Evaluating Financial Position of Roast Ltd

PART 1: INDUSTRY OVERVIEW

Current UK Coffee House Industry

The coffee shop industry in UK has always been a lucrative business for the economy where it is easier to open and successfully operate a new coffee joint.

• In the economy of UK, after the Brexit, the industry has not been affected, and they are still growing at the rate of 5.85% on an approximate basis even in the year 2018 (Robinson, 2020).
• In the market of UK, the major players in the coffee shop industry are Costa Ltd., Pret A Manger Ltd., Starbucks and Caffe Nero. The overall revenue of this industry is estimated to be £6 billion and since the year 2014, the industry has grown collectively by 6.1% (Cafes & Coffee Shops in the UK - Market Research Report, 2019).
• After Brexit, the major challenges that have been faced by this industry I that the there is a heavy reliance on obtaining the lower skilled workers because the wages are low and there are no prominent risks involved as well.
• The majority of coffee shops in UK have lost the capability hire lower wage and lower skilled employees as they have been separated in the form of division of EU and UK.
• Currently, UK is in free trade agreement with the EU where they have developed negotiated tariffs but as soon as Brexit occurs, it will impact the way the industry is operating.
• Apart from the challenges, there are many opportunities as well for the industry. There is a high degree of innovative practices that can be adopted in this industry and this is the most significant benefit that can be generated in the industry. This significantly helps in the growth of the industry (Eng, Tian and Robert Yu, 2018).
• Another major opportunity is that the industry will never face any downward movement or deflation in the economy and it is a highly prosperous business thus giving wider access of expansion and development.

PART 2: BUSINESS PERFORMANCE ANALYSIS

2.1 Statement of Profit or loss

Based on the data given in the exhibit 1 and 2, following calculation can be done for the Roast Ltd.:

The financial statement prepared above helps in concluding that the profitability of the company has increased in the past year with almost double as compared to the data available for the year 2017. The above profit and loss statement for the Roast Ltd. Shows that the revenue of the company has increased from 2022 in year 2017 to 2534 in 2018. The sales also increased in 2018 and ultimately the gross profit of the company also increased from the figure of 1505 in 2017 to 1990 in 2018. Apart from these figures, the fact that there were certain additional sources of income that the company was able to generate such as winning the court case that was filed against Caffe Tostato. Caffe Tostato was charged by the Roast Ltd. For copying and stealing a number of brand designs that were exclusively reserved for the Roast Ltd. After a long court case, it was ultimately ruled out in favour of the Roast Ltd. and the Caffe Tostato was asked to compensate with the total amount of £60 million where 25 million was charged for legal costs that the company incurred and 45 million was to compensated for the damages that the company incurred. This was added in the operating income of the company in the year 2018 whereas, there was no such operating income in the year 2017.

It can also be stated that other than the major source of operating income that the Roast Ltd. Was able to earn in the year 2018. This mainly consists of the remuneration that the company was able to save in the 2018 in the form of both employees salary and the remuneration of the directors (Arif, Noor-E-Jannat and Anwar, 2016). The employees of the company reduced from 20 in the support workforce to 13 employees and it was found that role of marketing and HR director as well as Non-executive director was removed thus reducing the cost of director's remuneration in the year 2018. This was also another additional factor in the increase of the profitability in the year 2018 as compared to the year 2017 where it resulted in the positive balance of the company. However, everything was not just incoming in the year 2018 because there were certain expenditures as well that the company incurred in the year 2018. There were certain costumers of the company i.e. one major customer who was experiencing some difficulties in the cash flows of his business. It was requested that the payment period on the sales be increased from the earlier period of 30 days to the 90 day period. This increase in the period led to the increase in the bad debts charges of the company thus increasing the operating expenses as well in the year 2018 (Mohanram Saiy and Vyas, 2018). The above analysis can be used to day that there were some major changes that took place in the company in the year 2018 and all of these collectively led to the increase in revenue of the company.

The profitability ratios of the company increased significantly in the past year where the ROE increased by 103% from year 2017 to 2018 and ROCE increased by 75.5% in 2018. Although the gross margin of the company declined by 16% but due to certain income sources that were described above, the net margin of the company increased by 98% approximately.

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2.2 Statement of Financial position

The data provided in the exhibit 1and 2 regarding the position and financial statements of the Roast Ltd. Company, it can be adequately used to analyse the financial position of the company. The data given regarding the balance sheet of the company can be used to analyse the company's data and develop solvency ratio (Ahmed and Safdar, 2018). These solvency ratios will further assist in evaluating the financial position of the company and its performance level and the liquidity ratio will determine that whether the company is able to repay it debt timely and whether the position of the company is strong or not:

The analysis of the balance sheet of the Roast Ltd. for the year 2017 and year 2018 shows that the assets and liabilities of the company have increased significantly from the year 2017 to the year 2018 and therefore, it can be interpreted that the fixed assets of the company as well as the current assets both have increased for the company. Although the cash equivalent of the company has become zero, it shows that company has started to deal mostly on the credit basis (Kaur, 2018). The retained earnings of the company has also increased and this can be majorly credited to the fact that the dividends that are to be paid to the shareholders of the company has become 0 in the year 2018 as compared to the amount of 30 million in the year 2017. The long term borrowings of the company have also increased from the year 2017 and this can be used to show that the proposal of giving loan to the company by the Finan Ltd. might get accepted because the debt financing increase shows that the company is being trusted by other financiers as well.

