Financial Analysis of Royal Dutch Shell

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Executive Summary

The purpose of the report is to outline the performance of Royal Dutch Shell based on the financial statements analysis. The investigation of the income statements indicated a decline in the revenues and profitability in the year 2016. The revenue in the year 2014, 2015, and 2016 was $431 billion, $272 billion, and $240 billion respectively. The sales declined because of the decreased demands for inputs in Japan and Latin America. The fall in the prices of crude oil also affected the sales recorded by the organization. There was an upsurge in the cost of sales which was attributed to the increased price of raw materials and maintaining the exploration sites. The gross profit was affected negatively because of the changes in cost of sales and the revenues. The total expenses increased from $45 billion in the year 2014 to $47 billion in the year 2015. In the year 2016, the expenses decreased by a margin of $3 billion to $43 billion. There is a huge decline in the earnings before interest and tax which has been caused by the increase in the depreciation and exploration expenses.

The overall cash flow report indicated that the business was in a position to meet its daily operation needs. The negative net cash flows were recorded since the firm used its funds to invest in long-term assets. The net cash flow declined in the year 2016 because of the changes in inventory, working capital, and non-cash item. Some of the factors that caused a decline in the cash flow from investments were payment of debts and dividends. The cash flow analysis indicates that the business is thriving due to the positive net cash flow recorded in the year 2014, 2015, and 2016. The balance sheet indicated that Royal Dutch is financially healthy but struggling as evidenced by the current ratio and debt/equity ratio. The day’s sales outstanding revealed a decline in the firm’s efficiency and the inability to convert sales into cash. In addition, there was a decline in cash and cash equivalents and an increase in total debt of the firm. The management of Royal Dutch should implement various strategies to ensure that the deteriorating performance is improved.

One of the measures that the firm should adopt is increased marketing for its products and services. The firm needs to reduce its reliance on long-term debt and use the retained earnings to finance long-term projects. Royal Dutch should also hedge to minimize the currencies’ fluctuation losses. A company that operates in the global context should put in place tools to mitigate exchange rates risks. In addition, Royal Dutch should improve its collection efficiency by reducing the number of days taken to collect cash from debtors. Therefore, the above strategies are inevitable if the business plans to achieve its growth and sustainability objectives.

Approach

The study will use various parameters to ensure that the report is valid and useful for the purpose of making investment decisions. One of the tools that will be used in the analysis is the financial ratios. The report will also analyze the changes in the financial statements of the entity for the last three years to determine the trend. Charts and tables will be utilized to show the changes in net income, cash flow, and balance sheet items. Projections of the company’s performance will be made based on the future strategies that the management plans to implement. The sense of the parameters is based on the information provided by the report and the number of years analyzed. The three financial statements were selected because they provide vital information about the changes that have occurred in the organization. The years that will be investigated are 2014, 2014, and 2016 since it would be imperative to use the most recent information in making the final decision about the performance of the entity. I would consult the financial directors in refining the parameters due to the expertise the person has in the field of finance.

Financial Performance and Health

Organization Context

Royal Dutch Shell is a group of companies that deals with energy and petrochemical products. The company was incorporated in the year 2002 and is situated in Netherlands. Some of the major activities carried out by the company include the exploration of natural gas and crude oil around the globe. The sources of its explorations are coal formation, shale, and tight rock. Royal Dutch provides two main products which are LNG and GTL. The company’s gas and oil exploration activities are carried out in various regions across the world. Some of the locations in which the production is carried out are Europe, China, Jordan, Russia, Australia, New Zealand, and other African countries. Moreover, Royal Dutch engages in the production of chemicals which include solvents, propylene, detergent alcohols, and oxides.

