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Financial Statments

Assignment Requirements
Phase 2 – Case Study
Case-Study Information
The Case Study has been made available from the reading week of your course. You can
begin to work on the assessment from that date onwards. At 09.00 on the morning of the
controlled assessment (January 9, 2015) further information regarding this case (including
all the specific question requirements) will be made available.
You are expected to consider this supplementary information and to include it in your final
submission. The completed assessment must be uploaded onto Turnitin by 16.00 on the day
of the controlled assessment.
Explanation of the assessment criteria and how the marking scheme works
Your assignment will be marked according to the Level Assessment Criteria for Level 4. The
criteria are designed to test your knowledge of concepts i.e. your understanding of relevant
financial terms, ideas, theories, notions and principles and your ability to apply those
concepts in a practical situation. You will also need to show your understanding of what
elements should be included in a professional report.
Word count policy
The maximum word count for the report is 1500 words (excluding headings, references and
appendices). The examiner will stop marking your submission at the point it reaches this
word count. Candidates should show how many words they have used on the front of their
It is best to allocate your word count in direct proportion to the weighting of the marks – so for
example, if one section has 30% of the marks allocated and as such you should aim to
allocate 30% of your word count to this section, i.e. approximately 450 words.
Referencing and the Harvard system
During the course of writing an essay, a report or an assignment, you would normally
support your points and your arguments by referring to the published works of others. The
nature of this assessment means that it is expected you will have minimal or no
If you are going to reference the work of others, for the purposes of this assessment these
references may be from work presented in journal or newspaper articles, government
reports, books or specific chapters of books, or material from credible sources on the
Internet (Wikipedia is not a credible academic source).
Giving a reference is the practice of referring to the work of other authors in the text of your
own piece of work. Within your assignment, each time you use the work of others it needs to
be referenced back to the ‘Bibliography’ at the end of the work; this gives the full details of
the source item and should enable it to be traced. Referring accurately to such source Understanding Financial Statements – Assessment
Page 3 of 17
materials is part of sound academic practice and a skill that should be mastered – it’s
important to give credit to others whose ideas you have used.
The Harvard referencing (Author, date, title) is the mandatory approach and a full
explanation as to how this system works is available in the Assessment section of the VLE.
Advice on plagiarism and collusion
Copying material i.e. plagiarism, from a third party source is a serious offence and may
result in your work not being accepted. Plagiarism involves presenting work as though it
were your own or using ideas of another author without acknowledging the fact.
Collusion takes place when two or more students submit work that is too similar i.e. similar in
words, content and style, such as might be put down to coincidence. Make sure that the
work you submit is your own or is appropriately referenced. If in doubt you should speak to
your tutor or the module leader.
Writing your report
The report should be presented in a professional manner. The writing should be clear,
concise and persuasive. The report should be well structured and the tone used should be
Please use Headings and Sub-Headings throughout the report to provide the reader with a
logical flow of content. You may use presentation aids such as colour and diagrams to
support the text where appropriate.
Candidates are advised to use a professional format for their work e.g. Ariel font type, font
size 11 or 12 and 1.5 line spacing to provide an overall proportion of 25% white space.
Understanding Financial Statements – Assessment
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Indicative requirements
The format of your assessment is as follows.
Question 1 will cover the purpose and key features of Sandell Arnold’s financial statements,
it will be split into 3 sub-requirements labelled ‘a to c’ which will total 12 marks, which will be
released at phase 3.
Questions 2-5 are set out below (but will also be released again at phase 3 along with
question 1 to provide you with the full set of requirements).
Auditing and Corporate Governance (14 marks)
Consider the comments made by Sandell’s external auditors and the Non-executive
Director in Exhibit four in Sandell’s governance arrangements.
Explain what type of modified (Not-so-Clean) audit report, the external auditors would
give Sandell if the accounting treatment of the £30 million damages remains
(2 marks)
If Sandell revised their financial statements for the £30 million damages in line with
Exhibit 5, the external auditors would give Sandell an unmodified (Clean) audit
Explain why the external auditors have changed their opinion on Sandell’s
financial statements when compared with part 2(a).
Describe ONE reason why companies prefer receiving clean audit reports.
