Financial Analysis of Harvey Company

This assignment requires a comprehensive financial analysis of Harvey Company. Students need to calculate and interpret various financial ratios such as gross profit margin, net profit margin, current ratio, quick ratio, etc. They will also analyze the company's cash flow statement, breaking down cash flows from operating, investing, and financing activities. Finally, students must calculate the cash conversion cycle to understand Harvey Company's efficiency in managing its working capital.

FINANCIAL DECISION
MAKING

Table of Contents
EXECUTIVE SUMMARY.............................................................................................................1
PART 1............................................................................................................................................1
Analysis of Profit and loss statement.....................................................................................1
Analysing the Balance Sheet of Harvey.................................................................................4
Analysing the cash flow statement of Harvey........................................................................7
Analysis of Market segments.................................................................................................9
PART 2..........................................................................................................................................13
Forecast of the management.................................................................................................13
Techniques for investment appraisal....................................................................................13
Sources of finance................................................................................................................15
Non financial factors to be considered by Harvey...............................................................16
CONCLUSION..............................................................................................................................16
REFERENCES..............................................................................................................................17
APPENDIX....................................................................................................................................18

Illustration Index
Illustration 1: Comparison of Gross Margin Ratio..........................................................................1
Illustration 2: Comparison of Net Margin ratio...............................................................................2
Illustration 3: Comparison of operating profits and capital employed............................................3
Illustration 4: Comparison of Current Assets and Current Liabilities.............................................5
Illustration 5: Comparison of Quick assets and Current Liabilities.................................................6
Illustration 6: Comparison of Long term assets and Total Assets...................................................7
Illustration 7: Cash flow from different activities............................................................................8
Illustration 8: Cash conversion cycle...............................................................................................9
Illustration 9: Gross and operating profits of Northern Region ....................................................10
Illustration 10: Gross and operating profits Midlands region........................................................11
Illustration 11: Gross and operating profits of Southern region....................................................12
Index of Tables
Table 1: Ratio Analysis from Profit and Loss Account.................................................................18
Table 2: Calculation of Capital Employed.....................................................................................18
Table 3: Ratio Analysis from Balance Sheet.................................................................................19
Table 4: Calculation of Quick Assets............................................................................................19
Table 5: Cash Flow........................................................................................................................19
Table 6: Calculation of cash conversion cycle..............................................................................20

EXECUTIVE SUMMARY
It is important to analyse the financial statement in better manner in order to make
effective decisions for the company (Frydman and Camerer, 2016). Harvey Homes is an entity
involved in providing quality homes to people. A comparative analysis of financial statement has
been made in the report discussing the financial positions of 2015 and 2016 through ratio
analysis. It is divided in three segments, Midlands, Southern and Northern. Out of which
Midlands in not able to generate higher profits for the organization. Further, NPV and ARR of
the investment have been evaluated and it is advised that the entity should invest in the project.
There is an increase in the revenues from all the three segments of Harvey. However, there
Midlands segment is not contributing much to it. It was 1083 million in 2015 which has
increased to 1297 million.
PART 1
Analysis of Profit and loss statement
Profit and loss account reveals the summarized revenue and expenses of the entity incurred in a
specific duration (Al and Alam, 2013).
Gross Margin Ratio
1

Gross margin ratio of the company depicts the profits earned by the company after paying
for all the direct expenses which are directly related to manufacturing. It helps in assessing the
financial health of the company (Almazari, 2012). According to the figures in the table
(Appendix 1), it can be assessed that there is an increase in gross profit margin ratio of Harvey. It
was 25.1% in 2015 and has managed to increase to 25.6% in 2016.
Gross profits of the enterprise have increased from 332 million in 2015 to 372 million in
2016. There is a significant increase in the sales of Harvey from 1083 million in 2015 to 1297
million in 2016.
There is a rise in customer's demand due to which it has managed to increase its sales.
Harvey has also increased its production which has resulted in coping up with the increased
demands. The entity is using more material and labour in comparison to the previous year in
order to satisfy the needs of the customers. The ratio reveals that the overall profits of the
organization have increased significantly.
The revenue of the entity have increased significantly in comparison to the previous year. It was
1083 million in 2015 which has increased to 1297 million in 2016. There is an increase in cost of
sales as well from 811 million to 965 million. It is due to increase in the manufacturing cost of
the products.
2
Gross Margin ratio
24.8
24.9
25
25.1
25.2
25.3
25.4
25.5
25.6
25.7
2016
2015
Illustration 1: Comparison of Gross Margin Ratio

