Chapter 3 Case study Solution and discussion 1. First, prepare the statement of profit or loss and statement of financial position for the business. The list which Jimmy has provided is a jumbled mixture of statement of profit or loss items and statement of financial position items, so a useful preliminary step is to identify a category for each item depending upon whether it goes in the trading account, the rest of the statement of profit or loss or the statement of financial position. For statement of financial position items, the terminology used in Chapter 2 can be used: •
Non-current assets
•
Current assets
•
Current liabilities
•
Non-current liabilities
•
Capital
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£ Revenue
Category
143,520
Trading account
Opening inventory
9,274
Trading account
Non-current assets
3,823
Statement of financial position: non-current assets
Opening capital balance 1 March 20X4
19,776
Statement of financial position: capital
Bank
1,685
Statement of financial position: current assets
Rental expense
16,500
Statement of profit or loss
Insurance
2,023
Statement of profit or loss
Electricity
2,056
Statement of profit or loss
Trade payables
8,229
Statement of financial position: current liabilities
Trade receivables
1,800
Statement of financial position: current assets
Drawings
23,153
Statement of financial position: capital
Bank interest received
118
Statement of profit or loss
103,221
Trading account
Income from repairs services
4,389
Statement of profit or loss
Repairs service expenses – bicycle
1,317
Statement of profit or loss
2,278
Statement of profit or loss
Assistant’s wages
8,902
Statement of profit or loss
Closing inventory
16,337
Trading account AND statement of
Purchases
parts Administration, finance and sundry expenses
financial position: current assets
Note that closing inventory always appears in both the trading account and the statement of financial position as a current asset. Inventory which remains unsold at the statement of financial position is deducted, as we have seen, in arriving at the cost of sales figure. However, it is also an asset of the business because it can be sold to make money in the next following accounting period.
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Having categorized all the items the next stage is to pick out those which appear in the trading account, and then prepare the trading account. Then, immediately below it, the rest of the statement of profit or loss items are listed, ending with net profit.
Remember that a heading with the name of the business (in this case Jimmy simply uses his own name – this is common amongst sole traders) and a description of the financial statement is always required.
Jimmy Bowden: Statement of profit or loss for the year ended 28 February 20X5 £ Revenue
£ 143,520
Less: cost of sales Opening inventory Add: purchases
9,274 103,221 112,495
Less: closing inventory
(16,337) (96,158)
Gross profit
47,362
Repairs service: income
4,389
Repairs service: expenses – bicycle parts
(1,317) 3,072
Other income – bank interest received
118 50,552
Expenses Rental expense
16,500
Insurance
2,023
Electricity
2,056
Administration, finance and sundry expenses
2,278
Assistant’s wages
8,902 (31,759)
Net profit
18,793
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Once all of the balances have been put into the statement of profit or loss the remainder should all relate to the statement of financial position, which can then be prepared.
Jimmy Bowden: Statement of financial position at 28 February 20X5 £
£
ASSETS Non-current assets
3,823
Current assets Inventory
16,337
Trade receivables
1,800
Bank
1,685 19,822 23,645
CAPITAL AND LIABILITIES Capital Opening capital balance 1 March 20X4
19,776
Add: net profit for the year
18,793 38,569
Less: drawings
(23,153)
Closing capital balance 28 February 20X5
15,416
Current liabilities Trade payables
8,229 23,645
Remember, the capital account shows the resources committed to the business by the owner. The balance on the capital account increases or decreases in the following ways: Capital introduced For use with Business Accounting and Finance 6th edition (ISBN 978-1-4737-9127-5) © Catherine Gowthorpe, 2024, published by Cengage
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PLUS Profits retained in the business MINUS Drawings MINUS Any losses made by the business
Jimmy Bowden’s capital account, as shown in his statement of financial position at 28 February 20X5 has been increased by the amount of net profit for the year (calculated in the statement of profit or loss) and has been decreased by the drawings he has made from the business.
2. Having prepared the statement of profit or loss and statement of financial position for Jimmy’s business, it is now possible to address his questions about the profitability of the business. A logical first step is to take the table of figures he provided for 20X4 and slot in the equivalent figures for 20X5:
20X5
20X4
Bicycle revenue for the year
143,520
164,728
Gross profit on bicycle sales
47,362
49,418
Profit on repairs service
3,072
3,422
Total expenses
31,759
27,263
Interest received
118
260
18,793
25,837
Net profit
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From this information a report with recommendations can be constructed by the business adviser, as follows:
18th March 20X5 Report to Jimmy Bowden on business profitability based on the financial statements at 28 February 20X5 There has been a substantial decline in revenue, gross and net profits between 20X4 and 20X5. The fall in sales is over £20,000, which represents a decline of almost 13 per cent.
There has been a small drop in profitability in the repairs service, but this is a fairly insignificant part of the business.
Total expenses have increased from £27,263 to £31,759, an increase of 16.5 per cent. A more detailed comparison of expenses would be useful in order to pinpoint the specific expenses which have risen. There may be a need for better control of business expenses.
Net profits have fallen from £25,837 to £18,793. The decline is significant and an action plan should be drawn up to address the problems the business faces. The business is not under immediate threat. The bank balance at 28 February 20X5 is £1,685 and there are no long-term borrowings. But trade payables total £8,229, and there could be problems if they start to press for immediate payment. However, because of the good record of profitability in the past, the bank is likely to grant overdraft facilities if they are required. The level of drawings from the business of a little over £23,000 is not justified by the present level of profitability. Closing inventory is much higher than opening inventory, because of the shortfall in Christmas sales.
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1. Mr Bowden could consider a campaign of local advertising. This could be allied to an inventory clearance sale at discounted prices. 2. The current level of business profitability does not support drawings at the level of £23,000 per year. Mr Bowden should plan for a lower level of personal expenditure until business profitability improves. 3. Business expenses should be considered item by item to identify areas where savings might be possible. 4. If other measures fail, the possibility of moving to new shop premises nearer the centre of town could be considered. Suitable premises should be identified and a business plan and budget drawn up on the basis of the likely increase in sales and expenses if the move were to be made.
Signed: Business adviser
Summary This case study pulls together in one example some of the basic content of Chapters 2 and 3. Students should ensure that they thoroughly understand how the figures in the financial statements fit together before attempting the more complex of the questions at the end of the chapter.
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Chapter 4 Case Study
Solution and discussion
1. If the amount owed by Charlie cannot be recovered it will be treated as a bad receivable in Richard’s accounts. The appropriate accounting treatment is to deduct the amount that cannot be recovered from the trade receivables balance, thus reducing assets, and from profit for the period. The latter adjustment directly affects the capital account.
The effect, in summary, will be as follows:
Profit for the nine months to 30 September 20X4 currently stands at £41,756. If the amount due from Charlie of £50,600 is deducted a loss arises: £41,756 – 50,600 = £8,844 Loss
In the statement of financial position, the receivable of £50,600 is deducted from the total trade receivables of £93,242, leaving a revised trade receivables balance of £42,642. The redrafted statement of financial position is as follows:
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Richard: Redrafted statement of financial position at 30 September 20X4 £
£
ASSETS Non-current assets
8,311
Current assets Inventory
19,870
Trade receivables
42,642 62,512 70,823
CAPITAL AND LIABILITIES Capital Opening capital balance 1 January 20X4
64,084
Add: loss for the year
(8,844) 55,240
Less: drawings
(61,760)
Closing capital balance 30 September 20X4
(6,520)
Current liabilities Trade payables
51,760
Accruals
1,722
Bank overdraft
23,861 77,343 70,823
2. Note that the statement of financial position now shows a negative capital account. The business is insolvent and Richard is in very deep trouble. There is no money available to pay the trade payables, and the overdraft limit is virtually reached. The future looks bleak for the business, and for Richard.
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Can the business survive this disaster? Looking at the original set of accounting statements before the adjustment is made for the bad trade receivable amount, we can see that the business is basically profitable. If it could be refinanced there is no reason for it not to continue to be a viable concern. The original statement of financial position before adjustment suggests that Richard’s spending has got out of hand: the high level of drawings of £61,760 is not sustainable. Even if new sources of finance were to be found, Richard would need to curtail his spending by a significant amount.
How likely is it that further finance would be available? If Richard had any personal assets these could be sold to raise much-needed cash for the business. What we know of Richard’s personal life suggests that he is short of assets; he cannot borrow on the security of a house because the family home is now owned by Hermione. If the business is to survive Richard needs urgently to explore other options. Some possibilities might be: •
A personal loan. It is possible that the bank may be prepared to lend Richard some money. However, even if this is the case, there are likely to be stringent conditions attached to any loan.
•
A personal loan from a private source. Richard’s mother originally lent him the money to start the business. It is possible that she may be willing to make further loans. There may be other relatives or friends who will stand by Richard in his difficulties.
•
Financial assistance from Richard’s supplier in Italy. For many years Giovanni has been supplying goods to Richard for distribution in the UK. If Richard goes out of business, Giovanni loses his UK outlet and it may be difficult and expensive to establish another. Giovanni may be prepared to, say, go into partnership with Richard in order to keep the distribution outlet open. As the business is basically profitable, it could be to Giovanni’s personal benefit to put money into the venture to keep it afloat.
•
Legal action against Charlie for recovery of the amount owed. This should probably be attempted in any case, but the reports of Charlie’s former business
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activities and the fact that he cannot currently be found indicate that it will probably be very difficult to recover any cash.
If Richard cannot obtain fresh finance for the business, it will not be able to meet its liabilities. Because he is a sole trader, he is personally liable for the debts incurred by the business, and it is quite likely that he will become personally bankrupt. In the circumstances, his panic seems completely justified.
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Chapter 5 Case Study Solution and discussion
a) Workings 1. Building depreciation: £80,000/100 years = £800 per year 2. Computer and software depreciation: £1,500/5 years = £300 per year 3. Van depreciation: £6,000 x 20% = £1,200 x 9/12 = £900 4. Accruals for statement of financial position: £650 (accountancy) + £223 (phone and broadband) = £873
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The Hayseed Gallery: Statement of profit or loss for the year ended 31 December 20X4 £
£
Sales: commissions
27,650
Sales: cards etc.
3,600
Cost of sales Opening inventory
-
Purchases of cards etc.
4,570
Less: closing inventory
(2,206) (2,364)
Gross profit
28,886
Expenses Staffing costs Insurance (£752 - 200)
2,663 552
Motor vehicle running costs
1,566
Telephone and website charges (£997 + 223)
1,220
Advertising
3,244
Mailshot expenses
3,454
Private view expenses
2,850
Building repairs and maintenance
660
Heating and lighting costs
951
Accountant’s fees
650
Depreciation – building (working 1)
800
Depreciation – computer and software (working 2)
300
Depreciation – van (working 3)
900
Other expenses
1,575
Interest paid
2,400 23,785
Net profit
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5,101
2
The Hayseed Gallery: Statement of financial position at 31 December 20X4 £
£
ASSETS Non-current assets Land at cost
40,000
Building at cost
80,000
Less: depreciation
(800) 79,200
Computer and software at cost
1,500
Less: depreciation
(300) 1,200
Van at cost
6,000
Less: depreciation
(900) 5,100 125,500
Current assets Inventory
2,206
Trade receivables
580
Prepayment
200
Cash at bank
648 3,634 129,134
CAPITAL AND LIABILITIES Capital Capital introduced
91,500
Add: profit for the year
5,101 96,601
Non-current liabilities Loan
30,000
Current liabilities Amounts due to artists
1,660
Accruals (working 4)
873 2,533
Net current assets 129,134
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b) Fergus’s business has made a profit of £5,101. For a new business start-up, making a profit of any size in the first year of operation could be regarded as an achievement. But no tax has yet been paid, and this will further reduce profit. Even before tax, Fergus’s profits amount to less than £100 per week. Considering the amount of work that he has put into the business, and the commitment he has made of his and Flora’s savings, this does not appear to be much of a return. Cash flow has been a minor problem during the year, with the need to utilize an overdraft facility from time to time. At the moment, even if Fergus wanted to take some drawings out of the business, the cash is simply not there to do so. At 31 December 20X4 he owes artists over £1,600 but he only has £648 in the bank, and the phone and broadband bill will have to be paid shortly.
Loan repayments of £2,400 are a significant drain on the business’s resources. And in just two more years, the business will have to start making repayments of capital as well, which will be a further drain on cash.
