Liquidity and Risk Assessment for Mothercare Plc - Example

Liquidity and Risk Assignment P number: Module code: ACFI3422 Table of Contents Part A 3 1. Mothercare Plc 3 1.1 Working Capital Analysis 4 1.2 Suggestions 8 References 8 Part B 10 1. Different Sources of Finance for the Refurbishment Project 10 1.1 Bank Credit 10 1.1.1 Cash Credit 10 1.1.2 Discounting of Bills 11 1.1.3 Loans and Advances 11 1.1.4 Overdraft 11 1.2 Trade Credit 11 1.3 Customer Advances 12 1.4 Installment Credit 12 1.5 Factoring 12 1.6 Accruals 12 1.7 Credit Cards 13 1.8 Deferred Incomes 13 1.9 Bill Financing 13 1.10 Inter Corporate Deposits 13 1.10.1 Three Month Deposits 14 1.10.2 Six Month Deposits 14 1.10.3 Call Deposits 14 1.11 Hire Purchase 14 1.12 Lease Financing 14 1.13 Fixed Deposits 15 1.14 Issues of Preference Shares 15 1.15 Issues of Debentures 15 2 Conclusion 15 References 17 Part A 1. Mothercare Plc Mothercare Plc is a retailer for children and parents and it operates on a global basis. Its first store was opened in the UK in the year 1961 and now it has 1500 stores across 60 countries, which are situated in four regions, i.e., Europe, Latin America, Middle East and Asia. There are 1273 franchise stores of Mothercare Plc and it has two brands, Mothercare and Early Learning Centre. Its products are sold via its physical stores, online stores, franchise retail stores and wholesale operations. The vision of Mothercare Plc is to be a global leader of retail for young children and parents. Further, they want to become the leader in the digital business and to expand internationally. The strategy to accomplish their vision is getting a support from a modern real estate, to run an organization while doing investments side by side and offering the products and services that are full of style, innovation and quality. The products of Mothercare Plc are of home and travel, toys, clothing and footwear. They create value for the customers in the form of sales, for employees in the form of benefits and total pay, for suppliers in the shape of total payment, for a social in the form of taxes and for franchises in the form of sales. High standards of Corporate Governance are aspired by the Mothercare Plc to advocate the interest of staff, customers, investors and other stakeholders [Mot15]. The top three competitors of Mothercare Plc are Marks and Spencer Group Plc, Toys "R" US Limited and Hamleys of London Limited [Hoo16]. 1.1 Working Capital Analysis To measure the efficiency and financial health on a short term basis of Mothercare Plc, Working Capital Ratio will be used. The following table is the calculation of this ratio for the five years: 2015 2014 2013 2012 2011 Current Assets 197,900 170,200 194,600 175,600 193,800 Current Liabilities 133,800 158,000 149,000 151,000 139,000 Working Capital Ratio () 1.47:1 1.07:1 1.30:1 1.16:1 1.39:1 Table 1: Working Capital Ratio In all the 5 years, the Working Capital Ratio is above 1 and it shows a positive working capital of the company. However, the ratio between 1.2 and 2.0 is considered to be sufficient for a company and from the above calculation, the year 2014 and 2012 do not lie in this range. This shows that the short term assets of the company are hardly covering its short term debts. Moreover, the trend of the Working Capital Ratio is vague and doubtful, because in one year the ratio seems to be positive and in the next year, it appears to be on the borderline. The trend analysis of the Net Current Assets for the last five years is prepared as below: 2015 2014 2013 2012 2011 Net Current Assets (Working Capital) 64,100 12,200 45,600 24,000 54,400 Trend Analysis () 117% 22% 83% 44% 100% Table 2: Trend Analysis of Working Capital In the above trend analysis of net current assets or working capital, year 2011 has been taken as the base year. This trend gives the impression of inconsistency in the use of short term assets against of the short term liabilities. Initially, the trend was going downwards, but in the year 2015, there is an upward movement in the working capital, which is a positive sign for the company. Similarly, the working capital can be analyzed by evaluating its needs each year. The following is the trend analysis of the working capital needs for the past five years: 2015 2014 2013 2012 2011 Working Capital Needs 86,500 71,700 77,400 75,300 89,500 Trend Analysis () 96% 80% 83% 86% 100% Table 3: Trend Analysis of Working Capital Needs There is a decreasing trend of working