Essay: Xero Limited's Market & Financial Analysis: PEST & Porter's Five Forces.

On the basis of official company sources and external literature, evaluate and report on the most recent annual report of a company, as if you were security analysts making a recommendation on whether or not your clients should invest in it. 

Please select one company from the list in Companies for group assignment file. Once your group agrees on the company, please email me at [email protected], so I can reserve this company for your group. The companies are allocated at first in-first out method.

Group work:

1.Students are expected to organise their group work and keep regular (weekly) meetings. 
2.A group is expected to appoint a group leader who will keep notes on group meetings.
3.If a person is unable to participate in a group meeting, he/she needs to notify their group immediately.
4.It is expected that each group member will make a fair and equal contribution to the group work. Free riding in group work will not be tolerated.  
5.An overall group mark (out of 25%) will be awarded to each student but the unit coordinator reserves the right to provide a reduced mark (up to 0 marks) where a student has provided a sub-standard contribution to group activities. 
6.In case of disputes/continuous absence/inability to contact a group member, a group needs to notify me at [email protected]  immediately.

Your report should include the following:

1. Business and Strategic Analysis (30%-35% of your word count)

Your report should include:

Analysis of the economy: 

1.discuss briefly (2-3 paragraphs) which macroeconomic factors (political, economic, social and/or technological factors – PEST analysis) may affect the industry that your company belongs to and your company performance. 
Industry analysis:

2.Identify the industry that you company belongs to and the company’s place in the industry (e.g. top performer, middle range, bottom; market share, etc.).
 

3.Identify a competitor company that belongs to the same industry and occupies similar position in the industry. You will use this company further in your analysis.

4.Conduct Porter’s five forces analysis, conclude with assessment of industry’s current profitability

5.Discuss the industry’s growth potential. You must include this section and refer to it in your prospective analysis (further)
Company’s competitive and corporate strategy:

6.Discuss company’s competitive strategy, key success factors (core competencies) and risk drivers. Identify the company’s growth potential.  

7.Discuss the company corporate strategy: not all companies have a well-defined corporate strategy.

Economic factors affecting Xero Limited

The purpose of the report is to analyze the market and financial position of the Xero limited. For this purpose, the market analysis and industry analysis of the organization is done by using PEST analysis and Porter’s five forces. Accounting analysis of the financial statements of the organization is also done in order to identify the red flags for the organization. Further ratio analysis is done for performing cross-sectional as well as time series analysis. In addition to this, prospective analysis of the organization is done in the report with the help of market multiple approach and abnormal earning method. The report also provides recommendation in order to suggest whether it is good to invest in company or not based on the overall analysis done in context to Xero limited.                           

Economy analysis

Economic factors which can impact the business of Xero Limited includes political, economical, social, and technological. Therefore, PEST analysis is the best tool to analyze the economic factors of the company.  

Political

Xero has become famous worldwide for its services in terms of accounting software and product related services. Policy of taxation is administered by software industry and it influences the progress of Xero. Government is providing some tax rebates to survive and flourish in the market (Kelsey, 2015). Policy on anti-piracy will also impact the overall business decisively. Unauthorised or illegal copy will have repercussions in countries like New Zealand which takes harsh measures to curb illegal activities. Also, Xero is a leading company of New Zealand for providing software related to accounting. Shareholders of the company want government interference so it could promote private funding and also promulgate economic policies for the betterment of the business.

Xero in New Zealand is flourishing rapidly and offering for nearly 50 jobs which include jobs IT and technical sector. The only problem is related to the coordination between capital inflow and students pursuing courses, but in can be seen as good news in near future.

The government last year declared to dispose of the tax losses in research & development. Exemption or rebate in taxes directly affects the business of Xero (Curtis and Averis, 2014). So now it can expect around $60mn capital inflow into business in 4 years. It will be a gentle push for companies in New Zealand to invest in things like prototype and people because New Zealand does not invest much in R&D. Further it will boost their economy as well.

