Royals Gyms is the fictional company at the heart of the February 2018 CIMA Strategic Case Study. Royals, under the guidance of GEM Venture Capital, has been pursuing a high-growth strategy. The purpose of this article is to provide an overview of the main insights to be drawn from Royals' financial statements.
The statement of comprehensive income for 2017 emphasises just how much Royals has been pursuing a growth strategy in recent times. We know from the pre-seen that they have been opening numerous budget gyms in recent times and plan to continue doing so. Revenues have grown by an impressive 44.1% in 2017 compared to 2016, and this matches almost perfectly the increase of 45% in new gyms in 2017. So, it is volume and not price increases that have driven this growth. That makes senses - there is little scope for budget operators to increase price. An article towards the end of the pre-seen tells us what happened to Cheepies when they tried to raise prices a few years ago (they went bankrupt). So, if a budget gym operator like Royals wants to continue growing, they need to achieve it through more customers. Having said that, the pre-seen tells us that Royals charges around H$15 compared to an average of H$20 for the budget gyms as a whole, so there is a little room to raise prices if they so wish. Overall, costs are running slightly ahead of revenues, which is slightly concerning. This means that the net profit margin has fallen slightly from 9.1% in 2016 to 8.9% in 2017.
The statement of financial position shows assets growing at roughly the same rate as revenues and new gym openings, with a 40% rise in total assets. We assume non-current assets is mostly comprised of gym equipment, as we are told that Royals leases its gyms rather than owning the properties. It's notable that cash has declined by 8.6% in 2017, and later in the pre-seen we see that Royals plans to use up all their remaining cash as it plans to keep growing. This company maintains very low liquid assets, and its current ratio is just 0.3, again emphasising that Royals is aggressively pursuing growth rather than opting to play it safe and hold onto some of its liquid assets. The risk of insolvency is therefore higher with such a strategy, and the this is indicated by the fact that the working capital figure continues to worsen, going from negative H$10,078,000 in 2016 to H$15,435,000 in 2017. Unsurprisingly, Royals is also operating with a high level of debt with gearing (long-term debt/equity) standing at 108%. This introduces high financial risk and there is really no more room to take on more debt funding. It's also interesting that Royals is retaining all of its net profit, and it has done so since the King brothers founded the company, opting to pump earnings back into the business rather than gain personally by way of high dividend payouts.
The statement of cash flows indicates that the investments of the last year have been financed by way of a combination of long-term and short-term debt plus operating cash flows. We see the extent to which depreciation erodes profit as H$12,128,000 of this non-cash item is added back. The rise in trade payables has a positive cash impact of H$4,095,000. Royals needs to be careful not to antagonise their suppliers by delaying payments to them for too long. It would be wise to consider converting short-term debt to long-term debt, as it would likely attract a lower interest rate and could be paid back over a longer period, thus positively affecting cash flows. Other than that, Royals might want to consider franchising to go on opening new gyms while transferring some of the financial burden and risk associated with opening new gyms. They might also consider an IPO, which would GEM Venture Capital an exit strategy and return on their investment, while providing Royals with an additional source of funding to open new gyms.
In conclusion, there are indications that Royals is overtrading. Their turnover is increasing but profit margins are down (slightly); their assets are growing but part of that growth is financed by overdrafts and/or short-term debt; and liquidity ratios are low. Royals is employing a risky strategy to pursue growth at all costs. If their main cuts off access to Royals' credit facility, they could be in huge trouble. Royals would do well to put their finances on a more stable footing by looking into an IPO and/or partnering with other firms to open new gyms through a franchising arrangement for example.
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Don't forget to check out our other free SCS February 2018 article here for more insights ahead of your exam