ocr avce business studies unit 5

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OCR AVCE BUSINESS STUDIES UNIT 5

Case Study Toolkit - Summer 2004

FINANCE

GRANNY GREENFINGERS (“GREENFINGERS”) © Tutor2u Limited 2004: All Rights Reserved

OCR AVCE Business Studies UNIT 5: Summer 2004 – Granny Greenfingers

© tutor2u 2004 (www.tutor2u.net) Granny Greenfingers Revision Toolkit of 26

CONTENTS

Introduction ....................................................................................................................................................3

Recording Financial Information............................................................................................................................4

Constructing Accounts ........................................................................................................................................8

Interpreting Financial Information........................................................................................................................ 16

Cash Flow Management.................................................................................................................................... 24

Glossary ...................................................................................................................................................... 26



Introduction This revision guide is designed to help you prepare for the Unit 5 AVCE Business Studies exam on Business Finance For 2004, your examination is based on a case study company – Granny Greenfingers – a privately owned, profitable garden centre business We’ve provided a range of example questions and answers that show how the examiner might test your understanding of the case – and relevant finance concepts. The example questions (and suggested approaches) are grouped into the main syllabus headings used by OCR – so that you can be sure that you are working through the syllabus step by step as you look at this toolkit. We have also analysed all the financial data provided in the pre-release document – so that you can focus on understanding what the numbers mean. Please note, that the guide is not meant to provide a complete list of all the possible questions that the examiner might throw at you. It is up to you to make sure that your revision covers all the main areas you have studied on the course. However, this guide will help you see how the information in the case can be used to respond to the kind of questions you will be set. We have focused on what we think are the key areas. On your CD you will also find an Excel Spreadsheet (in Microsoft Excel format and Adobe PDF format) that shows how we have calculated the numbers included in this document. We have also created a series of charts that illustrate the main comparative data the examiner may ask you to consider. Finally, we’ve also provided a brief glossary of the key terms used in the pre-issued materials. Don’t forget that you can also ask questions about this case study on the free tutor2u discussion boards (www.tutor2u.net/forum/default.asp) Good luck in your Unit 5 exam this summer! Best wishes Jim Riley Managing Director tutor2u™

http://www.tutor2u.net/forum/default.asp



Recording Financial Information

What this part of the syllabus is about: You need to understand why it is important for a business to create and maintain accurate financial records and know about the different users of financial information. Every business has to meet internal and external reporting requirements to show its financial health and to meet legal and other requirements. You need to understand the reasons why the following stakeholders of a business need financial information about the performance of the business:

Internal users – groups within the organisation, such as managers External users– groups outside the organisation, such as shareholders and creditors

You need to understand that financial information has to serve a variety of different purposes depending on the needs of different stakeholders. You need to know the range of documents used by businesses and how and why these are used. You need to understand how each contributes to the flow of financial information and how financial data is recorded to construct accounts. You also need to understand the management of these documents and explain their use and importance for stakeholders.

Example Questions Suggested Answers / Approach

1 To enable Toby, Amelia and the rest of the Greenfingers management team to run the business effectively. Financial information is the basis of most management information on which decisions are taken

2 To enable the directors of Greenfingers to look after the interest of shareholders in the company. For example, without financial records, the directors would be unable to produce their annual report and accounts which describes to the shareholders how the company has performed in the last year and what the latest financial position (balance sheet) is

State three reasons why Greenfingers needs to keep financial records

3 To be able to comply with laws. All businesses are required to make a certain amount of financial information available (e.g. VAT returns, corporation tax calculations). This is only



possible if relevant, accurate financial records are kept.