Economic

With the flourishing economy, the companies also require access to capital inflow which can help boost their business (Pikettey, 2015). Revenue and customer base rose for Xero in the past year to about $32.6mn which is 41% increase and 35% which is 138,000 respectively. Profits, prices and costs are determined by economic factors. Shareholders have more expectations from Xero as it is growing as par with New Zealand’s economy. Xero has changed its strategy and aligned towards us markets as per changing needs and global economic conditions.  Annual gross revenue of Xero increased to NZ $123.9mn and it has become a top accounting software company. Xero extends its services towards small and medium firms by helping them with accounts and financial sheets.

Social

Customer base for Xero is nearly about 280,000 which extend their services to small and medium business. Xero is flourishing expeditiously in international markets and beneficiaries of their applications are small and medium business. Xero has some brilliant people at work, work ethics are top and most importantly they provide peaceful environment to employees. Hiring team is very cautious and well-turned in choosing the best and talented employees to imbibe in their team and work accordingly (Urich, 2018). Goal and ethics of Xero is in conformity with the culture New Zealand follows that is being successful in business.

Technological

Business atmosphere in today’s world has a global and diversified approach which is driven by technology and competitiveness. With the changing technology every minute the companies have to cope up with the new innovations and have proper knowledge about dynamic technologies in business applications (Druker, 2014). To overcome the impediments, firms have to focus on new innovations which can influence their business. Modern companies face such technological problems in development of their product. With new technologies and innovations new opportunities and new markets can be created which in turn develops new goods and services; this can be done only when company has overcome the technological barriers. This will require investment in the R&D in companies. R&D is required for technological advancement so that companies can transform small and medium organizations into digital economy which will help rise up their business through information technology (Dodgson, 2018).

Xero as a software provider company has to abide by the needs of individuals in order to satisfy customers and runs business accordingly.  Xero is complicated as well as flexible business provider. For online purchase of software products internet and IT has provided a helping hand. Any time of the day, all around the globe it is possible to purchase software products from SaaS.  

Technological innovations and environmental factors

Legal

Organizational activities are regulated by some laws which are contract law, consumer protection, public protection, competition law. New Zealand has legislated laws to provide protection of information privacy and human rights of citizens. Contract laws determine freedom to issuing bargain with the contracting parties (Macaulay, 2018). Consumer protection includes fare trading practise and consumer guarantees act. Commerce act prevent trading of shares in a business. Competition law imbibes commerce act to govern business profits, refrain from illegal trade practices and imposes prise control or price restrictions in industries. Information and data related to company or individual is kept in a database. A personal legal access is required to see that data. Xero limited takes its privacy issues very strictly and try to reach customers in the different ways possible. With increase in global exposure and exporting business to different countries the company is adapting to changing rules and regulations which can affect company exports to outside world (Shenker, at al., 2014).

Environment

Xero is providing some simpler solutions to small and medium industries so that they can manage their finances effectively. With adapting to such technological innovations Xero has become sustainable and one of the leading business firms for providing technological solutions in software business (Hair, et al., 2015). Environmental factors such as costs, selling of materials, weather is suitable for company development. Xero is keeping environment safe by disposing of traditional practise of accounting in books which needs paper and they are made from trees, and cutting trees can be disharmonious with nature so avoiding this practise leads to environmental benefits. Evolving new technologies for storing data is also a good practise with no environmental unbalance. With adaption to new technologies Xero has extinguished environmental risks.

Industry and competitors: Xero limited is a New Zealand based public company which operates in the software industry as it provides cloud-based accounting software solution to small as well medium-sized businesses. The basis of the product is SaaS model which is sold to the companies according to the type of businesses in which they operate. Xero limited is a leading organization in the industry and is considered to be one of the top performers of the industry. It has also received Expert’s Choice Award in 2017 (Xero, 2018). On the major competitor of Xero limited is the Intuit. 

Porter’s five forces:

Porter five forces is a strategy which took decisions based on competition. Porter five focuses on how a maintainable competitive advantage can be build by Xero limited in service & software industry. Managers and workers in Xero company uses porter five forces not only to attain a crucial position within software industry but also can discover new profitable ventures arising throughout software & service sector.

Industry and competitor analysis with Porter's Five Forces

New comer threat:

With new comers come new innovations and new methods of doing things, they in turn put pressure on Xero LTD. Through reducing costs, price lowering strategy providing new value propositions to cliental (Nagle and Muller, 2017). Xero limited has to overcome all these challenges and provide with some effective obstacles to protect its competitive edge.

