Case Study
Jack Bennett, who had previously worked as a purchases manager for a large furniture retailer, started HomeCreate plc 15 years ago.
His job as a purchases manager had involved a considerable amount of travel and, during a buying trip to Sweden, he was drawn to the product range of a particular furniture manufacturer. Although he wanted to place a large order with the manufacturer, his employer rejected the idea. He was convinced, however, that the furniture would be very popular in the UK and that it was too good an opportunity to be missed. He therefore decided to start his own business to import and sell the furniture to UK furniture retailers.
HomeCreate plc was not an immediate success and during the first few years of its life it was far from certain that it would survive.
However, a breakthrough occurred when a department store began to place large orders for the furniture. This was soon followed by orders from other large retailers and the business then entered a period of sustained growth. The rate of growth since the initial breakthrough has been steady rather than spectacular. During the past four years, for example, the sales revenue of HomeCreate plc grew at a rate of around 5% a year and profits increased by around 6% a year.
Recently, Jack Bennett was taken ill and was advised by his doctor to stop working. He had, until his illness, been both chairman and chief executive of HomeCreate plc and had been the driving force behind the performance of the business. Although he had intended for his son, Daniel, to take over eventually, he had not envisaged this happening until some years into the future. At the time of Jack’s enforced retirement,
Daniel was not even working for the business. After graduating in marketing five years earlier, he worked in the US for a large furniture retailer to gain experience. Nevertheless, he was asked by his father to return to the UK and take over HomeCreate plc. Despite Daniel’s lack of experience of the UK business environment, Jack Bennett had faith in his son and, as he was the controlling shareholder, no one could challenge his decision that Daniel should replace him.
The abridged financial statements for HomeCreate plc at the time that Jack stepped down as chairman and chief executive are set out below:
Income statement for the year to 31 December 2015
£000
Sales revenue 14,945
Cost of sales (10,460)
Gross profit 4,485
Overheads (3,010)
Operating profit 1,475
Income from investments 100
Profit before taxation 1,575
Taxation (315)
Profit for the year 1,260
A dividend of £800,000 was paid during the year.
Statement of financial position (balance sheet) as at 31 December 2015
ASSETS £000
Non-current assets
Property plant and equipment (net of depreciation)
Premises 6,500
Fixtures, equipment and vehicles 1,450
7,950
Trade investments 1,200
9,150
Current assets
Inventories 1,750
Trade receivables 1,350
Bank 540
Total assets 3,630
EQUITY AND LIABILITES
Equity
Ordinary £1 shares 2,000
Retained earnings 9,870
11,870
Current liabilities
Trade payables 910
Total equity and liabilities 12,780
Daniel took over the business during a period when competitive pressures in the retail furniture sector were increasing. He soon became aware of these pressures from the board of directors, who had all worked for the business for several years. Once alerted to the difficulties faced by its customers, Daniel commissioned a firm of marketing consultants to examine the trends in the retail furniture sector and to suggest how
HomeCreate plc should position itself to take account of changes in its customer base. The consultants reported that the retail furniture sector would soon go through a period of consolidation and this would mean that smaller furniture retailers would either be swallowed up by larger retailers or would be forced out of business. To ensure that HomeCreate plc was able to survive consolidation in its customer base, the consultants argued that the business had to grow. They were convinced that HomeCreate plc would be better placed to meet the needs of its customers, who would be fewer in number but larger in size, if it were itself a much larger business. The recommendations set out in the report of the consultants chimed with Daniel’s own experience in the US and so he decided that HomeCreate plc had to become a bigger player in the market.
At the beginning of 2016 Daniel embarked on an expansion plan for the business that would require both skill and nerve. He immediately doubled the size of the sales team and set the sales director ambitious sales targets. He also entered into agreements with a number of Scandinavian furniture manufacturers to buy large quantities of furniture over the next three years. In order to secure the best possible prices, these agreements had to be binding and so there was considerable pressure on the sales force to meet the targets that had been set. During the three-year period 2016 to 2018, HomeCreate plc succeeded in meeting its sales targets and gaining greater market share. Daniel, however, was not satisfied with the progress that had been made and felt that there was much more to be done. He was convinced that HomeCreate plc needed to be an even more dominant force in the market in order to deal successfully with the large furniture retailers.
Unfortunately, further growth was being constrained by a lack of finance. The business had an overdraft facility, which had been exceeded many times, and the bank was now demanding a halving of the existing overdraft balance. Daniel decided that a new issue of shares would help to put the business back on track; however, the existing shareholders were unable to raise the funds to buy new shares. He therefore set up a meeting with a private equity firm, Vulturus Ltd, to see whether it would be prepared to help fund further expansion. A meeting between Daniel and the senior directors of Vulturus Ltd took place to consider the proposal took place in early 2019. At the meeting, Daniel pointed out that although much progress had been made, the business was only half way through its expansion plans. At the meeting, he also submitted the following financial statements of HomeCreate plc for the three-year period since he took over from his father, and which are set out below.