The company is organized and managed through four main geographical regions which are Europe, USA, Americas, Asia, Oceania, and Africa. The geographical sections affect accounting since the reports have to indicate the various segments. Royal Dutch’s clients are divided into commercial and retail customers. The company serves over 30 million customers on a daily basis through the retail stations that are situated in more than 70 countries. Royal Dutch is divided into four segments which are corporate and downstream, integrated gas, and downstream. The role of the integrated segment is to liquefy, produce, and transport gas. The integrated segment also converts gas into liquids to provide products such as fuel. The upstream section engages in the extraction and exploration of crude oil. The downstream department deals with marketing and manufacturing of chemicals and oil products. The various sections in which the operations of the firm are divided into influences the financial statements preparation. Therefore, since the year 2016, the company adopted segmental reporting as a way of measuring the performance of each department.

Recent Financial Performance

Consolidated income statement. The revenue movement of Royal Dutch indicates a significant decline as shown in the financial statements. The revenues in the year 2014, 2015, and 2016 were $431 billion, $272 billion, and $240 billion respectively. The decrease in the sales of the company is attributed to the reduction in the level of imports by Latin America and Japan. In addition, the revenues dropped due to the fall in price of the oil and crude products. The cost of goods sold reflects the management’s ability to control cost. The cost of sales in the year 2014, 2015, and 2016 was $357 billion, $222 billion, and $191 billion respectively.

The gross profit of the company is low compared to the revenues generated by Royal Dutch. Despite the decline in the cost of goods, it is evident that the cost of sales consumes much of the company’s revenue, which affects the income generated. The total expenses increased from $45 billion in the year 2014 to $47 billion in the year 2015. In the year 2016, the expenses decreased by a margin of $3 billion to $43 billion. There is a huge drop in the earnings before interest and tax since the EBIT recorded in the year 2014 was $28 billion while in the year 2016 the EBIT was $5.6. The weakened performance as indicated by the financial statement indicates that Royal Dutch would be faced by challenges if the trend continues in future. Notably, the cost of sales is one of the major elements that have led to the poor performance. Therefore, the management of the company should implement the appropriate mechanism to ensure that the cost of sales is proportionate to the amount of sales generated by Royal Dutch. Chart 1 below indicates the movement in the some components of the income statement from the year 2014 to the year 2016.

Chart 1: Consolidated income statement analysis (Royal Dutch Shell PLC., 2016)

Cash flow statement. The net fund from the operating activities in 2014, 2015, and 2016 was $45 billion, $29 billion, and $20 billion respectively. The net cash flow declined in the year 2016 because of the changes in inventory, working capital, and non-cash items. Royal Dutch recorded negative net cash flow figures in the year 2014, 2015, and 2016. The negative cash flow from investment reflect that the firm used its cash to purchase assets. Although results affect the short-term operations of the business, the shareholders returns might increase in future, if the property and plant purchased are utilized efficiently. In addition, the negative cash flow from investment was attributed to the upsurge of acquired investments.

The net cash flows from the financing activities in the year 2014, 2015, and 2016 were ($12) billion, $3.8 billion, and ($771) million. One of the factors that caused a decline in the cash flow from investments was payment of debts. The other factor that affected the cash flow from the investment activities was the payment of dividends. The financing activity section of Royal Dutch indicates that the company should invest in activities that generate dividend and interest returns. The cash at the end of 2016 reduced because of the negative net change in cash. Despite the negative results from financing and investment activities, Royal Dutch has managed to record a positive figure for cash at the end of year 2016. Therefore, based on the overall cash flow analysis, the figures reflect a good performance for Royal Dutch. In addition, the cash flow results indicate that Royal Dutch is in a position to meet its daily cash requirements. The chart below indicates the changes in the cash flow of the company for the year 2014, 2015, and 2016.

Financial performance. Based on the income statement analysis the company is struggling to meet its objectives as indicated by the decline in profits. One of the major factors that have affected the company’s performance of Royal Dutch is the fall in the prices of gas and crude oil in the international market. The other factor that caused the slump in the company’s achievements is the decision by the management of the company to stop the drilling activities in Alaska. Higher impairment charges have also been a reason why the company has recorded poor results in its income statement. The upsurge in interest expenses also had a negative influence on the financial reports due to the increased acquisition of debt and BG acquisition cost.

