A ratio analysis comparison of Rolls Royce and GE

Rolls Royce and GE are two of the most famous names in the engineering industry. The GE is located in the US while Rolls Royce has its origins in Europe. Due to the different nature of the countries, both companies have different accounting practices when accounting for their results. The GE utilizes GAAP in the US and Rolls Royce uses the IFRS. The different approach to the creation of the accounts is hard for interested parties to grasp and creates challenges in the assessment of the businesses. In this situation, it is the ideal method to evaluate the company. Because of the different nature of the accounting standards of companies, the accounting committees of IFRS and US GAAP are working towards the convergence of standards. This will resolve the issue of the various companies operating around the globe.

Introduction

The name Rolls Royce brings to mind the image of a classy automobile of the highest quality. The company was founded to make the luxury automobile in the beginning. But, as the company expanded, the company was divided and the license to production of the automobiles was awarded to BMW. Today, BMW manufactures the coveted automobile. The sought-after trademarks are utilized by the parent company under the name of Rolls Royce Plc. The company is one of the most prestigious companies in the engineering sector and has a presence in the aerospace and marine sector. The company’s clients are defense agencies from all the nations. The company’s name has become synonymous with the high quality of its products. Its long-standing heritage has drawn clients from all over the world. The company is headquartered in London and adheres to the accounting rules of the country when it publishes its annual reports. (History of its brand n.d.)

GE or General Electric has been the leading company in the electronic sector. Similar to Rolls Royce the main focus of the company is in the field of energy. This company is renowned for its long tradition that dates all the way back to Thomas Edison. Since the days of Edison the company was involved in the creation of new methods of electronic technology. With its current status the company has continued to carry on its heritage, and has created its own global brand. The brand’s global reach is a key factor in the growth of the business. The company’s innovation is a legacy since the time of Edison. The company operates its main office in the USA. In its financial reports , the company employs American GAAP principles. (Our history, n.d.)

The report will present the financial statements of the business and will also provide the performance of firms in a similar way by using ratio analysis. The different methods of reporting used by the company will be highlighted on.

The businesses

The reason for choosing these businesses is pertinent in this scenario. Both companies are alike as they both operate in the same business. Both have a reputable name in the field and possess distinctive brand names. They have been operating within the sector of industry. They are located in diverse geographical areas and adhere to different principles regarding financial reporting. The status of the business is in line with the requirements in the financial report.

Strengths and weaknesses in the financial world

This section will discuss the strengths and weaknesses of the businesses as reported in the financial statements of the respective companies. Because the structure of financial statements differs between both companies, the aid in the form of a ratio analysis is taken into consideration. The ratio analysis assists in ensuring consistency in the reporting of the two companies.

Rolls Royce

For Rolls Royce, the financial assessment will be conducted in the years 2006 until 2009. Ratio analysis can aid when it comes to the assessment. Since the company is located in England and the Pounds have been the currency of the report. All figures included in the analysis will be in pounds, with the exception of profits per share for the business.

Ratio of Profitability Analysis

Return on Equity (ROE)

Net Income/Shareholder’s Equity

The company has been operating well in line with the funds of shareholders except for 2008. In 2008, the business made a huge investment in its R&D of the business and the financing of its operations. The investment has held the company in good standing and the results of 2009 is proof of this.

The same is true for the ROA. Except for 2008, the business is performing fairly good. The year 2008 saw was more purchases of assets and an growth in the assets currently owned. This is reflected in the figures which is shown. The company has invested into the assets to support the expansion of the business.

The current ratio reflects the short-term solvency of the company. The assets at present should be able to pay for the liabilities that are currently owed to the business. For Rolls Royce, the current ratio has been satisfactory over time, which supports a an excellent case of solvency for the company.

Ratio for analysis of activities

The artwork of Rolls Royce clearly depicts that the company has been offering clients a more extensive credit terms over time. The company might have reviewed the situation following the onset of financial turmoil that hit in the latter half of 2008. This was necessary to ensure the pace of growth.

According to an ART that is followed by the business in accordance with the ART of the business, the ITR has decreased as well throughout the years. This indicates that the inventory is available to the business for longer. The current global economic crisis and marketplace’s competition could be a major factor in slowing down the selling process.

Long-term debt ability to pay ratio

The position of D/E for the company has improved over time through a more aggressive approach towards the financing. This will assist the business over the long term to expand.

