ASTON MARTIN FINANCIAL PERFORMANCE EVALUATION
PART A: CAPITAL STRUCTURE EVALUATION
According to Naseem et al. (2017:34), capital structure is the extent to which a company employs debt and owners’ equity in financing its activities. It is also called leverage or the level of gearing (Bajagai et al., 2019:37). It is the sum of debt and equity. Equity comprises ordinary share capital, preferred stock, and retained earnings while the debt component in the capital structure is the total liabilities comprising; notes payable, long-term debt, two thirds of operating lease in the principal amount, debentures, and redeemable preference shares. The capital structure components appear in the statement of financial position. Corporations which are highly geared have employed more debt financing over equity and are viewed to have high financial risk (Marwan & Sedeek, 2018:932). An evaluation of Aston Martin’s capital structure reveals that it is highly geared but this is aligned to its goals and objectives. However, this aspect has consequences to the corporation despite the firm’s perception that the higher the risk the more the returns as discussed in the paper.
Aston Martin has employed higher level of debt than equity over time. For instance, it employed debt and equity in this order; £1182.4 million and £804.1 million, £ 1011.3 million and £329.6 million, £730.5 and £449.4 million, and £996.5 million and £136.1 million in the financial years 2020, 2019, 2018, and 2017 respectively. These correspond to a net gearing of +71.23, +85.23%, +77.19%, and +91.66% for the financial years 2020, 2019, 2018, and 2017 under review (Share.com. 2021). Net gearing is computed by dividing total debt by total equity and the answer expressed in percentage form which gives the amount of available equity which would be needed to settle its liabilities outstanding. The corporation is highly geared in all the years under consideration despite light fluctuations between the periods.
The reasonable gearing ratio is basically set by individuals firms in relation to other firms existing in the same sector. Nonetheless, good or bad gearing can be considered based on these guidelines according to (Al-Hindawi, 2020:10-15), a highly geared company would report the ratio above 50% making the corporation to be at a higher financial risk since it would be more vulnerable to bankruptcy and defaulting loan repayments in the periods of increased cost of borrowing and low earnings generated. An optimal gearing ratio is believed to exist between 25% and 50% and is only possible for well-managed corporations (Mallinguh et al. 2020:79). Moreover, a gearing ratio below 25% is perceived to be of low risk to both lenders and investors.
The financial risk of Aston Martin is the risk to equity holders contributed by increased and more debt financing than equity. Bae et al. (2019:146) say that more debt financing is associated by high finance cost required to service the debt and this is connected to reducing the earnings per share (EPS). Capital structure is of importance to the organization hence the management should consider deciding on the amount of debt financing it will source to achieve sustainability in its operations (Li et al. 2019). The organizational financial managers should then evaluate the financial markets in determining loan agreements which would guide the firm in boosting its capital base. The activity is vital since the market can limit Aston Martin’s ability to issue securities at a cost which is reasonable.
Debt to equity ratio assists the firm to determine the influence of borrowing on its whole profitability. The ratio indicates the debt position of the company which includes total liabilities outstanding in comparison to the shareholder’s equity (Nukala & Rao, 2021:16). The high debt to equity ratio of Aston Martin implies the cost incurred in production and the routine business activities is high. On the other hand, according to Atidhira &Yustina (2017:145), low debt to equity ratio means that there is low finance cost associated with borrowing for supporting the business activities and perceived as good signal to investors and lenders. The results in the components of Aston Martin’s capital structure show that lenders possess larger portion of the organization’s assets as a collateral security for the debts advanced to it. The knowledge of the organization’s level of leverage provides a good insight on the riskiness of the firm which guides whether or not it is worthwhile to invest in it.
The organization’s capital structure is aligned to its goals and objectives. The firm considers maintaining capital structure which achieves investor confidence and capable of sustaining its future programs. The firm perceives being at a greater financial risk due to high gearing hence intends to make certain adjustments towards improving its performance. It intends to revise its capital structure by reducing debt and improving on its liquidity by issuing more shares through rights issue. It focuses on making operations stable to ensure sufficient cash is generated. It considers taking precautions on debt financing such as investing borrowed money in product lines whose demand in the market exceed supply to ensure sufficient cash is generated to meet the repayment terms.
