Case study 2 - Financial analysis of Boat Builders Pty Ltd* Learning objectives After completing this case study, you should be able to: 1. complete a detailed financial ratio analysis of a series of statements of financial position and a statement of financial performance 2. complete a detailed financial analysis of a cashflow budget using a five-stage checklist CASE ST 3. generate conclusions from this analysis about the risks you face as a lender to this business. Introduction You need to complete case study 1 (Boat Builders Pty Lid) before commencing this case study. The focus in case study I was on identifying any concerns that you had about the balance sheets and profit and loss statements for Boat . Builders, to ensure there was limited scope for garbage-in, garbage-out (GIGO) in the financial analysis stage. In this second case study, the focus is on the sub- sequent financial analysis stage. Based on the concerns that you identified in case study 1, you were asked to make adjustments to the financial statements. These are the adjusted financial statements that you will analyse in this second case study. Boat Builders Pty Ltd Date: 1 July 2003 Background Case study 1 provided a detailed background on Boat Builders. Here, you are asked to conduct a detailed financial ratio analysis of the balance sheets and the profit and loss statements that the directors of Boat Builders have supplied. Many different financial ratios could be used as part of this analysis, but we recommend that you use the following ratios (and ratio groups) Short term liquidity ro Current ratio Current assets divided by current liabilities Quick ratio (Current assets - stock) divided by (current liabilities - overdraft) Debtors turnover Trade debtors divided by average daily sales (continued) * Disclaimer: This case study is hypothetical. Any resemblance to actual events, locales, entities or persons is entirely coincidental. Case study 2: Financial analysis of Boat Builders Pty Ltd 507Stock turnover Average stock divided by daily cost of goods sold . Creditors turnover Trade creditors divided by average daily purchases Shareholders\" funds divided by total assets Shareholders\" funds divided by outside liabilities Fixed assets divided by shareholders' funds Gross margin _ (Sales - cost of goods sold] divided by sales ' Net margin Net profit divided by sales Operating expenses divided by sales A potential trap with ratio analysis is that it can end up being superficial if it focuses on the-ratio values Withoutgoing into What lies behind those values. Here are some ways in which to make your ratio analysis more in depth. 1. Refer to the source data Relate your analysis of each ratio back to the underlying figures in the balance sheet or profit and loss statement used in the calculation of the ratio. Consider a longer term solvency ratio: shareholders' funds divided by total-assets, for example1 which has changed from 47 per cent to 40 per cent to 37 per cent over a threeyear period. Why has this change in the ratio value occurred? Has it been due to a growth in'tota] assets while shareholders' funds remain constant? Or, to some other combination of change in total assets and shareholders' funds? 2. Relate comments to the type of business concerned Ratio analysis should be used to say something about the business concerned. If the business is a boat builder, then the comments about stock turnover should relate to the stock typically held by a boat building business. As an. example, What proportion of womanprogress is contained in Boat Builders' stock figure? ' 3. Make some cuttchrsitms about risks Lenders are ultimately interested about risks, soratio analysis should be used to make conclusions about the risks that the lender to this business faces. If the liquidity position of the business is poor, then What are risks to the lender? Request for increased funding The directors of Boat Builders have requested the following increase in bank funding. 511a Part 7: Case studies Overdraft $110 000 $300 000 - Increase in base limit (see discussion below] _ Bill facility $220 000 $210 000 Bill facility matures in October 2001 Facility is to be renanced on an interestonly basis for three years, Lease for boat lifter tu'a $60 000 To be purchased in October 2003 Lease for metal ' nfa $140 000 To be installed in the new factory fabrication machinery - (October 2003) his Not applicable ' The directors have provided a cashow budget, with the following notes, to support their request for an increase in the overdraft limit in particular: 1. The $300 000 overdraft limit will be required only until June 2004. At that point, the limit will be returned back to $110 000, 2. The increase in the overdraft limit is to cover: .