It would seem that Flora may well be right: the business probably cannot be regarded as a really profitable venture. Perhaps it will never be much more than a hobby.
c) We are told in the case details that Fergus has tried to keep a tight control over costs. Advertising and mailshot expenses total well over £6,000 but are probably necessary in order to keep a steady flow of potential customers coming to the gallery. Conventionally, exhibitions have a private view for artists and selected guests. It is usual to provide refreshments at these events – a glass of wine or mineral water per guest, and sometimes some snacks. Fergus has spent £285 on average per exhibition on these expenses and this is probably quite a modest sum. There are no items of expense that seem out of the ordinary, and there is probably little scope to economize on costs. For use with Business Accounting and Finance 6th edition (ISBN 978-1-4737-9127-5) © Catherine Gowthorpe, 2024, published by Cengage
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Fergus could try to increase revenue, although it is noticeable that actual revenue has rather exceeded his expectations: he has sold on average over 50 per cent of work exhibited, compared to the 40 per cent he expected. He could perhaps experiment with pushing the gallery’s exhibitions upmarket by exhibiting works costing over £1,000. However, he may be correct in his perception that more expensive items simply will not sell. Another possibility would be to raise his commission levels. Currently, he charges artists 40 per cent of the selling value of their work. If he were to raise this percentage, he might be able to increase the gallery’s profitability. On the other hand, the relationship he has built up with artists is important and could be endangered if he seeks to make substantial increases in commission levels.
It seems clear that Fergus will have to think hard about plans for increasing profitability. Flora is not happy in her role as sole provider, and if the gallery turns in a second year of only moderate profits, she may become even more convinced that the business is not a truly viable proposition. Fergus and Flora need to thoroughly discuss the issues arising from the business start-up and to reach agreement on a plan for developing the business. If they are unable to agree, the business is likely to be a continuing source of discord.
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Chapter 6 Case Study Solution and discussion
1. Dezzie’s: Statement of cash flows for the year ending 31 March 20X4
£
£
Operating profit Add back: depreciation on buildings
78,578
Note 1
2,000
1
Depreciation on fixtures and fittings
1,829
1
Depreciation on delivery vehicles
4,763
1
Profit on sale of delivery vehicle
(520)
1 8,072 86,650
Less: increase in inventory (6,186 – 5,630)
(556)
2
Add: decrease in trade receivables (5,914 – 7,419)
1,505
2
Add: increase in payables (8,510 – 6,340)
2,170
2 3,119
Cash generated from operations Interest received Interest paid
89,769 280
3
(4,617)
3 (4,337)
Net cash inflow from operating activities
85,432
Cash flows from investing activities Purchase of non-current assets (103,000 + 2,039 +
(120,222)
4
2,120
4
15,183) Proceeds of sale of non-current asset Net cash outflow from investing activities
(118,102)
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Cash flows from financing activities Capital returned to owner (drawings)
(53,000)
5
Mortgage loan
73,750
6
Net cash inflow from financing activities
20,750
Net decrease in cash
(11,920)
Cash at beginning of period
15,160
7
Cash at end of period
3,240
7
2. Explanation of the cash inflows and outflows 1) The starting point is operating profit. We must then add back all the items in the statement of profit or loss which do not involve cash movements. In Dezzie’s case these are the depreciation charges for buildings, fixtures and fittings and delivery vehicles. We must also adjust for the profit on the sale of the delivery vehicle of £520. (NB: there is a cash movement involved in the sale of the vehicle but we will take that into account – at the value of the cash actually received – later on in the statement of cash flows.)
2) The changes in inventory, receivables and payables must be calculated and recorded in this part of the statement. Comparing these elements in the two statement of financial positions we can see that: a) inventory has increased by £6,186 – 5630 = £556. This is the amount of the cash outflow in respect of this item. b) trade receivables have decreased by £5,914 – 7,419 = £1,505; this means there has been a release of cash (effectively, a cash inflow). c) trade payables have increased by £8,510 – 6,340 = £2,170. This means that the business is managing to obtain a slightly increased level of credit from its suppliers; this is equivalent to an inflow of cash.
3) Interest paid and received: these figures are taken from the statement of profit or loss.
4) The total cash outflow on non-current assets is calculated by taking the actual capital expenditure from the notes on movements in non-current assets. For use with Business Accounting and Finance 6th edn (ISBN 978-1-4737-9127-5) © Catherine Gowthorpe, 2024, published by Cengage
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Actual capital expenditure was:
Land and buildings
103,000
Fixtures and fittings
2,039
Motor vehicles
15,183
Total
120,222
These are outflows of cash from the business. The sale of an asset, on the other hand, produces an inflow of cash to the business. The correct amount to include in the statement of cash flows is the actual proceeds of sale received; in this case, £2,120.
5) Drawings are an outflow of cash from the business.
6) The mortgage loan received is an inflow of cash into the business in this year.
7) The net inflow or outflow of cash which is calculated in the statement of cash flows should equal the change in the balance of cash between the two year-ends. In Dezzie’s case there has been a net outflow of cash of £11,920. The final section of the statement of cash flows ‘proves’ this figure by calculating the difference between cash at bank at 1 April 20X3 and at 31 March 20X4.
3. Financial implications of following the consultant’s advice Delroy’s business has suffered a net outflow of cash in the course of the year. The statement of cash flows shows where the outflows have occurred. The principal items of outflow are, of course, the expenditure on new non-current assets. Delroy obtained a mortgage loan for some of the major expenditure on new premises, but financed part of it (£103,000 – 73,750 = £29,250) from the business’s own resources. In addition, over £15,000 was spent on acquiring new delivery vehicles and a further £2,000 on fixtures and fittings. The second largest item of cash outflow is Delroy’s own drawings, which have increased substantially (£42,500 increasing to £53,000).
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However, Delroy’s business is profitable (net profit margin for the year ending 31 March 20X4 is 21.8 per cent), and it has generated net cash inflows from operating activities of £89,769.
Delroy accepts the consultant’s analysis of the operating problems the business faces. The accounting information suggests that Delroy is happy to make investments in bricks and mortar, but is quite prepared to skimp on the furnishing of his restaurants. We can see from the figures that the fixtures and fittings are quite old (this shows up in the relatively high figures for accumulated depreciation), and that only around £2,000 was spent on new fixtures and fittings. Customers have obviously noticed Delroy’s cost-cutting approach to these matters and are not happy about the appearance of the restaurants.
It appears that Delroy will be obliged to invest more money in restaurant fit out, new tables and so on, in order to keep the customers happy. He should be advised to do a thorough appraisal of the restaurant fittings and decoration, possibly in conjunction with an interior design expert (given that Delroy obviously has a blind spot in all matters relating to the appearance of his restaurants).
Over £15,000 has been spent on new delivery vehicles; this investment may address some of the problems noted by the customers of bikes breaking down and long waits for delivery. However, there could also be a problem with staffing, and it certainly appears to be the case that Delroy’s managers are less effective than they should be. Delroy will have to arrange to employ higher paid staff. The obvious implication for cash and profits is that staffing expenses will increase. Also, he may have to spend extra cash on making existing staff redundant and could face legal problems if the staff consider themselves to have been unfairly dismissed.
However, if Delroy can sort out his staffing problems there are potential gains to be made in: •
increased customer satisfaction (leading to word-of-mouth recommendations, and an increased rate of return visits)
•
better control of the delivery service, resulting in fewer complaints
•
improved quality of service within the restaurants. For use with Business Accounting and Finance 6th edn (ISBN 978-1-4737-9127-5) © Catherine Gowthorpe, 2024, published by Cengage
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All of these factors could lead to increased revenue, and/or reduced costs.
Delroy’s restaurants are profitable and bring in substantial sums of cash. The second restaurant has been open for only part of the year (we do not know from the details how long it has been open), and it could be expected to produce higher revenue and profits in the year ending 31 March 20X5. Delroy should prepare forecasts for at least the next following year, to show how much cash is likely to be available for spending on restaurant improvement and additional/replacement staffing.
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Chapter 7 Case study 2 Solution Andrew Higginson was appointed as Chair of JD Sports & Fashion plc (JD Sports) in July 2022, approximately halfway through the company’s financial year. He stated in the 2023 Annual Report:
‘There was a significant ‘governance deficit’ in a listed business of JD’s size’.
Several aspects of JD Sports’ corporate governance arrangements required updating. The separation of the roles of chief executive is a fundamental aspect of corporate governance according to the UK’s Corporate Governance Code. Although it is more common in the USA to combine the two roles, it is unusual in the UK, and especially for a company of the size and economic significance of JD Sports. Finally, in 2022/23 JD Sports made separate appointments.
The new Chair also stated:
‘Starting with the combination of Chair and CEO roles, the business had not raised standards of Governance to the expected norms of a FTSE 100 business. The Non-Executive Directors, whilst bringing much relevant experience, had a lack of Plc experience’.
Pages 112-3 in the Annual Report list the non-executive directors. Most were appointed during the 2022-23 financial year. A committee structure was established, and by the year end in January 2023, the company appeared to be compliant with the Code. Page 123 of the 2023 Annual Report lists all the specific areas where the company was not compliant, and explains the actions that have been taken to address the problems.
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Chapter 7 Case Study Solution and discussion
1. Preparation of the financial statements Workings: a. Cost of sales:
£ Opening inventory
2,107,232
Add: purchases
13,720,216 15,827,448
Less: closing inventory
(2,238,400) £13,589,048
b. Administrative expenses £ Directors’ remuneration Other administrative expenses
556,400 3,088,192 £3,644,592
c. Tangible non-current assets £ Office building at carrying amount
3,390,008
Retail units at carrying amount
13,598,800
Vehicles, fixtures etc. at carrying amount
3,235,760 £20,224,568
d. Other payables Payable for corporation tax:
£1,274,101
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e. Retained earnings £ Retained earnings at 1 January 20X5
14,461,144
Profit for the year
2,962,899
Less: dividends
(468,000)
Retained earnings at 31 December 20X5
£16,956,043
The draft financial statements are as follows: Daley Limited: draft statement of profit or loss for the year ended 31 December 20X5 £ Revenue
22,350,400
Cost of sales (working 1)
(13,589,048)
Gross profit
8,761,352
Selling and distribution costs
(803,760)
Administrative expenses (working 2) Other operating income
(3,644,592) 234,800
Operating profit
4,547,800
Finance costs
(310,800)
Profit before taxation
4,237,00
Tax
(1,274,101)
Profit for the year
2,962,899
Daley Limited: draft statement of financial position at 31 December 20X5 £
£
ASSETS Non-current assets Tangible assets (working 3)
20,224,568
Current assets
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Inventory
2,238,400
Trade receivables
691,288
Cash at bank
76,360 3,006,048 23,230,616
EQUITY AND LIABILITIES Equity Share capital
150,000
Retained earnings (working 5)
16,956,043 17,106,043
Non-current liabilities
4,000,000
Current liabilities Trade payables Other payables (working 4)
850,472 1,274,101 2,124,573 23,230,616
2. Advice to Joe Daley
Initial financial analysis The draft accounts show that operating profit margin has dropped further this year, to 20.3 per cent (£568 475/2 793 800 x 100), which may help to convince the other directors that radical action needs to be taken. The proposed scheme involves borrowing a further £2,000,000. At a 4 per cent rate of interest this would increase interest charges by £80,000 each year. The other directors need to be convinced that the proposal will increase profits by at least that much. However, the additional charges constitute only about 1.8 per cent of the operating profit in the draft accounts, and it may be helpful to point this out at the meeting.
The board vote
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It seems likely from their initial response that Carol and Nasser will vote in favour of the proposal, but the other three directors appear to be very much opposed to it. It will almost certainly be very difficult to win them round. It is Joe’s proposal so he will vote for it. Therefore, if the proposal is taken to a vote, it seems likely that it will result in an even split of 3:3. Joe can use his casting vote, but this is likely to create a great deal of ill-feeling. The three directors most involved in the company’s day-to-day running will be split (Joe and Nasser voting for the motion and Gervase against), and this may create further problems.
The continuing decline in profit margins probably means that something will have to be done soon, and it may be that a radical change, such as the one proposed by Joe, is called for. However, if effective change is to be brought about, any proposal really needs the active support of most, if not all, of the directors.
Relevance of individual’ shareholdings What is the relevance of the individuals’ shareholdings? The directors each have an equal vote on the board, but their shareholdings are not the same (this is a quite common arrangement). The individuals’ shareholdings could be significant in a vote on reappointment of directors, because the proportion of shares held makes a difference to the voting. Suppose Gervase, Eric and Edward feel so strongly that Joe is taking the company in the wrong direction, that they try to vote him off the board? (A simple majority – i.e. 50 per cent - of votes is required to vote a director off the board). Between them they hold 49 per cent of the shares. Provided that Carol and Nasser will vote with Joe, his position is safe (just).
It may be relevant to query Edward’s and Eric’s retirement arrangements. How soon will they give up taking any active part in the business? Will they pass on their shares to their children? If they were to do this, presumably Eric would transfer all of his holding to Gervase, giving him a total of 34 per cent of the shares, and Edward would split his holding equally between his children Joe and Carol (this would leave Joe with 41.5 per cent, Carol with 17.5 per cent and Nasser with his existing 7 per cent). No one individual would control the company, although Joe and his sister would control a majority of the shares).