1 The records of how much stock the business has can easily become inaccurate if proper stock control is not maintained. Receipts of stock need to be recorded properly – for example deliveries from suppliers and retuned goods from customers. Stock leaving the business needs to be recorded – e.g. sales to customers and faulty goods returned to suppliers. Stocks are often difficult to control, which is why most businesses conduct periodic “stock counts” to check that their stock records are accurate

2 Movements of cash into and out of the business need to be recorded accurately. For example, if payments can be made without authorisation then the records of cash and bank balances can quickly become inaccruate. All customer receipts need to be properly counted and recorded. For example, the daily listings of money put in the shop tills needs to be matche with an actual count of the money in the till

Briefly explain three ways in which the financial records of Greenfingers might become inaccurate

3 It is imoprtant that accurate bookkeeping takes place in the business. If accounting transactions are not entered correctly (i.e. debit and credit entries recorded properly) then the trial balance will not work and it becomes much harder to construct an accurate profit and loss account and balance sheet

1 Management – to see how the business is performing (e.g. Toby reviewing daily and weekly sales statistics)

2 Employees – to help them process transactions (e.g. the accounts office using records of amounts owed to suppliers to process payments)

State three internal users of financial information at Greenfingers

3 Shareholders – to see how their investment is performing

1 For taxation purposes, all businesses must accurately record details of the profit made by the business. For a limited company like Greenfingers, the profit and loss acount (and supporting analysis) is required to be able to calculate how much corporation tax is payable on the profits for the year

Explain three ways in which the law requires a business to disclose financial information to external users

2 Payroll records – a business must provide the Inland Revenue with information about how



much has been paid to employees; how much income tax and national insurance has been deducted etc

3 VAT – businesses that have a turnover above a certain limit are required to charge VAT on some or all of their sales. Every three months, the business has to submit a report to the Customs & Excise on how much VAT has been charged (and incurred).

Record / Information Why Useful

Bank statement and cash book To understand the cash inflows and outflows of the business To ensure that the amount of cash acutally owned by the business is matched by the financial records (a “bank reconciliation” is the way that this can be checked

Sales reports These could be produed every day, week, month or other period. Sales reports show the value and volume of products sold. Ideally these reports categorise sales into different kinds (or departments) and also compare sales with the same period last year. Sales reports are crucial to deciding what stock items to hold and in understanding how and when customers shop.

Stock reports Records showing the quanity and value of goods in stock are vital to a business like Greenfingers – which holds a lot of stock (£85,000). These records can be used as the basis for stock control – for example deciding to offer promotional discounts on stocks that have now sold well, or for ordering more stocks of the best-selling items or those with low stock levels

List four different accounting records that would be used regularly by management of Greenfingers and provide a reason why the information is useful

Customer account records Greenfingers allows some customers to buy “on account” – which means that customers can buy now and pay later. So when a customer buys something using an account card, the value of the sale is recorded in debtors (amounts owed to the business). The record of customer accounts is crucial to managing working capital in the business. These will show how much is owed by each customer and for how long the amount has been due. Customers



who have not settled their accounts for a long-time are a major problem for a business. The records will identify these people.

External Stakeholder Interest in Financial Information

Suppliers Suppliers will be interested in the liquidity of Greenfingers – to make sure that the company is able to pay its debts if supplied on credit

Identify two external stakeholders in the Greenfingers business and provide an example of the kind of financial information they would be interested in

Government The government will be interested in the financial performance of Greenfingers – to make sure that it collects the right amount of tax on the profits earned!

1 The directors/shareholders of Greenfingers are interested in the company maximising the profit it earns This potentially conflicts with employees who have an interest in earning higher wages – which wold reduce profits

2 Management of Greenfingers have an interest in obtaining stocks of products at the lowest possible cost (to improve the gross profit margin earned). This potentially conflicts with the interests of suppliers – who are looking to achieve the best possible price for their goods

State three ways in which conflicts may arise between stakeholders in Greenfingers

3 The shareholders of Greenfingers want the company to make as much profit as possible to maximise the return on their investment This potentially conflicts with the interest of the government – who want to maximise the tax they earn on the profits of companies

1 To enjoy the benefits of limited liability – so that the shareholders of the company are only liable for the amounts they have invested in the share capital of the company.

