Financial Decision-Making

This document provides an executive summary, industry review, business performance analysis, investment appraisal, and sources of finance for Roast Ltd, an independent coffee house chain in the UK. It includes an analysis of the company's statement of profit and loss, statement of financial position, and statement of cash flow. The document also discusses the coffee industry in the UK and provides insights into Roast Ltd's financial position.

Financial Decision-Making

Contents
EXECUTIVE SUMMARY.............................................................................................................3
PART 1: Industry Review...............................................................................................................1
PART 2: Business Performance Analysis.......................................................................................2
2.1 Statement of Profit and Loss..................................................................................................2
2.2 Statement of Financial Position.............................................................................................4
2.3 Statement of Cash Flow.........................................................................................................6
PART 3: Investment Appraisal and Sources of Finance.................................................................9
3.1 Investment Appraisal.............................................................................................................9
3.2 Sources of Finance...............................................................................................................11
REFERENCES..............................................................................................................................13

EXECUTIVE SUMMARY
Roast Ltd. is an independent coffee house chain which was established in the year 2008 in
United Kingdom. In the first part of the report, it has been observed that the revenue and profit of
the company has increased from £36,000 in the year 2017 to £81,000 in the year 2018 which
shows that the company has increased the profitability of its operations with the help of better
operational performance and management of the company. A brief analysis of the statement of
financial position of the company shows that it is able to meet its short-term and long-term
payment obligations and continue smooth business operations and also has a strong cash and
liquidity position. It can be said that the financial managers of Starbucks Ltd. can take the
decision of acquiring the company. In the second part of the report, it has been concluded that
the managers of Roast Ltd. should invest in opening up a new store in Romania as it will result
into enhancement of the profitability of the company and business growth.

PART 1: Industry Review
Over the last few years, one of the largest and rapidly growing industry in the United
Kingdom is Coffee Industry with more than 90 million cups of coffee being consumed daily by
the people in the country. This has presented a huge market opportunity for investors and
entrepreneurs with more and more number of people establishing their own coffee houses at
local, national and global scale. The rapid growth in the industry is appealing and attracting to
business-minded people which has led to establishment of more than 16,000 cafes and coffee
shops in the entire UK. The industry employees more than 1,00,000 people and has a revenue
estimate of about £6bn. All the establishments which focus on selling coffee along with other hot
and cold drinks with light snacks as well are considered a part of the industry. The growth in the
coffee industry is driven by a force of changes in economic and social factors (Doumpos,
Zopounidis and Pardalos, 2012). With the rise in national income and income level of people in
the society, people are willing to spend more amount of money on their personal expenses which
gives them a sense of well-being and changes in consumption pattern and trends in the society
has attracted a large customer base for these café shops and coffee houses. Traditionally, UK was
considered as a tea-drinking nation but during the last few years, coffee culture is gaining more
and more popularity due to a shift in preference to cafes over other avenues of social gathering
and growing interest in coffee blends and cheesy snacks. The projected growth for the industry
for the coming year is 4.8% which is huge considering the current revenue and contribution to
the economy of this industry.
Some of the major companies in the industry includes Starbucks Coffee Company, Costa
Coffee, Caffe Nero etcetera with each company having a decent market share to maintain its
competitive position in the industry. Costa Coffee is the leader in the industry with a market
share of approximately 47% which is much higher than any of its competitors. Along with the
tremendous growth prospects and attractiveness, the industry also faces some challenges which
should be analysed and evaluated before making any investment into the industry. As a result of
high profitability and huge market potential, many players are entering the industry which has
increased the competition to a very high level and it is particularly difficult for any company to
face stiff competition from other players in the industry at a global or national level but many
companies have managed to capture a good market share at local levels (Brahmana, Hooy and
Ahmad, 2012). Increasing awareness about healthy diets and nutritional food items has
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influenced a change in the consumption pattern of people in the society who are now preferring
more healthy alternatives such as green tea which has affected the industry significantly. These
are some of the challenges which are being faced by the organisations in the coffee industry.
However, the industry still has a lot to offer to the firms with its market potential and customer
attractiveness capacity.