(4 Marks)
Review the narrative in Exhibit 4 from the Non-Executive Director relating to the
decision to increase director’s remuneration by 50%.
Identify and explain TWO corporate governance deficiencies demonstrated by the
board’s decision to approve this remuneration increase.
Describe TWO pieces of corporate governance good practice which Sandell
could put in place to make better quality decisions about director’s remuneration
going forward.
(8 marks) Understanding Financial Statements – Assessment
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Interpretation of the Income Statement (35 marks)
Use the case study information to analyse and comment on FIVE movements in
Sandell’s Income Statement (financial performance) during the year 2013 compared
to 2012.
Use the additional financial information in Exhibit 2 and the relevant ratios shown in
Exhibit 3 to enhance the quality of your analysis.
For each item you select to analyse and comment upon
Ensure you use an appropriate financial technique (Ratio, Trend analysis)
to ascertain the movement between 2013 compared to 2012;
Reflect and comment upon whether the movement is having a positive or
negative impact on Sandell’s financial performance; and
iii. Use the case study to identify and explain at least ONE reason why the
movement in part 3a(i) has happened.
(25 marks)
Using the revised financial statements set out in Exhibit 5: (You cannot answer all
of this question until Phase 3)
Calculate a revised net margin ratio (show your workings via a separate
Appendix to your report);
Explain how the net margin ratio helps assess a company’s financial
performance; and
iii. Compare your calculation in 3b(i) with the present net margin ratio
(Exhibit 3) and discuss whether the Chief Executive’s statement that the
company has managed to improve its profitability since 2012 remains
(10 marks)
Interpretation of the Statement of Financial Position and Statement of Cash Flows
(35 marks)
One of the main reasons that £22 million of operating profit earned by Sandell is only
producing £2 million of operating cashflow is due to how the company is managing its
working capital.
Identify which parts of the Statement of Cashflow show how working capital is
being managed;
Identify and use appropriate working capital ratios to illustrate movements in
working capital for 2013 as compared to 2012;
iii. Use the ratio’s in 4a(ii) above to calculate the Operating Cash Cycle (OCC)
for 2012 and 2013;
Comment on whether the movement in the OCC calculated in 4a(iii) is having
a positive or negative impact on Sandell’s cashflow; and
Use the case study to identify and explain at least TWO reasons why the
OCC movement (in part 4a(iii)) has occurred. Understanding Financial Statements – Assessment
Page 6 of 17
(15 marks)
Consider this quote from the sector briefing in Exhibit 4:
“This is a considerable expansion of the company’s operations and therefore Sandell
has been required to seek external finance to support this investment, they have
managed to raise some equity funding from the AIM market, some debt funding
through bank loans but it is generally known that the funding secured has not
been sufficient to cover this total investment.”
Identify and describe how Sandell’s Statement of Cash Flow supports the part of the
quote highlighted and demonstrates that the investment in Western Europe has not
been fully supported by external financing.
(5 marks)
Using the revised financial statements set out in Exhibit 5: (You cannot answer all
of this question until Phase 3)
Calculate revised interest cover and gearing ratios (show your workings via a
separate Appendix to your report);
Explain how the interest cover and gearing ratios help assess a company’s
long-term financial condition; and
iii. Compare your calculation in 4c(i) with the present interest cover and gearing
ratios (Exhibit 3) and discuss what impact losing this court case (and paying
£30 million damages) will have on the company’s solvency.
(15 Marks)
Professional report format (4 marks)
Marks are allocated for setting out your answer in the format of a professional business
(4 Marks)
The report should be no longer than 1500 words (excluding headings, references and
appendices), a suggested format in which to incorporate your answer is set out below. Understanding Financial Statements – Assessment
Page 7 of 17
Suggested report format
To: Parveen Rostom
From: Made up name (not your own)
Date: Assessment Day
Title: To complete
Introduction: To complete
Executive summary: To complete
Main Report:
Include Subsections/Paragraphs etc for each of the 4 main areas listed below
Part one – Purpose and key features of Sandell’s Financial Statements
Part two – Auditing and Corporate Governance
Part three – Interpretation of the Income Statement
Part four – Interpretation of the Statement of Financial Position and Statement of
Cash Flows
Understanding Financial Statements – Assessment
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Background – Sandell Arnold plc
A friend of yours, Parveen Rostom, has approached you seeking some advice. She has
been offered the position of Sales Director within a company called Sandell Arnold (referred
to from now on as Sandell)
Sandell is a building merchant, which has been trading for more than 40 years supplying a
range of materials to the building and construction industry. This includes ironmongery,
plumbing and heating, landscaping materials, timber and sheet materials, painting and
decorating, dry lining and insulation, doors and joinery, and hand and power tools.