capital needs for the year 2011 to 2014. This denotes that the firm is reducing its liabilities and is trying its best to meet its short term liabilities from its short term assets. However, the trend is increased in the year 2015, which is not a good sign. There are some other ratios that can analyze the working capital of a company [Pad06]. They are inventory-turnover ratio, days payable, receivables ratio, quick ratio and current ratio [Moh10]. Inventory is relatable to the working capital, because the longer the time the inventory is present in the warehouse, the longer the working capital of a company is tied up [Sin08]. Following is the Inventory Turnover Ratio of the Mothercare Plc for the last two years is prepared as below: 2015 2014 Sales 713,900 724,900 Inventory 87,700 93,100 Inventory Turnover Ratio () 8.14:1 7.78:1 Table 4: Inventory Turnover Ratio The Inventory Turnover Ratio of Mothercare Plc is increased from the past two years. High Turnover Ratio is useful for the firm, the sales are higher in this situation [Gau05]. This will impact on the working capital in the form of cash, which is generated through sales [Gar03]. The higher the cash, the better will be the Working Capital Ratio [Faz93]. In order to determine the timings of the cash flow to evaluate the abilities of the form to pay its liabilities, when they are incurred, Days Payable Outstanding (DPO) is used [Kot94]. This affects the accounts payable, which are a part of the working capital [Gan07]. The Days Payable Outstanding of the Mothercare Plc for the past two years is calculated as below: 2015 2014 Accounts Payable 54,200 63,500 Cost of Sales 656,300 694,900 Inventory Turnover Ratio () 30.14 33.3 Table 5: Days Payable Outstanding The number of days to pay the invoices of the suppliers is decreased in the year 2015, as compared to the year 2014. This is a positive sign, because the lesser the DPO, the more a company acquires discounts (on early payments). Likewise, Days Inventory Outstanding (DIO) and Days Sales Outstanding (DSO) have also an impact on the working capital [Dan10]. The DIO and DSO of the Mothercare Plc are calculated as below: 2015 2014 Accounts Receivables 53,000 42,100 Total Credit Sales 713,900 724,900 Inventory 87,700 93,100 Cost of Sales 656,300 694,900 Days Sales Outstanding () 27.09 21.19 Days Inventory Outstanding ) 48.77 48.90 Table 6: DIO and DSO of Mothercare Plc DSO is higher in the year 2015 as compared to the year 2014. It means that in the year 2014, the firm has managed to collect its receivables quicker than the year 2015. The DIO is almost the same in the two years. DIO shows the number of days a firm takes to sell its products [Buc08], which is higher in the year 2014. DPO, DIO and DSO are directly associated with the liquidity ratio and they can be explored more, if they are discussed with the liquidity ratios, i.e., Current Ratio, Quick Ratio, Cash Conversion Cycle and Cash Ratio [Pop13]. The Current Ratio is discussed above, the following table is about the calculation of the Quick Ratio, Cash Conversion Cycle and Cash Ratio of the Mothercare Plc: 2015 2014 Cash & Equivalents 31,500 17,300 Short Term Investments 9,700 - Accounts Receivables 53,000 42,100 Current Liabilities 133,800 158,000 Cash Conversion Cycle (DIO + DSO - DPO) (48.77 + 27.09 – 30.14) 45.72 (48.90 + 21.19 – 33.1) 36.99 Quick Ratio () 0.70:1 0.37:1 Cash Ratio ) 0.30:1 0.10:1 Table 7: Liquidity Ratios Quick Ratio or Acid Test Ratio determines the amount of most liquid assets that can cover the short term liabilities. The higher ratio shows the better liquidity condition of a firm [Ber95]. The firm has operated better in the year 2015, as compared to the year 2014 in terms of Quick Ratio. To payoff the current obligations in the urgent span of time, the most liquid assets (cash & equivalents and investment) can be used and this can be evaluated with the help of Cash Ratio [Ert09]. Since, it is not practical to get 1:1 in the Cash Ratio, the Mothercare Plc is working fine in the year 2015 in contrast to the year 2014. The Cash Conversion Cycle is the process to convert assets to cash and this process is appeared to be faster in the year 2014 as compared to the year 2015. 