Suggestion:

• By evolving to new services and products. New products will attract new clients and also will attract old customers to buy Xero limited product.
• By taking its economy to a big scale so that will help to reduce the cost price per unit.
• Building efficiency and providing money for research and development. New companies don’t risk entering a market which is evolving and innovating their standards regularly (Ottman, 2017). It effectively lowers the extra profits for new entrants therefore they don’t entre in such space.

Supplier threat

Nearly every company in software industry buys their raw material from various suppliers. Suppliers having monopoly can reduce prices and Xero limited can make profit in the market. Influential suppliers use their negotiating capabilities to attract higher profits from companies in this industry (McDonald and Wilson, 2016). With the increase in negotiating capabilities of suppliers lowers down the profits of software companies.

Suggestions

• By having many supplier options.
• By evolving capabilities to use different types of raw materials for same purposes so if effective price of one raw material goes up we can have its alternate or substitute.
• By choosing devoted suppliers whose business is dependent on the firm. Xero limited can also learn from Nike and Wal-Mart how they acquired third party manufacturers who are dependent on them and in turn reducing their negotiating power.

Negotiating capacity of the buyer

Buyers are cunning as they always wanted to buy good products at cheap prices. This put profitability of Xero limited in doldrums. When customer base will be smaller higher will be their bargaining power and higher will be their capabilities to fetch discounts thus reducing profits in long run (Kirschen and Strbac, 2018).   

Suggestion

• By increasing their cliental. It can help in two ways it will reduce bargaining power of buyers and provide a chance to organize its sales and production department.
• By evolving with new innovations and products. Customers avail discounts on old products but if they are provided with new technology then their bargain will be less effective.

Risk alternate product or services

When a new innovation satisfies customer needs in different ways, industries profit decreases (Slater, et al., 2014). For example, service like Google drive and drop box provide alternate to storage and Hardware disks. The fear of alternate product or service is high if its value in very different from that of present value.

Suggestion

• By providing best service rather than focusing on best products.
• By understanding the need of customer rather than selling product to customer.
• By giving flexible cost for customers.

Competition among existing opponents

If competition among rivals is intense then it will reduce profits of companies (Cooper, 2017). Xero limited works in a competitive market. This in long run reduces profits of industry.

Suggestion

By examining closely all the five forces of competition Xero limited strategists have a holistic view of what affects company profits and implications of competition in software industry. They can relate to various trends which can be game changer and can respond early to situations exploiting maximum profits from any situation. By examining the porter five forces in great detail the Xero limited strategist can avail those benefits in their favor.

Growth Potential of the industry:

From the past few years an immense growth has been observed in the SaaS industry. Software giants like Xero and Intuit are still competing for the market share. With the better gripping of legit software companies over the market, the industry of SaaS has been stabilized and more and more customers are getting adapted to SaaS (Nygard, 2018). The industry growth is still brisk as the dependency of users on SaaS solutions is increasing day-by-day.

Challenges and opportunities for Xero Limited

The growth is differentiated between horizontal and vertical solutions. The category of horizontal software has a strong focus on software category of accounting and modest growth will be seen in this category. The vertical solutions include industry specific SaaS solutions such as education, healthcare, real estate and high growth rate will be seen in this category.

Competitive strategy:

The competitive strategy of the company includes providing cloud-based accounting solutions as the modern entrepreneur are technically sound. The company keeps such things in mind and provides SaaS which are cheaper, smarter and faster than its competitors. The key success drivers also include simple and intuitive user interface, great system of integration, unlimited collaboration of users, fast and easy process of setup, and reasonable pricing (Pearlson, et al., 2016). On the contrary, the threats to the organization include increasing number of competitors who are developing new technologies, demand for profitable product, and imitation of the company’s products and shortage of workforce which is skilled.

The growth potential of the company is high as new customers are emerging from online channels. Apart from this, the changing trend in the behavior of the consumers can open new market for the company (Babin and Zikmund, 2015). The company can diversify its product range and generate more revenue from the new categories of the products too.