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Summary of Joe’s position Joe is in a very difficult position. Unless he can persuade at least one of the dissenting directors to his way of thinking, the issue is likely to split the board and may leave a residue of ill-feeling, whether or not he exercises his casting vote. He may need to think of a less radical plan to take the business forward, or accept suggestions by other directors on how to address the problem of declining profitability. In the worst case scenario, he may need to wait until he inherits sufficient shares to place him in a more secure position.
The case study illustrates a very typical family company scenario. The original founders of a business are often very reluctant to let go of a business which they have spent their working lives building up. Their children may become impatient and may try to reduce the parents’ involvement. This type of business arrangement can lead to lasting conflict and very serious consequences at both a personal and business level.
The business illustrated is a limited company, with uneven shareholdings amongst six members of the same family. Democratic arrangements for voting at board level may not reflect percentage shareholdings. Some of the directors participate more fully in business activities than others. However, it is worth reiterating that all directors are equally responsible in law.
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Chapter 8 Case study 2 Solution Report on the revenue and profitability of Elementis plc over the period 2018-2022
The company’s revenue dropped significantly in the middle of the five-year period in 2020, a drop which was probably attributable to the economic consequences of the response to Covid-19. By 2021, revenue had risen again and was almost at the same level as in 2019. Revenue achieved in 2022 was higher still at £921.4m, some 10% higher than the level achieved in 2018. However, the most recent two years have been subject to price inflation in most sectors of most economies, and so the apparent improvement may be less impressive than it seems initially.
In terms of profitability, the business is not currently doing well, compared to earlier years. Losses were made in 2020 which was probably to be expected given the circumstances. However, in 2022, the most recent period, an even greater loss (4.5% of revenue) was made.
Shareholders have not received a dividend since 2019, which may be a cause for concern.
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Chapter 8 Case Study Solution and discussion
PageGroup plc 1. Horizontal analysis of five-year summary of key information: percentage increases year-on-year
2022
2021
2020
2019
%
%
%
%
Revenue
21.1
26.0
(21.1)
6.7
Gross profit
22.6
43.8
(28.7)
5.0
Operating profit
16.4
989.6
(88.3)
3.0
Vertical analysis of five-year summary of key information
2022
2021
2020
2019
2018
%
%
%
%
%
Revenue
100.0
100.0
100.0
100.0
100.0
Gross profit
54.0
53.4
46.8
51.7
52.3
Operating profit
9.9
10.3
1.3
8.9
9.2
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2. Analysis of the geographical breakdown of gross profit and revenue for 2019 and 2018
2022
2022
2021
2021
Revenue - % of
Gross profit -
Revenue - % of
Gross profit -
total
% of total
total
% of total
Territory
%
%
%
%
EMEA
53.7
50.0
52.9
49.2
Asia Pacific
16.0
18.1
17.2
20.4
Americas
14.2
18.0
13.4
15.8
UK
16.1
13.9
16.5
14.6
TOTAL
100.0
100.0
100.0
100.0
3. Discussion of performance
PageGroup is clearly a profitable business. The vertical analysis of the five-year summary of key information shows, overall, an improved performance. Gross profit has improved in 2022 compared to 2018. There is a drop in performance, in all metrics, in 2020, which would be expected because of the effects of the response across the globe to COVID-19. PageGroup prepares its financial statements to 31 December each year, so the 2020 figures reflect over nine months of performance that had been adversely affected. The 2021 figures, however, show that recovery from the downturn was rapid.
The vertical analysis shows that gross profitability had improved between 2018 and 2022, with the expected drop in 2020. Overall, if past growth is an indicator of prospects for success in the future, then PageGroup’s outlook appears very good.
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The key performance indicator section of the 2022 Annual Report contains the following commentary on performance:
‘Gross profit increased […] resulting in a record year for the Group and for 27 individual countries. This was driven by strong trading conditions and the success of our strategic investments made over recent years.’
The geographical breakdown of gross profit shows that PageGroup operates in many different locations across the globe. This factor is likely to provide the group with some protection against regional downturns in trade. The analysis shows especially strong performance in the Asia Pacific and Americas territories. Profitability in the UK is declining and is lower than in the other regions.
This is what the Chair of the Board had to say about performance in the different regions of the business:
‘All of our regions grew against 2021, our previous record year, with 3 of our 4 regions delivering a record year. In our largest region EMEA, gross profit was up 26%, with particularly strong growth in our Large, High Potential market of Germany. Here, our Technology-focused Interim business delivered an exceptional performance, up 46% on 2021. Asia Pacific grew 5% against the prior year, with conditions becoming more challenging in the second half, due to the COVID-19 lockdowns and restrictions in Greater China. Elsewhere in the region, South East Asia, Japan and India all delivered record years, up 22%, 10% and 39% respectively. The Americas was our fastest-growing region in 2022, with North America up 24% and Latin America up 30%. The UK grew 17%, with stronger growth in Page Personnel of 57%, whilst Michael Page grew 4%’.
The business appears to be generally confident about its prospects, although the Chair does note potentially difficulties and uncertainties:
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‘As we enter 2023, a high degree of macro-economic and geo-political uncertainty remains across the majority of our markets. However, against this backdrop, we continue to see high levels of candidate shortages and vacancies, along with strong fee rates and salary levels.’
Conclusion
PageGroup is a highly profitable and successful business. It experienced a downturn, like most other businesses, in 2020 but has recovered well and rapidly since then. Its geographical coverage helps to protect the business against regional downturns in trade and local difficulties. Its prospects for the future look promising.
Note By the time you are working on this case study, there will be more information available about PageGroup. You will be able to access further trading statements and accounts via the PageGroup website, in order to bring the above analysis up to date.
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Chapter 9 Case Study 2 Solution and discussion Report on the performance of Persimmon plc Accounting ratios 2022
2021
Gross profit margin
22.7%
28.8%
Operating expenses as a percentage of
4.0%
3.6
19.0%
26.6%
sales Operating profit margin
Year-on-year changes calculated from the five-year record 2022
2021
2020
2019
%
%
%
%
Unit sales
2.2
7.2
(14.4)
(3.6)
Revenue from
7.1
10.2
(8.5)
(3.5)
4.9
2.8
6.9
0.06
house sales Average selling price
The company is profitable, although less profitable than previously. Although the average unit selling price of a house has increased between 2021 and 2022, gross profitability has declined, suggesting that costs are rising more steeply than prices. The decline in performance adversely affects operating margin as well. Persimmon has no apparent problems with cash flow; finance income exceeds finance costs comfortably in both 2021 and 2022.
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The company suffered a set back in terms of sales of houses in 2020 and it has not yet returned to its previous sales levels. In the Chairman’s statement he refers to adverse economic factors, notably a diminution in demand arising from higher mortgage rates. Elsewhere in the report he refers to shortages in both building materials and labour. On the positive side, he mentions that high build quality has been achieved. This is a particular issue for Persimmon as, in previous years, the company had been subject to a great deal of criticism because of its poor build quality. From the beginning of 2019, the company instituted a customer care improvement plan, and this appears to have paid off. First half performance in 2023 Persimmon’s first half results (to the end of June 2023) were published on 9 August 2023. (Persimmon Half Year 2023 Results Announcement (persimmonhomes.com)) The half year results statement included the following information: 2023 First half
2022 First half
4,249
6,652
New home average selling price
£256,445
£245,597
Total group revenue
£1.19bn
£1.69bn
Underlying new housing gross margin
21.5%
31.0%
Underlying operating margin
14.0%
27.0%
New home completions
The chairman’s pessimism in his statement in the 2022 Annual Report appears to be borne out in practice. Although the average selling price of a new home has continued to increase into 2023, all other metrics in the table above show a significant downturn. Conclusion Although Persimmon is a profitable company, it currently faces significant challenges, with a drop in sales volumes and profitability.
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Chapter 9 Case Study 3 Solution and discussion 1. Analysis Horizontal trend analysis Because there are three years of figures available it is possible to carry out, to a limited extent, horizontal trend analysis, as follows: Fitton Parker Limited: horizontal trend analysis for 20X3, 20X2 and 20X1
%age change over
%age change over
previous year
previous year
20X3
20X2
Revenue
21.5%
18.1%
Cost of sales
24.0%
19.7%
Gross profit
16.6%
15.2%
Selling and distribution costs
26.4%
16.0%
Administrative expenses
6.5%
(3.3%)
Directors’ remuneration
0%
0%
Finance costs
27.5%
23.0%
Non-current assets
4.3%
(11.9%)
Inventory
23.8%
23.0%
Trade receivables
25.0%
27.3%
Trade payables
36.7%
10.7%
Overdraft
0.6%
(5.2%)
What does the horizontal trend analysis show?
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There is a general trend towards increases in most items. The increase in revenue is substantial but although there is a corresponding increase in gross profit, the increase is not as great. It looks as though gross profit margin may be declining. Selling and distribution costs have risen a lot between 20X2 and 20X3, but administrative costs appear to be firmly under control. Also, the directors have not increased their own remuneration in the three-year period. Investment in non-current assets has been modest, but all current asset and current liability items have increased substantially. The overdraft remains at a fairly constant level, but trade payables have increased by a large percentage (over 36 per cent) in 20X3, suggesting that the business is relying to an increasing extent on the interest-free source of credit offered by trade payables. This is cheaper than increasing the overdraft (because interest has to be paid on an overdraft) but there is a danger of alienating suppliers if they are not paid promptly. Vertical analysis Vertical analysis of the statements of profit or loss is based upon revenue = 100 per cent. Vertical analysis of the statements of financial position is based upon equity = 100 per cent. The vertical analysis produces the following results: Fitton Parker Limited: vertical analysis of statements of profit or loss for the years ended 31 March 20X3, 20X2 and 20X1 20X3
20X2
20X1
%
%
%
Revenue
100.0
100.0
100.0
Cost of sales
(67.5)
(66.2)
(65.3)
Gross profit
32.5
33.8
34.7
Selling and distribution costs
(12.9)
(12.4)
(12.6)
Administrative expenses
(5.7)
(6.4)
(7.9)
Directors’ remuneration
(10.0)
(12.2)
(14.4)
Operating profit/ (loss)
3.9
2.8
(0.2)
Finance costs
(0.9)
(0.8)
(0.8)
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Profit/ (loss) before taxation
3.0
2.0
(1.0)
Tax
(0.6)
(0.5)
–
Profit for the year
2.4
1.5
(1.0)
Fitton Parker Limited: vertical analysis of statements of financial position at 31 March 20X3, 20X2 and 20X1 20X3
20X2
20X1
%
%
%
Non-current assets
89.1
100.6
125.2
Inventory
57.0
54.2
48.3
Trade receivables
72.2
68.0
58.5
Cash
–
1.0
–
Trade payables
48.8
42.0
41.6
Overdraft
11.0
12.9
14.9
Non-current liabilities
58.5
68.9
75.5
Share capital
46.2
54.4
59.6
Retained earnings
53.8
45.6
40.4
What does the vertical analysis show?
The vertical analysis of the statements of profit or loss confirms the suspicion that the gross profit margin is declining. Administrative expenses are declining as a percentage of sales. This may be because of very good controls over costs and a deliberate attempt to keep administrative expenses to a minimum. However, savings on such costs can be taken too far, and the business may be operating at less than optimal efficiency.
The operating profit margin is low, as is the margin of profit for the year to revenue. Although there has not been a loss since 20X1, profits are not impressive, and even at their highest level in 20X3, there would not be much scope for paying a dividend.
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Inventory and trade receivables have increased as a percentage of equity, with a particularly high increase in trade receivables between 20X1 and 20X2. Trade payables, as noted in the horizontal analysis, have also increased substantially.
Ratio analysis Performance Gross and operating profit margin were discussed in the vertical analysis section. Because Louise is looking to invest as an ordinary shareholder, she will probably be most interested in the return on equity: Profit before tax, and after interest Equity 20X3 Return on equity
18,023
x 100
20X2 9,642
x 100
20X1 (4,188)
x 100
97,368
82,695
75,459
= 18.5%
= 11.7%
= (5.6%)
The overall return has increased rapidly.
Liquidity Information is available to calculate two ratios: current ratio and quick ratio. 20X3 Current ratio:
20X2
20X1
125,765
101,830
80,615
58,187
45,385
42,640
Current assets
=
=
=
Current liabilities
2.2
2.2
1.9
Quick ratio:
125,765 – 55,450
101,830 – 44,791
80,615 – 36,425
Current asset –
58,187
45,385
42,640
inventory
=
=
=
Current liabilities
1.2
1.3
1.0
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Neither liquidity ratio appears to give any cause for concern. Although the figure for payables is very much higher in 20X3 than it was in 20X2 it is covered quite adequately by current assets.
