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Impact on Financial Forecasts

Table of Contents

Introduction.

Sector Review..

2.1. Growth in population.

2.2. Industrial revolution.

2.3. Economic Development

Company Assessment

3.1. Introduction.

3.2. Industry peers.

3.3. Growth.

3.4. Performance.

Conclusion.

References.

Introduction to Severn Trent

Severn Trent supplies water to business and individual customers. The customers choose the providers of water and decide who provides them with the billing and meter reading. The business works similarly as of gas, electricity, and telecoms. The customer can select the company and then the services are provided (Whetung, 2019). The business model includes the selection and promotion of the company. Once the company is selected they attach a pipeline or through cans, the water is transferred to the people. Severn Trent also provides online services. They have created a portal online and through that customers can keep a tab on the amount of water they have consumed or the bill that is to be paid. This is the business model that the company follows.

Sector Review of Severn Trent

In England and Wales, around 50 million household and non-household consumers are there who receive good quality water, sanitation, and drainage services. There are around 32 companies that provide these services. Access to water that is clean and sanitization is an important activity to prevent the disease spread. The sector has improved over the last 60 years and at present people receive their supplies from one or the other water companies (Lopez & Haines, 2017).

The water demand is driven by population increase and the revolution of industry. With that economic growth has also accompanied. Now, each area has its services of water and sewerage mostly under an individual Act of Parliament or Royal Charter.

  • Growth in population

The population of the UK plays a vital role in the industry, as the population grows so does the demand for water in the country. According to the census of the UK in 2011, the population stood at 63,182,000. The country is considered as one of the most populated countries and the density of population is 259 people per square kilometre. The population of the United Kingdom is steadily growing by an average of 0.6 per cent every year after 2002. Also, over 10 years i.e. from 2008 to 2018 the life expectancy ratio has improved from 79.6 to 81.26. This has also helped the population to increase. This increase in population has increased the usage of water in the UK. The average amount of water that is used by the household in the United Kingdom has increased by 70% since 1985. 50% of the increased water is consumed in homes (Harwatt, 2019). The reasons for which demand has increased include increasing use of washing machines and dishwashers in the households. These consume a huge amount of water. Also, as the population increased the number of people taking showers also improved. The trend of people taking care of personal hygiene has also improved. Earlier people used to take showers in a week and share water with the family members. On average a person utilizes around 149 litres of water per day.

  • Industrial revolution

The development of the water industry in the UK dates back to the 1600 century. From 1600 to 1800, the industry sold the water main to the large network of houses. The industry of water emerged in between the period from 1760-1830 due to the industrial revolution that happened in the country. The main sectors where the water demand increased include transportation, iron and coal, and the industries of chemicals. In these sectors, technological changes happened that were important. These shifts in technology increased the consumption of water and in turn sustained the growth of the water industry (Kalyviotis et al., 2017). Before the evolution of this industry, rivers in the United Kingdom were fulfilling the need but over the period, the rivers were getting dirty and water demand was increasing.

Before the industrial revolution, the textile business in the UK was merely a "cottage industry" where the work was being performed in small workshops or by the people at home by spinners or dyers. Once the revolution started various innovations like a flying shuttle, spinning jenny, the frame of water and the power loom came into existence. These developments led to the smelting of coals and in turned required water for doing so. Various industries for textile started developing and in turn, the water demand kept on increasing. This increased water demands. Over the yea more he industries are growing there is more demand for the water.

In the same manner, Steam engines were developed. These were used for pumping water out of the shafts and created a separate water condenser. These shafts are used in flour, paper, and cotton mills. This created demand for water and in turn leads to a rise in the water industry.

Transportation development has also increased the consumption of water in the country. The development of rail networks in the countries and other transportation increases the use of water which is provided by the water companies in the country. This revolution in the industry creates more demand for water.

  • Economic Development

Economic development and water supply go hand in hand. One thing supplements the other. When the supply of water improves then it leads to the boost in resource management and sanitation of the country. Also, the growth in the management of resources leads to eradication in poverty that in turn leads to economic development. Among the poor countries in the world, counties that have better access to improved resources of water can experience better growth in the economy at an average of 3.7%. While the countries that did not have access to an appropriate level have an annual growth rate of only .1%. Since the UK is developing at the pace it requires water which creates a demand for the products of Severn Tart.

Also, various economic benefits are derived from the water supply that is improved. It helps in outweighing the cost of investment. This sector provides an improved supply of water and benefits range from USD 3 to USD 34 per USD 1 invested (Overman, 2018). Economic development is derived from the industrial and agricultural sectors and the development and efficient functioning of these industries depend on the supply of water. The more the economy grows, the more are the industries that will grow, and the more the water demand will grow in the country.

