Accounting
A Strategic and Financial Analysis on Scottish and Southern Energy

Introduction

Scottish and Southern Energy is a company providing reliable and sustainable energy for the usage of people in UK and Ireland. The key strategy of the company is to deliver sustainable growth in dividend payment to shareholders through lean operation business structure and process as well as investing and expanding its businesses to the energy production, storage, distribution and supply industry (Annual Report 2011). In this article, the corporate strategy in relation to the financial achievement of the company will be discussed. Firstly, the discussions will be concentrated on the business environment in which the company is operating. For this, PEST analysis will be performed for the company to understand the business landscape the company is operating in (Johnson et. al., 2005). Besides, to understand the linkages between the firm to the external environment, SWOT analysis will be performed (DeWit & Meyer, 2004). Then, a financial ratio analysis on the company for the recent years will be conducted. Based on the changes in the financial ratio as well as other key performance indexes achieved by the company in the recent years, the strategy of the firm in the future can then be formulated. A discussion on the current strategy pursued by the company is also illustrated. Ultimately, the article will also present some suggestions on the best possible strategic direction and plans for the company in the future after considering the issues mentioned above.

Business Environment Analysis for Scottish and Southern Energy

PESTEL Analysis for Scottish and Southern Energy

Before viable strategies can be formulated or recommended for Scottish and Southern Energy, a review of the macroenvironment is necessary. The information gathered from such analysis will be useful for finding the strategic fit between the firm as well as the external environment facing the company (Johnson et. al., 2005). In this section, PESTEL framework will be used to analyze the macroenvironment facing the company.

Political. The company is operating in a regulated industry, thus, adherence to the rules and regulations or governmental policies is to be expected. However, the changes in governmental policies are hardly predictable. Nonetheless, it is reasonable to expect little changes to the price level of energy in the country is to be expected, as the government typically allow the businesses in the industry to earn a satisfactory profit margin (Fitzsimmons, 2010).

Economic. The economic outlook for UK and Europe is sluggish. Unemployment rate is high, and the government intention to implement fiscal austerity program is likely to dampen the economic outlook in the nation for the near future (Cardarelli et. al., 2010).

Social. People are becoming more environmentally conscious over the past few years, and this is pressing the firm to engage in prudent and environmentally friendly activities in conduction of its business (Forbes, 2011).

Technological. In the next decades, energy revolution is likely to be the hot topic as the world is facing depletion of traditional source of energy. Thus, development of renewable, alternative and sustainable source of energy is likely to be the emerging technological issues affecting the firm in the future (Margarito, 2008).

SWOT Analysis for Scottish and Southern Energy

In order to form practical strategy for the firm, both the external and internal factors should be understood well and considered seriously. The SWOT framework is particularly suitable for such analysis, and will be used to analyze the external and internal situation of Scottish and Southern Energy, before viable strategic directions can be recommend to the management in the final section of this article. The SWOT analysis for the firm is outlined as follow:

Strengths of the firm. The firm is a well diversified company, whereby the revenue of the company is stable as the profits of the firm are generated from a wide range of activities (Margarito, 2008), such as the gas-fire power, wind power, electricity supply and distribution, coal-fired power, hydro power, gas supply, biomass power, home services, gas production, distribution, and storage, street lighting, metering and many others. Thus, the risk due to adverse development in any one of the business will cause less negative impacts to the company. Other strength of the firm includes having excellent management working in the firm, as this is witnessed from the strong records (as measured by both financial and non financial metrics). Without excellent management, it is hard for the company to achieve 11 years of consecutive increase in profits for the firm since listing (Annual Report 2010).

Weaknesses of the firm. The weakness of the firm is that it is operating largely in a relatively highly regulated industry. There is a limit on which the energy price can be charged to the consumers. Government tend to control or pull down the energy prices for the benefits of the mass public, or to get re-elected in the election. Thus, the profit margin of the firm can only be enhanced through serious and prudent improvement on the efficiency of the company’s value chain and business process flow.

