Ratcliffes Executive Summary
Ratcliffes A Case Study
By Jonathan Pelley
Level 5 Professional Diploma in Management Studies
Report for Mick Landers
Executive Summary
This report has been produced to give an accurate indication of the current financial position of Ratcliffes Ltd.
At first glance it would seem that Ratcliffes is a successful profitable business with Gross Profit and Operating Profit both increasing year after year. However, if we look closer at Ratcliffes accounts we will see a company with some problems. With a low return on investment, poor stock turnover and excessive numbers of staff this is a business which needs to get control.
With more planned capital investment needed for expansion of the restaurant, Racliffe's need to look …show more content…
at more urgent improvements to the business, such as complying with Health and Safety features, repairs and maintenance and sorting out their complicated management and staffing structure.
This report will explore all aspects of the business mentioned here and make any necessary recommendations for improvement.
Introduction
Ratcliffes Ltd was founded by Jack and Ruth Ratcliffe in 1968. As time went by the restaurant began to build up a reputation for quality and good service. In the late 1980's Ratcliffes began to expand. It was in the late 1990's that a new management team was created to look after the day to day operations of the business.
The new management team have decided to make an initial assessment of the business. They have asked our team of consultants to look at the financial opportunities and constraints, the people within the business and whether they are being deployed effectively.
We have focused on three main areas:
- to asses the current performance of the business using relevant ratio analysis and to asses the business against its competitors
- to asses the viability of expansion of the restaurant upstairs using a cash flow forecast
- to asses the viability of a takeaway service using break-even analysis
The findings are discussed in this report followed by a series of recommendations on how the business should move forward.
Findings
Before we can make any recommendations to Ratcliffes we need to analyze the current performance of the business
At first glance it is easy to see that Ratcliffes has many strengths and weaknesses as a business.
One of the biggest strengths of the business is the reputation that has developed over the years of trading. The business is now well established, with a good reputation, which will be favourable to customers and suppliers. Another crucial factor of the business is the fact that the Ratcliffes now own the South Bristol branch. Ratcliffes have also recently been granted a liquor licence. A quick look at the Balance sheet and the Profit and Loss accounts also tell us that Ratcliffes is a profitable company and has had steady growth for the last few years. The company is also strong on fixed assets and turnover has been steadily rising.
However the business does have weaknesses. The organizational structure seems over-complicated and the Ratcliffes had to take out loans to get the business started. There is also some work to be done in order to meet health and safety requirements. The South Bristol branch has some rising damp and wet plaster issues and the North Bristol sites wiring is in desperate need of inspection.
We will look at some of these factors in more detail later in the report
It is also evident that there are no clear records of performance or accounts at either restaurant. This is an issue that will need to be addressed but for the purpose of this report we will look at both sites as one business
The findings here have resulted in analyzing the following areas: - the current performance of the business
- how the business performs in relation to its competitors
- other areas repairs, maintenance, management and staffing structure
- cash flow analysis concerning expansion of the business
- break-even analysis concerning takeaway service
Current Performance of Business
Our analysis of the business was carried out by applying a number a ratio's to the business accounts. These ratios's show how different areas of the business are performing. We can also see if there are any trends of the business over a certain time period. The ratio's do have some limitations which we will look at when we examine the ratio's individually
Gross Profit Margin vs Operating Profit Margin
The Gross Profit Margin (GPM) shows us the profit a business makes on its cost of sales and it tells us how much gross profit per £1 of turnover our business is earning. Generally the gross margin is an indicator of trading performance.
The Operating Profit Margin (OPM) tells us the amount of net profit per £1 of turnover a business has earned. That is, after taking account of the cost of sales, the administration costs, the selling and distributions costs and all other costs, the operating profit is the profit that is left. Trends in the net margins might provide pointers to the effectiveness of controls over the levels of overheads.
The Gross Profit Margin should be a lot higher than the Operating Profit Margin as it is the profit before we take off any administration costs.
When we compare the gross and the operating profit margins we can gain a good impression of their non-production and non-direct costs such as administration, marketing and finance costs.
It can be seen from the graph that Gross Profit Margin has been rising for the past four years up to 2007 where the figure was 67.6%. This means there is 67p left every pound after suppliers have been paid.
There was also a large increase in 2006 which could have been due to a lower cost of sales
Operating Profit Margin has also been rising over the last four years, and rising at a steeper rate than the Gross Profit Margin. As we would expect the OPM is lower than the GPM.
This rise in OPM could be due to many factors. There could have been a possible decrease in supply costs. This could be linked to the reputation of the business as has already been mentioned. Food and drink prices may have risen which would increase sales. The business may have also spent less on other factors like marketing and other operating expenses
It can also be seen that the gap between GPM and OPM is decreasing. This gap can be seen as the overheads of the business so the lower this value is, the better. In 2004 this value was 55.71% but in 2007 this has been reduced to 45%. This means that in 2007 45p in every pound was overheads compared to 55p in 2004.
To deduce more of a trend in these figures it would be desirable to have the figures for a longer period of time.
Return on Capital Employed
The Return on Capital Employed (R.O.C.E) tells us how well a company is doing at turning investment into a return, and is given as a percentage. In 2007 the R.O.C.E. was 8.8%. This means that for every pound invested in 2007, there was an 8p return on that investment.
By looking at the graph we can see that there has been year on year growth on R.O.C.E.
In 2004 the return was only 2.94%. This was a low figure as the operating profit for the year was low. There may have also been investment made in kitchen equipment which would decrease the return
It can be seen that as the operating profit increases, so does the return on investment. It can also be seen that the business has been controlling the Fixed costs of the business well. It is however, not a very high figure. As a benchmark, and it is quite a crude benchmark, investing money in a bank account would normally give you a return of around 10% so a worthwhile return would normally be above this level
Aging fixed assets mean lower capital employed and hence, higher R.O.C.E. However, in the case of Ratcliffes this may indicate a variety of potential operational problems such as higher maintenance costs due to the kitchen equipment in the South Bristol branch being old. Other operational problems that would affect R.O.C.E. would be competitive inefficiency, Ratcliffes being a labour intensive operation and impending obsolescence.
Stock …show more content…
Turnover
Stock turnover is an indicator of the average number of days a business takes to sell an item of stock. In 2007 the stock turnover for the business was 28.08%. This means on average it takes the stock 28 days to go through the business. A business would generally like their stock to move quickly through the business so ideally this value will be low.
