Gemma Lynns Catering Services - Term Paper Example

Gemma Lynn's Catering Services One of the most common mistakes small business owners make in running their businesses is neglecting "the numbers" that surround their enterprise. Oftentimes, they are satisfied by the fact that they have enough cash coming in to cover bills, pay for their staff, and support their lifestyle knowing that an accountant will always be there to accomplish documents that take care of the financial side in their business. Like Gemma Lynn, people do not recognize the need to take a more active role in the financial side until the time to make big investments and purchases come along and realize that they do not have enough cash to cover these expenses. Thus, in order to aid Gemma Lynn in her current dilemma, and prevent such problems to arise in the future, this report aims to provide her with the knowledge required to understand the financial side of her business, while at the same time shedding light on some issues that she finds confusing and giving her ideas that will help in her plans for business expansion and decision making. The report will be divided accordingly: The first section of the report will discuss the principles of bookkeeping and accounting, giving an understanding as to why financial statements are important and how Gemma can use these financial statements to aid her in decision making. It will also answer the Gemma's first question regarding her profits. The second pat of the report will discuss Gemma's business as it compares with the industry figures. Based on the figures, the report will also indicate the areas in her business that require improvements and provide suggestions on how these can be improved. The third part of the report will discuss Gemma's plans for expansion and provide suggestions on how profitability can be ensured during and after expansion. A section to coordinate the whole report will come after and provide concluding comments regarding the whole report. I. Understanding the Numbers Gemma's catering business is a private enterprise under single proprietorship. Even though this does not obligate her to publish her accounts, it does not exclude her from having to document her financial records for taxation and other legal purposes. There are at least three minimum documents needed to properly audit her company's finances. Among these are the balance sheet, the income statement, and the cash flow statement, each of which has a specific purpose within a business enterprise. The balance sheet, from which a company's assets are balanced with their liabilities, "shows a 'snap shot' of the firm at the particular point in time"(Blandon, 2001). It contains important information such as the company's assets (cash in bank, stock, debtors, and fixed assets), liabilities (creditors, tax payables, other types of liabilities such as long-term loans), and net worth. By understanding the relationship between the information contained in balance sheet, a business owner can learn valuable information such as: the sources and uses of cash, which indicates if cash was obtained through sales or loans and if the cash obtained was used to buy inventory, purchase equipment or kept in the bank; the type of assets a company owns that indicates where a company's profits are - is it in the form of cash, or could it be in the form of debit, which the company has yet to receive; how much money the company owes others, and with what timeframe should the company settle these accounts; the book value of a company's equipment and fixed assets; and more importantly, how much actual cash does the company have The aforementioned information contained in the balance sheet can greatly help company owners understand the trends in their business, and consequently aid them towards more informed decision making. In Gemma's case, the balance sheet reveals that most of her current assets are in the form of debtors. This shows that, while she constantly makes profits in her business, based on the profit and loss statement that she submitted, the bulk of her profits are in the form of money owed to her by her customers. Furthermore, since only 50% of her customers settle on the night of the event, and the rest of which settle one to two months after based on Appendix 5, the balance sheet informs Gemma, how her average debtor payment period of 30 days affects her current assets. This is important information that should guide Gemma regarding spending her money, because even though her profit and loss statement informs her that she made 6070 in profit, she does not have the whole amount in cash. Hence, regarding Gemma's first question about her profits and bank account balance as explained by the balance sheet, the profit of 6070 is not held by the company in cash through their bank account. Instead, only 3470 is in the bank and the rest of which are in the form of debtor's payment or account receivables, which she can expect within one to two months time based on her debtor payment period. Other relevant information that can be extracted from the Gemma Lynn's balance sheet are as follows: Gemma made a new long-term loan in the bank worth 10,000, which she used to buy new equipment and machinery. This should guide Gemma in making new loans in the future. Although Gemma's total assets minus liabilities amount to 19060, the bulk of which are in fixed assets. Hence, her current assets minus liabilities only amount to 2440. This should alert Gemma to her net worth based on book values because since most of her assets are in the form of machinery and equipment, her net worth may be valued differently in the marketplace if she decides to sell her equipment and machinery for cash. II. Business Analysis The information in the balance sheet, although it provide vital information regarding the state of Gemma's catering business is insufficient in itself. It is important to analyze them together with a second financial document - the profit and loss statement. It is imperative to look at how these figures relate with each other. One way of doing such is by doing a ratio analysis and comparing the