Net Margin Ratio
Net profit margin ratio of the entity reveals the profit earned after taking into
consideration all the cost incurred. It shows the net profits earned by the company on every
pound of sales made. According to the table of Net profit margin ratio (Appendix 1) there is a
decrease in the ratio from 20.5% in 2015 to 20% in 2016. The ratio has come down by 0.53%.
The operating profit of Harvey in 2015 was 222 million and it has increased to 259
million in 2016. Further, there is an increase in Revenue as well by 214 million. However, the
proportionate increase in sales is more than its profits. It shows that there is an increase in the
manufacturing cost of the company. Harvey has to use modern construction equipment which
has inflated the overall price of the building. The company is also involved in providing high
quality apartments and houses which has increased the cost for the enterprise. The entity is
required to take appropriate measures in order to decrease its operating cost so that an increase in
net profit margins can be experienced.
The operating cost of Harvey involves Training and apprenticeships, Market research,
Director's salary, legal cost etc. All the operating cost involved have increased significantly.
Return on Capital Employed
3
Operating profits Revenue
0
200
400
600
800
1000
1200
1400
2016
2015
Illustration 2: Comparison of Net Margin ratio

ROCE assess the profitability of the organization which calculates the efficient
generation of profits through its capital employed. It also indicates that operating profit earned
by the entity on every pound of capital employed. It is a long-term profitability ratio which helps
in evaluating the long term financial position of the enterprise (Babalola and Abiola, 2013). The
overall ROCE ratio of Harvey have decreased from 20% to 18%. There is a decrease of 2% in
return on capital employed ratio.
Harvey has managed to increase its operating profits from 222 million to 259 million.
Capital employed (Appendix 2) has also increased from 1094 million to 1412 million in 2016.
Capital employed is a result of deducting current liabilities from total assets. However, the
proportionate increase in operating profits is less in comparison to capital employed of Harvey.
Decrease in ROCE ratio can be due to increase in the manufacturing price of Harvey. It
also has not been able to acquire the targeted sites. It is advised that the company should increase
its operating profits in order to earn higher ROCE ration in near future. It will also help in
improving the long term financial condition of the entity.
4
Operating profits Capital employed
0
200
400
600
800
1000
1200
1400
1600
2016
2015
Illustration 3: Comparison of operating profits and capital employed

Analysing the Balance Sheet of Harvey
Balance sheet is the detailed analysis on assets and liabilities of the company. It is the
disclosure made by the entity for the stakeholders so that they can decide that whether they want
to invest in the entity or not. Further, it helps in making comparative analysis with the financials
of previous year or with another organization (Brigham and Ehrhardt, 2013). Based on the
Balance Sheet of Harvey Homes, following interpretation can be made:
Current Ratio
Current ratio is a liquid ratio discovering whether the entity is liquid enough in order to
pay out its short-term debts. Higher current ratio depicts that the enterprise has higher potential
to pay out its short-term liability. According to the current ratio of Harvey Homes (Appendix 3),
It is 2.90 for 2015 which has increased to 3.12. There is an increase in current assets from 1595
million in 2015 to 1979 million in 2016. There is a significant increase in current liabilities as
well from 550 million in 2015 to 634 million in 2016. The current ratio of Harvey is much higher
than the ideal ratio which is required to be 1 (Drivelos and Georgiou, 2012). It shows that the
organization is not properly utilizing its resources.
5
Current Assets Current Liabilities
0
500
1000
1500
2000
2500
2016
2015
Illustration 4: Comparison of Current Assets and Current Liabilities