The ratio analysis for the case of Rolls Royce PLC points out that the business has been well-positioned in the event of a bankruptcy and also the returns for shareholders. The shareholders receive a decent return on their money. In 2008, the company incurred losses due to investment in R&D. The field in which the company operates requires a constant flow of investments in R&D. The investments made in R&D has enabled the business to turn around the situation when it came to profits in 2009. The company is anticipated to expand over the next few years. (Company Balance Sheet, 2007 Consolidated Income Statement 2007, Rolls Royce, 2009 annual Report 2006)

GE

To ensure uniformity within the report, to ensure consistency, the statements on the finance of GE was gathered from the year 2007 to. The company is located in the USA therefore the report will be prepared on dollars. All figures, except for those related to the profits of the share are shown by millions dollars.

Ratio of profitability analysis

The ROE of the business has been steady throughout the years, and the business is performing very quite well. In 2009 it was evident that the ROE of the business fell dramatically. This was because the company was able to keep a large portion of retained earnings from shareholders. Furthermore the operations of the company slowed down as a result of the result of the slowdown in the economy.

The ROA of the business has been declining throughout the years. It is due to declining sales. Similar to the ROE The ROA for 2009 has declined significantly due to the effects on the world financial crises.

Liquidity Ratio

The ratio is currently growing over time which indicates that the solvency status of the firm has been satisfactory. The liabilities and assets of the company have been helped through the involvement of affiliates of the parent company. The company’s management has been paying off loans on the market in regular intervals. This has contributed to the reduction of current debts of the company.

Ratio of analysis of activity

The data from the chart show that the firm has been able to adhere to a specific policy on credit giving. This policy is not affected due to the global financial crisis.

I

The ITR is generally stable, with only a minor drop in 2009. It is, however, normal given the economic situation in the global economy. Management had to reduce the rate of sales, as increasing numbers of businesses were unable to pay their debts.

Long-term debt ability to pay ratio

The D/E ratio of the business is higher than the average, and indicates that the earnings of the business will fluctuate in the long run. The equity fluctuates throughout the years due to those retained profits. (Invest and deliver 2006 and We are GE Annual report for 2009,)

GE has performed well throughout the years and there is a consistency in its performance. But, it must be pointed out that shareholders have not received their share of the profits according to it is what the ROE suggests. The company was afflicted due to the financial crisis in the world. As it is located in the USA The division in the country was unable to perform. It was eventually saved through other divisions located in different regions of the world.

Overview of the industry

Rolls Royce has been a pioneer in the field of engine manufacturing for the military aircrafts as well as the artillery ships. The company’s clients are the defense agencies all over the world. For commercial aircrafts, the firm has always been the top player. The majority of leading aircraft manufacturers in the world, such as Boeing utilize engines made by Rolls Royce. Rolls Royce. There are few rivals in the business. The competition is international since there are only a handful of companies. GE as well as Pratt & Whitney are the principal competitors to Rolls Royce. Due to its size and customers, the company has an impact on an important portion in the marketplace. (Profile: Rolls Royce, 19th October 2001)

When it comes to GE the situation is quite different. Apart from the power industry the company is also a host of different factors. The competition of other variables is also tough. GE has a vast variety of divisions, and there are rivals in the majority different divisions. One of the biggest competitors to GE is Siemens similar to GE has a broad range of operations and a large market. Other competitors are Honeywell, Bank of America as well as The Walt Disney Company etc. These companies come from various sectors. (Industrial: GE competitors, n.d.)

Performance of the Stock Price

The value of the shares of both firms will establish their positions with respect to the market.

Rolls Royce

In the instance of Rolls Royce, the company is incorporated in the UK which means that the cost of shares of the company are listed in pounds. The prices for shares of the company may be described in the following manner:

In the instance of GE the company is registered in the USA which means that the shares of the company will be calculated in Dollars. The prices for shares of the company between the year 2006 until 2009 can be described as below:

Environment

The accounting statements for the two companies company and the management was faced with serious issues during the years between the years 2008 and 2009. The reason for this is the situation that the financial crisis of the business had a negative impact on the financial position of the business. The financial turmoil of the business led to the realization that the future prospects of the company were not as good. Both businesses were impacted by the financial crisis. Many of them were forced to declare bankruptcy. A company with the stature of GE had the worst dip in its share price in twelve years. (Cherniawski the 24th of January, 2009). It was therefore normal for the performance of the company would be sluggish during this phase and this was reflected into the financial reports of the firm.