The economies are at times resilient to the variability of rainfall and the growth of the economy is boosted when the shortage of water is improved. More development will require better storage and water supply. The supply of water will be done through these companies for development. An investment of around USD 15-30 billion will generate returns of USD 60 billion. The countries for the development of the economy are investing in water industries that are leading to their economic development too.

Over the years investment in the water, the industry has grown in the UK also the time from the development of water industries the GDP of the country has grown.

This shows that economic growth has brought in improvement in the industries of water. The development was interlinked for both and over the years the country has developed economically and the water industries have grown with it.

Company Assessment of Severn Trent

  • Introduction

Severn Trent plc is a company of water that is based in the United Kingdom. The company is registered on the London stock exchange and is a part of the FTSE 100 index. The company is running for the last 31 years and provides drinking water and recycled wastewater. The output of production for the company stands at 1.8 GI/day for drinking and 1.4 GI/Day as recycled. The company is regulated under the Water Industry Act, 1991. There are around 4.5 million households and the business to which the company provides the water services. Various reservoirs are operational under the company which includes the Carsington reservoir, Clywedog reservoir, Draycote water, Lake Vyrnwy, etc. In the year 2019, the net income of the company stood at 315.3 million pounds. The company employs more than 15000 people in the United Kingdom, the United States, and mainland Europe. The report aims at studying the financial health of the company concerning its peers.

  • Industrypeers

Severn Trent main competitors in the industry are Pennon group and United utilities. United utilities being the largest listed company of water and supply water to around 7 million households. The production of United utilities is also more than the Severn Trent. It produces around 2.0 GI/Day for drinking while 2.0GI/ Day for recycled usage. The company has a long list of reservoirs in the country. While Pennon Group plc is a smaller company than these two and has a smaller number of employees i.e. 5239. Also, the revenue is low in comparison to the above two companies.

  • Growth

The below chart depicts the growth of revenue in the 3 companies. Severn Trent revenue has improved since 2016. In the year 2016, the revenue was at 158.8 million while in the year 2017 it reached to 315.3 million. In the year 2018, the profits of the company declined a bit and reached 252.8 million while in the year 2019 the revenue was at 343.8 and in 2020 it stood at 330 million. While the United utilities had a profit of 324 million in the year 2016 and then in 2017 it was at 320 million. In the year 2018, the company's profit spiked and was at 434 million. While in the year 2019 it reached 355 million and in 2020 it reached to 363 million. The profits of United utilities were higher than Severn Trent. The Pennon group started with the same profits as of Severn Trent. But over the years the profit didn't match the growth of Severn Trent. The profits from the year 2016 declined to 116.6 million and in the year 2018, the position improved and profits reached to 160.3 million. In the year 2019 and 2020, the company showed growth but it had a huge gap from the other two companies.

The graph shows that Severn Trent has made significant progress from the last 5 years. In the year 2016, the company's profit was equal to the Pennon group while United utilities had very good profits. Over the years Severn Trent progress and reached to the profits margin of United Utilities. This shows that the company has improved and made progress over the years. This is a good sign as the company is improving its activities and generating more revenue for itself and gaining a place in the market.

  • Performance

Profitability Analysis:

Profitability analysis helps in analyzing the profits of the organization's output. These ratios help in analyzing the ability of the business to generate the profits that are related to its revenue, operating profit, gross profit, and net profit (Laitinen and Laitinen,2018). Profitability ratios are also a good measure of comparison from the other firms as dictating the values in percentage.

The gross margin ratio depicts the ability of the company to produce profits concerning the gross margin of a company from its revenue. It depicts the percentage of profit a company is making once the cost of goods sold is deducted from the revenue. Severn Trent has a gross margin of 91%. This shows that from the company's revenue 9% is the COGS. Pennon group has the largest gross margin of 97%. This means that the company is spending only 3% on its COGS. This is a good sign as the expenditure of the company is less and it will be able to generate more revenue.

The operating margin ratio of the company depicts the operating income that is generated from the Revenue. Severn Trent has the lowest operating profit. This means that the company is paying more of an operating cost than the other two. The operating margin of Severn Trent it at 30% while for the Pennon Group and United utilities it stands at 37%. The overall average will be at 34%. This means Severn tret is performing below the average while Pennon and Utility group are above the average. The company Severn Trent needs to reduce its operating expenses to improve its margin.

Pretax margin is the margin before tax has been charged. The company Severn Tret has the lowest margin while the Pennon group has the highest. The pretax margin of the company stood at 16.85% while for the Pennon group it is at 30% and united utilities at 23%. Pennon Group is performing well in the profitability measure. Severn tret is the lowest profit margin generation company from its revenue.