A few years back, in 2011, Sandell become a plc and is listed on the UK’s Alternative
Investment Market (AIM), which seeks to raise capital for smaller but fast growing
The growth which Sandell desired has not yet happened and therefore Parveen has been
offered a very generous remuneration package to implement a new aggressive sales
strategy to support Sandell’s expansion into new Western European markets. However
Parveen has been with her current employer for six years and wants to ensure her future
would be secure.
Your role
Though Parveen is a friend, she has approached you because you are a Financial Analyst
who is a specialist in the building and construction industry.
You have agreed to analyse the financial performance and position of Sandell and produce
a report for Parveen which sets out your findings and makes a recommendation as to
whether she should accept or reject the offer to become Sandell’s Sales Director.
To assist you with this task you have put together a pack of information as follows:
Exhibit 1: Extracts from Sandell Arnold’s Financial Statements for 2013, including the
Income Statement, Statement of Financial Position and Statement of
Exhibit 2: Additional Financial information which supports the Financial Statements in
Exhibit One.
Exhibit 3: Key ratio analysis for 2012 and 2013 of Sandell Arnold’s financial statements.
In addition to this pack, you have
Exhibit 4: Your Notes from various document reviews and industry discussions.
One further exhibit will also be provided at phase 3.
Exhibit 5: Revised financial statements which reflect the impact of losing the case for
Understanding Financial Statements – Assessment
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Exhibit 1: Extracts from Sandell Arnold’s Financial Statements for 2013
Financial Statements
Sandell Arnold plc Income Statement for the year ended 31/12/13
2013 2012
£’m £’m
Revenue 252 248
Cost of Sales (203) (223)
Gross Profit 49 25
Other operating income 7 0
Administration expenses (16) (11)
Distribution costs (18) (13)
Operating Profit/(Loss) 22 1
Finance costs (12) (8)
Profit/(Loss) before Tax 10 (7)
Income Tax expense (2) (1)
Profit/(Loss) for the period 8 (8)Understanding Financial Statements – Assessment
Page 10 of 17
Sandell Arnold plc Statement of Financial Position as at 31/12/13
2013 2012
£’m £’m
Non-current Assets
Property, Plant and Equipment 278 198
Current Assets
Inventories 53 44
Trade and other receivables 36 24
Cash and cash equivalents 0 6
89 74
Total Assets 367 272
Share Capital 60 45
Retained Earnings 109 103
Total Equity 169 148
Non-current Liabilities
Long-term borrowings 111 91
111 91
Current Liabilities
Trade payables 48 33
Bank overdraft 39 0
87 33
Total Liabilities 198 124
Total Equity and Liabilities 367 272Understanding Financial Statements – Assessment
Page 11 of 17
Sandell Arnold plc Statement of Cashflows for the year ended 31/12/13
£’m £’m
Cashflows from operating activities
Operating Profit 22
Adjustments for:
Depreciation 2
(Increase)/Decrease in inventories (9)
(Increase)/Decrease in trade and other receivables (12)
Increase/(Decrease) in trade payables 15
Cash generated from operations 18
Interest paid (12)
Income tax paid (2)
Dividend paid (2)
Net cashflow from operating activities 2
Cashflows from investing activities
Purchase of Property, Plant and Equipment (82)
Net cashflow from investing activities (82)
Cashflows from financing activities
Proceeds from issue of share capital 15
Proceeds from long-term borrowings 20
Net cashflow from financing activities 35
Net increase/(decrease) in cash and cash equivalents (45)
Cash and cash equivalents at the start of year 6
Cash and cash equivalents at the end of year (39)
2013Understanding Financial Statements – Assessment
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Exhibit 2: Additional Financial information which supports the Financial
Statements (set out in Exhibit one)
Sandell Arnold plc Supporting Notes to the Financial Statements for the year ending 31/12/13
Note 1 – Extract of supporting notes for the Income Statement
2013 2012
Administration expenses £’m £’m
Employee expenses 6.2 4.5
Directors remuneration 1.4 0.9
Bad Debt charges 1.2 0.1
Utility costs 1.3 1.2
