Cover Sheet: Non-Anonymous Marking
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Degree Title: |
Enterprise
and Innovation |
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7 (LONT041) |
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Module Title: |
Financial
Tools and the Legal Environment |
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Module Code: |
7 (LONT041) |
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Seminar
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Assignment
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Business
Financing Report |
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Word Count: |
2139 |
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Business Financing Report
based on a case study of a company YYY PLC
Table of contents
Executive summary .....................................................................................................4 Introduction..................................................................................................................5
1. Financial ratio analysis ............................................................................................5
2. Financial projections................................................................................................6
3. Breakeven analysis .................................................................................................7
4. Evaluation of main sources of financing ..................................................................8
5. YYY’s options for debt or equity financing ...............................................................9 Conclusion.................................................................................................................10
List of references .......................................................................................................11
Appendix 1. Financial ratios.......................................................................................14
Appendix 2. Financial projections ..............................................................................19
Appendix 3. Financial ratios (calculations).................................................................20
Executive summary
YYY Drinks PLC (hereafter YYY) was founded in 2005 and is a fast-growing company showing graduate growth based on the analysis of key financial indicators during the observed period of time (2014-2018 years). In order to make comprehensive analysis company’s financial performance in this report I will examine annual reports and financial statements for the last five years and make comparison to its peer group.
The purpose of financing planning is to optimize processes and to improve the business. Proper financing planning will allow company to enhance own financial and operational policies and strategies. This business financing plan will evaluate company’s current economic position and will predict theoretical future income, the amount of assets and liabilities. Based on published reports (latest available report is for 2018) the company was not facing any significant financial issues that required immediate attention. But at the same time it was still crucial for the management to pay extra attention to company’s inventory (taking into consideration 2018’s uncertainty around the United Kingdom leaving the European Union and all related predictions and preparations), to efficiently use their assets, to negotiate better deals with existing and future suppliers.
Should YYY seek to raise additional funding to scale its business this report also suggests possible and the most appropriate sources of financing for the company. This takes into the account existing internal policies and aims for the company to become debt free. The most innovative way to get both new ideas and additional funds for company to grow is crowdfunding. YYY hadn’t used this method before, but according to the theory and proven practical use cases of other product companies it is both effective and efficient way
Introduction
This report overviews YYY company which creates a range of soft drinks (e.g. tonics, lemonades, colas, ginger ales and many other). It covers current financial performance of the company (as of 2018) and previous four years, financial projection for the next five years. Report presents a breakeven point – a necessary level of sales to cover YYY’s total fixed costs. Several potential ways for YYY to attract additional finances are also provided in this report based on its current size and stage of growth.
1. Financial ratio analysis
In this section key financial indicators of YYY’s performance will be introduced and analysed (refer to appendices 1 and 3 to see detailed analysis and explanation to all ratios).
Profitability ratios are one of financial metrics that can be used to assess organisation's ability to generate profit, operating costs, assets and equity over period of time. Year 2016 was the most successful year for YYY in terms of profitability comparing to other years in observed period (2014-2018). Profitability is analysed with a help of gross margin, net profit margin, return on equity and operating profit margin, these ratios are then compared to the closest for YYY’s market competitor - Nichols PLC (hereafter Nichols)
Profitability ratios remained strong for the observed period. Period of 2016-2018 demonstrated a slight decline mostly due to:
- soft drinks’ new tax introduced in the UK (GOV UK 2018),
- rise of underlying costs (e. g. glass),
- company’s policy to stock more inventory as a measure to mitigate possible risks of Brexit (YYY 2018)
All YYY’s profitability ratios were above the average comparing to the competitor’s ratios. Performed cross-sectional analysis clearly demonstrated that YYY had a better profitability than Nichols for the period of 2014-2018.
As a potential recommendation, YYY may consider negotiating better deals with existing inventory suppliers, searching for cheaper deals on components or increasing products price.
Liquidity ratios allow to measure company’s ability to pay off short-term payments without raising external investment. For the observed period of 2014-2018 company had sufficient current assets to cover its current liabilities at a time. As of 6 2018, YYY’s had £3.6 of cash, cash equivalents and current receivables to cover each pound of current liabilities. Company’s cash amount grew much faster than its current liabilities. YYY’s ratios were not much higher than ratios of its competitor, so management still should have paid attention to the usage of assets efficiently.
