Critically analyse financial statements

During the case study all the figures showed a considerable profits in year 2018. All the activities were enhanced by companies using appropriate strategies so that the performance of companies could be better from last year. Company achieved the profits in company year and increase were considerable from previous year. Though company has showed increased profitability but it has negative cash flows the year that is a area of concern and company has to focus over turning the cash flows to positive. If the cash flows are not made positive it can affect the business sometimes to even shut down.

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PART 1 : Industry Review

Cafe and coffee shop industry includes every specialists unlicensed establishments which have focus over sale of coffees, adding to cold and hot drinks and light snacks. Industry performance is driven both by economic as well as social factors. It includes growth of disposable income of real household, preferences of people have driven from social venues and increased consumers interests in coffee blend and origins. Over the recent years industry is performing strongly well because of increased demands. Coffee culture is becoming very popular in between the consumers (Lang and Stice-Lawrence, 2015). Over five years by 2018-19 revenues of the industry is expected to raise at compounded annual rate of 4.8 percent, inclusive current years growth of 1.9% for reaching £ 6.6 billion. Companies holding the greatest market share in Cafe and Coffee shops in UK are Pret A Manger, Costa Ltd, Starbucks Coffee Company Limited and Caffe Nero Group Holdings Ltd. They are the major players of the industry but Cost is ranked highest with 2121 number of outlets in nation that is followed by Starbucks with 898 outlets and Caffe Nero with the 650 stores.

Challenges and Opportunities

• Minimum wage change can have significant influences over profit margins. Minimal wage is expected to raise in 2018/19 that can threat profit margins of the industry.
• Depreciation of pound will make the purchases through imports more expensive for the industry weighing over the profits of company.
• Household expenditures over beverages and food are also including cafe and restaurant products. Few of these expenditures will be supporting industries for competing with coffee and cafe shop industry.
• Spendings over non alcoholic beverages are tend to rise in the years that will present new opportunity for the industry operators.

PART 2 : Business Performance Analysis

2.1 Analysis of Statement of Profit or Loss

Key observations drawn from Profit or loss statements for the year ending 31 December 2018 are discussed below.

Sales and gross Profit

Company has performed exceptionally well during the current year. The opening of new outlets has helped the company to increase its revenues. Costa has raised the revenues by 25.32 % from past year. Increases are seen due to the new opening stores in the country with new products and services with completely new and unique Italian taste. The growth of the company in revenues in present year is very significant with the new strategies adopted by the company for attracting the customers. Company is having large customer base that is increasing every year due to the raising trend towards the cafe culture and increase in in household income of the consumers.

The gross profit margin of the company has decreased by 16.04%. Margin of the company during year 2018 is 21.47% which was 25.57 % in year 2017. The decline if in gross profit margin is seen as the import cost have made the purchases costlier. This has increased the costs of the product but the company has not transferred the costs to the consumers yet therefore despite of increase in revenues, the gross profit margin of the company has gone down.

Another factor that may have lead the margins to be lows may be the heavy discounting for the promoting the sales in new areas and outlets with new product ranges. It is to be considered that whether the promotional strategies of the company has worked as against its revenues. Net profit margin of company for the present year is 5.01% where it was only 2.52% in year 2017.

The profit margin of company has increased by 98.7% company has been able to have growth in the net profits even after the decrease in gross profits.

The revenues of the company has increased from last years that has left enough amount wit the company to carry out its operating costs. Revenues of the company has increased where the operating expenses of the company from previous years have decreased comparatively. The employee expenses of company have reduced by 15.64% in 2018. A Human Resource and Marketing director of the company has resigned from the company and the role has been combined with Chief executive director of the company Paola King. This reduced the cost of company as the chief was given role without any additions because of which the director remuneration of the company reduced by 32.24%. Company for increasing the revenues granted many of its product on credit, that helped the company in grabbing new markets and customers but the credit sales increased the bad debts by 49.06% from last years that is £ 79000 in year 2018. Utility cost of company has reduced from last year.

Last year company filed a law suit against Caffe Tostato for stealing and copying various brand designs of Roast Ltd. The results were in favour of the company and Tostato would be paying £25 million for legal costs and the £45 million for damages. Therefore this year the legal cost of the company has reduced by 87.46%. Company during the years purchased new plant and equipments as company has opened new outlet in number of regions of the country. Therefore the depreciation cost of the company has increased by 51.67% from previous year. The new outlets ans increased inflations of the company has increased the store maintenance and distribution cost of the company. For maintaining the stores company has hired new employees and purchased and renewed the existing warehouses of company. Products to be available in easy reach of the company it has collaborated with new distribution channels now the customers can buy their products over the online platforms. Now the products of the company are available at the doorstep of the consumers because of these distribution channels.