PART 2: Business Performance Analysis
2.1 Statement of Profit and Loss.
Income statement or Statement of profit and loss is a very important financial tool which
helps in analysis and evaluation of a company’s financial position with respect to its profitability
and profit margins (Kimmel, Weygandt and Kieso, 2018). Analysis of Income Statement of
Roast Ltd. is very important for financial manager of Starbucks Ltd. to take a decision regarding
the acquisition of the company. It can be observed from a brief analysis of the Income statement
of the company that the total sales of the company in the year 2017 yielded a revenue of
£2,022,000 which has increased to a revenue of £2,534,000 from the total sales of the company
in the year 2018. Along with the total revenue of the company, net profit and gross profit of the
company have also increased from the year 2017 to 2018 which suggests that the company is
capable enough to maintain its position in the competitive business environment. The
management of the company has taken significant steps which has resulted in an increased
market share as well as increase profit amounts for the company. The financial performance of
the company can be better evaluated with the help of a ratio analysis which is being done in the
following section of the report:
Gross profit ratio:
Gross profit ratio is a tool of ratio analysis which determines the gross profit of a
company in terms of the total revenue of the company. This ratio is used to determine the return
on the amount spend by company in production of the goods or service which is labour cost or
material cost. An increasing gross profit ratio indicates the efficiency of the company in its
production and manufacturing processes.
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It can be observed from the above table that the gross profit ratio of the company has
declined from 25.57% in the year 2017 to 21.47% in the year 2018. It is particularly due to an
increase in the cost of the products for the company. The operational efficiency of the company
can’t be judged effectively with the help of Gross profit ratio as the company had to procure
materials from other local suppliers as a result of exit of Britain from European Union which
resulted in an increase cost of raw materials and declined the gross profit margin of the company.
The management of Starbucks Ltd. shouldn’t take the decision to acquire Roast Ltd. on the sole
basis of analysis of gross profit ratio of the company.
Net Profit Ratio:
Net profit ratio is a tool of ratio analysis which is used to determine the profitability of a
company after deducting all the expenses for an accounting year (Palepu, Healy and Peek, 2013).
It compares the net profit earned by a company with the total revenue of the company for a fixed
period of time. Net profit ratio is a very important tool for the various stakeholders of any
organisation.
From the above table, it can be observed that the net profit ratio of the company has
increased from 1.78% in the year 2017 to a 3.20% in the year 2018 which shows that the overall
profitability of the business operations of the company has raised due to a better management of
the organisation and many other factors. This ratio is a positive indication for the financial
managers of Starbucks Ltd. to make the decision related to the acquisition of the company.
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Operating Profit Ratio:
Operating profit of a company can be defined as the profit earned by a business
organisation as a result of its main operations. A lot of times, an increase in the net profit of a
company might be a result of any abnormal profit which is contingent and may not occur every
year. Hence, operating profit ratio helps the investors to take a better decision regarding the
profitability of an organisation’s business operations.
From the above table showing operating profit ratio of the company, it can be analysed
that the operating profit ratio of the company has increased from 2.52% in the year 2017 to
5.01% in the year 2018 which is a positive factor to be considered by the financial managers of
Starbucks Ltd. The increased operating profit margin indicates the improvement in the
profitability of the operation of the company which is desirable.
It can be concluded from the above analysis of statement of profit and loss of the
company that the company is operating efficiently by improving the profitability of business
operations to maintain the position in a competitive and dynamic business environment and
decision can be taken to acquire the company by the financial managers of Starbucks Ltd.
2.2 Statement of Financial Position.
Balance sheet of a company is a statement which represents the financial position of a
company with respect to the assets and long-term and short-term debt obligations of the company
(Baker and Ricciardi, 2014). It can be evaluated from the statement of financial position of Roast
Ltd. that the value of assets and liabilities of the company has increased from £1,017,000 in the
year 2017 to £1,443,000 in the year which shows that the company is in a good position to
smoothly continue its business operations. The financial position of the company can be better
comprehended with the help of following ratio analysis:
Current Ratio:
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Current ratio is a tool of ratio analysis which is used to determine the short-term debt
paying capacity of the company by a comparison of the amount of current assets with the current
liabilities (Tsai, 2014). Current ratio of 2:1 is considered an ideal current ratio which shows that
the amount of current assets owned by the company is twice of the amount of current liabilities
of the company. Current ratio is a type of liquidity ratio which has the objective of determining
whether the firm or the company has adequate resources for meeting the short-term payment and
debt obligations for an accounting year.
