Part 1 questions
Briefly explain the general purpose of each of the three financial statements (the income statement, the balance sheet and the cash flow statement) and the usefulness of each of them for Quartz Antique Furniture Ltd. (20 marks)
Analyse the financial statements that have been prepared by Quartz Antique Furniture Ltd’s financial director. In particular, comment on the following aspects of the company: (50 marks in total)
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)
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)
CASE STUDY: (I CAN SEND THIS ON WORD WHICH IS EASIER TO UNDERSTAND)
Quartz Antique Furniture Ltd
Pat Dotella has always admired quality antique furniture. Her Aunt Sophie, who has built up an impressive collection of Georgian furniture, kindled Pat’s interest in antiques from a young age. Since then Pat has developed an expertise in identifying popular trends in antique styles and the antique furniture that is most in demand.
After studying Art at university, Pat worked for an auction house for five years where she learnt the trade of locating, buying and selling high quality antique furniture. About ten years ago, she started her own business in London. Her first shop ‘Quartz Antique Furniture – London’ soon became popular and profitable. Pat has since replicated her success in London to two other London venues as well as five shops around England in affluent locations in the following English cities: Brighton, Bristol, Manchester, Leeds and Birmingham.
Quartz Antique Furniture Ltd is a private company with only two shareholders. Pat owns 80% of the ordinary shares of the business and her aunt owns the balance. Pat is the chief executive of her business but is not as financially knowledgeable as she would like to be. She is thus dependent on her financial director, Owen, who was only recruited two years ago. While Sophie is not actively involved with the business she is a great source of knowledge and experience for Pat.
Pat’s retail outlets have been complemented by an effective and profitable website.
Until recently, Quartz Antique Furniture Ltd has been very profitable. Revenues have increased on average by 9% per annum in the last three years. In the year ending 31 December 2018 the company achieved a return on equity of 21%. The company’s financial performance has significantly benefited from an increase in gearing. In the last three years, a number of interest-only loans have been taken out that need to be repaid in between five and ten years’ time. Pat and Sophie have not taken dividends out of the firm over the last few years as another way of increasing funds available for reinvestment.
In the last year, Pat has relied mainly on Owen’s advice to invest in a number of areas of the business in order to improve its financial performance and health. Such investment included greater expenditure on advertising and office equipment. Under Owen’s guidance, in order to finance this investment, and to have more cash available for short-term opportunities, the company took out a further ten year long-term loan of one and a half million pounds. The loan is interest-only. Pat is now keen to improve profitability and reduce financial risk where possible, in order to put the business on a stronger and more sustainable footing. Unfortunately, the early indication is that the business seems to be suffering from a downturn in the economy. Sophie advised Pat against taking on the new loan and has recently suggested that the company has not performed well in the past year.
Pat now needs to properly understand the implications of the latest financial statements below to see if the company is on the right track, and if her aunt’s concerns are justified.
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
Less closing inventory 3,134 2,563
Cost of goods sold 34,585 31,479
Gross profit 10,653 11,777
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
Property 14,586 15,066
Computers and equipment 312 279
Vehicles 194 187
Total non-current assets 15,092 15,532
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
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
Bank loan 12,027 10,527
Net Assets Total10,630 Total10,072
Share capital 100 100
Reserve: retained earnings 10,530 9,972
Total Equity Total10,630 Total10,072
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
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
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)
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 Total5,189 Total4,247
The three main financial statements were introduced to you in Readings 23–25. You should use your own words to describe the purpose of the three statements for and also their usefulness. Ensure you discuss the purpose AND usefulness of all three statements in general and also make specific points about how they apply to Quartz Antique Furniture Ltd.
You should use your knowledge gained from Readings 23–25, together with the tools and techniques discussed in Reading 26 “Analysing Financial Performance”, to construct your answer. You should select those tools and methods that you feel are appropriate to this question to carry out any relevant calculations. Show the workings out for your calculations. State what each calculation might mean if you identify it as an area of concern, i.e. explain why your figures may be of concern to Quartz Antique Furniture Ltd.
Make sure that you note the most obvious matters of concern – they are not “hidden” or very complex if you undertake some simple, relevant analysis.
In assessing the value of Aunt Sophie’s recent concerns, you should respond in particular to the issues you have identified in your analysis in Question 2. Based on your financial analysis, discuss whether Sophie was right to be concerned about taking on the recent bank loan. You also need to discuss her statement that ‘the company has not performed well in the past year’ given your financial analysis. Justify your comments and your conclusions about the value of Sophie’s concerns.
The second part of the question is to make some practical suggestions for what Pat could do to meet her aunt’s concerns, and to achieve her objective of improving the financial performance and health of the business. You should also use your knowledge gained from Reading 27 “Financial Planning” to help you answer this part of Question 3.
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