Question

1. • i.Areas of concern in financial performance, focussing mainly on information from the income statement. (17 marks)
   • ii.Areas of concern in financial health, focussing on ratios dependent on the income statement and the balance sheet. (17 marks)
   • iii.Areas of concern in cash flow management, focussing mainly on information available from the cash flow statement. (16 marks)
2. Assess the value of Aunt Sophie’s recent concern that taking on the recent bank loan was not advisable and ‘the company has not performed well in the past year’ (the year to 31 December 2019). What practical steps should Pat now undertake in order to improve the financial performance and financial health of the business? (20 marks)

Quartz Antique Furniture Ltd Income Statements for the years ended 31 December 2019 and 31 December 2018

	Year to 31 Dec 2019		Year to 31 Dec 2018
	£k	£k	£k	£k
Sales revenue		45,238		43,256
Less: cost of goods sold:
Opening inventory	2,563		2,394
Purchases from wholesalers	35,156		31,648
	37,719		34,042
Less closing inventory	3,134		2,563
Cost of goods sold		34,585		31,479
Gross profit		10,653		11,777
Less expenses:
Salaries and other costs	6,849		6,738
Rent and office services	431		426
Insurance	72		68
Distribution and postage costs	283		268
Marketing and advertising expenses	693		632
Office administration	99		96
Energy and other utilities	176		167
Depreciation	493		456
Audit, Accounting & Legal Costs	53		51
Interest on bank loan	962		842
Total Expenses		10,111		9,744
Interest received		156		127
Profit before taxation		698		2,160
Corporation tax		140		432
Profit after taxation		558		1,728

Quartz Antique Furniture Ltd Balance Sheets at 31 December 2019 and 31 December 2018

	Year to 31 Dec 2019		Year to 31 Dec 2018
	£k	£k	£k	£k
Non-current assets
Property		14,586		15,066
Computers and equipment		312		279
Vehicles		194		187
Total non-current assets		15,092		15,532
Current assets
Inventory	3,134		2,563
Receivables	3,318		2,203
Other current assets	46		28
Cash at bank	5,189		4,247
Total current assets	11,687		9,041
Current liabilities
Payables	3,983		3,542
Corporation tax	139		432
Total current liabilities	4,122		3,974
Net current assets/working capital		7,565		5,067
Total assets less current liabilities		22,657		20,599
Long-term liabilities
Bank loan		12,027		10,527
Net Assets		Total 10,630		Total 10,072
Equity
Share capital		100		100
Reserve: retained earnings		10,530		9,972
Total Equity		Total 10,630		Total 10,072

Quartz Antique Furniture Ltd Cash Flow Statements for the years ended 31 December 2019 and 31 December 2018

	Year to 31 Dec 2019	Year to 31 Dec 2018
	£k	£k
Operating activity:
Operating profit	1,504	2,875
Corporation tax paid	(433)	(578)
Add back non-cash expenses:
Depreciation	493	456
Loss/(Profit) on disposal of non-current assets	0	0
Changes in cash invested in working capital:
(Increase)/Decrease in inventory	(571)	(169)
(Increase)/Decrease in receivables	(1,115)	(472)
(Increase)/Decrease in other current assets	(18)	8
Increase/(Decrease) in payables	441	1,854
Increase/(Decrease) in other tax liabilities	0	0
Net cash inflow/(outflow) from operating activities	301	3,974
Investing activity:
Purchase of non-current assets	(53)	(46)
Proceeds on disposal of non-current assets	0	0
Net cash generated (consumed) by investing activity	(53)	(46)
Financing activity:
Increase in bank loan	1,500	0
Interest paid on bank loan	(962)	(842)
Interest received on bank deposit	156	127
Net cash generated (consumed) by financing activity	694	(715)
Change in cash balances	942	3,213
Opening cash balance (overdraft) at 1st January	4,247	1,034
Closing cash balance (overdraft) at 31st December	Total 5,189	Total 4,247

Answer 1

Areas of concern in financial performance, focussing mainly on information from the income statement