Nonetheless, the organization should also consider debt financing as opportunity because if managed well, it would help the firm to finance its expansion plans, invest more on profitable projects, and achieve improved performance. On the other hand, it would be unable to take advantage of the growth opportunities available in the business environment if it fails to borrow from cheaper sources of finance in terms of low discount rates and requiring collateral of low value.
According to Buzduga (2020:176):
‘High gearing allows a firm to understand better debt management and place its balance sheet items both assets and liabilities into use towards improving performance and enhancing value to shareholders. Variables such as the corporation’s market share, its cash flow, and growth in the earnings should guide it in adjusting its gearing ratio to the reasonable level.’ Moreover, the firm can be in a position to repay its debt by considering alternative methods such as issuing ordinary shares when required. The organization perceives it’s gearing level as risky but possesses high returns. This aspect is considered as a strategic enterprise course of action because this may imply low portion of the business operations funded by equity hence low dilution of control associated with many equity holders becoming part of the Company. This would result to increase in the prices of stocks.
PART B: ASSESSING ASTON MARTIN’S FINANCIAL PERFORMANCE AND ITS OVERALL APPROACH TO MANAGING STAKEHOLDER’S EXPECTATIONS
Financial performance assessment involves performing financial analysis on a firm’s financial statements to help users enhance their process of making decision. The financial metrics also called key performance indicators used in assessing an organization’s financial performance include liquidity, efficiency, profitability, solvency, and market valuation ratios (Prajapati, 2019:35). These ratios are not useful in themselves unless they are computed for a firm at different periods or for different companies in the same industry for comparison purposes. They assist users of financial statements in their strategic decision making.
The financial statements are issued in a periodic basis which can be monthly, quarterly, semiannually, or annually. They include; statement of financial position, statement of comprehensive income, and statement of cash flow. Assessing Aston Martin’s financial performance computes liquidity, profitability, and market valuation ratios for different years 2017, 2018, 2019, and 2020 to obtain the trend in its performance which assists in making comparisons between the years.
It measures a firm’s ability to pay its current obligations from current assets as and when they fall due. According to Rashid (2018:110), a current ratio of less than one means current assets are insufficient in paying current obligations. A current ratio of one means current liabilities are fully covered while a current ratio of more than one means current assets are insufficient to pay current liabilities. The firm reported current ratios of 0.79, 0.70, 0.64, and 1.10 in the financial years 2017, 2018, 2019, and 2020 respectively (Aston Martin Lagonda Global Key investment ratios | AML – Morningstar, 2021). This shows that the firm was unable to settle its current obligations over the years under review except in the financial year 2020.
This ratio is similar to current ratio only that it measures a firm’s ability to pay current liabilities from its most liquid assets (Rashid, 2018:110). The firm reported quick ratios of 0.0.48, 0.0.49, 0.0.34, and 0.79 in the financial years 2017, 2018, 2019, and 2020 respectively (Aston Martin Lagonda Global Key investment ratios | AML – Morningstar, 2021). This shows that the firm’s most liquid assets were insufficient to settle its current obligations over the years under review.
These ratios assess a firm’s ability to produce profit from its sales revenue, assets, operating expenses, and owner’s equity during a given period of time (Musallam, 2018:106). Here, operating profit margin, net profit margin, return on assets, and return on equity, are considered.
Operating Profit Margin
Operating profit margin measure profits as a percentage of sales revenue before the deduction of interest and tax is done. A firm reporting higher operating profit margin ratio is considered better placed in paying fixed expenses and finance cost and can continue operating during low economic activities, and can charge lower prices than competitors in the market (Musallam, 2018:108). The firm reported the ratio as 0.14%, 0.12%, 0.01%, and -0.37 for the financial years 2017, 2018, 2019, and 2020 respectively (Aston Martin Lagonda Global Key investment ratios | AML – Morningstar, 2021). The corporation reported the lowest operating profit margin in the year 2020 compared to other years under consideration showing that there were more operating expenses than sales revenue.
Net Profit Margin
Net profit margin indicates the profitability of a company after deducting expenses, finance cost, and taxes. It is obtained by dividing net profit by net sales. The firm reported net margin ratio of 8.47%, -5.72%, -12.89%, and -68.54% for the financial years 2017, 2018, 2019, and 2020 respectively (Aston Martin Lagonda Global Key investment ratios | AML – Morningstar, 2021). The results indicate that the firm reports net losses meaning it spends more than it earns from sales.