Leverage ratios show the amount of capital coming in the form of loans. Alternatively, it can be used to assess company’s ability to meet its financial obligations. Companies have to balance between financing their operations of equity and debt. Stable decrease of debt/equity ratio can be observed starting from 2016. The main reason for this was a growth of retained earnings which was much stronger comparing to growth of total liabilities (2016 to 2018: 370% vs 145% respectively). In 2014-2016 YYY took more loans to finance its activities than in following years (2017- 2018). According to YYY’s accounting records, starting from the year 2016 company started using more of own funds to finance its activities and operations.
For the year 2018 YYY debt/equity ratios were lower than its direct competitor (Nichols), this indicated a low risk for potential YYY investors.
Operating ratios for Fever Tree show worse results in competitor analysis. The difference in ratios might be due to different sizes of companies, different production cycles, resource planning models
Cash flow ratio. In 2018 it took around 291 days for YYY to convert its account receivables and inventory into cash. There was a stable decrease of this ratio starting from 2016, which was a positive dynamic for the company.
Valuation ratio. Investors were willing to pay £50 on average for every pound of YYY's earnings (2015-2018). In 2014 it was £42. Earnings per share for 2014 were significantly lower than for the year 2015 and onward due to the fact that in 2014 the calculation of ratio included amortization, shareholder loan note interest and exceptional items and the statutory tax rates. This was no longer a case in 2015 and following years. Due to amendments in IFRS in 2014, company was required to change the accounting framework in use (this was a new requirement of FRS 100 “Application of Financial Reporting Requirements” which superseded FRS 22).
2. Financial projections
Projecting or forecasting financial performance is main element of many companies for making further decisions (Alexander 2007: 70). Some companies use financial projections for measuring future performance and planning future activities and expenses. Based on this information companies will determine general approach 7 to run business in the future, vision, set objectives and goals, development plan (Tyran 1973, Klonowski 2015: 67). Klonowski (2015: 67) believes that financial projection is the best way for a company to assess its future financial condition. It is important to mention that it is difficult to make any predictions. These assumptions must be updated by management according to understanding of current situation and estimated further market dynamic (Alexander 2007:74).
Based on YYY’s financial performance for years 2014-2018 I will make shortcut projections for main financial indicators for the next five years (refer to appendix 2 for details)
The YYY shortcut projection suggests that total net revenues will rise from £237.5m to £2740.6m for the period of next five years on the assumption that revenues’ annual growth rate would remain at 63.1%.
The shortcut projection for net income shows that it will go up to £582m by 2023 on the assumption that average profit margin would remain at 21.2%.
The YYY’s shortcut projection for total assets demonstrates the growth from £225.4m to £886.2m over the five-year projection period on the assumption that assets’ annual growth rate remains at 31.5%.
The shortcut projection for total liabilities and shareholders’ equity indicates that liabilities will go up to £198.5m by 2023 on the assumption that average proportion liabilities/assets remains at 22.4% and shareholders’ equity will increase from £183.2m to £687.7m over the five-year projection period on the assumption that proportion remains at 77.6%.
The company is expected to show growth for the next five years according to analysis of shortcut projections.
Breakeven analysis is a way for many companies to find a balance between profitability, volume and costs (Cafferky and Wentworth 2014: 1).
Some researchers as Paschal (2006) start conducting breakeven analysis by determining fixed and semi-fixed costs. Fixed expenses are those which happen each month during the entire year, for example salaries, rent, insurance and equipment loans. Bills for telephone, utilities, water, wages paid hourly are semi-fixed costs (Paschal 2006). Breakeven analysis allows to measure how much a company must generate monthly to cover fixed and semi-fixed expenses, in other words to break even.
In some cases, breakeven analysis can be used not only for calculating breakeven point (and making further decisions based on these findings, e.g. changing pricing policy), but for defining a measure (benchmark) to identify upper or lower bound for services or products (especially by regulatory agencies) as well. For example, some companies use it to calculate a price for their services when they have to estimate how much life or health costs (Farber 2014).
