Finance Case Study - Starbucks UK

Starbucks UK is the leading brand in UK coffee houses lists. The company is well-established and is looking for an expansion opportunity. They were interested in acquiring Roast ltd. Decisions related to investment and expansion are always risky and need so much care and attention as involve a huge amount of funds and the operations of an acquired business can also affect the operations of the acquirer company. 

Starbucks has tried to prepare a complete financial report for the acquisition of Roast Ltd and analyze the company through the help of its financial statements and market standing. Starbucks has looked into various future aspects of Roast Limited such as its expansion projects and available funds. Starbucks also looked into the funds that it will invest in Roast for its recovery option and time of recovery through different concepts of capital budgeting. 
 

Introduction:

UK Coffee Giant, Starbucks is looking for acquisition of another leading brand, Roast Limited who does not have operations in UK but in other countries too. However, before the company target Roast limited and move for acquisition, it is important to look into financial performance of company. This assignment is analysis of performance of Roast limited in recent past by computing different ratios of the company to assess their financial position. Overall coffee industry, its opportunities and threats are also identified in order to plan for the acquisition. 

Part 1: Review of the Coffee Industry. 

Introduction about Industry:
Coffee industry is big player in food service sector of UK. Coffee service sector in UK is not limited just serving the coffee to the customer but serves also some additional and ancillary food items like other drinks, snacks etc. 
•    The market is very much strong in its existence as growing over past 20 years. 
•    The market revenue is growing at the rate of approx 5% annually and now reach to approx UK pound 6.6 billion. 
•    Market has 16,199 businesses in this sector.
•    Base for employment of 101,034.

Biggest players
Costa limited, Pret A manger (Europe) Ltd, Starbucks coffee company (UK), Caffe Nero Group are the leading armlet players. Costa limited is holding around 2,121 outlets in industry followed by the Starbucks with near to 900 outlets whereas the Caffe Neuro has more than 600 stores. Costa is the most leading brand of coffee and a UK based organization where as the Starbucks is the only big company which is non British. But still the Caffe Neuro is come under most favorite category among consumer for coffee and is UK based company.

Challenges
Besides such a continuous growth, industry still has some of challenges such as 

• Brand expansion- Global market players and popular big brands in coffee sector always tried to continuous grow with new strategies, idea, market area and resources. Small independent coffee café & stores get acquired by these big brands making market a place of only such large players. 
• Technology and professionalism- Small coffee café are out of market due to old technology and traditional methods or lack of professionalism. In the present era, consumer are expecting to have premium quality and special grade coffee which is something that can be possible by the advanced super automatic machines, widening availability and well serving staff. The low cost model of small coffee joints is not able to serve the same. 
• BREXIT- Such a factor like BREXIT is something that can impact overall economy of UK. Government policies and BREXIT factors has very negative image over the industry player in terms of jobs, spending of consumers. Low income will directly impact upon the earnings and thus, reduced the revenue of this industry. 

Opportunities

Recently it was assumed that UK is tea based country but from the credential of coffee industry it is something that gets shifted to coffee based industry from consumption wise analysis. 
Now a days, coffee get preferred in offices as a consumption far from home. Coffee brands also getting good opportunities due to their great coffee shop experience and premium quality of beans. Most of pubs and fast food chains are collaborating with coffee brands for market share. Also, more demands and consumers can be creating with the help of more advertising and promotions over different platforms and by different methods. Café houses are also a place of not only coffee but have emerged out as alternative desk options for the youth. 

 

Part 2: Analysis of business performance. 

