Stenden University of Alexandru Piroi, 453633

Applied Science Annebel van de Langenberg,

436968 Diageo
Jordi de Fockert, 431168

FINANCIAL ANALYSIS

1
Preface
This assignment is written by Alexandru Piroi, Annebel van de Langenberg and Jordi de
Fockert. The writers are studying Hospitality management and they wrote this report in
module Environment of year two. The students retrieved information from workshops,
lectures and PBL sessions. The purpose of the assignment is to develop the skills to
interpreting and analyze a financial statement.

The assignment consists out of four different parts. First of all, Part A is about getting to
know the company and highlights. Secondly, part B is about the financial statements:
analyze the income statement, balance sheet and cash flow. Part C provides information
about the Risk analysis, performance and market view of the company. Lastly, part D
summarizes and concludes of the report.

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Table of Contents
Introduction..........................................................................................................................................4
Key business drivers...........................................................................................................................5
Review of the five year record..........................................................................................................5
Directors review and highlight..........................................................................................................6
Reviewing the profit and loss account.............................................................................................7
Probing the Balance Sheet for Financial Health.............................................................................8
Horizontal and Vertical analysis....................................................................................................8
Ratio analysis...................................................................................................................................8
Cashflow...............................................................................................................................................9
Risk Analysis.....................................................................................................................................10
Critical industry developments....................................................................................................10
Talent...............................................................................................................................................10
Responsible alcohol promotion and consumption.....................................................................10
Sustainable......................................................................................................................................10
Market view.......................................................................................................................................11

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Introduction
The figures presented in this rapport are based on analysis of the annual report of the
alcoholic beverage producer Diageo. The figures in the annual report of the establishment
are analyzed and will be discussed in three different chapters, each divided in three separate
subheadings. After discussing the findings in various chapters, there will be a conclusion
made in the final part of this report.

The first part of the report will contain information in order to get familiar with Diageo. In
this part of the report the business drivers will be discussed as well as a five year record of
the company and a summary about the director’s review presented in the annual report
which is analyzed critically. After the introduction of the company an in-depth analyze will
be presented for the profit and loss account (Income Statement), the balance sheet, and the
cash-flow statement of the past two years. Each of the financial statements is used to
benchmark the company with industry averages. After the information presented about the
financial statement of the company, there is a summary about the findings after analyzing
the investor’s perspective. In this part of the report the risks of the company are discussed
and in what way it is possible to manage these risks. The performance are also discussed
and presented in the report together with a DuPont Schedule. The schedule is used to
analyze the figures about the Return on Equity and the Return on Assets. These figures are
followed by a market view which is showing the gain or loss made by shareholders.

In the end of this report there will be a summary together with a conclusions about the
financial situation of Diageo presented. There is also a recommendation about investing in
this company or not.

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Key business drivers

The key business drivers are very important for Diageo because it has a major impact on the
performance of the company. The company is driving its business through global reach,
financial strength, the values and their role in society.

First of all, Diageo is focusing on financial returns and consistent financial performance.
They want to save 500 million over the next three years. They want to do this through
driving out costs so they can invest more in the business and brand. The company has also
world-leading brands. For example: Smirnoff, Captain Morgan, Johnnie Walker and Baileys.
They committed to providing these brands to developed and emerging markets on a
consistent basis. Diageo shifted their approach to luxury spirits, seven years ago. They made
it a strategic priority and it is still working as a business driver.

The relationship with customers is very important for the company. They win them through
sales, contributions and innovation. Creating new products and new categories keeps the
customers with them. Diageo is focusing on giving them new experiences. The company
keeps their employees satisfied because they motivate and value each other. They are very
proud of what they do. Diageo is built on long-term relationships which are based on shared
value and trust. So they make sure the whole company is on the same level in terms of
value.

Diageo put their resources and skills into ‘responsible drinking’ programs. Their goal is to
reduce and prevent alcohol misuse. Through this program, Diageo is in partnership with a
lot of international organizations and governments. It allows them to gains insights and
reach consumers all over the world. The programs and website is not only good for reduce
harmful drinking. Diageo can promote their brand and can make a lot of connections
worldwide. Working with partners will magnifies Diageo’s impact and it will bring their
brand to an increasing number of consumers.