Opportunities for the firm. The energy related industry is a stable and bright industry, as energy is required by people in carrying out daily activities. Besides, it is a stable industry, as the consumption of energy is expected to rise in tandem with the economic growth of a nation in the long term (Wilner, 2008). Generally speaking, the long term prospect of the industry is promising. There are also few changes in the industry landscape that can benefit the company in the recent years. One of the changes is the increasingly popular and acceptance of alternative energy for cleaner and better world. People around the world are getting more environmentally conscious. Thus, they will support the development and usage of alternative energy that can cause lesser harm to the surroundings (Forbes, 2011; Cornelius et. al., 2007).

Threats facing the firm. In the short term there are some threats facing the firm. The most significant threats perhaps are the gloomy and volatile economic outlook in UK and the Europe region (and worst, the unemployment rate remain high despite signs of recovery in various nations of the Western world). The government had been overspending in the past, and a financial austerity program is to be implemented to ensure conservative financial management by the government (Schmidt, 2010). This may reduce the demand of energy in the region, putting downward pressures to the financial performance of the firm. Besides, there is a trend whereby people are viewing that being frugal is now the cool things to do. This will again dampen the economic growth of the many courtiers in the West (Cardarelli, 2010).

Financial Ratio Analysis for Scottish and Southern Energy

Before the in-depth financial ratio is to be carried out for Scottish and Southern Energy, the various key financial metrics for the company will be discussed. It is critical to understand and study the trend of these key financial metrics to understand the company, the business as well as the industry the firm is working in. Besides, past track record can be used to evaluate the effectiveness of the company’s previous strategy and then to formulate future strategic direction for the company. The key financial metrics for the firm is displayed in Figure 1 below.

As shown in Figure 1, the company can be considered as a well managed and successful company, judging from the stable and ever increasing dividend payment to the shareholders. Besides, the Earning per Share (EPS) of the company is also increasing significantly and steadily from year 2006 to 2010, up from 74.7 pence to 110.2 pence. The profit before tax for the company is on an increasing trend as well since the year 2006. Generally, it can be safely conclude that the company performance is satisfactory, and perhaps has been performing at an above average rate if compared to other companies. Although the rate of growth for the company is not remarkable or high flying as compared to some other technological related firms, the improvement of profitability of the firm is steady and stable. This indicates that the firm is not the typical high growth rate but risky companies. However, it is also worthy to mentioned that it is witnessed that the capital expenditure of the company had increased tremendously in the past 2 years. This can be good or bad news, depending on the ability of the management to ensure those investments in capital expenditures bears fruit in the later years.

 

Figure 1: Key Financial Metrics for Scottish and Southern Energy in the Past

1

Source: Annual Report 2010

 

Figure 2 below shows the balance sheet of the company while Figure 3 shows the income statement of the company for the past three years. It is found that the total assets and the shareholders equity for the company had been increasing steadily over the past three years. However, it is also not hard to observe that the usage of debt in the past three years had been increasing at a very fast rate. This may be a concern for investors, but more data and information should be discussed before solid conclusion can be made on such issues (to be furthered discussed under financial ratio analysis). From the income statement, it is observed that the revenue had increase from year 2008 to 2009, but suffer a decrease from year 2009 to 2010. To understand the company in greater depth, ratio analysis on the firm is required. Such analysis will be presented in the next section.

 

 

Figure 2: Balance Sheet for Scottish and Southern Energy

2

Source: Financial Times Database

 

 

Figure 3: Income Statement for Scottish and Southern Energy

3

Source: Financial Times Database

 

In Table 1 below, the financial ratio analysis for Scottish and Southern Energy will be performed. The crucial financial ratio useful for analysis is presented from the year 2008 to 2010.

 

Table 1: Financial Ratio Analysis

Items 2010 2009 2008
Balance Sheet Items
Current Asset 6666 8074 5152
Current Liabilities 7212 8144 6707
Debt 6047 5396 3921
Equity 3125 2927 2980
Total Assets 18128 17769 13774
Income Statement Items
Revenue 21550 25424 15256
Operating Income 1904 188 1115
Net Income 1236 112 873
Interest 432 367 236
Financial Ratios
Gross Profit Margin 8.84% 0.74% 7.31%
Net Profit Margin 5.74% 0.44% 5.72%
ROE 39.55% 3.83% 29.30%
ROA 6.82% 0.63% 6.34%
Interest Coverage 0.227 1.952 0.212
Total Assets Turnover 1.189 1.431 1.108
Current Ratio 0.924 0.991 0.768
Debt/ Equity Ratio 1.935 1.844 1.316

