The November 2017 Operational Case Study presents Struans of Newland, an ice cream producer operating out of its own dairy farm for the past 105 years. The pre-seen materials provided by CIMA provide us with plenty of financial information to sift through and includes the statement of profit or loss, statement of financial position and cash flow statement for 2016 and 2015. We've been poring over the figures and this article walks you through the key changes between 2015 and 2016, the main trends and most important ratios.



Starting with the statement of profit or loss for 2016, it's good to see that revenue has increased by 4%. This represents a decent rate of growth for such a mature company, especially considering challenging market conditions in Newland; the entire ice cream market in Newland grew by just 0.7% in 2016. It's also good to see that Struans has exhibited cost control as cost of sales increased at a much slower rate than revenues over the last year. This demonstrates a degree of operational efficiency and it results in gross profit rising by a robust 8.2% in 2016. It's a little bit concerning to note administration expenses increased by N$394,000 in 2016. Is Struans over-staffed with full-time employees that have been there for a long period? Remember, the nature of this business is seasonal so it would be more appropriate to have some part-time staff that could come in during the summer months and would be released to keep the wage bill down in the quieter winter months. It seems to be a concern when we turn to the net profit and see it has declined by 3.7% in 2016 in spite of the revenue and gross profit growth we referred to above. There is little reason to worry however, as it is more a case of the 2015 net profit figure being inflated due to a very low taxation charge in that year. The effective tax rate for 2015 was just 7% compared to the 23% effective tax rate we see in 2016, which is more in line with the standard corporate tax rate of 20% in Newland. It's possible that Struans made a big investment in tangible assets that carried a high tax allowance rate in 2015, thus diminishing the overall tax obligation in that year. Alternatively, perhaps tax losses were carried forward into 2015 from prior years to reduce the tax bill.



The statement of financial position shows us that Struans seems to be making investments for the future in the form of a 20.7% increase in tangible assets. It's concerning to see that this investment seems to have been funded by a combination of retained earnings (which is ok) and short-term debt/overdrafts (this is not optimal). Ideally, a long-term investment like this should be funded with long-term financing. Current assets have increased largely due to receivables growing by N$955,000. Struans has customers with very high buyer power and it's likely they are lagging payments to Struans. Coupled with the fact that current liabilities grew by almost 65% in 2016, working capital (current assets - current liabilities) has declined from N$5,261,000 to N$4,053,000. This means that the firm is running more of a risk of insolvency. It's odd that cattle have been included in inventories. Normally, biological assets like cattle are included in non-current assets so I believe Struans has flouted IFRS standards here. It's notable that the company retains 100% of their net profit. Because the firm is privately-owned it is not exposed to the same market pressures as a public company. This allows the firm to take a long-term view and reinvest profits in various projects. There are indications that Struans is over-trading i.e. trying to do too much, too quickly, with too little capital. This is indicated by the fact assets are growing but are being financed by short-term liabilities and current and quick ratios are declining pointing to a less liquid company (although with a current ratio of 1.7, this is not yet a major problem).     



The cash flow statement indicates what a big expense depreciation is, as N$1.4m in non-cash depreciation is added back to the profit figure. This is an asset-heavy company so it's not surprising to see such high depreciation. The decline in inventories over the year frees up cash that was previously tied up in stock but the big increase in receivables means that supermarket customers are holding onto cash and lagging payments to Struans. There is little a small, family business like Struans can do to demand earlier payment from such large customers. The cash flow statement clearly shows that the net cash decline in operations and the investment in assets is being absorbed by the short-term borrowings income, which as I said before, is less than optimal.



In summary, the financial performance is reasonably solid for such a well established company, especially given the underwhelming growth in the ice cream industry in Newland. However, the company needs to take care in the way it is financing its investments. Struans should consider converting its short-term debt to long-term debt, which would most likely carry a lower interest rate also. It would also be wise to examine the payables figure to see if they can lag payments to their suppliers so that payable days (currently 83 days) at least matches receivable days (currently 96 days), which would have a favourable impact on the cash conversion cycle (inventory days + receivable days - payable days). 

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