Review of the five year record

In this chapter, information from balance sheet, income statement and financial ratios from
past 5 years are gathered together in order to establish trends that are used in benchmarking.
The following information retrieved from Diageo’s five year record shows that in 2013 the
profit margin was the highest, 16.7% compared with the other years average which is
15.5%. The profit margin is based on the relationship between sales and profit, in other
words, every pound
cashed out from sales Percent
needs has to represent PROFIT MARGIN
the actual profit a
company earned
(Chibili M. N, 2010). 17
chart
15
13
2012 2013 2014 2015 2016
Year

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In the next table the line of profit margin is shown, offering a clear overview of the five
years record.
From 2012 (14%) where the line is settled at its low point, in 2013 (16.7%), a significant
increase of profit margin is observed. From this highest point, a slightly decrease movement
is shown till 2016 where is registered 15.1%.The major element which affected the line of
profit from 2013 to 2016 is based on exceed duties. For Diageo, this income statement
factor is occurred in majority of countries as a production tax which can be classified as
external factors. In 2013 the exceed duty was 3973 and in current year is 5156 but
furthermore the numbers which are ascending predict that in upcoming years the exceed
duties will rise. Solvency ratio is based on a company potential of paying the debts. The
next table offers a brief overview of five years solvency numbers.
Solvency ratio
2012 2013 2014 2015 2016
1,43 1,47 1,49 1,55 1,55
The solvency ratio increase from 2014 with 0.6 which improved the capability of paying
debts on long term. In other words Diageo has a potential of 1.5 dollars to pay above of
every emerged debt.

Directors review and highlight

According to the statement of Dr Franz B Humer, chairman of Diageo for the past eight
years, the company became a stronger, more competitive business in the past years. An
important aspect of the growth was the investments made in the African and Indian markets
that represent almost half of the global growth of the market. Besides the growth of the
market share of the company in these specific areas, the organization is proud of their
positive influence on society, especially with reducing drink driving and underage drinking.
However, research shows that the percentage for drinking underage has gone up by 22,5% in
India during the last four years (Nair, 2015). In the same period of time there was a
significant growth of revenue as can been seen in figure 1. The executive chief of the
company, Ivan Menezes, is also referring to the positive role for alcohol in society as one
out of three most important roles for the establishment regarding the society. The role of
Diageo in improving the earlier mentioned aspects is at least doubtable. In the statement of
the executive chief can also be found information about the UK leaving the European Union.
The expectations of the company about the influence of the “Brexit” on the short term are
positive, having no negative affect on the performance of the company for the upcoming
year. To predict the influence in the future is difficult for the company but the management
of the company is working together with the UK government in order to experience
minimum interference.
Figure 1: The growth of revenue in specific markets.
2016 % 2015 % 2014 %
North America 4037 103,1 3909 99,8 3915 100
Europe, 4593 93,1 4683 94,9 4935 100
Russia and
Turkey
Africa 1875 101,6 1868 101,2 1846 100
Latin America 1078 76,8 1297 92,4 1404 100
and Caribbean
Asia Pacific 4022 223,3 4129 229,3 1801 100

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Reviewing the profit and loss account

As can be seen in figure 2, the asset turnover of Diageo is higher than the asset turnover of
Constellation Brand Inc. The higher asset turnover is considered as positive for shareholders and is
accomplished with effective use of the assets by the management of the establishment. The profit
margin of Diageo is as well higher than that of their main competitor. Out of this ratio can be
concluded that the management is doing well in controlling the costs and generating sales in the
industry. However, the growth of the profit margin of the main competitor means that Constellation
Brands Inc. did a better job in reducing costs and generating more revenue in 2016. The difference
between the return on equity is high. The return of equity (ROE) of Diageo is almost twice as high
as the ROE of the competitor. After analyzing these ratios it can be concluded that the profit that
Diageo made out of their shareholder investment is better than the profit of Constellation Brands
Inc.