It can be observed from the above table that the current ratio for Roast Ltd. has decreased
from an ideal 2.51 in the year 2017 to 1.45 in the year 2018 which is a not a good indication for
the financial managers of the Starbucks Ltd. A brief analysis of the balance sheet of the company
indicates that the decrease in the current ratio of the company is not due to operational
inefficiency but due to availing of the overdraft facility to clear the payment obligations of extra
amount due to procuring coffee beans from other parts of Europe as a result of Brexit.
Quick Ratio:
Quick ratio is used to determine the capacity of an organisation to pay its short-term debt
obligations without the need to sell its inventory or acquiring additional financing (Samanez-
Larkin, 2013). Quick assets are also termed as liquid assets which can be easily converted into
cash with minimal efforts. A quick ratio of 1:1 is considered ideal for any company. Higher the
ratio, higher the liquidity of the company.
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The above table shows that the quick ratio of the company Roast Ltd. has reduced from
1.64 in the year 2017 to 0.48 in the year 2018 which shows a decrease in the liquidity position of
the company and not a good indicator for the financial managers of Starbucks Ltd. However, the
decrease in quick ratio is also attributable to external factors impacting the company’s operations
and is not an indicative of operational inefficiency.
Debt-equity Ratio:
Debt-equity ratio is a ratio which depicts the information about the relative share of
equity and debt which has been used by an organisation or company to finance the assets. A
debt-equity ratio of 2:1 is considered ideal for organisation in this industry. A higher debt-equity
ratio shows that the company is relying more on debt-funding for financing its assets which
increases the potential risk of investment in the company.
The above table shows that the debt-equity ratio of the company has increased from 0.31
in 2017 to 0.68 in 2018 due to external factors but it is still in a favourable position for the
company as a large part of asset financing is being done through equity funds. This ratio is a very
positive indicator and might influence the decision of financial managers of Starbucks Ltd. to
acquire Roast Ltd.
It can be concluded from the above ratio analysis of the financial position of Roast Ltd.
that external factors such as Brexit has had a negative impact on the financial position of the
company but the management has made efforts to maintain the financial position of the company
and the company is still in a very good position to maintain its liquidity and position to smoothly
continue the business operations which can be a factor to be considered by the financial
managers of Starbucks Ltd. in taking the decision related to company acquisition.
2.3 Statement of Cash Flow
Cash flow statement of a company provides vital information related to the cash inflows
and outflows from three major kinds of activities of the company which are investing, operating
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and financing for a fixed period (López Salazar, Contreras Soto and Espinosa Mosqueda, 2012).
It helps in determining the liquidity position of the company. The following ratio analysis helps
to understand the cash flow position of Roast Ltd. in a better manner.
Operating Cash Cycle:
Operating cash cycle is a tool of ratio analysis which is used by the stakeholders of an
organisation to analyse and determine the time taken by an organisation to convert its raw
materials into inventory and subsequently into cash. In the context of Roast Ltd., operating cash
cycle is determined with the help of number of days for which inventory, sales and payment are
outstanding.
Working Notes:
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It can be evaluated from the above calculation of operating cycle period for Roast Ltd.
that the operating cash cycle for the company has increased form 13 days in 2017 to 32 days in
2018 which is a high increase due to many external factors such as exit of Britain from the
European Union affecting the consumption patterns but the operating cycle of 32 days still shows
that the company is able to convert into raw materials into cash in a period of about one month
which is a positive factor in the decision-making process of company acquisition by the financial
managers of Starbucks Ltd. An operating cycle of just above one month can be considered as an
effective benchmark in the industry in which company operates.
