Week 4 Morgan PLC Problem

FINANCIAL DECISION MAKING
Session 4 Interpretation of Financial Statements

Morgan plc
Morgan Plc’s financial statements for 2015 and 2016 are reproduced below.
At the end of 2015, and after a disappointing year, one of the investors in the
company had asked for a quick note from the Managing Director explaining what
could be done to improve performance in 2016.
This is what he received:

“We are disappointed with the profit earned in 2015 and met to discuss strategy for
2016. Our objectives are to increase revenue and market share and we have agreed
with following policies to be implemented:
1. An aggressive marketing campaign to be undertaken, directly targeting our
key customer base
2. A price promise to undercut other supplier’s prices, to be announced via TV
adverts
3. We intend to target rural and more remote areas of the country where we do
not have a local presence at the moment.”
The same investor has now received the 2016 financial statements and is very
concerned to see that not only has profit fallen in 2016, but also whereas as at the
end of 2015 the company had cash in the bank, now it has a bank overdraft of
£616,000.
Additional information
• As part of the marketing campaign the company provide payment incentives
that allowed customers to buy now and pay 10 weeks later.
• Because of the rapid increase in sales the company was unable to undertake
the usual credit checks on customers.
Statement of profit or loss for the year ended 31 December

2016 2015
£'000 £'000
Revenue 12,111 9,678
Less: cost of goods sold (10,588) (8,203)
Gross Profit 1,523 1,475
Less: Distribution costs (145) (98)

Sales and Marketing costs (234) (125)
Administrative costs (475) (433)
Profit before interest and tax 669 819
Finance costs (interest) (362) (234)

Profit before tax 307 585
Income tax expense (75) (121)
Profit for the year 232 464
1
Statement of Financial Position as at 31 December

2016 2015
£'000 £'000
Assets
Non-Current Assets
Property 6,670 5,285
Plant and Equipment 4,128 2,580
10,798 7,865
Current Assets
Inventories 2,451 1,872
Trade Receivables 3,012 1,387
Prepayments 385 329
Cash - 189
5,848 3,777
Total Assets 16,646 11,642
Equity and Liabilities

Equity
Share Capital £1 ordinary
shares 2,200 2,200
Revaluation Reserve 2,000 1,500
Retained Earnings 2,982 2,790
7,182 6,490
Non-Current Liabilities
8% Loan 4,125 2,925
Current Liabilities
Trade Payables 3,864 1,555
Interest Payable 764 466
Income Tax Payable 65 146
Dividends Payable 30 60
Bank Overdraft 616 -
5,339 2,227
Total Liabilities 9,464 5,152
Total Liabilities and Equity 16,646 11,642
2
Statement of cash flows for the year ended 31 December 2016
Cash flows from operating activities £'000 £'000

Profit before interest and taxation 669
Add /adjust:
Depreciation 411
Working capital changes
Increase in inventories (579)
Increase in trade receivables (1,625)
Increase in prepayments (56)
Decrease in trade payables 2,309
Cash generated from operations 979
Interest paid (64)

Dividends paid (70)
Income taxes paid (156)
Net cash from operating activities 839
Cash flows from operating activities

Purchase of non-current assets (3,459)
Proceeds from sale of non-current assets 615
Net cash used in investing activities (2,844)
Cash flows from financing activities

Increase in long term loan 1,200
Proceeds from share issue -
Net cash used in financing activities 1,200
Net decrease in cash and cash equivalents (805)

Cash and cash equivalents at beginning of period 189
Cash and cash equivalents at end of period (616)
Statement of Changes in Equity for the year ended 31 December 2016

Share Reval'n Retained
capital reserve Earnings
£'000 £'000 £'000
Balance at 01.01.16 2,200 1,500 2,790
Changes in equity for 2016
Revaluation gains 500
Profit for the year 232
Dividends (40)
Balance at 31.12.16 2,200 2,000 2,982
3
Part one:
We will start by calculating key profitability ratios for 2015 and 2016, and interpret the
financial performance for Morgan for 2016 in comparison with the prior year, the
financial statements and the additional information.
Why have the
Financial Ratio 2016 2015 numbers moved?
PROFITABILITY
Sales revenue growth (%) n/a
Revenue (yr1) – Revenue (yr0) x 100
Revenue (yr0)
COS growth (%) n/a

COS (yr1) – COS (yr0) x 100
COS (yr0)
Gross profit margin (%)

Gross profit x 100
Revenue
Net profit margin (%)

Net profit (PBIT) x 100
Revenue
Distribution cost evolution (%) n/a

[(Yr1 costs / Yr0 costs) -1] x 100
Sales and marketing cost evolution

(%) n/a
Administration cost evolution (%) n/a

Finance cost evolution (%) n/a

4
Part two:
Now calculate the efficiency1 ratios for 2015 and 2016, and interpret these in the
context of the company’s increasing bank overdraft, using the financial statements
and the additional information.
Why have the numbers

Financial Ratio 2016 2015 moved?
EFFICIENCY
Inventory days
Inventory x 365
Cost of Sales
Receivables days
Receivables x 365
Revenues
Payables days
Trade Payables x 365
Cost of Sales
Operating cash Cycle (OCC)

Inventory days +
Receivables days -
Payables days
5
Part three:
Now calculate the key liquidity and solvency1 ratios for 2015 and 2016, and interpret
these in the context of the company’s increasing bank overdraft, using the financial
statements and the additional information.
Financial Ratio 2016 2015 Why have the numbers moved?

LIQUIDITY
Current ratio
Current assets
Current liabilities
Quick ratio
Current assets less inventories
Current liabilities
SOLVENCY
Interest cover
PBIT
Finance costs
Capital gearing
Total debt* x 100%
Equity + debt*
*Includes bank overdraft

Debt/Equity
Debt* x 100%
Equity
*Includes bank overdraft

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FINANCIAL DECISION MAKING

Session 4 Interpretation of Financial Statements

This is what he received:

Statement of profit or loss for the year ended 31 December

Less: Distribution costs (145) (98)

Finance costs (interest) (362) (234)

Statement of Financial Position as at 31 December

Equity and Liabilities

Total Liabilities and Equity 16,646 11,642

Statement of cash flows for the year ended 31 December 2016

Cash flows from operating activities £'000 £'000

Interest paid (64)

Cash flows from operating activities

Cash flows from financing activities

Net decrease in cash and cash equivalents (805)

Statement of Changes in Equity for the year ended 31 December 2016

COS growth (%) n/a

Gross profit margin (%)

Net profit margin (%)

Distribution cost evolution (%) n/a

Sales and marketing cost evolution

Administration cost evolution (%) n/a

Finance cost evolution (%) n/a

Why have the numbers

Operating cash Cycle (OCC)

Financial Ratio 2016 2015 Why have the numbers moved?

*Includes bank overdraft

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