Non current assets of the company have increased due to increase in fixed assets and
machinery of the entity. There is significant increase in current assets of the company which
shows that there is an increase in liquidity performance of the organization.
Quick Ratio
Quick ratio reveals the liquidity of the entity based on the assets available with it. Quick
assets are the assets with the entity which are readily converted into cash. Inventories are not
considered while calculating it. The ideal ratio is 0.5 which shows that the enterprise will be able
to payout half of the current liabilities with the available quick assets immediately. Harvey's
Quick assets ration have raised from 95 in 2015 to 171 in 2016 (Appendix 3). There is a
significant increase in current liabilities as well. It was 550 million in 2015 which has increased
to 634 million in 2016. There is an increase of 0.10 in the overall ratio of quick assets and
current liabilities (Appendix 4). It is advised that Harvey should make use of its available quick
assets effectively and should make some investments in order to maintain the ideal ratio.
Long term debt to total assets ratio
6
Quick Assets Current Liabilities
0
100
200
300
400
500
600
700
2016
2015
Illustration 5: Comparison of Quick assets and Current Liabilities

Long term debt to assets ratio denotes obligation on the company for long term debt
which are required to be paid through total available assets of the entity. It helps in assessing the
long-term position of the entity. The ratio reveals that whether the entity will be able to pay its
long-term debts with the available total assets or not. It also keeps a check on debt structure
followed by the enterprise and determines its capacity in relation to debt (Higgins, 2012).
The long-term debt of the entity (Appendix 3) have increased from 245 million in 2015 to
395 million in 2016. Further, there is an increase in total assets by 402 million. The overall ratio
has increased from 0.15 in 2015 to 0.19 in 2016. The proportion change in long term debt is
significantly more than that of total assets. Higher ratio shows that Harvey have higher
obligation towards long term debts of the organization. It is advised that Harvey should increase
in finances through equity rather than using debt as a source of finance. It will reduce the burden
from the company and increase its efficiency (Vogel, 2014).
Analysing the cash flow statement of Harvey
7
Long term debt Total assets
0
500
1000
1500
2000
2500
2016
2015
Illustration 6: Comparison of Long term assets and Total Assets

Cash flows includes the inflow and outflow of cash that has been generated by the
business in a particular period. On analysing the cash flow statement of Harvey, it can be
interpreted that the entity is not able to generate cash from its operating activities. It shows that
the enterprise is utilising its savings in order to pay out to the short-term liabilities (Appendix 5).
The enterprise in experiencing cash outflow of 32 million through its operating activities.
Further, investing activities is also showing negative cash flow of 23 million which has a
negative impact on the organization. However, Harvey have cash inflow of 150 million from
financing activities. It is due to increase in loan for 150 million that has been taken by Harvey in
order to meet it expenses (WEBSTER, 2014). It can be calculated using the below formula:
Cash conversion cycle = Days inventory outstanding + Days sales outstanding - Days payable
outstanding
8
Cash flow from operating activities
Cash flow from investing activities
Cash flow from financing activities
-50
0
50
100
150
200
Cash flows
Illustration 7: Cash flow from different activities

According to the cash conversion cycle of Harvey, it can be interpreted that the days of
liquid conversion have increased from approximately 476 days in 2015 to 481 days in 2016
(Appendix 6). It is a bad position for the entity as it will be able to convert its resources in the
increased time in comparison to the previous year. It further reveals that the financial condition
of Harvey is degrading day by day. It should not declare dividends to the shareholders as there is
no operating fund present with the enterprise. The dividend of 26 million that has been paid by
the entity could have been used to conduct its operating activities rather than transferring it to the
shareholders. For the next year, it is advised to Harvey that it should not extend dividend in order
to improve the performance of the entity, Further, it will also be helpful in improving the
liquidity position of Harvey.
Analysis of Market segments
Harvey is operating in three regions that are Northern, Midlands and Southern. The
revenue generated from the segments are different from each other. The entity is experiencing
low profit margins for which it has taken several steps. Midlands have been giving the least
profits in comparison to the other two regions. It was able to collect only one fifth of the profits
9
Cash conversion cycle
473
474
475
476
477
478
479
480
481
482
2016
2015
Illustration 8: Cash conversion cycle

in comparison to last year. If the company keep experiencing low margins for long run, it would
be difficult to hold that place in the market.
Gross Profit Operating Profit
0
20
40
60
80
100
120
2016
2015
Illustration 9: Gross and operating profits of Northern Region
The gross profits of Northern region have significantly increased from 81 million to 101
million in year 2016. There is a bit increase in operating profits from 68 million to 71 million.
However, the proportionate increase in operating profit is less in comparison to the profits. This
is due to increased operating cost of the entity. Cost of sales have also increased from 250
million in 2015 to 320 million in 2016. Harvey is recommended to take adequate steps in order
to improve the performance by reducing the operating cost.
10