 

From the analysis, it is found that except for the year 2009, the data for year 2008 and 2010 is pretty consistent. This is because in the year 2008, the economic crisis had severely affected the financial performance of the firm, causing the under-performance of its financial reports in year 2009. Generally, the gross profit margin and the net profit margin or the firm is satisfactory. It is not reasonable to expect high profit margin in the largely regulated industry. Thus, it is perceived that a gross margin of 7-8% is the norm, and thus, the achievement of the firm from such profitability measure is satisfactory. From the ROE and ROA perspective, the management is performing a great job, as even under a regulated industry structure, the ROE and ROA achievement of the firm is not only comparable, but also exceeding many other firms from the fast growing industry. In today competitive business environment, any ROE figure above 20% can be considered good. However, it is also acknowledged that part of the reason contributing to such high ROE achievement in the company is due to the usage of debt in the firm. The firm is also financially healthy, viewing from the normally low interest coverage ratio.  However, in times of crises, the firm can become highly dangerous, as noticed from the interest coverage ratio in financial year 2009. At that year, the Earning before Interest and Taxes is not sufficient to cover the necessary interest payment to bondholders. However, from the current ratio perspective, the company can be perceived as having a moderately conservative financial management policies – due to moderate current ratio recorded in the past three years. Nonetheless, the debt to equity ratio has been increasing in the past three years, and this should be an alarming signal to the management, as the usage of debt can hurt the firm significantly in times of crises. Although it is acknowledged that usage of debt tend to be higher in the energy or power related industry (as the industry is largely regulated and thus the business environment is more certain and of lower risk), it should be aware that the trend of increasing usage of debt in the firm should be handled properly. Excessive use of debt will eventually cause disaster for the firm in the long term.

It should be informed that the financial ratio analysis performed above may not indicate a comprehensive picture of the firm. As the company is operating in the energy related industry, other key operating metrics should also be considered in depth before a truly complete analyses on the company can be performed (However, that is omitted due to the word limits on this article). Besides, it is worthy to mention that the financial ratio analysis performed can only conveyed general overview on the entire business. As the company is a diversified corporation, more meaningful analysis can be performed if each set of financial and operating data from the various business lines under the corporation is analyzed and studied carefully (Weetman, 2006).

Current Corporate Strategy of Scottish and Southern Energy

Currently, Scottish and Southern Energy has a stated and well-defined strategic direction as stipulated in the Annual Report 2010. According to the management, the firm key strategy is to deliver sustainable growth rate in terms of the dividend amount payable to the shareholders. This is to be achieved by two methods. The first is through efficient operation, and thus, lowering of operation costs to enhance the company profitability. The second method is to invest in the energy related industry (in both market-based and economically regulated energy sectors). The energy related industry includes the production, storage, distribution, supply of energy to people in UK and Ireland. The strategy of the firm can be discussed from different perspective as follow.

Marketing management perspective. In order to achieve the strategy mentioned above, the company management is also putting great efforts in enhancing customer service in both the energy supply and electricity distribution activities. Not only that, the company is already aggressively venturing into the alternative and sustainable energy segment in the industry, consistent with the trend of energy evolution in the world, as well as to safeguard the world environment for the future generations (Annual Report 2010).

Financial management perspective. Not only that, from financial management perspective, the management is adhering strictly to the guidelines that all the invested project should be able to yield earning returns above the costs of capital. In order to grow steadily, the management is always keeping close attention to ensure good progress on its major capital investment projects. Apart from that, the company is also engaging in share buyback to further enhance shareholders’ value (Annual Report 2010; Annual Report 2009).

Operation management perspective. Besides, from the operational perspectives, the firm is spending efforts in ensuring well-run power stations, energy network, as well as maintains tight control to ensure efficiencies of the value chain, thereby creating cost efficiency. Currently, that strategy is bearing fruit as the company is achieving competitive advantage in marketplace through the low-cost leadership status in UK and Ireland (Annual Report 2010; Annual Report 2009).