For the purposes of this report a traditional formula will be used for the breakeven analysis. It determines the necessary level of sales to cover YYY’s total fixed costs (Cafferky and Wentworth 2014: 2). For the year 2018 breakeven point for YYY was £66.26m (refer to appendix 3). For fixed costs to be fully payed YYY needed to have at least £66.26m in sales in 2018, this is a point at which YYY would have reported zero net profit/loss.
4. Evaluation of main sources of financing
Theory defines two types of financing entrepreneurial firms (Govori 2014; Oliner and Rudebusch 1992; Klonowski 2015: 66):
- internal (savings from efficient management, retained earnings),
- external sources (equity and debt instruments).
- debt financing (family, friends and personal savings, angels, government, foundations, banks, customer or supplier financing, factors, purchase order financing and credit cards);
- equity financing (family, friends and personal savings, angels, VC, private placement offering, private equity firms).
In case if YYY will consider expansion of operational activities or any other projects, it might be the right time to examine external financing for the company. First of all, the company must find out the purpose, amount and conditions for raising money. The answers to these questions will determine possible types of financing. The efficiency of funding will affect company’s capability to commence with specific projects and definitely will influence the level of profit from its operations (Govori 2014).
By reviewing YYY’s annual reports and financial statements (YYY 2018), we can conclude that company prefers to use own funds rather than debt financing (no borrowings and non-current loans were used in 2018). Company used a £10m credit line for the prior three years from Lloyds bank. YYY decided not to renew this line. Based on their internal policy it is better to propose alternative sources of financing for new projects, but it doesn’t mean that company will exclude debt financing at all. YYY has a continuous credit history and can get a loan from a bank in form of a corporate credit card (Glanz 2015: 9) or consider opening a new credit line, which can be done reasonably quick (as there is a credit history with Lloyds bank).
While YYY is a fast-growing company it is already mature (founded in 2005), that is why it will not be reasonable to finance new projects by personal, family or friends’ savings as well as angel investors’ or venture capitalists’ funds. Most of them have particular investment criteria, for example company should be on early stages of growth or have a revenue between £2m and £20m (2x Consumer, 2020). YYY had a revenue of £237m as of 2018. Moreover, company is listed on the Alternative Investment Market of London Stock Exchange and trading its securities there, which might be a possible source for getting additional funds. More likely that YYY will sell stocks on the market to attract additional capital.
While this would mainly depend on a purpose of a financing, should YYY want to launch a new drink – product crowdfunding might be the best source for this (Feld 2019: 137). Crowdfunding is the way to support initiative of a company by getting attention, cooperation and trust of people to pool their money into the project (Glanz 2015: 9). For example, UK based companies can launch their campaign at Crowdfunder (https://www.crowdfunder.co.uk/). By using crowdfunding, company will not only get a financing but will also receive customer support and collect useful marketing data and various product ideas (Kohler 2015). Company can reward customers for early orders with various perks or premium supplements complementing pre-orders (Rogers 2014: 279).
Conclusion
To summarise analysed financial performance of YYY for 2014-2018 (years when official reports are available), a stable growth of the company could be clearly recognized. According to calculated financial projections, the company will continue demonstrating steady growth for the following five years. This conclusion can be underpinned by the way company is growing each year – by penetration of existing markets and entering new ones, constantly developing new products.
