Key Assessment Requirements
Read the questions carefully and only answer what is required.
Present a critical report of your analysis and responses to all questions.
Where appropriate, present key financial and economic theories to support your answers and present assumptions used in your analysis and any practical implications these may have.
There are four questions in total, plus a recommendation. You are required to answer all questions in full. Marking for each question is allocated as below:
Marking Guideline for Students
To help structure your presentation in a professional manner, you should clearly identify which question you are attempting. The report is marked out of 100.
The following table shows the mark allocation and the approach required.
Questions
Allocated Marking & Word Count
Type
Q1
36 marks
Marks are awarded for accuracy of the calculation of the year-on-year change in revenue, operating expense, and net profit. (2 marks each up to a max of 6 marks)
Marks are awarded for accuracy of the calculations in the segmentation revenue analysis. (2 marks for each correct calculation, with a total of 6 marks)
Marks are awarded for accuracy of the calculations in gross profit margin segmentation analysis. (2 marks each up to a max of 6 marks)
Marks are awarded for the identification of the different levels of cost in the SPL – the explanation MUST be in your own words. (4 marks).
Marks are awarded for a correct explanation of the accruals method, which MUST be in your own words, supported by two examples. (2 marks for the explanation and 1 mark each for two examples, with a total of 4 marks)
Marks are awarded for accuracy of the calculations in the segmentation operating profit margin analysis. (2 marks each up to a max of 6 marks)
Marks are awarded for critical thinking in the interpretation of operating margin ratio results. (4 marks)
Q2
20 marks
Marks are awarded for critical thinking in the interpretation of the effects of depreciation on the SOFP and in the SPL, using your own words. (4 marks)
Marks are awarded for accuracy of the calculations for the company’s current ratios. (4 marks)
Marks are awarded for accuracy of the calculations for the company’s capital gearing ratios. (4 marks)
Marks are awarded for accuracy of the calculations for the company’s interest cover ratios. (4 marks)
Marks are awarded for critical thinking in the interpretation of the company’s financial solvency ratios, you MUST use your own words. (4 marks)
a) Marks are awarded for identifying whether the company has experienced a net cash inflow or outflow during the period (2 marks), showing the change in cash monetary terms (1 mark). Marks are also awarded for a brief explanation in operating activities to affect this (2 marks).
Q3
24 marks
Marks are awarded for the identification of three major changes in figures from 2020 to 2021 that contributed to a net outflow of cash. Marks are awarded for critical thinking and being able to give a valid reason why each cash outflow happened. (3 marks for each change identified and 2 marks for each accurate reasoning behind each movement, with a total of 9 marks)
Marks are awarded for accuracy of the calculations for the company’s inventory days, trade receivable days, trade payable days and the correct OCC calculation for both years (1 mark for each correct inventory, trade receivable & trade payable days, and 2 marks for each correct OCC in 2021 & 2020 with a total of 10 marks)
Recommendation
15 marks
This should be a brief synopsis of your critical evaluation of the company’s expansion into online and hotel activities.
You must include relevant facts, figures, and ratios which you have discovered during your analysis across the P&L, Balance Sheet and Cash Flow to support your recommendation.
Structure & Presentation
5 marks
Marks are awarded for:
appropriate use of business language (2 marks)
clear layout and structure (3 marks)
Total
100 marks
CASE STUDY ON NEXT PAGE
CASE STUDY – Aurora Plc
Background
Aurora Plc (Aurora) manufactures and sells its own-brand luxury perfumes, toiletries, and candles via its 55 stores in the UK and also to other larger retail companies.
Revenue and profits have been steady over the last 10 years up to the end of 2021.
During 2021, the company launched a new online shop to sell Aurora’s products and has also secured a lucrative deal with a famous hotel chain, Vita Bella Hotels (Vita Bella).
Your task
You work in Aurora’s finance department. As part of your role, the Finance Director has asked you to prepare the following:
An analysis of the financial performance of Aurora in 2021 compared to 2020.
A recommendation as to whether the new online shop and hotel deal have been a good idea for the business.