Recommendation of Future Strategic Direction

After considering all the data and findings from several sections presented above, future strategic direction for the company can be charted. To perform this, the concept of Balance Scorecard can be used, as such framework is holistic and comprehensive in nature, as it consider both the very crucial and important financial and non-financial key performance metrics in formulation of strategy for a company (Bushman & Smith, 2001; Libby et. al., 2001). Figure 4 below shows the concepts of Balance Scorecard and the various perspectives on how to formulate a viable strategic direction or the company.

 

Figure 4: Balance Scorecard

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Customer perspectives. It is vital for the firm to continuous provide excellent customer services and to fulfill the customer demand. Provision of clean and green energy for sustainable environment is vital as the society is expecting the development of such source of energy for the benefits of future generations.

Internal business process perspectives. The firm should continue aim to achieve increased dividend payment and growth rate for the shareholders. The strategic direction of the firm, which is to achieve consistent growth in dividend payout, by focusing on efficient operation, should be continued and enhanced.

Learning and growth perspectives. Continuous improvement should be adopted as the key philosophies in conducting the business of the firm. To learn, adapt and change to suit the environmental factors is required. For this, to expand to clean, green and alternative energy is critical. Besides, to continuously lowering the pollution effects of the existing plant owned by the firm is important as well. Not only that, the continuous improvement of the business process in the firm, towards a lean and yet responsive structure should be set as the long term goals in the organization.

Financial perspectives. As we had discussed that the usage of debt by the firm has been increasing, it is vital for the management to cut down the usage of debt. This can be done trough more prudent and conservative financial management of the firm, and to rely on usage of internally generated fund for growth and expansion purposes instead of relying on debt leverage for funding purposes.

Conclusion

Scottish and Southern Energy is a well-run company. It is the biggest listed energy company in UK. The bigger power come bigger responsibilities. Thus, the company should not engage only in activities to reward the shareholders. It will be ideal for the firm to exercise corporate social responsibilities, to implement measures to ensure sustainable environment and better world for the future generations. The strategic direction of the firm should follow such idea – for greater profitability, growth and better world in the future.

Appendixes

Annual Report 2009.

Annual Report 2010.

Bushman, R., and Smith. A. (2001), Financial accounting information and corporate governance, Journal of Accounting and Economics, Volume 32, Issues 1-3, December 2001, Pages 237-333.

Cardarelli, R., Elekdag, S., & Kose, M. (2010). Capital inflows: Macroeconomic implications and policy responses. Economic Systems, 34(4), 333-356.

Cornelius, N., Wallace, J., and Tassabehji, R. (2007). An Analysis of Corporate Social Responsibility, Corporate Identity and Ethics Teaching in Business Schools. Journal of Business Ethics 76, no. 1, (November 1): 117-135.

DeWit, B. and Meyer, R. (2004). Strategy Process, Content, and Context International Perspective, 3rd Edition, Thomson Learning.

Fitzsimmons, C. (2010, January). Our friends electric. New Statesman, 139(4984), 40-41.

Forbes, S. (2011, January). Fact and Comment. Forbes, 1.

Johnson, G., Scholes, K. and Whittington, R. (2005). Exploring Corporate Strategy: Text and Cases, 7th Edition, Financial Times Prentice Hall.

Libby. R, Libby. P and Short. D, (2001), Financial Accounting, The McGraw-Hill Companies, Inc.

Margarito, L. (2008, May). Direct choice: Scottish and Southern Energy. Marketing,10.

Schmidt-Hebbel, K. (2010). A gloomy outlook. Organisation for Economic Cooperation and Development. The OECD Observer, (270/271), 56-57.

Scottish and Southern Energy slashes staff attrition: Better, shorter induction program helps to double customer-satisfaction ratings. (2007). Human Resource Management International Digest, 15(2), 14.

Van der Stede, W. A., Chow, C. W., & Lin, T. W. (2006). Strategy, Choice of Performance Measures, and Performance. Behavioral Research in Accounting, 18, 185-205.

Weetman. P, (2006), Management Accounting, published by Pearson Education Limited.

Wilner, T. (2008, July). Long-distance runner. Regeneration & Renewal, 13.

 

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