Besides the comparison of different ratios with another business in the market, there is also a
horizontal analyze implemented. The first important figures are about the revenue of the company.
Between 30 June 2015 and 30 June 2016 there was a negative absolute difference of 325 million.
Possible reason for this negative figure are the sales of wines and non-core beer assets as stated in
the chairman’s statement. Another interesting figure stated in the income statement of the company
is about the marketing expenses. The expenses of the marketing department went down with 67
million. This means a relative difference of 4.1%. In comparison with Constellation Brands Inc. this
is a huge different because the number two in the market had a absolute growth of 98.8 million and
the costs for marketing expenses went up with 9.2%. As already been said in the chief executive’s
statement there are lots of opportunities in in the African market as well as in the Asia Pacific
market and especially in India. While comparing the figures from 2015 with the figures of 2014
there has been an absolute difference in revenue of 2382 million for the Asia Pacific area. This
means a relative growth of 132.3% in this area. After reading the statements in the beginning of the
report it seems that there is also a huge growth in sales for the African area but it is relatively low.
The absolute growth in the period between 2015 and 2016 is 7 million and this means a relative
increase of 0.34%. There is also something interesting to say about the staff of the company. The
wages and salaries went up 56 million and it is normal to assume that there were more employees in
2016 in comparison with 2015. However, a better understanding of the figures show a absolute
decrease in staff member of 1284. This means that the amount of staff dropped with 3.85%.
The most important products sold by the company are wine, beers, and spirits. The sales of spirits
went up with 1992 million between 2014 and 2016, but there is a small downturn in sales while
comparing 2016 and 2015. There was an absolute difference of 59 million between those years. The
sales of wine are nearly halved in 2016 after a small absolute increase of 11 million in 2015. The
relative downfall of 44.7% was already expected by the company because of the sales of wine assets
for over 1 billion. The last core product of the company is beer. Even after selling beer assets the
drop in sales was relatively small with 2.97%. Important reason for this small drop is the increase of
popularity of Guinness.
Figure 2: Comparison between ratios of Diageo and competitor Constellation Brands Inc. (The ratios
of Diageo are presented in red).
2016 2015 2016 2015
ASSET 0.55 0.62 0.43 0.44
TURNOVER
PROFIT 15.1% 15.5% 14.7% 12.5%
MARGIN
RETURN 23.2% 26.7% 12.9% 11.3%
ON EQUITY
RETURN 8.1% 9.6% 6.3% 5.5%
ON ASSETS

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Probing the Balance Sheet for Financial Health
This part of the assignment will analyze Diageo’s balance sheet by making use of horizontal and
vertical analysis.

Horizontal and Vertical analysis

By examining the balance sheet from 2015 and 2016 according to the horizontal analysis the current
assets raised with 15% due to other assets which growth up to 976%. In this case the company
focused on prepaid expenses and scrap value. Moreover the vertical analysis shows that other assets
represent only 1, 73% in 2016 on total assets, however these were significant important for growing
10% on total assets in opposite with 2015.Having a look at current liabilities using horizontal trend,
a substantial increase is observed. 16. 95% is the difference from 2015 to 2016 and this major fact is
retained from trade taxes which growth with 43.91% and borrowings/bank overdrafts which were
increased as well with 7.13%. This particular case shows that Diageo increase sales by trading more
and overdrawing money from the bank. As a consequence total liabilities rose with 10.65% and
according to vertical analysis trade taxes were the main problem by affecting total liabilities with
18.41% in 2016. On behalf of equity, the balance sheet shows an increase on total equity of 9. 98%.
The main cause is based on the company reserves which increased with 31.64% showing that the
company diluted their reserves and moreover according to the vertical analysis these represent only
25.78%. Overall the company is doing well having an asset increase and also enough reserves that
can be used to increase equity.

Ratio analysis
The ratio analysis is based on solvency and liquidity ratios which are the most reliable for analyzing
the balance sheet. As mentioned in five year record the solvency ratio shows the capability of paying
short term debts by having 1.55 but this number is near the limit of plummeting below. The debt to
equity ratio shows the potential of paying the debts by looking at owner’s equity. In case of Diageo
this ratios is 1.73 which means that the company have enough money to pay their debts. Furthermore
the current ratio is 1.55 indicating the Diageo has enough funds to pay the bank loans. To conclude,
the company has enough funds to pay its debts.

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Cashflow
The Cash flow statement was analyzed to see Diageo’s sources of cash and uses of cash. The free
cash flow of Diageo was £1,963 million in 2015. It is £2,097 in 2016 so it increased with £134
million. (see figure 3)

First of all, the capex has a positive result of £137 million. This can be seen in figure 4. Diageo
received £137 million more because they invested and purchased for less money than the revenues
of sales. They have had to issue 83 million on exchange differences. The operating profit had a
positive result of £152 million. The £(170) million of working capital movements is caused by better
inventory management. Also through an improved distribution between debtors and creditors. They
focus now on receiving the money of debtors as quickly as possible. And trying to pay the creditors
later. The interest tax had a positive result of £93. This is due to more revenue from interest than
taxation positives. Figure 3
Operational 2016£ 2015£ £
The major differences came through losses in Net cash 2,548 2,551
Joint ventures. For example, the joint Investments
ventures Heineken and Namibia. The
-Cash OUT 521 1,922 -1,401
alteration of net finance charges is due to
taxes. They received less from taxable -Cash IN 1,119 1,030 +89
activities. Net cash 596 894
Finance
The investment activities had a great amount
of cash out. Diageo disposed their non-core- -Cash OUT 2,800 3,299 -801
wine and beer-asset. They sold most of its -Cash IN 0 792 +792
wine and beer business to treasury wine Net cash 2,801 1,734
estates. Among other things the wine: Grand
Marnier. Through the sale of these assets, Diageo invested 1 billion in organic growth. Another
growth strategy of Diageo was to acquire the 50% stake in Don Julio. The dividends are paid
because Diageo can afford it.