It can be seen from the graph that the stock turnover percentage has been steadily rising for three years when it peaked in 2006 at 46%. This means that stock has been moving slower through the business. However, consideration should be given to both business trading factors as well as stock management issues. The recent acquisition of a liquor licence would also have a direct impact on the current percentage with stock levels increasing significantly
Stock turnover has improved in 2007 which means that stock is moving faster through the business. This improved stock turnover figure could be due to an increase in sales and an improved awareness of inventory, stock control and more control through the ordering process
Stock control is a key area to be examined by management with emphasis on improving awareness of stock control ensuring there is no likelihood of stock perishing.
Performance in Relation to Competitors
To try to gain an impression of how Ratcliffes are performing in relation to its competitors we will use ratio analysis to compare Ratcliffes to other similar businesses.
There are some limitations to these comparisons. We only have the figures for the competitor businesses for 2007, so they may not be a true reflection of how the businesses are performing. We are also not sure how long these businesses have been in operation for. For example we may be comparing one business in its first year of trading against another business which has been established for a number of years.
We are aware which properties are part of a chain but it is not clear how many stores they have so again, we are comparing the unknown. We also have no idea of the management structure within these competitor businesses.
For the purpose of this report I have looked at different features of the business which I feel can be compared fairly:
- Competitor GPM and OPM vs. Ratcliffes
- Competitor Stock Turnover vs. Ratcliffes
- Competitor Return on Capital Employed vs. Ratcliffes
- Competitor Revenue per Staff vs. Ratcliffes
Gross Profit Margin and Operation Profit Margin
Below is a graph which compares the GPM and OPM of Ratcliffes against some of its competitors.
Ratcliffes OPM is performing on average compared to the other restaurants we are comparing against. However the GPM at Ratcliffes is low in relation to the competitors and, at 67%, is below the average of 71%.
Both Sam Cooks and On The Green, who currently have a higher GPM and OPM than Ratcliffes, offer a takeaway service which is idea Ratcliffes are currently considering. The Melting Pot, Atkins and The Orchid also have a higher GPM and OPM than Ratcliffes with all three holding a liquor licence. Ratcliffes have recently acquired a liquor licence which may increase GPM and OPM in the future.
Stock Turnover
Next we will look at the stock turnover of Ratcliffes compared to its competitors.
It can be seen in the graph that Ratcliffes has the second highest stock turnover at 28 days. As previously mentioned this is a very high figure. The average number of days for stock turnover is 17 days.
On the Green and Sam Cooks are again performing very well, as are Atkins and The Melting Pot. This result is due to a number of key factors that Ratcliffes need to take into consideration in order to improve its competitive stance in the industry.
On the Green offering a takeaway service has helped their stock turnover remain very high.
Sam Cooks too has a very impressive turnover of 6 days. Factors such as geographical scope and services provided result in Sam Cooks having a competitive advantage over restaurants such as Ratcliffes. Being situated in the city centre, owning a takeaway service, providing a vegetarian option and owning a liquor licence all result in the restaurant having an excellent competitive strategy and this is reflected in many areas of the business, most noticeably the stock turnover days.
By Ratcliffes being situated in residential area, not providing a takeaway service or vegetarian option they have fallen behind in the marketplace and need to take corrective action to re-engineer its business strategy and processes.
Unfortunately we don't know much about the menus of the competitors but they might be changing their menus on a weekly basis, or introducing a number of daily specials. This would help use up and stock as they could plan new dishes on stock that had to be used
Return on Capital Employed
The next comparison that we will look at is R.O.C.E between Ratcliffes and its competitors.
We can see from the graph that once again Ratcliffes is well below the average when it comes to getting a return from investment. Once again Sam Cooks and On the Green offer the best return on investment at 23% and 22% respectively. With the average being 14% we can see that Ratcliffes comes under at 9%. This low return could be due to the high overheads that Ratcliffes currently have, especially the wage bill as Ratcliffes currently employ the greatest number of staff.
Ratcliffes need to learn how to best deploy resources in view of the company's internal and external position. Sam Cooks and On the Green, both offering a takeaway service have achieved the greatest R.O.C.E. Ratcliffes currently do not offer this service but with intangible assets such as brand name, loyalty and culture this would be a very viable option for the business.
Revenue per Staff
We will now take a look at the revenue generated per number of staff at Ratcliffes and its competitors.
It can be seen that Ratcliffes generates the least amount of revenue per employee at only £21,000.
I would suggest the reason for the low figure is the high numbers of staff that are currently employed by Ratcliffes. Part of the problem seems to be the extensive management structure that is currently in place at Ratcliffes. It is not possible to see whether any of the competitors operate a similar structure but looking at the number of staff employed by the other companies, they seem to have more control over their employment structure. On the Green for example take more than over £100,000 revenue compared to Ratcliffes but with five fewer
employees.
Other companies, for example Atkins and The Melting Pot, who take revenue similar to Ratcliffes, get by on fewer staff.
The high number of staff at Ratcliffes will really effect the costs of running the business which will reduce the Operating Profit Margin
Other Areas for Improvements
After looking into the business there are currently a number of areas that Ratcliffes need to look into. I think these can be categorised into three main area's:
- Health and Safety
- Maintenance and Repairs
- Staffing and Management structure
-
Health and Safety
Both of the branches of Ratcliffes are currently in need of work to meet the latest health and safety guidelines. The South Bristol branch will soon need work done on the kitchen equipment. The North Bristol branch is also in need of work. There is some rising damp and also evidence of wet plaster. The wiring in the building is urgently due for inspection/renewal.
Maintenance and Repair
The South Bristol branch at present does not reflect a very good image. The exterior is somewhat dated and the building could do with a new coat of paint. The signage in particular needs work.
The North Bristol branch as already mentioned may need some of the electrics looked at, and the kitchen could do with some more space. Staffing and Management Structure
At present Ratcliffes seem to employ a high number of staff, especially in relation to its competitors. Between the two branches Ratcliffes employ nineteen staff in addition to the contract cleaning staff at the South Bristol branch.
One of the problems seems to be the management structure spread over the two sites. This would seem excessive and it as area that will be looked at later in the report.
Viability of Expansion
The South Bristol branch is planning to expand the restaurant into the space upstairs. We will look firstly at the gearing ratio to see the ability of the business to borrow money for the investment and then use Cash Flow analysis to predict a cash flow forecast to see whether the expansion would be profitable
The Gearing ratio is the ability of a business to borrow money. The lower the outcome, the more flexibility the business has in trying to secure a loan.
