Finance at Les Maisonettes

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Finance at Les Maisonettes
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Financial issues to revise

• Downward pressure on profit margins
• The concerns highlighted in the balance sheet
• Line 152 Sophie is considering applying for a
  bank loan and knows she can do so with a good
  interest rate.
• She needs to prepare a business plan and consider
  her budget for the new holiday packages (line 91)

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Sources of Finance

• Sophie already took out a bank loan initially at
  the start to fund the new venture Les
  Maisonettes - 300,000 to be paid back in 2026.
  (Line 15)
• In 2004 conversion from sole trader to LTD.
• The classes are providing a large source of
  income for Sophie. But she had to take out an
  additional 5 year bank loan of 15,000 for
  equipment and start up costs.
• Share capital see balance sheet

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Gearing

• Using the following formula calculate LMs
  gearing ratio (see appendix four)
• Loan capital/capital employed 100

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Gearing

• 43.1 for 2005
• 34.4 for 2008
• Using the Raffo book what does this tell you
  about its gearing level?

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Non-Financial factors
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Non-Financial factors
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Non-Financial factors
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Non-Financial factors
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Dont forget

• Les Maisonettes is growing so there will be
  effects on costs and profit margins as this
  business grows.

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The 4 options

• Study each option and consider its impact on
  Sophies financial situation.
• Answer this question
• Using appropriate financial ratios, analyse the
  profitability, liquidity and activity of LM.

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The 4 options

• Overall, Sophie is pleased with her small
  business and the success. But she is concerned
  about its future direction and potential market
  share.
• She consulted with her parents, her bank manager
  and her employees and identified four options.

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Option One

• Retain the present focus of her business but
  improve operations and profitability.
• Impact on Finance?

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Impact of option One on finance

• v This will improve cost control it will allow
  her to reduce her costs overtime.
• vImproved marketing will lead to increased
  revenue
• vCreating a more flexible workforce will reduce
  her costs and will allow her to be more
  competitive.
• v This will improve profitability of LM.

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Option Two

• Develop an education centre to promote the ideals
  of sustainable tourism and fulfil the objectives
  of the AFE.
• This means modifying existing accommodation,
  cutting outdoor activities, converting one barn
  to an education centre and restaurant operations
  will be restricted to guests at LM.
• IMPACT ON FINANCE?

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Impact of option Two on Finance

• v This will support her move for eco-tourism so
  may attract eco-tourists to her increased
  revenue.
• v She can now consider marketing to the 18-30
  group of eco-tourists she wanted to target.
• v Cost savings by being more energy efficient and
  carbon neutral.
• X This will cost money to implement.
• X Cutting outdoor activities means loss of
  revenue, as they are a good source of income.
• X Restricting restaurant operations to guests
  will reduce their potential customers so loss
  of revenue.

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Option Three

• Reposition LM as a luxurious eco-tourist retreat,
  develop a new USP and targeting higher income
  market segment.
• High quality locally sourced produce will be
  offered and a range of services such as saunas
  etc.
• Impact on Finance?

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Impact of Option Three on Finance

• v Targeting high income segment will bring in
  more revenue. This move could make LM very
  profitable.
• v The services will add an extra source of
  income.
• v The quality will be a big focus and so will
  improve its image increased revenue.
• X She will need substantial investment to upgrade
  and expand existing facilities.
• X She will need to invest a great deal into
  recruiting and training staff, so her costs will
  increase.
• X This move could increase her gearing, which is
  currently low, but an increase could mean more
  interest payments for her. This will not make her
  very competitive.

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Option Four

• Sell the whole business to a timeshare operator
  who will redevelop the business.
• Money goes to her parents retirement and some
  will go towards renovating the shop.
• This means she loses control and ownership of LM.

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• RATIO ANALYSIS
• ANALYSING THE FINANCIAL SITUATION OF LES
  MAISONNETTES

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Ratio Analysis

• Ratios are used to interpret financial accounts.
• Ratio Analysis can be used to assess the
  financial performance of a business.
• Ratios can be used to analyse three separate
  issues on the operations of a business
• Performance which compasses profitability and
  productivity
• Liquidity which refers to the ability of the
  business to generate cash for operating the
  business as and when required
• Shareholder which concerns the variables that
  just the shareholders are likely to be interested
  in.

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Q What are the advantages and disadvantages of
using ratio analysis?

• The main advantages of ratio analysis will be
• You will be able to look at trends
• Ratios can be used to forecast and plan,
  summarise data, to identify problems before they
  become acute and to assess performance.
• You can do an inter-firm comparison
• You can see and analyse trends
• You can make future predictions based on your
  findings
• You can find areas with high problems and try to
  find ways to solve them

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Disadvantages of Ratios

• However, ratios should be used with caution.
  Ratio analysis does not provide a complete means
  of assessing a companys financial performance.
  There are problems with using ratios. The main
  disadvantages of ratio analysis are
• They only highlight the problem but not provide a
  solution.
• Based on historical information and does not take
  into account positive factors within a business
  such as location, quality of staff etc. all of
  which can affect performance.
• Ratios do not take many factors into
  consideration.
• They do not measure non-monetary factors.
• When making comparisons between ratios overtime,
  it is necessary to take into account the
  following
• Inflation
• Any changes in accounting procedures
• Changes in the business activities of the firm
• Changes in general business conditions and the
  economic environment.

