Introduction             The paper is dedicated to compare and evaluate selected accounting ratios of two London Stock Exchange (LSE) listed companies and suggest factors that may affect their future performances.  The Arena Leisure Plc is officially listed in LSE with market cap of GBX 142M and trading market size of 10,000 (LSE Website 2006).  It is under the travel and leisure sector and acclaimed as the largest UK operator of horseracing fixtures (Arena Website 2006).  On the other hand, Gallaher Group Plc relatively has both larger market cap and size of GBX 5.6B and 50,000 (LSE Website 2006) compared to Arena.  The primary business of Gallaher Group is under the regulated industry of tobacco in which they operate in over 80 countries worldwide (Gallaher Website 2006).  These two companies are worth comparing due to their differences in size, scope of operations, industry, regulation and LSE trading position, thus, making the paper derive several findings.  The source data for financial ratios will be the "year-ended 2005" annual reports of the two companies.                 Comparative Assessment on Financial Ratios (refer to appendix 1)             With higher ROE, Gallaher has higher earning capability per ordinary share.  Thus, holders of its shares has 8.4% (which can also mean 8.4 pounds) advantage of deriving share gains than Arena shares.  As an investor holds more of former, he increases its gain gap against latter (Investopedia 2006).  With this, a rational investor will prefer and invest to Gallaher shares which release the firm from over-reliance from a much riskier debt financing (Mcmenamin 1999).  Such situation is reflected in finance costs under common size analysis in which Gallaher has only 1.6% while Arena has 1.9%.  In effect, higher ROE does not only positively affect financing but also operating activities as showed by reduced pressure on profit after interest expense.  However, as potential and current investors vie for their shares, the backside for Gallaher is that it is prone to dissolve ownership control and may result to out-of-control especially on governance.                Arena has higher profit margin than Gallaher.  This is very much attributed to lower cost of sales, that is, 64.4% against 86.7%.  However, the cost of depreciation of Arena is 12.8% compared to 1% for Gallaher which suggest that the latter is using depreciation techniques to mitigate severely high cost of sales. In addition, it cannot be said that Arena is more profitable or cost-effective than Gallaher primarily due to the differences of the absolute amounts of profits.  Gallaher may be profiting a mere 4.5% for a turnover of about 8,214,000,000 pounds.  But this is equivalent to 369,630,000 compared to Arena's 11% on a 40,747,000 pounds turnover or 4,482,170 profits.  In effect, the upper hand of arena in this specific ratio is in doubt to credit as strengths much more as weakness.                              With higher gross profit margin, Arena has been able to exploit its key position in the UK market.  This indicates that it utilizes its brand name and intangible assets effectively as it have more control on its pricing (Investorwords 2006).  On the other hand, Gallaher's profit capability is still adversely affected by huge cost of sales primarily due to vulnerability to price shocks of tobacco inputs due to seasonality, weather conditions and unique country features.  As the latter can opt to pass the burden of cost to end-users or retailers, this may not be possible as tobacco is a commodity good.  This makes shifting costs to other brands less expensive with regards for both economic and non-economic variables.  As a result, Arena's relative monopoly status in UK has positively affected its gross profit margin while the reverse is true for Gallaher's relative competitive environment in the world market including the vulnerability of its input price.  However, the "absolute figure paradox" of profit margin may also apply to its gross counterpart.               As P/E ratio is inappropriate for firms within two different industries (Investopedia 2006), it cannot be said that Arena's shares are more prioritized by investors than Gallaher.  This is because both industries, and in analogy both firms, have different growth prospects in the future.  With isolated analysis for leisure sector, Arena's investors are willing to pay 33.1 pounds per 1 pound earning of the company while (for the tobacco sector) Gallaher's own are willing to pay 15.5 pounds for the same amount of earning.  However, as Gallaher's earnings are comparatively larger than of Arena's, the absolute investment that may enter the equity financing of Gallaher is definitely of bigger amounts (in millions).  In the contrary, Arena may not need such large amount that makes comparison not feasible.                                                           In common size analysis, Arena has more extra-revenues aside from its main operations.  This is made possible with the provision from sale of investments and finance income which is also the same case of Gallaher.  The smaller staff and depreciation costs of Gallaher imply its capability to operate within the level of economies of scale in both labor and semi-fixed capital.  Asset revaluation is beneficial for both firms which suggest that they use techniques like impairment of intangible assets to assess their value-added.  Finance and tax expense are somehow similar.  The net income for Gallaher is reduced to a large extent by the costs of duties and other costs associated with cost of sales. Obviously, the weakness of Gallaher with regards to common size is the international duties largely affected by political beliefs.               The backlash of having high profit margin is evident in the situation of Arena which led to relatively lower asset turnover (Investopedia 2006).  In the case of Gallaher, its high asset turnover means it is more efficient than Arena because it can use a minimal number of assets to produce maximum number of outputs that resulted into revenues.  Thus, it obtains optimal benefits from economies of scale and efficiency of its resources.  Further, the inventory turnover is futile for comparison because Arena is under service industry while Gallaher is in manufacturing.  In effect, the denominator of Arena is too small because it does not keep a significant amount of inventory unlike Gallaher whose inventory is close cost of sales because the bulk of latter is used to produce the output, therefore, the inventory stock-up.               Gallaher has more efficient collection platform than Arena primarily because its cigarettes are commodity products while leisure may require membership fees which can take annual payments.  