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

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 Improve Ltd.
2. Analyse the financial statements that have been prepared by Improve 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.
   • 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 Uncle Dave in relation to the business. What practical steps should Susan and Chris now undertake in order to improve the financial performance and financial health of the business?

Case study

Improve Ltd

Susan and Chris established a company together in 2010, Improve Ltd, to provide a home and garden improvement service. This involved hiring out equipment to customers to help them undertake their own home and garden improvements as well as offering a service covering home and garden renovations and repairs such as home decoration and the construction of conservatories. As part of the renovation service, the company offers credit for items such as conservatories.

The company has a series of shops where customers can come to hire equipment. Customers can also obtain quotes for any work they wish to have undertaken. Susan and Chris have noticed that the hiring of equipment is becoming less popular than customers asking for work to be carried out on their behalf.

Susan and Chriss work 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. Both Susan and Chris are concerned with how they will respond to increased economic uncertainty.

80% of the shares of the company are owned by Susan and Chris and the rest by Susans Uncle Dave. 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 42%.

Uncle Dave is concerned about how the business has been doing recently, its profitability and financial health. Uncle Dave 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. He has suggested that one option is for the business to consider paying back some or all of the bank loan.

Improve 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		39,000		37,000
Less cost of goods sold:
Opening inventory	5,800		6,200
Purchases	11,500		9,900
	17,300		16,100
Less closing inventory	6,700		5,800
Cost of goods sold		10,600		10,300
Gross profit		28,400		26,700
Less expenses:
Salaries	14,500		12,300
Insurance	700		550
Delivery costs	300		400
Marketing and advertising expenses	900		1,200
Energy and other utilities	700		600
Depreciation	1,100		650
Architects fees	5,100		4,300
Total Expenses		23,300		20,000
Operating Profit		5,100		6,700
Less Interest cost		120		120
Profit before taxation		4,980		6,580
Less Corporation tax		996		1,316
Profit after taxation		3,984		5,264

Improve 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 equipment for hire					15,712		14,062
Vehicles					800		650
Total non-current assets					16,512		14,712
Current assets
Inventory	6,700					5,800
Receivables	2,990					1,100
Cash at bank			700			1,126
Total current assets			10,390			8,026
Current liabilities
Payables	2,700					2,200
Corporation tax	996					1,316
Total current liabilities	3,696					3,516
Net current assets/working capital					6,694		4,510
Total assets less current liabilities					23,206		19,222
Long-term liabilities
Bank loan					1,500		1,500
Net Assets					21,706		17,772
Equity
Share capital					11,000		11,000
Reserve: retained earnings					10,706		6,722
Total Equity					21,706		17,722

Improve 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	5,100	6,700
Corporation tax paid	(1,316)	(2,520)
Non-cash expenses:
Depreciation	1,100	650
Changes in cash invested in working capital:
(Increase)/Decrease in inventory	(900)	400
(Increase)/Decrease in receivables	(1,890)	(800)
Increase/(Decrease) in payables	500	(2,500)
Net cash inflow from operating activities	2,594	1,930
Investing activity:
Purchase of non-current assets	(2,900)	(1,584)
Net cash outflow from investing activities	(2,900)	(1,584)
Financing activity
Interest paid on bank loan	(120)	(120)
Net cash outflow generated by financing activities	(120)	(120)
Change in cash balances	(426)	226
Opening cash balance at 1st January	1,126	900
Closing cash balance at 31st December	Total700	Total1126