Financial Management : Family Business Assessment Answer

Answer:

Introduction

Dragonfly Corporation is a family venture set up by a couple with the hope of having something of their own to do. Funded by family resources and also obtaining attorney services within the family made it an easy start for the business. But as time progressed, the business did not hit the level of expected sales and profits which landed Dragonfly Corporation into difficulties and even legal claims. The financial analysis along with the ratio analysis and the extent of competition, future course of actions are all discussed hereunder.

Analysis of Financial Statements

The unaudited Balance Sheets for 2009, 2010 and 2011 have been given and analyzed as below:

The Current Assets are on an increasing trend which is a good sign. The major contributor towards the increase in current assets is inventory and still the piling up of inventory and low sales is a matter of concern. Fixed Assets are more or less on the same level with the additions to Leasehold Improvements year after year (Melville, 2013).

In the Other Assets, the deposits are at the same level whereas the Organization Costs have seen a deferral due to amortizations. Overall on the Assets side, there are not much additions or deletions and almost a similar level has been maintained. On the Current Liabilities side, there is a huge increase estimated for the year 2011. Bank Notes payable and Stockholders notes payable are almost reasonable numbers.

The Accounts payable has increased in the year 2011 due to the Crossroad Rent outstanding. Accrued Liabilities and Other debts are almost on a similar level and hence there are no worrying indicators (Horngren, 2013).


The Long Term Debt gets accrued for Hepburns. Stockholders Equity is estimated to increase in the year 2011 due to the reclassification of the debt of Hepburns as Equity and so there has been no actual infusion of capital in the business. The most worrying factor is the accumulated deficit which keeps on adding year on year and this is the one factor that can bring down the entire balance sheet (Christensen, 2011).

Thus the balance sheet analysis predicts the instability of the financial position unless the sales and profits improve.

Profit and Loss Account

The Income Statements for the years 2009 and 2010 have been presented. The Sales for the year 2010 has increased a little and the expenses have also dropped due to which the net loss has lowered for the year 2010. As Dragonfly Corporation has taken significant steps towards the advertising costs and cutting down of expenses, the loss has dropped and it has been able to cope to an extent (Horngren, 2013).

Cash Flow Statement

The Cash flow for the year 2008 has been presented month wise and it indicates gross mismatch of cash.

The sales have been more or less on the same level except for a few months but due to the increase in expenses, the cash balance has become negative. To overcome this cash deficit, the cash will be pulled from the other long term sources which will also endanger the financial position and stability (Northington, 2011).

Pro forma Income Statement Analysis

After the addition of the second and third store, the projected revenues are set to increase. Also the location seems to be an advantage for the second and third store due to which the same level or even more sales are predicted to be generated from these stores. The situation of the store is an added advantage for the business and can helps to reap strong profit.

As the stores have increased, the operational costs are also set to increase. The selling and advertisement expenses remain on the same level as the Dragonfly has already been sufficient on the same even when it had just one store.

The other administrative expenses including rent, salary, maintenance and occupancy expenses are increasing in proportion to the number of offices added on. The resultant profit is seen to have increased year after year leading to a pretty comfortable position (Horngren, 2013).

The practical reality of the same can be tested only by the time as the projected and estimated sales levels have to be achieved on the first hand. As the fixed expenses have to be incurred irrespective of the level of sales, a drop in the sales or the not achieving of estimated levels of sales might pull down the firm into losses and that has been happening till recently.

Overall Analysis

As these future predictions present profits, until Dragonfly actually achieves these results, it might be difficult for any outsider or third party to place reliance on the same. On looking at the current position of the Dragonfly, bankruptcy seems to be the only recourse as it was no longer financially viable to run the business. The crunch in the financial position is a major hurdle in the progress. Undoubtedly, finance is the life blood of the business and a bankrupt position will spoil the functioning of the business (Choi & Meek, 2011).

Though the Thompsons had started to believe that the business was slowly and steadily reviving and recovering, Crossroads landlord was threatening to blow out the business. Hence it might be difficult to predict the certainty of the existence of the business. 

Ratio Analysis

Ratio analysis is a form of analysis of the financial statements that gives a quick indication about the performance of the business and the several key areas.  

The popular ratios are profitability ratios, solvency ratios, asset management ratios, turnover ratios and market value ratios.