Efficiency ratios Three will be calculated: non-current asset turnover, inventory turnover (in days) and trade receivables turnover (in days). Trade payables turnover cannot be calculated because no figures for purchases are available.
20X3
20X2
20X1
Non-current asset
596,860
491,383
415,985
turnover:
86,790
83,250
94,484
Revenue
=
=
=
Non-current assets
6.88
5.90
4.40
Inventory turnover:
55,450
Inventory
402,964
325,089
271,588
Cost of sales
= 50.2 days
= 50.3 days
= 49.0 days
Trade receivables
70,315
56,233
44,190
turnover:
596,860
491,383
415,985
Trade receivables
= 43.0 days
= 41.8 days
= 38.8 days
x 365
x 365
x 365
44,791
x 365
x 365
36,425
x 365
x 365
Revenue x 365
Non-current asset turnover shows an increasing rate. Inventory turnover at 50 days may indicate that inventory is being managed inefficiently, but we would need to know more about the business activities to be able to conclude on this point. It is gradually taking the business longer to collect trade receivables, although even at 43 days (assuming that trade receivables are allowed 30 days to pay), there is unlikely to be a serious problem.
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Note that the investor ratios are mostly irrelevant because of lack of information. No dividend has been paid in any of the years, and, of course, it would not be possible to calculate P/E ratio because the company is unlisted and so there is no market price for shares.
Gearing In the circumstances it is relevant to calculate gearing since the business has long-term borrowings of significant size: 20X3
20X2
20X1
Gearing:
57,000
57,000
57,000
Debt
57,000 + 97 368
57,000 + 82,695
57,000 + 75,459
Debt + equity
x 100
x 100
x 100
=
=
=
36.9%
40.8%
43.0%
Although debt remains constant at £57,000, equity gradually increases because of retained profits, so debt becomes relatively less important. Nevertheless, it is still significant at 36.9 per cent.
1. Points for Louise to consider in making an investment decision The business appears to be growing fairly rapidly, with increasing revenue, and non-current asset turnover. Current assets and liabilities are growing, but there do not appear to be any immediate liquidity problems. But it is not a particularly profitable business. Louise is being invited to buy into about 18 per cent of the shares of a business with equity at 31 March 20X3 of £97,368. Her ‘share’ of equity would be £97,368 x 18% - approximately £17,500 in exchange for £30,000 in cash. If the equity value in the statement of financial position approximates at all closely to current values it does not appear to be a very good bargain.
Also, a conscientious financial adviser should be pointing out to Louise that this type of investment is almost certainly not appropriate for someone in her position. Investing in shares is risky, and should really be undertaken only by people who are in a fairly sound
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financial position, and who could afford to lose all the money. Investment in a private limited company is especially risky. Usually, it is difficult, sometimes impossible, to get the money out again if it is needed for some other purpose. As Patrick points out, at least by investing in listed company shares, Louise would be able to turn her investments into cash again comparatively easily (although she might well lose money on such investments). It is up to Louise to make her own informed decision on the investment; she should try not to be influenced by either Ben or by her father. 2. Reservations about the information/more information required Ben asks Barney for the company figures towards the end of 20X4, but Barney is able to provide figures up to 31 March 20X3 only. Nine months or so after the year end of 31 March 20X4 it would be reasonable to expect 20X4 accounts to be available. If they are not yet available it may indicate some serious administrative problems within the business. There would be good grounds for serious doubts if the accounts had been prepared but Barney was unwilling to provide them. The question could be easily resolved by checking the latest filing at Companies House. Also, the information Barney provides is limited to the basic statement of profit or loss and statement of financial position. Although Barney assures Ben that the audit report is fine, he does not include it in the information; nor are the notes to the accounts or the directors’ report made available. This looks a little suspect.
Louise or any other potential investor, would need to know a great deal more about the prospects of the business and the directors’ plans for expansion in order to make an informed decision. As noted earlier in part 2, Louise is being invited to invest £30,000 for 18 per cent of a business which is worth, at book values, only around £17,500. The directors would no doubt argue that she would be buying into their expertise and the future prospects of the business, but, again, Louise would need to know a great deal more about these factors before she could commit to the investment. The other directors are not offering Louise a directorship and she will not, therefore, have much, if any, control over her investment.
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Chapter 9 Case Study 4 Solution 1. Accounting ratios
2023
2022
Gross profit margin
47.8%
49.1%
Operating profit margin
5.0%
8.4%
Profit margin
4.4%
7.6%
Interest cover
7.4
10.8
Pre-tax return on capital employed
16.7%
28.0%
Workings:
2023
2022
Gross profit margin (4,839.7/10,125.0) x
Gross profit margin: (4,208.0/8,563.0) x
100
100
Operating profit margin (509.8/10,125.0)
Operating profit margin (721.2/8,563.0) x
x 100
100
Profit margin (440.9/10,125.0) x 100
Profit margin (654.7/8,563.0) x 100
Interest cover (509.8/68.9)
Interest cover (721.2/66.5)
Pre-tax ROCE (440.9/2,633.4) x 100
Pre-tax ROCE (654.7/2,339.6) x 100
2. Report on the performance of JD Sports & Fashion plc in 2023 The accounting ratios calculated in part 1 show a deteriorating performance in the company between 2022 and 2023. On all measures, the company’s performance is worse.
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The gross profit margin has deteriorated only by a small amount, relatively speaking, but performance is much worse further down the statement of profit or loss. However, a review of the Chairman’s statement in the 2023 Annual Report suggests that 2023 was unusual. There have been several significant changes in the business’s board. A new chairman was appointed in the 2022/23 financial year, followed very quickly by a new chief executive. The chief financial officer also stepped down during this period, and there were changes to the non-executive structure of the board. The new chief executive, by the 2023 year end, had been in post for only four or five months and so had not had time to make many changes. However, the directors had decided, by the 2023 year end, to exit some of the fashion businesses with which the company is involved. The operating profit figure is after deduction of expenses. In the 2022/23 financial year, additional expenses were incurred as a result of strategic business decisions. The operating profit margin for 2023 (and the profit before tax) are quite likely to be unrepresentative of the group’s underlying performance, and the two sets of figures, for 2023 and 2022, are not strictly comparable. Fundamentally, the business remains profitable. The interest cover ratio, although it has worsened, does not give cause for concern, and the return on capital employed is likely to be quite acceptable to shareholders.
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Chapter 9 Case Study 1 Solution and discussion 1. Relevant accounting ratios The following table compares relevant ratios for the two companies Sainsbury
Tesco
2023
2022
2023
2022
(2,004/31,491)
(2,366/29,895)
(3,661/65,762)
(4,633/61,344)
margin
x 100 = 6.4%
x 100 = 7.9%
x 100 = 5.6%
x 100 = 7.6%
Operating
(562/31,491) x
(1,156/29,895)
(1,525/65,762)
(2,560/61,344)
100 = 1.8%
x 100 = 3.9%
x 100 = 2.3%
x 100 = 4.2%
(562/309) = 1.8
(1,156/322) =
(1,525/618) =
(2,560/551) =
3.6
2.5
4.6
(327/7,253) x
(854/8,423) x
(1,000/12,230)
(2,033/15,644)
100 = 4.5%
100 = 10.1%
x 100 = 8.2%
x 100 = 13.0%
Gross profit
profit margin Interest cover*
Pre-tax return on equity
*Interest cover has been calculated as (operating profit/finance costs). A valid approach would be to take net finance costs (finance costs less finance income) as the lower part of the fraction.
2. Report comparing the performance of Sainsbury’s and Tesco While both companies are major UK food retailers, it is worth pointing out that Tesco is a much larger company in terms of revenue and equity. Sainsbury's revenue in 2023 was only 47.9 per cent of Tesco's. Also, Tesco derives a substantial part of its revenue from outside the UK, whereas Sainsbury's is an almost entirely UK-based business. Comparing the 2022 and 2023 performance of the two companies, both have turned in poorer performance at gross and operating profit level. Sainsbury’s gross profit margin is slightly better than Tesco’s in 2023, but its performance at operating profit margin level is worse. Interest cover has deteriorated in both companies between the years, For use with Business Accounting and Finance 6th edition (ISBN 978-1-4737-9127-5) © Catherine Gowthorpe, 2024, published by Cengage
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and now stands at a low level. Pre-tax return on equity has declined in both companies. The earnings per share in both companies has fallen in 2023. Sainsbury has increased the number of stores by a net of two stores and has actually reduced its square footage. Tesco, on the other hand, has expanded the number of stores by 1.2% although it, too, has reduced its overall square footage. In summary, Tesco appears to be out-performing Sainsbury’s at the moment, although both businesses face pressures as demonstrated by Sainsbury’s Chairman’s statement and the reference by Tesco’s chairman to ‘circumstances outside our control’. Sainsbury’s operates only in the UK and Ireland, whereas a portion of Tesco’s revenues (around 8%) are earned outside the UK. The greater geographical spread may help to diversify risk. 3. There are factors that impact upon the comparability of the two sets of financial statements. The figures may not have been prepared or presented in exactly the same way - for example, there may be differences between classification of costs and expenses in cost of sales in the two companies. Such differences could affect the key gross profit margin ratio. The two companies may be applying International Financial Reporting Standards in slightly different ways (some of the standards offer a choice of accounting treatment). In addition, there are some differences in the nature of the information presented. Voluntary disclosures are unaudited and do not have to comply with an accounting standard. Also, there are business factors that undermine the comparability of the two companies. As noted earlier in the report, Tesco is very much larger than Sainsbury's. Usually, a larger company can take advantage of ‘economies of scale’ – for example, the ability to source products at lower prices because of the high volumes ordered. Also, Tesco's geographical profile is different. Tesco's strategy exposes it to greater risks in some respects - operating in overseas markets is likely to be riskier because of e.g. foreign exchange risks, and the risk of making misjudgements because of lack of knowledge of local conditions. On the other hand, Tesco is protected by its diversity of
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operations. If one market is doing badly, others may be doing well, and the effects offset each other
4. Advice to Reiner Reiner shares an attitude towards investment which is quite common: he would like to obtain good returns, but to minimize the risk of loss. Each investor must aim to find the appropriate balance between risk and return. Because Reiner is relatively more riskaverse than some investors he should confine his investment activities to investments in solid, well-established companies. He should realize, however, that investment in shares always carries some risk, even where the companies are well-established, like Sainsbury’s and Tesco. It makes sense to diversify risk as far as possible. Reiner might consider investing in both companies because of the difference in their profiles. Tesco’s greater size and diversity in operations may mean that it is not so vulnerable to adverse economic consequences. It is impossible to guarantee that Reiner will not lose money on his investments in shares. Apart from company specific issues there is the risk of more general downward movements in markets. If Reiner wants to invest in shares, he must be able to accept the risks involved. If he cannot accept the risks, he should probably put the money into a managed fund, or even a cash ISA if he is really not prepared to take any risk. Also, he should be prepared to undertake, or pay for, more thorough analysis than is presented here.
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Case study 2 for Chapter 10 Solution 1. Private equity: brief summary
(Note: there are numerous sources of information on private equity. The brief summary below is from www.forbes.com/advisor/investing/private-equity/ but there are many other possible sources).
The private equity market offers an alternative to conventional methods of raising capital. Private equity has become more and more attractive to both business and private investors. ‘In the third quarter of 2021, private equity deal value reached a new record, topping $787 billion for the year’.
PE funds typically invest in established businesses that are underperforming or that have growth potential that is not being exploited. PE funds may buy up the entire company or a substantial part of it, sufficient to have the authority to install new management where appropriate. Typically, after a period of intensive management, the investment will be sold on again, or possibly floated on the stock market via an Initial Public Offering (IPO). The private equity fund thus realizes its investment and potentially makes a significant profit on the deal.
These investments are usually risky, and are open only to established investment companies or people with a high net worth who are apprised of the risks and are able to sustain potential losses.
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2. Three large businesses that are owned and managed by private equity
1. Morrisons supermarket chain in the UK. In October 2021 Morrison’s existing shareholders approved a takeover offer from a US private equity group (Clayton, Dubilier and Rice). This deal was worth £7bn. 2. Also in 2021, Clayton, Dubilier and Rice acquired Wolseley UK, a leading specialist distributor of plumbing and infrastructure supplies. 3. Blackstone and the Benetton family paid £42.7bn in 2022 to privatize the Italian infrastructure group Atlantia.