Accounting styles differ Convergence

The introduction of accounting standards has proved beneficial to the businesses as well as the investors of companies. Accounting standards assist with the display of financial data of the business in a way that is able to be understood by investors of the businesses. Investors of companies are keen on the company’s performance and financial results are used to evaluate the performance. Therefore, companies need to be able communicate information that is beneficial to the investors as well as other stakeholders. The development of standards has helped in introducing uniformity to the way companies present their information. Investors have been benefited by the clarity of information as well as the scope that the data is available. In the case of companies, the management has been in a position to attract more investment from investors because of the clearness and clarity of information. The clearness of the information for the business helps to attract more capital. Thus, in a real sense, the expense of capital reduces. Accounting is a different types of formats and standards for the presentation of financial data. Due to the globalization of the economy, it was that there should be a common international standard. The current standards in various regions of the world are currently becoming a common standard. This process has been going on up to the present. In Europe due to the development of the EU guidelines and laws applicable to the conduct of businesses have become more strict. The IAS/IFRS governs the presentation of accounts for the businesses in Europe. For the US and North American countries, the US GAAP is the most widely accepted standard. Thus, there will be an inconsistency regarding the presentation of financial and accounting information of companies operating in these two areas. In this particular instance, Rolls Royce Plc is commissioned in England and is governed by the IAS while the GE adheres to GAAP. US GAAP. (Daske, n.d., pp.1-6).

There are differences between US GAAP and the IAS that affect the presentation of accounts of the business. In certain situations there are differences in the valuations of some of the assets in the company. The different valuations of certain items can be confusing for the investors. In the case of valuation of the non-controlling interest of the company the IAS permits the valuation to be at fair value, or at the proportionate value within the business. For the US GAAP the standard permits the valuation of fair value. This causes variations in the valuation of companies. The format of presentation of the financial statements is different between the IAS as well as the US GAAP. For the IAS the report must comprise of different sections of the changes to the equity as well as the comprehensive income. In the case of US GAAP the comprehensive income be able to report all the changes. In the case of IAS/IFRS, a comparison between the various years is mandatory, while in the case of American GAAP system, the requirement can be described as “desirable”. Deferred tax is recognized when using US GAAP whereas for the IAS/IFRS, tax is deferred if the income is likely. The reporting requirements for segments differs as well with respect to the standard. In the case of US GAAP, one basis of segmentation is needed, while in the case of IAS/IFRS, the entire segmentation must be completed. The segment has to provide the results of the IAS/IFRS , whereas in the case of US GAAP, it’s not required. These are the major differences between the two in the presentation of financial statements. (Key distinctions among IFRS as well as US GAAP July 2004; business Combinations, n.d.)

As the world economy grew more globalized accounting accounts of the business was a major issue. The EU expanded and included more recent countries within its ranks. Around 7000 companies that are that are registered in the EU are required to be compliant with the IFRS by the year 2005. This is a major issue since many of them are registered with the US. In the US businesses, they are able to report using IFRS from, but they need to create reconciliations in the GAAP format. Thus, companies need to prepare accounts twice. Furthermore the effects that come from that of the Sarbanes-Oxley Act require the preparation of the accounts to be in the best interests of the global business climate. So, in October 2002 the board of directors of both the IFSB along with the FASB (US GAAP) signed a contract to bring together the various accounting standards to create an international system. The bodies will undertake small-scale projects to bring convergence to the various aspects of the standard. This will benefit international business organisations. (Pacter March, 2003) Also, Byard, Li Y. And Yu, Y. (2008) discovered that finance analysts had fewer errors in forecasting future earnings and the accuracy of their forecasts was improved following introduction of IFRS in the European Union.

