Financial Analysis And Valuation Of White Dreams And Bridal Party Ltd

Financial Transactions Adjustments

The report provides a brief overview of the financial analysis conducted for White Dreams Limited, a UK based retailer which deals in providing wedding gowns and other accessories. Along with this, the report also focuses on the impact of transactions which are been omitted by the accountants of the store. The later part of the report emphasis on the valuation of Bridal Party Ltd., for the purpose of acquiring the same. Apart from this, White Dreams is willing to invest into a project and for this purpose, the company use various project appraisal methods to check out the viability of the proposal. All the analysis is been done in the report, followed by a conclusion.

1. The treatment for credit sales worth £465,740 will affect the value of trade debtors and will change the amount of total revenue earned by the store. Recording or reporting of such transaction will result in increase of accounts receivables in the balance sheet and upsurge in the total revenue in income statement. Along with this the cost associated worth £380,200 will bring a rise in the value of COGS, reported in profit and loss statement. The sales made will reduce the inventory also
2. Cash sales amounted to £33,670 will bring cash in the business, thus increases the current assets on balance sheet and revenue on income statement. As the sales has been made, the inventory will reduce and cost of goods sold will increase by £21,900. The net impact will be on the profit of the store.
3. As the rent was paid in advance so the journal entry for the same will be as follows:

Prepaid rent A/c Dr.         £152,500

To Cash/bank A/c £152,500

A new account will be opened and will be shown on the asset side with a name prepaid rent. On the other hand the balance of cash will reduce by the amount of rent paid.

1. Purchase of the sewing machine will impact both the assets and liabilities of the store. On one hand, the total assets will increase by £6,100 as the machine is introduced in the business and on the other the balance of creditors will rise by the same amount as it was purchased on credit.
2. S
3. Journal entry for purchasing inventory in cash is

Inventory A/c Dr. £38,700

To Cash A/c £38,700

When the stock is purchased on credit

Inventory A/c Dr. £ 102,555

To Accounts Payable A/c £ 102,555

In both the cases, the amount of inventory will rise which will increase the asset side of store’s balance sheet. However, the cash balance will reduce by £38,700 and trade creditors will increase by £102,555, showing all the effects on statement of financial position.

1. Wages worth £59,900 are already paid to the employees, so the reporting of the same will reduce the cash balance by the paid amount in balance sheet and one expense will be added to the income statement. However, the amount which is unpaid worth £7,870 will appear on the liability side as accrued wages or wages payable. With the same amount the expense also increases in profit and loss statement.
2. An unpaid electricity bill amounted to £962 will be treated as accrued expense in the books of the store. It will increase the balance of expense account as well as create a liability with the same figure on the balance sheet.
3. The trade payables will be reduced by £71,200 as a liability is been paid. On the asset side, the cash balance will also decrease by the same amount.
4. Dry cleaning cost of £34,699 will be charged as an expenses in the income statement of the store which is to be paid within the year.

Calculation of relevant ratios for White Dreams as per the financial is provided in Appendix 1.

• Return on Capital Employed: It measures the profitability of a company by evaluating the returns generated by it from its capital employed or invested. It can be observed that the ROCE of the store has increased in 2018 as compare to 2017. The ratio is been more than the double, reported at 45%. Moreover, it is way higher than the sector average of 25.80%. The reason might be the increased EBIT of the store which indicates that the business has made good profits (Higgins, 2012). 
• Net Assets Turnover: It is one kind of an efficiency ratio which determines the competency of the company to make revenue from its net assets that is the assets left after paying all the current liabilities. In 2017, the ratio was 1.71 which reduces to 1.60 in 2018. However, still higher than the industry average of 1.4. The decline indicates that the store does not utilize its assets properly to make revenue. Also increase in their amount reduces the same in 2018 (Jenter and Lewellen, 2015).
• Gross Profit Ratio: It is one sort of profitability ratio which shows the amount of profit made by an organization after paying off its COGS from its total revenue. As far as White Dreams is considered, the company’s GPR has shown an upward trend and has increased to 44% in 2018 as compare to 33% reported in 2017. In addition, the margin is more than the industry average of 35%. This reflects that company has made high profits in the year and is focused on improving its profitability situation (Krantz and Johnson, 2014). 
• Operating Profit Ratio: This ratio measures the amount made by the organization after paying all the operating expenses from its revenue, which is expressed in terms of percentage. When calculated it is observed that OPR of White Dreams also increases from 13.2% to 28% in 2018 and is also more than the sector average of 16%. This is due to the increase in EBIT of the store and might be the decrease in its distribution costs and expenses related to administration (Nikolai, Bazley and Jones, 2009). 
• Current Ratio: It is a liquidity ratio which identifies the capability of an entity to meet all its short term financial obligations with its current assets. The CR of White Dreams remains same in 2017 and 2018 that is at 1.80: 1 and is also more than the average of 1.77: 1. This means the store has enough CA to meet its CL. Moreover, the current liabilities of the store are way less than its current assets, which makes it easier for the organization to set them off smoothly (Saleem and Rehman, 2011).
• Average inventory turnover: This is also an efficiency ratio which calculates the number of times, a firm has converted its inventory into cash. The store has an ITR of 3.10 in 2018 which is less than the ITR of 2017 that is 3.90 and of the sector average of 3.35. This is due to the significant increase in the amount of inventory worth £100,200 during the year. It indicates that company is not efficient enough to generate cash from its stock quickly (Salunke and Bagad, 2009). 
• Trade Payables period: It determines the time an organization take to pay its creditors. The number of the days has been increased from 40 days to 59 days during the year. It is because of the rise in amount of creditors and availability of insufficient cash to pay them. Yet, the days are less than the average of industry that is 64 days (Tracy, 2012). 
• Debt to Equity Ratio: It is a type of gearing ratio which shows the amount of debt taken by the company against its equity portion. The ratio rises to 34% in 2018 from 14% in 2017. It is also more than the sector average of 23%. This means that the store has borrowed some funds during the year. However, its equity component is still more than its debt, indicating low financial risk (Vogel, 2014). 