2 To help raise new finance. For example, when the company was incorporated, this provided an opportunity for the shareholders to invest further in the business by buying shares

State three reasons why the owners of Greenfingers may have decided to “incorporate” the business five years ago

3 To improve the reputation of the business. For example, suppliers may be more willing to provide stock to a limited company that makes its accounting information public than to a sole trader or partnership



Constructing Accounts

What this part of the syllabus is about: You need to understand how the information in financial documents is recorded and used to generate the final accounts. You will need to understand the basic flow of accounting information between the following:

Books of original entry General ledger and personal ledger Trial balance Final accounts

You should know how to construct a simple balance sheet and profit and loss account. To do this you will need to be able to distinguish between the following:

Assets Liabilities Expenses Revenues

You should also be able to explain the concept of depreciation in simple terms and how it is calculated.


Explain what is meant by the term “accounting system”

An accounting system records the data from various financial documents and organises this so that relevant information can be created to manage the business. There are two main stages in any accounting system:

(1) Bookkeeping – recording information from records into the books of account (e.g. cash book, sales ledger, purchase ledger, trail balance, journal)

(2) Accounting – drawing up financial reports from the bookkeeping records (e.g. profit and loss account, balance sheet, notes to the accounts)

1 Cost of goods bought for sale in the garden centre (“ stock purchases”) State two examples of direct costs incurred by Greenfingers

2 Direct wages (e.g. wages of employees providing the consultancy service for customers)

State four examples of indirect Select from options such as:



1 Wages and salaries of the administration team (e.g. accounting, stock control)

2 Insurance for the business and its property

3 Fees for accounting and legal advice received by the business

4 Marketing costs – e.g. advertiing; promotional discounts

5 Bad debts – e.g. when customers fail to settle amounts owed on their store cards and Greenfingers is unable to recover amounts due

costs or overheads that you would expect to find in the Greenfingers business

6 Security, lighting and heating of the premises

Explain the difference between revenue expenditure and capital expenditure. State three examples of each of these kinds of expenditure that you would expect Greenfingers to incur

Revenue expenditure: Revenue expenditure is on business expenses or costs that only temorarily benefit the business. These are recorded as costs in the profit and loss account in the period in which they are incurred. Examples:

- Marketing campaigns - Wages and salaries - Cost of goods bought for resale

Capital expenditure: Capital expenditure is expenditure on fixed assets. These are assets that provide a longer-term benefit for the business and are not regarded as a cost in a particular year. Capital expenditure is recorded as an asset in the balance sheet. If the value of the fixed asset falls over time (e.g. through wear & tear or obsolescence) then this reduction in value is charged as a cost through “depreciation” Examples:

- Purchase of shop equipment (e.g. fixtures, fittings) - Purchase of delivery vehicles and equipment - Improvements and extensions to the Greenfingers land and buildings



Using the data provided by Amelia in the table on page 3 of the pre-issued material, construct a profit and loss account for Greenfingers for each of 2002 and 2003

Profit and Loss Account 2002 2003

Turnover 340,000 350,000Cost of sales 189,750 210,500Gross Profit 150,250 139,500Expenses 108,000 105,000Net Profit (before tax) 42,250 34,500Taxation 6,000 5,500Profit after tax 36,250 29,000

Select five from option such as:

1 Profit and loss account (including comparative figures for previous year)

2 Balance sheet (and balance sheet for previous end of accounting period)

3 Cash flow statement

4 Five year trading summary

5 Notes to the accounts

6 Auditor’s report

State five kinds of financial report or statement that would be included in the annual report and accounts of a public limited company like Kingston Gardens plc

7 Directors’ report

Explain why the profit and loss account of Greenfingers includes an amount for “taxation”

Taxation is a chrage (cost) on the profits of the business. In the UK, a company must pay corporation tax on the profits it earns. The rate of corporation tax depends on the value of profits. Greenfingers qualifies as a small business and so pays a much lower percentage of its profits in tax than a larger, more profitable business

From your profit and loss account, state what the “retained profit” was for the year ended 31 March 2003. Was this more or less than the

Retained profit was £29,000 (i.e. profit after tax) No dividends were paid in the year The retained profit in 2003 was lower than 2002 by £7,250



retained profit for 2002?