Legal and Professional fees 1.1 0.5
Depreciation charges 2.0 1.5
Sundries 2.8 2.3
16.0 11.0
Distribution costs
Distribution & Transport costs 12.4 7.2
Marketing & Advertising costs 5.3 5.3
Other distribution costs 0.3 0.5
18.0 13.0
Note 2 – Extract of supporting notes for the Statement of Financial Position
Statement of changes in Equity (Extract)
Retained earnings column only 2013 2012
£’m £’m
Opening balance 103 111
Profit for the year 8 (8)
Dividend Paid (2) 0
Closing balance 109 103
Retainsed EarningsUnderstanding Financial Statements – Assessment
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Exhibit 3: Key ratio analysis for 2012 and 2013
ROCE Profit b Tax/Int
Equity + Debt* 22 x 100 = 6.90% 1 x 100 = 0.42%
169 + 150 148 + 91
* Includes bank overdraft
Gross Margin
Gross Profit 49 x 100 = 19.44% 25 x 100 = 10.08%
Revenue 252 248
Net (Operating) Margin
Operating profit 22 x 100 = 8.73% 1 x 100 = 0.40%
Revenue 252 248
Current Ratio
Current Assets 89 = 1.02 74 = 2.24
Current Liabilities 87 33
Quick Ratio
CA – Inventories 89 – 53 = 0.41 74 – 44 = 0.91
Current Liabilities 87 33
Inventory Days
Inventories 53 x 365 = 95.30 44 x 365 = 72.02
Cost of Sales 203 223
Receivable Days
Receivables 36 x 365 = 52.14 24 x 365 = 35.32
Revenue 252 248
Payable Days
Trade payables 48 x 365 = 86.31 33 x 365 = 54.01
Cost of Sales 203 223
Debt* 150 x 100 = 47.02% 91 x 100 = 38.08%
Debt + Equity 150 + 169 91 + 148
* Includes the bank overdraft
Interest cover
Profit b Tax/Int 22 = 1.83 1 = 0.13
Finance costs 12 8
2013 2012Understanding Financial Statements – Assessment
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Exhibit 4: Your Notes from various document reviews and industry discussions.
As a financial analyst in the construction industry you have various contacts across the
sector both inside and outside the company with whom you have been able to hold various
discussions and from whom you have been able to obtain various document.
The extracts from these have been set out below.
Review of Sandell’s annual report – Chief Executive’s review
The Chief Executive’s report was very positive in both reviewing the 2013 year and looking
to 2014 onwards, the following statements were specifically of interest to me:
In 2013 the company had a focus on improving profitability, which it managed to achieve
through securing new supplier relationships that year.
It meant that the company was able to declare and pay a dividend to shareholders for
the first time since the global financial crisis occurred in 2008.
Now that profitability issues have been fixed, the focus of the company in 2014 onwards
is growth and the expansion of the company into new markets in Western Europe, the
infrastructure for which has been put in place during 2013.
Discussion with Sandell’s operations manager about the new supplier relationships
put in place in 2013.
Key points from that discussion are set out below:
With the issues around the company’s financial performance (in particularly its
profitability) we sought to retender the supply of timber and ironmongery materials to us,
which are two of our main product lines making up around 60% of our revenue across
the last 10 years.
It was a very competitive tendering process, which a supplier called Ashwell won due to
the low price they were offering to supply goods to us. This was on average 10% lower
than our previous suppliers of these materials.
However since the Ashwell contract commenced in January 2013 we have had various
problems with it including:
o An issue with quality which has meant we have been provided with a higher
proportion of faulty goods, this has included split timber and ironmongery of
incorrect dimensions.
o These quality issues have resulted in two business issues, firstly unhappy
customers, who when receiving faulty goods are disputing the invoices that follow
and are either slow in paying the invoice or are not paying the invoice at all, Understanding Financial Statements – Assessment
Page 15 of 17
which we then have to write off as bad debt.
o Secondly, because the goods are faulty it means we have to pick up the items
from the customer sites and deliver new product so effectively we are having to
make a number of deliveries twice.