In 2007, the Gearing ratio for Ratcliffes was 19.7%. This is a fairly low figure and will give the business more of an opportunity to borrow money. If Ratcliffes do choose to borrow money then can then use this money for: - repairs and modernization
- marketing to gain new business
- helping to meet health and safety requirements
Ratcliffes does have a lot of cash floating around in the business that it could also use for the expansion.
Next we will have a look at a cash flow forecast to see how feasible the repair work will be and how it will affect the company financially. It is useful to bear in mind that the cash flow forecast is based on predictions of what the company will do, not actual figures.
May June July August September October £ £ £ £ £ £
Receipts
Sales 0 0 0 5000 7000 8000 Total Receipts 0 0 0 5000 7000 8000
Payments
Building Work 20000 20000 20000 0 0 0
Furniture/Fitting 0 0 40000 0 0 0
Expenses and Labour Costs 0 0 0 2000 2500 2500
Marketing 500 500 500 500 500 500 Total Payments 20500 20500 60500 2500 3000 3000
Opening Balance ----- -20,500 -41000 -101500 -99000 -95000
Add Receipts 0 0 0 5000 7000 8000
Less Payments 20500 20500 60500 2500 3000 3000 Balance Carried Forward -20500 -41000 -101500 -99000 -95000 -90000
Looking at these figures it can be seen that expansion of the business will take a lot of initial investment and will put the business over £100,000 in debt. The expansion will start to make money in August but it will take a long time for the business to pay off the balance. However, be examining the performance of its competitors it is evident that investment in the business will prove very profitable in the future.
Viability of Takeaway Service
Another area that Ratcliffes are looking at creating more business is by offering a takeaway service. By using break-even analysis we can assess the viability of this proposed service.
The break-even chart is based on the figures in appendix 9 and the estimate they will be able to sell 70 takeaway meals per week.
By looking at the break-even chart we can see that to break even with a take-away service Ratcliffes will only have to sell 20 meals per week. If they were to operate at the estimated capacity, selling 70 meals per week, they would make just under £400 profit per week. This equates to over an extra £20,000 per year. If they only sold 50 meals per week they would still make almost £350 per week.
There are a number of advantages for Ratcliffes to start a takeaway service. The fixed costs will be very low as the business is already up and running. There will also be no investment needed as there will be no capital costs to start up the takeaway service. A takeaway service may be a great opportunity to use some of the extra raw materials in the business, therefore using stock quicker and speeding up the stock turnover. The extra work will also be a good way of utilising the large numbers of staff. The last major benefit of a good takeaway service is that if the customers enjoys the food, it will entice them into the restaurant, where they will spend more money on higher mark up items like alcohol.
On the other hand, in the short term, having a successful takeaway may mean that Ratcliffes will be losing business inside the restaurant on table sales.
There are some risks in using break-even analysis as the figures used are based on predictions of what we expect to happen, not using results of what has happened. This does not make it entirely accurate but can still give a good indication. For example in the takeaway business Ratcliffes are predicting they will be able to sell 70 meals a week when if fact they may sell only 40. The fixed costs and variable costs can fluctuate as well.
Using break-even analysis it is fairly easy to accommodate a change of circumstance. For example if the variable costs of the takeaway service went up to £6 it would be fairly easy to calculate a new break-even point.
Number of Meals Profit Generated
26 Break-Even Point
50 £140.04
70 £260.04
You could also use break-even analysis to find a new break even point if the fixed costs of the business were to change, for example they rose to £200.We will keep the variable costs at £6 for this example. The number of takeaway meals Ratcliffes would now have to sell to break-even would be 33.
Conclusions
This aim of this report was to clearly identify the present financial situation of Ratcliffes and to determine how Ratcliffes performs in relation to its competitors.
It was also to have a look at the business as a whole and to look at various options open to the business to increase profitability, such as expansion and the creation of a takeaway service
Present Financial Situation
At present Ratcliffes seems to be a well established, profitable company. The Gross Profit margin is steadily rising year on year and the difference between the Gross Profit margin and the Operating Profit margin in decreasing which is a good sign as it means that overheads are decreasing. The overheads do still seem high compared to Ratcliffes competitors.
After careful analysis of the company's current financial position there are some issues that need to be highlighted. I would be apprehensive about recommending Ratcliffes to any potential investor. Although Operating Profit Margin does seem to be slowly increasing, the return on investment seems to be very low due to a number of contributing factors. The staff levels seem to be very high in comparison to similar business performing to the same level as Ratcliffes. The return may be bad because the Current Assets are also fairly high. There seems to be a lot of cash floating around the company and also high levels of stock due to the poor stock turnover.
It is always good to have some cash in the business as you will always be able to pay bills, have money available for an unforeseen crisis and there will be greater confidence in the short term security of the business. However this money will not be gaining any interest as it could be in a bank. There will also be less capital available for business expansion.
It is also in Ratcliffes best interests to have some stock in the business as you will always be able to meet customer demands and for a business like Ratcliffes, discounts are readily available for bulk purchases. Unfortunately too much stock also carries its own problems. There will be less capital available for expansion as its tied up in the stock and for a business like Ratcliffes there is the risk of the stock perishing.
So although it is good to have some levels of stock and cash, it can be deduced that Ratcliffes are not doing a very good job at controlling either of these areas. This is an area that needs to be addressed urgently.
It should be mentioned again that the figures we used represent both the North Bristol and South Bristol sites so do not give a good indication of how each site is performing.
New Opportunities
Using various methods such as break-even analysis and cash flow forecasting we have looked into the viability of expanding the restaurant and starting a takeaway service at weekends.
I would suggest that at present, the takeaway service is a more realistic course of action. As the restaurant is already in operation there will be no investment needed to start up the service. It is a very good way of using up stock and as the break even point is low, even if the takeaway service does not hit capacity at 70 meals per week, they will still be making a profit fairly early. The service may not be extremely profitable but it is still expected to make an extra £20,000 per year for the business and is a good way of getting the name of the business spread over a wider area and enticing customers into the restaurant so it can be seen as a good marketing tool.