In effect, Arena may have uncollected fees because customers has high bargaining power with regards to payment scheme while Gallaher could make a monthly invoice towards international customers.  Further, the higher debt-asset ratio of Gallaher suggests that it may have more attractive shares but investors may see high risks and uncertainty attached on them.  In effect, its high cost of sales would not go anywhere for funding but debt.  On the other hand, the partial monopoly position of Arena in the UK suggests more stable and growing share gains which limit its debt asset ratio.  Lastly, Gallaher has a more positive working capital than Arena.  The latter has not enough cash to cover current liabilities.  On the other hand, Gallaher's position of having significant number of inventories should not cause an apprehension due to its high collection ratio as well as its has commodity products on hand easily saleable.       Factors that may Affect Future Performance                 Access to equity financing.  Gallaher is in need of equity investments to avoid insolvency especially in the long-term.  Although it has a higher working capital ratio than Arena, this may only suffice the short financing needs of the company.  In addition, the vague international issue it is confronting to do business is tied with high risks that include duties, cost of tobacco, exchange rates and terrorism.  As a result, it is more comfortable to situate its operations within a less risky form of financing.  They are large and so it is possible to obtain higher cap investors trading in the LSE.  This will support their international operations which are of little significance for Arena which only requires relatively smaller amounts of equity capital.  Further, for both companies, increase in equity capital can optimize financing income and minimize interest expense which can be diverted to other expansion efforts.               Use of accounting techniques.  Both firms are able to minimize their finance, depreciation and tax burden due to deferrals as well as maximize financial ratios due to inclusion of intangible asset valuations.  However, they should bear in mind that these costs and opportunities are exhaustive in the long-run.  All deferred payments should be settled and valuations will already in place or even diminish when the business is performing poorly.  In effect, forecasting and governance structures should be rationalized in order to achieve maximum potential of current techniques being applied and future prospects/ direction of the firm.             Government regulations.  This is more critical for Gallaher because almost all governments are concerned with the health of its human resources as well as associated public costs when smoking ailments are within uncontrollable levels.  In effect, the company must use its lobbying power, if not "greasing", together with other industry players to collaborate with international organizations like United Nations to remain profitable.  In the UK recently, it was prohibited to smoke within public houses like pubs and clubs which adversely affected UK sales of the firm (Gallaher Website 2006), if not, the industry itself.  For the part of Arena, it should also caution its future operations by monitoring any government proposal to regulate some forms of gambling or to raise taxes for the operators.   Conclusion                                                              As observed, the essay would have provided a more fruitful discussion if only two companies within the same industry is compared.  Perhaps, the compassion would be more consistent if their market cap, size and shares under trade are coinciding.  In this particular analysis, however, there are also several findings that have been realized.  First, financial ratios are useful baseline comparison to evaluate two different firms ideally under the same industry or have the same size.  In this way, investment priorities can be rationalized according to the ability of the firm to provide capital gains or dividends.  Second, merely comparing financial ratios in isolation could provide misleading assessments regarding the financial health of the company.  Thus, using other ratios, studying consolidated accounts and browsing explanations to financial statements and other corporate information is deemed crucial to further explain the relationship of ratios and corporate performance/ standing.  Lastly, there are other industry and size specific factors that can affect future performance of a firm.  As a result, future analysis should include two companies within the same industry and/ or have the same size.    Appendices Appendix 1:  Comparative Computation of Accounting Ratios Crucial Ratios Arena Gallaher Return on Equity 19% 27.4% Profit Margin  11% 4.5% Gross Profit Margin 35.6% 13.3% P/ E Ratio 33.1   15.5 Common Size Analysis ·        Turn-over and other revenues ·        Cost of Sales ·        Other Revenues (except revaluation surplus) ·        Staff Costs ·        Depreciation ·        Surplus from Asset revaluation ·        Finance Cost ·        Tax Expense ·        Net Income   100%   64.4% 2.9%     14.6% 12.8% 8.8%   1.9% 0.0% 11%   100%   86.7% 1.2%     3.6% 1.0% 8.9%   1.6% 1.8% 4.5% Asset Turn-Over 49% 212% Inventory Turn-Over 138,078.95% 1,502.32% Collection Ratio 4,286.27% 3,608.23% Debt-Asset Ratio 28.1% 96.5% Working Capital Ratio 37.6% 78.6%   Note: See computations on excel spreadsheet which is attached.  Those in green highlights are from actual report values.   Appendix 2: Ratio Computation ROE = Profit after interest & tax/ Ordinary shareholder's funds (Ordinary share capital + reserves) Profit Margin = Net Income/ Revenue Gross Profit Margin = (Revenue – Cost of Goods Sold)/ Revenue EPS = (Net Income – Dividends on Preferred Stock)/ Average Outstanding Shares = already given in the financial books of any firm Common Size Analysis = Entity/ Total Entity = Turn-over and other revenues/ Turn-over and other revenues; Cost of Sales/ Total Entity; Other Revenues/ Total Entity; Staff Costs/ Total Entity; Depreciation/ Total Entity; Surplus from asset revaluation/ Total Entity; Finance cost/ Total Entity; Tax expense/ Total Entity; Net Income/ Total Entity. Asset Turn-Over = Revenues/ Total Assets Inventory Turn-Over = Cost of Goods Sold/ Average or Current Period Inventory Collection Ratio = Accounts receivables except trade receivables/ (Revenue/365 days)       Debt-Asset Ratio = Total Liabilities/ Total Assets Working Capital Ratio = Current Assets/ Current Liabilities Note: All computations are multiplied by 100 except P/E ratio.