Company can be analyzed on the basis of different financial factors and these are 

2.1 Income Statement
(a) Profit and loss statement shows the performance during the period in terms of revenue and expenditure, profit and loss during the period. It also classifies the nature of expenses such as financial, non financial, operating, and non-operating; cost of goods sold etc. company can obtain the trend and forecast the future periods on the basis of past experience.  (Broihahn, 2015)
 

Particulars	2018	2017	Change in percentage
Revenue	2534	2022	25.32%
Gross profit	544	517	5.22%
Operating profit	127	51	149.02%
Profit before tax	101	45	124.44%
Profit after tax	81	36	125%

 

Roast ltd is quite good in terms of revenue as there is a growth of 25.32% in one year. Also, due to mid stage in expansion of coffee chain shops in Romania may be some contribution has been made from the Romania. That shows company has suitable degree of capability to manage and grow in market. (Martín, 2015)

In terms of gross profit, company hasn’t record such increment as such in revenue. Some of factor that increase the cost of goods sold can be initial year in Romania, as to maintain the quality and in starting Phase Company have to suffer high cost and need to keep low margin on sale to make a place in market. Also, however there is still increasing trend in gross profit of 5.22% which is in favor of company and investor. 

Operating profit gets increased due to other operating income which is not a regular source of income. However, company has taken the some correct decisions due to which employee, director expenses get reduced. Overall expenses have reduced but expenses such as store maintenance, distribution and advertising have increased due to expansion. So, overall operating profit is reasonable and correct for investing as it is still increasing. (Penman, 2013)

(b) Net profit and gross profit margins are show the relation of sales and margin after different expenses. Also, these are the basic ratios to get a view of profit performance. 

Particulars	2018	2017
Gross profit margin	21.47%	25.57%
Net profit margin	3.20%	1.78%

 

As the ratios indicates company has get some reduction in gross profit but that was due to high COGS for new expansion in Romania and for Net profit. However, still they have managed to increase both the NP as well as GP ratio. The increased cost of getting the raw material has decreased the gross profit ratio in business. However, the company has been able to increase the NP ratio by considerable margin and same is positive sign. (Brooks 2015)

(C) Asset turnover ratio is the relation that shows how much revenue company has created from the asset or from overall application of funds. Higher the ratio, the better it is. 
 

Particulars	2018	2017
Revenue	2534	2022
Total assets	1443	1017
Asset turnover ratio	1.76 times	1.98 times

 This ratio shows that company has maintain quite same ratio in both years. In the year 2018, company has more asset value as compare to 2017 and as compared to that company has not maintain such increment in revenue. The reason d behind the same can be initial year of expansion in Romania. Also, no such major reduction is in the 2018.

(d) Return on equity is reflection of earning or return that is made by the shareholders on their invested funds in the business.  (Mahajan, 2019)

Particulars	2018	2017
Earning	127	51
Equity’s funds	860	779
Assets turnover ratio	14.76%	6.55%

The company had performed well in 2018 as compare to 2017. As the ratios are increasing that’s in favor of company. 

2.2 Balance Sheet

Financial position refers to the status of company in terms of asset and liabilities of the company at a given point of time. Before capturing any business or while lending money financial position speaks a lot. This shows the liquidity, funds, assets, borrowings, own capital of business. 
(a)    As compared to 2017, in the year 2018 company has increased its overall assets that are sign of growth but need to go in details. Company has increment in value of property, plant & equipment that is around 1.5 times of current asset value in 2017. That is major figure and may be arise due to Romania investment. Also, under current assets company has increase its trade receivable and inventory that almost double from previous year. These excess purchase of stock and increase in debtors results in no cash availability to company. Such as low liquidity can create troubles for routine operations and require additional working capital in business.  (Masli, 2019)
(b)    In terms of liabilities, there is no such major increment in shareholders fund as same equity and no major change in retained earnings. However, for expansion or to increase in noncurrent assets company has increased its borrowings and bank overdraft. Also, because of liquidity crunch, company has increased its trade payables. Also, no dividend gets distributed.
Ratios:
(c)    Current ratio shows the relation of current assets and current liabilities of company. This will help to better understand the liquidity position of company. 