The cash flow analysis indicates that Royal Dutch is thriving due to the positive net cash flow recorded in the year 2014, 2015, and 2016. Despite the negative cash flows that have been recorded for investment and financing activities, the firm has still managed to record positive net cash flows. The negative cash flows from the investment activities indicate that the company has engaged its recourse into activities that will generate returns in future. One of the major investments that have been undertaken by Royal Dutch is the acquisition of BC Group PLC. The acquisition of the investments of the company is expected to increase the sales of Royal Dutch by $30 billion from the year 2016 to the year 2018. The organization has also purchased capital investments, which are expected to improve the revenues generated. Currently, the return on the capital employed increased in the year 2016 to 3% from 1.5%. The changes in ROCE imply that if the company continues increasing its investment, the shareholders are guaranteed an increase in future returns. In addition, the company divestments in the year 2016 increased which reflected a diversion of the investments into more profitable ventures.

Chart 2: Cash flow analysis (Royal Dutch Shell Plc., 2016)

Current Financial Health

How the organization is capitalized. The financial health of the firm can be analyzed using the balance sheet of the company. The report will analyze the current ratio, day’s sales outstanding, total debt, the shareholders’ equity, and the debt to shareholders equity to analyze the performance of Royal Dutch. Tables 1 and Charts 3, 4, and 5 below indicate the movement of the above indicators in the year 2014, 2015, and 2016. Based on the analysis of the financial statements, the company financial health is deteriorating as indicated by the decline in cash and cash equivalents and the increase total debt of the firm. The number of days taken to collect debt has also increased for the three years analyzed and, therefore, a reflection of Royal Dutch’s liquidity problems. However, the company has been able to maintain significant performance as shown by the current and debt/equity ratios.

Table 1: Balance sheet movement analysis (Royal Dutch Shell PLC., 2016)

2016

2015

2014

Current ratio

1.17

1.32

1.16

Debt/equity ratio

1.20

1.09

1.05

Days' sales outstanding

53.98

39.44

34.30

Cash and cash equivalents

19,130.00

31,752.00

21,607.00

Total debt

224,629.00

177,281.00

181,150.00

Total Stockholders' equity

186,646.00

162,876.00

171,966.00

Chart 3: Statement of financial position analysis

Chart 4: Statement of financial position analysis

Chart 5: Statement of financial position analysis

Table 2 below indicates the current ratio of Royal Dutch for the year 2014, 2015, and 2016. The current ratio for the three years is above 1, which is an indication that the firm is able to meet the obligations that are due in a period of less than one year. The current ratio also indicates the company is financially healthy since its total current assets are more than the total current liabilities.

Table 2: Liquidity analysis (Royal Dutch Shell PLC, 2016)

2016

2015

2014

Current assets

86,569.00

93,358.00

99,778.00

C.L

73,825.00

70,948.00

86,212.00

Current ratio=C.A/C.L

1.1726244

1.3158651

1.1573563

Table 3 below indicates the debt to shareholders’ equity of Royal Dutch. The amount of total debt is more than the amount of total shareholders’ equity. The results indicate that the company relies more on debt than equity to finance its long-term projects. A company that has a high level of debt is considered risky due to the high interest payment required to service the debts. The total debt in in the year 2016 increased since the company required funds to finance its acquisition investments.

Table 3: Debt/equity ratio analysis (Royal Dutch Shell PLC, 2016)

2016

2015

2014

Total Debt

224,629.00

177,281.00

181,150.00

Total Shareholders’ equity

186,646.00

162,876.00

171,966.00

Debt to shareholders equity=Total debt/shareholders' equity

1.20

1.08

1.05

Table 4 below shows the days’ sales outstanding for the business in the year 2014, 2015, and 2016. The ratio indicates the efficiency of the company to collect the sales that have been made on credit. The days’ sales outstanding ratio for Royal Dutch for the year 2014, 2015, and 2016 was 34 days, 39 days, and 53 days. The results reflect that the company’s efficiency to collect debts has declined since it currently takes more days to receive the cash. In addition, the ratio indicates that the company might be faced by challenges to meet its daily cash requirements. Therefore, the management should ensure that the collection period is decreased by implementing various policies at the credit control department. A 30 day period would be appropriate for the company given the current cash requirements as reflected in the cash flow statement.

