the financial position of Roast Ltd.,
The purpose of the report is to review the financial position of Roast Ltd., which is an independent chain in the coffee industry of the UK. The financial condition of the company will be evaluated to judge its attractiveness as a target for acquisition by Starbucks Company. The report will undertake a study of the different financial information of the company, such as a statement of profit and loss, statement of financial position, dividend policies, and statement of cash flow. The investment appraisal information and funding techniques will also be considered in the study.
From all the findings, it can be seen that the company, that is Roast Ltd. has revealed robust features in some of the financials such as investment in fixed assets and impressive returns from future investments. Despite these strong points, the company also has shown certain weak elements that relate to its current financial condition. Currently, the company possesses concise liquid assets and no cash in hand. This might be detrimental in running the daily operations of the business. Considering all the positive and negative factors, it can be inferred that Roast Ltd. has excellent future opportunities owing to its large-scale investments and considerable returns. Therefore, Starbucks can acquire Roast Ltd. for expanding its business and market share in the industry.
Part 1 – Industry Review
The UK has always been regarded as a nation, which is familiar with tea. However, in the new scenario, the coffee culture has shown a massive upheaval among the consumers of the UK. In modern society, the coffee market has outgrown rapidly, contributing to approximately £17.7 billion to the economy.
(Source: https://www.market-inspector.co.uk/blog/2019/09/uk-coffee-market)
From the above graph, it is clear that the coffee industry has shown rapid growth in the last five years, from 2012 to 2017 (Morland 2017). The total turnover has segmentations, in which 4 billion sales are generated from the branded coffee shops, and 3.2 billion have been made from the coffee products belonging to the foodservice industry. Yearly, the British coffee market is expected to grow at a rate of 10% in the coming years.
In the current business environment, the key players of the UK coffee industry are Costa Ltd, Pret A Manger Ltd, Starbucks Coffee Company, and Caffe Nero Group Holdings Ltd. Costa Ltd. It is currently enjoying the top position with the reported revenue of 1.34 billion in 2019, which has grown up to 0.5 billion from the previous year (Barahona et al. 2020). Pret A Manger Ltd. Currently holds the second position with a turnover of £270 million in the current year. Starbucks rules in the third position, with an annual turnover growth of 10.02%. The company enjoys revenue of $24.71 billion. The fourth position is Nero Group Holdings Ltd, with revenue of £227.9 million.
The two essential opportunities of the UK coffee market are the increase in the consumption of coffee among consumers and a higher rate of employment. Due to the rise in the turnover of the companies, the market can easily make use of these two factors to achieve considerable growth in the upcoming years (Wijaya and Yustina 2019). However, the extension can be hindered by certain crucial factors such as the cost of the property, labor, and the adverse effects of Brexit policies.
Part 2
2.1 Statement of Profit or Loss
Ratio Analysis
To judge the financial performance of Roast Ltd. The company, crucial financial information has been extracted from its statement of profit and loss, and two ratios have been calculated accordingly.
- Gross Margin Ratio
The gross margin ratio indicates the extent up to which a company can profitably sell its inventories or merchandise (Hassim 2017).
From the above table, it is clear that the gross margin profit of the company has decreased from 2017 to 2018. Individually, both the figures for net sales and gross profit have increased, but the increase has not been at par with the previous year. The company needs to come up with better methods for profitably selling its products and utilizing its inventories.
- Operating profit margin ratio
The operating profit margin ratio indicates the amount the profit that is left after the meeting up of the variable expenses of the company (Lessambo 2018). These variable costs can be wages, raw materials, and many other costs.
From the above analysis, it can be observed that the trend of the ratio has been upward. This has been primarily due to a large-scale increase in the operating profit figure. The figure shows that the company has been efficient in controlling its costs and expenses, which are largely associated with its business operations.
Considering the statement of profit and loss of the company for the current year, it can be observed that the revenue has shown a positive trend from 2017 to 2018. The cost of sales has also increased subsequently but has been compensated with the large-scale growth of the income. As a result, the gross profit has shown as an upward trend from 2017 to 2018. The operating expenses have slightly increased, which have also been nullified by the growth of operating income (Ketz 2016). Due to an increase in the overall profit figure, the company income tax expenses of the company have also shown an increase. Some of the finance costs have also increased. Despite these expenses, the high turnover figure has been able to bring to improve the overall profit of the company in one year.
