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 the owners of Snip Snip Ltd.
2. Analyse the financial statements that have been prepared by Snip Snip Ltd. In particular, comment on the following aspects of the company:
   • Areas of concern in financial performance, focussing mainly on information from the income statement. (22 marks)
   • Areas of concern in financial health, focussing mainly on ratios dependent on the income statement and the balance sheet.
   • Areas of concern in cash flow management, focussing mainly on information available from the cash flow statement.
3. Using the analysis in your answer to question 2, assess the validity of the concerns raised by Susan in relation to the business. What practical steps should Becky and Dan now undertake in order to improve the financial performance and financial health of the business?

Case study: Snip Snip Ltd

Note: For the purposes of this case study you should assume that Snip Snip Ltd traded for the entirety of 2020 and that the COVID-19 pandemic and associated lockdown did not occur.

Becky and Dan established a hairdressing company together in 2010, Snip Snip Ltd. At first, they had one salon but over time they have opened six more, two of which opened at the very end of 2019. In other words, the 2019 figures are for five branches, whereas those for 2020 are for seven branches. The salons, which are all roughly the same size, cater to both men and women. Their business model now is to rent out chairs, a system whereby self-employed hairdressers pay a monthly rent to use a chair in one of the salons. The rents are set annually in advance and should be paid monthly in arrears. Becky and Dan no longer style hair themselves but oversee the business. This involves the accounting and administration from their home-office, marketing and branch visits.

Additionally, they sell hair products in store. These are typically sold at a 150% mark up (that is, the sales price is two and half times the cost of purchase. For example, if a product cost Snip 10 then it would be sold at 10 + (10 x 1.5 = 15) = 25, or 10 x 2.5 = 25.). Hairdressers do not get a commission for making product sales, but those who sell more get reduced chair rents at the annual re-negotiation. Any receivables in the balance sheet relate to hairdressers chair rents.

Although most of the hairdressers are self-employed, Becky and Dan take a salary. They also currently have twelve apprentices on their books, whom they help to train. The apprentices help the self-employed stylists and only receive a salary. The customers payments go to the stylists. Hence the apprentices do not generate income for Snip Snip.

The Snip Snip chain has a reputation for high quality and a loyal customer base locally. This has been done through a combination of recommendations by satisfied customers and by marketing and advertising. However, they have noticed a drop in customers recently with a trend in some customers deciding to cut their own hair at home.

80% of the shares of the company are owned by Dan and Becky and the rest by Beckys mother, Susan. The shareholders have not been taking dividends out of the business in order to increase funds for investment by the company.

Over the past few years, the return on equity has been around 34%. Part-way during 2019 Snip increased their debt to 125,000 to help fund expansion.

Susan is concerned that the business is not realising its full potential as well as how to address the possibility of falling customer numbers. For example, she has read that more men are starting to cut their own hair at home. Susan wishes to understand more about the latest financial statements, any trends indicated by an analysis of the financial statements and any future plans as to how any concerns may be addressed. She is quite concerned that the cash flow statement was negative last year and not very positive this year.

Snip Snip Ltd income statements for the years ended 31 December 2020 and 31 December 2019

	Year to 31 Dec 2020		Year to 31 Dec 2019
	k	k	k	k
Sales revenue
Products		752		713
Rent of chairs		1,698		1,389
		2,450		2,102
Less cost of goods sold:
Opening inventory	130		98
Purchases	381		343
	511		441
Less closing inventory	167		130
Cost of goods sold		344		311
Gross profit		2,106		1,791
Less expenses:
Salaries	417		254
Insurance, legal and professional	81		75
Rents and local taxes	759		680
Energy and other utilities	356		282
Marketing and advertising	56		90
Depreciation	123		115
Total expenses		1,792		1,496
Operating profit		314		295
Less interest cost		12		3
Profit before taxation		302		292
Less Corporation Tax		37		38
Profit after taxation		265		254

Snip Snip Ltd balance sheets at 31 December 2020 and 31 December 2019

	At 31 Dec 2020					At 31 Dec 2019
	k				k	k	k
Non-current assets
Property and fixtures					715		617
Total non-current assets					715		617
Current assets
Inventory	167					130
Receivables	147					119
Cash at bank			293			237
Total current assets			607			486
Current liabilities
Payables	260					305
Corporation tax	37					38
Total current liabilities	297					343
Net current assets					310		143
Total assets less current liabilities					1,025		760
Long-term liabilities
Bank loan					125		125
Net Assets					900		635
Equity
Share capital					50		50
Reserves: retained earnings					850		585
Total Equity					900		635

Snip Snip Ltd cash flow statement for the years ended 31 December 2020 and 31 December 2019

	Year to 31 Dec 2020	Year to 31 Dec 2019
	k	k
Operating activity:
Operating profit	314	295
Corporation tax paid	(38)	(25)
Non-cash expenses:
Depreciation	123	115
Changes in cash invested in working capital:
(Increase)/Decrease in inventory	(37)	(8)
(Increase)/Decrease in receivables	(28)	3
Increase/(Decrease) in payables	(45)	2
Net cash inflow from operating activities	289	382
Investing activity:
Purchase of non-current assets	(221)	(492)
Net cash outflow from investing activities	(221)	(492)
Financing activity
Interest paid on bank loans	(12)	(3)
Net cash outflow from financing activities	(12)	(3)
Change in cash balances	56	(113)
Opening cash balance at 1 January	237	350
Closing cash balance at 31 December	Total293	Total237