1.2 Suggestions From the above working capital analysis, it can be seen that the firm is not doing better in most of the aspects. Mothercare Plc can improve its working capital position by increasing its sales through increasing the production of products and the marketing activities. The firm must collect its receivables from the debtors in good time to decrease its liabilities. The company can reduce the number of days to convert the assets into the cash by increasing its inventory and sales. References Mot15: , (Mothercare Plc, 2015), Hoo16: , (Hoovers, 2016), Pad06: , (Padachi, 2006), Moh10: , (Mohamad & Saad, 2010), Sin08: , (Singh, 2008), Gau05: , (Gaur, et al., 2005), Gar03: , (Garrison, et al., 2003), Faz93: , (Fazzari & Petersen, 1993), Kot94: , (Kothari & Ball, 1994), Gan07: , (Ganesan, 2007), Dan10: , (Danuletiu, 2010), Buc08: , (Buchmann & Jung, 2008), Pop13: , (Popa, 2013), Ber95: , (Berger & Udell, 1995), Ert09: , (Ertuğrul & Karakaşoğlu, 2009), Bla02: , (Black & Strahan, 2002), Fis03: , (Fisman & Love, 2003), Oth01: , (Othman & Owen, 2001), CHI01: , (CHIEN & Devaney, 2001), Bec06: , (Beck & Demirguc-Kunt, 2006), Slo96: , (Sloan, 1996), Man01: , (Manning, 2001), Gro10: , (Grochulski & Piskorski, 2010), Pik06: , (Pike & Neale, 2006), ElD07: , (El‐Din & Abdullah, 2007), Mil76: , (Miller & Upton, 1976), Tob63: , (Tobin & Brainard, 1963), DeJ06: , (De Jong, et al., 2006), Arn05: , (Arnold, 2005), Part B 1. Different Sources of Finance for the Refurbishment Project Now, it is April 2015 and the Mothercare Plc has taken the decision to close its stores and to refurbish the remaining outlets. The refurbishment project has been designed in which the stores will have the interactive screens with the help of iPads that can show demonstrations to the customers about the products. It also includes the upgradation of the computer systems and the purchase of the distribution vehicles in order to improve the delivery of services. For this kind of spending, the Managing Director thinks of acquiring the short and medium term finance. For this purpose, different sources of finance can be taken into account. The following are the description of different sources of finance for short and medium term that can be acquired for the purpose of the refurbishment project: 1.1 Bank Credit The commercial banks grant credit to the firms, which are in need of short term finance. It can be taken in four forms and the borrower can withdraw the money at once or at a couple of times with an agreed amount [Bla02]. 1.1.1 Cash Credit It is a short term finance that the Mothercare Plc can obtain for its refurbishment project. A certain amount of cash is agreed to be withdrawn from the bank by the borrower against a security. The interest is only applied if that amount is withdrawn. In this case, the Mothercare Plc has to keep its asset to the bank till the execution of the refurbishment project. 1.1.2 Discounting of Bills This type of short term finance can be taken from an individual or a company through the bank by making bills of exchange. The bank gives the guarantee of payment to the lender and the borrower can get the discount, if the payment is done before the agreed time period. The Mothercare Plc can take advantage of this type of finance in its refurbishment project. 1.1.3 Loans and Advances It is a short term finance that a company can get by using its assets. The assets are kept with the bank in the name of security and then the bank lends money to the borrower. The borrower does not only has to repay the loan amount to get the security back, but there is an addition of payment with the borrowed amount, which is named as interest. Here, the Mothercare Plc has to pay the borrowed amount with the interest. 1.1.4 Overdraft It is similar to the Cash Credit, but here the Mothercare Plc can get a hold of money due to its credit worthiness and not the security. Moreover, the rate of interest in this case is lesser than that of Cash Credit. 1.2 Trade Credit It is a short term finance that can be used to purchase the things and in which the payment is done afterwards. The credit is given by the producers (other firms/individuals) from whom the supplies are purchased [Fis03]. The Mothercare Plc can fulfill its refurbishment project by utilizing this type of finance, in which the suppliers of delivery vehicles, computer systems of latest technology and iPads can be asked for the Trade Credit. 1.3 Customer Advances In this type of short term finance, the firm asks its customers to make advance payments of the products that they want to buy. In this situation the goods are not available in the market and the customers want those goods on an urgent basis [Oth01]. 