YYY is on its early maturity stage of growth, which gives the company an opportunity either to rise funds on stock exchange or to use traditional bank loans or use internal funds as retained earnings to finance own activities and to expand
List of references
2x Consumer (2020) Investment Profile. 2x Consumer Products Growth Partners [online] available from https://www.2xpartners.com/investment-profile/ [28 March 2020]
Alexander J. (2007) Performance Dashboards and Analysis for Value Creation. Hoboken, N.J.: John Wiley & Sons. Wiley Finance Ser. [online] available from https://onlinelibrary.wiley.com/doi/pdf/10.1002/9781119197324.ch4 [29 March 2020]
Burk Lehman (2004) Financing Your Small Business. 1st ed. Naperville, Ill.: Sphinx Pub. [online] available from https://ebookcentral.proquest.com/lib/coventry/reader.action?docID=3035116 [28 March 2020]
Cafferky M. and Wentworth J. (2014) Breakeven Analysis: The Definitive Guide to Cost-volume-profit Analysis. Second ed. Managerial Accounting Collection [online] available from https://ebookcentral.proquest.com/lib/coventry/reader.action?docID=1767126 [28 March 2020]
Farber D. (2014) Breaking Bad? The Uneasy Case for Regulatory Breakeven Analysis. California Law Review 102.6 (2014): 1469-493 [online] available from https://www.jstor.org/stable/pdf/24758175.pdf?refreqid=excelsior%3Af1ab84a10 c7f87f0d2df59ead3b7812c [27 March 2020]
Feld B. and Mendelson J. (2019) Venture Deals: Be Smart Than Your Lawyer and Venture Capitalist. John Wiley & Sons, Incorporated [online] available from https://ebookcentral.proquest.com/lib/coventry/detail.action?docID=5880909 [27 March 2020]
YYY (2014) Annual report and financial statements for the year ended 31 December 2014
YYY (2015) Annual report and financial statements for the year ended 31 December 2015
YYY (2017) Annual report and financial statements for the year ended 31 December 2017
YYY (2018) Annual report and financial statements for the year ended 31 December 2018
Glantz M. (2015) Navigating the Business Loan. Elsevier Inc [online] available from https://www.sciencedirect.com/science/article/pii/B9780128016985000017?via %3Dihub [28 March 2020]
GOV UK (2018) Soft Drinks Industry Levy Gov UK [online] available from https://www.gov.uk/guidance/check-if-your-drink-is-liable-for-the-soft-drinksindustry-levy [28 March 2020]
Govori F. (2014) The Development of Capital Market and its Impact on Providing Alternative Sources of Business Financing: Empirical analysis, Federal Reserve Bank of St Louis, St. Louis [online] available from https://mpra.ub.unimuenchen.de/58189/1/MPRA_paper_58189.pdf [27 March 2020]
Klonowski D. (2015) Strategic Entrepreneurial Finance: From Value Creation to Realization. Routledge Advanced Texts in Economics and Finance [online] available from https://www.taylorfrancis.com/books/9780203094976
Kohler T. (2015) Crowdsourcing-Based Business Models: How to Create and Capture Value. California Management Review 57 p. 63-84 [online] available from http://web.b.ebscohost.com/ehost/pdfviewer/pdfviewer?vid=1&sid=9412ebe9- d0ee-4efb-93ff-2cb0c790b5be%40sessionmgr103 [28 March 2020]
Oliner St. and Rudebusch Gl. (1992) Sources of the Financing Hierarchy for Business Investment. The Review of Economics and Statistics, Vol.74(4), p.643-654 [online] available from http://web.a.ebscohost.com/ehost/detail/detail?vid=0&sid=86bd86da-2433-45f8- a136-5b0128f2b13f%40sdc-vsessmgr01&bdata=JkF1dGhUeXBlPWlwLHNzbyZzaXRlPWVob3N0LWxpdmU %3d#AN=4645436&db=bth [28 March 2020]
Paschal B. (2006) Breakeven Analysis: EMB. EMB, Embroidery Monogram Business, vol. 2, pp. 20 [online] available from https://search.proquest.com/docview/235932099/fulltextPDF/D779863C0CE444 E9PQ/1?accountid=10286 [27 March 2020]
Rogers S. and Makonnen R. (2014) Entrepreneurial Finance and Business Strategies for the Serious Entrepreneur, McGraw-Hill Education [online] available from https://bibliu.com/app/#/view/books/9780071824064/epub/ops/cover.html# [28 March 2020]
Sherrod L. (2000) Financing Your Business. Essence 31.3 [online] available from https://search.proquest.com/docview/223151794/fulltextPDF/4A22650B98 0C4656PQ/1?accountid=10286 [26 March 2020]
Tyran M. (1973) A Financial Projection Plan. Management Accounting 55.1: 19 [online] available from https://search.proquest.com/docview/229773380?accountid=10286&rfr_id =info%3Axri%2Fsid%3Aprimo [26 March 2020].
Appendix 1. Financial ratios
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