The net profit margin of the companies depicts the percentage of net profit that has been generated for the company after paying off all the expenses (Abdul, 2017). Severn Trent has the lowest net profit margin at 8%. This depicts that the company is only able to save 8% from its revenue while its peers can create a margin of 19 to 20%. So, Severn Trent needs to reduce its cost and create more margins for its profitability.

Profitability

Severn taunt

Pennon group

United Utilities

Gross Margin 

91.54%

97.66%

 

Operating margin 

30.56%

37.32%

37.70%

Pretax margin 

16.85%

30.33%

23.96%

Net Profit margin

8.61%

19.24%

20%

Management Effectiveness

These ratios depict the effectiveness of management in generating the return for the shareholders (Ugoani, 2018). Severn Trent, Pennon group, and United utilities are all three listed companies and their share is traded on the stock exchange. Investors will invest in a company only when they are receiving returns. Return on equity depicts the return that a company made in comparison to the number of shareholders of equity. Severn tart made 26%. The other two companies made lesser returns than Severn Trent. The return of the Pennon group is at 6% while united has a return of 12%.

Management Effectiveness

Severn tart

Pennon group

United Utilities

Return on Equity

26.48%

6.88%

12.50%

Return on Assets

2.89%

1.85%

2.89%

Return on Investment 

1.65%

1.96%

1.45%

Return on assets means how efficiently the assets are performing. This is an important ratio as assets are the main source of revenue generation and if not utilized efficiently company will lose its resources which will be a loss for the company (Yanti and Dwirandra, 2019). Severn Trent and United provide an equal return while the Pennon group has a lesser return. This ratio depicts the efficiency of the company to use its resources. Severn tart is using its resources appropriately in comparison to the Pennon group.

Return on investment measures the amount of return that a company is making on the investment. Pennon group has the highest return on investment at 1.96% while United utilities have the lowest return. Severn Trent ratio is at 1.65%. Severn Trent is performing at a medium level and has a scope to improve. Overall the management of Severn Trent is the best among the other two peers as the company is generating the most returns.

Liquidity

Liquidity ratios are the ratios that measure the position of debt paying capacity of the companies. These ratios help in estimating the requirement of funds and its capability of paying off its debt in the short and long run (Bunker, Cagle, & Harris, 2019. The company in case of emergency should have appropriate funds for handling the losses and paying off its creditors. These ratios help in measuring the capability of the company for its payoff.

The current ratio is the ratio that helps in measuring the abilities of the companies in paying back its short term creditors. Severn Trent has the lowest liquidity among the three companies. The liquidity ratio of the company is at .57 while for United utilities it is at .67 and the Pennon group is at 4.64. Pennon group has a very high ratio. This is also not a good position as this shows that the company is not utilizing its funds appropriately and they are lying idle which is a waste of resources. While for Severn tart the ratio is a bit low. It should be around 1 to become more financially viable. The company needs to improve its short term liquidity.

The quick ratio reflects highly liquid assets excluding of inventory from the current assets. The company needs to maintain certain liquid assets in case of emergency but they should not be high as then the returns will reduce which could have been generated from putting them to use. Severn tret quick ratio is appropriate at .54 while Pennon group has a high quick ratio too. This depicts that the Penon group is not utilizing its assets and they are lying idle. United utilities too have an appropriate ratio at .67. this means that Severn tret and United utilities have enough resources to cover the debt while Pennon has an over excessive debt.

Liquidity ratio

Severn tart

Pennon group

United Utilities

Quick Ratio 

0.54

4.64

0.67

Current Ratio 

0.57

4.67

0.69

LT Debt to Equity

479.03%

213.49%

253.81%

Total Debt to Equity 

517.25%

216.99%

282.34%

Long term debt to Equity shows the company's position of debt as per the equity of the company. The higher the debt, the higher the chances of business risk. Severn Trent has a huge amount of long term debt in comparison to equity. The percentage is at 479% while for the Pennon group it is at 213.49% and United utilities are at 253%. The debt of Severn Trent is almost double of the other two companies. In the same manner Total debt to equity for Severn Trent is also very high and stands at 517.25% while for United it is at 282% and Pennon is at 216%. These ratios depict that Severn Trent has huge debt in its balance sheet. The company should reduce it as huge debts increase the chances of bankruptcy. More to that higher the debt, higher will be the interest which will reduce the margins of profits for the company. This is one reason for the low profits ratio for Severn Trent. The company should reduce the amount of debt and increase its profits.

Valuation ratio

Valuation ratio depicts the market value of the company. These ratios depict the price that is being paid by the investors for the earnings or the revenue or cash flow of the company (Giordani and Halling, 2019). These ratios help in evaluating the status of publicly traded companies. Thus, overall these ratios help in valuing the companies share or earning or revenue.