1.4 Installment Credit The industrial goods such as refrigerators, computer systems and machinery are purchased by the firm in this type of finance. The total payment is not done at the time of purchasing the equipment. However, the supplier charges the borrower in the form of interest till the total payment is paid [CHI01]. This short term finance can cater the Mothercare Plc refurbishment project. 1.5 Factoring It is a type of short term finance in which the account receivables plays an important role. The Mothercare Plc can sell its receivables to a factor, such as bank, and then obtain the cash on urgent basis. In this case, the borrower does not have to wait for the payment from its debtors. In getting the funds on the urgent basis, the firm has to give some discount, to the factor as a fee [Bec06]. 1.6 Accruals Accruals are the accounts that are either non-cash based assets or they represent liabilities. It includes accounts receivables, accounts payables, future interest expense, future tax liability and goodwill. It is about knowing the revenue that is expected in the future and with the help of this information, a firm can finance its needs on a short term basis [Slo96]. 1.7 Credit Cards It is a type of short term loan that is given by the bank to an individual or a company. The bank issues a card to its client, who can purchase goods on credit and charge interest after the purchase of goods. However, the amount of money to be borrowed by the bank is restricted to a certain limit. The amount of credit depends upon the reputation and the credit worthiness of the borrower [Man01]. 1.8 Deferred Incomes Deferred Incomes are the advance payments that are received by a firm before rendering its services to the client. It can be considered as a short term financing, if the firm takes most of the payments before providing the services to the clients. Therefore, it is a liability of a firm, but when the services are provided to the client, the liability from the balance sheet is moved to the income statement [Gro10]. 1.9 Bill Financing It is a type of financing in which the finance company decreases the pressure of the firm, which is facing problems in its cash flows. The finance company provides funds to the firm and relieves the firm from its issues of commitments [Pik06]. 1.10 Inter Corporate Deposits These are the deposits that are made by two companies on three different time durations. One company has the surplus money to lend and the other has deficit money [Pik06]. They are discussed as below: 1.10.1 Three Month Deposits This type of deposit is useful for the short term financing in which the annual rate of interest is 12%. One corporate lend money to another one for the period of three months. 1.10.2 Six Month Deposits An agreement is made between the first class borrowers for the period of six months under this Inter Corporate Deposit type. The annual rate of interest in this case is 15%. 1.10.3 Call Deposits There is no time duration in this type of Inter Corporate Deposit. The lender can withdraw the deposit at any time on one day notice. The annual rate of interest on Call Deposit is 10% approx. 1.11 Hire Purchase It is the type of short and medium term loan in which one party uses the asset of another party under the rental agreement. The payment is done on the monthly basis and on the last installment, the ownership is transferred to the first party [ElD07]. It is another useful source of finance for the refurbishment project of the Mothercare Plc. 1.12 Lease Financing It is a type of medium term financing in which the finance company (lessor) is the owner of the asset. The asset is given under the agreement to the lessee. The lessee is bound to pay the certain amount of payment at the regular intervals of time. The payment includes the principal amount and the interest as well [Mil76]. The Mothercare Plc will be needing delivery vehicles and computer systems for the refurbishment project and this kind of financing will be appropriate to use. 1.13 Fixed Deposits A firm can get interest on a fixed period of time, if it deposit money in fixed accounts. It is an interest bearing account in which the firm has to deposit a high amount of money to get high interest income [Tob63]. 1.14 Issues of Preference Shares It is a type of shares through which a firm can get loans on a medium term basis by issuing it. The shareholders of preference shares have the priority to get the dividend (if announced) as compared to the ordinary shareholders. But, the preference shareholders cannot vote like the ordinary shareholders [DeJ06]. 