Apart from this, the solvency and the liquidity ratios that were calculated above can be used to interpret that from the year 2017 to the year 218, the overall solvency of the company has improved drastically. The debt to equity ratio of the company has increased by approximately 150% showing that the debt financing in the company has increased in the past year i.e. the goodwill of the company has increased in the market. The gearing ratio has also increased of the company from 11.38% in 2017 to 24.23% in 2018. However, the interest cover was found to have declined in the company and the dividend ratio turned zero because the company decided to restructure the company which might not be the best move (Monahan, 2018). It is becoming increasingly dependent on the debt financial only and this can affect the company negatively as well because the risk factor increases.

Therefore, it can be concluded that the financial position of the company has increased and the company has started to become successful but the dependency on the debt financing has also increased and owing to the market risk factors this might turn out to be a redundant move.

2.3 Statement of Cash Flows

The cash flow given in the Exhibit 1 can be used to state that the cash inflow in the Roast Ltd. Has significantly dwindled in the past year when in the beginning of the year the cash and cash equivalents were equal to the 134 million in the beginning of 2017 and due to all the operating, financing and investment expenditures, the revenue of the cash flow has dwindled (Dicle and Meyer, 2018). The cash flow form the operating activities was negative in the year 2018 by the amount of negative 24 million. This was mainly due to the increase in the interest and income taxes that were paid the amount of negative 24 million and the investing activity was also negative in terms of cash inflow since there was increased investment in the fixed assets of the company by a negative outflow of 358 million.

Operating Cycle: The operating cash cycle of the company can be determined in following manner:

The table above shows that the operating cycle of the Roast Ltd. Has mainly increased in the past years and every aspect has increased in year 2018 as compared to the year 2017. The inventory days have increased from the year 2017 by 26 days and this can be credited to the fact that raw material procurement has also increased. The receivable days have increased by 5 days due to increase in the payment period of the debtors. The payables days has also increased by 10 days since the liabilities of the company have increased and therefore the operating cycle of the company has increased all over by the period of 21 days as compared to the year 2017 and 2018.

Dividend Policy: The company i.e. Roasty Ltd. Decided to reduce the equity financing option in the company and it was found that the there was a higher increase in the long term borrowings of the company. The decision of the company to not make any dividend payment of the shareholders of the company was not a good decision because it is not a prudent decision to depend heavily on the source of debt financing (Hasibuan and Syahrial, 2019). Also, share holders are the major investors in the company and if they would not be given timely and adequate dividend from the profits of the company, then it would affect the performance and goodwill of the company negatively.

PART 3 : INVESTMENT APPRAISAL

3.1.a Management Forecast

Roast ltd is running the business of coffee from 2008 in UK. It is an Coffee house chain that is serving the market with different coffee taste. It has created a considerable customer and developed recognition in he market using the marketing strategies. These marketing strategies have been successful and helped it to gain competitive advantage. Company has been offering something new to the market since from the beginning and developed high preference among the customers. The business is a family business inspired by the Italian heritage. Company is famous for using the Italian technology in its coffee machines. The opening of the new coffee chains have been successful for the company and it had successfully attained the desired targets with slow initial growth (Kengatharan and Nurullah, 2018). Company seeing its demand has planned to expand its business over new areas and has established the business in Romania. For the business before expanding to the new areas have to identify the viability and other factors that may affect the business.

Roast ltd for the expansion is proposing to acquire share in the manufacturer of coffee machines. To acquire the share it is requiring the initial investment of 400 million pounds. It is significant investment and should be assessed before the funds are invested in he project. Acquiring share in coffee manufacturer. This will make the coffee machines available to the company at reasonable cost that will help in reducing the costs of coffee. This will also help company in generating two way income. One from the sale of machines and other from the coffee outlets in Romania. Income from double sources will help it to stabilise as well in supporting the business in its initial years. If company do not check the profitability of the project before investment it may have to suffer losses which may also affect its current coffee business.

 Management has forecasted the cash flows for next five years from the adoption of the project. New project will have the cash inflows after covering its variable costs of £60, £112, £148, £180 and £224. The cash flows from the project seems to be adequate as company will achieve effectiveness in controlling the operational cost of running the business as well as diect cost associated with processing of coffee. Management has used the techniques of capital budgeting for analysing the acceptability of the project. This techniques are used widely by the businesses before investing their funds in the project. Payback period, NPV of the project and ARR has been used by the company so that project proves to be successful (Jibril and Jagun, 2018). These have shown positive outcomes for the project. The project will be accepted by the management as it is going positive results in methods used. If the cash flows are not positive and not adequate than the project would have been rejected by the enterprise without checking further the investment methods. The project should be adopted as the estimated cash flows will recovered the cost as well as also help it to spread roots in new business.