Valuation Ratios

Severn tart

Pennon group

United Utilities

       

P/E Ratio

35.75

39.13

57.9

Price to Sales 

3.08

7.15

3.2

Price to Tangible Book

5.69

2.73

2.08

P/E ratio or Price/Earnings ratio depicts the amount an investor is willing to invest to receive a dollar of the company's earning (Kumar and Babu. 2018). The PE ratio of Severn tart company is at 35.75 which earns that an investor is willing to pay $35.75 for 1 dollar earning of the company. The Pennon group PE is at 39.13 while for United utilities it is at 57.9. The higher the PE ratio, the higher will be the value of the firm in the market. According to the ratio, Severn Trent has the lowest PE ratio which means people are willing to pay less for 1 dollar of companies earning from the other two companies. A higher dent can be one of the reason due to which investors are not willing to invest. The company can improve its PE ratio by improving its value in the market. This can be done by depicting better profitability and lesser debt in the balance sheet of the company.

Price to sales ratio is the ratio that compares the stock price of the company concerning its sales revenue. It represents the value that is placed on each dollar of company sales. The highest price that has been put on is for the Pennon group i.e. 7.15. While for Severn Trent and United utilities the ratio is at 3.08 and 3.2. It means for $1 sales of company price that has been put for Pennon group is at 7.15 while for Severn Trent it is at 3.08 which is the lowest amongst the three.

The price to tangible book value ratio depicts the share price as per the tangible book value of the company. This helps in estimating whether the share prices of the company are undervalued or not. Severn Trent has the highest price to tangible book ratio at 5.69. While Pennon group is at 2.73 and United utilities is at 2.08. This shows that Severn Trent shares have more value than the others. The company Severn tart is performing well and has a good value of shares in the market concerning its book value. Thus, The Company's valuation ratios show an appropriate position of the company concerning its peers it is a bit low in PE ratio but remaining it has managed to create its value.

Conclusion on Severn Trent Analysis

Severn Trent is a company that is showing a growth in its revenue and also has appropriate ratios. Yet it has low profitability in comparison to its two peers and also the debt of the company is too high. Still, the company is performing on an average level and generating good returns on its equity and appropriate on the investments. So, the company should reduce its debt that in turn will increase the profitability and improve its position in the industry.

References for Severn Trent Analysis

Abdul, A. A. A. 2017. The Relationship between Solvency Ratios and Profitability Ratios: Analytical Study in Food Industrial Companies listed in Amman Bursa. International Journal of Economics and Financial Issues7(2), p.86.

Bunker, R. B., Cagle, C., and Harris, D. 2019. A Liquidity Ratio Analysis of Lean vs. Not-Lean Operations. Management Accounting Quarterly20(2), p.10.

Giordani, P., and Halling, M. 2019. Valuation ratios and shape predictability in the distribution of stock returns. Swedish House of Finance Research Paper, (17-5).

Harwatt, H. 2019. Feeding a growing population within planetary boundaries: A three-step strategy: Identifying the fierce necessity of “how?” in the fierce urgency of now. In Environmental Nutrition (pp. 305-324).

Kalyviotis, N., Rogers, C. D., Tight, M. R., Hewings, G. J., and Doloi, H. 2017. Transport Infrastructure Interdependencies with Energy, Water, Waste, and Communication Infrastructure in the United Kingdom. [Online]. Available at: http://epapers.bham.ac.uk/3204/1/Transport_Infrastructure_Interdependencies_with_Energy_Water_Waste_and_Communication_Infrastructure_in_the_United_Kingdom_(2).pdf [Accessed on July 17, 2020].

Kumar, N. V. and Babu, M. G. 2018. Impact of valuation ratios on the performance of major Indian sectoral market indices. Asian Journal of Multidimensional Research (AJMR)7(9), pp.336-344.

Laitinen, E. K. and Laitinen, T. 2018. Financial reporting: profitability ratios in the different stages of the life cycle. Archives of Business Research6(11).

Overman, H. G. 2018. Uneven economic development and its implications for policy: Lessons from the UK. Journal of the Statistical and Social Inquiry Society of Ireland47, pp.106-111.

Ugoani, J. 2018. Performance Ratio Analysis and Management Effectiveness. Business, Management, and Economics Research4(12), pp.171-177.

Whetung, M. 2019. (En) gendering Shoreline Law: Nishnaabeg Relational Politics Along the Trent Severn Waterway. Global Environmental Politics19(3), pp. 16-32.

Yanti, N. M. Y. W. A. and Dwirandra, A. A. N. B. 2019. The effect of profitability in income smoothing practice with good corporate governance and dividend of payout ratio as a moderation variable. International research journal of management, IT and social sciences6(2), pp.12-21.

Remember, at the center of any academic work, lies clarity and evidence. Should you need further assistance, do look up to our Accounting and Finance Assignment Help

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