Gross Profit Operating Profit
0
10
20
30
40
50
60
70
2016
2015
Illustration 10: Gross and operating profits Midlands region
According to the above graph of midland region, it can be interpreted that the-segment
have been able to increase its gross profits from 41 million in 2015 to 60 million in 2016.
However, it is quite less in comparison to the other two segments of the entity. Further,
Operating profits have increased from 31 million in 2015 to 48 million in 2016. The entity is
advised to improve its product and service portfolio in order to attract more customers and earn
high profits from this segment. It is important for Harvey to focus on this segment of the
company as if the profit level will remain low it will be difficult for the enterprise to survive.
11

Gross Profit Operating Profit
0
20
40
60
80
100
120
140
160
180
2016
2015
Illustration 11: Gross and operating profits of Southern region
The gross profit and operating profit report of southern region shows that the segment
have managed to get higher gross returns in the current year by 21 million. It has also
experienced increase in operating profits by 17 million in 2016. However, the increase is not in
proportion to the rise it has experienced in its revenue.
Harvey's operating cost in all the three segment is higher than it should have been. It is
advised to take fruitful measures that can reduce its cost of sales and increase its profits (Gamble
and et.al., 2014). Another case of low profits can be due to poor margin that has been kept by the
entity. The reason can be wrong study of market that has been conducted by the enterprise.
Midlands region is experiencing lower amount of profits. . Harvey is expected to conduct
a study and analyse the tastes and preferences of the customers. It will help to assess the demand
and provide what is asked by the customers of that area. It can provide customized product and
services as it deals in providing quality houses to its customers. It will help to hold stronger grip
in the market place in comparison to the competitors. Harvey can put its investment in improving
its infrastructure in order to expand in the central region of the country. It will help to attract
maximum number of customers in order to avail services from Harvey. Moreover, it is important
to expand the business to stay competitive in the market.
12

PART 2
Forecast of the management
The management is planning to invest 500 million in Midlands region. It is expected that
the payback period of the investment made in 4 years and 6 months.
Using Accounting Rate of return method of capital budgeting it is assessed that the entity
will be able to earn 6% return. However, the management expected it to be 5%. It is noticed that
the actual ARR is more than the expected one by 1%. The capital investment made by Harvey
will be able to generate 6% of return from its initial investment. Average annual profit can be
calculated by dividing initial investment, that is, 500 million by 2. It shows that the investment
will prove to be beneficial for the entity. However, the calculated ARR may vary according
change in economic and social conditions of the country.
Using Net Present Value (NPV) method of capital budgeting, it can be assessed that it is
4% for the investment made in Midlands. This method considers time value money factor while
assessing the return. Hence, the value of 500 million may not be the same in next 5 years.
Considering the cost of capital as 3%, the present value differs for each year. Adding all the
present value shows that the NPV of the project will be 4%. Harvey homes had a target to get
3.5% as an investment target. The estimated NPV is more than the targeted one by 0.5%.
Moreover, it is positive as well. It is advised that the enterprise should invest in Midlands as it
will prove to be beneficial for the enterprise.
Techniques for investment appraisal
There are various techniques that can be adopted by the entity in order to assess that
whether the investment made will prove to be beneficial or not. Some techniques are discussed
below:
 Net Present Value: It is an important method of capital budgeting which is calculated by
deducting present value of cash outflows from present value of cash inflows. NPV
analyses the profitability of the investment or any project. It can be calculated by using
the below mentioned formula:
13