However the planned expansion of upstairs is probably not a sensible development for the short term. Although the expansion would increase the going concern' and the value of the property, the company would need to spend £100,000 which is a huge capital cost. Looking at the cash flow forecast it would take a long time for the expansion to start to earn the company money, taking into account this initial investment
Other Areas for Improvement
There seems to be a lot of work that needs doing to Ratcliffes regarding Health and Safety and general maintenance and repairs. This work seems to be of a high importance as without the relevant health and safety accreditations the business would be forced to close.
It also seems that the staffing levels are high and the management structure is excessive and these are both areas that will need to be addressed. Ratcliffes competitors who are operating fairly similarly manage to function successfully on less staff.
Recommendations
After careful consideration and analysis of the present financial situation at Ratcliffes I would like to make the following recommendations
1. Split up the accounts of each branch we need to have clear visibility of how each branch is performing. Then we can make more accurate assessments of how each branch affects the business financially.
2. Carry out important modifications use some of the excess cash floating around the business to carry out all work required to meet Health and Safety specifications. Also update and modernise the interior and exterior of both sites with decoration and cleaning. We do not want to use all of the cash though as it is good to have a certain amount in the business for emergencies and future investments. We could perhaps use some of the cash for marketing purposes, announcing the refurbishment of both sites.
3. Change management structure and staffing levels there are a few changes that need to be made in this area. First of all I would recommend Ratcliffes employ a General Manager in each branch to oversee all day to day running of each branch, including daily operations, purchasing and staffing. I believe the Company Secretary and Accountant role can also be merged into one role, Office Manager, as long as the applicant has accounting experience. By removing this management structure the company can save a lot in wages. In the North Bristol branch I would also recommend terminating the full time receptionist/till role and training the waiting staff to greet customers and use the tills. By just making these changes we can cut down the number of employees by three people.
4. Introduction of Takeaway Service I think the takeaway service is a viable proposition for this business. It will take little work and no cost to get up and running and will bring the business over £20,000 per year. Looking at Ratcliffes competitors it is clear to see that a takeaway service has proved very successful for those who currently operate the service. It seems that the takeaway service fits this business perfectly and will be a good way of spreading the name of the business
5. Postpone the Expansion the business has more important areas that need investment at present as mentioned in my second recommendation. The investment of £100,000 needed for the expansion is too great a risk at the present time. If any expansion was to be done at present I would recommend to increase the size of the kitchen. The expansion would also cause a massive disruption to the business. The work could not be carried out whilst the restaurant is still open so the business would be forced to lose all revenue during this closure.
Appendix
Figure 1 Gross Profit Margin and Operating Profit Margin
Year GPM OPM
2004 62.8 7.09
2005 63.6 15.83
2006 67.1 19.72
2007 67.5 22.5
Appendix 2 Return on Capital Employed
Year R.O.C.E.
2004 2.94
2005 6.97
2006 7.9
2007 8.8
Appendix 3 Stock Turnover
Year Stock Turnover
2004 26.54
2005 36.21
2006 45.62
2007 28.08
Appendix 4 Competitor Gross Profit Margin and Operating Profit Margin
Company GPM OPM
Atkins 70 25
The Orchid 73 31
Templars 57 13
On the Green 82 31
Sam Cooks 76 30
Mayfields 69 17
The Melting Pot 77 20
Ratcliffes 67 22
Average 71.375 23.625
Appendix 5 Competitor Stock Turnover
Company Stock Turnover
Atkins 12
The Orchid 18
Templars 22
On the Green 13
Sam Cooks 6
Mayfields 29
The Melting Pot 10
Ratcliffes 28
Average 17.25
Appendix 6 Competitor Return on Capital Employed
Company R.O.C.E.
Atkins 14
The Orchid 18
Templars 9
On the Green 22
Sam Cooks 23
Mayfields 7
The Melting Pot 11
Ratcliffes 9
Average 14.125
Appendix 7 Revenue per Staff
Company Revenue per Staff
Atkins 26
The Orchid 30
Templars 37
On the Green 54
Sam Cooks 36
Mayfields 32
The Melting Pot 39
Ratcliffes 21
Appendix 8 Gearing Ratio
Year Gearing
2004 20.3
2005 21.7
2006 19.8
2007 19.7
Appendix 9 Break-even Analysis
Fixed Costs £160 per week Variable Costs
Raw Materials £3
Cooking Expenses 50p
Packaging 50p
Revenue per Takeaway Meal £12
Appendix 10 -Accounting Concepts
Over the years, accounting has evolved rules that all accountants use when preparing the final accounts of a business
The Going Concern Concept
This states that, unless we have knowledge to the contrary, we can assume that Ratcliffes will be trading in its current form for the next 12 months. By doing this we can value all assets, for example kitchen equipment, at cost, not what they would fetch if sold.
Objectivity Concept
This states that as far as possible, accounts should be based on verifiable evidence such as receipts and financial documents, rather than personal opinions. This means whenever Ratcliffes purchase new equipment or machinery they must keep the receipt of the transaction rather than use their own opinion of how much the item should be worth
Business Entity Concept
The business entity concept states that the financial affairs of a business should be completely separate from those of the owner. The business is treated as a separate entity. This means that Mr and Mrs Ratcliffe must keep their personal financial affairs separate from the company's financial affairs. Any money used for personal reasons taken out of the company account will be recorded in the drawings account. Drawings are a reduction in the capital introduced to the business by the owner.
The Accruals and Matching Concept
These two concepts have slightly different meanings, but their effect id similar.
The Accruals concept states that revenue should be recognised when it is earned and not when money is received. The same rule is applied to goods purchased on credit. Cost should be recognised when they are incurred, not when the money is paid. For example if Ratcliffes were to buy new kitchen equipment on credit, the cost incurred would be at the point of ordering the equipment, not when the money is exchanged
The Matching concept states that, in calculating profit, revenue should be matched against expenditure incurred in earning it
Prudence
The Prudence concept states that accountants should be cautious when reporting the financial position of a business. Ratcliffes should always understate profits or the value of assets rather than overstate them
Materiality
If the inclusion or exclusion of information in a financial statement would mislead the users of that statement, then the information is material. What is classed as material and immaterial depends on the size of the firm. In the case of Ratcliffes as single fork might be considered as too trivial to record but a new freezer will need to be recorded.
The Concept of Consistency
The consistency concept states that the accounts of a business should be prepared on the same basis every year. In other words Ratcliffes should have consistent treatment of similar items within each accounting period and from one period to the next.