Corporate strategy: The corporate strategy of the company is well defined and includes marketing the product to earn trust and build relationship with the customers. Moreover, the company uses partnership approach and collaborated with big companies like Apple, Google, Adobe, and Dropbox to expand its business and provide more benefit to the customers. The company also spends huge amount in the research so that they can target a particular market and sell their product according to the demand of the products (Ward, 2016).

Key accounts

The three key accounts identified in the balance sheet and income statement of the Xero and Intuit are sales and marketing, current assets, and retained earnings. These three accounts as these also play a vital role in the competitive and corporate strategies of each company. Firstly, the sales and marketing account depicts the expenses bear by the company to generate sales through marketing activities. It was observed in the corporate strategy that the company invests in the marketing activities to build relation and trust with the customers. It is observed that both the companies are spending a huge amount on the sales and marketing but Xero has taken the lead in this aspect. Secondly, the current asset account is also significant as it shows that how much assets a company has which can be turned into cash in near future (Buckley and Casson, 2016). It was observed in the competitive strategy that company offers cheap and profitable products to the customers. The production of such products in only possible if company as enough amount of cash with it. Both companies have enough assets which can favor their growth. Thirdly, the retained earning account is also significant as the higher amount of retained earnings is a sign of successful future of the business (Bhaumik, et al., 2017). It was observed in the corporate strategy that company spends hugely on research which is possible only if a company has retained earnings to further invest in the development of the company. Both the companies are competitive to each other and have maintained enough amounts of retained earnings with them.

Disclosure quality

The disclosure quality is usually evaluated on the basis of qualitative characters such as understandability, verifiability, comparability, relevance (Diouf and Boiral, 2017). The disclosure quality of both the companies is good as the information is easy to compare and understand. The information is also audited therefore its shows that it is relevant and verifiable as well. However the disclosure quality of Intuit is better as it provides a more detailed information of the different aspects of the financial statements.

Red flags

By observing the financial statement of the company it can be concluded that there are certain red flags of the company. Current liability is a red flag as its value is increasing which could be a threat to the company. Account receivable is another red flag. Lastly the unsteady cash flow is also a red flag.  

The financial analysis of Xero Company is carried out in order to measure the performance of business over the last 3 years.  

Over the review of financial statement of Xero Company, DuPont analysis is determined. The DuPont is referred to the evaluation of operational performance of organization in particular time duration. The DuPont analysis is determined as a method through which the equation of return on investment is breaking down into the three parts as operating efficiency, asset efficient and leverage (Xero, 2016). The equation for ROE is as follows      

ROE = Net profit margin × Total asset turnover × equity multiplier  

=  ×   ×    

=   ×   ×    = 0.215

Note: The Xero Company is facing the loss from last three years so the return on equity might incur change and it might be able assess the exact financial information.    

Over the analysis, it is determined that the total asset turnover component of company is perfuming strongly and the net profit margin is not performing well as the business is tempted from loss so the return on equity is influenced from the negative balance of financial data.      

