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FINANCE FOR ENTERPRISES S2 2019-20 CW2

Read the case study below and answer the questions that follow.


easyJet, Europe’s second largest low-cost airline, saw its share price rise strongly on its first day of trading as a public limited company, rising 10% to £3.42. The offering was priced at £3.10 a share with the issue of 63 million shares raising £195 million. The issue, solely to institutional investors, represented about 25% of the enlarged share capital. The stake held by Georgiana Haji-Ioannou, founder and chairperson of the company, was valued at about £328 million. Mrs. Haji-Ioannou and her brother and sister still control about 75% of easyJet.

Investment bankers said the issue attracted strong interest. The performance of the shares had been helped by the strong rise of Ryanair, the leading European low-cost airline, which has been used by investors as a yardstick for the easyJet offering. easyJet shares have also proved attractive because the company has seen its passenger numbers rise markedly over previous years. Capital raised from the share issue is earmarked to support the purchase of new aircraft as part of the group’s plans for a rapid expansion during the next few years, which includes the addition of 32 new Boeing 737-700s, more than doubling the size of the fleet. 

Define the terms:  

  • Public limited companyA Public limited company can be defined as an enterprise who offers its shares, or stocks to the public for the purpose of raising finds in order to boost its size. The buyers of the shares are the actual owners of the company but they could not participate directly in the management but only can elect the directors as well as appoint the auditors. Moreover, they have a limited liability that means they cannot be held accountable for any loss in the business in excess of the sum they paid to purchase the shares (Meissner, 2019, p.1341).

     

    Reference:

    Meissner, D., 2019. Public-private partnership models for science, technology, and innovation cooperation. Journal of the Knowledge Economy, 10(4), pp.1341-1361.

  • Share price: The price of a single stock of shares that has been issued by a company in order to raise funds is known as Share price. Many companies try to keep stock prices low, relying in part on "whole hand trading". The Company can adjust the price of its shares by dividing the shares and replace the number of different shares with the price adjusted by the number of shares. Currently, the value of x share price remains the same (Willows and Rockey, 2018).

     

    Reference:

    Willows, G.D. and Rockey, J.A., 2018. Share price reaction to financial and integrated reports. South African Journal of Accounting Research, 32(2-3), pp.174-188.

Outline two possible sources of long-term finance available to easyJet.

Since the operations of the easy jet are going well, thus there are numerous sources of long term finance available for the purpose of enhancement of the company’s size in future. One of them is Equity funding that is raising of the capital for the company’s future growth by selling its shares in the open market. It is worth considering that the share price of easy jet has been increasing since the first day of its operation, moreover the stock of worth £328 million has been owned by the founder and the chairperson of the easy jet that could be a good sign of the company’s strength. Apart from the equity funding, the company may also go towards borrowing in the form of a bank loan or from other financial institution. In fact, it is fully meeting all the requirements that a bank or any other finance providing institutions usually consider before approving a loan application. Both of the methods could be beneficial in enabling the enterprise to nurture and develop in a long run (CHHABLANI, 2020).

Reference;

CHHABLANI, P., 2020. Sources of Finance (long term).

Explain why an expansion in easy Jet’s passenger numbers has increased the need for short-term and long-term finance. 

Since it has been already given in the above passage that easy jet is the second largest low cost airline and hence due to its satisfactory service and reputation in the market, the number of customers has been increased to a large extent and it is keep on increasing day by day.  Therefore in order to meet the requirements, it is mandatory to purchase new aircrafts that could be fulfilled by the company through short term and long term financing.

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It is a wisely decision taken by the company to fund the company through equity funding that is selling its shares in the open market and hence distributing the ownership of the company to the shareholders with respect to the shares they have purchased. One of the significant advantage of such type of financing is the funds need not to be repaid. Furthermore, there is no loan to repay like debt financing in the form of bank loans. On the other hand, borrowing from a bank or debt financing, the company will be compelled to pay back the principal amount that has been borrowed along with an interest amount. So if the easy jet suffers from the financial or cash flow issue, there is unlikely for it to repay the amount borrowed with in the time frame. As a consequence, penalty could be imposed on it if it fails to repay the debt in future. Taking everything into consideration, I pen down by concluding that in order to minimize a risk to some extent that is always inborn and associated with a business entity, an organization should always go for equity financing rather than debt financing i.e. bank loans, borrowing etc. so that it could survive even though after it has bear a major loss (Fahn et al., 2019, p.123).

Reference:

Fahn, M., Merlo, V. and Wamser, G., 2019. The commitment role of equity financing. Journal of the European Economic Association, 17(4), pp.1232-1260.