Each of the ratios has its own significance and conveys the trend of movement of the various items on the financial statements. It is easy to calculate as it just a mathematical formula and helps in decision making as it gives meaningful interpretations. The ratios of the entity in question are compared with the industry standard ratios and the increase or decrease is analyzed. Thus ratio analysis facilitates comparison across companies and also helps in the identification of the strengths and weaknesses.

Profitability Ratios

Gross Profit Ratio

This ratio is also known as Operating Margin as it typically indicates the proportion of sales generated against the direct expenses of the business. The Gross Profit Ratio of Dragonfly is worked out as in the table (Appendix 1).

Thus we can see that the operating margin has definitely improved and this is one positive sign indicating that there is the possibility of continuing the business. This has kept the business alive and can be kept as one of the positive factor. The year 2010 has been strong as 39% gross profit was posted as compared to the year 2009.

Net Profit Ratio

This Ratio considers the proportion of sales against all the direct and indirect expenses. It is calculated in the table (Appendix 1).

As there is a loss reported for both the years, the proportion of loss has decreased for the year 2010. The net loss was more in the year 2009 while declined to a considerable extent in the yar 2010. In this case, the operating profit ratio and net profit ratio are typically one and the same as the profits are not computed separately unlike a company.

Liquidity Ratios

These ratios depict the liquidity of the company whether it is able to meet its current liabilities or not. The sufficiency of the available cash and liquid funds to meet the liabilities is indicated by these ratios.

Current Ratio

This is the ratio of the Current Assets to the Current Liabilities. It is calculated in the table (Appendix 2)

The ideal Current Ratio is considered to be 2:1 which indicates that the current assets should be twice the current liabilities. Though in this case for both the years, the ratio is below 1 the stability of the business is a concern (Albrecht et. al, 2011). Dragonfly does not seem to have sufficient current assets to cover all its current liabilities. This will prove to be a problem in meeting the obligation.

Cash Ratio

This ratio indicates whether the cash balance is sufficient to cover the current liabilities or not. It is calculated in the table (Appendix 2).

In this cash, the Cash Balance is grossly insufficient to cover up the current liabilities and if Dragonfly increases the sales revenue, then this ratio is likely to improve. Hence, it is important for Dragonfly to keep a check on revenue and enhance the same as it will lead to a better position.

Turnover Ratios

These Ratios indicate the number of times items like fixed assets, inventory, debtors’ and creditors have rotated in a year.

The Fixed Assets have shown a considerable turnover and it is in line with the industry standards. This is another strong factor in the company’s working. The result is average and in tune with the standards (Deegan, 2011).

Return Ratios

These ratios indicate the proportion of returns on the fixed assets and capital employed. It is calculated as under:

As there has been a loss, the returns are negative, though the proportion and percentage of loss and negative returns has reduced in 2010 and is estimated to reduce further in 2011; still it remains to be a cause of concern.

Success in the future or what will help it achieve success

At the current state of business, it is though difficult to predict how the business will turn to be a successful one in future. The current state of business is completely disturbed and from here on any prediction is difficult. Still if Dragonfly really wants to become a successful venture, then it has to do some major restructuring in the pattern of sale and fine more dedicated customers who will make repetitive purchases. For this reason, it is essential that Dragonfly also starts online business for selling its products and tries out such modes of advertisement that will involve a personal touch and get customers to the store (Merchant, 2012). Apart from this, merging with some other well operating business can help Dragonfly increase its sales. As it has taken sufficient measures towards working out cost reduction, increase in sales is the only way to revive the revenues and turn Dragonfly into a successful business venture.

Impact of competition on business

As the store is located in a mall, there are chances of stiff competition. The rent is pretty high and even a few other stores located in the mall are in the plans of shifting out.

Due to these reasons, the sales for the first year itself were lower than expected and most of the inventory has to be written down and marked down significantly. Dragonfly had set the sales prices on a higher side which also acted as a drawback. If the customers get the initial feel of a high priced store, they might not be willing to come in for a subsequent purchase.

Thus the results were significantly lower than the industry standard and in the garments business; the effect of competition is seen. The presence of cut-throat completion has further marred the situation.