• Gross profit has decreased from 11,777 to 10,653 from Dec 2018 to Dec 2019.
• Profit before Taxation has decreased from 2,160 to 698 from Dec 2018 to Dec 2019. This indicates increased cost
• Interest on Bank Loan has increased from 842 in Dec 2018 to 962 in Dec 2019 i.e. increase of 14% as Compared to Increase in Sales by 4.5% leading to lower profits
• Increase in Marketing and Advertising Expenses by 9.65% from Dec 2018 to Dec 2019 has not resulted in corresponding increase in Sales which has increased by 4.5% from Dec 2018 to Dec 2019.
• Gross Profit has decreased by 1,124 (10,653 - 11,777) Compared to Increase in Sales by 1,982 (45,238 - 43,256) indicating decrease in magins / increase in Cost

The above details indicates Decrease in profits indicating pressure on Revenue due to lower demand in increase in cost of cost of Goods and Expenses

Areas of concern in financial health, focussing on ratios dependent on the income statement and the balance sheet

• Increase in Receivables by 50.6% as compared to increase in Sales Revenue by 4.5 %. Number of Days receivable has increased in Dec 2019 of 26.77 days compared to 18.58 days Dec 2018.

(receivable ÷ Sales revenue) x Number of days in the year = Number of Days receivable

The measurement indicates that customers are having cash flow troubles, since it will attempt to stretch out the amount of time before it pays invoices

• Ratio of Profit Before Taxation to sales Revenue has decreased to 1.54% in Dec 2019 as compared to 5% in Dec 2018

(PBT ÷ Sales revenue)

Decrease in PBT indicates that the demand is week and margins are under pressure and the price of inputs are increasing without coresponding increase in Sales Price

• Increase in Computer and Equipments by 12%. However Salaries and Other cost have increased by 2% and Revenue increase by 5%.

Hence the increase in Non Current Assets is not in line with increase in either of Sales Revenue or Salaries Cost (Staff Nos) There is a possibility of misuse of Assets in the Business and lower utilisation of assets

Areas of concern in cash flow management, focussing mainly on information available from the cash flow statement.

• Increase in Bank Loan of 1,500 Comapred to purchase of Non Current Assets of 53 in Dec 2019. Long Term loans are not taken for financing long term use assets
• Cash flow from financing activities indicate Bank Loan taken mainly for financing Interest payment of 962 indicating a Debt Trap where the Business is not able to generate enough cash flow to finance its interest Obligations
• Increase in Loans in Dec 2019 has resulted in increase in Bank balance as on year end. This indicates that the Long term loans have been taken by business but not utilised.
• Cash flow from Operating Activities have decreased from 3,974 for Year ended Dec 2018 to 301 for year ended Dec 2019 indicating stress on Operating Activities Cash Flow
• Increase in Receivable in Dec 2019 by 1,115 comapred to increase in Revenue by 1982 indicating financial troubles at the Customers end or a possible display of higher revenue by the Quartz Antique Furniture Ltd

Assess the value of Aunt Sophie’s recent concern that taking on the recent bank loan was not advisable and ‘the company has not performed well in the past year’ (the year to 31 December 2019). What practical steps should Pat now undertake in order to improve the financial performance and financial health of the business?

The various details thaat indicate that recent bank loan was not advisable are as under

1. Bank Loan Increased by 14% as compared to Sales Revenue of 4.5%.
2. Increase in Bank Loan of 1,500 Comapred to purchase of Non Current Assets of 53 in Dec 2019. Long Term loans are not taken for financing long term use assets
3. Cash flow from financing activities indicate Bank Loan taken mainly for financing Interest payment of 962 indicating a Debt Trap where the Business is not able to generate enough cash flow to finance its interest Obligations
4. Increase in Loans in Dec 2019 has resulted in increase in Bank balance as on year end. This indicates that the Long term loans have been taken by business but not utilised.

Steps to improve financial performance are as under

• Increase in cost has to be controlled and brought down to increase profitability and maintain Profit before tax to Sales Revenue around 5%
• Receivables Credit Control to be taken up on priority and future sales to such customers to be done on Cash basis rather on credit
• Long term Loans not to be taken for working Capital Requirement. Business has to earn enough profits on Operating Activities Cash flow to take care of Interest payouts
• Loans from Banks to be reduced through increased cash flow from Operating Activities so that interest payments are sustainable and does not go in a Debt trap

1.