SECTION B: RATIO ANALYSIS

CSeaC plc is a satellite television company, selling subscriptions to television channels to viewers. During the year ended 31 March 2020 CSeaC acquired all the operations of DDeeD together with all their subscribers and channels. Below are the income statements, extracts from the statements of financial position and extracts from the notes to the financial statements for CSeaC plc for the financial years ended 31 March 2020 and 31 March 2019.

 

2020

 

2019   

 

£m

 

        £m

Revenue

4,462

 

3,394

Cost of sales

3,570

 

2,591

Gross profit

892

 

803

Administration expenses

401

 

464

Operating profit

491

 

339

Finance income

4

 

2

Finance expense

200

 

174

Profit before tax

295

 

167

Income tax

59

 

42

Profit for the year

236

 

125

 

 

 

 

Non-current assets

5,400

 

3,640


 

2020

 

2019

 

Number

 

Number

Employees: average during the year

24,906

 

17,544

Number of subscribers (millions)

24.262

 

16.556

Calculate the following ratios for 2020 and 2019 for CSeaC plc:

  1. Gross profit percentage
  2. Operating profit percentage
  3. Profit before tax percentage
  4. Profit after tax percentage
  5. Non-current asset turnover
  6. Revenue per employee
  7. Operating profit per employee
  8. Any other ratios you consider to be relevant to an assessment of the profitability of CSeaC plc

Evaluate the changes in profitability for CSeaC plc between 2019 and 2020, suggesting reasons for the changes in profitability in 2020.

From the results above, evaluate the changes in profitability by examining the profitability ratios.

To begin with the overall ratio analysis of the enterprise between two years i.e 2019 as well as 2020, it is worth considering that there is a significant changes in 2020 in terms of profitability like gross profit & operating profit ratio. One of the key factor behind this is the revenue which was 3394 in 2019 that has been significantly jumped till 4462 and increased by 24%. According to the general rule there is always an inverse relation between sales/ revenues and the cost of goods sold as an increase in the sales of a company ultimately decline its cost of goods sold, but that does not seem to happen in this case, since there is a slightly big difference in the cost of goods sold between both of the years and it has been increased to a large extent as compare to the previous year and went by 27% in the current year. It may be due to a huge intensification in the supplies or raw material, maintenance along with the transportation cost as well. On the other hand the operating profit margin has been increased by 2% in the current year as a result of decline in the administration cost. Likewise, there is a huge difference between the incomes before tax of both of the years as it was merely 167 in 2019 before it rapidly jumps till 295 in 2020. Not only this, but also the profit after tax has been raised to a large extent from 125 to 236 even though both of the finance cost and income tax expense were higher in the current year (Chen et al., 2019, p.369).

Reference:

Chen, Z., Harford, J. and Kamara, A., 2019. Operating leverage, profitability, and capital structure. Journal of financial and quantitative analysis, 54(1), pp.369-392.

SECTION C: BUDGETING

Cautious Limited is planning a major capital investment in September 2020 which requires an extension of the company’s bank overdraft. The company provides you with the following financial information:

 

RATIO

FORMULA

CALCULATIONS

2020

2019  

 

a

Gross profit percentage

Gross profit/net sales*100

 803/3394*100

 892/4462*100

 

 

19.99%

 

 

23.6%

b

Operating profit percentage

Operating profit/net sales*100

 339/3394*100

491/4462*100

 

11.004%

 

9.98%

c

Profit before tax percentage

Profit before tax/net sales*100

 167/3394*100

 295/4462*100

 

 6.61%

 

 

4.9%

d

Profit after tax percentage

 

Profit after tax/ net sales *100

125/3394*100

236/4462*100

 

5.2%

 

3.68%

e

Non-current asset turnover

 

Net sales/ non-current assets

3394/3640

4462/5400

 

0.82 times

 

0.93 times

f

Revenue per employee

 

Revenue/ total employees

3394/17544

4462/24906

 

0.19

 

0.18

g

Operating profit per employee

 

Operating profit/total employees

339/17544

491/24906

 

0.019

 

0.019

  1. The bank balance at 1st August 2020 is expected to be £35,000.
  1. 30% of sales are for cash with the other 70% being made on credit. 60% of credit sales pay in the month following the month of sale with the other 40% paying 2 months after the month of sale.

Purchases are paid for in the month after the month in which they are made.

68% of wages are paid in the current month with the other 32% (representing tax and national insurance deductions) being paid over to the taxation authorities in the following month.

Overheads are paid in the month in which they are incurred.

The Directors of Cautious Limited are planning to purchase new property, plant and equipment for £300,000 in September 2020 in order to expand the business.

