

0.50

0.00
2020 2019 2018 2017
-0.50

-1.00

-1.50

-2.00

-2.50

Figure 7 Return on Assets of Rolls Royce

 Return on Assets
0.20

0.15

0.10

0.05

0.00
2020 2019 2018 2017
-0.05

-0.10

-0.15

Figure 8 Profit Margin of Rolls Royce

Profit Margin
0.30

0.20

0.10

0.00
2020 2019 2018 2017
-0.10

-0.20

-0.30

Table 6 Cash Flow Ratio of Rolls Royce

Ratio/Years 2020 2019 2018 2017

Cash Flow to Total Assets -0.10 0.07 0.07 0.07
Cash Flow to Sales -0.25 0.14 0.14 0.11

Figure 9 Cash Flow to Total Sales of Rolls Royce

 Cash Flow to Total Assets
0.10
0.08
0.06
0.04
0.02
0.00
-0.02 2020 2019 2018 2017

-0.04
-0.06
-0.08
-0.10
-0.12

Figure 10 Cash Flow to Sales of Rolls Royce

Cash Flow to Sales

0.20
0.15
0.10
0.05
0.00
2020 2019 2018 2017
-0.05
-0.10
-0.15
-0.20
-0.25
-0.30

The cash flow to total assets is constant for the three years but then becomes negative due to

negative cash from operations in 2020. The trend of cash flow to sales showing upward trend till

2019 but then negative in 2020. The reason is the same as of cash flow to total assets that is negative

cash flow from operations.

Discussion:

Considering the above results, the performance of the Rolls Royce is not good. The company

liquidity is getting weaker with passing years. The liquidity ratio is at the edge, further decrease

can be brought the company into trouble as it is highly dependent on the debts. The company failed

to make a profit. Facing the loss constantly from 2018 to 2020. The company's dependency on the

debt is increasing with passing years. In the year 2020, the interest expenses paid by Rolls Royce

were extremely high. The company due to negative operating profit failed to make interest

payments. The cash flow from operation was positive in all three years from 2017 to 2018 but was

negative in 2020. Indicating that the company failed to make a profit from its regular operations.

The British airline company is making significant losses, especially in the years 2019 and 2020. It

has been published in economic times that the loss is faced by the company is due to the hit of the

Covid 19 pandemic. The aviation industry has been hit hard by the virus spread all over the world.

The aviation industry took a beating last year when the virus grounded planes all over the world

and triggered a crisis in air transportation. Rolls Royce, which has operations in the aerospace,

defense, and energy industries, has reduced its workforce and expenses as it attempts to navigate

the potentially devastating impact of the health catastrophe. It has been found from the ratio

analysis that Rolls Royce is facing financial difficulties.

Recommendation:

As per the analysis, the performance of the company is not good currently. But the company is

putting efforts to improve their performance. According to Chief Executive Warren East, the year

2020 for them was so unprecedented year. He said that it was our civil aircraft industry that

absorbed the brunt of the Covid-19 pandemic's effects the most intensely. He further added that
our first response was to address our cost base by conducting the greatest restructure in our

company's recent history, unifying our worldwide production network, and implementing major

cost reduction initiatives. The company has taken decisive action to improve the efficiency of its

operations and finances. They feel regret but the company management believes that to bring

improvement it has become a must to reduce the workforce size. They took the step to improve

the liquidity by issuing bonds, right issues, and disposal of assets. They the program of disposal

will remain to continue. These steps will surely improve the financial position of Rolls Royce. On

the other hand, currently, the price of the company stock is low. Considering the above discussion

my recommendation to the investors is:

1. The investors should consider both the pro and cons of the company's recent step and then

make a final decision related to the investment.

2. Before investing, investors should consider other financial indications. While financial

statements and ratios can help investors understand a company's past, they should not be

relied upon alone. Instead, they should take market risk into the account.

3. Investors should investigate the firm's future plans. Because some ventures benefit the

investors while others are a waste of time and money. So, the investor should examine

Rolls and Royce's future projects and rivals. They should also factor in estimated risk;

higher risk is equal to higher reward.

Conclusion:

The corporation Rolls Royce is the subject of this study, which included a ratio analysis. Rolls

Royce PLC is a major British manufacturer of aviation and marine engines. The headquarters are

located in London. The quantitative and secondary data are derived from Rolls Royce's annual
reports, which are available online. The time span covered is from 2017 through 2020. The

financial statement depicts the company's image, and accounting ratios are an important tool in the

analysis of financial statements and other financial statements. An analysis of two or more

variables utilizing fractions, proportions, percentages, and the number of times each variable

occurs results in a mathematical calculation called a ratio.

Given the preceding results, Rolls Royce's performance is poor. The company's liquidity is

deteriorating. Because the corporation is heavily reliant on borrowing, a further decline in the

liquidity ratio might spell difficulties. Constantly is facing from 2018 through 2020. The

company's debt reliance growing with time. Rolls Royce's interest expenditures in 2020 were

unusually high. Due to a loss, the corporation did not pay interest. From 2017 to 2018, operating

cash flow was positive, but in 2020 it was negative. Indicating that the company's regular activities

were not profitable. The decisive strategies have been adopted by the company management.

According to them, the performance of the company will improve in nearby future therefore, it is

recommended to invest in company shares. It is expected that with improving performance the

share price will also improve and investors can enjoy the capital gain.
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