Particulars	2018	2017
Current assets	447	347
Current liabilities	308	138
Current ratio	1.45 times	2.51 times

Current ratio has been reduced due to low liquidity in terms of no cash. Also, company has increased its borrowings from bank overdraft as for expansion. Sometimes, ideal ratio is taken as 1.33 times but still company is comfortable to pay off its current liability by releasing its stock and trade receivables. 

(d)    Debt equity ratio defines the relation of equity owned fund and borrowing & debt fund. It reflects how much Times Company owns from outside sources as compare to self owned. 

Particulars	2018	2017
Debt	275	100
Equity	860	779
D/E ratio	0.32 times	0.13 times

Company has very low debt equity ratio even less than 1. Company has very low debt equity ratio in 2017 as such almost nil. But in 2018 is get increased but still negligible. 

 

2.3 Statements of cash flows

Cash flow statement: It shows the flow of cash inside and outside of company. It analyze every activity from cash flow point of view and ignore the non cash entries. This cash flow however gets distributed into three parts and these are as follow. 
Cash flow from operating activity: Company has negative cash flow from operating activities. Investment has been made in inventory and debtors, company has to suffer excess outflow of cash.  Also, at the end of year there is no availability of cash. Even, company has not paid dividend in 2018.  (AMOAH, 2016)
Cash flow from investing activity: Investing activity includes the cash flow from procurement of plant, property and equipment that are mainly noncurrent assets and cash flow related to investment or sale of such assets. As in the year 2018, there is one cash flow related to procurement of non-current asset for expansion in Romania, company have to suffer from negative cash flow. 
Cash flow from financing activities : This includes the activities related to payment and borrowings from banks or other means. In the year 2018, company has borrowed additional funds from banks for expansion or other related activities, which is why company has inflow of cash from financing activities. 
Ultimately, overall cash flow for the year says negative cash flow during the period. 

(b) Operating cash cycle:

It refers to cycle or time that require by the business for realizing the cash from operations. It includes in payment have to made for procurement, conversion of stock into sales for generating cash and conversion of trade receivables into cash. The lower the time the better it is. Thus it is a combination of three ratio or cycle that is inventory holding period, receivable collection period and trade payable period. 

Particulars	2018	2017
Inventory	299	120
COGS	1990	1505
Inventory turnover (COGS/Inventory)	6.66 times	12.54 times
Inventory holding period (365/inventory turnover ratio)	54.80 days	29.11 days
Trade receivable	148	93
Net credit sales	2534	2022
Trade receivable turnover ratio (net credit sales/ trade receivables)	17.12 times	21.74 times
Receivables collection period (365/trade receivables turnover ratio)	21.32 days	16.79 days
Trade payables	235	138
Net credit purchase	1990	1505
Trade payable turnover ratio (net credit purchase/ trade payables)	8.47 times	10.91 times
Trade payable period (365/trade payable turnover ratio)	43.09 days	33.46 days
Operating cycle (IHP+DHP-CHP)	54.80+21.32-43.09= 33.03 days	29.11+16.79-33.46= 12.44 days

Hence, the cash operating cycle has to face an increase of approx 21 days in 2018 which arise due to excess inventory maintenance and poor quality of trade receivables follow up. (Cathey, 2019)

(c) Dividend policy:
Dividend is share of profit that gets distributed by the company to its equity shareholders. It results in reducing the retained e arnings of the company and cash outflows. In the present situation, Roast limited is not in that position to pay dividend as per the liquidity availability. Also, as the company is looking for better growth options so it need more funds and retained earning can be great source of fund. 
If the company declared and paid dividend, then it will result in more negative cash flow or borrowing from banks. On the other side, if company able to make more profits from such non distribution of dividend then it is far better for company and its shareholders. 
Hence, no payment of dividend is a good option.

 

Part 3: Appraising the investment decision

Investment appraisal is use for final decision to check whether the project is financially sound and can provide adequate recovery of funds with suitable return and within suitable time period. 