The increase in the cost of sales can be due to the rising price of the supplies provided to the company. The adoption of new technology may curtail down the increasing figure of the cost of sales. Operating expenses have also shown a growing trend due to an increase in its sub-elements, such as employee expenses, bad debt charges, depreciation costs, and many other costs. Further, financing costs might be high due to inventory costs, infrastructural costs, equipment costs, and furniture costs (Bhandari et al. 2019). Similarly, tax expenses have increased due to an increase in the operating profit figure of the company. Despite all these expenses, the company has managed to retain a promising figure of its profit in one year from 2017 to 2018.
Considering the operating costs separately, it can be observed that employee expenses have decreased from 2017 to 2018. The remuneration of the Directors has also reduced in this one year. The highest percentage of the increase can be observed for three significant expenses. These expenses are store maintenance, distribution costs, and the costs of marketing and advertising. Maintenance costs are incurred for keeping an item in good condition such that it can perform effectively in the long run. The company should buy capable coffee machines such that it does not have to incur such high maintenance costs. The high distribution costs might be due to the high costs of the suppliers or the expenses incurred in setting up the channel (Ha and Lee 2017). Setting up of the channel is a one-time expense. Therefore, the company must try to curb down the costs of the suppliers. Another cost which has increased rapidly is the marketing and advertising cost. The company should look after its promotional strategies and try to bring out effective techniques that will bear less cost in the long run. Another element of expense important in this context is the bad debt charges. The company must extent credit to customers in a wise manner such that there is less risk for the receipt of such payments.
2.2 Statement of Financial Position
Ratio Analysis
For the purpose of examining the financial position of the company, the statement of financial position of the company has been considered. The important financial information has been extracted from the statement of financial position and three ratios have been calculated accordingly.
- Current Ratio
The current ratio is used for analysing the liquidity position of the company, which determines the ability of a company to meet up its short-term obligations.
From the above calculation it can be inferred that the current ratio figure has declined in the one-year period from 2017 to 2018 (Jin et al. 2017). The reason for this is the massive increase of the short-term obligations, which has outpaced the increase of the current asset figure in this period. The company needs to invest more in its short term assets for meeting up its high liability figure.
- Debt-to-asset Ratio
The debt-to-asset ratio indicates the ability of a company to leverage its debt condition with its assets (van Eeghen and Visscher 2017). An increasing trend in this ratio could prove to be detrimental for a particular company.
From the above analysis, it can be observed that the figure of this ratio has been on the upward side in 2018 as compared to the previous year. The total debt figure has increased enormously from 2017 to 2018 and the increase in asset structure has not been sufficient to leverage to meet up the increase in debt.
- Debt-to-equity Ratio
The debt-to-equity ratio signifies the relative proportion of a company’s debt and the shareholder’s equity that has been used for financing the assets of the company (Sankar and Kumar 2018). In an ideal condition, the debt figure should be less compared to equity as debt laden companies are less likely to progress in the long term.
Considering the above analysis, it can be inferred that the company’s debt-to-equity figure has shown a sharp increase in the one-year period. This is because the debt figure of the company has increased quite enormously, while the equity has shown a little change in this period. Presently, the company has been debt laden as most of its assets are financed through debt, which is not a very good sign of its financial position.
Critical Evaluation of the Statement of financial position of Roast Ltd.
From the examination of the statement of financial position of the company, it can be observed that the increase of non-current assets have been massive from 2017 to 2018. The company has invested a substantial amount in the fixed assets. In contrary to this, the increase in current assets has been quite less, which shows that the company does not have sufficient short-term liquid funds to meet up its short-term liabilities (Ganga and Girija 2020). Individually, the company has no cash at hand presently, which might be hinder the current operations of the company.