A system based on principles VS Rules-based system

Prior to the convergence, and even during the course of it, the debate regarding which set of standards were more superior. The main issue lies with the core of the two different styles of accounting. A lot of scholars believe that IFRS is based on principles while GAAP is based on rules. GAAP is based on rules. However, Bennett et al. claim the distinction to be not valid since the only difference is in the amount of professional judgment required to implement both systems. (B. Bennett, M. Bradbury, H. Prangnell (2006)) In addition, Goldberg, and Kim (2005) claim they believe that IFRS in addition to GAAP are not different in the quality of reporting. Benston et al. claim that a principle-based approach with a fair and true override enables the application of professional judgment, and this is the difference between the two approaches. (G. J. Benston, M. Bromwich, A. Wagenhofer, 2006) In a world economy, the concept of accounting harmonization is receiving more focus. Principles-based systems are favored by academics and in practicians as a principles-based system i.e. IFRS allows countries with different accounting practices to adhere to, and keeping its core values to ensure a fair and fair presentation. (S. Carmona, M. Trombetta, 2008) Although the spirit of the principles-based system is lauded but there are some instances that demonstrate the inability of this system. R. G. Walker believes that the effectiveness of a system based on principles is heavily on the human factor, such as the willingness of auditors to comply, and the capacity of regulators to oversee aspects that a system based on rules overlooks due to its rigidity. The rigidity of a system based on rules is also a drawback. Berkowitz et al. argue that strict rules create numerous loopholes to manipulate accounting as demonstrated in the Enron scandal, where management managed to manage to keep transactions that were not on the balance sheet within GAAP guidelines. (Berkowitz and Rampell 2002) Zeff also argues that different cultures can result in differing accounting methods, making the convergence useless.

However, every reform has advantages and disadvantages. We’ll choose one when the benefits outweigh the negatives. To allow the convergence to be successful the debates provided provide ample proof for the task force to take into consideration. It is therefore plausible to predict that, in the future, due to the convergence of two distinct styles of accounting, standard accounting practices will be more robust, offering more assurance to investors. According to Leuz and Verrechia. The convergence between IFRS and GAAP in the US GAAP reduces the cost of raising capital, due to the benefits of both systems. (Leuz and Verrechia 2000).

Fair value vs. historical costs

The IFRS encourages the use of fair value because fair value is relevant and decision-making utility. (J. M. Hitz 2007.) Historic cost has been utilized in US GAAP to ensure credibility and prudence. Issues that the convergence should be able to overcome are largely due to the use of costing systems. Because historical cost is widely used in many countries, it offers inherent advantages. Today, researchers argue that fair value costing could be more precise and provide pertinent information. Except for times of financial turmoil as fair value can cause changes in accounting figures that renders it less reliable. Furthermore, it can cause instability even in a situation that is stable, even though it in certain circumstances triggers an early reactions to reduce risk. (C. Laux, C. Leuz, 2009)

Like in the principles-based systems VS the rules-based debate there is a need for a compromise to create a strategy for convergence. Assessing the weight given by the relevance or reliability of the system is, therefore, crucial.

The Case: The impact on IFRS as well as US GAAP on the accounting figures

In the instance between Rolls Royce and GE, the distinctions were evident. For GE the segmentation was made using only one segment. In the case of Rolls Royce segment, there was no other segment. When it comes to the presentation structure there were significant variations, which could impact investors. The information presented by firms could be confusing for investors. For instance, the Rolls Royce Company followed the IAS and the comparison of figures with years was made available. The same information was provided for GE however, the information was missing in certain places. This could affect the information provided to investors. In the case of investment of companies they invest in, GAAP recognizes them at cost, while when using IFRS it is valued at fair value. In the instance of GE it was noted that there were substantial investments in the other industries. These were recognized at cost, whereas in cases like Rolls Royce and Rolls Royce, it was recorded in fair market value. For GE it was a help in reporting the profit of owners of the business. For the inventory in the case of GE, the GAAP value is calculated on a last-in-first-out basis. This allows for the identification of the current conditions of the business. In the times of recession, GE forecasted profits in accordance with the circumstances and shareholders gained because of this. For Rolls Royce inventory, it was appraised on a first-in-first-out basis, which does not adhere to the current situation. GAAP recognizes revenue only after the delivery is completed. In the case of IFRS the delivery is not necessary. Thus, the recognition of revenue in the case of GE was not a realistic and actual sales. For Rolls Royce, the revenue was not recognized until the delivery was completed. This could have serious implications as losses could occur in transportation. (Lajara, 11th June, 2008)

Conclusion

The differences in the presentation of the financial and the financial data can affect the interest of the business. Investors won’t have access to all the information they require and the company won’t be able receive investment. This could affect the efficiency of the business. The differences in accounting standards could be confusing for investors due to the differences in the structure. The performance of companies is not able to be evaluated in a global perspective. Therefore, a true assessment will never be completed. It is therefore necessary to ensure the convergence of standards, which will lead to an international standard.

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