Return on Equity
The ratio indicates the proportion of net earnings in relation to owner’s equity guides investors on stock purchasing decision (Pattiruhu & Paais, 2020:32). Corporations reporting high return on equity generates more internal cash hence relies less on debt financing. The firm reported 81.94%, -22.83%, -34.33, -76.01% for the financial years 2017, 2018, 2019, and 2020 respectively (Aston Martin Lagonda Global Key investment ratios | AML – Morningstar, 2021). The firm reported negative return on equity in all the years under review except for the financial year 2017. This shows that the ratio is unfavorable which makes a firm’s stock prices unattractive to investors. The results also indicate that the firms cash is inadequate hence it relies on debt financing to support is activities.
Market Valuation Ratios
These ratios guide investors in determining whether a firm’s stocks are undervalued or overvalued in the market (Vagner, 2020). According to Kadim et al. 2020:860), price earnings ratio and price to book ratio are part of market valuation ratios useful to investors.
Price Earnings Ratio
The ratio is computed by dividing a firm’s present market price per share by the earnings per share reported and indicates the value of every firm’s stock in the market. The corporation never reported price earnings ratio except in the year 2018 where the ratio was 36.
Price to Book Ratio
The ratio is used in comparing a corporation’s market capitalization to its book value and obtained by dividing individual share price by its book value (Husna & Satria, 2019:50). It guides investors who seek growth and considered together with return on equity for decision making Aston Martins price to book ratio for the years 2017, 2028, and 2029 were 19.63, 3.38, and 3.21 respectively (Aston Martin Lagonda Global Holdings PLC Ordinary Shares (AML) Valuation – XLON | Morningstar, 2021). These values indicate that Aston Martin’s stock are overvalued hence not good for investors seeking growth.
PART C: RECOMMENDATIONS
Capital structure is important as it indicates the of a firm’s sources of finance to fund its activities. The paper recommends that the organization should weigh between risks and returns associated with every component of its capital structure to guide on the optimal gearing ratio which would expose the organization to excessive risk with minimal returns. The organization should also evaluate and compare various sources and opt for one with reasonable charges in the market. The organization should be cautious about consistent high level of debt as reported on the reviewed financial years. This decision is because high debt level makes it become more vulnerable to bankruptcy and default in loan repayments to creditors and lenders hence lowering its credit rating.
The paper recommends that the organization should carefully evaluate its investment proposals and only channel funds to profitable ones to increase its cash flows for repaying back the borrowed money. The organization should drop projects which consistently report losses hence affecting its cash flows needed for debt repayment. The organization should also dispose its assets which no longer have economic use to assist in generating cash for repaying back the borrowed. Despite the organization is required to check on its excessive borrowing, it should not drop debt financing fully because carefully managed debt would to be profitable to the organization. The organization should also negotiate its debt repayment terms and interest rates to help check on excessive debt servicing and principal amount repayment hence restoring its profitability. Thus, the organization should practice debt management and employ competent financial managers to help keep reasonable mix of debt and equity.
Despite reporting improvement in the current ratio between the financial years 2019 and 2020, the organization should consistently ensure there is sufficient amount of current asset to pay for current liabilities as and when they fall due to avoid experiencing liquidation issues. However, the firm should not let this ratio exceed two because this would indicate lack of proper working capital management.
Operating profit margin has indicated that the organization incurs more operating expenses than it earns from sales. Thus, the organization should avoid price cuts, consider increasing selling prices, and monitor its operating expenses to ensure that it restores its profitability. Increased profits can also be achieved by investing more on marketing and other promotional activities to increase awareness about its products and services in the market. This activity attracts potential customers and actualizes the purchasing needs. The organization should consider issuing additional ordinary shares to help raise cash for servicing debt. It should also go cheaper debt financing to help it check on the finance cost which lowers its profitability.
The organization should also consider improving on its market valuation ratios by considering expansion in other profitable market through franchises, new geographical markets, and acquiring small rivals in the market. This would send signal to investors that the organization has future growth potential which increases value of the market. The organization should also consider working on its reputation by avoiding negative media publicity which would scare away investors.