3.1.b Investment Appraisal Techniques

Payback Period

It is an investment appraisal technique used for assessing whether a project should be adopted or not. Payback period is used for determining the amount of time that is required by the project for recovering its initial investment. In other words it is a method that is used for calculating the time required for earning back the cost incurred in investment through cash inflows. It is also the break even point after which the investments starts earning profits. In the given case company has will be able to recover the cost in 4 years. Period is not very much longer as the cost of investment is high (Mahmoud, 2016). It takes time to recover the cost of investment. Project as per the pay back period should be adopted by the company. The advantages and disadvantages are

Advantages

• This method is easy and simple to calculate as well as to understand.
• Method analyses the risks associated with investments in terms of time.
• Beneficial for the sectors where the investment tend to become obsolete in shorter time.
• Liquidity of the project is also measured by this method.

Disadvantages

• This method do not consider the time value of money concept.
• Cash flows generated after the payback period are not taken into account by this method.
• It do not consider other factors that may affect the project.

Accounting Rate of Return

The method is also called average rate of return. It is also financial metric used for assessing the viability of investment. This method does not takes in takes into account the time value concepts. It is used for measuring the returns that are generated from the cash inflows in the current investment. Accounting rate of return from the proposed investment is 18%. the rate is adequate as per the sector and investment. The rate is not very higher therefore also significant variations will not be seen from the actual inflows. The methods also provides for accepting the project as the rate is significant and will help to improve the business. Advantages and disadvantages are

Advantages

• It helps to compare the two projects as project with higher return is adopted.
• The profitability of the project is presented clearly by this method and satisfies the interest of owner.
• This method also easier to calculate and understand (Harris, 2017).
• The methods helps n creating the perception about the earnings that are required to be earned by the project.

Disadvantages

• This method also ignores the concept of time value of money.
• External factors affecting the earning capacity of project are not considered by this method.
• This method is not useful in the event where project involves instalments.

Net Present Value

It means the present value of money in contrast with the future amount of money. It considers the time value and concepts. It takes intro account the inflations and interest that will be generated if the funds are invested elsewhere. The present value denotes whether investing in a particular project will be profitable or not for the industry after discounting the cash flows using adequate discounting factor. The NPV of the project has shown positive outcomes, that could be interpreted that the project is viable. It will provide profitable return to the company if it adopts the project as Npv is positive (Alkaraan, 2017). Advantages and disadvantages of the method are given below

Advantages

• It takes into account the time value concept which helps in knowing the present worth of future flow of money.
• This helps in analysing whether the project will be viable using the discounting rates.
• This method also takes into account cost of capital & the risks attached with the projections made for the future.
• This provides clear image of the contributions that will be made by the project.

Disadvantages

• It involves estimation of future cash flows from the project.
• It is not beneficial for comparing two projects with different cost of capital and investment.
• It is difficult to decide the discounting rate for the project.

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3.2 Sources of Finance

Roast Ltd. Can raise finance for their new venture from various sources and there are various alternatives through which this can be done. The two best alternatives of raising finance for the Roast Ltd. Are:

Venture Capitalists: Venture Capitalists are those who invest in those companies that have innovative ideas and are capable of generating higher returns. Venture capitalists are a type of private equity investors in those companies that exhibit higher growth potential (Robinson, 2020).

Equity Financing: Equity financing involves raising capital by issuing shares in the market i.e. amongst the shareholders who finance the company by buying the shares in the company. This type of capital also has certain advantages and disadvantages:

The best option for the company currently would be to go for equity financing so that an appropriate ration can be maintained between the debt and equity financing in the company.

REFERENCES

• Ahmed, A.S. and Safdar, I., 2018. Dissecting stock price momentum using financial statement analysis. Accounting & Finance, 58. pp.3-43.
• Alkaraan, F., 2017. Strategic investment appraisal: multidisciplinary perspectives. In Advances in Mergers and Acquisitions (pp. 67-82). Emerald Publishing Limited.
• Arif, T.M.H., Noor-E-Jannat, K. and Anwar, S.R., 2016. Financial Statement and Competitiveness Analysis: A Study on Tourism & Hospitality Industry in Bangladesh. International Journal of Financial Research, 7(4). pp.180-189.
• Dicle, M.F. and Meyer, J., 2018. Financial Statement and Ratio Analysis: A Classroom Perspective.
• Eng, L.L., Tian, X. and Robert Yu, T., 2018. Financial statement analysis: evidence from Chinese firms. Review of Pacific Basin Financial Markets and Policies, 21(04). p.1850027.

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