Dividend Policy:
Dividend policy of a company can be defined as the policy of top management which
decides the amount of profits which are to distributed among the shareholders of the company by
a way of declaration of dividend (Klačmer Čalopa, 2017). Earning dividend is the major
objective of any shareholder along with maximisation of the value of his investment. The
decision of allowing dividend depends on a number of factors such as business growth plans and
profit margins. The management of Roast Ltd. decided not to declare any dividend in the year
2018. According to the investigator of the company, this is a valid decision by the management
of the company mainly because of two factors which are that the company is currently facing a
lot of issues related to funds management due to external factors such as Brexit and secondly, the
company is a small organisation and it is fair and reasonable for the company to invest the profits
earned in the business operations to provide growth and expansion prospects for the company.
It can be concluded from the above analysis and evaluation of the income statement,
financial position and cash flow of Roast Ltd. that the company has a limited scale of operations
and revenue but has high prospects of growth and development and it can be argued that the
decision to acquire the company by the financial managers of Starbucks Ltd. can be taken
considering the growth potential and the current levels of efficiency in the operations and
management.
PART 3: Investment Appraisal and Sources of Finance
3.1 Investment Appraisal
Management Forecast:
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The management of Roast Ltd. has proposed a business growth plan for the company to
open up a new chain of company store in Romania and develop the business operations of the
company in this region. The project is expected to launch in the year 2017. As per the forecasts
made by the management, expected revenue to be earned by the organisation is £300,000 in the
initial year of project launch which is 2017 which is expected to rise to a level of £560,000 in
2018, £740,000 in 2019, £900,000 in 2020 and £1,120,000 in 2021. After a deduction of the
variable costs estimated by the management for the period, the project is expected to yield a
contribution of £60,000 in 2017, £112,000 in 2018, £148,000 in 2019, £180,000 in 2020 and
£224,000 in 2021. It can be observed that the management has forecasted high amount of
revenues and profits for the proposed project of development of business operations in Romania
by establishing a new coffee house in the region.
Investment Appraisal Techniques:
Investment appraisal can be defined as the process of evaluation of various alternative for
investment available for a firm or a company on the basis of potential risk and profitability and
many other factors (Lusardi, 2012). Some of the techniques used by the management of Roast
Ltd. for investment appraisal are:
Pay-back Period:
Pay-back period is a technique of investment appraisal which is used to determine the
period which is required to cover the initial investment made into a project by an organisation. It
determines the number of years in which the cash flows from the investment opportunity will
become equal to the amount which was initially investment by the company (Hsu and Willis,
2013). It is one of the simplest method used for capital budgeting and doesn’t require a great deal
of time, cost and efforts for its implementation. The pay-back period for the investment
opportunity for Roast Ltd. is estimated to be 4 years which means that the company will be able
to recover the cost of initial investment in a period of 4 years. However, pay-back period has
certain limitations which are that it ignores the time-value of the money and profitability and
assumes all cash flows to be even which is highly uncertain in the dynamic business
environment.
Accounting Rate of Return:
This is a method which is used to determine the profitability of an investment project on
the basis of projected or estimated profit. It helps in comparison of various projects simply by a
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comparison of their rate of return. Decision-making becomes simpler with the help of accounting
rate of return method. The ARR expected for the project by Roast Ltd. is 18% which is higher
than the company’s target ARR of 10%. However, this method also ignores the time value of
money and the decision of the management can’t be entirely based on the outcomes from this
method.
Net Present Value:
It is a method which is used to determine the present value of cash flows which are
occurring in different time periods in the future (Nga and Yien, 2013). Conversion of values of
cash flows in future into present value with the help of a rate of capital or discount helps the
company to determine the net present value of the investment opportunity. The net present value
for the investment project is estimated to be about £110,000. It is a great method for capital
budgeting which takes into consideration time value of money as well but it has certain
limitations that it only considers the opportunity cost and only projects optimistic value which
makes it difficult to arrive at a rationale conclusion.
It can be concluded from the above analysis of investment appraisal that the option to
invest in opening a new branch in Romania will be profitable for Roast Ltd. and will yield good
amount of revenues and help in growth and expansion of the company.