Table 4: Days’ sales outstanding ratio (Royal Dutch Shell PLC, 2016)

2016

2015

2014

Accounts Receivable

35,497.00

29,408.00

40,534.00

Credit sales

240,033.00

272,156.00

431,344.00

Days' sales outstanding=Accounts receivable/Credit sales*365 days

53.98

39.44

34.30

Cash and other resources. Royal Dutch has adequate resources to run the operations of the business. One of the main priority of the business is to continue growing the resources to enable it achieve its growth objectives. According to the financial statements, the firm plans to utilize the excess cash to pay dividends, reduce its debts, and buy back its shares. Royal Dutch has enough liquid resources to meet the short-term obligations. The organization has skilled personnel and this has been enhanced through continuous training program.

Royal Dutch has also invested in most recent technology to meet the market needs. The company has made contributions in the reduction of carbon emission. In the year 2016, the Royal Dutch spent $1 billion in research and development to meet the energy demands of the world. The investments have also enabled Royal Dutch to survive in the competitive industry.

Financial value. One of the indicators that can be utilized to measure the business health is the price to earnings ratio. According to Morningstar (2017), the price earnings ratio of the company as at the January 2018 was 28.2. The five year average of the price earnings ratio was 27.8. The valuation recorded in the year 2018 indicates an improvement and shows that the business is financially stable. However, the price earnings ratio of the company is less than the industry’s ratio by a margin of 0.6. Therefore, the stakeholders should consider investing in the business since it has a prospective future. The price to book ratio is 1.6, which is above the industry’s rate of 1.5 (Morningstar, 2017).

Success Factors and Risks

Financial and Strategic Priorities

There are various plans that have been adopted by Royal Dutch to ensure an increase in shareholders’ returns. The management has affirmed that the demand for oil and energy will increase in future due to the population growth. It is therefore imperative to ensure that the firm has the right strategy to ensure that the demands are met. The main objectives of Royal Dutch include creating a shared value for the community, increasing cash flow, reducing carbon emissions, and attaining a competitive advantage. The strategies adopted by Royal Dutch have affected the accounting procedures. In 2016, the business recorded $1.9 in its financial statement as the cost of restructuring. Royal Dutch also uses estimated in the annual report to account for new oil reserves. The management of Royal Dutch is growth-oriented since the goals of the business are focused on increasing investments across the world.

The company is exposed to many risks and, therefore, various approaches have been adopted to mitigate them. One of the techniques used by Royal Dutch is divesting in areas that have a low return. In addition, Royal Dutch uses hedging to minimize the price fluctuations threats.

Non-Financial Factors Capitalization

There are various ways in which Royal Dutch can use its market share, human resources, patents, and physical facilities. The company can utilize its personnel to build a strong culture in the organization. According to Deloitte (2009), culture is regarded as a powerful tool for achieving the objectives of an entity. Royal Dutch can use its market share to increase its revenue and profitability. In addition, Royal Dutch should also use its physical facilities efficiently to enhance its production process. Patent can be used by Royal Dutch to create a competitive advantage and, therefore, increase the revenues generated by the entity (Choski & Parr, 2017).

Significant Internal Risk

One of the major threats that the company is prone to is lack of skilled labor (Royal Dutch Shell PLC, 2016). As technology evolves, the demand for employees who can operate the machine for exploration is increasing. Therefore, the management of the company should ensure that it retains its experience personnel by providing exceptional working condition. The other internal risk in the firm is changes in technology, which will require Royal Dutch to invest additional resources.

Projections

Consolidated Financial Performance

Table 3 in the appendix represents the growth of the projected financial statements for the year 2018. Since the company has not yet released the financial statements for 2017, the financial reports for the year 2016 were used as the basis of forecast. The assumption made is that the revenues will increase by 5% while the cost of sales will decrease by 10%. The 5% growth rate is because the company had made significant investment as at the year ended 2016, and, therefore, it is expected that the sales will yield to an upsurge in the sales generated by the business.