The improvement is caused by reduced investment. Subsequently an increasing of the operational

results. The interest payments are lower mainly through better debt payment relative to 2015.
Diageo received the money faster in 2016 compared to 2015.

The conclusion is that Diageo had enough money from the operating activities to cover all the
financial and investing activities.
Figure 4

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Risk Analysis Critical industry developments
Critical industry developments
It can be difficult for Diageo to keep pace with developments in technology. It is easy for a company
to fail in participating the critical industry developments. The hospitality industry is a developing
and dynamic industry and that’s why there is a high probability. It can happen that consumers move
away from the brand because competitors have more developments in technology. So it has a high
probability and impact. Diageo has to diversified the portfolio of brands so they stay up to date with
consumer trends.

Talent
The risk ‘Talent’ contains the inability to retain, recruit and develop good commercial and
marketing talent. It is a low probability because Diageo has connections and partnerships with
people and company’s all over the world. It is easy for them to recruit people and come in contact
with talents.
When the company can’t recruit and retain new talents, the impact on the company will be high.
Diageo can’t achieve their growth plans if they have not enough new talent. Diageo can manage this
by focusing and intervention on moving talent for particula r roles in developing markets.

Responsible alcohol promotion and consumption

Stakeholders can see Responsible alcohol promotion and consumption as a risk because governments
can impose restrictions on access. They can also increase the tax.
It has a low probability and risk because Diageo provides already 55 countries with responsible
drinking programs. And the amounts of programs are increasing since 2014. So if one county
doesn’t agree, the impact is not big.

Sustainable
Diageo sees a risk in the Sustainability of the company. They are afraid of failing in meeting the
sustainable expectations of stakeholders. It has a low profitability and risk because Diageo is
already focusing on water efficiently and carbon emission. They are sustainable based on material
issues and stakeholder expectations at global and market level. They do that by focusing on the key
elements of our environmental and industrial impact: reducing impacts in the areas of water,
packaging, carbon and waste.

Du Pont Schedule
An DuPont analysis is a method in order to measure the performance of the company over a period
of two years (Chibili, 2010). This method is used in order to calculate the Return on Equity (ROE)
and the Return on Assets (ROA) of Diageo and compared with averages of the industry. The results
of the DuPont Analysis are presented in figure 5.

As can be seen in the figures, the company had a downfall in total revenue as well as in the net
profit. However, the net profit reduced with 5.75% and the total revenue went down with 3.05%.
This means that the costs of the company were higher in 2016 in comparison with 2015. As a result
of the downfall, the net profit margin of the company had decreased. In order to calculate the Return
On Assets the company need to calculate the asset turnover. This aspect, together with the profit
margin of the company will affect the ROA. The Asset Turnover is calculated with the total revenue
divided by the total assets. The amount needs to be multiplied by 100 in order to come to a
percentage. The net profit margin multiplied by the asset turnover will give the figures for the
Return on Assets. The average for the industry of alcoholic beverages was 10.35% which means that
the ROA percentage for Diageo was lower. This means that the average of the industry to generate
sales with their assets is higher than the performance of Diageo. Only the Financial Leverage

10
Multiplier needs to be calculated in order to measure the Return on Equity. This is done by summing
up the total liabilities with the total equity and divide it by the total equity. After this process is
done the company shows a leverage multiplier of 2.79 (2015) and 2.80 (2016). Multiplying this
figures with the earlier mentioned Return on Assets will provide a Return on Equity of 25.84%
(2015) and 22.05% (2016). In comparison with industry averages it can be concluded that the return
on equity for Diageo is much higher than the average Return on Equity in the industry (15.15% for
2015, 13.68% for 2016). According to Chibili (2010), Diageo is doing a great job with the use of
investments of their shareholders. This means that the company is earning 22.05% on every pound
that is invested in the company by their shareholders.

Total
Revenue
2015 10.813
Net Profit
2016 10.485
Margin
2015 22.02%
Net Profit 2016 21.40% Return on
Assets (ROA)
2015 2.381
2015 9.23%
2016 2.244 Assets 2016 7.88%
Turnover Return on
2015 41.90% Equity
2015 25.84%
Total 2016 36.80%
Assets 2016 22.05%
2015 25.804 Financial
2016 28.491 Leverage
Multiplier
2015 2.79
2016 2.80
Total
Liabilities
2015 16.548
2016 18.311

Total
Equity
2015 9.256
2016 10.180
Figure 5: Du Pont Schedule from Diageo. All numbers are in millions £ (except percentages).

