DETERMINANTS OF PROFITABILITY

Determinants of Profitability of Oil Companies Listed in London Stock Exchange

Table of Contents

CHAPTER 1: INTRODUCTION2

Overview2

Background3

Aims and Objectives4

Hypothesis4

Limitation4

CHAPTER 2: LITERATURE REVIEW6

Financial Theory and Company Management6

Productivity and Profitability8

Firm size and Profitability9

Vertical Integration and Profitability10

Past Profitability10

CHAPTER 3: METHODOLOGY12

Research design12

Secondary research12

Data collection13

Data Analysis13

REFERENCES14

CHAPTER 1: INTRODUCTION

Overview

The profitability of a company, which translates into its liquid assets, whether generated by the corporate cash flows from operations or by the attraction of new firm shareholders, is considered as the most important source of the business continuance over the long-run. Thus, profitability, defined as the capacity to generate resources or performance, has been one of the indicators most commonly used to define the success or failure (right or wrong decision making) of company management. It allows to evaluate the efficiency of the implemented strategy and, therefore, to assess the company´s competitive position. This indicator has become a concern for shareholders, who have invested their resources in the company, and a worry for the directors (managers/executives) of the companies because this result reflects their capacity to keep the business running.

Adequate profitability both compensates shareholders for their risk taking and may finance the growth of a company through internally generated funds, which, according to Hastings (2004), constitutes one of the preferred funding alternatives for a firm's expansion. At the same time, profitability facilitates efficient resource allocation as investors devote their resources to more promising alternatives. That is, unless a company reaches at least its competitors' profitability level, it will find it difficult to attract capitalists. The alternative of involving financial institutions in the financing of the company's growth may impose certain limitations, as lenders would require compensation in the form of higher interest rate to cover the higher risk born.

In this context, not being able to attract the necessary funds to finance the growth may harm future profitability of firms, since, as Duffy (1996) shows, there is a positive relationship between growth rates of companies and their profits. Motivated by the importance of company performance, various authors seek factors that increase the level of profitability.

Background

Given their misperceptions of who owns Oil Companies, many commentators and consumers have the misperception that retail stations are extremely profitable. The misperception is derived from press reports of the large-scale profits earned by major oil companies in recent years. Table below lists the top six major oil companies in terms of their annual pretax profits for 2003-2006. In 2006, ExxonMobil earned nearly $40 billion and Shell and BP both earned over $20 billion.

The top six oil companies alone earned over $125 billion and saw their combined pretax profits increase by 112 percent from 2003. The last column of Table 2.1 lists 2006 pretax profit as a percent of 2006 total sales for each company. ExxonMobil recorded the highest profit margin at 10.5 percent of sales. Four of the top six oil companies realized profit margins of just over 8 percent of sales and the group weighted average margin was 8.6 percent of sales.

Aims and Objectives

The general of objective ...