Using the data provided by Amelia in the table on page 3 of the pre-issued material, construct a balance sheet for Greenfingers at 31 March 2002 and 31 March 2003

Balance Sheet 31-Mar 31-Mar 31-Mar 31-Mar 31-Mar 31-Mar2002 2002 2002 2003 2003 2003

Tangible Fixed Assets Cost Depn NBV Cost Depn NBV

Buildings (cost) 150,000 0 150,000 150,000 0 150,000Equipment (cost) 50,000 20,000 30,000 50,000 25,000 25,000Vehicles (cost) 100,000 40,000 60,000 100,000 50,000 50,000Net Book Value 300,000 60,000 240,000 300,000 75,000 225,000Current Assets Debtors 45,000 56,000Cash Held 2,000 6,000Cash at Bank 21,500 30,500Stocks 65,500 85,000Total Current Assets 134,000 177,500

Current Liabilities Creditors 18,000 17,500

Net Current Assets 116,000 160,000

NET ASSETS 356,000 385,000

CAPITAL AND RESERVES Share Capital 200,000 200,000Retained Profits 156,000 185,000

356,000 385,000



Explain why depreciation is charged on fixed assets

Although the cost of fixed assets is recorded as an asset in the balance sheet, this does not mean that the value of those assets does not decrease over time. Like a carpet in your home, most fixed assets will wear out eventually, or will be replaced by something new and better. The correct accounting procedure is to charge any reduction in value of a fixed asset to the profit and loss account as a cost. We call this cost – depreciation. Normally, businesses account for depreciation by estimating how long a fixed asset will last when it is first bought. Then an estimate of how much the value of the fixed asset will fall over its useful life is made. This fall in value is then charged in equal installments as a cost in the profit and loss account. This is known as the straightline depreciation method.

Explain why Greenfingers does not charge depreciation on the value of its land and buildings

Not all fixed assets fall in value over time. Some assets – such as land and buildings – usually increase in value. So no depreciation needs to be charged.

Describe a way in which Amelia could change the way in which depreciation is charged on Greenfinger’s equipment and vehicles

The straightline method is the most common way of calculating depreciation on fixed assets. However, there is an alternative method – the reducing balance method. The reducing balance method involves deciding upon a set percentage for depreciation each year and applying this to the book value of the asset at the start of the year

Explain what the difference is between “opening stock” and closing stock. Why would the Greenfingers accountant need to know both figures in order to be able to calculate the profit for a period

Difference between opening and closing stock: Opening stock is the value (cost) of stock that was held at the start of an accounting period. Closing stock is the stock that is left at the end of an accounting period. Using stock figures to calculate profit: The Greenfingers accountant needs to know what the cost was of the goods that were sold during the year. This would enable her to calculate the “cost of sales” and match this with sales to work out the gross profit. The calculation of cost of sales requires knowledge of both the opening and closing stock value as shown below: (using examples from Greenfingers accounts for 2003)



£

Opening Stock (at cost) 65,500

Purchases of stocks during the year (at cost) 230,000

Less Closing Stock (at cost) (85,000)

Cost of Sales 210,500

1 Finished goods held for sale in the garden centre retail areas (e.g. lawnmowers & other gardening equipment; decking, seeds and fertilisers)

2 Raw materials used for producing plants grown at the garden centre nursery

Describe three kinds of stocks that you might to expect a business like Greenfingers to hold

3 Work-in-progress (e.g. the value of plants that are growing not yet ready for sale; the value of landscaping work done for clients that has not yet been invoiced)

When customers visit a garden centre they normally pay cash for what they buy. Given this, explain why Greenfingers has such large amounts owed by “Debtors”

Most retail businesses like garden centres are very “cash generative” since customers pay cash or use credit cards to pay for their goods at the time of purchase. However, Greenfingers allows some customers to obtain goods using an account card (i.e. “on credit”). In theory, the balance owed on each customer account card should be settled each month. This depends on the terms that Greenfingers set for account settlement. The risk is that balances are allowed to build up too high on these account cards and that customers do not settle their bills. This damages the cash flow of Greenfingers, since the suppliers of the goods that customers have bought still have to be paid on time.

