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Read through the case study below, and then answer the following questions. Part 1 questions Briefly explain the general purpose of each of the three

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

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