Market view
The share price is based on an amount of money paid for owning a share from a specific company.
In case of Diageo, in the last two years the share price grew by 7.9% from 1933 pence to 2086 and
the dividend that is paid per share is 160 pence. As a consequence, in the date of 30 June 2016 the
shareholders made an outstanding gain of 7.6% in the opposite with the previous year. In 2016 the
WACC is 6.83% with the return of invested capital of 12.54% which indicates a reliable source of
shares investment. In the previous year the numbers are slightly different with the WACC of 6.67%
and 12. 10%, return on invested capital. In both cases every pound spent on shares is received on
dividends as 1/2 more. As an overview of the market Diageo stands above it with 1, 24% more in the
case of WACC.
In the past five years the share price was on ascending line, from 2012 when was 1407 pence until
2016 with 2086 pence.
As shown in the figure on the right, the main 2300
Pence SHARE PRICE
fluctuations on the graph are settled from 2012 till
2200
2013 and 2015 till 2016. In both cases the share
price grew over the barrier of 2000 Pence. 2100
According the annual report of Diageo, it is shown
2000
that the share price rose due to company’s chart
efficiency and productivity. In 2015-2016 case the 1900

1800 11
1700 Year
2012 2013 2014 2015 2016
share price rose due to design where the company tries to improve the net income with 25% and
among the rise of share price, the dividend percentage is grown as well.
In figure 6 is presented the Diageo share ratios in opposite with industry averages. In the first place
is observed that the company is above competitor’s average at Ratios Diageo Industry
earnings per share and dividend yield. These two factors prove the P/E 21.5 32
fact that Diageo is a potent company to invest in and furthermore DPS 4.8 6.94
based on profitability aspects, earnings from shares are obviously P/B 9.9 12.32
very high. In conclusion, Diageo allows investors to come through Dividend 4.4 2.54
yield %
company’s share earnings and by paying dividends at a higher scale
EPS 0.93 0.7
than industry average.
Figure 6.
Conclusion
According to the results presented in this report it is possible to make a conclusion about the
financial situation with regards to the establishment. First of all the company is driving his
business through global reach, financial strength, the values, and their role in society.
Despite of the self-claimed positive influence of the company regarding responsible
drinking the facts are different in their fastest growing market India. According to the five
year record, in spite having descending trend from 2013 till 2016, Diageo is still a very
powerful, productive company which generates massive profits. Furthermore the solvency
ratio shows that the company has enough resources in 2016 to pay short term depts. in
accordance with the 1.55 ratio number.

The most important change on the income statement was the reduce of revenue for selling
wine. The reason can be found by the sales of different wine assets. Besides the sales of
wine assets, some beer assets were sold as well but the reduce in revenue was less because
of the growth of Guinness. The balance sheet indicates through horizontal and vertical
analysis, that Diageo improved their assets and equity because of pre-paid taxes which
indicates a large number of sales. Diageo had enough money from their operating activity’s
to cover all the financial and investing activities. The risk of the company are the critical
industry developments, shortage of talent, responsible alcohol promotion, and sustainability.

All the risks can be managed and can be categorized in probability and impact. According to
the market view, the relation between WACC and return of investment is very high, almost
6%. This means that at this moment it is very worthy to invest in the company as the
numbers shows. This can be confirmed by the Return on Equity which is showed in the Du
Pont Schedule. The ROE of the company dropped slightly which means that the risks are
lower for investing in Diageo.

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Referencelist:
- Chibili, M, N. (2010). Basic management accounting for the hospitality industry. Groningen:
Noordhoff Uitgevers.
- Nair, H. (C2015). Underage drinking in India. Retrieved 23 September, 2016, from
http://indiatoday.intoday.in

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Scoring Rubrics Unit 3: financial
analysis
Group number:
Module period:
Academic year:
Name assessor:

Student name Student Analyses Grade

number
Income
statement
Balance sheet

Cash flow
statement
(*) A group of 2 students have exemption from analysing the
cash flow statement
Elements Scoring Rubrics
Group/ contents Score remarks
individual 1-10

Part A: (25%) group Business drivers

Getting to
know the 5 year record
company
Directors review

Part B: (30%) individual Income Statement

The
financial
statements Balance Sheet

Cash Flow Statement (*)

Part C: (25%) group Risk analysis

Investors
perspective Performance

Market view

Part D: (10%) group Overall conclusions

Summary (A+B+C)

Part E: (10%) group Lay-out, Spelling,

presentational referencing, grading
aspect sheet added

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