1 Higher sales – the turnover of Greenfingers rose by £10,000 in 2003 – some of this may have been customers using their store cards

2 Customers have taken longer to pay outstanding amounts on their account cards – this would be supported by any increase in the debtor days ratio (which increased from 48.3 days at 31 March 2002 to 58.4 days at 31 March 2003). This is bad news for cash flow

State three reasons why the value of “Debtors” rose from £45,000 at 31 March 2002 to £56,000 at 31 March 2003

3 Greenfingers encouraged more customers to open and use account cards during the year. Remember that there can be positive benefits from operating an account card system; e.g.

- Encourage higher spending in the garden centre



- Obtain details on what customers have bought

Explain what is meant by the term “working capital”

Working capital is defined as current assets of a business minus its current liabilities. This figure shows the company's liquidity and ability to meet its short-term debts

From the information provided in the balance sheet, describe what happened to Greenfinger’s working capital between 31 March 2002 and 31 March 2003

The value of working capital (as measured by “net current assets” in the balance sheet) rose by £44,000 in the year ended 31 March 2003. The main reasons for the increase in working capital were:

- An increase in debtors of £11,000 - Higher stocks (£19,500)

What was the total amount of cash owned by Greenfingers at 31 March 2003?

There are two parts to the cash balances owned by Greenfingers – cash in hand, and cash balances at the bank. At 31 March 2003 these balances were: Cash in hand: £6,000 Cash at bank: £30,500 Total cash owned = £36,500

What was the net cash flow of Greenfingers in 2003? Show how this might be calculated from the information provided in the pre-issued material

The net cash flow of Greenfingers in the year ended 31 March 2003 was £13,000 This can be calculated as follows:

£

Profit before tax in 2003 34,500

Increase in Stocks (19,500)

Increase in Debtors (11,000)

Decrease in Creditors (500)

Decrease in Fixed assets (Net book value) 15,000

Taxation Paid (5,500)

Net Cash Flow 13,000



1 Encourage customer account card holders to settle their balances more promptly

2 Offer incentives for customers to pay using cash or credit cards in the garden centre (increasing the proportion of cash sales)

Suggest three ways in which Greenfingers could improve its working capital position in the next year (2004)

3 Increase the length of time taken to pay creditors (this needs to be done with care – as suppliers may either refuse to allow extra credit or increase their prices to compensate

Explain why retained profits are treated as part of the capital of a company

Retained profits are the profits earned by a business that are not distributed to shareholders by way of dividend. By retaining profits in the business, the shareholders are effectively re-investing the money in the business. However, retained profits are still owned by the shareholders (and owed to them) – hence they are part of shareholders’ capital



Interpreting Financial Information

What this part of the syllabus is about: The information contained within profit and loss accounts and balance sheets can be interpreted in a variety of ways. You need to understand how different stakeholders use financial ratios to assist them in interpreting accounts and in making judgements about the effectiveness of business. You need to be able to calculate and use ratios relating to:

Performance Solvency Profitability

You need to be able to identify and compare past and present data for a business. You also need to understand the limitations of using ratios to make judgements about the effectiveness of businesses. Financial performance is also measured using other indicators. You need to be able to understand and explain how the following indicators can be used to show the performance of a public limited company:

Share prices Dividends Price earnings ratios


Profitability Ratios

Using the profit and loss account of Greenfingers derived in the previous section and the comparative information provided on Kingston Gardens plc, answer the following questions in relation to the profitability of those two businesses

By how much did sales (turnover) in 2003 increase compared with 2002 as expressed in percentage terms?