1.15 Issues of Debentures Debentures are a type of loans that are taken by a company against its reputation and credit worthiness. They are not secured loans and they can be redeemed. In an indenture, they are documented [Arn05]. The Mothercare Plc can issue the debentures to acquire loan on a medium term basis. 2 Conclusion There are three aims of the refurbishment project of the Mothercare Plc. They are to equip the stores with the interactive screens through the use of iPads that can show demonstrations to the customers about the products. It also includes the upgradation of the computer systems and the purchase of the distribution vehicles in order to improve the services of delivery. Since, the working capital of the Mothercare Plc is not in a position to support the refurbishment project, the company has to go for the short and medium term financing. The short and medium term financing for purchasing the iPads, computer systems and delivery vehicles for each outlet can be Bank Credit (Cash Credit, Discounting of Bills, Loans and Advances and Overdrafts), Trade Credit, Installment Credit, Inter Corporate Deposits (Three Month Deposit, Six Month Deposit and Call Deposit), Hire Purchase and Lease Financing. There are six different sources of short and medium term financing that can aid in the execution of the refurbishment project of the Mothercare Plc. The rest of the nine sources of finance that are discussed in the above section are not appropriate for the project, because they cannot produce the desired capital, which is required to buy the industrial goods. Moreover, the advances and account receivables are not enough to generate the money to complete the refurbishment project. The Mothercare Plc can acquire loans from the bank through Cash Credit and Loans or Advances by giving one of its assets as a security. In the case of Cash Credit, the Mothercare Plc has to keep its asset to the bank till the execution of the refurbishment project. In the Advances and Loans, the Mothercare Plc has to pay the borrowed amount with the interest. In the Overdraft, the Mothercare Plc does not have to submit the assets as a security, because its creditworthiness is enough to show its repute. Bills of Exchange are another instrument through which the firm can obtain loans. The bank will give the guarantee of payment to the lender and the Mothercare Plc can get the discount, if the payment is done before the agreed time period. The Mothercare Plc can fulfill its refurbishment project by utilizing this type of finance, in which the suppliers of delivery vehicles, computer systems of latest technology and iPads can be asked for the Trade Credit. Because it is difficult for the firm to pay the invoices, it will be easier for the firm to pay the invoices afterwards. Installment Credit can also be used by the firm in which the Mothercare Plc has to pay the amount of interest till the total amount is being paid. Inter Corporate Deposits can be used by the firm to purchase the goods with the assistance of the other corporations that have surplus money for lending. The Mothercare Plc can use the Inter Corporate Deposit in the form of Three Month Deposit, Six Month Deposit and Call Deposit. Another appropriate way to acquire the goods for the refurbishment project is to choose Hire Purchase and Lease Financing. Through these sources of financing, the Mothercare Plc can obtain the medium term financing. References Mot15: , (Mothercare Plc, 2015), Hoo16: , (Hoovers, 2016), Pad06: , (Padachi, 2006), Moh10: , (Mohamad & Saad, 2010), Sin08: , (Singh, 2008), Gau05: , (Gaur, et al., 2005), Gar03: , (Garrison, et al., 2003), Faz93: , (Fazzari & Petersen, 1993), Kot94: , (Kothari & Ball, 1994), Gan07: , (Ganesan, 2007), Dan10: , (Danuletiu, 2010), Buc08: , (Buchmann & Jung, 2008), Pop13: , (Popa, 2013), Ber95: , (Berger & Udell, 1995), Ert09: , (Ertuğrul & Karakaşoğlu, 2009), Bla02: , (Black & Strahan, 2002), Fis03: , (Fisman & Love, 2003), Oth01: , (Othman & Owen, 2001), CHI01: , (CHIEN & Devaney, 2001), Bec06: , (Beck & Demirguc-Kunt, 2006), Slo96: , (Sloan, 1996), Man01: , (Manning, 2001), Gro10: , (Grochulski & Piskorski, 2010), Pik06: , (Pike & Neale, 2006), ElD07: , (El‐Din & Abdullah, 2007), Mil76: , (Miller & Upton, 1976), Tob63: , (Tobin & Brainard, 1963), DeJ06: , (De Jong, et al., 2006), Arn05: , (Arnold, 2005), Read More