Understanding Financial Statements:
Auditing and Corporate Governance:
Consider the comments made by Sandell’s external auditors and the Non-executive
Director in Exhibit four in Sandell’s governance arrangements.
a. Explain what type of modified (Not-so-Clean) audit report, the external auditors would give Sandell if the accounting treatment of the £30 million damages remains unresolved.
b. If Sandell revised their financial statements for the £30 million damages in line with Exhibit 5, the external auditors would give Sandell an unmodified (Clean) audit report.
i. Explain why the external auditors have changed their opinion on Sandell’s financial statements when compared with part 2(a).
ii. Describe ONE reason why companies prefer receiving clean audit reports.
c. Review the narrative in Exhibit 4 from the Non-Executive Director relating to the decision to increase director’s remuneration by 50%.
i. Identify and explain TWO corporate governance deficiencies demonstrated by the board’s decision to approve this remuneration increase.
ii. Describe TWO pieces of corporate governance good practice which Sandell could put in place to make better quality decisions about director’s remuneration going forward.
3. Interpretation of the Income Statement (35 marks)
a. Use the case study information to analyse and comment on FIVE movements in Sandell’s Income Statement (financial performance) during the year 2013 compared to 2012.
Use the additional financial information in Exhibit 2 and the relevant ratios shown in Exhibit 3 to enhance the quality of your analysis.
For each item you select to analyse and comment upon
i. Ensure you use an appropriate financial technique (Ratio, Trend analysis) to ascertain the movement between 2013 compared to 2012;
ii. Reflect and comment upon whether the movement is having a positive or negative impact on Sandell’s financial performance; and
iii. Use the case study to identify and explain at least ONE reason why the movement in part 3a(i) has happened.
b. Using the revised financial statements set out in Exhibit 5: (You cannot answer all of this question until Phase 3)
i. Calculate a revised net margin ratio (show your workings via a separate Appendix to your report);
ii. Explain how the net margin ratio helps assess a company’s financial performance; and
iii. Compare your calculation in 3b(i) with the present net margin ratio (Exhibit 3) and discuss whether the Chief Executive’s statement that the company has managed to improve its profitability since 2012 remains valid.
4. Interpretation of the Statement of Financial Position and Statement of Cash Flows
a. One of the main reasons that £22 million of operating profit earned by Sandell is only producing £2 million of operating cashflow is due to how the company is managing its working capital.
i. Identify which parts of the Statement of Cashflow show how working capital is being managed;
ii. Identify and use appropriate working capital ratios to illustrate movements in working capital for 2013 as compared to 2012;
iii. Use the ratio’s in 4a(ii) above to calculate the Operating Cash Cycle (OCC) for 2012 and 2013;
iv. Comment on whether the movement in the OCC calculated in 4a(iii) is having a positive or negative impact on Sandell’s cashflow; and
v. Use the case study to identify and explain at least TWO reasons why the OCC movement (in part 4a(iii)) has occurred.
Understanding Financial Statements – Assessment
b. Consider this quote from the sector briefing in Exhibit 4:
“This is a considerable expansion of the company’s operations and therefore Sandell has been required to seek external finance to support this investment, they have managed to raise some equity funding from the AIM market, some debt funding through bank loans but it is generally known that the funding secured has not been sufficient to cover this total investment.”
Identify and describe how Sandell’s Statement of Cash Flow supports the part of the quote highlighted and demonstrates that the investment in Western Europe has not been fully supported by external financing.
c. Using the revised financial statements set out in Exhibit 5: (You cannot answer all of this question until Phase 3)
i. Calculate revised interest cover and gearing ratios (show your workings via a separate Appendix to your report);
ii. Explain how the interest cover and gearing ratios help assess a company’s long-term financial condition; and
iii. Compare your calculation in 4c(i) with the present interest cover and gearing ratios (Exhibit 3) and discuss what impact losing this court case (and paying £30 million damages) will have on the company’s solvency.
5. Professional report format:
Marks are allocated for setting out your answer in the format of a professional business report.