where, Ct = Cash inflow during period t
C0 = Initial investment
r = discount rate
A positive NPV denotes that the project will be profitable and a negative NPV shows that
the entity has to suffer losses and it should not be chosen for investment. It considers time value
money concept while performing this activity as the present worth will be less in near future.
However, the activity is sensitive to discount rates. A fluctuation in discount rate can bring
variations in the final results (Seshan and Yang, 2014).
 Payback period: It is the length of time which is required to cover the investment
amount. The major drawback of this method is that it does not consider time value of
money factor while calculating the period. Payback period is calculated by using the
following method:
X + Y/Z
where, X = Last period with negative and progressive cash flow
Y = Definite value of increasing cash flow
Z = Total cash flow
It will help Harvey to evaluate the intrinsic risk which is involved in the project. It is an
easy technique that can be used to assess the profitability of any investment. The payback period
of Harvey suggest that the company will be able to get all its investment back in 4 years and 6
months. It is a good indicator where company can plan to invest.
 Accounting rate of Return: It helps to assess the return that the managers can expect out
of the investment. However, the major drawback of this capital budgeting technique is it
do not consider time value and money framework while calculating expected return.
However, NPV is the important method on which the company can rely its decisions.
The target of ARR was 5% and actual one is 6%. It shows that the entity should invest in
the project as it is giving higher average return than expected.
Sources of finance
There are various sources through which Harvey can finance its activities. Some are
discussed below:
14

 Equity fund: Investors invest in the entity in lieu of which shares are given to them.
Company provides dividend to the shareholders. The value of shares increase or decrease
based on company’s financial performance (Agarwal and Mazumdar, 2013).
Advantages:
 It reduces the liability as the dividend is given based on the profits earned.
 It increases the financial health of the enterprise.
Disadvantages:
 Transactions cannot be reversed.
 Difficult for the entity to get investors if financial performance of the entity is
degrading. Debt fund: It acts as a borrowing for the company where a certain amount of interest is
required to be provided even if the entity is not earning profits. High debt ratio shows that
the enterprise has high borrowings and the company is dependent on investors for money.
The major sources of debt financing are, Credit finance companies, leasing entities,
commercial finance enterprises etc.
Advantages:
 It is an easy method to meet the short-term obligation of the enterprise.
 Debenture holders do not involve in decision making of the company.
Disadvantages:
 It is a riskier source as it adds fixed liability to the entity.
 Borrowing more debts affect the cash flow of the entity.
 Lender can put restrictions based on amount it is investing.
Non-financial factors to be considered by Harvey
Apart from financial factors it is important for Harvey to have a strong command on non-
financial factors as well. The business ethics of France is required to be evaluated before setting
up its business in a new territory.
 Hiring Local workers: The local workers are aware of what is liked by the customers of
France and they can give better suggestions to the company. It can hire French architect
as well as it will be easy to understand the main criteria of French houses that are
constructed there (Mitchell, Hammond and Utkus, 2017).
15

 Make corporate connections: Harvey has to make corporate connections which will
help it to get better refined artists and architects in order to set up its business in France.
It also has to stay competitive in the other country and bring brand loyalty among the
customers as various other competitive companies will be available in France.
 Promotional strategies: The marketing strategies adopted by the entity should be made
after analysing the taste and preferences of the customers. It helps to deliver what is
required by them (Sadovykh and Sundaram, 2017).
Harvey have increasing profits however, it need to concentrate on Midland segment of
the entity. It will help in generating higher revenues. There is an in the liabilities of the company
due to increased cost. It has also been able to increase non current assets by investing in
technology and upgraded machinery.
CONCLUSION
From the above report, it can be concluded that, the financial performance of Harvey
Homes is not good and it is required to cut down its operating cost in order to improve its
financial condition. Further, Midlands region of Harvey has not proved to be much profitable for
the entity hence, it is planning to make an investment of 500 million in that region. In the end in
order to expand in France, various non-financial factors are to be considered such as, hiring local
workers, adopting appropriate promotional strategies etc.
16