Notes 

Month

Sales

Purchases

Wages

Overheads

 

£

£

£

£

June 2020 (budgeted)

200,000

100,000

45,000

10,000

July 2020 (budgeted)

225,000

125,000

50,000

12,000

August 2020 (budgeted)

240,000

130,000

52,000

13,000

September 2020 (budgeted)

260,000

135,000

55,000

15,000

October 2020 (budgeted)

250,000

132,000

52,000

14,000

  • The bank balance at 1st August 2020 is expected to be £35,000.
  • 30% of sales are for cash with the other 70% being made on credit. 60% of credit sales pay in the month following the month of sale with the other 40% paying 2 months after the month of sale.
  • Purchases are paid for in the month after the month in which they are made.
  • 68% of wages are paid in the current month with the other 32% (representing tax and national insurance deductions) being paid over to the taxation authorities in the following month.
  • Overheads are paid in the month in which they are incurred.
  • The Directors of Cautious Limited are planning to purchase new property, plant and equipment for £300,000 in September 2020 in order to expand the business. 

SECTION C Questions

Prepare the cash budget for Cautious Limited for August, September and October 2020.

Cash Budgeting

 

 August

 

 September

 

 October

 Balance

     35,000

 

 

 

 

 Sales

   124,200

 

     70,200

 

     69,400

 Purchases

- 125,000

 

- 130,000

 

- 135,000

 Wages

-    51,360

 

-    54,040

 

-    52,960

 Overheads

-    13,000

 

-    15,000

 

-    14,000

 

-    30,160

 

- 128,840

 

   132,560

Calculate the figures that will appear in the budgeted statement of financial position of Cautious Limited at 31st October 2020 for:

  • Trade receivables
  • Trade payables
  • Wages and salaries

You must show your working out:

  • Since it has been mentioned in the question that 30% of sales are cash based while the remaining are credit based. Moreover the 60% of the credit sales will be received in the month following while the remaining 40% would be recovered two months later the month of the sale. Do find the excel sheet attached with this word file in order to see it’s calculation.
  • Likewise all the business purchases have been paid in one month later after they have made.  In the month of August a purchase of 125000/- is payable which has been made in July. Similarly in September, the amount of 130000/- is payable which has been raised against the purchase made in August. Furthermore 135000/- is payable in October for the purchase made in the month of September,  over all the amount due in the three months is:273000/-
  • Moreover, 68% of the wages are being paid in the current month while remaining 32% in the following month. See the excel sheet attached with for further computation in this regards.

Figures that will appear in the budgeted statement of financial position

  • Trade receivables

                199500+69400= $268900

  • Payables

                Purchases are paid the month after they are made = $260000

  • Wages

                52960 + 14000 = $66960

Discuss the steps that the directors of Cautious Limited could take to fund the company’s operations if the bank refuses to agree to the required overdraft in September and October 2020.

Use this space for your answer…

Usually a bank do refuse to grant a business loan if the net income or revenue of the enterprise is not sufficient enough in order to meet its obligations, liabilities as well as the loan amount itself or if the company is facing bad credit rating issue as well. If the cautious limited could not manage to maintain these all then it would be certainly refused by its bank for the loan provision. So in this scenario, the first option that is suitable for the directors to arrange funds for the company is retained earning that could be defined as the selling of a product or service for more than it’s reasonable price. These funds could be utilized in order to meet all organization’s expenses as well as to enhance the size of the business.

Another way to generate income for the enterprise is Equity funding that could be referred as to sell and distribute the possession and the ownership of the business in the market in the form of shares. Hence the buyer of the shares become the shareholders and thus the owners of the company with respect to the number of shares they do purchase. But it is a worth noting fact that the company will have to distribute its future profit among the shareholders in the form of dividends. On the top of that these investors (means shareholders) could enjoy a voting right for the election of directors along with an appointment of auditors for the purpose of inspection of the company’s books of accounts. They can also be entitled to take a legal action against the directors appointed or elected by them.

References:

Schell, J.M., 2020. Private equity funds: Business structure and operations. Law Journal Press..

Christie, A.L., 2019. The new hedge fund activism: activist directors and the market for corporate quasi-control. Journal of Corporate Law Studies, 19(1), pp.1-41.

Chen, Z., Harford, J. and Kamara, A., 2019. Operating leverage, profitability, and capital structure. Journal of financial and quantitative analysis, 54(1), pp.369-392.

CHHABLANI, P., 2020. Sources of Finance (long term).

Christie, A.L., 2019. The new hedge fund activism: activist directors and the market for corporate quasi-control. Journal of Corporate Law Studies, 19(1), pp.1-41.

Fahn, M., Merlo, V. and Wamser, G., 2019. The commitment role of equity financing. Journal of the European Economic Association, 17(4), pp.1232-1260.

Schell, J.M., 2020. Private equity funds: Business structure and operations. Law Journal Press..

Willows, G.D. and Rockey, J.A., 2018. Share price reaction to financial and integrated reports. South African Journal of Accounting Research, 32(2-3), pp.174-188.

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