The third example, Atlantia, comprised the highest value PE transaction in 2022, according to a report by PwC, the accounting firm. For those who would like to read more on the subject, the 2023 PwC report on private equity trends is worth a look: www.pwc.de/en/private-equity/private-equity-trend-report.html
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Chapter 10 Case Study
Solution and discussion The situation outlined in the case study is by no means unusual. The founder of a company who remains in control through a period of growth is often unwilling to accept that the nature of the business has changed. The approach to business management which worked so successfully when the business was small may not be appropriate once it has grown past a certain point. The investors, Walter and Jennifer, have managed to persuade Paco to bring in additional management expertise, but the new directors clearly face a struggle if they are to bring Paco round to their way of thinking about management information.
1. Tracey and Karim’s point of view In order to illustrate the need for management information in the company we will look at the four proposals made by the new directors:
1. Introduce a commission scheme for the sales force based on the extent to which their actual performance exceeds budget performance A system of commission to reward the sales force can often be an effective way of motivating staff to increase sales. However, management needs to be sure that the scheme is set up in such a way that: •
It does not cost more than the additional profit which can be generated from extra sales.
•
It is fair to all staff and sets achievable targets (if the targets are too high staff are likely to be demotivated).
This proposal will require a decision, based upon an informed analysis of the existing costs involved in running the sales force and upon future projected figures. Various types of commission scheme are possible, and a range of options could be considered.
2. Concentrate sales efforts on the more profitable ranges of cards We know from the details in the case that the company’s gross profit margin has been falling. It might make sense to concentrate on the more profitable ranges of cards, but, as
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Tracey points out, in order to do so the directors need to know which ranges are most profitable. There is no management information on this point, making it very difficult to plan and make realistic decisions for the future. This is a good example of the need for detailed costing information.
3. Invest in some new printing equipment This is another proposal which involves a decision. There may be several possible courses of action here, and information will be needed on all of them before an informed decision can be made. The directors really need to know quite a lot about: •
the costs of running the existing production facility
•
the extent and cost of the wastage which appears to be taking place
•
projected costs of alternative production facilities.
Until and unless this type of information is made available the directors will find it impossible to reach a properly informed decision.
4. Employ designers to work full-time for the company This is another proposal which involves the directors in decision-making. As Karim says, they need to compare the costs of employing designers with the costs of buying in work from freelance designers. There are several aspects to this type of decision, not all of which are related to cost. For example, employing a team of designers might lead to a stronger corporate approach to design. On the other hand, the designs might become predictable and repetitive over time if they are being produced by the same team.
These proposals all involve, to a greater or lesser extent, decision-making. Managers and directors of businesses need relevant information to feed into the decision-making process, so that they can make fully informed appraisals of alternative courses of action. It is quite clear that the directors of Calder Calloway do not have information to hand which will permit them to do this. Their ability to plan and to control the business is severely constrained because of the lack of management information.
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In short, management information can help managers in planning, controlling and decision making.
2. Paco’s point of view Is there anything to be said for Paco’s point of view? He does not appear to accept the need for any formalized source of management information, and thinks he can continue to run the business by instinct as he did in its early days. This is not a realistic approach. However, Paco’s views have some validity in that the cost of provision of management information is an important factor. Managers need to have enough relevant information upon which to base their decisions, but the process of providing information must, itself, be controlled. Sometimes organizations are criticized for having excessive bureaucracies and too much paperwork. Sometimes, accountants get the blame for being responsible for pushing too much paper around the organization.
Calder Calloway, however, is an organization that clearly lacks relevant information, and Paco should be persuaded to implement some systems which will provide what is necessary in order to plan, control and make decisions effectively.
Tutorial Note: A final, very important, point In their enthusiasm to get started in their new jobs and to make a positive impact on the company both Tracey and Karim have produced lists of ideas for consideration. This is premature; they are rushing into action without considering the longer-term strategy of the business. What are the objectives of the business? What are its priorities in the mid- to longterm? What strategic decisions need to be made in order to achieve the objectives? These issues need to be thrashed out and decided at board level – the directors are ultimately responsible for deciding on where the business should be going. Then, and only then, is it appropriate to consider the detailed aspects such as those suggested by Tracey and Karim.
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Chapter 12 Case Study Solution and discussion a) Overhead apportionment Basis
Total
Cutting
Assembly
£
and
and
turning
finishing
£
£
Factory rental
Floor area
75,000
52,500
22,500
Factory insurance
Floor area
7,600
5,320
2,280
Cleaning
Floor area
8,900
6,230
2,670
Canteen
No of employees
11,100
3,552
7,548
Floor area
9,500
6,650
2,850
Actual
22,500
15,200
7,300
Machinery maintenance
No of call-outs
16,464
14,112
2,352
Machinery depreciation
Net book value
30,000
25,000
5,000
Canteen depreciation
No of employees
3,500
1,120
2,380
Supervisors’ wages
Actual
57,936
29,716
28,220
Other factory costs
Floor area
23,000
16,100
6,900
265,500
175,500
90,000
Factory rates Electricity
The total production overhead apportioned to the cutting and turning cost centre is £175,500 The total production overhead apportioned to the assembly and finishing cost centre is £90,000.
b) i) overhead absorption rate on the basis of machine hours Cutting and
Assembly and
turning
finishing
Production overhead
175,500
90,000
Machine hours
22,500
5,000
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Overhead absorption rate
£7.80
£18.00
b) ii) overhead absorption rate on the basis of labour hours Cutting and
Assembly and
turning
finishing
Production overhead
175,500
90,000
Labour hours
12,500
25,000
Overhead absorption rate
£14.04
£3.60
c) Machine hours The details of the number of machine hours spent on each product are given in the case study (be careful not to get machine hours confused with labour hours).
Greenhouse Dept C&T
2 hours x
Garden chair £
Dept
15.60
C&T
£7.80 A&F
0.5 hours x
2.50 hours x
19.50
£7.80 9.00
A&F
£18.00 Total
£
0.50 hours x
9.00
£18.00 £24.60
Total
£28.50
If 5,000 greenhouses and 5,000 garden chairs are produced and sold the total overhead absorbed will be: Greenhouses: 5,000 x £24.60
= 123,000
Garden chairs: 5,000 x £28.50
= 142,500 265,500
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Labour hours The labour hours spent in each department on greenhouses and garden chairs are given in the prime cost details in the case study. Greenhouse Dept C&T
1 hour x
Garden chair £
Dept
14.04
C&T
£ 1.50 hours x
£14.04 A&F
2 hours x
£14.04 7.20
A&F
3 hours x
£3.60 Total
21.06
10.80
£3.60 £21.24
Total
£31.86
If 5,000 greenhouses and 5,000 garden chairs are produced and sold the total overhead absorbed will be: Greenhouses: 5,000 x £21.24
= 106,200
Garden chairs: 5,000 x £31.86
= 159,300 265,500
(Tutorial note: This example demonstrates that, whichever method of overhead absorption is selected, the total amount of overhead absorbed remains the same. The only difference is the way in which the total overhead is allocated to products.)
d) For this part of the case, we use the overhead absorption information calculated in part c) together with the prime cost information given in the case study.
Greenhouse (per unit) Overhead
Overhead
absorption –
absorption – labour
machine hours
hours
£
£
Selling price
85.00
85.00
Less: prime cost
(32.00)
(32.00)
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Less: overhead absorbed
(24.60)
(21.24)
Gross profit
28.40
31.76
NB: Gross profit %age
33.4%
37.4%
Garden seat (per unit) Overhead
Overhead
absorption –
absorption – labour
machine hours
hours
£
£
Selling price
103.00
103.00
Less: prime cost
(45.00)
(45.00)
Less: overhead absorbed
(28.50)
(31.86)
Gross profit
29.50
26.14
NB: Gross profit %age
28.6%
25.4%
Tutorial note It is important to remember that there is no definitively correct way of absorbing production overheads. From the figures given above the greenhouses certainly appear to be relatively more profitable than the garden seats. However, the gross profit and gross margin per unit depend to some extent on the basis of overhead absorption used.
Because of this variability, figures based upon the absorption method of accounting (i.e. including production overheads) are not likely to be reliable for decision-making which involves questions such as: How much more profitable is one product than another? Which product should we concentrate on producing? How much of product X should we produce? Students should be aware that absorption costing, while it is useful for information and for stock valuation, should be treated with some caution as a tool for decision-making. For use with Business Accounting and Finance 6th edn (ISBN 978-1-4737-9127-5) © Catherine Gowthorpe, 2024, published by Cengage
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e) The cutting and turning department relies more heavily on mechanized processes and for this reason it may be more appropriate to use an overhead absorption rate based on machine hours in respect of overheads allocated and apportioned to this cost centre. The assembly and finishing department, by contrast, is much more heavily reliant upon manual processes, and so the use of an overhead absorption rate based on labour hours may make more sense in this cost centre.
f)
The effect on product cost would be as follows:
Overheads absorbed, per unit of product Greenhouse Dept C&T
Garden seat £
Dept
15.60
C&T
2 machine
£ 2.50 machine
hours x
19.50
hours x £7.80
£7.80 A&F
2 labour
7.20
A&F
3 labour hours
hours x
10.80
x £3.60
£3.60 Total
£22.80
Total
£30.30
Effect on total production cost per unit and on gross profit per unit: Greenhouse
Selling price
Garden seat
£
£
85.00
103.00
Prime cost
32.00
45.00
Production overhead absorbed
22.80
30.30
Production cost per unit
54.80
75.30
Gross profit
30.20
27.70
NB: Gross profit %age
35.5%
26.9%
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Tutorial note If we compare these with the equivalent calculations in part d) we can see that using different overhead absorption rates for the two departments produces a gross profit per unit that lies between those calculated earlier. Because this approach steers a middle course by using machine hours for one cost centre and labour hours for the other, it may be most appropriate in the circumstances.
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Case study for Chapter 13 Solution 1. There are only two major retail grocers in New Zealand: Foodstuffs and Woolworths. Although the report notes the existence of other competitors at the fringes of the market, such competitors do not provide choices for all consumers, and have a limited impact only. The market in New Zealand therefore is a duopoly. The ComCom discovered that most consumers continue to shop with one of the two main retail grocers. Competition between the two retail grocers is ‘muted’, and does not reflect competition. Prices are, therefore, higher than they would be if there was a truly competitive market, and prices appear high by international standards. The two major retailers are each other’s closest competitors and they have well-known and similar competitive strategies. They can easily monitor each other’s prices and quickly respond to any changes. The ComCom expects that competition would be more intense if there were more large-scale grocery retailers. However, there are high barriers to entry into this market. There is a lack of suitable sites for development of rival grocery stores. This arises from a range of problems: restrictive planning laws, costs, delays and uncertainty related to planning, and the existence of restrictive covenants in land purchases and leases (this means, for example, imposing a restriction in a lease in allowing competitors to operate in nearby sites). Another difficulty is that of obtaining competitively priced wholesale supplies of grocery products. The two large retailers are in a position to negotiate good terms with suppliers. The report notes, however, that new, smaller, competitors would be disadvantaged, for example, because they lack the resources to negotiate volume discounts. The report finds that the two major retailers achieve higher profitability than would be expected. An estimated reasonable Return on Average Capital Employed (ROACE) is 5.5% but the actual returns are well over 12%. Prices charged to consumers do appear to be relatively higher than those paid elsewhere in the world. New Zealand consumers consider that they pay more than they would in other countries. As well as being potentially unfair to consumers, the current position is unfair to suppliers, because there is an imbalance in bargaining power. Because there are only two major retailers, there is limited competition for suppliers’ products. Also, because of the lack of other customers, suppliers are in a weak bargaining position. They cannot afford to antagonize the two major retailers because of the threat of having their products removed from the retailers’ shelves.
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2. The report identifies a key recommendation to improve conditions for entry and expansion into the NZ grocery market. Two main areas are identified: • •
Freeing up sites for retail grocery stores Improving access to groceries for resale
In order to free up sites, amendments will have to be made to planning laws to ensure that more land is made available, and to limit the grounds on which new developments can be declined. It would also be necessary to restrict, or make unenforceable, restrictive covenants that impede the development of competition. The report suggests that improving access to supplies for new entrants to the market could be achieved by requiring one or both of the major retailers to voluntarily offer supply of goods to new entrants at wholesale prices. This would allow new entrants to gradually develop their own direct relationship with suppliers. Related to this last suggestion, the report recommends a mandatory grocery code of conduct and sharpening up regulation relating to unfair contract terms. The code of conducts would require competitors to act in good faith, and would require access to a timely, independent and affordable dispute resolution process. A further set of recommendations relates to improving consumers’ ability to make informed decisions on purchasing. Pricing and promotions should be simple and easy to understand, and retailers should co-operate with price comparison websites. New rules should be introduced in order to ensure a standard presentation and format for unit pricing. Finally, the report recommends the establishment of a new grocery sector regulator. Also, a review should be taken (three years after the implementation of the new recommendations) to assess effectiveness in practice. 3. Answers to this requirement will depend upon students’ location.