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Profitability Ratios

• These ratios focus on the firms profit.
• We will look at profit in relation to the value
  of sales revenue.
• GPM known as mark-up. This shows the gross
  profit made on sales turnover.
• NPM helps to measure how well a business covers
  its overheads. If the difference between the
  gross profit and net profit is small, then
  overheads are low.
• ROCE an important ratio. It tells what returns
  the firm has made on the resources made.

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Ratios to Calculate - Profitability
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Profitability Ratios
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Analysis of Les Maisonnettes profitability

• The level of profitability has reduced at LM.
• There is a large difference between the GPM and
  NPM, showing the difficulties Sophie is facing
  with controlling overheads.
• A reduced NPM is not a good sign, showing she has
  less profit to distribute to shareholders and to
  reinvest in the business.
• The drop in ROCE does not show LM to be a safe
  investment.

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Analysis of Les Maisonnettes profitability

• Her overheads are clearly not being spread over a
  greater level of sales.
• She is not benefiting from economies of scale.
  She needs to improve productivity and lower
  costs.
• The ROCE has decreased, this means that sales
  growth has been slower than the rise in capital.
• The ROCE will drop due to reduced gross and net
  profit.
• It seems that LM has poor cost control in terms
  of direct costs.

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Causes of LMs declining profitability

• It could be because she has only relied on word
  of mouth promotion and she needs to alter her
  marketing strategy.
• The costs of the activities are high. (Her
  expenses increased by 8000 euros in 3 years (see
  appendix 3).
• Sales declined and cost of sales increased
  (appendix 3)
• She was charging the same amount all year and not
  taking advantage of peak season.
• Competition (Sanctuary) and other external
  factors such as the housing market, weather
  conditions.
• Health and safety regulations meant increased
  costs for her.
• No business website not taking advantage of
  online bookings.

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How can profitability improve?

• Improve her marketing strategy to increase sales
  revenue. Strategies such as sales promotion may
  help to boost sales.
• Reduce costs such as labour costs (but this may
  impact on morale and productivity customer
  service)
• Reduce indirect costs overheads - without
  damaging effects to the firm.

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Liquidity Ratios

• Liquidity ratios measure how assets of a business
  can be converted into cash.
• A business must make sure it has enough liquid
  assets to pay any immediate bills that arise.
• These ratios are concerned with the short-term
  financial health of the business.
• They are concerned with the firms working
  capital and whether or not it is being managed
  effectively.
• Too much and it may not be making the most
  efficient use of its financial resources.

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Liquidity Ratios to Calculate
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Liquidity Ratios - Calculations
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Analysis of LMs Liquidity

• It is generally accepted that a current ratio of
  1.5 to 2.0 is desirable this will allow for a
  safety margin.
• In 2005, LMs current ratio was in a comfortable
  position at 1.751. However, in 2008, it had
  declined to 0.55, showing insufficient working
  capital. This means that as a result of the ratio
  being below 11, the short term debts of the
  business are greater than its liquid assets,
  which is not a good position to be in.

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Analysis of LMs Liquidity

• This means that LM does not have enough working
  capital it could be over-borrowing or over
  trading.
• As a general rule, the ATR should be at least
  11. This means that, in 2008, LMs ratio fell to
  0.221, and this is not a good sign. This shows
  that Sophie may be experiencing working capital
  problems, and if this continues, she could face a
  liquidity crisis.
• ATR shows that she could be unable to cover
  short-term debts

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Solutions to LMs liquidity problems

• Increase its current assets relative to its
  current liabilities. OR
• Reduce its current liabilities relative to its
  current assets.
• In LMs case, it is her short term borrowing that
  has increased drastically by 15,000 Euros and
  this will have to reduce in order to improve
  liquidity.
• She should also consider reducing short term
  creditors.

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Efficiency Ratios

• Also called activity ratios.
• These are used to measure how effectively a
  business employs its resources.
• They look at how well a firms financial
  resources are being used.

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Efficiency (Activity) Ratios
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Efficiency Ratios - Calculations
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Summary of LMs Efficiency

• Stock turnover has reduced, which is not a good
  sign for LM. This means less stock is sold and
  less profit generated. Sophie is not benefiting
  from purchasing economies of scale.
• LMs debtors days ratio is low, which is good,
  but increasing. This means that it takes upto 4
  days for debtors to pay. But too low a ratio is
  not good either, as customers may seek other
  suppliers if the credit period given to them is
  uncompetitive. It could also suggest that there
  are not enough firms buying on credit. Good
  credit control should be within 30-60 days.
• Creditors days should also be between 30-60
  days. LMs is very high. This could mean that LM
  is taking too long to may have a harmful effect
  on her cash flow.

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Solutions to LMs efficiency

• Develop a closer relationship with customers,
  suppliers and creditors.
• Improve levels of stock control in the business.
• Improve credit control, which will help improve
  its working capital.
• Increase turnover using the same assets, so that
  assets work more effectively is a way to improve
  asset turnover.

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You must also revise

• Advantages and disadvantages of bank loan as a
  source of finance?
• What additional sources of finance would you
  recommend for Les maisonettes?
• Revise what a business plan and what should be
  included in it and why it is used?
• You need to revise budgeting!!
• You need to revise the meaning of all ratios and
  apply them to LM.
• You need to learn and revise WORKING CAPITAL.