- t- - a taxation payment of $95 000 due in October 2003 w construction costs of $220 000 which will be payable during October and November 1003 superannuation payments due in December 2003 ' - the purchase of additional stock following a reduction in stock before the move to the new factory, 3. Since May 2003, Deep Sea Fishing Enterprises Ltd (DSFE) has owed $280 000 to Boat Builders. This debt relates to a boat that was built for use in - a joint venture between DSFE' and the Commonwealth Scientic and Indusv trial Research Organisation (CSIRO). DSFE is waiting for payment from its government partner. According to documents provided by DSFE, this pay ment will be made in four trenches as follows: October ($100 000)1 November [E 100 000), December ($40 000] and. january [$40 000). 4. The figure of $1 615 000 for 'Sales' is made up of contracts with both DSFE (ES'per cent) and other customers {35 per cent). Boat Builders expects that these sales will be paid Within thirty days. ' 'Y 011 are asked to analyse the cashow using the fiveStage cashow checklist outlined in table 9.7 (page 300). in particular, you are asked to concentrate on parts 4 and-5 of the checklist: analysing the validity of the underlying assump- tions and critically considering. the issue of sensitivity analysis. {Case study a Financial analysis of Boat Builders Pty Ltd 5093 Boat Builders Ply Lid Cashflow budget for the year ended 30 June 2003 Jan. Feb. Mar. App. May 510 Part 7: Case studies 2003 2004 2004 2004 2004 2004. 2004 2004 - 2004 2004 Opening overdraft balance 10 000 -126 870 -120 416 -240 175 -226 845 -280 191 -299 155 -294 510 -259 014 -95 885 -54 839 -107 907 -1 545 957 CASH INFLOWS OSFE Lid Payments 100 000 100 000 40 000 40 000 280 000 Sales 10 000 110 000 ODO OCT 120 000 165 000 190 000 220 000 235 000 110 000 105 000 190 000 1 615 000 TOTAL CASH INFLOWS 100 000 140 000 150 000 170 000 120 000 165 000 190 000 220 000 235 000 110 000 105 000 190 000 0 1 895 000 COST OF SALES s (welding) 1 545 1 545 3 656 9 050 9 050 2 361 2 754 7 869 9 443 74 503 Drafting services 2 820 1 963 5 188 1 353 1579 4 511 5 414 40 941' Direct wages 13 596 13 596 20 600 20 600 20 600 20 600 20 600 20 600 20 600 20 600 20 600 20 600 233 192 Electricity 103 103 180 288 317 332 332 346 87 101 288 346 2 823 Freight 194 309 340 355 355 371 93 108 309 371 2 805 Repairs - plant 62 68 19 22 62 74 561 Tools 247 272 284 284 87 247 297 2 243 Material purchases {mainly aluminium) 2 060 2 0GO 169 950 106 605 117 420 123 600 123 600 31 930 36 050 106 090 127 720 1 074 805 Subcontractors 7 725 12 360 13 390 14 420 14 420 14 420 -4 120 4 120 12 360 14 420 1 11 755 CASH EXPENSES Accountant fees 5 923 7 57 13 493 Advertising 133 133 133 133 133 133 133 133 133 133 133 133 1 594 Bank charges 22 275 440 484 412 506 506 528 132 155 440 528 4 048 Hire of equipment 412 412 412 412 412 412 412 412 412 412 417 4 944 Interest - overdraft 5.180 5 180 180 180 24 720- Interest - term loan . 511 511 511 511 51 511 51 511 6 131 Motor vehicle expenses. 1988 1 983 1 988 1988 1 988 1 988 1 988 1 988 1988 1 988 1 988 23 855 Licence 20 206 Postage 149 149 149 149 149 149 149 149 149 149 145 792 248 248 248 903 Protective clothing 258 258 258 258 1 030 Rates and taxes + 120 1 170 ken 918 918 918 2 753 Staff training 1 545 1 545 Superannuateon 51 500 51 500 Telephone 1 407 1 407 1 407 1 407 5 628 Travel expenses 185 185 185 185 185 185 185 185 185 185 185 185 2 225 Union fees 927 027 OTHER CASH OUTFLOWS Taxation 95 000 ! 95 000 Construction costs TOTAL CASH OUTFLOWS 110 000 110 000 220 00 236 870 133 546 269 759 156 670 173 346 183 964 185 355 184 504 71 871 Closing overdraft balance -126 870 -120 416 -240 175 -226 845 -280 191 -299 155 -294 510 -259 014 68 953 158 058 188 771 2 011 678 -95 885 -54 839 -107 907 -106 678 -1 662 635.5] Discussion questions 1. Comment on the shortterm liquidity, longer term solvency and business performance of Boat Builders based on your analysis of the ratios. Remember that you should be analysing the modified financial statements that you gen erated as part of case study 1. 2. Comment on what your analysis of the easbow budget has revealed Overall, do you see the cashow budget as being pessimistic, optimistic or realistic? Do you think that Boat Builders" request for an increase in bor~ . rowing facilities is- justied? In your opinion, Will the business be able to reduce its overdraft to below $110 000 byjuly 2004? 3. Based on your ratio analysis of the statement of nancial position and state ment of financial performance, plus your analysis of the eashow budget, do you consider that Boat Builders is in a strong position as a borrower? As the lender to Boat Builders, What are the major risks tbat you face? Case study 2: Financlal analysis of Boat Builders Pty Ltd 511