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Chapter 14 Case Study Solution and discussion a) In calculating contribution as the basis for deciding on whether or not to accept an order, Vinnie’s general approach to the business problem is fine, in principle. Because the business does not have costing systems it has obviously been difficult for him to establish totals for variable and fixed costs. In consequence, he has had to use estimates, and, of course, these may be quite inaccurate. His basic conclusion, that there will be a positive contribution to fixed overheads from the Jay Johnson contract, appears to be supported by the calculations.
b) The figures show that the business is certainly profitable, but not very profitable. Net profit as a percentage of sales is only about 6 per cent. Also, the margin of safety at current level of sales appears small. It is possible to calculate an estimated margin of safety based on Vinnie’s figures. Break-even point in units =
Fixed costs Contribution per unit = £591,400 650 =
910 (to nearest unit).
Actual sales in 20X7 were 1,030 ranges, a margin of safety of 120 units, or 11.7 per cent of actual sales. Arthur and Vinnie should perhaps be looking at the overall profitability of the business as well as thinking about negotiating special prices on contracts. It may be that costs are not very well controlled. Costs are perhaps higher because of inefficiencies in the production process. Vinnie mentioned the very high cost of heating, and if the factory building is of a poor standard there may be other high costs in maintenance, cleaning and insurance.
c) Although A & A Wright is, clearly, a profitable business, it appears to be facing several problems. Arthur plans to have Vinnie take over the business, but he is not finding it easy to let Vinnie have any say in running it. Arthur is probably going to find it harder than he anticipated to let his son take over completely. In family businesses like this one, relationship problems can create major obstacles to the smooth running of the business. The case study For use with Business Accounting and Finance 6th edn (ISBN 978-1-4737-9127-5) © Catherine Gowthorpe, 2024, published by Cengage
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describes a classic succession problem; the father unwilling to admit that his son may be right, and the son equally reluctant to allow that his father might just know a thing or two about running a business.
Is Vinnie correct? If we try to decode what Vinnie is saying, it’s actually about a great deal more than the acceptance or non-acceptance of the contract; the sub-text is one of impatience with his father’s approach to running the business. Vinnie wants to introduce a more systematic approach to management, using accounting figures to help make business decisions. He also sees, as perhaps his father cannot, that the factory itself has become a liability. Because he has a business studies education he feels, rightly, that he knows a great deal and is capable of generating good ideas. What he obviously lacks is the experience of making real business decisions.
What about Arthur’s view? Arthur is impatient with Vinnie’s use of figures as an aid to decision making. He dismisses the notion of ‘positive contribution to fixed overheads’ with contempt. However, he does have a point: there are other factors apart from the figures to consider. If the business sells at such a large discount what impact will there be on other sales? If Leonard of Leonard’s Kitchens discovers that Jay Johnson, a new customer, is getting a £250 discount, he will no doubt feel entitled to object to receiving a £30 discount. Accepting this contract may mean a general drop in the selling prices that A & A Wright can command.
Where do Arthur and Vinnie go from here? They have some major problems to tackle, none of which can be solved unless they can find some way of working harmoniously together. One approach would be to take some advice to help them build a strategy for the business that they can both agree on, perhaps by employing the services of a management consultant (but imagine what Arthur would say about that suggestion!). If they do not employ outside help, they will have to solve the problems themselves. However, their relationship appears to be deteriorating fast, and they may find themselves unable to resolve the problems on their own.
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d) If the order from Jay Johnson was accepted, and led to a general fall in selling prices to £1,050 per range, what would be the effect on the business? Contribution would fall to approximately £420 per range, and the break-even point would become higher. We can estimate a new break-even point based upon lower contribution: Break-even point in units
=
£591,400 420
=
1,408 units (to nearest whole unit).
This level of sales is clearly impossible under current circumstances; even if 1,408 sales could be sold in theory, the factory capacity at 100 units per month is a limiting factor. If the order were accepted, and if it led to a general fall in prices, the business could be in serious trouble, and might even go under.
Tutorial note The case study illustrates the following points about decision-making: •
Calculations of break-even, contribution and so on, can be very useful in providing input to business decisions.
•
There are always other factors to consider. The correct decision may seem obvious on paper, but matters are rarely so clear in practice.
•
Making business decisions is really difficult, especially where human factors play a major role (and that is often the case).
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Chapter 15 Case Study 2 Ortega Ruiz – Solution and discussion
a) NPV calculations Gina Time
Cash flow
Discount factor
Discounted cash
(from table)
flow
£
£
0
(340,000)
1
(340,000)
1
(15,000) + 85,000
0.901
63,070
2
85,000
0.812
69,020
3
85,000
0.731
62,135
4
85,000
0.659
56,015
5
85,000
0.594
50,490
5
50,000
0.594
29,700
Total
(9,570)
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Gary Note that the expenses of travelling to visit machinery manufacturers are regarded as sunk costs for the purposes of capital investment appraisal. They are not, therefore, taken into account in the NPV and IRR calculations. Time
Cash flow
Discount factor
Discounted cash
(from table)
flow
£
£
0
(260,000)
1
(260,000)
1
60,000
0.901
54,060
2
80,000
0.812
64,960
3
80,000
0.731
58,480
4
80,000
0.659
52,720
5
80,000
0.594
47,520
5
20,000
0.594
11,880
Total
29,620
b) IRR (using Excel) Gina IRR is 9.7% Gary IRR is 14.9%
c) The directors clearly cannot agree on a set of criteria for capital spending decisions, because they have quite different approaches to business decision making. Emilio prefers to work on instinct; his decisions are not informed by any consideration of detail. Gonzalo, on the other hand, prefers a more structured approach. Emilio ‘feels’ that Gina’s entrepreneurial proposal should be accepted, but the figures do not bear this out. Using the company’s cost of capital of 11 per cent the For use with Business Accounting and Finance 6th edition (ISBN 978-1-4737-9127-5) © Catherine Gowthorpe, 2024, published by Cengage
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project produces a negative net present value. The IRR of the project is actually fairly close to the cost of capital (10%), and it is possible that the directors might want to consider it further. Perhaps some market research on the potential market for chocolate bars with fillings could be undertaken.
Gary’s proposal produces a positive net present value, and an IRR that is substantially in excess of the company’s cost of capital. Emilio’s reaction against this project seems to be based partly upon his perception of Gary’s management skills. However, Gary took over the division only a couple of years ago, and it may be that problems with ageing machinery have had an adverse effect on the division’s profitability during that period. It may be unfair to blame Gary for a problem over which he has no control. If the directors wish to retain the pastille-making operations they will have to make the decision to replace the machinery sooner or later. Emilio thinks that the existing machinery has another couple of years of life in it, but perhaps it would be sensible to have the condition of the machinery assessed by an expert engineer. The directors must decide on whether or not they intend to retain pastille making as a key part of the company’s operations. If so, it is likely to be in the best interests of the company overall to invest sooner rather than later.
Gonzalo is correct in maintaining that the two projects are not strictly comparable, and in his view that they should be examined in the context of the long-term strategic plan. His remarks suggest that such a plan actually exists, so the directors have presumably thought about some key issues relating to the development of the business. The directors should try to reach agreement about the criteria for capital spending. They probably need more detailed information in order to be able to assess the validity of capital expenditure proposals. At Emilio’s insistence, proposals for consideration by the directors are kept to a bare minimum. There are some merits For use with Business Accounting and Finance 6th edition (ISBN 978-1-4737-9127-5) © Catherine Gowthorpe, 2024, published by Cengage
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in this approach; it forces managers to be concise and to concentrate on the really important facts. However, it means that the directors are not likely to be fully informed about the thinking behind the proposals. It is clear in this case that the directors need to thoroughly rethink their approach to capital investment decision making.
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Case study 3 for Chapter 15 Solution 1. Just under 6% 2. £2.2 billion 3. Some NHS buildings and equipment fell into increasing disrepair, with rising numbers of patients experience safety incidents caused by estate or infrastructure failures. 4. £11.3 billion
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Chapter 15 Case Study 1 Lawson Pollard – Solution and discussion
a) NPV calculations Year
Discount
Realistic
Discounted
Optimistic
Discounted
factors
cash flows -
cash flows -
(12%)
realistic
optimistic
£000
£000
£000
£000
0
1
(7,800)
(7,800)
(7 800)
(7,800)
1
0.893
1,380
1,232.34
1 680
1,500.24
2
0.797
1,470
1,171.59
1 770
1,410.69
3
0.712
1,530
1,089.36
1 860
1,324.32
4
0.636
1,590
1,011.24
1 950
1,240.20
5
0.567
1,650
935.55
2 040
1,156.68
6
0.507
1,710
866.97
2 130
1,079.91
7
0.452
1,770
800.04
2 220
1,003.44
8
0.404
1,830
739.32
2 310
933.24
9
0.361
1,890
682.29
2 400
866.40
10
0.322
1,950
627.90
2 490
801.78
10 (sale of
0.322
180
57.96
300
96.60
plant) Total
1,414.56
3,613.50
Both the realistic and the optimistic projections produce a positive NPV. The realistic ratio of positive cash flows to initial investment is: 9,214.56
= 1.18
7,800 The optimistic ratio of positive cash flows to initial investment is: 11,413.50
= 1.46
7,800
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The optimistic plan, naturally, produces a higher ratio than the realistic plan. However, would it be high enough? If Donna produces a better proposal for the plastics division it is likely to be preferred.
b) The company’s approach to capital investment decisions is highly competitive and it places divisional managers under a lot of pressure. Ernie, the chief executive, encourages this approach on the grounds that it acts as an incentive to management teams. This argument does have some force, and indeed, the circumstances in the case demonstrate a positive strength of the approach - Doug has been goaded by fear of competition into genuinely considering ways to improve the management and operational effectiveness of his division. However, there are several weaknesses in the approach: •
It may mean that one or two divisions are starved of capital funding simply because their managers have poorer presentational skills;
•
It may encourage managers to exaggerate the figures in their bids in order to be able to compete with other divisions;
•
It has led to collusion between divisional managers in the past; this type of collusion may not be in the best overall interests of the company;
•
Senior management should really be looking at capital funding bids with a view to assessing the extent to which they address the strategic objectives of the business. The competitive bidding system may reward the best bids, but it has resulted in the cardboard division operating inefficiently with fully-depreciated machinery and demoralized local management. Surely senior management did not intend this situation to develop?
c) Doug is proposing to put forward a bid for funding based upon quite unrealistic estimates of future performance. Where local managers are placed under a great deal of pressure, they may react by exaggerating performance, both present and future. This is a step on the road towards outright fraudulent reporting. At the very least, Doug’s proposal might be regarded as somewhat unethical. Doug, himself, would no doubt argue that he has been forced into this position because of senior management’s system of allocating capital funds. He might also argue that, in trying to secure funding for his division, he is ensuring that people keep their jobs (including himself, of course), and that ‘the end justifies the means’. For use with Business Accounting and Finance 6th edn (ISBN 978-1-4737-9127-5) © Catherine Gowthorpe, 2024, published by Cengage
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The approach to capital budgeting in this business is flawed. A system of competitive bidding has resulted in a senior manager in the business trying to subvert the process by projecting figures which are unrealistically optimistic. This cannot be in the best long-term interests of the company. Senior managers should be wary of instituting systems which encourage this type of behaviour.
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Chapter 16 Case Study 2 Piers – Solution and discussion
1. Piers – Cash flow forecast for six months ending 30 September April
May
June
July
August
Sept
£
£
£
£
£
£
2,500
Receipts Weddings
–
3,000
2,500
2,500
2,500
Corporate events
–
–
–
6,000
6,000
–
3,000
2,500
8,500
8,500
2,500
Payments Marquee
28,000
Furniture
8,000
Advertising
1,000
Stationery etc
400
Labour (working 1)
–
400
2,000
2,000
400
400
Truck hire (working 1)
–
550
2,750
2,750
550
550
37,400
950
4,750
4,750
950
950
40,000
2,600
4,650
2,400
6,150
13,700
Receipts
–
3,000
2,500
8,500
8,500
2,500
Payments
(37,400)
(950)
(4,750)
(4,750)
(950)
(950)
2,600
4,650
2,400
6,150
13,700
15,250
Opening balance
Closing balance
Working 1: payments for labour and truck hire It is assumed that labour and truck hire must be paid for immediately. The following number of events are scheduled to take place: May – 1 wedding. £400 for labour and £550 for truck hire.
