MARKETING STRATEGY & FINANCE
COURSEWORK:
FINANCIAL REPORT
NAME: RAASHI SUNEJA
CID: 01268832
WORD COUNT: 1468
Pace Leisurewear is clothing company founded by Jill Dempsey and Mike Greaves, which targets its manufactured casualwear to the young audience with high-income. The five-year old company commenced its operations during the recession period with consequently low sales. However, with the opening of markets for exports in France and Switzerland and the recovery of the economy from the crisis led to a substantial increase in the sales of the company. Arena, one of the big national players of the industry has been placing consistent and significant orders with Pace and has recently placed a large order. Presently, the company is facing a catastrophic situation because its bank has demanded a 50% reduction in the company’s overdraft, which is deterring Pace from meeting Arena’s order without maintaining the overdraft. Fulfilling this order is imperative as it is likely to determine a promising future performance for Pace.
Problems: The company is seemingly facing both, administration, financial and liquidity problems. The company lacks financial expertise. When faced with a problematic situation, the auditors are turned to for solutions. This lack of financial direction and guidance has misled the company’s decision-making. The board of directors are looking at the draft accounts and falsely attributing success to the increase in profits and sales, disregarding the low cash levels and tight-liquidity situation in the business. Moreover, the company has surpassed its permissible overdraft limit on numerous times in the past which has instigated the bank’s tolerance levels to decrease, clearly indicating negligence and lack of discipline from the company’s end. It seems as though the board of directors are unable to arrive at a collective decision due to contrasting opinions and disintegration among their probable solutions. The situation calls for an injection of funds or further issue of capital in the business. The Keeble Brothers’ real-estate business was also hit hard by recession, as a result of which they are unable to invest further in the business. At the same time, they are insecure about dilution of their power to influence future decisions if the board brings in another major investor. The refusal of the Keeble Brothers to further invest or get another investor, Jill Dempsey’s illogical action plan of continuing to convince the bank to change its decision and Mike Greaves and Jane Barker’s pessimistic attitude towards dealing with the crisis situation all point towards the low motivation levels of Pace’s board of directors.
In addition to these problems, the company is facing numerous financial and liquidity problems. A thorough analysis of the firm’s financial statements clubbed with an analysis of the key ratios helps in understanding what has gone wrong.
Analysis and Ratios
Profitability Ratios: The Gross Profit Margin for the year before last was 46.48% and was 48.16% last year. [1] The Net Profit Margin was approximately 15% for the year before last and this figure increased to 20.61% last year. [2] This confirms that the company’s performance has improved post-recession and the profits have been increasing every year. Both these ratios express profit in relation to the sales. This improved performance is driven by efficient and smooth operations within the business and the ability to cover the manufacturing costs while selling clothing items to the high-income consumers. The Return on Equity or Shareholder’s Funds was 18.2% year before last and 32.5% last year. [3] This indicates that the shareholders of the company were generating increasing returns on their capital investment from the profits generated after interest and tax were paid. The Return on Capital Employed increased from 20.05% to 29.6% last year. [4] Therefore, the funds in the business have been allocated prudently.
Although the company has been generating increasing profits and return on capital employed and shareholder’s funds, by looking at the balance sheet, there is evidently a severe liquidity crunch or shortage of cash within the company. The company has spent an extravagant amount last year on the acquisition of non-current assets such as machinery. They did not get much for the fixed assets that they sold. Although the Return on Assets Ratio has increased from 12.87% in the year before last to 15.16% last year [5], the Total Debt to Assets Ratio 47% to 63% [6] which reveals an increase in the assets financed by debt and consequent exposure to risk. Pace have increased their long-term borrowings and used a bank loan to finance these capital expenditures. Such capital investments can be beneficial in the long-term, but this money should have ideally been utilized to meet working capital requirements for the daily operations of the business. This would have prevented the overdraft situation in the first place.
Liquidity Ratios: A fall in the Current Asset Ratio from 1.76:1 year before last to 1.12:1 [7] last year and is lower than the ideal 2:1 ratio, which clearly shows that the money is not being utilized productively in carrying on day-to-day functions of the business as monetary resources are tied up in other avenues. The Quick Ratio too has fallen from 0.78:1 to 0.47:1 [8] which suggests that without inventories, the company does not have sufficient liquid cash to fulfill its short-term obligations. In a nutshell, the company’s short term solvency is very poor.
Efficiency Ratio: The Sales Revenue to Capital Employed Ratio increased from 1.34 times in the year before last to 1.44 times last year as the company was obtaining more revenue from sales. [9]
However, the balance sheet reveals that the accounts receivables figure has nearly double last year from year before last. Therefore, the company has been increasing its credit sale. In addition to this, the average settlement period for trade receivables has increased from approximately 42 days to 61 days. [10] The inventory turnover has fallen from 5.8 times to 3.85 times. [11] Due to lack of efficiency to manage inventories, inventory levels have risen as they are not being sold or utilized optimally.
Gearing Ratios: The interest cover ratio has increased from 4.86 to 5.06 times. [12] indicating that there is a higher risk associated with the company’s ability to repay loans. The gearing ratio too has increased from 34.4% to 42.3% or to 0.42:1. [13] However, although the gearing levels have increased, there is still scope for the company to raise debt from sources other than the bank.
Recommendations:
Based on the above analysis of the financial statements, ratios and problems being faced by Pace Leisurewear, the proposed recommendations for a future plan of action are as follows:
To address the liquidity problem, the first and ideal option is for Jill and Mike to impress upon the Keeble brothers to allow them to bring in a new investor into the company since they cannot invest further in the business so that the overdraft can be brought down as required and there will also be enough to finance the operations of the business. In addition to this, eventually the company will have to raise capital by issuing shares as sales are anticipated to increase even more with larger orders. However, keeping in mind that the Keeble Brothers are major investors of the company and have expressed concern over dilution of their power and influence by this decision, there is a second option. Since there are retained profits in the business and there is still scope to raise debt, based on the gearing ratio – it is suggested that Pace should fund capital expenditures and reduce the overdraft through long-term funding by issuing debentures to private investors or the public who may still be interested in investing the company. By issuing non-convertible debentures secured over the assets of the company and creating a sinking fund for 3 to 5 years (where every year a predetermined proportion of the profits are kept aside), creating a charge in registrar of companies and paying interest on debentures, the company can raise long-term sustainable capital. A 3 to 5-year window to redeem the debenture will hopefully give the real-estate market enough time to bounce back and enable the Keeble Brothers to infuse equity into the business. This way, they need not worry about the dilution of their power. The company is urged to appoint a Chief Financial Officer in the company who can not only take important financial decisions but also provide expert advice for investment purposes. There are a few short-term measures of increasing the cash flow within the firm such as cancelling the dividend that is yet to be paid, reducing the debtor days and collecting the accounts receivables from the debtors of Pace. It is also recommended to ascertain optimal level of inventories using management accounting tools and bring down the current inventory levels to ideal levels. And most importantly, all the employees and directors of the company must keep their personal interests aside and take appropriate action to take the company forward on a high growth trajectory.