| Category | Assignment | Subject | Finance |
|---|---|---|---|
| University | Leeds Beckett University | Module Title | Financial and Economic Analysis |
Diversifying to survive recessions OLA plc is a software development company in Leeds that has been developing mobile apps and web platforms for over 15 years. Its business has proven to be successful over the years with profits tripling over the last doubling over the last 4 years. At a recent board meeting, members of the board of directors expressed the desire to diversify its operations into unrelated industries in the wake of uncertainties in the global economy and the threat of a recession. The chairperson of the board has proposed that the company can diversify into either the furniture industry or the pharmaceutical sector. They requested the accountant to prepare cash flow projections for the first 8 years and the finance officer to prepare estimates of the costs involved in either project and suggest sources of finance. The cash flow projections by the accountant is in Table 1.
Table 1: Net Cashflow projections
|
Year |
Clothing Retail |
Automotive |
|
1 |
-15,000 |
-55,000 |
|
2 |
-10,000 |
-35,200 |
|
3 |
0 |
-5,500 |
|
4 |
25,000 |
45,350 |
|
5 |
42,500 |
98,510 |
|
6 |
56,350 |
163,850 |
|
7 |
68,750 |
244,100 |
|
8 |
84,000 |
327,750 |
The finance officer has estimated that the company will need an initial investment of £90,000 for the Clothing Retail business and £325,000 for the Automotive business. She also provided information on some ratios for both industries which is shown in table 2.
Table 2: Financial ratios
|
|
Clothing Retail industry |
Automotive Industry |
||||
|
2023 |
2022 |
2021 |
2023 |
2022 |
2021 |
|
|
Gearing Ratio |
35% |
41% |
56% |
55% |
57% |
59% |
|
Current ratio |
1.85 |
1.55 |
1.15 |
2.63 |
1.90 |
1.72 |
|
Acid Test ratio |
0.99 |
0.82 |
0.72 |
1.20 |
1.29 |
1.01 |
|
Gross profit margin |
75% |
72% |
64% |
59% |
54% |
44% |
|
Operating Profit margin |
6.3% |
7.9% |
7.1% |
7.2% |
8.3% |
9.6% |
|
Return on Capital Employed |
4.8% |
3.9% |
3.1% |
2.6% |
2.8% |
3.1% |
The accountant and the finance officer have submitted the estimates and projections to the Board, but the members of the Board are not clear how to interpret or use the information they have been given.
In a meeting with the Board, the finance officer expressed scepticism about the timing of the new project. She thinks because of the political tensions in the MiddleEast and its potential effects on the European and the UK economy, along with the continuing conflict in Ukraine, a recession is imminent.
She also pointed to recent inflation and interest rate patterns citing the Office for National Statistics and the Bank of England websites. She is suggesting that the proposed project should be postponed for at least 2 years.
The Board chairman however disagrees with her and has argued that the uncertainties are the reasons why the business needs to diversify.
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