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June – 1 wedding + 4 evening events = 5 events in all. Each event costs £400 in labour (total £2,000) and £550 for truck hire (total £2,750) July – 1 wedding + 4 evening events = 5 events in all. Total for labour and truck hire is the same as for June. August – 1 wedding. £450 for labour and £550 for truck hire. September – 1 wedding. £450 for labour and £550 for truck hire.
2. Piers – Budget statement of profit or loss for six months ending 30 September £
£
Sales (3,000 + 2,500 + 8,500 + 8,500 + 2,500)
25,000
Expenses Advertising
1,000
Labour (400 + 2,000 + 2,000 + 400 + 400)
5,200
Truck hire (550 + 2,750 + 2,750 + 550 + 550)
7,150
Stationery
400
Depreciation – marquee (working 1)
3,000
Depreciation – furniture (working 2)
1,000 17,750
Net profit
7,250
Working 1 Depreciation of marquee Depreciable amount = cost – residual value = £28,000 – 4,000 = £24,000 Over four years on the straight-line basis: £24,000/4 = £6,000 per year. For six months the charge is £3,000.
Working 2 Depreciation of furniture Depreciable amount = £8,000 (Piers estimates no residual value)
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Over four years on the straight-line basis: £8,000/4 = £2,000 per year. For six months the charge is £1,000. Piers – Budget statement of financial position at 30 September £
£
ASSETS Non-current assets Marquee at cost
28,000
Less: accumulated depreciation
(3,000)
Net book value
25,000
Furniture at cost
8,000
Less: accumulated depreciation
(1,000) 7,000
Non-current assets at carrying amount
32,000
CURRENT ASSETS Cash at bank
15,250 47,250
CAPITAL Capital introduced
40,000
Profit
7,250 47,250
3.
Piers has assumed that his parents will store the marquee at their home, free of
charge, and that they will let him use their phone for business purposes. Piers’ parents will, presumably, want him to make other arrangements in the longer term. Therefore, in order to assess the viability of the business, he should take reasonable storage and telephone expenses into account, even if he will not have to pay them immediately. He has made no allowance for insurance. If one of his workers has an accident while putting up or taking down the marquee, Piers could be personally liable and the uninsured loss is potentially very large. If the marquee collapsed on the wedding guests For use with Business Accounting and Finance 6th edn (ISBN 978-1-4737-9127-5) © Catherine Gowthorpe, 2024, published by Cengage
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the liability could be even greater. Piers must recognize the need to insure his business against this type of risk.
Piers is proposing to ignore ‘all that tax nonsense’. This is extremely unwise. He should make proper arrangements to deduct income tax from his employees’ wages and to account fully for National Insurance obligations. In all probability, he will need to employ an accountant to help with this aspect of the business, and to make sure that adequate records are kept for income tax, and possibly VAT, purposes.
The budget statement of profit or loss and statement of financial position take six months’ depreciation into account. However, Piers’ business is likely to be highly seasonal in nature (who wants to hire a marquee for a January wedding in the UK?). The six-month period between April and September is likely to be his busiest period, and he may get no other business outside these months. If that is likely to be the case, he should perhaps take into account a full year’s depreciation in the draft accounts. If he were to do this, his budget profit would fall by £4,000 (£3,000 for the marquee and £1,000 for the furniture).
4.
The budget statement of profit or loss shows a profit of £7,250 for the six-month
period. This represents a profit margin of 29 per cent, which might be considered quite a good return. However, once the seasonal nature of the business is considered, plus the other expenses in 3. above that Piers has not yet considered, the business proposition looks less promising. If a reasonable allowance were to be made for the expenses in c) Piers might find that his budget profit is an extremely small figure (and indeed, it may even turn into a loss). In order to plan the business properly he needs to consider the full range of costs. Only then will he be able to assess whether the proposition is viable or not. If he can significantly increase the volume of business that he does over the summer months (for example, one or more weddings each week) then the proposition could be profitable.
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At the moment, Piers has not spent enough time thinking through the financial implications and considered all the relevant costs.
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Chapter 16 Case Study 1 Pete – Solution and discussion 1. Working Sales receipts can be estimated as follows from the information given in notes 1 and 2 above:
Month
Calculation
£
1
55 customers per day for 26 days x £4.50 average spend
6,435
2
55 customers per day for 26 days x £4.50 average spend
6,435
3
55 customers per day for 26 days x £4.50 average spend
6,435
4
60 customers per day for 26 days x £4.50 average spend
7,020
5
60 customers per day for 26 days x £4.50 average spend
7,020
6 - 12
65 customers per day for 26 days x £4.50 average spend
7,605
Cost of sales is, in each case, estimated at 28 per cent of sales revenue (if gross profit percentage is 72 per cent, cost of sales percentage is therefore 28 per cent). From this, and the information and assumptions given, it is now possible to prepare the cash flow forecast, and the budget statement of profit or loss and statement of financial position:
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Pete: cash flow forecast for first year of trading
Month
Receipts (sales)
1
2
3
4
5
6
7
8
9
10
11
12
Total
£
£
£
£
£
£
£
£
£
£
£
£
6,435
6,435
6,435
7,020
7,020
7,605
7,605
7,605
7,605
7,605
7,605
7,605
86,580
1,802
1,802
1,802
1,966
1,966
2,129
2,129
2,129
2,129
2,129
2,129
2,129
24,241
Payments Cost of sales (28% x sales) Legal fees
3,000
3,000
Launch party
2,300
–
–
–
–
–
–
–
–
–
–
–
2,300
Advertising
1,000
–
400
–
–
200
–
–
–
–
–
–
1,600
Wages
233
233
234
233
233
234
233
233
234
233
233
234
2,800
Rental
5,000
–
–
5,000
–
–
5,000
–
–
5,000
–
–
20,000
Business rates
2,600
2,600
Water rates
72
72
71
72
72
71
72
72
71
72
72
71
860
Power, heat, light
–
–
400
–
–
400
–
–
400
–
–
400
1,600
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Phone charges
–
–
200
–
–
200
–
–
200
–
–
200
800
500
–
–
–
–
–
–
–
–
–
–
–
500
–
–
–
–
600
–
–
–
–
–
–
600
1,200
Drawings
2,000
2,000
2,000
2,000
2,000
2,000
2,000
2,000
2,000
2,000
2,000
2,000
24,000
Total payments
15,907
4,107
7,707
9,271
4,871
5,234
9,434
4,434
5,034
9,434
4,434
5,634
85,501
Opening balance
5,000 (4,472) (2,144) (3,416) (5,667) (3,518) (1,147) (2,976)
195
2,766
937
4,108
Add: receipts
6,435
7,605
7,605
7,605
7,605
Insurance Accountant’s fees
6,435
6,435
7,020
7,020
7,605
7,605
7,605
Less: payments
(15,907) (4,107) (7,707) (9,271) (4,871) (5,234) (9 434) (4,434) (5,034) (9,434) (4,434) (5,634)
Closing balance
(4,472) (2 144) (3,416) (5,667) (3,518) (1,147) (2 976)
195
2,766
937
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4,108
6,079
3
Pete: Budget statement of profit or loss for first 12 months of trading
£ Sales
86,580
Less: cost of sales
(24,241)
Gross profit
62,339
Expenses (excluding depreciation)
(37,260)
Depreciation: £13,000/5
(2,600)
Net profit
22,479
Pete: Budget statement of financial position at the end of year 1
£ ASSETS Non-current assets at cost
13,000
Less: accumulated depreciation
(2,600)
Non-current assets at carrying amount
10,400
Cash at bank
6,079 16,479
CAPITAL AND LIABILITIES Capital at beginning of year
15,000
Add: profit for the year
22,479 37,479
Less: drawings
24,000 13,479
Liabilities Loan: Dave
3,000 16,479
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2. The bottom line of the cash flow statement shows us the maximum amount that Pete would need to borrow. The largest negative figure occurs in month 5 – £5,667. However, it is possible that revenue will be less than expected and/or expenses will be higher, in which case the maximum negative figure could be substantially worse. It would be sensible to look at 'what if' scenarios, identifying the worst likely figures in each category of income and expense, in order to identify the maximum borrowing required. Even if the estimates turn out to be accurate, the business will have increased its cash resource by only a little over £1,000 in the first year of business. There are some nonrecurring set-up costs, like the legal expenses in month one, but much of the expenditure is recurring and so future years' profits and net cash inflow may not improve by very much. Pete's budget profit for the year is £22,479, but he will have drawn more than that (£24,000) out of the business. It is worth bearing in mind, too, that in real life Pete would have to save enough cash to pay income tax on the profits of the business. Pete's prospects of success depend upon how he defines 'success'. His business is budgeted to produce both a positive cash inflow and a net profit in its first year, which might well be regarded as a success. However, he is taking on a lot of risk in starting a new business venture, and it may be that the return does not justify the risk involved.
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Chapter 17 Case Study Francis & Follett Limited – PART 1 – Solution and discussion
1. Francis & Follett Limited: Flexed budget for 1,650 units for March 20X4 £ Sales: 1,650 units x £103
169,950
Costs: Direct materials: 1,650 units x (12 metres x £2.50 per metre)
(49,500)
Direct materials: 1,650 units x 1 bag of metal components x £4.50
(7,425)
Direct materials: 1,650 units x 1 packaging box x £3.50
(5,775)
Direct labour: 1,650 units x (2.5 hours x £6.00 per hour)
(24,750)
Variable production overheads: 1,650 units x (1.5 machine hours
(9,900)
per unit x £4) Fixed production overheads: 1,650 units x (1.5 machine hours per
(24,750)
unit x £10) 47,850 Selling and administration overheads
(16,600)
Net profit
31,250
Summary of original budget, flexed budget and actual statements:
Sales
Original
Flexed
Actual
budget
budget
£
£
£
164,800
169,950
169,950
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Direct materials: wood
(48,000)
(49,500)
(54,351)
Direct materials: components
(7,200)
(7,425)
(7,425)
Direct materials: packaging
(5,600)
(5,775)
(5,775)
Direct labour
(24,000)
(24,750)
(23,760)
Variable production overheads
(9,600)
(9,900)
(10,050)
Fixed production overheads
(24,000)
(24,750)
(23,960)
46,400
47,850
44,629
(16,600)
(16,600)
(16,420)
29,800
31,250
28,209
Selling and administration overheads Net profit
2. Calculation of variances Sales volume profit variance Flexed budget net profit
31,250
Original budget net profit
29,800
Sales volume profit variance
1,450 (F)
There are no variances for: sales price or for direct materials (components and packaging).
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Direct materials price variance Actual quantity at actual price
12.2 metres was used for each of 1,650 units: actual quantity used is 12.2 metres x 1,650 = 20,130 metres.
20,130 metres x price actually paid (£2.70) 54,351 Actual quantity at standard price
20,130 metres x standard price (£2.50)
Direct materials price variance
50,325
4,026 (A)
Direct materials quantity variance Actual quantity at standard price
Actual quantity used (already worked out) – 20,130 metres Standard price per metre: £2.50 Actual quantity at standard price = 20,130 x £2.50 50,325 Standard quantity at standard price
Standard quantity: 12 metres x 1,650 units = 19,800 metres
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Standard price per metre: £2.50 Standard quantity at standard price = 19,800 x £2.50
49,500
Direct materials quantity variance
825 (A)
There is no variance for direct labour rate (because the actual rate of £6.00 is the same as the budget). Direct labour efficiency variance Actual hours at standard rate
Actual hours used: 1,650 units x 2.4 hours = 3,960 hours Standard rate per hour - £6.00 Actual hours at standard rate = 3,960 x £6.00
23,760
Standard hours at standard rate
Standard hours: 1,650 units x 2.5 hours = 4,125 hours Standard rate per hour - £6.00 Standard hours at standard rate = 4,125 x £6.00
Direct labour efficiency variance
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24,750
990 (F)
4
Variable overhead variance Actual expenditure 10,050 Overhead absorbed at standard machine hours
1,650 units at 1.5 hours of machine time (standard rate) = 2,475 hours. At the absorption rate of £4.00 per hour: £4.00 x 2,475
9,900 Variable overhead variance
150 (A)
Fixed overhead variance Actual expenditure
23,960
Expenditure absorbed
Standard machine hours used in production x absorption rate: 1,650 x 1.5 machine hours x £10 24,750
Fixed overhead variance
790 (F)
Selling and administration overhead variance Actual expenditure
16,420
Originally budgeted
16,600
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180 (F) We can now insert the variance figures for March into the quarterly statement: Francis & Follett Limited: standard cost operating statements for the quarter ending 31 March 20X4 January
February
March
£
£
£
Budget net profit (original)
28,350
29,800
29,800
Sales profit volume variance
1,450
1,450
1,450
Flexed budget net profit
29,800
31,250
31,250
–
–
–
(3,904)
(3,934)
(4,026)
(360)
(413)
(825)
–
–
–
Direct labour efficiency variance
990
990
990
Variable overhead variance
(592)
(460)
(150)
Fixed overhead variance
776
750
790
Selling and administration overhead
210
(26)
180
26,920
28,157
28,209
Sales price variance Direct materials price variance Direct materials quantity variance Direct labour rate variance
variance Actual net profit
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PART 2 The second part of the case demonstrates the importance of investigating all variances thoroughly, and of tracking variances from period to period to see if they indicate persistent problems. Francis & Follett has not previously had a standard costing budgetary system and it seems likely that the identification of this problem has emerged because of the tighter control which is now being exercised over the company’s activities. Therefore, one important control is already in place.