Considering the equity and liability figures of the company, it can be observed that total shareholder’s equity has increased due to increase in the figure of retained earnings. This shows that the company has paid less dividend to its shareholders in the current year as compared to the previous year (Juárez et al. 2017, October). In the liability section, it can be observed that both current and non-current liabilities have increased making the company debt laden. However, the company can use its retained earnings to pay-off its liabilities in care of emergency purposes due to shortage of cash in hand.
2.3 Analysis of Statement of Cash Flow
Through an analysis of the cash flows from the different activities, like operating, investing and financing activities, the cash position of the company can be understood.
The cash flow generated from the investing activities has been negative. This might signal two kinds of future cash position for the company (Hasanaj and Kuqi 2019). It can be affirmative if the company plans to invest cash in its future growth and development. It can be a threat if the company has made poor purchasing decisions of the assets.
The cash flow generated from the operating activities has also been negative in the year 2018. This means that the cash generated from the normal business of the company has been zero. This could be detrimental for the business as it has to survive only through borrowing activities (Anggraeni and Kiswanto 2018). The company has to borrow funds for paying its bills or raising additional capital for its business.
The cash flow from the investing activities of the company has been positive. This means that the company has been making profitable investments in physical assets and other securities (Arnold et al. 2018). The figure of the proceeds from the long-term borrowings reflect that the company has been successful in repaying its long-term debt over a short maturity period.
Operating Cash Cycle (OCC) for 2018 and 2017
The operating cash cycle shows the number of days taken by the company to convert its input into output that is conversion of raw material into the collection of cash from the customers (Booth and Zhou 2017). From the figure of operating cash cycle in the year 2017, it can be stated that the company took 27 days approximately to carry out the entire process, starting from the processing of raw materials to the receipt of cash from the customers.
From the analysis of the figure of the operating cash cycle in the period of one year from 2017 to 2018, it can be observed that the company has cut-short the number of days in the operating cash cycle. In the year 2018, the number of days of the operating cash cycle has been 20 as compared to 26 in 2017 (Benlemlih 2019). This is a positive signal for the company as it has taken up methodologies for easing up its operations and get quick cash from the customers in a short period of time.
Critical evaluation of the dividend policy of the company
Through the analysis of the retained earnings figure, it can stated that the figure has shown an increase from 2017 to 2018. Alternatively, this can signify that the company has paid less dividend in 2018 as compared to 2017. However, the profit figure of the company has shown an upward trend from 2017 to 2018 (Al-Rahahleh 2017). Considering this situation, it can be predicted that the company follows stable dividend policy for releasing the dividends to the shareholders. The pay-out of dividend remains stable every year irrespective of the earnings. Due to this reason, the retained earnings have increased from 2017 to 2018.
Following the above dividend policy, it can be inferred that the company should pay dividends to the shareholders in the year 2018. One of the reasons is that the shareholders should get a percentage of share from the profit so that they can have are in good terms with the company in the long run (Khan et al. 2016). Even if the earnings are volatile in each quarter, still the company can align its dividend structure with its long-term growth.
Part 3
Investment Appraisal
3.1a) Management forecast
The cash flow estimated in the above table has provided a clear picture of the cash outflow, which the initial investment and the various cash inflows to be expected in each year of the business. The cash flow has been prepared for the next five years considering the sales value as well as the variable costs to be incurred each year of the business (Mahmoud 2016). The contribution figures obtained each year can be regarded as the cash inflow for that particular year. From the study of this cash flow forecast, the actual income and expenses can be compared in order to find out the over or underperforming areas of the business.
From the above table it can be observed that the cash inflow every year is at increasing rate. Likewise, the variable costs of the company are also estimated to be greater in the subsequent years. Taking the sum of all the present values of the cash inflows for each year, it can be compared with the initial investment (Crosetto and Filippin 2016). If the present value of the cash inflow is greater than the initial investment, then the forecast is positive and will earn benefit. On the other hand, a negative net present value might prove bad for the business in the long run.
3.1b) Investment Appraisal Techniques
Payback Period
Payback period relates to the time when the net cash inflow will be equal to the initial investment of a project. The companies can focus on short payback period for enhancing liquidity (Hsiao and Kelly 2018). However, the process ignores the time period in which the cash inflow takes place.
