Case study 2 - Financial analysis of Boat Builders Pty Ltd* CASE STUDY 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 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 Ltd) 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 Ply 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 ratios Current ratio Current assets divided by current liabilities Quick rato (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 of persons is entirely coincidental Short-term liquidity ratios continued Stock turnover Average stock divided by datly cost of goods sold Creditors turnover Trade creditors divided by average daily purchases Longer term solvency ralios Shareholders' funds divided by total assets Shareholders' funds divided by outside liabilities Fixed assets divided by shareholders' funds Business performance ratios Gross margin (Sales -- cost of goods sola) 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 without going 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 example, which has changed from 47 per cent to 40 per cent to 37 per cent over a three-year period. Why has this change in the ratio value occurred? Has it been due to a growth in total 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 work-in-progress is contained in Boat Builders stock figure? 3. Make some conclusions about risks Lenders are ultimately interested about risks, so ratio 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. Current balance/limit Proposed balance/limit Facility Comment Overdraft $110 000 $300000 Increase in base limit (see discussion below) Bill facility $220 000 $220 000 Bill facility matures in October 2003. Facility is to be refinanced on an interest-only basis for three years, To be purchased in October 2003 To be installed in the new factory (October 2003) Lease for boat lifter n/a $60 000 n/a $140 000 Lease for metal fabrication machinery wa Not applicable The directors have provided a cashflow 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: a taxation payment of $95 000 due in October 2003 construction costs of $220000 which will be payable during October and November 2003 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 Scientific and Indus- trial Research Organisation (CSIRO). DSFE is waiting for payment from its government partner. According to documents provided by DSPE, this pay- ment will be made in four tranches. as follows: October ($100 000), November ($100 000), December ($40 000) and January ($40 000). 4. The figure of $1615 000 for 'Sales' is made up of contracts with both DSFE (65 per cent) and other customers (35 per cent). Boat Builders expects that these sales will be paid within thirty days. You are asked to analyse the cashflow using the five-stage cashflow 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. Boat Builders Ply Lid Cashllow budget for the year ended 30 June 2003 DEE. Jan. Feb War Apr. 2003 2004 2004 2004 2004 Oct. 2003 Nov. 2003 May 2004 June 2009 July 2004 Aug. 2004 Sep. 2004 Total 10 000 -126 870 -120 416 -240 175 -226 845 -280 191 -299 155 294 510 -259 014 -95 885 -54 839 -107 907 -1 545 957 100 000 100 000 40 000 40 000 280 000 40 000 110000 130 000 120 000 165 000 190 000 2.20 000 235 000 110 000 105 000 190 000 1615 000 100 000 140 000 150 000 170 000 120 000 163 000 190 000 220 000 235 000 110 000 105 000 190 000 1 895 000 1 545 I 545 7 369 4511 20 600 9050 5 188 20 600 13 596 13 596 103 8 656 4963 20 600 317 4 918 2 820 20 600 180 194 39 155 103 9050 5188 20 600 332 355 71 284 288 309 332 9443 5414 20 600 346 371 74 297 7 869 4 511 20 600 288 309 2 361 1 353 20 500 87 93 19 74 2754 1 579 20 600 301 108 22 87 9443 5414 20 500 345 371 7+ 297 74 503 40 941 233 192 2 823 2 805 56 2 243 62 247 68 272 355 71 284 247 2060 2060 169 950 106 605 7 725 12 360 117 420 123 600 123 600 127 720 13 390 14 420 14 420 14 420 31 930 4 120 36 050 4 120 106 090 12 360 127 720 1 074 805 14 420 111 755 7571 133 133 133 133 Opening overdraft balance CASH INFLOWS DSF6 Ltd