Sales increased by 2.9% (£10,000) in 2003

It is worth making the point that sales didn’t grow very much in the year! Select from options such as:

Suggest three reasons why Greenfingers; turnover may have risen in 2003

1 More visitors to the garden centre who actually bought things during their visit (higher customer volumes)



2 Increased selling prices across the product range

3 Better “sales mix” – i.e. in general customers bought more goos with higher selling prices than in 2002

4 Divesification into new revenue areas – e.g. higher sales of consultancy services

Define what is meant by the term “gross profit margin”

The gross profit margin is a measure of business profitability. Gross margin shows the relationship between gross profit and sales. The margin is the gap between the direct costs (in this case the cost of stock) and the selling price of stock. If a business raises selling prices or if purchase prices are lower, then the gross margin percentage will rise – and vice versa.

Select from options such as:

1 Higher prices from suppliers that were not passed onto customers

2 Increasing proportion of sales were for lower margin products (a change in the “sales mix”)

3 Greenfingers had to offer more promotional discounts and price cuts to encourage sales

Suggest three reasons why the gross profit margin of Greenfingers fell from 42.2% in 2002 to 39.95 in 2003

4 There were higher stock losses (e.g. damaged stock; theft) during the period; these would result in higher cost of sales



How do Greenfinger’s gross profit margins for 2002 and 2003 compare with those achieved by Kingston Gardens plc in the same years?

As the chart above shows, Kingston Gardens achieved a much higher gross margin than Greenfingers in both 2002 and 2003 Kingston also managed to increase their gross margin in 2003 whilst Greenfingers saw there gross margin fall

Select three from options such as:

1 Because of its greater size, Kingston should be able to obtain better prices from its suppliers than Greenfingers. For example, suppliers of gardening equipment would be prepared to offer a better deal to Kingston provided it offered its products in a large number of garden centres. Greengfingers (at the moment) can only offer the prospect of sales via one outlet

2 Kingston should enjoy economies of scale in its nursey options (i.e. growing plants for sale). It is likely to have much larger nurseries making the average cost per plant lower

Suggest three reasons why Kingston Gardens would be able to achieve better gross margins than Greenfingers

3 Kingston may sell better, higher margin product ranges than Greenfingers. For example, it may sell more DIY-type products or electrical and gift items – which can achieve a better grosss margin



Define what is meant by the term “net profit margin”

Net profit margin is another measure of busines profitability. It shows the relationship between net profit and sales. Net profit margin measures the ultimate profitability of a business. It takes into account the gross profit made and also the indirect costs and overheads of a business.

Stakeholder Reason Interested in Net Profit Margin

Management See whether the overall profitability of the business is in line with targets

Competitors Check to see whether Greenfingers is able to operate its business more effectively than them

Government Spot whether Greenfingers is reporting the right level of profits for taxation purposes (a very low profit margin might mean that profit is being hidden)

Suggest, with reasons, three stakeholders who would be interested in the net profit margin of Greenfingers

Employees See what kind of profit is being earned by the business. This might be helpful in any negotiations about wages and salaries!

Analyse the main reasons why Greenfinger’s net profit margin fell from 12.4% in 2002 to 9.9% in 2003

The main reasons was: - A decrease in the gross profit margin from 42.2% to 39.9%. Changes in gross profit margin

feed straight through to net profit unless the business is able to reduce operating costs - As a result of the lower gross profit margin, total gross profit fell by £10,750, even though

sales had actually increased by £10,000 Greenfingers was able to reduce overheads by a small amount - £3,000 – but this was not enough to make for the reduction in gross profit margin



Compare and comment on Greenfingers and Kingston Gardens’ net profit margins in 2002 and 2003

Kingston Gardens is significantly more profitable than Greenfingers – in fact, its profit margin is over twice the level achieved by Greenfingers! Kingston also managed to increase its net profit margin in 2003 whereas Greenfingers saw its net margni fall. By any measure, Kingston Gardens is a VERY profitable business. It is unusual for a business to have such a high net margin.

