Ethics: Changes in Estimate Mike Crane is an audit senior of a large public accounting firm who has just been assigned to the Frost Corporation’s annual audit engagement. Frost has….
Liquidity ratios; Current Ratio
In this report I will examine the performance of one of the top oil and gas producers; Royal Dutch Shell PLC. The selected ratios will be calculated (see app. 2) and compared with other leaders in this industry, such as Exxon Mobil, British Petroleum (BP), Chevron Corp. and Sinopec. This will provide an understanding of the company’s profitability, financial risk, earnings and their cash flows over past 5 years using company’s financial statements (see app.1). By comparing Royal Dutch Shell with other industry (see app.3) leaders the report hopes to provide a balanced and transparent overview of the aforementioned ratios. This ratio analysis and benchmarking will give us an informed insight into whether or not to acquire the Royal Dutch Shell as a profitable and reliable investment in the future.
‘Profitability ratios indicate how successful the managers of a company have been in generating profit’ (Watson and Head, p.48, 2010). Here we will be looking at Royal Dutch Shell Return on Capital Employed (ROCE) and Net Profit Margin known also as Operating Profit Margin ratios (calculations can be seen in app.2) over past 5 years.
ROCE is easy to calculate and interpreted as results are in percent. Therefore it is easy to compare with different companies. This ratio looks at the company’s overall profitability.
Royal Dutch Shell has had a healthy increase in ROCE; from 15.9% in 2010 to a peak of 22.9% over the 5 year period, as shown in the above graph in 2011. This sharp increase could be due to company’s strong performances and their share price increase. Industry average in this time scale is also following the lead of growth ROCE between 2010 and 2011.
Starting from 2011 onwards there is a decrease in ROCE. This is due to generally weaker oil prices.
‘Royal Dutch Shell Plc, Europe’s biggest oil company, reported a larger decline than expected in second-quarter earnings as crude prices dropped and maintenance work on fields held back production’ (Gismatullin and Lacqua , 2012).
The oil industries average decrease is more even than that reported by Shell. Shell’s ROCE is steadily above industries average, only in 2013 it fell under industries average by 12.7%, where the overall industry average was 13.76%.
Net Profit Margin is shown as percentage. This ratio measures how much the company earns per each dollar spent.
In 2010 Shell had an income of 9.6 cents per every dollar they spent, where industry average earned 7.74 cents per every dollar spent. Shell reached a peak high in 2011 with 11.8 percent with the industry average just 1.52% below that.
‘Shell also said it had sold $4bn of non-core assets in the first six months of the year, which was a “key driver” to reducing costs and improving its operating performance’ (bbc.co.uk, 2011).
Receivable turnover ratio monitors how well the company deals with their receivables.
‘The lower the amount of uncollected monies from its operations, the higher this ratio will be. In contrast, if a company has more of its revenues awaiting receipt, the lower the ratio will be’ (financeformulas.net, 2012).
This ratio is also known as debtor’s turnover ratio. This looks at companies’ ability to issue credit and collect the debt in sensible time.
In 2010 Shell had a record high account receivable turnover, collecting payment from customers every 986 days. However, this data seems unrealistic; with the average payment schedules usually amounting to between 19 and 21 payments annually. One could argue this anomaly a possible mistake in the account receivable data (see app. 1).
‘A very high accounts receivable turnover number can indicate an excessively restrictive credit policy, where the credit manager is only allowing credit sales to the most credit-worthy customers, and letting competitors with looser credit policies take away other sales’ (accountingtools.com, 2016).
Due to this high number of receivables, industry average was significantly influenced. For the following 4 years there is a more reasonable time for accounting receivable turnover which is between 11 and 18 days. Where industries average are between 19 and 21 day.
‘The accounts payable turnover ratio indicates how many times a company pays off its suppliers during an accounting period’ (thestrategiccfo.com, 2015).
According to the payable turnover Shell pays their payables only twice a year; in 2010, 2011 and 2013. In 2012 Shell received payables only once a year. In 2014 they made their payments 4 times in a year. Where industry averages pays their payables as many as 26 times a year.