High Target Summer Wear Ltd (HTSW)
‘This is absolutely typical of British banks. As soon as you have any success they want to pull the plug and stop you trading.’ Sera Smith was very angry. She is the managing director of Summer High Target Summer Wear Ltd and had just received a letter from the company’s bank requiring a significant reduction in the overdraft. ‘This is ridiculous,’ agreed Mark Groves, the production director. ‘Last year we had a cracking year and it looks set to continue. We had a big order in from Hollandaise just this morning. If we can’t keep up the overdraft, we won’t be able to fulfil that order.’ Hollandaise was one of several national chains of casual and summer wear stores that were placing substantial orders with HTSW, usually to be sold under the HTSW label but in some cases under the stores’ own-brand label.
High Target Summer Wear Ltd was started by Sara Smith and Mark Groves five years ago. The business is a designer and manufacturer of casual and leisure clothes aimed particularly at the younger, higher-income market. Before starting the company, both had been employed as senior managers with Abada plc, a large UK clothes manufacturer. They decided to form HTSW after their ideas for developing a new range of clothes for younger people had been rejected by Abada. Although their former employer liked the ideas proposed, it was restructuring its operations after three consecutive years of losses and had decided to focus on certain core brands aimed at meeting the needs of older people requiring smart day and occasion wear. The proposals by Sera and Mark did not, therefore, fit with the strategies that Abada had just begun to implement.
From the outset, Sera and Mark decided that HTSW would be a design-and-marketing led business. Both felt that many of the problems experienced by Abada could be traced to weaknesses in these areas and they were determined that this would not occur in their newly formed business. Much of the forward planning was concerned with integrating the product design and development with the sales and marketing operations of the business. The new company had taken a lot of trouble and spent a lot of money on employing a young and talented design team, led by Julie Bowden who had been employed previously as a chief designer for a leading sportswear brand. The range of clothes designed by Julie and her team was greeted with enthusiasm by the major buyers, and this was converted into firm orders by the marketing team led by Sera Smith. The order book began to grow and, for the new season, orders had reached their highest level ever.
High Target Summer Wear began trading during a period of recession when people did not have a great deal of money to spend on clothes. However, sales started to increase significantly as the economy began to come slowly out of recession and as export markets in Italy and Spain were opened. Sera and Mark were both surprised and delighted by the speed with which the sales of the business had grown in recent years and by the growing base of regular customers. The order just received from Abada was seen as particularly important. If Abada became a regular customer, the sales of the company were likely to increase rapidly over the next few years and would establish HTSW as a major player in the market.
Sera and Mark had both invested their life savings in the business and had taken out large mortgages on their respective houses to help finance the new company. However, this provided only a relatively small amount of the total ordinary share capital needed. In order to raise the remaining share capital, friends, family and business contacts were approached. The largest shareholder of the business was Jefferson Real Estates Ltd, owned by Danny and Jerry Jefferson. The two Jefferson brothers had made large profits by property and land speculation over the years but were keen to diversify into other areas as their business had been particularly hard hit poor economic conditions. They had known Sera for many years and were convinced that she and Mark would make a success of the new business.
The board of directors of High Target Summer Wear Ltd and their shareholdings were as follows:
Sera Smith Managing director and marketing director (470,000 shares)
Mark Groves Production director (470,000 shares)
Julie Bowden Design director (30,000 shares)
Danny Jefferson Chairman (2,000,000 shares owned jointly with brother Jerry through
Jefferson Real Estates)
Jerry Jefferson Non-executive director
In addition to his role as production director, Mark tended to look after financial matters.
Though the company had accounts staff who dealt with the day-to-day transactions, there was no one within the company who had any great financial expertise. When there was a problem, the company’s auditors were normally asked for advice.
On the day that the letter from the bank was received, a board meeting was due to take place to consider the draft accounts of the business for the year that had ended two months earlier. At this meeting, the letter from the bank was also distributed to board members for discussion.
Mark Groves began the discussion by saying:
“We’ve just received the draft accounts from the auditors, which seem to confirm our success. Profit has more than doubled. I really can’t see how the cash situation is so poor. I know that we spent a lot on that additional plant and that we didn’t get anything from the old machines we got rid of, but most of that was covered by the bank loan. Really, the cash situation should be even better than the profit level implies because the expenses include about £3.2 million for depreciation and we don’t have to write a cheque for that”.
Sera Smith, who was still angry at what she regarded as the high-handed attitude of the bank, pointed to the difficulties that the bank’s demands would cause:
“The bank wants us to reduce the overdraft by half over the next six months! This is crazy. I tried to explain that we have important orders to fulfil but the manager wasn’t interested. How on earth can we find this kind of money in the time available? We are being asked to do the impossible”.
Both Mark and Jill had, before the meeting, hoped that the Jefferson brothers would be prepared to help out by purchasing further shares in the company or by making a loan. However, it was soon made clear by Danny Jefferson that further investment was not a possible option. Jefferson Real Estates had been experiencing considerable problems over recent years and simply did not have the money to invest further in HTSW. Indeed, the Jefferson brothers would be prepared to sell their shares in HTSW to generate much-needed cash for their ailing company.