To assist you with this task you have been provided with information as follows:
Exhibit 1: Extracts from Aurora Plc’s Financial Statements for year-end December 2021 and 2020, including:
The Statement of Profit or Loss,
The Statement of Financial Position, and
The Statement of Cash Flows.
Statement of Profit or Loss at year-end December 2021
2021
2020
£’000
£’000
Revenue
9,000
5,550
Cost of Sales
(6,125)
(3,885)
Gross Profit
2,875
1,665
Operating Expense
(2,002)
(1,154)
Operating profit
873
511
Finance costs
(65)
(51)
Pre-Tax Profit
808
460
Income tax expense
(202)
(120)
Net Profit
606
340
Statement of Financial Position at year-end December 2021
2021
2020
£’000
£’000
ASSETS
Non-current Assets
Property, Plant and Equipment
570
600
Development costs
30
15
600
615
Current Assets
Inventories
1,575
1,470
Trade and other receivables
683
465
Cash and cash equivalents
0
63
2,258
1,998
Total Assets
2,858
2,613
EQUITY AND LIABILITIES
Equity
Share Capital
825
760
Retained Earnings
768
680
Total Equity
1,593
1,440
Non-current Liabilities
Long-term borrowings
618
606
Current Liabilities
Trade and other payables
545
567
Bank overdraft
102
0
647
567
Total Liabilities
1,265
1,173
Total Equity and Liabilities
2,858
2,613
Statement of Cash Flows at year-end December 2021
2021
2020
£’000
£’000
£’000
£’000
Cashflows from operating activities
Profit before tax
873
511
Adjustments for:
Depreciation
60
78
933
589
Increase in inventories
(105)
(12)
Increase in trade & other receivables
(218)
(6)
Decrease/increase in trade payables
(22)
11
Cash generated from operations
588
582
Interest paid
(65)
(51)
Income tax paid
(202)
(120)
Net cash flow from operating activities
321
411
Cashflows from investing activities
Purchase of Property, Plant & Equipment
(75)
(53)
Investment in product development
(15)
0
Proceeds from sale of property, plant & equipment
45
0
Net cash flow from investing activities
(45)
(53)
Cashflows from financing activities
Proceeds from long-term borrowings
75
0
Repayment of long-term borrowings
(63)
(109)
Dividend paid
(453)
(225)
Net cash flow from financing activities
(441)
(334)
Net (decrease)/increase in cash and cash equivalents
(165)
24
Cash and cash equivalents at the start of the year
63
39
Cash and cash equivalents at the end of the year
(102)
63
Exhibit 2: Additional financial information which supports the Financial Statements in Exhibit 1.
Segmental Analysis: year-end December 2021
Retail
Online
Hotel
Total
£’000
£’000
£’000
£’000
Revenue
6,006
1,644
1,350
9,000
(4,206)
(1,150)
(769)
(6,125)
Gross Profit
1,800
494
581
2,875
Administration expenses
(683)
(165)
(158)
(1,006)
Distribution costs
(573)
(123)
(300)
(996)
Operating Profit
544
206
123
873
Exhibit 3: Notes from a discussion with the Finance Director which covers the two new business segments in 2021.
Online store
Aurora developed the infrastructure for the online store in April 2021 with the website going live at the start of May 2021. Sales have been in line with target across the first nine months of operations.
The selling price and costs of making our products have remained the same across the retail and online operations.
The company has incurred additional costs around employing staff to help maintain the website and general online environment, along with additional people to increase capacity within customer services (to deal with any online issues customers might experience).
As customers no longer pick the products up directly, the company has secured a distribution deal with a national logistics company to deliver the products to their door.
These additional costs have been more than offset by not needing incur the usual overhead costs associated with significant additional sales seen in retail stores, including rent, rates, marketing, and additional shop staff.
Hotel chain contract
Aurora has secured a lucrative two-year deal with a boutique hotel chain, Vita Bella Hotels. The deal will see Aurora manufacture products for the hotel, carrying the hotel name and logo.
The contract commenced in January 2021.
The agreement is based on a range of Aurora’s products being labelled with the hotel’s branding. The company is able to charge a premium price on the products
supplied. Example: one of the company’s main beauty products (Everbright Moisture Mist) which costs us £35 to produce would normally sell for £50, but with the hotel’s logo attached this can now be sold for £62.