Best-worst Case Scenario

The analysis will be based on the assumption that the all the items that causes an increase in profit will have a growth while the items that cause a reduction in income will have negative growth. Table 4 in the appendix represents the financial forecast established on the two situations. The best-case option illustrates that the profits will increase in the year 2018. The worst case concept reveals that the business will record a loss in the year 2018 since the assumption made is that the sales will decrease while the cost of sales and expenses will decline.

Factors That Affect Projection

One of the assumptions made is that the revenues will increase due to the investment strategies that have been adopted by Royal Dutch. In addition, the business has divested in various entities and, therefore, the cost of running the operations is expected to decrease. Another factor that has been taken into consideration while making the projection is the economic growth that is expected for oil products.

Business Opportunities

Investments That Should Be Considered

One of the investments that can be implemented by Royal Dutch to reduce cost is the use of robotics. The technology of robotics is evolving and is providing essential services to companies across the world. The robotics could be used to connect drill pipes that are located in oceans. The use of robotics will enhance efficiency in the process and improve the employees’ safety. According to the financial statements of Royal Dutch, the management has indicated interest in offshore exploration. In addition, offshore exploration is one of the sites from which the firm gets its natural resources. Some of the robotic applications that could be useful to the company production include underwater vehicles, robotic drills, and aerial drones.

Cost and Benefits of the Investment

The acquisition of the robotics will require the company to spend funds from its retained earnings or borrowings. If the firm uses debt to finance the assets, additional interest payment will be recorded in the financial report. The increase in interest expense will lead to a reduction in the profitability of the business during the first year. After year one, the use of the technology will result into numerous benefits. One of the advantages of adopting the use of robotics is the reduction in the cost of operations. Since a robot is operated by computers, the cost of fuel will reduce since the company does not have to send its employees to fix simple task in the exploration sites. In addition, the company will be able to save on wages and salaries since it does not have to employ many people. The investment strategy will improve the safety in the work place and, therefore, the company will save on medical cost incurred because of injured employees. The projection of the cost saving is estimated to be 5% for the first year of operating bearing in mind that funds will be spent to install the technology. In the long run, the estimated savings in future could reach 15% if Royal Dutch embraces the investment idea fully. However, it is imperative to note that the loss of employment caused by the use of technology will be viewed negatively by the community served by Royal Dutch.

Impact of the Investments on Budgets

The technology will affect the budgeting process since its initial adoption requires significant amount of cash to be spent. Since Royal Dutch does not have adequate cash flow as indicated by the financial statements, the short-term operations of the business might be affected. If the company decides to use debt to finance the investment, the long-term projections of funds will be reduced due to the additional interest payment. The robotics would also require the company to spend its money on training and installation. The cost will have a major impact on the short-term cash flow of the entity. However, after the first year of operation, the company will start recording cost savings due to the decline in operation expenditures. Overall, the benefits far much outweigh the cost and, therefore, it is a viable idea to implement the project.

Recommendation

It is evident that Royal Dutch needs to change its strategies to improve profitability and overall performance. One of the weaknesses identified in the analysis was the management of cost of operations. The firm needs to minimize its expenses by implementing cost reduction techniques. Moreover, Royal Dutch reliance on debt is risky for the business and could results to reduced profits and shareholders returns. The organization should consider using equity in future to finance the long-term projects. To improve the income potential of the company, Royal Dutch should reduce its reliance on long-term debts. The days’ sales outstanding ratio indicates that Royal Dutch is taking long to collect credit sales. The period of collection should be reduced to provide funds for running the daily operation of the business. The report identified that Royal Dutch is prone to the risk of exchange rate fluctuations. Therefore, hedging techniques are required to ensure that the losses from price changes are minimized. In future, the company needs to invest in the use of robotics technology to improve efficiency and reduce the cost of operations. In the short-run, the investment strategy will require a huge cash outlay but the firm will be able to recover the initial amount spent from the technology’ future earnings.