3.2 Sources of Finance
In a rapidly changing and competitive business environment, finance is required by every
firm or organisation for various purposes such as growth and expansion, meeting long-term debt,
maintaining liquidity etcetera. Sources of finance can be defined as the various alternatives
which are available for a business organisation to procure from where it can procure funds. In the
context of Roast Ltd., the management of the company is considering a growth project for which
it requires a substantial amount of investment (Hirshleifer, Jian and Zhang, 2018). To meet this
financial requirement of the company, the management of the company has various alternative
sources of finance which are being discussed below:
Bank Loan:
Loans from bank and other financial institution is a very popular option among business
firms for meeting their long-term financial requirements. The interest is paid to bank on a half-
yearly or quarterly basis with instalments being paid each year. Bank loan as an alternative
source of finance has both merits as well as demerits (Lu, Won and Cheng, 2016). The advantage
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of availing loan from bank is that once the loan has been sanctioned and passed, the bank is not
going to interfere in the operations of the business and it gives liberty to business managers. The
disadvantage of bank loan is that it comes with a fixed interest obligation which increased the
fixed expenses of the company. Increasing fixed payment obligations might result into
operational inefficiency of the company.
Angel Investors:
Investor can be defined as a person who is willing to invest money in any business
organisation or company and willing to take the risk associated with business environment with
an aim of earning higher returns on his investment. In the past few years, this concept has gained
vast popularity with many business firms obtaining capital from different investors. Investors are
people with a great deal of knowledge of business conditions and are subject-matter experts who
can guide the management of the company in business operations and taking key managerial
decisions (Agarwal and Mazumder, 2013). However, raising capital from investors results into
dilution of control and profit sharing which is not desirable for every business manager.
It can be said that bank loan is a better option for the managers of Roast Ltd. after
considering the potential risk of dilution of control and flexibility hindrance associated with
obtaining funds from investors.
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REFERENCES
Books and Journals
Agarwal, S. and Mazumder, B., 2013. Cognitive abilities and household financial decision
making. American Economic Journal: Applied Economics. 5(1). pp.193-207.
Lu, Q., Won, J. and Cheng, J.C., 2016. A financial decision making framework for construction
projects based on 5D Building Information Modeling (BIM). International Journal of
Project Management. 34(1). pp.3-21.
Hirshleifer, D., Jian, M. and Zhang, H., 2018. Superstition and financial decision
making. Management Science. 64(1). pp.235-252.
Nga, J.K. and Yien, L.K., 2013. The influence of personality trait and demographics on financial
decision making among Generation Y. Young Consumers.
Hsu, J.W. and Willis, R., 2013. Dementia risk and financial decision making by older
households: The impact of information. Journal of human capital. 7(4). pp.340-377.
Lusardi, A., 2012. Numeracy, financial literacy, and financial decision-making (No. w17821).
National Bureau of Economic Research.
Klačmer Čalopa, M., 2017. Business owner and manager’s attitudes towards financial decision-
making and strategic planning: Evidence from Croatian SMEs. Management: journal of
contemporary management issues. 22(1). pp.103-116.
López Salazar, A., Contreras Soto, R. and Espinosa Mosqueda, R., 2012. The impact of financial
decisions and strategy on small business competitiveness. Global Journal of business
research. 6(2). pp.93-103.
Samanez-Larkin, G.R., 2013. Financial decision making and the aging brain. APS
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Tsai, C.F., 2014. Combining cluster analysis with classifier ensembles to predict financial
distress. Information Fusion. 16. pp.46-58.
Palepu, K.G., Healy, P.M. and Peek, E., 2013. Business analysis and valuation: IFRS edition.
Cengage learning.
Kimmel, P.D., Weygandt, J.J. and Kieso, D.E., 2018. Financial accounting: tools for business
decision making. John Wiley & Sons.
Baker, H.K. and Ricciardi, V., 2014. Investor behavior: The psychology of financial planning
and investing. John Wiley & Sons.
Brahmana, R.K., Hooy, C.W. and Ahmad, Z., 2012. Psychological factors on irrational financial
decision making. Humanomics.
Doumpos, M., Zopounidis, C. and Pardalos, P.M. eds., 2012. Financial decision making using
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