3.1. A Forecast of management.
Decisions related to investment and expansion is such that they are taken only by the management. So, management always needs to try to look over all the aspects before investing in any project. Here, in the current scenario, company has analyzed the project according to the different methods and figures. 
Future is always uncertain and possible results can be just estimate and accordingly necessary planning need to do. Management have estimated the revenue of 300 in the initial year and that was good as the actual figures are 350, 350 is more than expected. But here the initial year is 2018 instead of 2017. It has reduced the cash flow and now ultimately 4 years are available.

However, before investing the funds company should also determine the sources of funds. Company has to borrow some funds for investing as per cash flow statement and interest on such funds is not showing while calculating the present value and other figures. Such as cost of funds to be deducted from future benefits. As per the all criteria and figures, management is not good to invest due to non availability of investing funds, some crises can be seen in near future in either new or existing business.

3.1. B Techniques for appraising the investments

There been different techniques available for the investment appraisal which are as below:

• Payback period- It is the period in which company will recover its initial investment from the project. While calculating the payback period, the method ignores the time value of money and also, it will reflect the flow of funds to recover the initial cost. In the present case, company has project life of 5 years and payback period is 4 years. So, company should decide to continue the project to get more return after 5 years as highest revenue and cash flow is estimated at the last year of the project. As already one year has been gone which is 2017 and operations get started in 2018. So one year get automatically reduce. Company should not invest as now no extra benefit get achieve and only cost will be recover.  (Yohn, 2015)
• Accounting rate of return-  Accounting rate of return shows the return that company will get on the fund invested. Company then compare both rates which are expecting and that actually can be obtained got arrive at the conclusion. Here, as per the calculation ARR is 18% and required rate of return is 10%. So, company tries to invest to get additional 8%. (Rossi, 2015) But in actual the results are gone wrong as such amount of cash flow not achieved and neither such return in initial two years. 
• Net present value-  It reflects the present value of all cash flow in future. It use time value of money and analyze the net benefits value in present time. It is most simple method to evaluate the project that is why it gets mostly used for analysis. However, NPV method looks for the cash flow only and not for the total tenor of the plant and trends of flows.  In the present case, company’s project has a NPV of 110 that is good to go. But now after year 2018, estimated figures were not achieved and hence NPV is not reflecting correct picture. The project investment idea was not good.  

3.2 Different Sources of finance

The source of finance is always requiring by business for supporting their investment and expansion plans. Also, for day to day operations funds are always requiring. Following can be the source of funds

• Equity or private investment- Company can choose to raise finance by the equity share issue as this is a great and easy source. But due to some limitation is not consider as primary however it is less risky among other sources. Equity share issue or private investment result in distribution of control of entity. Share pr profit gets distributed. While taking different decision, voting always creates a problem as these shareholders have the right to vote in some of important decision in the company. 
• Debt or borrowings-  There are various sources for raising debt such as loan, mortgage, debentures and bonds. These are interest bearing instruments and involve fixed obligations for payment of principal amount and for interest as well. However, these are considered as more risky among other options. However, no such voting control gets distributed in this option. Also, payments made to debt owners are tax deductible. 

Company’s long term liquidity position is already low on account of borrowed funds. So, equity or private investment can be more appropriate method in order to expand their operation which will also be positive sign for long term liquidity in business. 

Conclusion:

In order to reach at decision for acquisition of Roast limited, Starbucks require analyzing the both, macro and micro factors impacting them. Coffee industry is continuous growth industry but the present Brexit and other small players in the industry can be threat for the company. Looking into the performance of Roast Limited, the profitability margins have improved from their recent expansion into other countries. However, the company is suffering from low short term as well as long term liquidity. Also, they have failed to manage their operating cycles with increased operations and have increased substantially within a year. It seems management needs more advanced management in order to plan their operations which the Starbucks can provide. For further expansion, options are available in form of debts and equity and opting for equity should be preferred looking the current liquidity ratios in the company as well as their expansion plans. 
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