1 Higher gross profit margin – this gives Kingston Gardens an advantage of around 5-6% over Greenfingers

2 Marketing economies of scale – e.g. Kingston Gardens can advertise all of there garden centres at once, effectively spreading the advertising cost over a larger number of outlets

Suggest three reasons why Kingston Gardens is so significantly more profitable than Greenfingers

3 Lower overheads per pound of sales; e.g. Kingston can spread the cost of adminstration over a larger sales base than Greenfingers



Define what is meant by the term “return on capital employed” (ROCE)

Return on capital employed (ROCE) is an important measure of the profitability of a business. Capital employed represents the total funds invested in a business ROCE shows the percentage return on the capital employed. It should at least equal the returns that shareholders could obtain elsewhere (e.g. interest rate at a building society)

1 Businesses have different accounting policies – so we might not be comparing profits calculated in the same way. For example, two companies might decide to account for depreciation in different ways

Suggest two reasons why care needs to be taken comparing the ROCE of different businesses

2 The amount of capital employed in a business will vary from industry to industry. Some businesses are “capital intensive” – i.e. they need a lot of investment in plant and equipment – whereas others require relatively little capital.

Compare and comment on Greenfingers and Kingston Gardens’ ROCE in 2002 and 2003

Kingston Gardens generates a much higher ROCE than Greenfingers due to its much higher profitability



Performance Ratios

Explain what is meant by the term “stock turnover”

Stock turnover measures the number of times that stock is sold (or “turned over”) during a specific trading period. Businesses with high stock turnover often have low gross margins – so it important to keep stock turning over quickly in order to make good profits.

Describe what has happened to Greenfingers’ stock turnover ratio in 2003 compared with 2003

Greenfingers’ stock turnover fell from 3.2 in 2002 to 2.8 in 2003 This means that the business Greenfingers was not able to rotate its stock as quickly as previously. Although sales rose slightly, the deterioration in stock turnover led to a significant increase in stocks.

1 Offer promotion discounts to customers to buy slow-moving stock items

2 Lower the re-order level – so that stock is not replenished from suppliers until existing stock quantities have reached a lower level

Suggest three ways in which Greenfingers could improve its stock turnover ratio in 2004

3 Obtain stocks from suppliers on a sale-or-return basis (where suppliers are prepared to accept this)

Calculate the debtor days ratio for Greenfingers in 2002 and 2003 and suggest reasons for the change

Calculation: 2002: 48.3 days 2003: 58.4 days Reasons for Change

- Poorer credit control; customers have been allowed to delay settling their overdue accounts - Greenfingers have relaxed the repayment terms for account customers, allowing them to take

longer to repay

1 Insist that customers settle their store card accounts when due – take recovery action where customers don’t do this

Suggest two ways in which Greenfingers could reduce the value of debtors in working capital 2 Offer discounts to customers who pay cash or credit card



Describe how the creditor days ratio helps understand how Greenfingers manages its working capital

The creditor days ratio indicates how long a business takes to pay suppliers who provide goods and services on credit. Trade credit is an important source of business finance – since it is effectively a free loan from suppliers. However, it is important to pay suppliers according to their terms.

Calculate the creditor days ratio for Greenfingers in 2002 and 2003 and suggest reasons for the change

Calculation: 2002: 32.4 days 2003: 27.8 days Reasons for Change - Timing of payments (perhaps a cheque was made to a key supplier just before the year-end

Liquidity Ratios

Explain what is meant by the liquidity of a business

Liquidity refers to the ability of a business to turn its assets into cash as and when creditors need paying. A business may have many assets of great value (e.g. land, buildings, stocks). However, it needs to have access to cash resources in order to be able to pay debts as they fall due. Two liquidity ratios are often used to measure the ability of a business to generate cash from its assets – the current ratio and the acid-test ratio

Calculate two liquidity ratios for Greenfingers at both 31 March 2002 and 31 March 2003. Using these calculations, comment on the liquidity position of Greenfingers at 31 March 2003