Finding a prospective buyer for the shares was not, however, a likely prospect at this point. Both Danny and Jerry Jefferson had been heavily involved in recent years with the problems of Jefferson Real Estates and had taken little interest in the affairs of HTSW. The board meeting made them realise that they should have been much more attentive, and they now faced the prospect of being major shareholders of two failed companies unless things could be radically improved.
The accounts of High Target Summer Wear Ltd for the past two years are set out below.
Income statement for the year ended 31 December:
Year before last Last year
£000 £000
Revenue 26,000 46,800
Cost of sales 19,000 37,000
Gross profit 7,000 9,800
Operating expenses 3,900 7,650
Operating profit (before interest and taxation) 3,100 2,150
Interest payable 1200 1200
Profit before taxation 1,900 950
Taxation 400 550
Profit for the year 1,500 400
Note:
Dividends proposed in each year
These are paid in the following year.
600 300
Balance sheet as at 31 December Year before last Last year
₤000 ₤000
Non-current assets 9,800 18,360
Current assets:
Inventory 3, 400 6,967
Trade receivables 1,800 7,000
Other receivables 430 2,970
Cash 43 6
Total Current Assets: 5,673 16,943
Total Assets: 15,473 35,303
Equity:
Ordinary shares of ₤0.60 each 7,903 7,903
Retained profit 1,100 800
Total Equity 9,003 8,703
Non-current liabilities
Loan notes 3,780 9,600
Current liabilities
Trade payables 1,940 9,000
Other payables (inc. taxation) 750 3,000
Bank overdraft 0 5,000
Total Liabilities 6,470 26,600
Total equity and liabilities 15,473 35,303
The board of directors were not able to agree on a way of dealing with the financial problem faced by the company. Sera believed that their best hope was to continue to wrangle with the bank over its demands. She felt that there was still a chance that the bank could be persuaded to change its mind once the draft accounts for last year were made available and once the bank was informed of the implications for the company of paying off such a large part of the overdraft in such a short period of time. Mark and Julie, on the other hand, were not optimistic about the prospects of changing the bank’s position. The company had breached its overdraft limit on several occasions over the past few years and they knew that the patience of the bank was now wearing thin
The directors believed that the only real solution was to look for someone who was prepared to make a significant investment in the business. They felt that only a large injection of new funds could keep the business on track. Like Sera, the other board members believed that the draft accounts demonstrated the success of the business over recent years and that this evidence would make the business attractive to a potential investors. The Jefferson brothers rejected both of these views as being impractical. In addition, they were against the idea of introducing another major shareholder to the company as this was likely to dilute their influence over the future direction of the business. The brothers believed that drastic and immediate action was required by the board, although they were not sure what form of action should be taken.
After several hours of discussion, it was clear that the financial issue was not going to be resolved at the meeting. Instead, it was agreed that expertise from outside the company should be sought to help the company find a feasible solution to the problem. The board decided to approach Brainy Financial Consultants, which specialises in helping businesses with financial problems, and to ask the firm to produce a plan of action for the board’s consideration. Sera agreed to contact the firm of consultants on behalf of the board and to agree to the terms of reference for the work required. She was, however, apprehensive about what the proposed plan of action would contain. Immediately after the board meeting she discussed her concerns with Mark. She said, ‘It seems we have to pay a penalty for our success. I only hope this penalty won’t involve undoing all our good work over the years.’
Required:
Assume that you are a member of Brainy Financial Consultants.
- Prepare a report for the board of directors of High Target Summer Wear Ltd which analyses the problems faced by the company and that sets out a detailed plan of action for dealing with its financing problem.
(60 Marks)
- Would you support the bank’s request for a significant reduction in the overdraft facility granted to Summer Bodysuit Ltd.? Full justification is required to support your position.
(20 Marks)
- If you were a member of the board of directors of HTSW and charged with the responsibility of working with the consultants, present a sample ‘Terms of Reference’ you would give to Brainy while engaging them in the work.
(20 Marks)
Solution
Introduction
A financial report communicates monetary information to potential users or different stakeholders who are interested in the function of financial management in the organization. The most probable users of the information include shareholders, potential investors, government departments, the general public, and other relevant personnel. The function of financial reporting encompasses all the commercial communication from the business organization to external parties. These includes through press releases, management letters, shareholders’ meetings, auditors reports, and the notes attached to different financial statements (Beattie & Smith, 2013). Any material that can portray fiscal information regarding the organization to the members of the public is deemed as financial reporting.
It is through financial reports that business organizations can discern their financial positions and make decisions regarding strategic plans such as the capital structure. Potential investors are either attracted or repelled to a business organization through studying the financial report. They can depict the team’s foreseeable future in terms of financial stability and operational soundness. Government agencies enforce the different corporate financial obligations such as taxation through studying the commercial report (Brigham & Ehrhardt, 2013)………………………………………….To access the rest of the solution for $10, please click on the purchase button.