Other major reasons behind the increased profits were decreased heat and power charges. Company has outsourced many of its business support areas inclusive of human resources, payrolls, finance and customer support teams. These all the above factors have contributed to raise the profit margin of the company.

Return over capital employed of company for the year 2018 is 8.80% which was 5.01% in year 2017. It showed a increase of 75.50% due to other operating income of 60 in current year. Company has generated return higher than previous year that will enable the company in attracting new investor towards the outlet. It is essential for company to earn adequate return over its capital employed for having growth in the business. If company is no able to earn enough return over the capital employed that represent the inefficiency of company to make effective utilisation of its resources. Company can further increase its return by disposing off the surplus assets and inefficient that are not generating much revenues for the company. Company shall adopt for new promotional and marketing strategies current year being initial for the new outlets therefore the low pricing helped company in grounding its roots. But gradually company should increased its prices for getting high returns over its capital employed.

Return on equity of the company has increased by 103.81% to 9.42%. Company has seen increases as its profits after tax are increased where the equity capital of the company have remained constant during the year. The increased return will create new base for company ion the market. Company will be able to raise more funds through financial leverage and equity capital for the expansion plans.

2.2 Analysis of Statements of Financial position

Reviewing the financial position of the company following analysis has been made.

Gearing and liquidity

Company is growing with an enormous speed and is showing considerable growth fro the past year company has struggled through various issues in the past year. Liquidity position of the company could be measured using the liquidity ratio of the company. Current ratio of the company present the ability of company to meet its short term obligations with the current assets. Current liquidity ratio of company is 1.45 where it was 2.51 last year in 2017. The liquidity position of company should be strong as company is a service industry it company should have strong liquidity position. The standard current ratio is 2:1 where ratio of company is below the standard level. Company had strong liquidity position last year. This year the decline is seen as company is running negative in cash. Trade payables of the company have increased this year and also the negative cash has raised the bank overdraft that is current liability of the company. Current assets of the company have not raised as that of its current liabilities. Weak liquidity position could be very dangerous for the company.

Quick ratio of the company measures the liquidity position of company excluding the inventories of the company. Inventory by many investors is not considered to be current asset as does not have the ability of generating quick cash for the company when required. The inventory of the company could not be sold in market instantly therefore it is not a liquid asset. The inventory of the company for the year is £299 that is high amongst the current asset. Quick ratio of company is 0.48 that is very low in comparison to previous year. Last year inventory of the company was only 120 as number of stores were less and also the cash balance had sufficient funds for the company. The liquidity position of the company has gone down this year and company as against these are required to take considerable steps for making strong liquidity position of company. The trade payables of company has raised very high company should lay policies for ensuring that the payments are made on time.

Debt-equity ratio of the company this year has raised to 31.98% with an increase by 149.10%. company has increased the debt from previous year £175 which were raised for implementing the expansion plan and purchasing new equipments for the outlets. The trends are within the industry average that are high as 40-50%. Company do not raise funds from the market every year and the loans will be repaid within few years. This does not affects the position of company. Gearing ration of the company is 24.38% it will be reduced when the debts of company will be repaid. Company can face significant problems in repayment of the loans as it is already running negative in cash and that is a great matter of concern.

2.3 Analysis of Cash Flows of company

Cash flows of the company

Company had a opening cash balance of £134 that has gone negative in the current year to £73. These variations are seen mainly due to working capital and the substantial capital expenditures. The cash expenses of the company have increased as this year increased borrowing has increased the interest expenses of the company from previous year. Due to increased revenues also the company had to pay income tax of £ 20 for current year. Major expenses of the company has occurred due to purchases of plant property and equipments for the new outlets of company. All theses expenditures of £ 358 were paid in the current year. Where the company has not disposed any asset for the year. This dis balanced the cash position of the company. During the year it raised long term loans of £175 for carrying out the expenses. There are cases where company is showing an increase in profits and is having negative cash flows. This can have negative impact over the market position of the company. Suppliers may stop supplies on credit and the investors may start withdrawing their investment for being on the safer side. This could significantly affect the company and its future operations. Though it is seen the cash will be turned positive as it may not purchase PPE for next year. It is essential for company to give proper disclosures for going negative in cash balances.

Working Capital management

The net working capital of the company that are defined as inventory + receivables – trade payables (299+148-235) that is £212 in 2018. It shows that company is showing increased working capital tied up. This could be explained more clearly by cash operating cycle of company.