ratios with the industry best figures Gemma submitted in appendix 1. Seven ratios were submitted for comparison: gross profit margin, net profit margin, direct wages to sales, average debtor payment, current ratio, acid test, and gearing ratio, each of which measures a specific aspect of Gemma's catering business. Based on the aforementioned measures, the following data is extracted: Exhibit 1. Financial Ratio Comparison Financial Ratio Industry Average Gemma's Catering based on Profit/Loss Statement ending 31st July 2004 Gross Profit Margin (Gross Profit/Sales) 70% 74% Net Profit Margin (Operating Profit/Sales) 11% 9.9% Direct Wages/Sales 22% 44.5% Average Debtor payment Period 10 days 23 days Current Ratio (Current Assets/Current Liabilities) 1:1 1.2:1 Acid Test (Cash + Account Receivables/ Current Liabilities) 0.8:1 1.1:1 Gearing (Debt/ Total Liabilities) 50% 48.3% Based on the figures above, the following results can be deduced: Profitability. Based on the Gross Profit Margin, Gemma's catering business is operating as profitably as it should be, at a rate that is 4% higher than the industry average. By looking at the company's profit and loss account, her gross profits are enough to cover her operating expenses, at least for the year ending 31st July 2004. However, her Net Profit Margins indicate that there is still room for improvement in terms of maximizing every dollar that comes from her sales. Based on the net profit ratio, she can still improve her profitability by at least 1.1% to reach the industry average. This implies that compared to other companies in the industry, her expenses are slightly higher than the average, accounting for the lower net profit margin. In addition, since her Gross Profit Margin is higher than the industry average, it should follow that her Net Profit Margin should be slightly higher as well. The fact that it is actually lower implies that even though she can charge slightly higher than most companies in the industry for her catering services, she is not as efficient in delivering these services. A look into Gemma's Direct Wages/ Sales Ratio provides a possible explanation for the lower net profit margins. Based on the ratio, 44.5% of her total sales are paid to wages and salaries, compared to the 22% in other companies. Hence, looking into the aforementioned ratios, Gemma's catering business is profitable. However, there is still a lot of room for improvement because based on the industry average, it is still possible to increase her profit margins if she finds a way to lower the ratio between the wages paid to her staff and her sales. Furthermore, a more accurate picture of her company's profitability can be best gauged by looking at the trend at which the three aforementioned ratios change monthly. Such trend will indicate to Gemma if her profitability is improving, declining or erratic. By discovering such trends, she can better understand how to improve on the business's performance. Liquidity. With regard to the catering business's liquidity, two industry averages were given to compare the business with - the current ratio and the acid test, which is also known as the quick ratio. Based on these numbers, Gemma's catering business fairs well. First, the current ratio of 1.2:1 is slightly better than the industry average because it indicates that the business has more than enough current assets to cover her current liabilities, compared to the industry average of 1:1. The number suggests that for every 1 of current liability, she has 1.20 worth of current assets, which is more than enough. A difficulty with the ratio, however, is that it includes all current assets in the accounting including stock. This is a problem because it doesn't account for the time gap that could exist between the amount of time stocks can be sold and the date that current liabilities must be paid. A second ratio, the acid test, accounts for some of the current ratio's shortcomings. Based on the second ratio, Gemma's catering business still performs better than the industry average. Similar to the current ratio, the acid test indicates that, taking inventory out of the picture, Gemma still has more than enough current assets, at 1.10, to cover every 1 of current liability she owes. However, although it is more accurate than the current ratio because it does not include stocks into the equation, it still fails to account for Gemma's debtors, which also brings the problem of time gaps into the equation. This is a poor measure, especially for a company like Gemma's where debtors account for 57% of current assets. Thus, even though the measure indicate that Gemma Lynn's business has more than enough current assets to settle her current liabilities, the reality that most of her assets are in the form of stock and debtors only indicate that she may not have enough financial liquidity to cover them if her creditors ask her to settle all these accounts at the same time. In addition, looking into her Average Debtor Payment Period, this indicates that while most companies in the industry receive all payments due them within ten days, Gemma's debtors take a slightly longer time of 23 days on the average, which unfortunately extends to 60 days for some. Safety. The last ratio identified in the journal is gearing. Based on this measure, while most firms in the industry finance 50% of their assets through debt, Gemma's business fairs slightly better, which finances only 48.3% of assets through debt. This indicates that the business's creditors are not at risk in giving loans to the company. It also indicates that Gemma can still get a new loan, which at present is somewhere around 7% of her total liabilities, to make investments, purchases, or to spend on intangibles, such as marketing and advertising to better improve her business. By comparing all seven industry averages with Gemma's catering, improvement must be made in the following areas: Gemma's catering business is profitable, but it can still improve if funds can be spent more efficiently, beginning with staff wages and salaries. There is enough current assets to cover all the company's current