Payments Sales TOTAL CASH INFLOWS COST OF SALES Consumables (welding Drafting services Direct wages Electricity Freight Repairs -- plant Tools Material purchases (mainly aluminium) Subcontractors CASH EXPENSES Accountant fees Advertising Bank charges Hire of equipment Interest - overdraft Interest - term loan Motor vehicle experts Licences Postage Printmg Protective clothing Rates and taxes Rent Stall training Superannuon Telephone Travel expenses Union fees OTHER CASH OUTFLOWS Taxation Construction costs TOTAL CASH OUTFLOWS Closing overdraft balance 5 923 133 22 +12 440 506 133 $28 412 133 155 412 133 440 412 412 133 SOS 412 6180 512 1 986 412 133 275 412 6.180 $11 1 988 412 412 133 132 412 6 150 511 1 988 133 528 412 6180 511 1988 511 1988 206 511 1968 511 1 988 S11 1968 51.1 1 988 311 1 511 1988 511 1988 149 149 149 149 149 149 149 149 149 149 248 258 149 248 258 248 149 248 158 13 493 1 594 4 048 4 944 24 720 6 131 23 655 206 1792 993 1030 4120 2 753 3 090 51 500 562B 2 225 927 258 4 120 912 916 S18 1 543 1549 51 500 1 407 185 1 407 185 1407 185 1 407 185 185 185 165 185 185 185 185 185 927 95000 95 DOO 110 OD 110 000 220 000 236 870 133 546 269 759 156 670 173 346 183 964 185 353 184 504 71 871 68 953 158 068 188 771 2011 678 -126 870 -120 416 -240 175 -226 845 -280 191 -299 155 - 294 510 -259 014 -95 835 -54 839 -107 907 -106 678 -1 662 635 Discussion questions 1. Comment on the short-term 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 cashflow budget has revealed. Overall, do you see the cashflow budget as being pessimistic, optimistic or realistic? Do you think that Boat Builders' request for an increase in bor- rowing facilities is justified? In your opinion, will the business be able to reduce its overdraft to below $110 000 by July 2004? 3. Based on your ratio analysis of the statement of financial position and state- ment of financial performance, plus your analysis of the cashflow 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 that you face? Case study 2 - Financial analysis of Boat Builders Pty Ltd* CASE STUDY 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 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 Ltd) 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 Ply 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 ratios Current ratio Current assets divided by current liabilities Quick rato (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 of persons is entirely coincidental Short-term liquidity ratios continued Stock turnover Average stock divided by datly cost of goods sold Creditors turnover Trade creditors divided by average daily purchases Longer term solvency ralios Shareholders' funds divided by total assets Shareholders' funds divided by outside liabilities Fixed assets divided by shareholders' funds Business performance ratios Gross margin (Sales -- cost of goods sola) 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 without going 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 example, which has changed from 47 per cent to 40 per cent to 37 per cent over a three-year period. Why has this change in the ratio value occurred? Has it been due to a growth in total 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 work-in-progress is contained in Boat Builders stock figure? 3. Make some conclusions about risks Lenders are ultimately interested about risks, so ratio 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. Current balance/limit Proposed balance/limit Facility Comment Overdraft $110 000 $300000 Increase in base limit (see discussion below) Bill facility $220 000 $220 000 Bill facility matures in October 2003. Facility is to be refinanced on an interest-only basis for three years, To be purchased in October 2003 To be installed in the new factory (October 2003) Lease for boat lifter n/a $60 000 n/a $140 000 Lease for metal fabrication machinery wa Not applicable The directors have provided a cashflow 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: a taxation payment of $95 000 due in October 2003 construction costs of $220000 which will be payable during October and November 2003 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 Scientific and Indus- trial Research Organisation (CSIRO). DSFE is waiting for payment from its government partner. According to documents provided by DSPE, this pay- ment will be made in four tranches. as follows: October ($100 000), November ($100 000), December ($40 000) and January ($40 000). 