Income statement for the year ended 31 December
2016 2017 2018
£000 £000 £000
Sales revenue 16,650 18,900 22,700
Cost of sales (12,050) (14,175) (17,800)
Gross profit 4,600 4,725 4,900
Overheads (3,500) (3,705) (3,900)
Operating profit 1,100 1,020 1,000
Income from investments 100 100 –
Profit before taxation 1,200 1,120 1,000
Taxation (240) (224) (200)
Profit for the year 960 896 800
Dividends remained at £800,000 per year throughout the period.
Statement of financial position (balance sheet) for the year ended 31 December
2016 2017 2018
ASSETS £000 £000 £000
Non-current assets
Property plant and equipment (net of depreciation)
Premises 6,500 6,500 6,500
Fixtures, equipment and vehicles 1,580 1,800 2,420
8,080 8,300 8,920
Trade investments at cost 1,200 1,200 –
9,280 9,500 8,920
Current assets
Inventories 2,150 2,720 3,400
Trade receivables 1,800 2,310 3,000
Cash 120 – –
4,070 5,030 6,400
Total assets 13,350 14,530 15,320
EQUITY AND LIABILITES
Equity
Ordinary £1 shares 2,000 2,000 2,000
Retained earnings 10,030 10,126 10,126
12,030 12,126 12,126
Non-current liabilities
Loan – (Repayable 20X9) – 600 600
Current liabilities
Trade payables 1,320 1,600 1,920
Bank overdraft – 204 674
1,320 1,804 2,594
Total equity and liabilities 13,350 14,453 15,320
Although HomeCreate plc was a public limited company, it was not listed on a recognised stock exchange. However, Daniel was keen for the business to become listed and felt that it should be floated immediately after the current expansion phase was completed in three years’ time. He therefore saw Vulturus Ltd as providing ‘bridging’ finance to help HomeCreate plc through the period leading up to a public flotation. The Bennett family owned most of the shares of HomeCreate plc and Daniel was prepared to issue a further 100,000 shares to Vulturus Ltd to help finance the business. He expected Vulturus Ltd to pay £8 a share. Daniel pointed out that a similar business listed on the London Stock Exchange had a price/earnings ratio of 22 times and so the shares of HomeCreate plc were a real bargain that Vulturus Ltd should snap up quickly. Daniel was relaxed about the outcome of the meeting as he felt that he held all the cards. The business was a great investment for those who were able to see its potential and, if Vulturus Ltd did not see it, others surely would.
Question 1
Analyse the performance and position of HomeCreate plc over the period that Daniel Bennett has been chairman and chief executive and comment on the changes that have occurred since Jack Bennett retired.
Identify the major categories of financial ratios (such as: profitability ratios, liquidity ratios, efficiency ratios, investment ratios and gearing ratios), also state some of the factors influencing key ratios.
Calculate key ratios for assessing financial performance and position (See appendix).
Explain the significance of the ratios calculated and evaluate the financial health of HomeCreate plc.
Question 2
Examine the offer that has been made to Vulturus Ltd and state whether or not Vulturus Ltd should accept the offer.
Your comments should be based on investor’s ratios, value per share (book-value, market value).
Share price based on cost price vs market value (reasoning difference (if any).
Expand your discussion using P/E (Price Earning) ratio, large share premium as compared to unlisted rival companies, marketability of shares etc.
Question 3
What advice would you give Daniel concerning the future of HomeCreate plc?
What feasible approaches you recommend for HomeCreate plc’s problems?
(Hint: Liquidity, profitability, scale of operations, debt financing).
Appendix (Minimum criterions required to support the answers)
Trends/Change
2015 2016 2017 2018
Sales (£000s) 14,945 16,650 18,900 22,700
Trend
Yearly change
Cost of Sales (£000s) 10,460 12,050 14,175 17,800
Trend
Yearly change
Gross profit (£000s) 4,485 4,600 4,725 4,900
Trend
Yearly change
Profit for the year (£000s) 1,260 960 896 800
Trend
Yearly change
Long-term capital employed (£000s) 11,870 12,030 12,726 12,726
Trend
Yearly change
Ratios (one decimal point)
Profitability
GP margin % % % %
OP margin % % % %
ROSF % % % %
Efficiency
Sales/capital employed (times)
Average receivables (days)
Inventories turnover (days)
Liquidity
Current ratio
Acid test ratio
Gearing
Gearing ratio
Investment
Dividend payout % % % %
Earnings per share (two decimal points