liabilities. However, since her cash in hand is only 31% of her current assets, Gemma may encounter some problems regarding the time difference that may exist between the day that bills are due and the day that 79% of her current assets arrive. It is important for Gemma to find ways to shorten her average debtor payment period. This could be done by demanding a higher down payment from customers based on the size of the banquet Gemma is catering for. Another way is to set an easier payment scheme (20% down payment - 30% on the night of the event - 50% within one month). Although this may not necessarily be faster than the industry average, at least it will give a more accurate schedule as to when payments will be expected, allowing Gemma to better schedule her own expenses. III. Expanding the Business In order to ensure the profitability of the business after expansion, the following measures should be taken; first, it is imperative to increase the efficiency at which she uses her funds. One of the biggest problems businesses have during expansion is the shortage of money. In Gemma's case, this is no less true, especially because her current assets are composed mainly of stock and debtors, who pay on the average 23days after the transaction is executed, and her expenses are a large percentage of her profits. In order to ensure that this does not affect her business negatively, she should do the following: Decrease average debtor payment period by implementing a more defined payment scheme for her services. In this case, she can ask for a 20% down payment two months prior to the event, 30% a month before and the full payment upon the night of the event or the day immediately after for small banquets. For medium sized banquets, she can give an allowance of 10 days for completion, provided that 50% of the total amount has already been paid before the event. While for large banquets, she can ask for the full amount two months after the event, provided that a 50% down payment was already made. With regard to efficiency, she should study her monthly profit and loss statement for the year ending 31st July 2004 and study her expenditure trends to determine areas where cost-cutting can be made. Based on her gearing value, her company can still take advantage of a loan, which she could use to invest on new equipment or to cover other expenses that can come along as a result of her expansion. With regard to her estimates about her future cash flow, she should make sure that these estimates are accurate and make an appropriate cash flow projection, based on actual numbers. Furthermore, it would be best if she can contact a good banker to help her with her finance, which she can work with for the long-term to make sure that her loans and other financial concerns can be addressed before getting complicated in the future. In addition, she should make sure that the business maximizes the new space and reaches the capacity of 30000, she should spend some time and money on advertising and marketing her company. She could, for example, give away her calling card and brochures to some guests who attend her banquets, owners of the places they rent for the banquet, or previous customers who can give them away to their friends. Putting-up a website could also be a good idea. She should then track how her advertising efforts are working by keeping a log of how new customers were able to find her business. For example, did the bulk of customers contact her based on recommendations from friends who have tried her catering Or did they find her through flyers Did they find her through her website, perhaps Afterwards, she should determine the advertising activity with the least effect and find ways to change that or use the resources to fund the more effective campaigns. Aside from the aforementioned measures, Gemma can also consider offering new services that complement her catering business. In this sense, she will grow her business not only in terms of scale, but also in terms of scope. New services that she can offer, which does not require high investments or complicated learning curves are the following: She can include finding a venue for her customers' events as part of her business and charge a minimal fee. This will not require any resources except making deals with the places that she has done business in. She can steer her company in the direction of becoming a full events coordination company, instead of just catering. IV. Conclusion As this report has emphasized understanding the financial aspect of a business - regardless of size - is an integral business element, which should be taken into account for informed decision making. Financial documents such as the balance sheet, the profit and loss account, and a cash flow statement are important documents should always be studied and understood together to understand the current condition of a business - how much and what kind of assets are owned, how much liabilities are owed, and how efficiently cash is being used, among others; identify weak points that need improvement; and forecast a plausible direction for the company. In Gemma's case, her balance sheet indicates that although she has enough current assets to cover her current liabilities, most of her assets are in the form of debtors, which means that there might be a time gap between the day her liabilities must be paid and the day that she can expect debtors to pay, implying that she needs to find ways to generate more cash. In addition, she also needs to improve her business' efficiency by decreasing costs to make sure that she gets more out of every 1 she earns. Bibliography Alonso, Ramon L and Cline W. Frasier "JIT Hits Home: A Case Study in Reducing Management Delays," Sloan Management Review (Summer, 1991), pp. 59-67. Blandon, P. (2001) "Basic Accounting: Terms and Concepts." Available online. http://www.blandon.co.uk/finance/chap1/chap1.htm ________. (2001) "Financial Ratio Analysis." Available online. http://www.blandon.co.uk/finance/topic2/t2other.htm ________. (2001) "Developments of Financial Ratio Analysis." 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