The Realisation Concept
This states that profits are normally recognised when the title of the goods passes to the customer, not necessarily when the money changes hands
By Jonathan Pelley
Level 5 Professional Diploma in Management Studies
Report for Mick Landers
Executive Summary
This report has been produced to give an accurate indication of the current financial position of Ratcliffes Ltd.
At first glance it would seem that Ratcliffes is a successful profitable business with Gross Profit and Operating Profit both increasing year after year. However, if we look closer at Ratcliffes accounts we will see a company with some problems. With a low return on investment, poor stock turnover and excessive numbers of staff this is a business which needs to get control.
With more planned capital investment needed for expansion of the restaurant, Racliffe's need to look …show more content…
at more urgent improvements to the business, such as complying with Health and Safety features, repairs and maintenance and sorting out their complicated management and staffing structure.
This report will explore all aspects of the business mentioned here and make any necessary recommendations for improvement.
Introduction
Ratcliffes Ltd was founded by Jack and Ruth Ratcliffe in 1968. As time went by the restaurant began to build up a reputation for quality and good service. In the late 1980's Ratcliffes began to expand. It was in the late 1990's that a new management team was created to look after the day to day operations of the business.
The new management team have decided to make an initial assessment of the business. They have asked our team of consultants to look at the financial opportunities and constraints, the people within the business and whether they are being deployed effectively.
We have focused on three main areas:
- to asses the current performance of the business using relevant ratio analysis and to asses the business against its competitors
- to asses the viability of expansion of the restaurant upstairs using a cash flow forecast
- to asses the viability of a takeaway service using break-even analysis
The findings are discussed in this report followed by a series of recommendations on how the business should move forward.
Findings
Before we can make any recommendations to Ratcliffes we need to analyze the current performance of the business
At first glance it is easy to see that Ratcliffes has many strengths and weaknesses as a business.
One of the biggest strengths of the business is the reputation that has developed over the years of trading. The business is now well established, with a good reputation, which will be favourable to customers and suppliers. Another crucial factor of the business is the fact that the Ratcliffes now own the South Bristol branch. Ratcliffes have also recently been granted a liquor licence. A quick look at the Balance sheet and the Profit and Loss accounts also tell us that Ratcliffes is a profitable company and has had steady growth for the last few years. The company is also strong on fixed assets and turnover has been steadily rising.
However the business does have weaknesses. The organizational structure seems over-complicated and the Ratcliffes had to take out loans to get the business started. There is also some work to be done in order to meet health and safety requirements. The South Bristol branch has some rising damp and wet plaster issues and the North Bristol sites wiring is in desperate need of inspection.
We will look at some of these factors in more detail later in the report
It is also evident that there are no clear records of performance or accounts at either restaurant. This is an issue that will need to be addressed but for the purpose of this report we will look at both sites as one business
The findings here have resulted in analyzing the following areas: - the current performance of the business
- how the business performs in relation to its competitors
- other areas repairs, maintenance, management and staffing structure
- cash flow analysis concerning expansion of the business
- break-even analysis concerning takeaway service
Current Performance of Business
Our analysis of the business was carried out by applying a number a ratio's to the business accounts. These ratios's show how different areas of the business are performing. We can also see if there are any trends of the business over a certain time period. The ratio's do have some limitations which we will look at when we examine the ratio's individually
Gross Profit Margin vs Operating Profit Margin
The Gross Profit Margin (GPM) shows us the profit a business makes on its cost of sales and it tells us how much gross profit per £1 of turnover our business is earning. Generally the gross margin is an indicator of trading performance.
The Operating Profit Margin (OPM) tells us the amount of net profit per £1 of turnover a business has earned. That is, after taking account of the cost of sales, the administration costs, the selling and distributions costs and all other costs, the operating profit is the profit that is left. Trends in the net margins might provide pointers to the effectiveness of controls over the levels of overheads.
The Gross Profit Margin should be a lot higher than the Operating Profit Margin as it is the profit before we take off any administration costs.
When we compare the gross and the operating profit margins we can gain a good impression of their non-production and non-direct costs such as administration, marketing and finance costs.
It can be seen from the graph that Gross Profit Margin has been rising for the past four years up to 2007 where the figure was 67.6%. This means there is 67p left every pound after suppliers have been paid.
There was also a large increase in 2006 which could have been due to a lower cost of sales
Operating Profit Margin has also been rising over the last four years, and rising at a steeper rate than the Gross Profit Margin. As we would expect the OPM is lower than the GPM.
This rise in OPM could be due to many factors. There could have been a possible decrease in supply costs. This could be linked to the reputation of the business as has already been mentioned. Food and drink prices may have risen which would increase sales. The business may have also spent less on other factors like marketing and other operating expenses
It can also be seen that the gap between GPM and OPM is decreasing. This gap can be seen as the overheads of the business so the lower this value is, the better. In 2004 this value was 55.71% but in 2007 this has been reduced to 45%. This means that in 2007 45p in every pound was overheads compared to 55p in 2004.
To deduce more of a trend in these figures it would be desirable to have the figures for a longer period of time.
Return on Capital Employed
The Return on Capital Employed (R.O.C.E) tells us how well a company is doing at turning investment into a return, and is given as a percentage. In 2007 the R.O.C.E. was 8.8%. This means that for every pound invested in 2007, there was an 8p return on that investment.
By looking at the graph we can see that there has been year on year growth on R.O.C.E.
In 2004 the return was only 2.94%. This was a low figure as the operating profit for the year was low. There may have also been investment made in kitchen equipment which would decrease the return
It can be seen that as the operating profit increases, so does the return on investment. It can also be seen that the business has been controlling the Fixed costs of the business well. It is however, not a very high figure. As a benchmark, and it is quite a crude benchmark, investing money in a bank account would normally give you a return of around 10% so a worthwhile return would normally be above this level
Aging fixed assets mean lower capital employed and hence, higher R.O.C.E. However, in the case of Ratcliffes this may indicate a variety of potential operational problems such as higher maintenance costs due to the kitchen equipment in the South Bristol branch being old. Other operational problems that would affect R.O.C.E. would be competitive inefficiency, Ratcliffes being a labour intensive operation and impending obsolescence.
Stock …show more content…
Turnover
Stock turnover is an indicator of the average number of days a business takes to sell an item of stock. In 2007 the stock turnover for the business was 28.08%. This means on average it takes the stock 28 days to go through the business. A business would generally like their stock to move quickly through the business so ideally this value will be low.