Purchasing frauds, of the type described here, occur relatively frequently, but are difficult to detect. At Lambert’s, Judith is responsible for many aspects of the administration of the business, and so she has been able to carry out the fraud successfully over a long period. Collusion between employees of different companies makes detection even more difficult. At Francis & Follett, Perry has been an employee for a long time, and throughout a period of growth. It is quite likely that his activities are not tightly controlled and that he has had a high level of autonomy in decision-making about purchases.
Note The costs of such a fraud can be substantial. In this case, 20p was added to the price of a metre of wood; each unit of product requires 12 metres, so the additional cost would be 12 x 20p = £2.40 per unit. Even though, presumably, not all of the timber would be purchased from Lambert’s, the amount of cash siphoned off by the criminals could have been very significant indeed over a period of years.
In conclusion, the case study demonstrates how useful a system of full budgetary control can be, and how important it is for management to keep a tight control over the activities of the business.
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Chapter 18 Case Study Solution and discussion
1. The big problem facing Khaleb and the Components division is lack of profitability as measured by ROI. Any strategy adopted by the division or by the company as a whole must tackle this fundamental problem. It seems likely that ROI for the division will improve to some extent because of the improvements to the non-current asset base that were made by Lara. However, the division is a very long way from achieving the level of ROI targeted by the company. Specific problems that cannot be addressed at divisional level include the following: a) There appears to be a significant transfer pricing problem. The contribution margin of products sold to other divisions is far smaller than that achievable on sales to outsiders. The component cost to Chem and Pharma divisions is highly advantageous, and produces significant cost savings for them. Although it is possible to tackle transfer pricing problems by negotiation between divisions, this option may not be open to Khaleb. He is new to the business, and probably lacks bargaining power. His fellow divisional heads will be very reluctant to accept higher transfer prices, in part at least because of the adverse effect it will have on their own bonuses. Renegotiation of transfer prices on a significant scale will probably require intervention at a senior level. Khaleb needs to begin the process of lobbying head office management to review the position. b) The ROIs of the three divisions may not be strictly comparable. Components has acquired a lot of new non-current assets recently, and its asset base may be relatively higher than that of the other two divisions. The improvements that might be expected to the return part of the equation (because better non-current assets should produce better returns) may not have fully emerged yet, and in any case, we know from the case that non-current asset capacity is not fully used. It is important when comparing ROI that like is compared with like. c) The company appears to take a very simplistic approach to performance appraisal, relying wholly on ROI. The assessment of performance probably needs to be managed in a more subtle way, but any changes to performance assessment need to be determined at head office level. Khaleb may be able to For use with Business Accounting and Finance 6th edn (ISBN 978-1-4737-9127-5) © Catherine Gowthorpe, 2024, published by Cengage
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exert some influence in any debate on the best way to assess performance but as a divisional manager he has no power to insist on any revision to the company’s appraisal systems. d) The problems inherent in the use of the ROI measurement have particular impact in the context of SCI because of the key role played by ROI in the awarding and calculation of bonuses. It is rarely a good idea to award performance-related bonuses on the basis of a single measure of performance. Even if Khaleb manages his division spectacularly well, Components’ ROI is so far away from target that he does not stand to benefit personally. Lara, his predecessor, was clearly not well regarded in the company, but this assessment of her may prove to have been unfair. The non-current asset replacement programme that she instituted was a step in the right direction, but it would not have paid off for her personally for a very long time, if ever. Khaleb may find that he grows discouraged because the odds are stacked against his division. e) Sales volumes, it appears, are not as high as they could be. Extra productive capacity is available if additional sales volumes can be achieved, but there is a problem in that sales staff are not well-motivated and, in any case, tend to lack experience. It may be that Khaleb can tackle this problem, at least in part, at divisional level, if he has the authority to alter the basis of employment contracts. If he can improve sales’ staff remuneration and incentives, the division could probably perform much better. However, if conditions of employment are uniform throughout the company (i.e. if they are under senior management control), the problem can be addressed only at head office level. f)
The bonus system is very limited in its application. There may be benefits to be gained across the company by extending performance-related bonuses to senior divisional managers such as Ester.
2. SCI’s senior management probably needs to undertake a fundamental review of the company’s operations, and of its performance review and incentive systems. This could involve the following steps:
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a) Immediate review of transfer pricing arrangements to ensure that they are equitable to all of the divisions. Khaled’s division appears to be at a significant disadvantage. b) Review of the whole performance review system. The reliance on a single measure (ROI) is potentially very damaging to the interests of the company as a whole. Performance measurement should be more complex, and should ideally involve consideration of a range of both financial and non-financial indicators. The company could consider implementing a Balanced Scorecard system. In order to do this properly, a full re-appraisal of business strategy would probably be in order, and this might be of great help in challenging increased competition. c) It may be appropriate to agree a set of specific targets for Khaled’s division that are geared to improving its current position, and to rewarding the staff accordingly. Where the position of the divisions is unequal, as in this case, staff in the struggling division can easily become demotivated. Targets need to be set with a view to encouraging and rewarding improvements in performance. d) The performance bonus system could probably be extended to a greater number of senior managers in the divisions so as to encourage better performance. Also, if employment contracts are under central control, senior managers need to reconsider the incentives that they provide.
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Case Study for Chapter 19 Solution 1. Ver�cal analysis Land Securities £m
Imperial Brands £m
31 March 2023
%
30 September 2022
%
6
0
17,777
57.4
9,658
88.1
1,887
6.1
770
7.0
2,373
7.7
10,434
95.1
22,037
71.2
Inventories
118
1.1
4,140
13.4
Trade and other receivables
365
3.3
2,543
8.2
Other current assets
4
0
388
1.3
Cash
45
0.4
1,850
6.0
532
4.9
8,921
28.8
TOTAL ASSETS
10,966
100.0
30,958
100.0
EQUITY
7,072
64.5
7,473
24.1
3,249
29.6
12,346
40.0
Current liabilities
645
5.9
11,139
36.0
TOTAL LIABILITIES
3,894
35.5
23,485
75.9
EQUITY AND LIABILITIES
10,966
100.0
30,958
100.0
ASSETS Non-current assets Intangible assets Property, plant and equipment/investment property Investments and other noncurrent assets Current assets
LIABILITIES Non-current liabilities
Note: ver�cal analysis columns may not add up exactly, because of rounding.
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2. Features of company asset informa�on Land Securi�es: a) Most of the company’s assets are comprized under the heading of investment proper�es (88.1% of total assets). This is consistent with Land Securi�es’ principal ac�vity of holding real estate. b) The company holds very litle in inventories. These are proper�es held for trading, and presumably it is intended to dispose of them within twelve months of the date of the Annual Report. c) Cash and trade receivables are low, rela�ve to the amounts held by Imperial Brands. Imperial Brands a) Intangible assets is the largest single asset category. Note 11 to the financial statements further categorizes intangible assets as goodwill, intellectual property and product development, supply agreements and so�ware. b) Inventories comprize 13.4% of total assets. This includes supplies of leaf tobacco and workin-progress and finished goods. It would be expected to have a rela�vely high level of inventory in this type of business. c) There is a large amount of cash (6% of total assets). Note 17 to the financial statements shows a breakdown into cash (£703m) and short-term deposits and other liquid assets (£1,147m). Cash in 2021 was not as high at £1,287m.
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Case study 2 for Chapter 20 Solution 1. Private equity: brief summary
(Note: there are numerous sources of information on private equity. The brief summary below is from www.forbes.com/advisor/investing/private-equity/ but there are many other possible sources).
The private equity market offers an alternative to conventional methods of raising capital. Private equity has become more and more attractive to both business and private investors. ‘In the third quarter of 2021, private equity deal value reached a new record, topping $787 billion for the year’.
PE funds typically invest in established businesses that are underperforming or that have growth potential that is not being exploited. PE funds may buy up the entire company or a substantial part of it, sufficient to have the authority to install new management where appropriate. Typically, after a period of intensive management, the investment will be sold on again, or possibly floated on the stock market via an Initial Public Offering (IPO). The private equity fund thus realises its investment and potentially makes a significant profit on the deal.
These investments are usually risky, and are open only to established investment companies or people with a high net worth who are apprised of the risks and are able to sustain potential losses.
2. Three large businesses that are owned and managed by private equity
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1. Morrisons supermarket chain in the UK. In October 2021 Morrison’s existing shareholders approved a takeover offer from a US private equity group (Clayton, Dubilier and Rice). This deal was worth £7bn. 2. Also in 2021, Clayton, Dubilier and Rice acquired Wolseley UK, a leading specialist distributor of plumbing and infrastructure supplies. 3. Blackstone and the Benetton family paid £42.7bn in 2022 to privatise the Italian infrastructure group Atlantia.
The third example, Atlantia, comprised the highest value PE transaction in 2022, according to a report by PwC, the accounting firm. For those who would like to read more on the subject, the 2023 PwC report on private equity trends is worth a look: www.pwc.de/en/private-equity/private-equity-trend-report.html
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Chapter 20 Case Study Solution and discussion
In order to assess the advantages and drawbacks of the proposed flotation, it would be sensible first to assess the financial impact of the deal.
Would the company be at risk of becoming a takeover target? A company is usually only at risk of becoming a takeover target if more than 50 per cent of the voting shares are available for purchase. This deal involves the issue of a further 200,000 shares. Added to the existing 700,000 shares, this gives a prospective total of shares in issue of 900 000. How many of the shares will retained by the current directors? Holdings now (before flotation)
700,000
To be sold on flotation
(300,000)
Retained after flotation
400,000
So, the directors will hold 400,000 of 900,000 shares, i.e. less than half of the issued share capital. If another person or company wished to take over Gropius & Garner it would be technically possible to do so. Judy’s concerns are, therefore, realistic in the circumstances. In total, 500,000 shares will be sold. If the corporate finance advisers’ estimates are approximately correct, this would mean that 500,000 x £10.50 could be raised, i.e. £5,250,000. The sale of the shares belonging to the directors will raise 300,000 x £10.50 = £3,150,000 and new capital raised for investment in children’s programming will be 200,000 x £10.50 = £2,100,000.
Is it unreasonable of Bernard and Amelia to want to sell their shares? Flotation on the stock market is a common way for founders of companies to turn part or all of their investment into cash. As both Bernard and Amelia are thinking ahead to retirement, the proposal to float the company makes perfect sense from their point of view. It is not unreasonable of them to propose this step.
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How much money will the four directors make from selling their shares? Bernard holds 40 per cent of the shares currently in issue, and so he will be entitled to 40 per cent of the proceeds of the directors’ shares: 40% x £3,150,000 = £1,260,000. Amelia holds 30 per cent of the shares currently in issue, and so she will be entitled to 30 per cent of the proceeds: 30% x £3,150,000 = £945,000. Sigmund and Karl-Heinz each hold 15 per cent of the shares currently in issue, and so will each be entitled to: 15% x £3,150,000 = £472,500. Clearly, all the directors (except Judy) stand to make substantial sums out of the flotation. All will retain large holdings of shares in the business, and so they could potentially make more money out of selling more shares in the future.
Is Bernard correct? Because Bernard stands to gain a substantial sum of cash from selling part of his shareholding he is, perhaps, not very likely to dwell on the potential drawbacks of the flotation. However, Judy has pointed out one significant potential drawback in the form of a future takeover bid. If the company were taken over, the existing management might not be able to hold onto their lucrative directorships. Even if they did, they would find that they no longer have complete control over the company’s activities.
Other possible drawbacks include: •
Increased public attention which is not always welcome. Following flotation, the company would find itself subject to much more media interest than before.
•
The company would have to start producing interim financial statements as well as a full annual report, and there are various other forms of additional regulation which would come into play. A listed company incurs additional costs in complying with regulation.
•
There might be pressure from the City to produce better and more consistent results.
Most of these drawbacks are unavoidable. The company could help to minimize the possibility of takeover by floating rather fewer shares than originally intended. If 400,000 of
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900,000 shares were to be made available, this would leave a majority in the hands of the four shareholder/ directors. The company could, of course, still be vulnerable if one or more of the four were persuaded to sell all or part of their shareholding.
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