4. The figure of $1615 000 for 'Sales' is made up of contracts with both DSFE (65 per cent) and other customers (35 per cent). Boat Builders expects that these sales will be paid within thirty days. You are asked to analyse the cashflow using the five-stage cashflow 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. Boat Builders Ply Lid Cashllow budget for the year ended 30 June 2003 DEE. Jan. Feb War Apr. 2003 2004 2004 2004 2004 Oct. 2003 Nov. 2003 May 2004 June 2009 July 2004 Aug. 2004 Sep. 2004 Total 10 000 -126 870 -120 416 -240 175 -226 845 -280 191 -299 155 294 510 -259 014 -95 885 -54 839 -107 907 -1 545 957 100 000 100 000 40 000 40 000 280 000 40 000 110000 130 000 120 000 165 000 190 000 2.20 000 235 000 110 000 105 000 190 000 1615 000 100 000 140 000 150 000 170 000 120 000 163 000 190 000 220 000 235 000 110 000 105 000 190 000 1 895 000 1 545 I 545 7 369 4511 20 600 9050 5 188 20 600 13 596 13 596 103 8 656 4963 20 600 317 4 918 2 820 20 600 180 194 39 155 103 9050 5188 20 600 332 355 71 284 288 309 332 9443 5414 20 600 346 371 74 297 7 869 4 511 20 600 288 309 2 361 1 353 20 500 87 93 19 74 2754 1 579 20 600 301 108 22 87 9443 5414 20 500 345 371 7+ 297 74 503 40 941 233 192 2 823 2 805 56 2 243 62 247 68 272 355 71 284 247 2060 2060 169 950 106 605 7 725 12 360 117 420 123 600 123 600 127 720 13 390 14 420 14 420 14 420 31 930 4 120 36 050 4 120 106 090 12 360 127 720 1 074 805 14 420 111 755 7571 133 133 133 133 Opening overdraft balance CASH INFLOWS DSF6 Ltd Payments Sales TOTAL CASH INFLOWS COST OF SALES Consumables (welding Drafting services Direct wages Electricity Freight Repairs -- plant Tools Material purchases (mainly aluminium) Subcontractors CASH EXPENSES Accountant fees Advertising Bank charges Hire of equipment Interest - overdraft Interest - term loan Motor vehicle experts Licences Postage Printmg Protective clothing Rates and taxes Rent Stall training Superannuon Telephone Travel expenses Union fees OTHER CASH OUTFLOWS Taxation Construction costs TOTAL CASH OUTFLOWS Closing overdraft balance 5 923 133 22 +12 440 506 133 $28 412 133 155 412 133 440 412 412 133 SOS 412 6180 512 1 986 412 133 275 412 6.180 $11 1 988 412 412 133 132 412 6 150 511 1 988 133 528 412 6180 511 1988 511 1988 206 511 1968 511 1 988 S11 1968 51.1 1 988 311 1 511 1988 511 1988 149 149 149 149 149 149 149 149 149 149 248 258 149 248 258 248 149 248 158 13 493 1 594 4 048 4 944 24 720 6 131 23 655 206 1792 993 1030 4120 2 753 3 090 51 500 562B 2 225 927 258 4 120 912 916 S18 1 543 1549 51 500 1 407 185 1 407 185 1407 185 1 407 185 185 185 165 185 185 185 185 185 927 95000 95 DOO 110 OD 110 000 220 000 236 870 133 546 269 759 156 670 173 346 183 964 185 353 184 504 71 871 68 953 158 068 188 771 2011 678 -126 870 -120 416 -240 175 -226 845 -280 191 -299 155 - 294 510 -259 014 -95 835 -54 839 -107 907 -106 678 -1 662 635 Discussion questions 1. Comment on the short-term 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 cashflow budget has revealed. Overall, do you see the cashflow budget as being pessimistic, optimistic or realistic? Do you think that Boat Builders' request for an increase in bor- rowing facilities is justified? In your opinion, will the business be able to reduce its overdraft to below $110 000 by July 2004? 3. Based on your ratio analysis of the statement of financial position and state- ment of financial performance, plus your analysis of the cashflow 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 that you face