It can be seen from the graph that the stock turnover percentage has been steadily rising for three years when it peaked in 2006 at 46%. This means that stock has been moving slower through the business. However, consideration should be given to both business trading factors as well as stock management issues. The recent acquisition of a liquor licence would also have a direct impact on the current percentage with stock levels increasing significantly
Stock turnover has improved in 2007 which means that stock is moving faster through the business. This improved stock turnover figure could be due to an increase in sales and an improved awareness of inventory, stock control and more control through the ordering process
Stock control is a key area to be examined by management with emphasis on improving awareness of stock control ensuring there is no likelihood of stock perishing.
Performance in Relation to Competitors
To try to gain an impression of how Ratcliffes are performing in relation to its competitors we will use ratio analysis to compare Ratcliffes to other similar businesses.
There are some limitations to these comparisons. We only have the figures for the competitor businesses for 2007, so they may not be a true reflection of how the businesses are performing. We are also not sure how long these businesses have been in operation for. For example we may be comparing one business in its first year of trading against another business which has been established for a number of years.
We are aware which properties are part of a chain but it is not clear how many stores they have so again, we are comparing the unknown. We also have no idea of the management structure within these competitor businesses.
For the purpose of this report I have looked at different features of the business which I feel can be compared fairly:
- Competitor GPM and OPM vs. Ratcliffes
- Competitor Stock Turnover vs. Ratcliffes
- Competitor Return on Capital Employed vs. Ratcliffes
- Competitor Revenue per Staff vs. Ratcliffes
Gross Profit Margin and Operation Profit Margin
Below is a graph which compares the GPM and OPM of Ratcliffes against some of its competitors.
Ratcliffes OPM is performing on average compared to the other restaurants we are comparing against. However the GPM at Ratcliffes is low in relation to the competitors and, at 67%, is below the average of 71%.
Both Sam Cooks and On The Green, who currently have a higher GPM and OPM than Ratcliffes, offer a takeaway service which is idea Ratcliffes are currently considering. The Melting Pot, Atkins and The Orchid also have a higher GPM and OPM than Ratcliffes with all three holding a liquor licence. Ratcliffes have recently acquired a liquor licence which may increase GPM and OPM in the future.
Stock Turnover
Next we will look at the stock turnover of Ratcliffes compared to its competitors.
It can be seen in the graph that Ratcliffes has the second highest stock turnover at 28 days. As previously mentioned this is a very high figure. The average number of days for stock turnover is 17 days.
On the Green and Sam Cooks are again performing very well, as are Atkins and The Melting Pot. This result is due to a number of key factors that Ratcliffes need to take into consideration in order to improve its competitive stance in the industry.
On the Green offering a takeaway service has helped their stock turnover remain very high.
Sam Cooks too has a very impressive turnover of 6 days. Factors such as geographical scope and services provided result in Sam Cooks having a competitive advantage over restaurants such as Ratcliffes. Being situated in the city centre, owning a takeaway service, providing a vegetarian option and owning a liquor licence all result in the restaurant having an excellent competitive strategy and this is reflected in many areas of the business, most noticeably the stock turnover days.
By Ratcliffes being situated in residential area, not providing a takeaway service or vegetarian option they have fallen behind in the marketplace and need to take corrective action to re-engineer its business strategy and processes.
Unfortunately we don't know much about the menus of the competitors but they might be changing their menus on a weekly basis, or introducing a number of daily specials. This would help use up and stock as they could plan new dishes on stock that had to be used
Return on Capital Employed
The next comparison that we will look at is R.O.C.E between Ratcliffes and its competitors.
We can see from the graph that once again Ratcliffes is well below the average when it comes to getting a return from investment. Once again Sam Cooks and On the Green offer the best return on investment at 23% and 22% respectively. With the average being 14% we can see that Ratcliffes comes under at 9%. This low return could be due to the high overheads that Ratcliffes currently have, especially the wage bill as Ratcliffes currently employ the greatest number of staff.
Ratcliffes need to learn how to best deploy resources in view of the company's internal and external position. Sam Cooks and On the Green, both offering a takeaway service have achieved the greatest R.O.C.E. Ratcliffes currently do not offer this service but with intangible assets such as brand name, loyalty and culture this would be a very viable option for the business.
Revenue per Staff
We will now take a look at the revenue generated per number of staff at Ratcliffes and its competitors.
It can be seen that Ratcliffes generates the least amount of revenue per employee at only £21,000.
I would suggest the reason for the low figure is the high numbers of staff that are currently employed by Ratcliffes. Part of the problem seems to be the extensive management structure that is currently in place at Ratcliffes. It is not possible to see whether any of the competitors operate a similar structure but looking at the number of staff employed by the other companies, they seem to have more control over their employment structure. On the Green for example take more than over £100,000 revenue compared to Ratcliffes but with five fewer
employees.
Other companies, for example Atkins and The Melting Pot, who take revenue similar to Ratcliffes, get by on fewer staff.
The high number of staff at Ratcliffes will really effect the costs of running the business which will reduce the Operating Profit Margin
Other Areas for Improvements
After looking into the business there are currently a number of areas that Ratcliffes need to look into. I think these can be categorised into three main area's:
- Health and Safety
- Maintenance and Repairs
- Staffing and Management structure
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Health and Safety
Both of the branches of Ratcliffes are currently in need of work to meet the latest health and safety guidelines. The South Bristol branch will soon need work done on the kitchen equipment. The North Bristol branch is also in need of work. There is some rising damp and also evidence of wet plaster. The wiring in the building is urgently due for inspection/renewal.
Maintenance and Repair
The South Bristol branch at present does not reflect a very good image. The exterior is somewhat dated and the building could do with a new coat of paint. The signage in particular needs work.
The North Bristol branch as already mentioned may need some of the electrics looked at, and the kitchen could do with some more space. Staffing and Management Structure
At present Ratcliffes seem to employ a high number of staff, especially in relation to its competitors. Between the two branches Ratcliffes employ nineteen staff in addition to the contract cleaning staff at the South Bristol branch.
One of the problems seems to be the management structure spread over the two sites. This would seem excessive and it as area that will be looked at later in the report.
Viability of Expansion
The South Bristol branch is planning to expand the restaurant into the space upstairs. We will look firstly at the gearing ratio to see the ability of the business to borrow money for the investment and then use Cash Flow analysis to predict a cash flow forecast to see whether the expansion would be profitable
The Gearing ratio is the ability of a business to borrow money. The lower the outcome, the more flexibility the business has in trying to secure a loan.