The cash operating cycle of the company has increased from 12 days to 33 days. Reason for decline in cash balance is including the faster payments to the supplier of raw coffee (Cristea, 2017). Payments has been fastened by the company as it imports for foreign countries and delay in payments results in interest changes that costs high because of the exchange rate differences. Company has increased the payable period from the last year by 10 days but requires to be extended further maintaining the conversion during its expansion plan. Receivable periods of the company have also been increased by 5 days but this essential for creating the base in market. For having the bargaining capacity company is required to make quick payments. Seeing the liquidity position of the company it would be challenging tasks to get increased supplies for new outlets. Concerns are serious as against the inventory period as it has increased from 29 days to 55 days. For delivering higher efficiency over its assets base company is required to have higher sales volume by discounting policies or lower margins. Inventory is required to have faster movements for having high margins with low volumes.

Dividend policy

Last year the dividend of company was £30 when the profits were £36 and this profits are £81 than also company has not paid any dividend this year. Dividend coverage is around 1.2 last year. The dividends are essential as investor make investments for earning returns. This year company did not paid the dividend. The decision of not paying dividend was right and accurate. Company is going through an expansion that requires funds and if the funds are distributed in the form of dividends company would be required to borrow more funds from the outside sources. Also the company is running out of cash this year. Payment of dividend would have required more cash funds and that would have caused the cash balance to go even more down. Therefore the decision of company of not paying the dividend is viable as per current situation and circumstances.

PART 3 : Investment Appraisal

3.1. a Management Forecast

Roast ltd is planning to expand it business to new region of the nations for which it requires loans of £500 million. The company is planning to purchase new coffee machines from the Italian Supplier. The Italian technology will in coffee machines will give an immense experience to its customers. It would be more beneficial for the company if it starts with phase two of its strategies. The management should not go with the first phase as the sales starts in January. Till then company can make its business stable by the new machines it is planning to adopt. Management will be requiring the initial investment of around £ 500 million. For raising the funds company can raise funds through banks as it has shown high growth in year. The banks provide loans on the profitability and liquidity of business. Profitability is seen but company has gone negative in cash balances. Therefore it would be a difficult task for the company to raise loan through financial institutions.

Management forecasts that Net present value of the investment will be £ 110 million if discounted taking 5% as the base rate. NPV of the project is positive but the discounting rate of the company is too low that shows high profitability. This not may be the case in actual situations. The average rate of return in company do not consider the time value of money therefore it could not be relied blindly by the company. The average rate of return is 18% where the target is 10%. The returns are considerably high as it does not considers time value. Management also forecasts the pay back period of 4 years. Pay back period of company is very high where benefits are derived only if pay back period is low. Company will not earn sufficient returns if the pay back period is less.

3.1.b Investment Appraisal Techniques benefits and limitations

Net Present Value

Advantages

• It represents whether company will exceed the initial investment of cash or not at present.
• It takes into account time value of money and factors risks.

Disadvantages

• There are not set guidelines for determining required rate of return.
• It cannot be used to compare projects with different sizes (Crowther, 2018).

ARR

Advantages

• It is easy to calculate and for understanding and considers total profits over the entire period of economic life cycle.
• Method considers accounting concept of profits for calculation of accounting rate of return.

Disadvantages

• Time factor is not considered in this method.
• The method do not considers the external factors affecting the profitability of the company.

Pay Back Period

Advantages

• It is simple and easy to understand method.
• The method is most beneficial in case of uncertainty.

Disadvantages

• This method also ignores time value of money(Williams and Dobelman, 2017).
• The method do not covers all the cash flows and ignores profitability.

3.2 Sources of Finance

Equity finance

Equity financing refers to process of raising capital by selling shares of company in the market.

Advantage

• The equity finance is committed to the business and is intended for the projects it is planning to expand.
• Company is not required to pay back the finances as shareholders are given ownership in the company.
• Company can get capital from the market more easily as compared with other sources (Nielsen, Roslender and Schaper, 2016).

Disadvantages

• It involves high cost to the company to raise funds from market.
• Shared ownership lays more pressure on the business that can intervene the operation of company.

Bank Borrowings

Bank borrowings are raised by company for financing the projects as well as for meeting short term business requirements. Banks provide different kinds of loans for working capital, fixed assets and for investment appraisals.

Advantages

• Company are payable at fixed periods at fixed instalments. They are not required to be paid on demand.
• Loan can be availed by the company as they are available on charge over assets.
• Fixed interests rates allow the company to make budgets in previous so that they are not required to make disturbance in their present cash flows in between (Robinson and et.al., 2015).

Disadvantages

• Banks charge high interests for the long term loans and have to be paid at fixed time intervals otherwise companies are required pay high interests.
• The assets of company have charge, that could be sold by banking case of failure to repay the bank loan

Recommendations

Roast ltd based on its current financial position should go for equity financing as it will provide funds to the company for its expansion plan without any interests payments and extra costs. Loan will be a difficult option for the company as company has a negative liquidity position of company.

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