Ethical considerations on Insolvency

On an ethical note, the business should be wound up as it would take many years to wipe out the huge accumulated losses and also the legal notice received from the landlord seems to be a significant issue. There is the possibility of more legal actions expected if the business continues (Needles & Powers, 2013).

It is also not a healthy practice to run the business on the money of outsiders as this will only worsen and dampen the financial position of the business and render insolvency in the near future. The circumstances that warrant the disclosure of all the material items should be made due to which the users of financial statements can make informed judgments about the continuity of business and decide on the future course of actions (Davies & Crawford, 2012).

Thus it is not really ethical to continue the business at this rate and Dragonfly should focus on winding up and repaying the amounts due to the creditors and other parties. Acute difficulties are seen at the current level and the progress is stalled owing to the difficulties in the financial numbers (Kaplan, 2011).

External factors indicating chances of merger or acquisition

Currently there are no specific indicators of a merger or acquisition on its way. The reason for the same is that no entity would like to merge with a loss making business. Always for a merger, the acquiring party looks for benefits. Apart from inventory, there is not much any entity can benefit by merging with Dragonfly (Williams, 2012). Still if any other successful entity expresses interest in the acquisition, then Dragonfly could at best hit a profitable deal and work out for its restructuring and future business prospects.

Recommendation

Dragonfly is in financial crisis and so it is not a wise decision to invest in this point of time. If the business is able to generate real sales, then the accumulated losses might slowly and steadily get reduced which is seen to be a good time to invest in the company (Brigham & Daves, 2011). The intention of Thompsons is not wrong, they are not willing to cheat or defraud anyone by doing business. There is a genuine crisis as the business did not take off as expected and predicted. Hence this is not the right time to make an investment in Dragonfly and if there are signs of profitability and increased stock turn around, then it would be feasible to make an investment (Libby et. al, 2011).  At the current position it is difficult to gauge whether it will form a bottom or will tank further below. Since there is immense difficulty in the management and the progress it is important to stay away from the stock.

Conclusion

There is a huge expectation of Christmas Sales though the possible returns in January pose a threat. Thus, it would be wise to wait until February to know the real state of business and judge if there are any positive indicators to continue the business or not.  Knowing the real state of business is important because it will help in ascertaining the performance. In a short, it is in a crisis position and going through a very difficult position (Parrino et. al, 2012). As per the scenario, it can be said that the environment is not safe for investment and hence, the management must stress on key factors and try to iron out the difficulties.

References

Albrecht, W., Stice, E. & Stice, J 2011, Financial accounting, Mason, OH: Thomson/South-Western.

Brigham, E. & Daves, P 2012,  Intermediate Financial Management , USA: Cengage

Choi, R.D. & Meek, G.K 2011, International accounting,  Pearson .

Christensen, J 2011,  ‘Good analytical research’, European Accounting Review, vol. 20, no. 1, pp. 41-51

Davies, T. & Crawford, I 2012, Financial accounting, Harlow, England: Pearson.

Deegan, C. M 2011, In Financial accounting theory, North Ryde, N.S.W: McGraw-Hill.

Horngren, C 2013, Financial accounting,  Frenchs Forest, N.S.W: Pearson Australia Group.

Kaplan, R.S 2011, ‘Accounting scholarship that advances professional knowledge and practice’, The Accounting Review, vol. 86, no.2, pp. 367–383.

Learning.

Libby, R., Libby, P. & Short, D 2011, Financial accounting, New York: McGraw-Hill/Irwin.

Melville, A 2013, International Financial Reporting – A Practical Guide, 4th edition, Pearson, Education Limited, UK

Merchant, K. A 2012, ‘Making Management Accounting Research More Useful’, Pacific Accounting  Review, vol. 24, no.3, pp. 1-34.

Needles, B.E. &  Powers, M 2013, Principles of Financial Accounting, Financial Accounting Series: Cengage Learning.

Northington, S 2011, Finance, New York, NY: Ferguson's.

Parrino, R., Kidwell, D. & Bates, T 2012, Fundamentals of corporate finance, Hoboken, NJ: Wiley

Spiceland, J., Thomas, W. and Herrmann, D 2011,  Financial accounting, New York: McGraw-Hill/Irwin,University Press

Williams, J 2012,  Financial accounting, New York: McGraw-Hill/Irwin.

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