Ratio's Name	Formula for Calculation	2016	2017	2018
Profitability ratio
Operating margin ratio	(Gross profit/revenue)*100	75.910	76.511	81.2469
	Gross profit	157179	226004	330333
	Revenue	207060	295389	406579
Net margin ratio	(net income (after tax)/revenue)*100	-39.826	-23.378	-6.8481
	net profit/ loss	-82464	-69057	-27843
	Revenue (net)	207060	295389	406579
Return on capital employed	EBIT/(Equity + liability)*100	-24.673	-22.871	-9.4508
	EBIT	-80952	-67070	-27320
	(Equity + liability)	328101	293250	289076
Return on equity	Profit after tax/Equity*100	-29.548	-24.744	-12.422
	Profit after tax	-82464	-69057	-27843
	Equity	279089	279089	224150
Efficiency ratio
Asset turnover ratio	Net revenue/Average assets	-0.283	-0.222	-0.0788
	Net loss	-82464	-69057	-27843
	Average assets	291163	310675	353249
Receivable days	Trade receivables/revenue*365	47.77	40.55	30.9925
	Trade receivables	27098	32817	34523
	Revenue	207060	295389	406579
Payable days	Trade payables/Cost of sales*365	152.08	40.33	35.8524
	Trade payables	20783	27980	27336
	Cost of sales (Staff cost)	49881	69385	76246
Working capital ratio	current assets/current liabilities	4.52	2.25	1.93164
	Current assets	211480	147710	117979
	Current liabilities	46774	65656	61077
Liquidity ratio
Current ratio	Current assets/current liabilities	4.521	2.250	1.93164
	Current assets	211480	147710	117979
	Current liabilities	46774	65656	61077
Quick ratio	Total current assets-inventories- prepaid expenses/current liabilities	4.38	2.16	1.76
	Total current assets	211480	147710	117979
	Inventories	0	393	993
	Prepaid expenses	6463	5340	9007
	Current liabilities	46774	65656	61077
Time interest earned ratio	Income before interests and taxes/interest expenses	58.9114	33.7544	52.2371
	Income before interests and taxes	89074	67070	27320
	Interest expenses	1512	1987	523
Capital structure ratio
Debt-equity ratio	Total liabilities/shareholders equity	0.149	0.236	0.22814
	Total liabilities	49012	69100	65949
	Shareholders’ equity	328101	293250	289076
Capital gearing ratio	Total debt/(total debt+ total equity)*100	13.10	19.07	18.58
	Total debt	49012	69100	65949
	Total debt+ total equity	374113	362350	355025
Debt ratio	Total liabilities/Total assets	0.14938	0.23564	0.22814
	Total liabilities	49012	69100	65949
	Total assets	328101	293250	289076
Equity ratio	Total equity ratio /total assets	0.85062	0.95171	0.7754
	Equity	279089	279089	224150
	Total assets	328101	293250	289076

Competitor’s performance: Oracle Net suite

Ratio's Name	Formula for Calculation	2017	2018
Profitability ratio	Description formula	Oracle Net suite
Operating margin ratio	(Gross profit/revenue)*100	34.34	33.69
	Gross profit	13,679	12,710
	Revenue	39831	37728
Net margin ratio	(net income (after tax)/revenue)*100	9.60	24.74
	net profit/ loss	3825	9335
	Revenue (net)	39831	37728
Return on capital employed	EBIT/(Equity + liability)*100	3.53	4.06
	EBIT	4843	5481
	(Equity + liability)	137264	134991
Return on equity	Profit after tax/Equity*100	7.373	5.956
	Profit after tax	3408	3231
	Equity	46224	54246
Efficiency ratio
Asset turnover ratio	Net revenue/Average assets	0.03	0.06
	Net loss	3825	9335
	Average assets	136127	152438
Receivable days	Trade receivables/revenue*365	48.38	51.27
	Trade receivables	5279	5300
	Revenue	39831	37728
Payable days	Trade payables/Cost of sales*365	238.57	524.40
	Trade payables	4491	9797
	Cost of sales (Staff cost)	6871	6819
Working capital ratio	current assets/current liabilities	3.96	3.08
	Current assets	75,964	74,515
	Current liabilities	19,195	24,178
Liquidity ratio
Current ratio	Current assets/current liabilities	3.96	3.08
	Current assets	75,964	74,515
	Current liabilities	19,195	24,178
Quick ratio	Total current assets-inventories- prepaid expenses/current liabilities	3.78	3
	Total current assets	75,964	74,515
	Inventories	0	0
	Prepaid expenses	3424	3137
	Current liabilities	19,195	24,178
Time interest earned ratio	Income before interests and taxes/interest expenses	7.570	7.817
	Income before interests and taxes	4141	3760
	Interest expenses	547	481
Capital structure ratio
Debt-equity ratio	Total liabilities/shareholders equity	1.970	1.488
	Total liabilities	91040	80745
	Shareholders’ equity	46224	54246
Debt ratio	Total liabilities/Total assets	0.663	0.598
	Total liabilities	91040	80745
	Total assets	137264	134991
Equity ratio	Total equity ratio /total assets	0.337	0.402
	Equity	46224	54246
	Total assets	137264	134991

Trend analysis and Cross sectional analysis

Over the above analysis, it is determined that the Net suite is performing well as it has generated the profit for the financial year 2017 and 2018 but the Xero ltd has generated the loss in its consecutive three financial years (Xero, 2017).