REFERENCES
Books and Journal
Agarwal, S. and Mazumdar, B., 2013. Cognitive abilities and household financial decision
making. American Economic Journal: Applied Economics. 5(1). pp.193-207.
Al Karim, R. and Alam, T., 2013. An evaluation of financial performance of private commercial
banks in Bangladesh: ratio analysis. Journal of Business Studies Quarterly. 5(2). p.65.
Almazari, A. A., 2012. Financial performance analysis of the Jordanian Arab bank by using the
DuPont system of financial analysis. International Journal of Economics and
Finance. 4(4). p.86.
Babalola, Y. A. and Abiola, F. R., 2013. Financial ratio analysis of firms: A tool for decision
making. International journal of management sciences. 1(4). pp.132-137.
Brigham, E. F. and Ehrhardt, M. C., 2013. Financial management: Theory & practice. Cengage
Learning.
Drivelos, S. A. and Georgiou, C. A., 2012. Multi-element and multi-isotope-ratio analysis to
determine the geographical origin of foods in the European Union. TrAC Trends in
Analytical Chemistry. 40. pp.38-51.
Frydman, C. and Camerer, C. F., 2016. The psychology and neuroscience of financial decision
making. Trends in cognitive sciences. 20(9). pp.661-675.
Gamble, K. J. and et.al., 2014. Aging and financial decision making. Management
science. 61(11). pp.2603-2610.
Higgins, R. C., 2012. Analysis for financial management. McGraw-Hill/Irwin.
Mitchell, O. S., Hammond, P. B. and Utkus, S. P., 2017. Financial Decision Making and
Retirement Security in an Aging World. Oxford University Press.
Sadovykh, V. and Sundaram, D., 2017, January. Decision Making Processes in Online Social
Networks: A Comparative Analysis of Health and Financial Online Social Networks.
In Proceedings of the 50th Hawaii International Conference on System Sciences.
Seshan, G. and Yang, D., 2014. Motivating migrants: A field experiment on financial decision-
making in transnational households. Journal of Development Economics. 108. pp.119-127.
Vogel, H. L., 2014. Entertainment industry economics: A guide for financial analysis. Cambridge
University Press.
WEBSTER, A., 2014. Financial decision making under uncertainty. Academic Press.
17

APPENDIX
Appendix 1:
Table 1: Ratio Analysis from Profit and Loss Account
Formula 2016 2015 Increase /
Decrease
Gross profit
Gross Margin / Net
Sales*100
332 272 60
Net sales 1297 1083 214
Gross Margin
ratio 25.60% 25.10% 0.500
Operating profits
Operating profit /
Revenue*100
259 222 37.00
Revenue 1297 1083 214.00
Net Margin Ratio 20% 20.5% -0.500%
Operating profits
Operating Profits / return on
capital employed * 100
259 222 37.00
Capital employed 1412 1094 318.00
Return on capital
employed 18.00% 20.00% -2.00%
Appendix 2
Table 2: Calculation of Capital Employed
Calculation of Capital employed
Formula: Total Assets – Current Liabilities
2016 2015
Total Assets 2046 1644
Less: Current Liabilities -634 -550
Capital Employed 1412 1094
18

Appendix 3
Table 3: Ratio Analysis from Balance Sheet
Formula 2016 2015 Increase / Decrease
Current Assets Current assets / Current
liabilities
1979 1595 384
Current Liabilities 634 550 84
Current Ratio 3.12 2.90 0.22
Quick Assets
Quick Assets / Current
liabilities
171 95 76
Current Liabilities 634 550 84
Quick Ratio 0.27 0.17 0.1
Long term debt
Long term debt / Total assets
395 245 150
Total assets 2046 1644 402
Long term debt
to assets ratio 0.19 0.15 0.04
Appendix 4:
Table 4: Calculation of Quick Assets
Calculation of Quick assets
Formula: Current assets - Inventories
2016 2015
Current assets 1979 1595
Inventories 1808 1500
Quick Assets 171 95
Appendix 5:
Table 5: Cash Flow
Cash flow statement for Harvey
Particulars Cash flows
Cash flow from operating activities -32
19

Cash flow from investing activities -23
Cash flow from financing activities 150
Appendix 6:
Calculation in Days inventory outstanding (DIO), Days sales outstanding (DSO) and Days
payable outstanding (DPO)
Table 6: Calculation of cash conversion cycle
Particulars 2016 2015 Formula
Inventories 1808 1500
(Inventory / Cost of
sales)* days in
accounting periodCost of goods sold 965 811
Days in accounting
period 366 365
DIO 685.73 675.09
Accounts receivable 36 39 (Accounts receivable /
Net credit sales) *
Days in accounting
period
Net credit sales 1297 1083
Days of accounting 366 365
DSO 10.16 13.14
Accounts payable 566 471 (Accounts payable /
Cost of sales) * Days
in accounting periodCost of sales 965 811
Days of accounting 366 365
DPO 214.67 211.98
20