As with the online shop, this contract also had an impact on the company’s cost base (which is reflected in the segmental analysis costs in Exhibit 2 for the hotel contract).
The company rented additional machinery which attaches the hotel’s logo to the products.
It also hired an administrator to oversee and co-ordinate the contract.
Additional notes from a discussion with the Finance Director:
The segmental analysis provided in Exhibit 2 includes an allocation of administrative and distribution costs across the various business segments. It should be noted that the costs under the online store and hotel contract columns relate to the additional costs the company is now incurring across these new business segments.
When considering how the company manages its cash position, most of its customers are retail or online who pay at the point of sale. Receivables mainly arise from businesses to which it supplies goods, and its usual payment terms are 30 days from date of invoice.
In negotiating the contract with the hotel chain, Aurora managed to negotiate preferable payment terms of 21 days when agreeing the distribution fee.
Good supplier relations mean that the company has been able to negotiate some preferable payment terms (an extended period of credit) with suppliers. However, it does not have the same level of history and trust with new suppliers and therefore it is not yet in a position to negotiate similar terms.
In 2020, Aurora’s bank decided that it would not extend any more loans until the current debt has been repaid. The company has therefore been trying to use cash flow over the last couple of years to pay off the loans. Over the last year, the bank agreed to provide some additional long-term loans to help fund the online and hotel projects, but the interest charged on this new debt was higher than previously.
You must answer ALL the questions.
Q1: Interpreting Aurora’s Statement of Profit or Loss (SPL) Total: 36 marks
Using the SPL in Exhibit 1, calculate the percentage changes to identify the movements between 2021 and 2020 of the following SPL items:
Total sales revenue
Operating expenses, and
Net profit.
(6 marks)
Both the online store and the hotel contract were new in 2021. Using the segmental analysis in Exhibit 2, calculate the percentage of total revenue contributed by:
The retail operations,
The online store, and
The hotel contract.
(6 marks)
Using the segment analysis provided in Exhibit 2, calculate the gross profit margin ratio for EACH of the following segments of the business:
The retail operations,
The online store, and
The hotel contract.
(6 marks)
Using your own words, describe the key difference between cost of sales and
operating expenses in the Statement of Profit or Loss.
(4 marks)
Explain in your own words what you understand by the accruals method in relation to recording transactions in the SPL. Please support your answer by giving TWO examples.
(4 marks)
Using the segmental information in Exhibit 2, calculate the operating profit margin ratio for EACH of the following segments of the business:
The retail operations,
The online store, and
The hotel contract.
(6 marks)
Using the information calculated above and in the case study, explain why the operating profit margin for the online store is higher than that for the other segments of the business.
(4 marks)
Q2: Interpreting Aurora’s Statement of Financial Position (SOFP)
Total 20 marks
In your own words, explain why depreciation is charged, and its effect on the value of non-current assets in the SOPF and operating profit in the SPL.
(4 marks)
Calculate the following:
Current ratios for 2021 and 2020.
(4 marks)
Calculate the following:
Capital gearing ratios for 2021 and 2020. (4 marks)
Interest cover ratio for 2021 and 2020.
(4 marks)
Explain in your own words how gearing and interest cover ratios help us assess a company’s financial solvency.
(4 marks)
Q3: Interpreting Aurora’s Statement of Cash Flows (SCF) Total: 24 marks
Briefly explain what has happened to Aurora’s cash position at the end of 2021 compared to the beginning of the year, with particular reference to operating activities. (5 marks)
Identify THREE movements that contributed to this cash movement across the SCF. You MUST give a reason why each cash flow item has occurred. (9 marks)
Calculate the following for 2021 and 2020:
Inventory days
Trade Receivable days
Trade Payable days
Operating Cash Cycle (OCC)
Please round up/down your answer to the nearest whole days, (10 marks)
Recommendation
Total: 15 marks
Your recommendation should draw on the answers you have found from your analysis as to whether the new online shop and hotel deal have been a good idea for the business.
You must include relevant facts, figures, and ratios which you have established from all the financial statements to support your findings.