In 2007, the Gearing ratio for Ratcliffes was 19.7%. This is a fairly low figure and will give the business more of an opportunity to borrow money. If Ratcliffes do choose to borrow money then can then use this money for: - repairs and modernization
- marketing to gain new business
- helping to meet health and safety requirements
Ratcliffes does have a lot of cash floating around in the business that it could also use for the expansion.
Next we will have a look at a cash flow forecast to see how feasible the repair work will be and how it will affect the company financially. It is useful to bear in mind that the cash flow forecast is based on predictions of what the company will do, not actual figures.
May June July August September October £ £ £ £ £ £
Receipts
Sales 0 0 0 5000 7000 8000 Total Receipts 0 0 0 5000 7000 8000
Payments
Building Work 20000 20000 20000 0 0 0
Furniture/Fitting 0 0 40000 0 0 0
Expenses and Labour Costs 0 0 0 2000 2500 2500
Marketing 500 500 500 500 500 500 Total Payments 20500 20500 60500 2500 3000 3000
Opening Balance ----- -20,500 -41000 -101500 -99000 -95000
Add Receipts 0 0 0 5000 7000 8000
Less Payments 20500 20500 60500 2500 3000 3000 Balance Carried Forward -20500 -41000 -101500 -99000 -95000 -90000
Looking at these figures it can be seen that expansion of the business will take a lot of initial investment and will put the business over £100,000 in debt. The expansion will start to make money in August but it will take a long time for the business to pay off the balance. However, be examining the performance of its competitors it is evident that investment in the business will prove very profitable in the future.
Viability of Takeaway Service
Another area that Ratcliffes are looking at creating more business is by offering a takeaway service. By using break-even analysis we can assess the viability of this proposed service.
The break-even chart is based on the figures in appendix 9 and the estimate they will be able to sell 70 takeaway meals per week.
By looking at the break-even chart we can see that to break even with a take-away service Ratcliffes will only have to sell 20 meals per week. If they were to operate at the estimated capacity, selling 70 meals per week, they would make just under £400 profit per week. This equates to over an extra £20,000 per year. If they only sold 50 meals per week they would still make almost £350 per week.
There are a number of advantages for Ratcliffes to start a takeaway service. The fixed costs will be very low as the business is already up and running. There will also be no investment needed as there will be no capital costs to start up the takeaway service. A takeaway service may be a great opportunity to use some of the extra raw materials in the business, therefore using stock quicker and speeding up the stock turnover. The extra work will also be a good way of utilising the large numbers of staff. The last major benefit of a good takeaway service is that if the customers enjoys the food, it will entice them into the restaurant, where they will spend more money on higher mark up items like alcohol.
On the other hand, in the short term, having a successful takeaway may mean that Ratcliffes will be losing business inside the restaurant on table sales.
There are some risks in using break-even analysis as the figures used are based on predictions of what we expect to happen, not using results of what has happened. This does not make it entirely accurate but can still give a good indication. For example in the takeaway business Ratcliffes are predicting they will be able to sell 70 meals a week when if fact they may sell only 40. The fixed costs and variable costs can fluctuate as well.
Using break-even analysis it is fairly easy to accommodate a change of circumstance. For example if the variable costs of the takeaway service went up to £6 it would be fairly easy to calculate a new break-even point.
Number of Meals Profit Generated
26 Break-Even Point
50 £140.04
70 £260.04
You could also use break-even analysis to find a new break even point if the fixed costs of the business were to change, for example they rose to £200.We will keep the variable costs at £6 for this example. The number of takeaway meals Ratcliffes would now have to sell to break-even would be 33.
Conclusions
This aim of this report was to clearly identify the present financial situation of Ratcliffes and to determine how Ratcliffes performs in relation to its competitors.
It was also to have a look at the business as a whole and to look at various options open to the business to increase profitability, such as expansion and the creation of a takeaway service
Present Financial Situation
At present Ratcliffes seems to be a well established, profitable company. The Gross Profit margin is steadily rising year on year and the difference between the Gross Profit margin and the Operating Profit margin in decreasing which is a good sign as it means that overheads are decreasing. The overheads do still seem high compared to Ratcliffes competitors.
After careful analysis of the company's current financial position there are some issues that need to be highlighted. I would be apprehensive about recommending Ratcliffes to any potential investor. Although Operating Profit Margin does seem to be slowly increasing, the return on investment seems to be very low due to a number of contributing factors. The staff levels seem to be very high in comparison to similar business performing to the same level as Ratcliffes. The return may be bad because the Current Assets are also fairly high. There seems to be a lot of cash floating around the company and also high levels of stock due to the poor stock turnover.
It is always good to have some cash in the business as you will always be able to pay bills, have money available for an unforeseen crisis and there will be greater confidence in the short term security of the business. However this money will not be gaining any interest as it could be in a bank. There will also be less capital available for business expansion.
It is also in Ratcliffes best interests to have some stock in the business as you will always be able to meet customer demands and for a business like Ratcliffes, discounts are readily available for bulk purchases. Unfortunately too much stock also carries its own problems. There will be less capital available for expansion as its tied up in the stock and for a business like Ratcliffes there is the risk of the stock perishing.
So although it is good to have some levels of stock and cash, it can be deduced that Ratcliffes are not doing a very good job at controlling either of these areas. This is an area that needs to be addressed urgently.
It should be mentioned again that the figures we used represent both the North Bristol and South Bristol sites so do not give a good indication of how each site is performing.
New Opportunities
Using various methods such as break-even analysis and cash flow forecasting we have looked into the viability of expanding the restaurant and starting a takeaway service at weekends.
I would suggest that at present, the takeaway service is a more realistic course of action. As the restaurant is already in operation there will be no investment needed to start up the service. It is a very good way of using up stock and as the break even point is low, even if the takeaway service does not hit capacity at 70 meals per week, they will still be making a profit fairly early. The service may not be extremely profitable but it is still expected to make an extra £20,000 per year for the business and is a good way of getting the name of the business spread over a wider area and enticing customers into the restaurant so it can be seen as a good marketing tool.