References

Deloitte (2009). Cultural issues in mergers and acquisitions. Retrieved from https://www2.deloitte.com/content/dam/Deloitte/us/Documents/mergers-acqisitions/us-ma-consulting-cultural-issues-in-ma-010710.pdf

Morningstar. (2017). Royal Dutch Shell PLC. Retrieved from http://financials.morningstar.com/cash-flow/cf.html?t=RDS.B&region=usa&culture=en-US

Royal Dutch Shell PLC. (2016). Annual Report. Retrieved from http://reports.shell.com/annual-report/2016/servicepages/downloads/files/entire_shell_ar16.pdf

Appendices

Table 5: Income Statement

Royal Dutch Shell PLC

Income Statement

2016-12

2015-12

2014-12

$ Millions

$ Millions

$ Millions

Revenue

240,033.00

272,156.00

431,344.00

Cost of revenue

191,008.00

222,739.00

357,316.00

Gross profit

49,025.00

49,417.00

74,028.00

Costs and expenses

Research and development

1,014.00

1,093.00

1,222.00

Sales, General and administrative

12,101.00

11,956.00

13,965.00

Depreciation and amortization

24,993.00

26,714.00

24,499.00

Interest expense

2,007.00

1,888.00

1,804.00

Other operating expenses

3,304.00

5,719.00

4,224.00

Total costs and expenses

43,419.00

47,370.00

45,714.00

Income before income taxes

5,606.00

2,047.00

28,314.00

Provision for income taxes

829.00

(153.00)

13,584.00

Net income from continuing operations

4,777.00

2,200.00

14,730.00

Other

(202.00)

(261.00)

144.00

Net income

4,575.00

1,939.00

14,874.00

Net income available to common shareholders

4,575.00

1,939.00

14,874.00

Earnings per share

Basic

1.16

0.62

4.72

Diluted

1.16

0.60

4.72

Weighted average shares outstanding

Basic

3,917.00

3,160.00

3,156.00

Diluted

3,946.00

3,197.00

3,156.00

EBITDA

32,606.00

30,649.00

54,617.00

Table 6: Cash flow statement

ROYAL DUTCH SHELL PLC

Cash Flow Statement

2016-12

2015-12

2014-12

Cash Flows From Operating Activities

$ Million

$ Million

$ Million

Net income

4777

2200

14730

Depreciation & amortization

24993

26714

24499

Deferred income taxes

-1720

Accounts receivable

Inventory

-5658

2827

7958

Other working capital

-631

2694

-1553

Other non-cash items

-2866

-4625

1130

Net cash provided by operating activities

20615

29810

45044

Cash Flows From Investing Activities

Investments in property, plant, and equipment

-22116

-26131

-31854

Property, plant, and equipment reductions

2072

4720

9873

Acquisitions, net

-11186

-620

2737

Purchases of investments

Sales/Maturities of investments

Other investing activities

267

-376

-413

Net cash used for investing activities

-30963

-22407

-19657

Cash Flows From Financing Activities

Debt issued

18144

21500

7778

Debt repayment

-7070

-6023

-4089

Repurchases of treasury stock

-409

-3328

Cash dividends paid

-9677

-9370

-9444

Other financing activities

-2168

-1886

-3707

Net cash provided by (used for) financing activities

-771

3812

-12790

Effect of exchange rate changes

-1503

-1070

-686

Net change in cash

-12622

10145

11911

Cash at beginning of period

31752

21607

9696

Cash at end of period

19130

31752

21607

Free Cash Flow

Operating cash flow

20615

29810

45044

Capital expenditure

-22116

-26131

-31854

Free cash flow

-1501

3679

13190

Table 7: Projected Financial statements

ROYAL DUTCH SHELL PLC

INCOME STATEMENT

2016-12

Rate

Projected Financia performance

Revenue

240033

5%

252,034.65

Cost of revenue

191008

-10%

171,907.20

Gross profit

49025

80,127.45

Costs and expenses

-

Research and development

1014

10%

1115.4

Sales, General and administrative

12101

5%

12706.05

Depreciation and amortization

24993

10%

27492.3

Interest expense

2

January 19, 2024
Category:

Business

Subcategory:

Corporations

Subject area:

Company

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