Twiggy\'s ple operates in the UK &Ireland builder\'s merchants and DIY retail se

Question

Twiggy's ple operates in the UK &Ireland builder's merchants and DIY retail sector. Twiggy's, in line with most of its peers in this sector, suffered significant operating losses in the period 2008-2012. As a result, a new senior management team was appointed in mid-2013. This new management team was given three years to turn the business around and specifically to increase sales, profitability and dividends to ordinary shareholders. While there has been a general economic recovery in the period since, leading equity analysts have consistently determined that growth in the overall builder's merchants sector has been "flat to sluggish" at best. The following is a summary of some key line items from the financial statements of Twiggy's plc for the three years ended 31 December 2015 Twiggy's ple 2014 E000 2015 E000 Income Statement Revenue COGS Gross Profit 95,000 57,950 37,050 25,935 276 6,442 4,397 485 2,912 1,102 108,300 59,565 48,735 31,678 527 5,068 11,463 2,866 8,597 1.653 6,944 120,213 62,511 57,702 36,641 680 4,689 15,692 5,970 9,722 2,480 7,243 Interest Expense Depreciation Pre-Tax Profit Taxes Net Proft Retained Eamings Balance Sheet Non-Current Assets Total Assets Current Labiities Non-Current Lablities Net Assets Total Equity 28,150 13,450 11,875 10,431 35,756 63,906 8,906 5,520 49,480 49,480 23,082 17,390 18,672 16,678 52,741 75,823 10,242 7,020 58,560 58,560 18,393 19,391 24,043 25,817 69,251 87,644 12,291 8,000 67,353 67,353 Operating Cash Fow (excl dividends) 2,164 1,956 1,951

Explanation / Answer

New Senior management team joined in mid-2013 and based on the data provided, the revenue and profits have since shown an upward trend. The three motivating factors for executive team to manage this upward trend can be-

1. Rewards and recognition:- Employees always like recognition of the hard work they put in to help a business grow. With properly designed and communicated rewards policy, the executive team can be provided with targets for sales, upon achieving of which they will get monetary and/or non-monetary. This will continuously motivate the employees for improving sales and hence profitability.

2. Stock options:- Stock options are given to the employees over a long period of time and the value of those shares is directly related to the profitability of the company. This motivates the employees to think for the long term benefit of the company and increase its profitability and hence the value of the shares they will get.

3. Culture of team work and harmony:- A healthy and happy working environment always motivate the employees to work efficiently and effectively, which improves the business and hence profitability of the company. Healthy competition and cordination among various teams, with constant motivation by top leadership helps to improve the company.

Four potential accounting warning signs are:-

1. Although the net profits of the company are increasing over a period of time, so is the Receivables of the company. The amount to be received from debtors is substantially increasing over time, which is not a healthy sign because if some of them turn bad debts, it will directly effect the profits of the company. The sales of the company are increasing but much of them are credit sales whose ultimate collection is not confirmed. The company should strive to recover these receivables soon.

2. The inventory is also substantially increasing. Although inventory is normally kept in a growing company, but the proportion of inventory to sales should be maintained at a prudent level. It has increased from 11% in 2013 to 21.5% in 2015 which is both dangerous and blocks the working capital of the company.

3. The cash in hand has also increased which indicates that company is keeping idle funds and not employing those surplus funds to productive uses. As the company is in growing stage, it should invest the surplus in productive activities or invest it in income generating investments.

4.Although the profitability of the company is increasing, the operating cash flows is decreasing which indicates that the actual cas is not flowing to the company indicating that this profitability may not be real or sustainable as the actual cash from profits is still not flowing to the company. The company should work towards increasing the cash profits for future sustainability of the operations.  

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