Following are the limitations of ratio analysis conducted above:

• It is performed on the basis of historical data which might prove to be unreliable for predicting future growth and success of the company.
• Sometimes, the comparison is not possible because of the different accounting policies and procedures adopted by different entities.
• The analysis does not consider the changes ongoing in the business. It calculates the ratios on the basis of amounts presented in the financial statements of the corporation.
• The interpretation of some ratios is difficult for the managers who are from both financial and non-financial background.

White Dreams is planning to acquire Bridal Party Ltd and for that the value of the company is been calculated by applying following methods which are shown in Appendix 2. The suitable P/E ratio will be 12 and the required rate of return is calculated by using CAPM model.

Under this approach, the value of the business is equal to the amount of its net assets. The BV includes the amount of total assets of the entity which are reported on its balance sheet. NAV is basically the difference between company’s total assets and its current liabilities. In other words, it is the equity amount which is been left with the shareholders (Pinto, Henry, Robinson and Stowe, 2015). 

For conducting a valuation of Bridal Party Ltd, book value method is used and on the basis of which, the net assets of the company are been calculated. The amount derived stands at £15,450 and represent the value of firm at time of acquiring it.

It is a model used for evaluating the stock prices of a company. It is also known as dividend discount model which includes the calculation of future dividends on the basis of the growth rate observed in past year (Kumar, 2015). The value is derived with the help of future dividends and a required rate of return. For Bridal Party, the value as per DVM is £38,008.31. However, the figure is more than the amount obtained from asset based method.

It evaluates the current share price of the entity in relation with its earnings per share. The suitable P/E for the company is 12 which indicates that it will be paying £12 for every £1 of current earnings.

Financial Analysis

From all of the above method, the price at which White Dreams should acquire Bridal Party Ltd should be £38,008.31. Though, it is higher but the dividends shows the actual earnings to the shareholders and also determines the future value of the firm.

CAPM helps in calculating the cost of equity which is later used for the calculation of WACC. For performing the calculation of NPV, WACC is been used as a cost of capital sometimes which includes the return on equity derived from CAPM. Companies must use WACC in their NPV calculation because it presents the overall required rate of return and provide reliable results related to the investments to be made in a particular project. Thus, using CAPM rate as cost of capital might give misleading results to the management.

The NPV of the project is £17,550,319.93 which is positive and more than zero (refer Appendix 3). The store should accept the project as the proposal will be profitable for the organization in the coming five years. It will recoup its initial investment and will generate positive cash flows in future. Also as per the decision rule of NPV, the proposal having high and positive Net present value should be accepted (Baker, Jabbouri and Dyaz, 2017).

• Market research costs are sunk cost and are not included in the calculation of DCF. It is assumed that this expense is been incurred earlier and will not be recovered in future, irrespective of the fact that whether project is accepted or rejected.
• Interest payments on loan are deducted from the cash flows and the residual cash flows are obtained which are then discounted later on.
• Depreciation is a non-cash expense and is usually deducted from the net profit arrived after subtracting cost from revenue. While calculating the cash flows, the same amount is added back after excluding the tax and interest expense.

Apart from NPV, IRR and payback period are also investment appraisal methods which are used by the managers to evaluate a particular project. IRR is basically that rate where the PV of cash inflows is equal to PV of cash outflows. PBP period determines the time a project will take recover the initial investment. Both help in knowing the feasibility of a project, but when compared NPV is the reliable method because it takes into account the time value of money and provide accurate results related to profitability and viability of an investment proposal (Bierman and Smidt, 2014). 

Conclusion 

From the above report, it can be concluded that White Dreams has a good financial position and is focused on increasing its profits. In addition, the store is capable for acquiring Bridal Party Ltd. to expand its operations. Moreover, the company should go for its proposed investment in new dry cleaning services as it will give high returns and profits to it.

References

Baker, H.K., Jabbouri, I. and Dyaz, C. (2017). Corporate finance practices in Morocco. Managerial Finance, 43(8), 865-880.

Bierman Jr, H. and Smidt, S. (2014). Advanced capital budgeting: Refinements in the economic analysis of investment projects. Oxon: Routledge.

Higgins, R. C. (2012). Analysis for financial management. New York: McGraw-Hill/Irwin.

Jenter, D. and Lewellen, K. (2015). CEO preferences and acquisitions. The Journal of Finance, 70(6), pp.2813-2852.

Krantz, M., and Johnson, R. R. (2014). Investment Banking for Dummies. New Jersy: John Wiley and Sons.

Kumar, R., (2015). Valuation: Theories and concepts. United States: Academic Press.

Nikolai, L. A., Bazley, J. D., and Jones, J. P. (2009). Intermediate Accounting. USA: Cengage Learning.

Pinto, J.E., Henry, E., Robinson, T.R. and Stowe, J.D., (2015). Equity asset valuation. New Jersey: John Wiley and Sons.

Saleem, Q. and Rehman, R.U. (2011). Impacts of liquidity ratios on profitability. Interdisciplinary Journal of Research in Business, 1(7), pp.95-98.

Salunke, M., and Bagad, A. (2009). Humanities and Social Sciences. India: Technical Publications.

Tracy, A. (2012). Ratio analysis fundamentals: how 17 financial ratios can allow you to analyse any business on the planet. RatioAnalysis. Net.

Vogel, H.L. (2014). Entertainment industry economics: A guide for financial analysis. New York: Cambridge University Press.

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