2002 2003

Current ratio 7.4 10.1

Acid test ratio 3.8 5.3

Both liquidity ratios have improved in 2003, reflecting the retained profits (cash) left in the business from 2003. The liquidity ratios do not indicate any particular problems for Greenfingers



Cash Flow Management

What this part of the syllabus is about: Businesses need to manage their finances; this includes collecting and recording financial information, and making judgements about the effectiveness of the information. The two main elements of financial management are budgeting and cash flow. Budgets help businesses to plan, set targets and control expenditure. To understand how budgets are used you need to know what they are, how they work, and what their particular purposes are. You will need to be able to identify and interpret variance and explain the benefits of budgeting to businesses. Businesses need to control their working capital. To understand how they can do this you need to know what working capital is and how businesses manage their cash. You also need to know that businesses may have cash flow problems and that these need to be solved. This involves examining credit control and other methods that businesses use to maintain their working capital.


1 Amounts owed by customers on their Greenfingers store cards are allowed to grow too high (i.e. customers take too long to pay

2 Too much stock is held and the rate of stock turnover slows further

3 Greenfingers needs to significantly reduce its selling prices to respond to new competition (reducing the gross profit margin and gross profit earned

Suggest four ways in which a business like Greenfingers might run into cash flow problems

4 Too much is spent on fixed assets (e.g. setting up a new garden centre; setting up an e-commerce venture

1 To identify whether the business will have adequate cash resources to be able to pay its debts

2 To identify the cash flows arising from new investments

Describe three key uses of a cash flow forecast

3 To identify times when surplus cash can be invested in interest –bearing accounts



At the Greenfingers Board Meeting, Amelia is asked to prepare a cash flow forecast for the proposal to open an additional garden centre somewhere in the region that currently lacks such facilities. Outline the main areas that the cash flow forecast should cover

The cash flow forecast for the proposed new garden centre would include: - Cost of the land & buildings - Cost of the fixtures and fittings required to equip the new centre - Amount of stock required before centre opens - Pre-trading losses (e.g. wages and salaries of people employed before the centre opens) - Marketing costs (e.g. advertising campaign for launch; special promotions aimed at the early

visitors) - Likely sales and gross profit in the first trading months

Possible Positive Effects (Cash Inflows)

- Reach new customers (who might not otherwise be able to visit the garden centre)

- Customers more likely to pay by credit card (cash) rather than use account card

- Able to offer wider range of products (website not constrained by physical space like the garden centre)

Possible Negative Effects (Cash Outflows)

- Costs of developing, testing and hosting the website

- Costs of marketing the website (e..g runner banner advert campaigns; advertising on google)

Outline the potential cash flow positives and negatives of Greenfingers setting up an e-commerce venture as outlined in the materials?

- Costs of employing staff or outside agencies to keep the website up-to-date

The Greenfingers Board decide that they also wish to pursue the option to diversify into landscape gardening and services. Amelia calculates that the total investment would be around £100,000. Describe the ways in which Greenfingers could raise funds for this investment

There are various options for funding the investment: - Existing cash resources (the business has cash of around £30,000 - £40,000, although it would

be wide not to use all this up on one project - Bank overdraft; this could be a temporary source of finance whilst the investment is made. It

could be repaid once the profits start to arise from the new service - Raise additional finance by issuing more shares (a more time-consuming process; probably not

necessary)



Glossary The table below provides definitions for key terms used in the Granny Greenfingers case study

Term Definition / Description

Account card Like a credit card. It allows Greenfingers customers to buy goods now and pay later.

Incorporation When a limited company is formed.

Board meeting An official meeting of the directors of a company to consider issues relating to the business

Diversification Where a business starts to offer new goods and services -usually in markets that are already well established. This is an important option for growing a business, but it is not without risk (not the least from competitors whose market they are entering)

E-commerce venture Setting up an online store to enable customers to browse, order and pay for goods via the Internet

Straighline method A method of calculating depreciation based on the useful life of the fixed asset concerned. The annual depreciation charge is the same each year until the asset has been fully depreciated to its residual value

ocr avce business studies unit 5

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