However the planned expansion of upstairs is probably not a sensible development for the short term. Although the expansion would increase the going concern' and the value of the property, the company would need to spend £100,000 which is a huge capital cost. Looking at the cash flow forecast it would take a long time for the expansion to start to earn the company money, taking into account this initial investment
Other Areas for Improvement
There seems to be a lot of work that needs doing to Ratcliffes regarding Health and Safety and general maintenance and repairs. This work seems to be of a high importance as without the relevant health and safety accreditations the business would be forced to close.
It also seems that the staffing levels are high and the management structure is excessive and these are both areas that will need to be addressed. Ratcliffes competitors who are operating fairly similarly manage to function successfully on less staff.
Recommendations
After careful consideration and analysis of the present financial situation at Ratcliffes I would like to make the following recommendations
1. Split up the accounts of each branch we need to have clear visibility of how each branch is performing. Then we can make more accurate assessments of how each branch affects the business financially.
2. Carry out important modifications use some of the excess cash floating around the business to carry out all work required to meet Health and Safety specifications. Also update and modernise the interior and exterior of both sites with decoration and cleaning. We do not want to use all of the cash though as it is good to have a certain amount in the business for emergencies and future investments. We could perhaps use some of the cash for marketing purposes, announcing the refurbishment of both sites.
3. Change management structure and staffing levels there are a few changes that need to be made in this area. First of all I would recommend Ratcliffes employ a General Manager in each branch to oversee all day to day running of each branch, including daily operations, purchasing and staffing. I believe the Company Secretary and Accountant role can also be merged into one role, Office Manager, as long as the applicant has accounting experience. By removing this management structure the company can save a lot in wages. In the North Bristol branch I would also recommend terminating the full time receptionist/till role and training the waiting staff to greet customers and use the tills. By just making these changes we can cut down the number of employees by three people.
4. Introduction of Takeaway Service I think the takeaway service is a viable proposition for this business. It will take little work and no cost to get up and running and will bring the business over £20,000 per year. Looking at Ratcliffes competitors it is clear to see that a takeaway service has proved very successful for those who currently operate the service. It seems that the takeaway service fits this business perfectly and will be a good way of spreading the name of the business
5. Postpone the Expansion the business has more important areas that need investment at present as mentioned in my second recommendation. The investment of £100,000 needed for the expansion is too great a risk at the present time. If any expansion was to be done at present I would recommend to increase the size of the kitchen. The expansion would also cause a massive disruption to the business. The work could not be carried out whilst the restaurant is still open so the business would be forced to lose all revenue during this closure.
Appendix
Figure 1 Gross Profit Margin and Operating Profit Margin
Year GPM OPM
2004 62.8 7.09
2005 63.6 15.83
2006 67.1 19.72
2007 67.5 22.5
Appendix 2 Return on Capital Employed
Year R.O.C.E.
2004 2.94
2005 6.97
2006 7.9
2007 8.8
Appendix 3 Stock Turnover
Year Stock Turnover
2004 26.54
2005 36.21
2006 45.62
2007 28.08
Appendix 4 Competitor Gross Profit Margin and Operating Profit Margin
Company GPM OPM
Atkins 70 25
The Orchid 73 31
Templars 57 13
On the Green 82 31
Sam Cooks 76 30
Mayfields 69 17
The Melting Pot 77 20
Ratcliffes 67 22
Average 71.375 23.625
Appendix 5 Competitor Stock Turnover
Company Stock Turnover
Atkins 12
The Orchid 18
Templars 22
On the Green 13
Sam Cooks 6
Mayfields 29
The Melting Pot 10
Ratcliffes 28
Average 17.25
Appendix 6 Competitor Return on Capital Employed
Company R.O.C.E.
Atkins 14
The Orchid 18
Templars 9
On the Green 22
Sam Cooks 23
Mayfields 7
The Melting Pot 11
Ratcliffes 9
Average 14.125
Appendix 7 Revenue per Staff
Company Revenue per Staff
Atkins 26
The Orchid 30
Templars 37
On the Green 54
Sam Cooks 36
Mayfields 32
The Melting Pot 39
Ratcliffes 21
Appendix 8 Gearing Ratio
Year Gearing
2004 20.3
2005 21.7
2006 19.8
2007 19.7
Appendix 9 Break-even Analysis
Fixed Costs £160 per week Variable Costs
Raw Materials £3
Cooking Expenses 50p
Packaging 50p
Revenue per Takeaway Meal £12
Appendix 10 -Accounting Concepts
Over the years, accounting has evolved rules that all accountants use when preparing the final accounts of a business
The Going Concern Concept
This states that, unless we have knowledge to the contrary, we can assume that Ratcliffes will be trading in its current form for the next 12 months. By doing this we can value all assets, for example kitchen equipment, at cost, not what they would fetch if sold.
Objectivity Concept
This states that as far as possible, accounts should be based on verifiable evidence such as receipts and financial documents, rather than personal opinions. This means whenever Ratcliffes purchase new equipment or machinery they must keep the receipt of the transaction rather than use their own opinion of how much the item should be worth
Business Entity Concept
The business entity concept states that the financial affairs of a business should be completely separate from those of the owner. The business is treated as a separate entity. This means that Mr and Mrs Ratcliffe must keep their personal financial affairs separate from the company's financial affairs. Any money used for personal reasons taken out of the company account will be recorded in the drawings account. Drawings are a reduction in the capital introduced to the business by the owner.
The Accruals and Matching Concept
These two concepts have slightly different meanings, but their effect id similar.
The Accruals concept states that revenue should be recognised when it is earned and not when money is received. The same rule is applied to goods purchased on credit. Cost should be recognised when they are incurred, not when the money is paid. For example if Ratcliffes were to buy new kitchen equipment on credit, the cost incurred would be at the point of ordering the equipment, not when the money is exchanged
The Matching concept states that, in calculating profit, revenue should be matched against expenditure incurred in earning it
Prudence
The Prudence concept states that accountants should be cautious when reporting the financial position of a business. Ratcliffes should always understate profits or the value of assets rather than overstate them
Materiality
If the inclusion or exclusion of information in a financial statement would mislead the users of that statement, then the information is material. What is classed as material and immaterial depends on the size of the firm. In the case of Ratcliffes as single fork might be considered as too trivial to record but a new freezer will need to be recorded.
The Concept of Consistency
The consistency concept states that the accounts of a business should be prepared on the same basis every year. In other words Ratcliffes should have consistent treatment of similar items within each accounting period and from one period to the next.
The Realisation Concept
This states that profits are normally recognised when the title of the goods passes to the customer, not necessarily when the money changes hands