Xero analysis

Trends	2016	2017	2018
Assets	328101	293250	289076
Liabilities	49012	69100	65949
Gross profit	157179	226004	330333
Net loss	-82464	-69057	-27843

Oracle Netsuite company

Trend	2017	2018
Assets	137264	134991
Liabilities	91040	80745
Gross profit	13679	12710
Net profit	3825	9335

Over the financial performance indicator, it is assessed that the industrial and economic performance of Oracle is better than the Xero ltd but the Xero ltd is generating higher revenue as compare to the Oracle Net suite but it is facing the loss in its operating activities. On basis of trend analysis of financial performance, the assets are decreasing and liabilities are increasing for the Xero ltd but the Asset and liabilities are decreasing for the Oracle Netsuite. On the other hand, the net profit for Oracle Net Suite is increasing from 2017 to 2018 but the loss for the Xero is also decreasing. So it can be stated that the Xero business has adopted the strategy to improve its operational strategy so the company is able to reduce the loss.

Forecasting of the  Sales growth rate

Sales	Xero Company
2016	1	207060
2017	2	295389
2018	3	406579

Forecasting for sales 2019 and 2020

R^{2 =} 0.995

Y = 99760x + 10349

Sales for 2019= 99760 * 4 + 10349 = 409389  

For year 2020 = 99760 * 5 + 10349 = 509149

For Oracle Netsuite

Y= 753.5x + 15042

For year 2019= 753.5*3 + 15042 = 11781.5

For 2020 = 753.5*4+15042 = 11274.5

Forecasting for debt ratio of Xero Company

Y = 0.044*x + 0.111

= 0.044*4+0.111 = 0.287

As per the industry trend and prior financial performance of Xero Company, it can be stated that the Xero Company might generate the profit for the upcoming years as it is recording the positive return (Xero, 2017). On basis of overall performance of business, it can be determined that the company is generating the good amount of revenue but the net income is not subsequent to the market competitors.     

Valuation of company using abnormal earning valuation model

Abnormal earnings valuation model
Price earnings ratio	Share price / Earnings per share	-250.8
	Share price	50.16
	Earnings per share	-0.2
Price to book value	Share price / net book value per share	0.00022
	Share price	50.16
	Net book value per share (Total assets - Total liabilities)	223127

Price earnings ratio = Share price / Earnings per share

= $50.16/ (0.20) = -0.250.8       

Price to book value = Share price / net book value per share

= 50.16 / 223127 = 0.00022

Return on investment  

ROE = Net profit margin × Total asset turnover × equity multiplier  

=  ×   ×    

=   ×   ×    = 0.215

Over the valuation of company, it is determined that the return on investment, price to earnings ratio and price to book value. On the other hand, the return on investment, it is determined as negative net income for the company in its latest financial performance (Tracy, 2012). At the same time, the price earnings ratio is also negative due to the negative return of share price and the price and price to book value of company is also not strong so the overall performance of Xero Company is not satisfactory and it might influence its shareholders while employing the capital in its shares.                               

On the basis of above analysis of financial performance of Xero Company, it can be recommended that the first of all the company should focus on its improvement in return as the company is facing the loss in its operating performance. It can also be recommended that the company should be focused on its reduction of operating expenses so that it can generate the positive return. On the other hand, Xero business should focus on developing the cheap and quality accounting software as the marketers are not more emphasized on accounting software. The cost of software should also be decreased so that it can gain profit from operating activities (Goel, 2015). In relation to this, the company is recovering the loss so the Xero business should also engaged into the marketing activities to increase the business operations. On the other hand, the industry is performing well so the business has good opportunities to increase the shared market. Moreover, it can also be recommended that the business should engage into the innovation and creativity to attract the mass market customers to experiencing the service.                                          

Conclusion

On the basis of above analysis, it can be concluded that there are many factors which can affect the performance of Xero ltd as political, economical, environmental, social and legal. Over the evaluation of financial performance of Xero ltd, it can also be summarized that the financial position of company is not as strong as compare to its competitors and industry standards. As per the financial condition of business it can be stated that the business should be focused on the enhancement of its revenue generation strategy. Overall analysis, it is suggested that the investors should be careful while investing in the business.                

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