We do have penalty clauses in the contract with Ashwell which are linked to quality and
because of these issues they have had to pay us around £7 million in compensation
during 2013.
Review of a construction industry sector briefing covering Sandell.
The briefing focused on Sandell’s expansion plans into Western Europe, the key points of
interest are listed below:
Sandell has an established presence in the UK construction industry (with 10 distribution
centres) and has now identified Western Europe as a potential new market to access
and obtain growth from.
During 2013, Sandell focused on putting infrastructure in place across this new market
from which it will then seek create sales, this infrastructure included:
o 4 new distribution warehouses in Rouen (France), Koln (Germany), Utrecht
(Netherlands) and Bern (Switzerland)
o A fleet of Lorries to enable distribution to each new warehouse.
o Additional employees to staff the above functions, taking the company’s
workforce from 100 to 130 employees.
o Purchasing inventory to ensure various product lines are available at each new
This is a considerable expansion of the company’s operations and therefore Sandell has
been required to seek external finance to support this investment, they have managed to
raise some equity funding from the AIM market, some debt funding through bank loans
but it is generally known that the funding secured has not been sufficient to cover this
total investment.
To date this investment has resulted in minimal return (around £4 million of sales in
2013) but the scope for growth from this new market is considerable (pessimistic
estimates put potential annual sales from these markets at around £80-100 million per
year). Therefore an aggressive and effective sales strategy is needed to benefit from this
opportunity. Understanding Financial Statements – Assessment
Page 16 of 17
Sandell has been seeking to put a Sales director in place to since the middle of 2013 to
develop this strategy and are hoping to make an appointment shortly.
Notes from discussion with Sandell’s external auditors regarding the 2013 financial
The audit is near to completion, the key points are set out
We have one remaining audit issue which is in regard to the accounting treatment of a
claim from one of Sandell’s main customers. The background for which is set out below.
A major customer, a House Builder, is suing Sandell, claiming that it has supplied faulty
goods. The customer had to rectify some of its building work when investigations
discovered that a building material, recently supplied by Sandell was found to contain a
hazardous substance.
Sandell’s legal team has stated that Sandell is very likely to lose this case, though the
timing of payment and the amount of damages to pay is presently uncertain, a reasonable
estimate has put the likely amount at around £30 million.
Presently Sandell’s directors have not made any disclosure of this in the financial
statements on the basis that it is uncertain and that they feel confident that they would be
able to seek damages from Ashwell (who supplied the original materials).
The external auditors think that Sandell should make a provision in their financial
statements for this £30 million of potential damages.
The external auditors consider this matter to be material and therefore are considering
issuing a modified audit opinion (known as a ‘not so clean’ audit report from the syllabus)
if the matter remains unresolved.
Sandell’s finance team are keen to obtain a ‘clean’ audit report and therefore are
presently producing amended financial statements (which will be provided in exhibit 5) to
reflect this £30 million provision.
Notes from discussion with a Sandell Non-Executive Director (NED) regarding
Directors Remuneration
Sandell’s board voted to increase directors’ remuneration in 2013, the decision for which this
NED had some concerns. Key points from this discussion set out below:
Sandell have been seeking to put in place a Sales Director since the middle of 2013, as
this position has been deemed a key factor in establishing the company in new markets Understanding Financial Statements – Assessment
Page 17 of 17
in Western Europe.
At present the company’s board is made of 5 executive directors and 1 non-executive
The other directors were aware as to how generous the remuneration package was for
this new post (50% higher than other directors) as the company were keen to secure
someone with the talent and experience to fill this post.
Because the level of remuneration was higher, it was felt that the remaining directors
needed their remuneration packages increased to bring them in line with this new post.
At the meeting this NED raised a concern that the 50% difference was all performance
related pay (linked to success in growing the Western European Market) but the increase
proposed for the other directors to bring them in line was on basic salary (which is not
performance related).
The Board meeting noted this concern, but when it was voted on the results were 5 in
favour of the increase and 1 against. So the NED felt he was effectively outvoted.
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