Part 1: Case study analysis

Part 1 of this TMA will be marked out of 90 marks.

Read through the case study below, and then answer the following questions.

TMA 03 Part 1 questions

1.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 Home Styles Ltd.(20 marks)

2.Analyse the financial statements that have been prepared by Home Styles Ltd's financial director. In particular, comment on the following aspects of the company:(50 marks in total)

oi.Areas of concern in financial performance, focussing mainly on information from the income statement.(17 marks)

oii.Areas of concern in financial health, focussing on ratios dependent on the income statement and the balance sheet.(17 marks)

oiii.Areas of concern in cash flow management, focussing on information available from the cash flow statement.(16 marks)

3.Assess the value of Jana Jaril's parents' recent concern that 'the company has not performed well in the past year' (the year to 30 June 2019). What practical steps should Jana now undertake in order to improve the financial performance of the business?(20 marks)

Case study

Home Styles Ltd

Jana Jaril comes from a family that has bought, renovated and sold or rented houses as a side-line to their main forms of employment for a number of years. This family interest has proved to be a profitable small business. Her mother is an electrician by trade but has developed skills in other areas such as basic plumbing work and carpentry. This has greatly reduced the cost of 'doing up' old properties. Jana's father works as a part-time bookkeeper, so he has enough spare time to keep proper financial records for the business.

Jana's favourite subject at school was Art. While still at school Jana discovered a knack for helping her parents to tastefully furnish renovated properties in preparation for their sale or rent. After school Jana studied interior design while helping run her parents' business.

About 20 years ago Jana was left money by a grandparent. She used this to open her first Home Styles shop in an exclusive part of Edinburgh. It sells home furnishings and accessories to a range of customers.

Jana's luck, good taste and business acumen have proved very successful. The private company she formed nearly 18 years ago, Home Styles Ltd, has grown to comprise a chain of 25 stores in Edinburgh and southern Scotland. The retail outlets have been complemented by an effective and profitable website.

Jana is the majority shareholder, while her parents own the remaining shares in the business. Jana has recently decided she wants to sell the business in about three years. She is conscious that her parents are growing old and she also wants to spend more time with her young family.

Jana's parents have decided to retire from formal employment in the next few months. They will still, however, run their property business. While they are essentially passive shareholders in Home Styles Ltd, Jana still relies on them for common sense advice she can trust.

Home Styles Ltd has been profitable since the global financial crash that began in 2007. It appears to Jana and the new joint chief executive director of the company, Peter, that the domestic furnishings market has not been affected by cuts in government expenditure. Revenues have increased on average by 4% per annum in recent years. In the year ending 30 June 2018 the company achieved a record return on equity of 21%. This has generated some media interest in Home Styles Ltd, as well as a number of serious offers to buy the company.

In the last year, Jana has relied mainly on Peter's advice to improve financial performance and financial health ratios, invest in new staff, and improve back office and other business systems by means of technology. The joint chief executive director has also concentrated on buying higher quality goods that can be sold with a higher profit margin. A more contentious strategic decision by the joint chief executive director was to increase marketing and advertising expenses in order to significantly improve sales. Peter is keen to improve profitability and reduce financial risk where possible, in order to put the business on a stronger and more sustainable footing. Jana's parents have recently challenged Peter's views and advised their daughter that the company has not performed well in the past year.

Jana 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 parents' recent advice is justified.

Home Styles Ltd Income Statements for the years ended 30 June 2019 and 30 June 2018

Year to 30 June 2019

Year to 30 June 2018

k

k

k

k

Sales revenue

89,572

82,674

Less: cost of goods sold:

Opening inventory

4,234

4,462

Purchases from wholesalers

42,856

41,387

47,090

45,849

Less closing inventory

3,832

4,234

Cost of goods sold

43,258

41,615

Gross profit

46,314

41,059

Less expenses:

Salaries and other costs

17862

16,054

Rent and office services

639

629

Insurance

94

103

Distribution and postage costs

321

308

Marketing and advertising expenses

861

828

Office administration

187

161

Energy and other utilities

251

228

Depreciation

649

669

Audit, Accounting & Legal Costs

46

44

Interest on bank loan

10

6

Interest on bank overdraft

0

0

Total Expenses

20,920

19,030

Interest received

1,395

1,285

Profit before taxation

26,789

23,314

Corporation tax

5,358

4,595

Profit after taxation

21,431

18,719

Home Styles Ltd Balance Sheets at 30 June 2019 and 30 June 2018

Year to 30 June 2019

Year to 30 June 2018

k

k

k

k

Non-current assets

Property

23,428

24,098

Computers and equipment

396

334

Vehicles

247

226

Total non-current assets

24,071

24,658

Current assets

Inventory

3,832

4,234

Receivables

3,178

2,182

Other current assets

43

39

Cash at bank

87,958

65,121

Total current assets

95,011

71,576

Current liabilities

Payables

10,942

10,421

Corporation tax

5,358

4,595

Other tax liabilities

309

276

Bank overdraft

0

0

Total current liabilities

16,609

15,292

Net current assets/working capital

78,402

56,284

Total assets less current liabilities

102,473

80,942

Long-term liabilities

Bank loan

200

100

Net Assets

Total102,273

Total80,842

Equity

Share capital

1,000

1,000

Reserve: retained earnings

101,273

79,842

Total Equity

Total102,273

Total80,842

Home Styles Ltd Cash Flow Statements for the years ended 30 June 2019 and 30 June 2018

Year to 30 June 2019

Year to 30 June 2018

k

k

k

k

Non-current assets

Property

23,428

24,098

Computers and equipment

396

334

Vehicles

247

226

Total non-current assets

24,071

24,658

Current assets

Inventory

3,832

4,234

Receivables

3,178

2,182

Other current assets

43

39

Cash at bank

87,958

65,121

Total current assets

95,011

71,576

Current liabilities

Payables

10,942

10,421

Corporation tax

5,358

4,595

Other tax liabilities

309

276

Bank overdraft

0

0

Total current liabilities

16,609

15,292

Net current assets/working capital

78,402

56,284

Total assets less current liabilities

102,473

80,942

Long-term liabilities

Bank loan

200

100

Net Assets

Total102,273

Total80,842

Equity

Share capital

1,000

1,000

Reserve: retained earnings

101,273

79,842

Total Equity

Total102,273

Total80,842

Home Styles Ltd Cash Flow Statements for the years ended 30 June 2019 and 30 June 2018

Year to 30 June 2019

Year to 30 June 2018

k

k

Operating activity:

Operating profit

25,404

22,035

Interest paid on overdraft

0

0

Corporation tax paid

(4,595)

(6,485)

Add back non-cash expenses:

Depreciation

649

669

Loss/(Profit) on disposal of non-current assets

0

0

Changes in cash invested in working capital:

(Increase)/Decrease in inventory

402

228

(Increase)/Decrease in receivables

(996)

(472)

(Increase)/Decrease in other current assets

(4)

8

Increase/(Decrease) in payables

521

1,854

Increase/(Decrease) in other tax liabilities

33

94

Net cash inflow/(outflow) from operating activities

21,414

17,931

Investing activity:

Purchase of non-current assets

(62)

(47)

Proceeds on disposal of non-current assets

0

0

Net cash generated (consumed) by investing activity

(62)

(47)

Financing activity:

Repayment of bank loan

0

0

New bank loan

100

0

Interest paid on bank loan

(10)

(6)

Interest received on bank deposit

1,395

1,285

Net cash generated (consumed) by financing activity

1,485

1,279

Change in cash balances

22,837

19,163

Opening cash balance (overdraft) at1st January

65,121

45,958

Closing cash balance (overdraft) at31st December

Total87,958

Total65,121

Guidance to students

Question 1

The three main financial statements were introduced to you in Readings 23-25. You should use your own words to describe the essential characteristics and uses of the three statements for Home Styles Ltd. Ensure your answer is both about the usefulness of the three statements in general terms, as well as how they apply to the particular situation of Home Styles Ltd.

Question 2

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. State why the answers you reach might be of concern to Home Styles 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.

Question 3

In assessing the value of Jana's parents' recent concern, you should respond in particular to the issues you have identified in your analysis in Question 2. The second part of the question is to make some practical suggestions for what Jana could do to meet hers parents' concerns, and to achieve hers objective of improving the financial performance of the business. You should also use your knowledge gained from Reading 27 "Financial Planning" to help you answer this part of Question 3.