Considering the payback period of the company, it can be observed that the life of the project is 5 years, where the payback period falls at the end of 4 years. This might not be beneficial for the company as it would require longer time to recover its initial cash outlay.
Accounting Rate of Return
Accounting rate of return is the financial ratio, which calculates the return through the net income generated from the proposed capital investment (Afra 2017). One of the benefits of this process is that it considers the profit over the total life of the project and is easy to understand. However, Return on investment fetches a result different from accounting rate of return, hence creating ambiguity in taking decisions.
Considering the above table, it can be observed that the target ARR for the company has been 10%, while the actual result has been 18% (Kring and Gallagher 2019). This shows that the return has been quite healthy for the company and the company should take up the project for its future benefits.
Net Present Value
This is another capital budgeting method, which is used for finding out whether a project should be accepted or rejected based on the comparison between the initial outlay and the present value of all the cash inflows (Alexopoulos and Stratis 2016).This is beneficial for the management in making appropriate decisions regarding the acceptance or rejection of a project. However, the net present value method does not consider the hidden costs, which might be incurred by the company in the course of the project, thus creating anomaly in the value of the result.
From the above analysis, it can be understood that the net present value of the company has been positive, which means that the returns earned from the project will be greater than the initial investment. Therefore, the project should be accepted.
3.2) Assessment of two alternative sources of finance for the upcoming investment of Roast Ltd
Roast Ltd. has come up with another investment plan, which requires investment of £400,000 in Italy. For the purpose of this investment, the company can suitably adopt two alternative funding options. One of the funding options can be through the usage of private equity. Private equity refers to private capital markets as well as private equity firms, which are engaged in providing capital to the investors for future investments (Wong 2018). These markets and firms specialise in various investment strategies for providing support to the investors. Many institutional and non-institutional investors are involved in the funding process. The capital is returned back to the investors through events such as initial public offering or acquisitions activities. On the whole, private equity is a general term used for all start-ups, venture capital and other firms who finance the growth phases of the company and also acts as a source of finance for future investments of the company. Therefore, Roast ltd. can suitably adopt this method as a funding option for its investment.
However, there can be many challenges faced by the company, while selecting private equity as a funding option. Most of the private equity firms are notorious and their main objective is to turn the companies around and eventually sell them in the market to capture a large share of their profit (Vassallo et al. 2018). The private equity firms mainly target the companies for scooping up their beleaguered business. These firms acquire the new companies and create redundancies after the occurrence of acquisition. The private equity firms also use their power to restructure the business portfolio of the companies. Even for the new investments, the private equity firms may restructure the format of the cash flow. The main focus of the private equity firms is to generate profit from the new investments and they also replace many talents of the organisations for this purpose. This may further lead to the damage of a community, which relies on the industries for their daily income.
Another important way for raising fund for an investment can be through the application of the hedge funds. Hedge funds are the pooled investment funds which are used for investment in various strategies and types of assets (Vassallo et al. 2018). The investors can invest in the hedge funds for raising funds through a variety of options and financial instruments. Some of the common techniques and financial instruments used as hedge funds for raising finance are long and short equity, arbitrage options, distressed assets and macro-trends. The application of hedge funds can be far more beneficial than private equity or venture capital. This is because the hedge funds provide investors with the opportunity to invest in public equities. Through public equities, the investors can redeem their returns on a higher frequency and will never have to face liquidity issues.
Despite the advantages, the hedge funds also have certain disadvantages which should be taken into concern by the investors. The first disadvantage is the limited liquidity of the hedge funds. Though there is a stable income flow from the hedge funds at regular intervals, still this inflow is limited. The investors can encounter issues with the withdrawal of their money and they might have to rebalance their portfolio in the long-run. There could be occurrence of a large number of events that are uncertain and may lead to the loss of money of the investor. Along with all these issues, the investors have less control over the ongoing process and are unable to customise the system according to their preferences. Another issue is the lack of transparency between the hedge fund and the investor as the nature of the hedge fund is kept unknown to the investor.
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